Friday’s resignation letter from Federal Reserve Governor Daniel Tarullo represents the first domino in what is likely to be a series of changes at the central bank that will afford President Trump the opportunity to substantially and rapidly alter the composition of the Fed’s Board of Governors.
To put this in context, there are seven governor slots on the Federal Reserve, which account for seven of the 12 votes on the policy-setting Federal Open Market Committee (FOMC). The other five votes are held by a rotating subset of the 12 Federal Reserve Bank presidents.
{mosads}The regional Federal Reserve Banks choose their own presidents, with some input from the Board of Governors, so that the political influence on these positions is limited. In contrast, the Federal Reserve Board positions are nominated by the president and confirmed by Senate.
President Trump walked into office with an opportunity to fill two open Fed Board positions. Ironically, these slots were open in part because of Governor Tarullo. Dodd-Frank legislation created a new position on the Fed Board, vice chair for supervision. However, President Obama never formally nominated anyone for that spot.
Tarullo, who had effectively already taken on that role when he joined the Board in 2009 (i.e. before Dodd-Frank created the position), has continued to be the Fed’s point person on financial regulation. It is unclear why President Obama failed to nominate Tarullo to formally fill the role, though perhaps the Republican majority in the Senate had privately objected to Tarullo and/or signaled that he would not be confirmed.
In any case, Obama did nominate candidates for the two open Board spots, but Senate Republicans declared that they would not begin the confirmation process for those spots until a supervision vice chair was named, resulting in a standoff that left the Fed shorthanded for an extended period of time.
Sources in the Trump administration have signaled to the media that the president would use one of the two current openings to name a vice chair for supervision. If and when that person was confirmed, Governor Tarullo would effectively be demoted, a fact that led to rampant speculation that he would step down at some point this year. As it happens, his resignation occurred earlier than expected, even before the administration has named his de facto replacement.
Tarullo was known as a tough overseer of the banking system, projecting little sympathy for the suggestions and objections of the regulated entities as the Fed set about to write the regulations that would determine the outcomes of Dodd-Frank. Not surprisingly, the Trump administration is expected to appoint a supervision vice chair who will probably be more open to give-and-take with the financial firms being regulated.
I would expect the basics of the main changes to financial regulation since the crisis, most notably the push for stronger capital standards, to remain in place. However, a new regime may employ more flexibility and, in particular, may call for greater sensitivity to the ways that regulation may have gone too far, such as creating excessive compliance burdens and discouraging lending that is not excessively risky but helps generate economic growth.
Tarullo’s departure will create a third Board opening for President Trump and mark a major shift in the way that financial regulations interface with the financial system. Monetary policy will likely undergo a similar transformation. In addition to the three slots that can be filled soon, Chairperson Janet Yellen’s term on the Board of Governors ends Jan. 31, 2018, and Vice Chair Stanley Fischer’s term ends next June.
In theory, either or both could stay on as a governor after their leadership roles are over, but such a move would be highly unusual and both of them are in their 70s and likely to retire. That means that President Trump will probably be afforded the chance to name at least five of the seven Fed Board governors within the first 18 months of his term.
President Obama assembled a Federal Reserve Board that was probably more in favor of easy money (“dovish” in the parlance of Fed watching) than any Board in the modern history of the Fed. It is premature to conclude that President Trump would swing to the other extreme and nominate hard money (or “hawkish”) policymakers.
However, I do believe that the Board, in a few years, will look very different than what became the norm over the past eight years. Expect the central bank to shift from an institution run by academic economists and regulators to one led by businesspeople and bankers, i.e., a shift toward real-world private sector experience, a change that would mirror President Trump’s own experience and his record so far in filling key roles within his administration.
Stephen Stanley is the chief economist for Amherst Pierpont. He is a frequent guest on CNBC and Bloomberg TV programming.
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