By Simon Johnson
Throughout the Federal Reserve's 100-year history, the Senate has generally deferred to the president's choice of leader for the central bank. If Larry Summers is picked for the job, however, the debate around his nomination would be unlike any that has come before.
For reasons that make a great deal of political sense, some Republicans and more Democrats will resist the nomination. Such a roll of the dice by the Barack Obama administration could have short-term unsettling consequences for financial markets. Over time, whatever the outcome, the Summers nomination process will be viewed as a lesson in why and how American democracy works.
Democrats have major concerns about Summers' record on regulation, in particular his role in deregulation in the 1990s, his defense of "free markets" in the 2000s and his refusal to fully remove implicit subsidies for very large financial companies during the Dodd-Frank legislative process in 2009-2010.
Special: How to make your first million!
There is a general perception that, if Summers is confirmed, the regulatory debate would somehow be closed. Anyone who holds this view hasn't studied the Federal Reserve Act or thought much about the way in which the Fed chairman must operate in the political sphere.
By putting pressure on the Summers nomination, Democratic senators such as Sherrod Brown of Ohio, Jeff Merkley of Oregon and Elizabeth Warren of Massachusetts would be able to make broader points about the need for stronger regulation. If Summers was rejected, Fed Vice Chairman Janet Yellen would be an outstanding pick.
If Summers does get the job, a bruising confirmation fight would embolden his critics to put even more effective pressure on the Fed as it tackles a wide range of regulatory initiatives in the coming years.
The many smart Republicans on the Senate Banking Committee understand this, too. Sen. Richard Shelby of Alabama, the panel's former chairman and ranking member, voted against the reconfirmation of Ben Bernanke (a Republican) in 2010, and against some of the deregulation championed by then-Treasury Secretary Summers in 1999. Mike Crapo of Idaho, now the ranking Republican on the committee, also voted against Bernanke. How likely are they to support Summers, a Democrat, particularly given their broader concerns about his views on macroeconomic policy?
Sen. David Vitter, a Louisiana Republican, is co-author, with Brown, of legislation that proposes to increase capital requirements for any financial institution that could be "too big to fail." Achieving that goal requires a great deal of pressure to be brought on the Fed. Win, lose or draw, the Summers nomination is perfect for this purpose.
Confirmation hearings can cover a lot of ground, but they tend to end up focusing on specific issues. For example, Summers will almost certainly be asked to describe his current thinking on the abilities and career possibilities of women (comments he made on this subject in 2005 cost him his position as president of Harvard University).
But even more attention may be drawn to the former Treasury secretary's relationship with Citigroup Inc., for which he has worked as a consultant since at least 2012.
Criticism from right and left will naturally coalesce around this point. Citigroup was at the center of what went wrong with the financial system in the years leading to the 2007 crisis. The cozy relationship between then-Chief Executive Officer Vikram Pandit and Tim Geithner, as head of the New York Fed and then as Treasury secretary, has attracted a lot of negative attention, and for good reason. The bank was bailed out on very generous terms in both 2008 (under President George W. Bush) and in 2009 (on President Obama's watch), because many top officials worried that its collapse would crater the economy.
There are two entirely reasonable, specific questions that must be answered. First, how much has Citigroup paid Summers? Any number above $200,000 will grab national attention.
Second, Summers should be asked what he would do as Fed chairman if Citigroup were to face again the kind of difficulties it encountered in 2007 and 2008. Would he want to apply the resolution powers created by Dodd-Frank and are now under development by the Federal Deposit Insurance Corp., which are intended to impose losses on creditors? (I'm a member of the FDIC's systemic resolution advisory committee, but I'm not involved in drawing up or implementing these rules.) Or would he side again with the view championed by Geithner in 2008 and 2009 that Citigroup's shareholders and creditors must be protected at all costs?
Peggy Noonan and George Will have both argued brilliantly that crony capitalism and too big to fail financial institutions are a potentially large political liability for the Democrats. The Summers nomination would be a golden opportunity for a Republican politician to take up this point on the national stage.
The big political win for the Republicans would be to tarnish Summers as being too close to the big banks. Once that stamp is on his record, they have nothing to lose if he becomes Fed chairman. And the only way to get the message across is to vote against him in committee and on the Senate floor.
In 2010, Bernanke received the most lukewarm support of any Fed chairman when he was reconfirmed by a vote of 70-30. Paul Volcker was reconfirmed in 1983 by a vote of 84-16. Summers may struggle to match even Bernanke's level of support.
Some feel that such an expression of Senate disfavor would undermine the credibility of the Fed, including its political independence. But this autonomy is based ultimately on its legitimacy. In other words: Do Congress and the public understand and believe in what the central bank is doing?
The Summers hearing will bring much more scrutiny to Fed thinking, as well as to the way it works with the administration and big political donors such as large banks. More transparency, including on how regulatory decisions are made, ultimately will benefit U.S. democracy.
Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is co-author of "White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You."
© Copyright 2021 Bloomberg News. All rights reserved.