Jared Kushner for Fed Chair?

A powerful, no-holds-barred New York scion paves the way for his smooth operating, ill-equipped son-in-law to wield the kind of awesome power that shapes the fates of Americans in every corner of the country.

It’s not just the Jared Kushner story. Kevin Warsh, the son-in-law of billionaire and Estée Lauder heir Ronald Lauder, is the leading candidate to replace Janet Yellen as Federal Reserve Chair early next year. President Trump put Warsh on his corporate CEO council while Lauder is playing defense for the president and appears to have his ear. The New York Times reports that Lauder’s influence with Trump is growing.

Warsh seems to be positioning himself for the big job, but his main claim to it — he was the youngest Fed governor (there are seven governors, including the Chair) in American history and served for five years — came only after his father-in-law donated significantly to the GOP after the 2000 election.

His service was a disaster:

  • He was tasked with keeping tabs on Wall Street but instead preached about the wonders of financial innovation right up until it exploded the economy;
  • He helped save the big financial institutions — including rescuing his former employer, Morgan Stanley — but was ready to pull the plug on help for the real economy before it even hit rock bottom; and
  • He wrongly warned of catastrophic consequences from Fed policy but didn’t even have the confidence of his own convictions to vote against them.

Kevin Warsh isn’t fit to sit on Janet Yellen’s committee let alone take her job. And if he fails up into the world’s most powerful economic position we will all pay the price.

Federal Reserve

The Fed is a difficult institution to understand. One part of its job is pretty straightforward — regulating banks. How much money do they have to keep on hand? What can they do with “their own money”? The other major Fed responsibility — monetary policy — is harder to conceptualize.

Because it works through banks and other financial institutions, the Fed doesn’t touch you directly. But the CEO who closes your mom’s office doesn’t deal with you directly either and yet he can change your life. Whether or not you can afford a mortgage, find a job, get a raise, or retire on a fixed income depends in part on Fed policy.

The Fed has a lot of power over interest rates and so it can influence the availability of loans (to companies, households, etc.) in the U.S. economy, which in turn affects how much stuff is produced and purchased. With this power, Congress has instructed the Fed to achieve maximum employment, stable prices and moderate long-term interest rates. Defining each of these is not obvious (does “maximum employment” mean no unemployment?) and achieving them all at once is a significant feat. So, the meat of the Fed’s job is defining the terms and determining the trade-offs between them. For example, can unemployment go below 4%? Even if it can, would Fed efforts to get us there mess up other things like prices (which might go up) or financial stability (like creating a bubble in the stock market)? Even though most prices haven’t moved very much for many years, should the Fed pay attention to surveys of what people expect to happen and fight inflation (by trying to slow economic activity) before it actually shows up?

These are not easy questions to answer in any circumstance. They have been made harder over the last decade by

  • the economic cratering that followed the bursting of the housing bubble and the financial crisis of 2008;
  • a global downturn — especially depressed economic activity in Europe — that made our recovery harder; and
  • an uncooperative Congress that mostly refused to play its role in lifting up the economy after it fell so far so fast.

In the face of these unprecedented challenges, the Bernanke-Yellen Fed delivered. Unemployment is below 4.5%, which has only happened during a handful of years over the past four decades, inflation is below but not too far from its 2% target, and long-term interest rates are low.

(Check out Tim Duy’s graph comparing Yellen’s performance with past Fed leaders).

Kevin Warsh would not have steered us to this safe harbor. And it is a safe harbor. We need to get more people into the workforce and move wages up, but the Fed’s progress gives us an opportunity to address these challenges. If Warsh had been guiding it, the Fed would still be debating whether or not to even try to bring down crisis-level unemployment rates.

Early Warsh

When nominated by President Bush, Warsh was panned in unusually harsh terms:

Most of President Bush’s nominees to the Federal Reserve have earned accolades from across the economic and political spectrums.
And then there’s Kevin Warsh.
Bush’s nomination of the 35-year-old White House aide — a lawyer by training who would become one of only two members of the Fed’s seven-member board of governors without a doctorate in economics — has been greeted by criticism and bewilderment by some former Fed officials and economists. They point to his political connections and inexperience, and say the White House could have found a better-known, more qualified choice.
“Kevin Warsh is not a good idea,” said former Fed Vice Chairman Preston Martin, who was appointed by Republican President Ronald Reagan in 1982. “If I were on the Senate Banking Committee,” which must approve Fed nominees, “I would vote against him.”

