By James Kwak
Donald Kohn recently announced that he is resigning as vice chair of the Federal Reserve Board of Governors, after forty years in the Federal Reserve system, most of it in Washington. Articles about Kohn have generally been positive, like this one in The Wall Street Journal. The picture you get is of a dedicated, competent civil servant who has been a crucial player, primarily behind the scenes, in the operation of the Fed.
It’s a bit interesting that Kohn is generally getting the soft touch given that he was the right-hand man of both Alan Greenspan and Ben Bernanke. Here are some passages from the WSJ article:
“‘Don was my first mentor at the Fed,’ Mr. Greenspan says. Mr. Kohn told Mr. Greenspan how to run his first Federal Open Market Committee meeting, the forum at which the Fed sets interest rates. He became one of Mr. Greenspan’s closest advisers and defender of Mr. Greenspan’s policies.”
“Mr. Kohn has spent the past 18 months helping to remake the central bank on the fly as Chairman Ben Bernanke’s loyal No. 2 and primary troubleshooter.”
“Mr. Kohn has been at Mr. Bernanke’s side for nearly every critical decision during the crisis. He also has been asked to solve some of Mr. Bernanke’s biggest challenges — from finding a way to melt frozen commercial-paper markets to keeping peace among occasionally warring factions inside the Fed.”
Let’s not mince words. Kohn was one of the leading cheerleaders for the Greenspan Doctrine. Here’s one example. In 2005, Raghuram Rajan gave a now-famous paper at the Fed’s Jackson Hole conference warning of the impending financial crisis. Kohn gave a response, which we describe this way in 13 Bankers:
“Fed vice chair Donald Kohn responded by restating what he called the ‘Greenspan doctrine.’ Kohn argued that self-regulation is preferable to government regulation (“the actions of private parties to protect themselves . . . are generally quite effective. Government regulation risks undermining private regulation and financial stability”); financial innovation reduces risk (“As a consequence of greater diversification of risks and of sources of funds, problems in the financial sector are less likely to intensify shocks hitting the economy and financial market”); and Greenspan’s monetary policy resulted in a safer world (“To the extent that these policy strategies reduce the amplitude of fluctuations in output and prices and contain financial crises, risks are genuinely lower”). Kohn’s conclusion reflected the prevailing view of Greenspan at the time: “such policies [recommended by Rajan] would result in less accurate asset pricing, reduce public welfare on balance, and definitely be at odds with the tradition of policy excellence of the person whose era we are examining at this conference.”
(Emphasis added.) Now this does not mean that Donald Kohn is a bad person; it just means that he was wrong, along with Alan Greenspan and Ben Bernanke. If recent accounts are to be believed, he, like Bernanke, was relatively quick to shift gears when the crisis exploded and figure out effective responses, for which he deserves credit. (He also oversaw the stress tests, for better or worse.) But from where I’m sitting, the fewer members of the old guard, the better.
So now the question is, who will fill Kohn’s seat — and the other two empty seats on the Board of Governors? The Board is supposed to have seven members, and they matter because they have seven of the twelve seats on the Open Market Committee, which sets the fed funds rate. Business Week says that the search is being led by Tim Geithner and Larry Summers, and that the likely goal is to find people to back Bernanke.
This confuses me for a few reasons.
First, it’s not clear what Bernanke stands for. He was a Greenspan clone for about two years; then he turned into a pragmatic firefighter; and recently he’s been avoiding taking positions on issues, except to say that he’s against anything that reduces the power of the Fed (like an independent CFPA). So even if you wanted to find three mini-Bens, how would you even identify them? For starters, is he an inflation hawk or a dove?
Second, why is the Democratic establishment uniting behind Bernanke? Bernanke was a Bush appointee to the board, a chair of the Bush Council of Economic Advisers, and then Bush’s pick to replace Greenspan. He’s a Republican whose main selling point to Obama was that he was already in the job and accepted by “the markets,” and he was the clear choice of Wall Street this winter. Does this mean that Obama is going to appoint three centrists who follow the (recent) central banking orthodoxy of putting inflation control over economic growth, and who oppose tighter regulation of banks? For anyone who thinks that there is such a thing as a coherent Democratic economic policy, that seems like shooting yourself in the foot.
Finally, and I know I’m in the minority here, why are we trying to increase the power of the Fed chair — especially a Fed chair from the opposite party? Leaving aside policy questions, I think the deification of the Fed chair in the past two decades has been a decidedly bad thing. The sensitivity of the markets to one man’s pronouncements (and, just imagine, his health) is a bad thing; the fact that an unelected person is widely considered the second-most powerful person in the country is a bad thing; and if our economic fate actually depends on one person’s wisdom, that’s also a bad thing. The point of a committee is to have differing views, arguments, and a vote — not to have a bunch of suck-ups and yes men. If we put some real progressives on the board, then that’s what you would have — diversity of opinion and meaningful votes. (Including Bernanke, three of the four current members are Bush appointees, including a former investment banker and a former chair of the ABA.)
I know people will say I don’t understand, and if we had debate on the board the markets would be spooked. I think that effectively amounts to saying that dictatorship is good for the markets, so we should have a dictator.
* If you’re wondering why I begin so many posts with “The Importance of . . .,” it’s something I picked up from The French Laundry Cookbook by Thomas Keller.