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Fed's on thin ice in a Trump administration, expert says
MARKETWATCH 9:32 AM ET 3/13/2017
President may hold fire over looming rate hike, but may not forever

Don't blame the Federal Reserve if it looks jittery these days.

The U.S. central bank is holding its breath waiting for a tweetstorm from President Donald Trump they are sure is coming.

Fed Chairwoman Janet Yellen has decided to pick up the pace of interest rate hikes this year, and some Republicans are already muttering darkly that the Fed seemed perfectly happy to hold interest rates low for President Obama but seem unwilling to continue the favorable treatment now that the GOP has recaptured the White House.

Sarah Binder, a professor of political science and George Washington University and a senior fellow at the Brookings Institution, says that Trump is more likely to pounce if the economy deteriorates than now.

Another open question is whether Republicans will cease their endless campaign to tie the Fed's hands now that Trump can place his nominees at the central bank, Binder said. The Trump White House has three of seven vacancies at the Fed board of governors that can be filled in the near future. And Yellen has less than one year left as chairwoman.

Hard money economists, left out of the Fed's inner circle during the Obama years, have been angling for positions at the Fed but may be disappointed, Binder said.

Binder is an expert on how Congress has revamped the central bank's powers since it was founded in 1913. Her new book, "The Myth of Independence, How Congress Governs the Federal Reserve," co-written with hedge fund owner Mark Spindel, will be released in August.

MarketWatch: The Fed is set to raise interest rates and pick up the pace of tightening this year. How will Trump react?

Binder: My sense is the Fed is wondering whether another shoe going to drop, right? Early on in the campaign, Trump probably showed his true self, when he said he was a 'low-rates type-of-guy.' (http://www.marketwatch.com/story/low- interest-rate-trump-wants-to-replace-yellen-refinance-us-debt-2016-05-05) That would be consistent with most presidents who want to juice the economy, particularly for a president who said he wants 4%-5% growth. That contrasts quite a bit with his attack on Yellen as the campaign heated up in the fall, saying she should be ashamed of herself for keeping her thumb on the scale for Clinton, trying to juice the economy. That seemed out of character but it's hard to know.

How does Trump react given that everybody expects the Fed to start to raise rates next week? My sense is, on the question of rates and monetary policy generally, it is an open question whether Trump reacts, how he reacts and whether it comes out as an attack on the Fed, or whether his advisers can kind-of hem him in.

MarketWatch: Already there are mutterings from the GOP that the Fed is going to take away the punchbowl under Trump but it didn't under Obama. Would that criticism stick only if the economy falters?

Binder: If they are able to take away the punch bowl without any bumps that would probably be unusual for them to be able to pull that off. So I think it depends if they are to do it without having disruptions in the economy. How do markets react, both stock and bond prices? And also Congress, how do they react? Are there signals coming from Capitol Hill that Trump wants to pick up on? It might be kind of quiet, but the moment that the economy turns down, my guess is Trump will be eager to blame somebody for it.

MarketWatch: Because of those promises of robust growth rates

Binder: Those demands, those expectations, those promises, about growth, which are certainly out of sync with what Congressional Budget Office and the Fed predict.

MarketWatch: So, the Fed is on thin ice?

Binder: I think that is probably a good way to think about it.

MarketWatch: There are a lot of vacancies on the Fed. Doesn't Trump have a chance to put his imprint on the central bank right away?

Binder: First there is the ever-vacant vice chair for supervision which there have been rumblings about but no nominee. Then are two other Fed vacancies. And then of course, in advance of January, Trump will have to think about whether or not to ask Yellen to stay on or whether to replace her. And that's all subject to the Senate finding time on its agenda to actually take up nominees.

MarketWatch: What are the odds that he asks Yellen to stay for another term?

Binder: It seems more likely Trump finds someone he perceives as "on his team." And rather than someone in academia, I think he'll pick someone with experience in the real economy. That's my guess. But he's unpredictable.

MarketWatch: So what will the Trump Fed look like?

Binder: Well, on the one hand, it may be a lot less dovish because he is going to look for people who don't look like Yellen. But on the other hand, there is not a track record of presidents appointing a lot of hawks to the Fed. Bernanke was certainly not a hawk.

MarketWatch: But Republicans in Congress have relied on hard-money economists.

Binder: Well, the Republicans were pretty hard-money when it was an Obama-appointed Fed. They don't have much say in nominations.

MarketWatch: But these economists are hoping to be tapped.

Binder: That is the question. Is that what Trump is looking for? You can imagine a nominee who looks like a classic Republican Fed nominee, those who are more hawkish, the John Taylors of the world. That would certainly be one type. There is not a lot of evidence that that is the type of economic person that Trump is drawn to. Think about Gary Cohn, his top economic adviser. The Treasury Secretary post has gone to someone from finance. You could easily imagine Trump wanting somebody who is well grounded in the real economy, not in monetary economics. That would discount the John Taylors of the world and be more in favor of somebody who has got industry experience. That would be my guess given his background. Trump doesn't seem to glom onto experts, any academic experts.

MarketWatch: So a top businessman, not even an economist? For Fed Chairman?

