Bush Appoints a Crony To the Federal Reserve

I am, by profession, a monetary policy geek. Still, I didn't notice, until Daniel Greenbaum (I think his last name is Greenbaum) posted on TPMCafe that Bush appointed an unqualified crony to a spot on the Board of Governors for the Federal Reserve Bank. You can read a detailed account of the appointee and appointment here.

This appointment has not received much scrutiny, even though the Federal Reserve can dramatically influence our economy by controlling short term interest rates. Actually, though it makes decisions about interest rates, what it really does is control the money supply. In it's most basic sense, less dollars available means that they're worth more but are harder to get and that tends to slow economic growth. More available means they're worth less but are easy to come by, which spurs economic growth as people and businesses spend the plentiful greenbacks, but also causes inflation as people selling products demand more of those dollars because, well, there's just so many of them.

The Fed, especially under former chairman Alan Greenspan, tries to control the money supply in such a way as to allow for growth but to keep prices stable. The new chairman, Ed Bernanke, seems to be of the same mold. The Fed chairman, as the person ultimately responsible for the policy, tends to get the majority of attention. But the Federal Reserve isn't a one-man show. The Fed has a board of governors, who advise the chairman, debate with the chairman and can, though they rarely do it, overrule the chairman.

Greenspan ran the Fed for so long and was such a celebrity and, though I don't agree with him at all politically, is such a smart guy, that he really made the governors underneath him seem irrelevant. He was an imperial chairman of sorts.

Bernanke might be the same type of guy. By all accounts, he's an expert in monetary policy with a long academic track record behind him. He knows his stuff. But, unlike the imperial Greenspan that we all got to know, especially during his heyday in the 1990s, Bernanke doesn't have a track record behind him. It seems at least possible that, being so new to the job, that the governors of tghe Federal Reserve will have more influence over the neophyte chairman than they did over the veteran Greenspan who had been christened "The Maestro" by both the markets and the press.

So, it makes no sense that Bush appointed 35-year-old Kevin Warsh, a White House aide and married into the Republican-backing Lauder (of Estee Lauder) family to a board where he'll be one of only two members without a doctorate in economics and alone in having never published even a single paper about monetary policy. I'm not saying Warsh can't rise to the job, since I don't know him (maybe he can) but this seems like a "Michael Brown" appointment that we'll only know was bad well after things go wrong.

And, with the Fed, I mean, well, well, after. Brown's shortcomings were evident just hours after Hurricane Katrina hit New Orleans. The Federal Reserve, though its members are appointed by the President, is not a political institution that only shares information about how it makes its decisions weeks and months after those decisions are not only made but implemented. One of the reasons that people don't tend to know anything about the Fed aside from its basic function and the name (and maybe, after a long time, the inclinations of) the chairman is that the Fed basically operates outside of the public's view. It's meant to be free from the influence of public sentiment and, like the Supreme Court, it basically is.

The appointment of a governor with questional qualifications also comes at an odd time for the U.S. Forgive me, but I'm about to get really geeky here -- you may or may not have heard this but we've been, for a few months now, in a situation where the yield curve of the bond markets is "inverted."

Don't fall asleep. An inverted yield curve means this: The interest charged for borrowing money on a short term basis (3 months or 3 years, for example) is actually higher than the interest charged for taking a loan of a longer duration (say, 10 or 30 years). Usually, because the longer you let a loan go unpaid the more risk you take, longer loans charge higher interest. When shorter loans charge higher interest than longer loans, it implies that traders and managers in the bond market are more afraid of the immediate economic prospects than long-term prospects.

At the moment, though short rates are higher than long, they're not higher by much. It's almost a wash. It basically costs the same to borrow money for a year that it does to borrow for 30. So rather than signalling disaster, since the rates are, though tilted towards the short side, perhaps a wash, it might just signal confusion on the part of bond traders.

The bond market has tended to be a good prognosticator of the economy, though, so confusion isn't entirely comforting.

Also, this kind of screws up the way banks make money. Why should a bank take a 30 year risk on a loan right now by extending credit so far into the future that even the smartest banker has no idea what will happen, when they can make the same amount of money on a loan due to be paid in 3 months, which is such a short amount of time that even the dumbest banker can make the easy bet that economic conditions won't be so different than they are the moment?

We have a new Fed chairman, and a slightly inverted yield curve that is an oddity, and NOW, of all times, Bush appoints an unproven rookie to the board of the Federal Reserve? It deserves far more scrutiny.