Since he touted his experience on Wall Street at his nomination hearing, The Financial Times tried to track down people who might vouch for him:

At his hearings this week, he said he hoped his nearly seven years on Wall Street would prove beneficial to the Fed. Wall Street’s response: who is he? His name barely gets a blink of recognition among the bankers Observer has spoken to. They add that their Morgan Stanley buddies are struggling to remember him. “He has some of the lightest qualifications for Fed governor we can remember,” says Christopher Whalen, of Institutional Risk Analytics. Warsh is slated to take the lead on banking regulation issues at the Fed. Good thing they’re starting him off easy.

Perhaps Bush picked Warsh because he was a true savant who outshined more senior officials in the White House. Or, perhaps Warsh was really good at the DC self-promotion game. Not every rich son-in-law or aspiring Fed official claims a spot on Washington Life Magazine’s 100 Most Invited, as Warsh did in 2006. But it is at least worth taking seriously the idea that his father-in-law helped muscle him in.

Ronald Lauder is a fine art collector and non-profit leader. He also seems to use money to gain political influence:

  • At thirty-seven and without any foreign policy or defense experience, Lauder became a Pentagon official and then ambassador to Austria after raising big bucks for the Republican Party.
  • In what became a scandal in Israel, Lauder, who owned an Israeli television channel until 2013, was recently questioned by investigators about gifts to Prime Minister Netanyahu and his family.
  • Federal prosecutors investigated allegations that he paid $1 million in bribes to officials in Ukraine in exchange for a television license.

There’s more. Governor Pataki’s wife was on Lauder’s company payroll as an advisor while Lauder ran Pataki’s Commission on Privatization. And he’s not shy about putting direct, legal pressure on government officials when he is not getting his way.

The reason to even mention Warsh’s father-in-law is because Warsh’s ascent from staffer on the National Economic Council to Federal Reserve Governor is so unusual. “Working for the White House” runs the gamut; it can mean crafting policies with billion dollar price tags or answering the phones. Even within the National Economic Council, which is just one part of the bigger White House economic team, Warsh was not the senior policymaker. Here’s the staff directory:

At the time, Warsh joining the most important economic decision-making body in the world didn’t get much play because the economy was doing OK and most of the public doesn’t understand enough about the Fed to care about its leadership, but this nomination was outrageous. It was akin to a president nominating a mid-level staffer (without a law degree) in the White House Counsel’s office to become Associate Justice on the Supreme Court.

(If you doubt that Warsh’s experience was especially shallow, check out the biographies of past Fed governors).

So what?

Lincoln wasn’t ready for the presidency! The one-term Congressman managed pretty well once he got his chance. How Warsh came by the job isn’t irrelevant, but ultimately he should be judged on his performance as a Fed governor.

As Roger Lowenstein wrote in January 2008, Warsh’s “unofficial role is to keep tabs on Wall Street.” The Fed doesn’t just monitor. It has the power to change how banks lend and fund their operations.

To say that Warsh was an ineffective Wall Street supervisor is a vast understatement. At precisely the time he should have been screaming about lending and securitizing practices and demanding banks build up buffers to absorb losses, he was preaching about the wonders of our financial system. This from a March 2007 speech is especially cringe-worthy:

“First, liquidity is significantly higher than it would otherwise be due to the proliferation of financial products and innovation by financial providers. This extraordinary growth itself is made possible by remarkable improvements in risk-management techniques. Hewing to my proposed definition, we could equally state that financial innovation has been made possible by high levels of confidence in the strength and integrity of our financial infrastructure, markets and laws. Moreover, remarkable competition among commercial banks, securities firms and other credit intermediaries have helped expand access to — and lower the all-in-cost of — credit. Interest rate risk and credit risk exposures are now more diversified. Look no further than dramatic growth of the derivatives markets. In just the past four years, notional amounts outstanding of interest rate swaps and options tripled, and outstanding credit default swaps surged more than ten-fold. These products allow investors to hedge and unwind positions easily without having to transact in cash markets, expanding the participant pool. Syndication and securitization also lead to greater risk distribution. An important source of strength has been financial innovation, and while we have yet to see how some new products will play out in a more stressful environment, there almost certainly will remain a greater dispersion and insurability of risks.”

The very products and practices he championed reaped unfathomable destruction.

Instead of adjusting once trouble emerged, Warsh couldn’t keep his eye on the right ball. Even after Bear Stearns failed early in 2008, Warsh urged the Fed to keep the focus on preventing inflation. A popped housing bubble and financial institutions on the ropes should lead to disinflation (lower prices) not inflation, but Warsh seemed to think that those factors would be swamped by a run-up in commodity prices (oil is the big one). At a June 2008 meeting he told his colleagues, “inflation risks, in my view, continue to predominate as the greater risk to the economy” and then in September 2008, a day after Lehman failed, he reiterated his position, “but I’m still not ready to relinquish my concerns on the inflation front.”

