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Analysis
Why Obama must appoint Summers

Why Obama must appoint Summers

Financial market experience needed at Fed

by John H. Makin

Mon 5 Aug 2013

Can 20 Democratic senators and the New York Times Editorial Board be wrong? You bet they can. Both are advocating Janet Yellen as the next Fed chairman, claiming that those who prefer Larry Summers’ appointment are closet sexists who are in bed with the banking lobby.

Specifically, they say they are concerned about Summers’ involvement in financial markets, as a paid consultant to Citigroup, hedge funds like DE Shaw, and other financial institutions. And they are clucking about what a shame it would be for President Obama to pass up the chance of nominating a woman to the top Fed post.

The President should be asking himself: Since when does involvement in financial markets – for pay, no less – disqualify someone for chairmanship of the Fed? ‘The Maestro’ Alan Greenspan, who presided over the prosperous and stable 1991-2001 ‘Golden Age’ decade of solid growth, low unemployment and low inflation, was a Wall Street consultant before he came to Washington.

Larry Summers has had three distinguished careers: in academia, government service and financial markets, with substantial emphasis on the first two.

Those, myself included, who were intimately involved in the 2007-08 financial crisis and its aftermath (full disclosure: I was chief economist at a large hedge fund) understand well that the Fed would have benefited from more market experience before and during the crisis.

Chairman Bernanke has acknowledged publicly that the Fed should have acted more quickly to recognise and respond to the cascading financial crisis surrounding, the March 2008 collapse of Bear Stearns and, six months later, the collapse and bankruptcy of Lehman Brothers. Financial market experience would have helped to produce a more proactive response.

The global financial system was severely threatened during both episodes. Markets approached total collapse as counterparties withdrew cash from each other. There was a virtual run on the investment banks, from Morgan Stanley to Goldman Sachs, and yes, even the mighty J.P. Morgan was at risk, notwithstanding subsequent denials of J.P. Morgan CEO and Chairman Jamie Dimon.

The September 2008 collapse of Lehman Brothers defined systemic risk. Had the Bernanke Fed not intervened, the entire global financial system would have collapsed. That said, had the Fed better understood the extent of the crisis – perhaps a former Treasury Secretary with both real world and academic experience could have helped – the substantial costs engendered by imminent financial collapse, including the severity of the Great Recession that followed, might have been mitigated.

The other candidate for Fed Chairman, Janet Yellen, is a well-respected academic economist and a much-admired member of the Federal Reserve System community. She would make a good Fed chairman.

Larry Summers, by virtue of the breadth of his market, government and academic experience, is more likely to make a great Fed chairman. God knows we need (another) one.

 

John H. Makin is a resident scholar at the American Enterprise Institute (AEI) in Washington.

This is the second of two OMFIF articles on 5 August 2013 on the selection of the new Fed chairman. This article first appeared for the AEI on 31 July.

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