Binder: Not an economist. For Yellen's job or the supervision job. Early on in the campaign, Trump was listening to Judy Shelton, who seems to be a gold bug. One never knows with Trump, but my sense is given the other names that have been floated like Paul Atkins, and David Nason, these are all business people, some with government experience, some without. [Editor's note: Nason has withdrawn from consideration (http://www.marketwatch.com/story/ges-nason-a-front- runner-for-fed-post-drops-out-reports-2017-03-08).] That seems more in the line with what Trump seems to be comfortable with. Now, whether they are naturally more hawkish or more dovish, it is hard to tell. They may have a far lighter touch on regulation and supervision. That may be what Trump cares about. It may be he is looking for somebody to do their part to put a weak supervisory touch on the New York banks.

MarketWatch: Could they get rid of the stress tests?

Binder: They could do that. They could give away the recipe to the stress test that everyone seems to want to know how to perform well on the test. Make it open-book. How do you adjust that to the extent that you are not getting tough pushback from the Hill. You may get tough pushback from the Elizabeth Warrens of the world or even from the Richard Shelbys of the world, who doesn't like Dodd-Frank but didn't like how banks were supervised before.

MarketWatch: Could the Fed even get out of the supervisory game?

Binder: My sense is central bankers want to keep both. At least that was Bernanke's argument. That they do a better job at monetary policy if they know what's going on. Now maybe institutions don't like to lose turf. Conceptually, there were efforts to consolidate supervisory regulatory policy during Dodd-Frank, but it seems like a tough legislative thing to do.

MarketWatch: Douglas Holtz-Eakin, a Republican economist, said the Fed's independence will always be threatened as long as the Fed oversees banks. Congress is the natural court of appeals for the regulated. So the Fed's independence will always be insecure. What do you think?

Binder: At least based on past patterns in the wake of the financial crisis, the Fed gets hit from both sides. They get hits by Republicans for having too loose monetary policy and being too tough on the banks. And on the other side, you have Democrats encouraging them to stay loose on monetary policy and toughen up oversight of the banks. It probably is a no-win situation. You're going to get hit by both sides at least on one issue. If the economy started really booming and taking off, my hunch is lawmakers will find other things to think about, right, they are more likely to hone in and blame the Fed when they need somebody to blame for a bad economy. But lawmakers don't typically pay a lot of attention to the Fed when things are going well. The economy doesn't seem to be booming, it seems to be tepid.

MarketWatch: Republicans tried unsuccessfully to reform the Fed during Obama's eight years.

Binder: The one little thing that they got was that one seat on the Fed's board had to be reserved for a community banker. They snuck that by.

MarketWatch: Surely now they control the executive branch and two houses of Congress they will try again?

Binder: The question for me, which I don't have the answer to, is whether Republicans stop complaining about monetary policy and reigning in Fed discretion as Trump points appointees on the Fed. Do Republicans become perfectly fine with the degree of discretion the Fed holds? And do they give up their push for the audit. Did they want the audit more when the Fed is filled with Obama nominees or are they principled about wanting more transparency?

The House seems intent on Dodd Frank, repeal and their measure seems to include all the measures restraining the Fed from the last Congress. That is the audit, and imposing a monetary policy rule, probably making transcripts available more quickly, more staff for the governors and possibly rearrange the voting rules on the FOMC to give all 12 regional bank presidents a vote every time. In general, a move for more transparency and sort-of decentralizing power as opposed to concentrating power on the board. I could easily see the House finding time and ambition to do that.

The Senate -- [Mike] Crapo, the new chairman of the Banking Committee, doesn't seem terribly interested. He seems a little more interested in the supervisory side, FSOC and dealing with community banks. At least by reputation, he's a little more temperamentally bipartisan. At least more so than Shelby who was willing to push a Fed reform bill through that had no Democratic votes. I don't know. Perhaps Crapo's reluctance on Fed legislation so far is that he wants to concentrate on things where he can get Democratic support. But even if he were to pursue a partisan bill through the banking committee, he would never get 60 votes for anything that really took the Fed to task, I don't think. Certainly on imposing any type of constraint on the Fed's discretion. Democrats don't seem very into that. Will they be more into that if there is a Trump nominee at the head of the Fed? For now, with an Obama Fed in place, they don't seem terribly eager to change the rules of the game.

MarketWatch: I was wondering if defending the Fed is a winning political stance for Democrats.

Binder: Democrats do get pressure from the left, the sort of Fed-Up crowd. But if even the most dovish governors vote to raise rates in March, that leftist critique of the Fed is going to be harder to get buy-in from Senate Democrats, because they will look to Yellen, they will look to Brainard, to Tarullo and if they are raising rates, it is not a good sign for their anti-rate hike campaign. The other part of that campaign is about diversifying the makeup of the Fed. My guess is that movement continues but once you have eventually have Trump nominees on the Fed, they could be far less amenable to making a difference. I don't know the current board under Yellen or Bernanke was terribly activist on encouraging the reserve banks to go for a more diverse set of directors or presidents.

MarketWatch: So comprehensive reform of the Fed is off the table?

Binder: We don't have too many episodes of Fed reform, but when they happen, they are always pretty immediately, a year or two, three four at tops, in the wake of crisis that creates the opening. Usually with unified Democratic control. We have a couple episodes of Republicans reforming the Fed but you have got to go back to the 1920s. I think Dodd Frank was the time for reform of the Fed and they did a little bit of it, but I think the window's closed unless there is some scandal or generates attention on both sides of the aisle.

-Greg Robb; 415-439-6400; [e-mail]


(END) Dow Jones Newswires
03-13-170932ET
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