Correction to This Article
This article referred to the Commodity Futures Trading Commission as the Commodities Futures Trading Commission.

Obama Takes First Shot at Reshaping Fed by Naming Board Member

By Neil Irwin
Washington Post Staff Writer
Friday, December 19, 2008

President-elect Barack Obama has an unusual opportunity to remake the Federal Reserve in the early part of his presidency, shaping the institution at a time that it is undergoing dramatic change.

Obama said yesterday that he will name Daniel K. Tarullo, a law professor and banking regulation expert, to the Fed's Board of Governors. Because of current expired terms, Obama can appoint two more governors, subject to confirmation by the Senate.

Then in January 2010, Obama can either reappoint or replace Chairman Ben S. Bernanke when his term expires and make the same decision about Vice Chairman Donald L. Kohn when his term ends in June of that year. Fed governors serve a 14-year term, though in practice most leave after a few years.

Thus within 18 months of taking office, Obama will likely have appointed five of the seven Fed governors. The central bank is designed to be independent from politics, so a president's best chance of influencing how the Fed will regulate banks or respond to economic changes is through these appointments.

Tarullo, a Georgetown University law professor and top aide to former President Bill Clinton on international economic matters, has been generally skeptical of key parts of the Basel II international standards for bank regulation, arguing that the approach needs to be changed in major ways to prevent financial crisis like the one underway. As a Fed governor, Tarullo would have a place at the table to reshape international bank regulations according to that philosophy.

At a news conference yesterday, Obama also named Mary L. Schapiro, a former member of the Securities and Exchange Commission, to chair that body, and Gary Gensler, a Treasury undersecretary in the Clinton administration, to chair the Commodities Futures Trading Commission.

Obama, in announcing the picks, said that the overhaul of financial regulation will be "one of the top legislative priorities" of his administration. "We have been asleep at the switch," he said, referring to the SEC, other financial regulators and Congress. He declined to offer details of the overhaul.

The Obama administration will come to power at a time when the Fed is taking on vast new responsibilities. Just this week, the central bank signaled that it will take more unconventional steps to stimulate lending. Now the primary regulator of almost every major financial firm, the Fed also could be given new powers to oversee any company that is big enough to pose a systemic risk to the financial system.

"The Fed needs to be thinking about both the overall strategy of regulation, and what role the Fed itself should play in implementing that strategy," said Marvin Goodfriend, an economist at Carnegie Mellon University. The Fed's structure is designed to insulate its leaders from politics. The president has no direct authority over governors once they take office. Obama has told Bernanke that he will maintain the recent tradition of respecting the Fed's independence and not trying to arm-twist the bank on its interest rate policies.

But in choosing whom to appoint to the Fed's board of governors, and especially to the chairmanship, a president has considerable power to shape the approach the central bank will take to major policy decisions. The most frequent lines of disagreement among Fed officials in the past have been over whether, at any given time, inflation or growth is the greatest risk. Obama could choose nominees whose theories about the risks facing the economy match his own.

For example, President Clinton named Fed governors who were open to the premise that technological innovation in the 1990s enabled the economy to grow faster than it had in the past without sparking inflation. That gave then-chairman Alan Greenspan latitude to allow strong growth to continue instead of trying to choke it off with rate increases.

At the moment, the biggest concerns are how the Fed should respond to the financial crisis and, eventually, whether and how to remove some of the unprecedented lending programs it has launched.

"The Fed's immediate challenge is to stop the hemorrhaging of the economy and stabilize the patient," said Peter Hooper, a former Fed official who is now the chief economist at Deutsche Bank Securities. "Next, it will face a huge challenge in picking up the timing of exiting from this very aggressive foray into unconventional policies."

If it moves too fast in eliminating the programs, the Fed could stoke a return and deepening of the financial crisis. If it doesn't draw them down quickly enough, it could stoke inflation.

The biggest Fed-related decision Obama must make in his first year as president is whom to appoint chairman when Bernanke's term ends in January 2010. Bernanke has won praise from Democrats in Congress for being pragmatic, responding aggressively and creatively to the financial crisis, and working to build consensus.

But there are strikes against him. In his first 18 months as chairman, he did not see the crisis looming and then had a relatively reserved response in its initial months. Moreover, it may be politically difficult to reappoint a Fed chairman if the economy is still in the dumps.

Fed watchers say former Treasury secretary Lawrence H. Summers would be a leading contender to replace Bernanke if Obama seeks a new chairman. Summers, who will be working closely with the president as director of the White House National Economic Council, is an accomplished academic economist with financial market experience. In a series of newspaper articles during the first months of the financial crisis, he advocated a government response that was more activist than that embraced by Bernanke at the time.

But Summers's often combative style might not sit well at the Fed, where decisions are traditionally made by consensus. According to Fed observers, other candidates for chairman could include Janet Yellen, president of the Federal Reserve Bank of San Francisco and a former official in the Clinton administration; Timothy F. Geithner, the New York Fed president whom Obama plans to nominate as Treasury secretary; and Christina Romer, a highly regarded economist who is to be chairman of the Council of Economic Advisers.

© 2008 The Washington Post Company