Many, including conservatives, have argued that the focus on inflation in the summer and fall of 2008 greatly exacerbated the crisis. The moment before the patient needed emergency surgery, Warsh and a few of his colleagues were getting ready to discharge him from the hospital. A frustrated Chair Ben Bernanke — nominated by George W. Bush — vented in an e-mail at the time: “I find myself conciliating holders of the unreasonable opinion that we should be tightening even as the economy and financial system are in a precarious position and inflation/commodity pressures appear to be easing.”

Warsh’s role in the financial rescue that followed is a bit opaque. David Wessel, the plugged-in Fed watcher formerly of the Wall Street Journal, writes that Warsh joined Chair Bernanke, Vice Chair Don Kohn, and New York Fed President Tim Geithner as the “four musketeers” who together “would call every significant play during the Great Panic at the Fed.”

In the run-up to Lehman’s failure there is some evidence that Warsh didn’t want to commit government resources for a rescue, but by December 2008 he was defending the Fed’s rescue of the financial sector:

“It’s a completely new set of liquidity tools that fit the new needs, given the turmoil in the financial markets,” Kevin Warsh, the Fed governor, said. “We have basically substituted our balance sheet for the balance sheet of financial institutions, large and small, troubled and healthy, for a time. Without these credit facilities, things would have been a lot worse. We’d have a lot more banks needing to be resolved, unwound, or rescued, and we would have run out of buyers before we ran out of sellers.”

According to the Wall Street Journal, in September 2008 when the Federal Reserve took the extraordinary step of turning Morgan Stanley into a bank holding company so it could receive loans from the Fed, it was Geithner and former Morgan Stanley employee Warsh who “sort[ed] out the details with Goldman and Morgan Stanley.”

Warsh’s role during these critical weeks is fuzzy, but those writing about the crisis paint a picture of Warsh always in the right room, on the phone with the key players, and possessing everyone’s confidences. David Wessel sums up Warsh’s value to the Fed during this period, “what he had was two things: great connections to republicans in Washington, and a great rolodex of people and bankers on Wall Street who he could call and get a sense of things.”

The real economy

In the aftermath of the Wall Street rescue, the real economy fell deeper and deeper into what seemed like a bottomless hole. From October 2008 to October 2009 unemployment climbed from 6.5% to 10%. Millions were thrown out of work. As Bernanke scrambled to generate economic activity, Warsh adopted a skeptical and increasingly oppositional posture. He doubted the Fed could do much good without creating much bigger problems. He was wrong. The Bernanke-Yellen Fed’s extraordinary actions pushed the economy forward and generated lower unemployment than Warsh thought possible while avoiding all of the calamities Warsh predicted.

Zooming in on a few moments in 2009 and 2010 sheds important light on Warsh’s judgment.

In March 2009 he told his Fed colleagues that he was “quite uncomfortable with the idea of purchasing long-term Treasuries in size” because “if the Fed is perceived to be monetizing debt and serving as a buyer of last resort in the name of lowering risk-free rates, we could end up with higher rates and less credibility as a central bank.” Warsh is warning his colleagues that while they may think lowering long-term interest rates to reverse a once-in-a-generation downturn is warranted, the financial markets will see it as a withdrawal of the discipline that undergirds the whole system. In other words, it’s not a life vest to an overboard sailor, but rather a crate of booze that gets the crew so rip-roaring drunk they crash the ship. The argument predicted a sudden break in faith with the United States of America — one day the market would say “enough” to all this government effort to boost the economy and would stop buying its bonds. Not only was Warsh wrong but he was as far from right as you can get. Buyers gobbled up government bonds. Instead of spiking, treasury rates reached historically low levels where they have stayed for years.

In June 2009, as the unemployment rate was closing in on 10% and fifteen million Americans were looking for work, he told his Fed colleagues, “I think it is confidence-inducing, not risk-inducing, for the world to know that we are thinking about exits.” He’s suggesting that in this moment — before we had even hit rock bottom — the Fed should start telling markets, companies and workers it would soon unwind its support to the economy. Almost three years later, as the unemployment rate slid below 8% and the recovery seemed to be generating some encouraging momentum, Bernanke basically said publicly that the Fed was thinking about the exits. His pronouncement was met with a severe negative reaction — the so-called “taper tantrum” in which the markets signaled that the economy was not ready for the Fed to withdraw support. The reaction would have been even worse if Bernanke had followed Warsh’s advice three years earlier.

