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Commentary By Nicole Gelinas

Ask Trump's Fed-Chief Pick If He's Sorry About 'Too Big to Fail'

Economics Finance

Jerome H. Powell, President Trump’s pick for Federal Reserve chairman, isn’t a Ph.D. economist. So he doesn’t have an academic philosophy of the economy.

But he does have a real-world philosophy: Powell was partly responsible for the West’s “too-big-to-fail” policy for big banks — a policy that helped cause the 2008 financial crisis and that still harms our economy.

If the Senate confirms him, Powell will replace Janet Yellen in February. His career, as a Treasury official and private lawyer and banker, has been behind the scenes, but what Powell has said about that career is illuminating.

“If the Senate confirms him, Powell will replace Janet Yellen in February.”

In 2013, he told a Washington audience of bankers he’s a veteran of bank rescues, beginning with his work at Treasury under President George H.W. Bush. He noted that he joined Treasury in 1990, “only a few years after the rescue of Continental Illinois, which is sometimes said to have codified the practice of ‘too big to fail.’ ”

Indeed. In 1984, Continental Illinois was the country’s eighth-biggest bank. When its bad investments got it in trouble, the Reagan-era Fed, Treasury and FDIC moved to protect all its bondholders, not just small depositors, from losses.

This was a huge shift — and encouraged investors to lend cheaply to big banks, figuring they were safe investments.

Powell notes that some of his career after that was spent deciding which banks were big enough to save. In 1991, for example, the Bank of New England was teetering. Given a choice between saving all of its bondholders or risking a financial panic, “We chose the first option, without dissent.”

To avoid “the failure of a large commercial bank, we chose to extend the safety net” — with no legislation or public discussion, and no thought to what it might mean for the future.

A year later, Salomon Brothers, an investment bank with dealings in Treasury bonds, “came under severe market pressure after some of its traders were caught submitting phony bids.” Powell said he’s “grateful that we resolved that crisis with neither a bailout or a failure.”

But that’s not quite right: Powell brokered a deal, as The New York Times reports: “Powell spent an August weekend making phone calls from Cape Cod, arranging for the company’s top managers to resign and for Warren Buffett . . . to become chairman.”

When a top government official hints at special treatment for a firm, it usually gets it.

These rescues created the financial-markets complacency that in turn created 2008 — which resulted in the biggest bailouts of all time. Eventually, the anger over these bailouts helped make Trump president.

In the 2013 speech, Powell said, “Bailouts may have been more tolerable in the early 1990s when they were rare,” but “that is no longer the case,” with “large and numerous bailouts as a result of the financial crisis.” Also, people started to notice.

But without the earlier bailouts, we wouldn’t have had the later ones. Warier investors never would have let financial firms get so big and take so many risks.

In Powell’s confirmation hearing, senators should focus on his views here. The Fed played a huge role in the 2008 bailouts, and would lead any future crisis, too. Does Powell think, in hindsight, the actions of decades ago were mistakes?

What does he mean by: “We need a credible mechanism to manage the failure of even the largest firms, without causing . . . a systemic crisis”?

Should Washington still protect large bondholders to prevent a crisis — and doesn’t such action make a worse crisis inevitable years later?

Powell says the government should limit extraordinary actions to “rare” occasions. But even one bailout can set a precedent — and have ripple effects. Helping Continental Illinois in 1984 helped elect Trump in 2016.

This piece originally appeared in the New York Post


Nicole Gelinas is a senior fellow at the Manhattan Institute and contributing editor at City Journal. Follow her on Twitter here.

This piece originally appeared in New York Post