It didn’t take a crystal ball to see that the jockeying for who will be the next Fed Chairman would begin to heat up. On June 15, I pointed out that the assumption going around has been that either Bernanke will be reappointed or Summers would take over the reigns. In light of blistering testimony today, it is increasingly clear that Bernanke will not be reappointed. I can’t see Summers as Fed Chairman either. I do see Alan Blinder. I started my personal lobbying campaign for Blinder on June 16. He is the only sensible choice.
Now it seems to be within the realm of possibility that Geithner and Bernanke are both in jeopardy.
President Obama, here is what you need to do.
It should be obvious to you by now that Geithner is incapable of instilling confidence. He may or may not be competent, but that is less important than having the ability to instill confidence.
Although I am no fan of Summers, I think most people would agree that he is a natural choice for Treasury Secretary. After all, the transition will be seamless since he is basically running things already from behind the scenes.
That leaves Alan Blinder for Fed Chairman.
Now, if you really wanted to salvage your presidency (you know your political capital is waning quickly and you will need it for your other programs), then you might also consider appointing Volcker to head the NEC.
This dream team would instill tremendous confidence and I would once again be optimistic about the future of our economy:
- Secretary of the Treasury – Larry Summers
- Chairman of the Federal Reserve – Alan Blinder
- Director of the National Economic Council – Paul Volcker
This is a team that could carry us out of this crisis. It is not too late.
PS: Don’t let the recent jubilation fool you. As I told you before, the credit crisis is much larger than residential mortgages. Easy credit pervaded every aspect of the debt markets. We need to be prepared for the next round. The troubles have still only begun.
PPS: You might also kindly request that Greenspan shut up.
Dear President Obama,
I say this as a supporter and as someone who wishes you success as we face extreme challenges on many fronts. I work among conservative Republicans and actually had to sneak out of the office to watch your inauguration. It was a touching and historic moment I will never forget.
You are on the verge of losing whatever political capital you had coming into office due to your refusal to acknowledge that the people you are relying on for economic policy are the very people who are responsible for getting us into this situation. Greenspan, Bernanke, Paulson, and now Geithner (and Summers) all continue to fail to see the causes of the crisis. As a consquence, current proposed regulatory reform is bound to fail yet again.
At this point, the rapid loss of confidence in both Geithner and Bernanke are weakening your ability to push your agenda in other critical matters. You must do something to remove them both or you will imperil your potential to accomplish lasting and necessary change.
He enunciates six unacceptable weaknesses in your proposal:
1) No major changes for the ratings agencies!
2) Turn Derivatives into Ordinary Financial Products
3) If they are too big to fail, make them smaller.”
4) The Federal Reserve, Despite its Role in Causing the Crisis, Gets MORE Authority
5) Require leverage to be dialed back to its pre-2004 levels.
6) Restore Glass Steagall
All of which suggests that the status-quo-preserving, sacred-cow-loving, upward-failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall-Street Rahm Emmanuel have yet to assert authority over the finance sector.
All these should be considered uncompromising requirements of any regulatory reform. Anything less than these six items will have no positive effect and will likely lead to another crisis before the end of your first term.
You are running out of time.
Yesterday, I started a personal campaign to nominate Alan Blinder to be the next Fed Chairman in the hopes that someone picks up the torch and carries it further than I can.
Today, a story appeared on Bloomberg confirming my fears:
Lawrence Summers, the former Treasury secretary who heads Obama’s National Economic Council, has been mentioned as a possible successor should Bernanke not be re-nominated.
It would be a tragedy if that happens.
Speaking of a “voice of reason”, I stumbled onto a very good Charlie Rose segment from last week with Alan Blinder, Alan Auerbach, and David Leonhardt:
Alan Blinder would make a fantastic Fed Chairman.
Today, we had the pleasure of a long article published in the Washington Post penned by no less than the dynamic duo: Geithner and Summers (listed in that order?).
Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world.
Oh, and by the way, we are both largely responsible for the ill-conceived deregulatory bank-friendly policies that got us into this mess.
We have taken extraordinary measures to help put America on a path to recovery.
Since everyone knows that the way out of a credit crisis is to artificially extend credit at irrationally cheap levels.
This current financial crisis had many causes.
The authors being two big ones.
It had its roots in the global imbalance in saving and consumption, in the widespread use of poorly understood financial instruments, in shortsightedness and excessive leverage at financial institutions. But it was also the product of basic failures in financial supervision and regulation.
But please don’t think we had anything to do with that.
In recent years, the pace of innovation in the financial sector has outstripped the pace of regulatory modernization, leaving entire markets and market participants largely unregulated.
Thanks to us.
First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole.
This is actually a thinly veiled attempt to RELAX regulation. The idea is similar to that adopted by Basel II and new rules allowing margin requirement be set at the portfolio level rather than the individual security level. Diversification helps. So when you group things together, the apparent risk is decreased allowing for additional leverage. Nice try.
The administration’s plan will impose robust reporting requirements on the issuers of asset-backed securities; reduce investors’ and regulators’ reliance on credit-rating agencies; and, perhaps most significant, require the originator, sponsor or broker of a securitization to retain a financial interest in its performance.
I’m sorry to be the one to break it to you, but the guys at Goldman are smarter than you. They will find a way around this.
All derivatives contracts will be subject to regulation, all derivatives dealers subject to supervision, and regulators will be empowered to enforce rules against manipulation and abuse.
What is your definition of a “derivative”? Does a credit default swap count?
We will lead the effort to improve regulation and supervision around the world.
Can you hear those Chinese college students laughing again?