In a September 2009 speech Warsh said that the Fed couldn’t wait for the economy to recover before it started fighting potential inflation: “if policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal — and the economy has returned to self-sustaining trend growth — they will almost certainly have waited too long… There is a risk, of much debated magnitude, that the unusually high level of reserves, along with substantial liquid assets of the banking system, could fuel an unanticipated, excessive surge in lending.” Instead of sparking runaway inflation, the Fed has had the opposite problem — despite its extraordinary push to generate more lending, borrowing and buying it has struggled to reach the 2% inflation target. As Tim Duy wrote in response to Warsh’s speech, “the spate of FedSpeak in recent days leaves one with the uneasy feeling that monetary policymakers are more willing to use unconventional monetary policy to support Wall Street than Main Street.”

In June 2010 Warsh argued that “excessive growth in government spending is not the economy’s salvation, but a principal foe” while expressing skepticism that more Fed action was warranted. Paul Krugman summarizes: “The bottom line of Warsh’s speech — although expressed indirectly — is that it’s time for fiscal austerity, even though the economy remains deeply depressed; and no, the Fed can’t offset the effects of fiscal contraction with more quantitative easing. In short, the responsible thing is just to accept 10 percent unemployment.”

Unreformed

Instead of acknowledging that his dire predictions were never realized, Warsh spent the last few years grasping at new reasons to oppose a Federal Reserve that takes its responsibility to full employment seriously. Last year Warsh lectured the Fed about inappropriately devaluing the dollar although it was quite strong, in 2015 Warsh claimed that its program to lower long-term interest rates actually reduced business investment (which Larry Summers described as “the single most confused analysis of US monetary policy that I have read this year”), and in 2013 Warsh wrote that “the more the Fed acts, the more it allows elected representatives to stay on the sidelines.” This is completely backwards — Bernanke practically begged Congress to help the economy, but he wasn’t willing to ignore the Fed’s legal mandate because Congress was dysfunctional. As Bernanke wrote in his memoir in response to this argument, “The reality was that the Fed was the only game in town. It was up to us to do what we could, imperfect as our tools might be.”

It didn’t have to be this way. As late as the summer of 2010 Narayana Kocherlakota, the head of the Minneapolis Federal Reserve (the Fed has a hybrid structure with permanent policymakers in DC and rotating policymakers in twelve regions), was arguing that the Fed couldn’t do much to lower unemployment. Two years later “Kocherlakota returned to Michigan’s Upper Peninsula to announce that he had changed his mind. Contrary to his prediction, inflation was slowing. That meant the Fed had the opportunity and responsibility to do more.” Kocherlakota let reality reshape his view of the economy. The same cannot be said of Warsh.

Chances are the next Fed Chair will face a recession. If you wouldn’t accept an unrepentant and unreformed Donald Rumsfeld leading America into war, you shouldn’t accept Kevin Warsh leading us out of a recession.

Why write this now?

We won’t know Trump’s nominee for a few months at least. He might even keep Yellen in place; Reagan, HW Bush, Clinton, W Bush and Obama all nominated Fed Chairs who had been initially chosen by predecessors. And recently Trump told the Wall Street Journal that Yellen is “not toast.”

But, if it is Warsh, he will have all his ducks in a row. The rollout will be smooth and forceful. To watch Warsh at a think tank event or to experience him through the transcripts of a Fed meeting, is to observe a master of courting the powerful. As Wessel put it in recounting a story about a college-age Warsh flattering legendary conservative William F. Buckley, “it was typical Warsh, the agile networker successfully impressing those senior to him in years and experience.”

The Fed is hard to understand and the contributions of its decision-makers are genuinely opaque. Most reporters, members of Congress, and civil society leaders will look to a handful of validators to signal whether or not someone is “acceptable.” Warsh has cultivated so many of these people. They will stay silent if they are skeptical of his nomination but most will champion him.

Ben Bernanke is a case in point. His description of Warsh’s departure from the Fed is remarkably kind given the circumstances — Warsh announced to Bernanke in one of his last Fed meetings, “If I were in your chair, I would not be leading the Committee in this direction” — and Warsh’s subsequent doomsaying about the programs of which Bernanke rightly takes pride. Bernanke writes in his memoir,

Despite hearing from a few FOMC colleagues [other voting members of the Fed] who were piqued at Warsh’s op-ed [in which he expressed skepticism about further Fed action], I was comfortable with it. I never questioned Kevin’s loyalty or sincerity. He had always participated candidly and constructively, as a team player, in our deliberations. And I was grateful that he had voted for the second round of asset purchases despite his unease.

