Fleeing The Fed Ship

William Dudley, the president of the Federal Reserve Bank of New York, has become the latest senior Fed official to announce his retirement. He follows Fed Vice Chair Stanley Fischer, who announced his intention to resign in September, and Daniel Tarullo, the central bank's top financial regulator, who announced his resignation back in February.

Of course, the biggest departure at the Fed was one that wasn’t voluntary, namely President Trump decision not to renominate Janet Yellen for another term as Fed chair, ignoring 40 years of precedent to reappoint a sitting Fed chief. Instead, of course, he nominated Fed governor Jerome Powell to replace her when her four-year term ends in February. Still, Yellen is entitled to finish her 14-year term as a member of the Fed’s Board of Governors, which doesn’t expire for another seven years, on January 31, 2024, although her staying on would also be unprecedented.
All told, there are now three open seats on the seven-member Board of Governors, which of course may rise to four if Yellen elects to leave.

It’s pertinent to ask, then: What are all the departures at the Fed, both voluntary and involuntarily, signaling? Is it simply senior officials graciously moving aside to let a new president get a chance to pick his own people? Or is there something more sinister afoot, namely, do they indicate that a big change in the market is about to occur and they want to get out before the chickens come home to roost?

Despite all the plaudits Yellen, her predecessor as Fed chair, Ben Bernanke, and other Fed officials have won for their roles in steering the economy through the darkest days of the global financial crisis and since, let’s not forget that there is still a lot of baggage left behind from their tenure. The fact is that we still don’t know the ultimate consequences of eight years – and counting – of zero or near-zero short-term interest rates or the ballooning of the Fed balance sheet from well under $1 trillion to $4.5 trillion today. (To put that number in perspective, the Fed owns nearly 30% of all outstanding mortgage-backed securities and more than 10% of all U.S. Treasury securities).

While the Fed has indicated that it plans to unwind both of those strategies at the pace comparable to paint drying, we really don’t know if that’s too fast, too slow, just about right, or something else entirely. Will it have a benign effect on market and economic activity, as the Fed hopes, or will it unleash a market selloff or wave of inflation or other unforeseen and unanticipated negative effects?

Let’s look back at the legacy of Bernanke’s predecessor, Alan Greenspan. Greenspan was originally nominated by Ronald Reagan and reappointed five more times, serving from 1987 to 2006, the second-longest tenure in that office. He’s generally credited with presiding over a long period of vibrant economic growth, lasting through the terms of both Presidents Bush and President Clinton.

Yet his reputation has largely escaped unscathed from the consequences of his policies of leaving interest rates too low for too long and the Fed’s rather laissez-faire attitude toward financial regulation. Many believe those policies caused the housing bust, which then exploded into the global financial crisis that took place shortly – conveniently, one might say – after he left office. Greenspan’s legacy must encompass both of those things; which one has had more lasting effects I suppose history will decide, although here we are 10 years after the financial crisis and still suffering the after-effects.

The legacy of the more recent members of the Fed, Bernanke and Yellen especially, is likely to be a lot more positive. After all, they came in trying to clean up a gigantic mess. I remember all too well how scary those days were back in 2007 and 2008. One day it was Bear Stearns going under, then Lehman Brothers, then worries that even some of the largest financial institutions on the planet – Citigroup, AIG, UBS, Merrill Lynch – were going to collapse without enormous government intervention.

The Fed did what it had to do, and need make no apologies for it. Those involved leave with the markets at record highs and the economy in pretty decent shape.

But there are legitimate questions that need to be asked, namely: Was it necessary to keep those measures – low rates and an enormous bond portfolio – in place for so long? And what will be the consequences once everything is said and done? Will the cure be worse than the disease? Will our economic system ever return to a pre-2006 normal? Will the Fed always be so interventionist? The departing members of the Fed will never have to deal with those issues.

Rather, those questions will need to be faced by Fed Chair-designate Powell and the other people President Trump will be nominating to the Fed over the next few weeks and months, whether they be John Taylor, Kevin Warsh, Gary Cohn, or someone else. They surely have their work cut out for them.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.