Most of the commentary about Janet Yellen, President Obama's historic choice to lead the Federal Reserve, is focused on her views about controlling inflation and unemployment, the Fed's twin mandate. (And here, promisingly, the "dovish" Yellen has said clearly that she is more concerned about unemployment, which is a huge problem, than she is about inflation, which presently is not.)
But another huge part of the Fed's job, especially since the 2008 financial crisis, is re-regulation of the banking system and Wall Street, where Yellen will finish the task that Ben Bernanke started. And here, too, while her track record is not quite as pronounced as it is on monetary policy, she is expected to be very aggressive in reining in risky practices. Yellen, who is almost certain to be confirmed by the Senate, may turn out to be even bolder in her prescriptions than Bernanke or the Obama administration have been, according to officials who have watched Yellen from the inside of the Fed during her three years as vice chairman.
For now, Wall Street is reacting mostly favorably to Yellen's long-anticipated appointment, thanks to her dovish views on inflation and the likelihood that she will not support "tapering" off Bernanke's quantitative easing program, so as to spike the economy's still-tepid growth and ease long-term unemployment.
But the banking community may not quite know what it is getting.
Yellen's views are considered very close to those of Daniel Tarullo, a progressive-leaning Fed governor and expert on global financial regulation whom Bernanke has deputized to oversee new banking and capital standards. In her public remarks, Yellen has echoed Tarullo's push for higher capital standards for "systemically important" or too-big-to-fail banks, and his concerns about curtailing the unstable short-term funding sources of too-big-to-fail banks. Tarullo has been more aggressive than the Obama administration in proposing "a set of complementary policy measures" that goes beyond the Dodd-Frank law. Among them: limiting the expansion of big banks by restricting the funding they get from sources other than traditional federally insured deposits.
Yellen, in an important speech in Shanghai, China in June, went beyond what Bernanke has said by explicitly endorsing some of Tarullo's efforts, saying, "I'm not convinced that the existing SIFI [systemically important financial institutions] regulatory work plan, which moves in the right direction, goes far enough." She also spoke of doing much more, as Tarullo has, to constrain the "shadow banking" sector that caused so much trouble in 2008, including broker-dealers and money market funds. Yellen said "a major source of unaddressed risk" is the hundreds of billions of dollars of short-term securities financing used by these firms, adding: "Regulatory reform mostly passed over these transactions."
Michael Greenberger, a former deputy director of the Commodity Futures Trading Commission and a leading voice for more transparent regulation of derivatives and other arcane Wall Street products, says that Yellen backed his stand for a tougher Dodd-Frank law than the Obama administration, Senate, and House were advocating back in 2010—a time when a fierce fight raged over the historic legislation to reorder the financial system. "I told her about weaknesses in the then existing Senate draft bills and the House bill. She was clearly sympathetic to my concerns, which, in turn, were a reflection of progressive legislative advocacy at that time," Greenberger said this week, recalling a talk he and Yellen had at the so-called Minsky conference in New York, where she gave the keynote address (noteworthy in itself, given that it is named for the late economist Hyman Minsky, who presciently described how financial markets are inherently unstable). Adds Greenberger: "The Obama Administration was not being particularly helpful about these substantive concerns. Compared to the powers that be at that time on the Hill and at the White house, she was a breath of fresh air."
Yellen is thus likely to continue a distinguished line of female regulators who have demonstrated a striking degree of vision, courage and integrity in taking on one of the most chauvinistic of industries, Wall Street. Among her predecessors and peers: new Massachusetts Sen. Elizabeth Warren, who has used her position on the Banking Committee to dress down Wall Street CEOs and the prosecutors who have failed to go after them; Sheila Bair, the former chairwoman of the Federal Deposit Insurance Corp. who angered then-Treasury Secretary Tim Geithner by pushing for harsher treatment of banks during Obama's first term; retired regulator Brooksley Born, who like Bair ran up against accusations that she wasn't a "team player" in the old boys' club when she sought to rein in over-the-counter derivatives trading back in the 1990s; and most recently Mary Jo White, the no-nonsense head of the SEC who has warned she's going to crack down much harder on Wall Street fraud.
Yellen, a former economist at the University of California at Berkeley, has a notable pedigree of skepticism about Wall Street's proclivities: A student of arch-market-interventionist James Tobin at Yale—who famously proposed a tax on financial transactions—she is also the wife and writing partner of George Akerlof, who shared the 2001 Nobel Prize in economics with Joseph Stiglitz for work that showed how markets can fail thanks to imperfect information. As such, she is likely to be even tougher than Bernanke, a former free-marketer and Republican nominee who changed his views somewhat after 2008 and has since turned the Fed into a major interventionist force in the economy.
The late Tobin and Akerlof fought career-long battles to make the case that financial markets work differently, and are more inherently prone to failure, than ordinary markets in goods and services. Their work has tended to back the prescription of John Maynard Keynes, as far back as the Bretton Woods conference in 1944, that "nothing is more certain than that the movement of capital funds must be regulated." In a 2010 interview, Akerlof said he "was always apoplectic" at the kind of rapid deregulation advocated by Harvard economist Larry Summers, who almost certainly would have been nominated in Yellen's place had he not backed out last month—in particular, the abrupt opening up of capital flows around the world, which has arguably led to financial bubbles in one economy after another.
While Yellen did not always act on regulation when needed—claiming that as head of the San Francisco Fed she had to wait on Washington's guidance—the record shows that she appeared to be somewhat ahead of Bernanke in appreciating the dangers of the securitization-led housing bubble. At the Fed's June 2007 she warned that the failing housing sector was the "600-pound gorilla in the room." That was only a month after Bernanke, in congressional testimony, said he saw only a "limited impact of subprime mortgages on "the broader housing market."
Yet Yellen also offered up a refreshing mea culpa after the financial collapse, telling the Financial Crisis Inquiry Commission in 2010 that she "did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.'s [structured investment vehicles]— I didn't see any of that coming until it happened."
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