The last sentence is the key to understanding this passage. Warsh’s refusal to dissent from Bernanke clearly meant a lot to a Chair who wanted to be seen as in command as his predecessor, the legendary “maestro” Alan Greenspan. Bernanke valued unity especially among the Fed governors; Warsh delivered. And even when he disagreed Warsh found the most agreeable ways to do it:

My respect for you [Bernanke] during this last four and a half years is incredibly high. I am awed by the burdens that you are confronting, and I wouldn’t want to undermine at this important moment the chance that this program could be successful… I think this is called the Bernanke Fed for a reason.

Warsh gets to have it both ways. To Fed critics who are furious at “Helicopter Ben” (as in dropping money from helicopters), Warsh can suggest that he quit in protest of the Fed’s interventionist policies. To Bernanke himself, Warsh can say that he would rather give up his seat than oppose the wise master.

If we look at the larger picture — the duty to do what you think is right in a position of significant responsibility — there’s a troubling question of integrity here. After all, if you believed that the Bernanke Fed was pursuing policies that might lead to runaway inflation or a massive United States debt crisis or was letting the real policymakers off the hook, would you leave the Fed less than halfway through your term? Would you give up your dissent?

Personal Experience

The Fed is as dry and technocratic as it gets, but its framers saw fit to consider personal experience in determining its leadership. There was a well-justified fear that the bank of the banks would be captured by those who didn’t understand or care about the interests of farmers, laborers, small businessmen, and the like.

When Warsh served on the Fed’s Board of Governors, his personal wealth was more than that of every other member of the Board combined. That’s not surprising since his wife is a billionaire heiress by way of her grandparents. The embrace of upper crust culture — for example, a partnership in a thoroughbred stable with Wall Street players — might be overlooked if it wasn’t combined with condescension for those who don’t have as much. In one of his last meetings Warsh responded dismissively to a report from New York Federal Reserve President Bill Dudley about Dudley’s visit to upstate New York and how “a modest amount of additional stimulus could have outsized effects over the longer run by changing the dynamic from the current stasis to one in which additional demand growth led to employment gains that improve confidence.” Warsh joked:

“The report on economic activity in my neighborhood in Georgetown is strong. [Laughter] Also, President Dudley mentioned that he visited upstate New York, where I’m from, and he noted that the economy there appeared to be ‘hunkered down.’ That’s not a near term phenomenon — it’s been going on for about 40 years. [Laughter] He also noted that the economy there was at a tipping point, and that is true, but the only way it ever tips is over.”

Contrast this mocking fatalism about a working community — which, by the way, has seen its unemployment rate come down by more than three percentage points since Warsh’s nothing-can-help-them message — with the optimism of coming face-to-face with excited corporate directors. He told his colleagues at one of his first Fed meetings:

“CEO confidence — that look in their eyes, their view of the animal spirits — appears to be back in stronger measure than I at least have heard in some time. What then happens when CEOs go into the boardroom, as I think most of my colleagues around the table know, is that they tend to generate some excitement by directors themselves. Directors are really starting, in some regard, to go back to basics. One CEO said to me about a week ago, ‘Being a board member is starting to be fun again,’ and that is not something this particular CEO, who is on a lot of large-cap boards, would have said a year ago.”

This is a blue-collar nightmare: policymakers measuring the economy by how much fun corporate boards of directors are having.

There’s no perfect set of life experiences that could allow a Fed Chair to understand the intimate textures of America’s diverse communities, but there are age-old traps to avoid. The temptation to reflexively trust the CEO and discount that the discouraged worker might be pulled back into the labor force is already great. Especially at this moment when the Fed is groping in the dark to find a new paradigm that doesn’t sacrifice past victories against inflation but better delivers real gains for workers, we need a Fed Chair who actively resists this temptation. Warsh seems to luxuriate in it.

Conclusion

Its leaders and harshest critics for different reasons minimize the importance of the Fed. The latter suggest that the Fed is somewhere between an irritant and an oppressor, but either way it is a distraction from the Randian producers who really determine the outcomes for all of us. The former have lately been humble academics who don’t want the quarterback’s spotlight. They are more comfortable on an offensive line where they have studied the finer points of blocking for decades.

And yet when the ground shifts and the economy shakes it is the Fed that must act as stabilizer-in-chief. Your paycheck rides on its response.