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Janet Yellen and Fed Expectations

Janet Yellen, Chair, U.S. Federal Reserve Bank

Janet Yellen, Chair, U.S. Federal Reserve Bank

U.S. Federal Reserve Bank Chair, Janet Yellen

Janet Yellen became one of the world’s most powerful players when President Barack Obama appointed her Chair of the U.S. Federal Reserve Bank. As such, she carries more financial sector influence than any other civil servant in the world.

Ben Bernanke, Former Chair, U.S. Federal Reserve Bank

Ben Bernanke, Former Chair, U.S. Federal Reserve Bank

Replacing the brilliant Ben Bernanke, as Chair of the Fed, challenges the bright, able, talented  and widely respected economist. What can be expected from Janet Yellen and the Fed under her leadership?

The key questions concern continuing current Fed policy, financial stability, banking regulation issues, asset bubbles, government budgets as well as the actions of congress around budget and fiscal policy matters.

A little crisis background

To best understand our current situation and where we are going forward, we need a little background. In the years leading to September, 2008, huge international banks were permitted to use astounding amounts of leverage. This money magic found a way to massively grow both derivatives and mortgage-backed securities.

That leveraged bank activity very significantly multiplied the availability of mortgage funding and aggressively pushed it into the U.S. housing market. To put that fast growing and seemingly endless ocean of money to work, qualifications for borrowers fell to minimums.

Then pushed by greed and irrational bonus structures, qualifications were increasingly completely ignored. Ever growing amounts of easily available mortgage funds poured into the U.S. housing market.

That immense financial torrent pumped up a hugely inflationary house price bubble. U.S. house prices rapidly headed for the sky! The inevitable happened, with great financial drama, the bubble popped.

That put the dark side of massive leverage into play. It wiped out equity and rapidly shrunk economic activity. Credit froze. The entire economy teetered on the brink of a financial abyss. Collapse was possible.

The U.S. Government and Fed immediately responded with massive unprecedented intervention and multiple rounds of stimulus spending. All intended to open credit markets and get economic activity moving.

Credit transactions again started and very slowly economic activity has been steadily building. The effects of the financial crisis had quickly flashed around the world. Over 5 years later, the effects continue to linger. We continue digging out from the greatest economic downturn in 8 decades.

With that very light overview as background, we turn our attention to statements Janet Yellen has made. From her words we hope to learn what to expect. Where will the Fed head, under Janet Yellen?

Fed policy under Janet Yellen

Janet Yellen swearing in 2010

Janet Yellen swearing in 2010

In multiple statements she strongly committed to continuing the work of the Federal Open Market Committee (FOMC). The FOMC is the Fed Committee of economic experts that regularly reviews economic activity.

Importantly the FOMC also sets the Fed interest rate. That rate serves as the base of most bank rates around the world. That FOMC work also includes approving and monitoring any Quantitative Easing (QE).

QE programs continue providing massive economic stimulus. Janet Yellen has indicated these programs will continue, “I consider it imperative that we do what we can to promote a very strong recovery.”

Financial stability by Janet Yellen

Janet Yellen talks of, “ramping up and monitoring of the financial system…to detect financial stability risks” as a most important task. At this point, we do not know exactly what that means.

However, it certainly means increased monitoring of banks compared to the pre 2008 hands off regulatory environment. The 2008 financial crisis shocked and froze the international financial system. If more monitoring means avoiding future shocks, I am all for it.

Mega-bank Questions

The huge international banks and their banking and business failures were at the center of the financial crisis. We need to know the position Janet Yellen takes on this topic. How will she address questions about controlling these financial and economic behemoths?

Mega-bank regulation by Janet Yellen

Janet Yellen has said, “It’s extremely important for our banks to have more capital, higher quality capital.” That could point to decreasing the extreme leverage the huge banks used to inflate the financial crisis.

With other regulators around the world, she could take steps to more tightly control, “the most important systemically important institutions.” I think that means big banks will be required to use less leverage. We have yet to see if real changes of substance will happen.

She has said “those who failure would create financial distress, will be asked to hold more capital.” She has been reported as believing that the capital surcharge proposed for systemically important financial institutions may not be enough. That could be good news.

At least she indicated awareness of the issue and seems to consider it important. If so, should she take action we all will be better off.

Mega-bank market benefits under Janet Yellen

The huge banks have power and benefits of no other institution. “Our objective in regulation should be to put in place tough enough regulation and capital and liquidity standards that we level the playing field and make it costly.”

Hmmm…she refers to the world’s most powerful financial institutions. I am skeptical that any significant changes will happen on this front.

She said, “We should make it tougher for them to compete and encourage them to be smaller.” This I have got to see to believe! I am very skeptical but certainly would applaud any effort made to achieve this lofty goal. Again on this front, we shall see.

Oversight on all banking by Janet Yellen

Thousands of other financial institutions rank as smaller than the handful of maga-banks. These other banks also need effective oversight to make the system work. “I absolutely believe that our supervisory responsibilities are critical and they’re just as important as monetary policy. We need to take just as much time to devote to them.” Janet Yellen.

If effective, this is all good news. “We don’t want these entities to fail” Janet Yellen said, “We want to make them much more robust and less likely to come under pressure,” she said. “Then if something did happen, we would have a way to deal with it that we were not able to do during the financial crisis.”

Janet Yellen on asset bubbles

Everyone was affected by the U.S. housing asset bubble in one way or another. That makes it easy to agree with Janet Yellen saying, “No one who lived through that financial crisis would ever want to risk another one…”

She promises, “We have a variety of different tools that we can use if something like that were to occur.” We have to wait and see, but good to know that someone so able and knowledgeable is on the scene.

She remains central to the economic rescue program and remains on watch. I am inclined to give her the benefit of the doubt and expect the best.

Janet Yellen tells Congress to do their job

She has the courage to tell Congress they are blockheads, “… but some of the near term reductions in spending we have seen have certainly detracted from the momentum of the economy and from demand, making it harder for the Fed to get the economy moving, making our task more difficult.”

This bright, knowledgeable and courageous woman also has told Congress how they can help rather than hinder the economic recovery. “It certainly would be helpful going forward for deficit reduction efforts to focus on the medium term while not subtracting from the impetus we need to keep a fragile economy moving forward.”

Well, good luck with that. I hope Congress proves me wrong and actually does what is right rather than continue their primitive political games. There are very significant budget and fiscal policy issues that need adult attention.

“We are worried about a fragile economy and more supportive fiscal policy or one that creates less drag would be helpful” Janet Yellen. Congress, are any adults in the house?

I think Janet Yellen is an excellent pick and will do a great job as U.S. Federal Reserve Chair.

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