With Larry Summers's withdrawal from the race to be the next chairman of the Federal Reserve, there's new attention on the remaining candidates: Janet Yellen, the likely front-runner, and the third person President Obama has mentioned, former vice chair turned Brookings Institution scholar Donald Kohn.
Conveniently for us, Kohn had a previously scheduled appearance at a Brookings seminar Monday, where he dropped a few clues about where he thinks efforts at financial repair and regulation stand. Bottom line: He may be open to some experimentation, but is not terribly hopeful that the system can be completely fixed.
The overall topic was “Making Macroprudential Policy Work,” an unspeakably dry way of asking whether bureaucrats should bust market bubbles – i.e. keep your house or portfolio from getting too valuable on the upswing in hopes of preventing a complete crash on the way down. It’s a bit of market and social engineering that has come into vogue in financial regulatory circles since the Lehman collapse, though no one’s quite sure what it means in practice or how quite to apply it.
Some takeaways from Kohn:
The jury is still out on Dodd-Frank. He appears not to be convinced that the set of institutions and laws set up since the crisis are the ones the country needs. “There jury is still out whether there are sufficient tools” to avoid another crisis, Kohn said. He avoided giving any details on what changes he might advocate.
There are still some big holes in financial regulation. In specific cases, such as the rules governing money market mutual funds, Kohn regards the country’s response as “discouraging” and “not as strong” as needed to promote financial stability.
Regulators should have a spirit of experimentation. The crash of five years ago warrants a lot of work looking at new approaches to regulation, of the sort that the International Monetary Fund, international regulatory groups and others are advocating. Some of the ideas have clear cost-benefit tradeoffs – anytime regulators intervene or lean against a market they risk destroying more value in the present than they save by avoiding future problems. But this was “the deepest recession since the Great Depression … the cost of not doing something and allowing this to build up are huge.”
Regulators should know what they don't know. At the end of the day, Kohn is “not very optimistic” about finding all the subtle links and dependencies among different parts of the financial system that may be needed to better smooth out credit and asset cycles.