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Fed’s dark succession games

by Kevin Rafferty

Special To The Japan Times

A very strange thing occurred in the first half of this year: The humans beat the robots in the dark art of correctly interpreting the gnomic utterances of Ben Bernanke, the chairman of the U.S. Federal Reserve. Currency funds that rely on computer trading managed a return of a mere 0.7 percent, whereas human-managed funds earned 2.3 percent. The robots were more baffled by Bernanke’s various pronouncements giving clues about the schedule for slowing the Fed’s bond purchase program, the interpretations and misinterpretations of which caused big swings in the euro-dollar exchange rate.

Carbon- and silicon-based market participants have to react quickly or funds in the carry trade across currencies get into difficulties. Normally the quant funds outperform the humans by relying on indicators and formulae, but this year reactions to Bernanke’s comments caught them wrong-footed and caused losses when the carry trade reversed.

No doubt the robots would be baffled even more if they had access to the dark political games being played in Washington to find a successor to Bernanke when his term ends at the end of January.

The job of Fed chief is one of the most powerful in the world, yet the method of selection, by underhand lobbying of the president, who makes the choice, followed by partisan politicking during confirmation hearings in the Senate underlines yet again how dangerously dysfunctional and demagogic rather than democratic is the so-called most powerful country in the world.

According to the economic commentator Ezra Klein of The Washington Post, the battle is not quite over bar the inevitable shouting in the Senate, but professor Larry Summers has the inside track in a close contest with Janet Yellen, who is Bernanke’s deputy at the moment. If Summers is chosen, he would be the first treasury secretary to become Fed chairman; if Yellen wins, she would be the first woman.

Klein wrote on the Post’s WonkBlog site that support for Summers had grown rapidly. He offered five considerations:

• President Barack Obama’s liking of Summers, helped by the fact that he is surrounded by Summers’ longtime colleagues and friends;

Obama’s top concern is choosing someone who will care about the Fed’s mandates to maintain full employment and to keep inflation low, on which Summers and Yellen both score well;

Obama also knows that the modern economy could collapse at any time, and is comfortable with Summers as first responder to any crisis;

Trust by the markets is another important area where Obama believes that Summers has the advantage;

The open question is Summers’ reputation for being difficult to work with, and how he will manage the Fed’s open markets committee, but the White House believes, according to Klein, that the “reputation is overblown — after all they worked with him, and enjoyed working with him, and there’s some sense that maybe a more aggressive Fed chair wouldn’t be the worst thing in the world.”

Klein’s article was quickly taken up by the commentariat. The New York Times pointed to a hard core of Summers’ supporters who have been key economic policymakers in both the administrations of Bill Clinton and Obama, including Summers’ predecessor at the Treasury Robert Rubin, Gene Sperling, Clinton and Obama’s chief economic adviser and former Treasury secretary Timothy Geithner.

But this is not some genteel academic or television show debate, and may the best person win. Klein himself in an earlier post wrote about a “subtle, sexist whispering campaign” against Yellen, and quoted Richard Fisher, chairman of the Federal Reserve Bank of Dallas, who said on CNBC that if Yellen were chosen it would have been “driven by gender.” Klein had the grace to admit that this was more part of a shouting than whispering campaign.

If anything, Summers’ critics are more hostile, vicious and personal, and Klein’s article set off an eruption of fury with myriad critics damning the former Treasury secretary, former Harvard president and former economic supremo to Obama.

“Stop Larry Summers before he messes up again” and “No more second chances for Larry Summers,” wrote William Greider in two posts, accusing Summers of being “a toxic retread from the old boys’ network and a nettlesome egotist who offended just about everyone during his previous tours of government.” Greider admitted writing previously that he called Summers “Professor Pants-on-Fire.”

In pure intellectual candlepower, Summers is far ahead of anyone else, but one of his problems is that he always wants to prove that he is the smartest guy in the room; another is that he won a reputation for bullying those he considered his inferiors while sucking up to those in power.

Years ago, before he became Treasury secretary, some close friends told me that the job that Summers really coveted was being chairman of the Fed. He clearly relishes being close to the center of power. Since leaving as Obama’s economic supremo in late 2010, Summers has visited the White House on at least 13 days, on four of them to meet Obama himself. Yellen in contrast has visited only once, to meet Alan Krueger, who was then chairman of the council of economic advisers.

Summers was a controversial vice president of the World Bank, especially when he wrote a memorandum suggesting that African countries were underpolluted and that “the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that …” He later claimed that it was intended to be sarcastic, but when he served in the Clinton administration he argued against the United States signing the Kyoto Protocol.

As president of Harvard University, he won the hostility of African-Americans and of women for remarks seen as hostile. Summers suggested that women’s under-representation in top positions in science and engineering could be due to a “different availability of aptitude at the high end”; he even dared to say that his comments were “provocative.”

The New York Times in an editorial last month also remembered that Summers had clashed disastrously with women on several occasions: In 1998 when he and Rubin opposed Brooksley Born, head of the Commodities Futures Trading Commission, for calling for the regulation of derivatives; in 2009, he successfully rejected the pleas of Christina Romer for a larger stimulus; and he also clashed with Elizabeth Warren, who was chairing the congressional panel overseeing the bailouts, and with Sheila Bair, head of the Federal Deposit Insurance Corporation.

In a Fortune article Bair went to the heart of the matter in advocating Yellen’s claim to be the next Fed chief, noting that “Unlike Larry Summers, Tim Geithner and other Bob Rubin minions frequently mentioned in the financial press as potential Bernanke successors, she was not part of the deregulatory cabal that got us into the 2008 financial crisis.”

That is only half of it. When he left the treasury, Summers made his own millions from Wall Street. Given that an important part of the job of Fed chairman, apart from taming unemployment and inflation, is regulating the financial system, it is a bit of a risk to give the job to someone who played a key part in creation of the TBTF (too big to fail) banks and then profited from deregulation.

The arguments over Summers got so heated that Obama himself told the Democratic caucus in the House of Representatives that they must give Summers a “fair shake.” Did this mean that Obama has made up his mind to nominate Summers, or is damning him with praise before dropping him?

One irony is that in office, the Fed chief is supposed to be above politics and above all to resist political pressures, yet the debate over who it should be is intensely political, and you can rely on the politicians on all sides not to let the facts as to who is the best candidate get in the way of a good story.

Kevin Rafferty is a professor at the Institute for Academic Initiatives at Osaka University.