Warsh's Departure May Reduce Fed’s Insights Into Wall Street

Friday, 11 Feb 2011 07:20 AM

 

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Federal Reserve Governor Kevin Warsh’s departure may reduce the Wall Street intelligence that Chairman Ben S. Bernanke gathers as he weighs policy options following record easing, former central bank officials said.

Warsh, 40, resigned yesterday effective around March 31, opening a second vacancy on the Fed’s Board of Governors. Bernanke, who relied on Warsh as a close adviser, may depend more for insights about markets on New York Fed officials including President William Dudley, said Vincent Reinhart, a former Fed monetary-affairs director.

Warsh was the only governor to work on Wall Street and the only one to question the benefits of the Fed’s plan to buy $600 billion in Treasury securities. Without Warsh’s connections, Bernanke may face greater odds of erring as he drains an unprecedented amount reserves from the banking system, said Stephen Stanley, a former Fed economist.

“Unless they put someone in place who has a similar level of dialogue, I think that’s something that will probably be missed,” said Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. “To the extent that a lot of this is probably going to be trial and error anyway, it may just make the process a little rougher.” That may increase volatility in the bond market, Stanley said.

Warsh, a former Morgan Stanley investment banker who was the youngest-ever Fed governor when he was appointed by then- President George W. Bush in 2006, submitted his resignation yesterday to President Barack Obama.

Five-Year Term

Separately, Dudley will probably be reappointed to a five- year term starting March 1, a person familiar with the matter said yesterday. He was named New York Fed chief in January 2009 to finish the term of Timothy F. Geithner, who became Treasury Secretary. The board of the regional bank appoints presidents to five-year terms, subject to approval by the Board of Governors in Washington.

His departure may give Bernanke a stronger hand to complete or potentially expand the $600 billion in Treasury purchases through June. Dudley, by contrast, has been one of the stimulus’s strongest supporters.

“You lose a forceful internal advocate for ending QE and trying to renormalize policy quicker,” said Reinhart, referring to the stimulus program known as quantitative easing.

The move also “deepens the void” in financial-markets expertise at the Board of Governors after former Vice Chairman Donald Kohn, a 40-year central bank veteran, left in September, said Reinhart, a scholar at the American Enterprise Institute in Washington.

Second Vacancy

Warsh’s term would have run through January 2018; most Fed governors don’t serve out their full terms. His resignation opens a second vacancy on the seven-member Board of Governors and leaves Elizabeth Duke, a former community banker, as the only governor not appointed or reappointed by Obama.

Duke’s term expires in January 2012, and she can stay after that until a replacement is appointed. Obama’s nomination of Peter Diamond, a Nobel Prize-winning economist from the Massachusetts Institute of Technology, is pending in the Senate again after failing last year.

“Contact with markets, knowing what markets think is very important for Fed policy,” former Fed Governor Lyle Gramley said. “Kevin had very close contact with Wall Street. It would be nice if they appointed somebody that brought that kind of connection with Wall Street to the board.”

Supervisory Chief

The White House also must designate a Fed governor to be a second vice chairman in charge of supervision, as required by last year’s Dodd-Frank Act overhauling financial regulation. It has two other regulatory vacancies in the chiefs of the Office of the Comptroller of the Currency and the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac.

“I am honored to have served at a time of great consequence,” Warsh, who never dissented from a Federal Open Market Committee decision, said in his resignation letter. Bernanke said in a statement that Warsh’s “intimate knowledge of financial markets and institutions proved invaluable during the recent crisis.”

Warsh is still on good terms with Bernanke and is leaving because he sees it as the right time with an improving economy and not because of a policy dispute, said another person familiar with the matter who spoke on condition of anonymity. He’s likely to return to the private sector.

Adviser on Fannie Mae

After graduating from Stanford University, Warsh earned a law degree from Harvard University but never practiced, opting instead to join Morgan Stanley in New York, where he worked in the mergers and acquisitions department from 1995 to 2002. He then joined the White House, advising on policies including Fannie and Freddie, the government-chartered home-finance companies.

Warsh was an architect of the terms the Treasury dictated to nine of the biggest U.S. banks in October 2008 in return for a $125 billion injection of government funds. He played a central role in negotiating the sale of the ailing Wachovia Corp., mediating a takeover fight that erupted between Citigroup Inc. and Wells Fargo & Co.

In January 2009, Warsh was passed over for the presidency of the New York Fed in favor of Dudley, a former Goldman Sachs Group Inc. economist and leading advocate of the Fed’s stimulus, dubbed QE2 by investors for a second round of quantitative easing.

Fed Operations

Warsh has served as the Fed’s representative to the Group of 20 and the Board of Governors’ emissary to emerging and advanced economies in Asia. He also managed Fed operations and personnel as the governor assigned to administration.

Warsh staked out an anti-inflation stance on monetary policy in September 2009, when he published a Wall Street Journal opinion piece and gave a speech saying the Fed may need to raise interest rates with “greater force” than it has in the past. In June, he said any decision to expand the $2.3 trillion balance sheet must be subject to “strict scrutiny.”

On Nov. 8, he said in a speech and opinion piece that the Fed’s Treasury buying “poses nontrivial risks” even after he voted to support the stimulus. He hasn’t publicly discussed his views on the purchases since November and backed the policy at the Fed’s subsequent meetings in December and January.

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