Like all financial crises, the current crisis is a crisis of confidence and trust.
As long as the two of you have any say at all in policy matters, I know I will not experience anything remotely like “confident and trust”.
Reassuring the American people that our financial system will be better controlled is critical to our economic recovery.
Can you hear the unemployed graduating American college students laughing this time?
By restoring the public’s trust in our financial system, the administration’s reforms will allow the financial system to play its most important function: transforming the earnings and savings of workers into the loans that help families buy homes and cars, help parents send kids to college, and help entrepreneurs build their businesses. Now is the time to act.
It is too bad that the only solution you are capable of seeing is easy credit. Easy credit is what got us into this mess. Easy credit will not get us out of it. I don’t know what is so complicated about that concept that you cannot get it into your head. This is America. We don’t need and we don’t want your easy credit. If we let the big banks fail, would the availability of credit disappear? No way. Give me a break. That is fear mongering on your part to scare policy makers into excessively banker friendly policies. No. If every big bank failed tomorrow, there would almost immediately spring up 100s or 1000s of small banks in their place. There is great money to be made these days in opening a bank IF you would let competition play its course. Currently, the playing field is unfairly stacked against the small banks. I am tempted to start a bank myself. That is, if I thought you weren’t unfairly propping up economic sink holes.
To get this country back on its feet, we need entrepreneurs not oligarchs.
The history books will not make light of your misguided policies. The sooner you are both out of the picture, the sooner we can get back on the road to recovery.
For a while now, Paul Krugman has been tinkering with a model to simulate a Minsky moment. See, for example,
This sounds like a fun project, so I think I’ll do some brainstorming and see what happens. Comments welcome.
Finite Equity Market
One aspect I’d like to incorporate that is motivated by my experience at large asset management firms is to model the equity market as finite. Most models assume the market is infinite so that you can purchase and sell as much of any security as you like. In practice, we have size constraints. For example, when you own 10% of the outstanding market cap of any security, you cannot sell it without moving the market. Modeling a finite market will introduce liquidity. This will be important for modeling a Minsky moment.
Positions can be expressed as a fraction of the outstanding market cap.
I think we should model agents with continuous leverage, i.e. the amount of leverage is inversely proportional to market volatility.
This is motivated by both theory and recent experience. Clients expect stable or increasing returns. However, returns are commensurate with risk. Prior to the crisis, we were experiencing a period of decreasing market volatility with corresponding decreasing returns. To maintain high (and unsustainable) returns, investors began to increase leverage. This is also consistent with bank’s capital requirement being determined by value-at-risk (VaR).
To be continued…
Bernanke’s term as Chairman of the Federal Reserve ends on January 31, 2010. There seems to be a silent understanding that there are two possible outcomes:
- Summers slips into the role
- Bernanke stays
Both of these outcomes would be dreadful. It is not too early to start making noises now. The one person that stands out in my mind who should be the next Fed Chairman is Alan Blinder. Hands down. Throughout this crisis, he’s been a voice of reason. Bernanke, on the other hand, has been a bumbling disappointment.
I hope we can start a discussion early so that people are well informed ahead of time. These are challenging times and we need someone at the Fed we can feel confident about.
My vote would be to nominate Alan Blinder for Chairman of the Board of Governors of the Federal Reserve. Help make it happen.
The recent letter from David Einhorn contains many wonderful nuggets. One I’d like to highlight is a simple and elegant solution to the problem of excess compensation on Wall Street. He states:
I believe most of the discussion about compensation at financial institutions is a populist diversion. If the goal is to avoid excessive risk in the system, the proper response is to reduce it directly by enforcing much greater capital requirements. The lower leverage will also have the side effect of reducing the future peak returns, which will mean less egregious compensation.
Sometimes the best solution is the simplest. Instead of creating an expensive bureaucratic monster led by a Special Master of Compensation (give me a break), the simplest and most direct way to limit executive compensation is to reinforce existing SEC regulations that limit leverage.
An interesting article in Asia Times Online:
For Russia, as former prime minister and well-known scholar academician Yevgeniy Primakov observed ruefully in a recent Izvestia interview, “Russia will not come out of the crisis anytime soon … Russia will most likely come out of the recession in the second echelon – after the developed countries … The trap of the present crisis is that it is not localized but is worldwide. Russia is dependent on other countries. That lessens the opportunity to get out of the recession in a short period of time.”
I suspect that Russia may come out of this crisis sooner than it thinks. The real determinant of when Russia recovers will be oil prices. If oil continues its climb, which I think it will if not in a straight line, Russia will see strength return quickly. It will be interesting to see what they do when the money spigot turns on again.
The dynamics in this part of the world are changing rapidly. The brewing gravitational pull of its financial influence is undeniable.
Barry Ritholtz is a phenomenal blogger and has been a huge influence on the way I think about things. He’s got a new article this morning
One sentence in particular caught me a little off guard:
The spat in question is between Sheila Bair, the exemplary FDIC chairwoman, and the asshat being the speaker of the above WTF quote, John C. Dugan, the comptroller of the currency.
I tried to leave a comment there, but apparently it didn’t make it through his new souped up spam filters (which is understandable due to its length and the fact it contains little more than a link, i.e. the markings of “spam”).
Here it is:
Sheila Bair an examplary FDIC chairwoman? I’m afraid I’m with John Hempton on this one:
Other than that, I agree that Dugan seems to be an “asshat”.
PS: I love your blog and you’ve been a huge influence on the way I think about things, so I’m pretty shocked to see your comments about Bair. She is an idiot and maybe even an “asshat” as well.