WASHINGTON -- Leading Democrats are struggling with the idea that President Barack Obama may actually nominate economist Larry Summers to head the Federal Reserve. If he does, he'd pass over Fed Vice Chair Janet Yellen, who saw the warning signs of the 2008 financial collapse, for Summers, whose deregulatory advocacy as treasury secretary contributed to it.
Summers' critics typically cite his role in the 1999 repeal of Glass-Steagall financial regulations and the 2000 deregulation of the derivatives market as key contributors to the financial collapse of 2008. But Yellen accurately read signs of bank trouble before the crash, when she served as president of the San Francisco Federal Reserve.
"She's steady, she's been right and she hasn't ignored the real economy and the role of employment," former Rep. Tom Perriello (D-Va.), now president of the Center for American Progress Action Fund, said Wednesday. "The reputation she has is as someone who has certainly been more interested in the full employment side of the mission than just the anti-inflationary side." Yellen pushed for transparency at the Fed before it was popular and ate with fellow workers in the cafeteria, Perriello noted.
Yellen's ability to spot the problems on Wall Street, and Summers' failure to foresee the consequence of deregulation, both flow from the perspectives they have as economists. Yellen looks first at what's known as the "real economy" -- unemployment, wage growth, housing, and other gauges of how real people are faring. Summers, for most of his career, has been oriented toward Wall Street. Faith that Wall Street could regulate itself led Summers to press for some of the most sweeping reforms of financial regulations, including the final repeal of Glass-Steagall, a Depression-era law that barred banks from gambling with federally backed dollars. Following his time at Treasury, Summers went to Harvard, where a complex investment strategy he created lost billions just as Yellen was warning that complex financial instruments had become a threat to the real economy.
Yellen "has the experience, the temperament and the intellect to be the next Fed chair," Sen. Barbara Boxer (D-Calif.) said, a pointed endorsement given Summers' checkered past with women.
If Yellen isn't passed over for Summers, she would be the first woman to lead the Fed. Former Federal Deposit Insurance Corp. Chairman Sheila Bair, who like Yellen, issued strong warnings about problems in the banking system well before the crash, penned an op-ed for Fortune on Monday, endorsing Yellen as the "most qualified" candidate to succeed retiring Fed Chairman Ben Bernanke. Bair said that even though she strongly disagreed with Yellen on monetary policy tactics, Yellen's record on bank regulation is strong, and her policy judgments have proved accurate.
"Unlike Larry Summers, Tim Geithner, and other Bob Rubin-minions frequently mentioned in the financial press as potential Bernanke successors she was not part of the deregulatory cabal that got us into the 2008 financial crisis," Bair wrote. "In fact, she had a solid record as a bank regulator at the San Francisco Fed and was one of the few in the Fed system to sound the alarm on the risks of subprime mortgages in 2007."
A spokeswoman for Sen. Sherrod Brown (D-Ohio) declined to attack Summers directly, but emphasized the importance of countering unemployment and thinking beyond Wall Street's priorities.
"Sen. Brown believes the next chair of the Federal Reserve should fully embrace the Fed’s dual mission -- which necessitates a focus on reducing our nation’s unemployment level," Brown spokeswoman Meghan Dubyak said. "Specifically, he believes that the country needs a Fed chair who will focus on strengthening our entire economy, and not just the financial sector."
On Tuesday, as word trickled out that Summers was the leading contender for the position, Sen. Jeff Merkley (D-Ore.) tweeted that his consideration was "disconcerting."
Summers does have Democratic supporters. While Perriello backed Yellen, Neera Tanden, president of the Center for American Progress, a think tank closely aligned with the Obama administration, spoke warmly of Summers, her former White House colleague who is now a fellow at CAP.
"Larry Summers' work with CAP has focused on rising inequality, developing policies that ensures prosperity is inclusive and government policies to redress unemployment," Tanden told HuffPost. "All areas where Larry's positions are in the square center of progressive thought."
Some of Summers' recent actions on bank reform have sullied his reputation with progressives beyond the deregulatory excesses of the Clinton years. Many Democrats who worked closely with the 2010 Dodd-Frank financial reform bill remember Summers acting as an enemy as often as he served as an ally. Summers played a leading role marshaling opposition to the Volcker Rule within the Obama administration. The Volcker Rule is intended to ban big banks from speculating for their own accounts with taxpayer guarantees, but the law has been weakened with loopholes in the implementation process as regulators have bowed to bank lobby pressure.
"You should be very concerned about the implementation of Dodd-Frank if Larry Summers becomes Fed chairman," said one aide to a progressive senator active on bank reform issues.
Yellen has stood out in the typically dry world of monetary policy, generally followed only by academics, economists, market participants and policymakers. She is among a select group of Fed officials who have won fans in Democratic political circles for persistent emphasis on joblessness and its impact on households and people. Sarah Bloom Raskin, a Fed governor reported to be under consideration for a top job at Treasury, is the other central bank official who has won plaudits from labor leaders and other groups that work on behalf of American workers and families.
While some Fed officials have paid particularly close attention to potential signs of inflation, for example, or keep their public remarks devoid of anything that could suggest empathy, Yellen has sought to explain how today’s lackluster economy may leave lasting scars on households, and why it’s necessary for the Fed to maintain its easy-money policies.
In a February address to a crowd at the AFL-CIO, Yellen focused on unemployment. After rattling off a string of depressing figures about joblessness, stagnant wages, and poverty, Yellen surprised the audience with a personal admission.
“These are not just statistics to me,” she said. “We know that long-term unemployment is devastating to workers and their families. Longer spells of unemployment raise the risk of homelessness and have been a factor contributing to the foreclosure crisis. When you're unemployed for six months or a year, it is hard to qualify for a lease, so even the option of relocating to find a job is often off the table.
“The toll is simply terrible on the mental and physical health of workers, on their marriages, and on their children,” she added.
Labor leaders said at the time they were awed by Yellen’s comments. Considerations such as the toll joblessness takes on the mental well-being of workers or on their marriages typically aren’t publicly acknowledged by Fed policymakers. Market participants said then that Yellen's speech showed her commitment to keeping interest rates low for as long as needed until employment returned to normal levels.
Summers may maintain the same policies. Since leaving the Obama administration, Summers has repeatedly urged policymakers to take advantage of historically low interest rates to pursue grand investments, such as increased infrastructure spending on new projects.
"If at a time when we have unemployment approaching 20 percent in construction, and a 10-year bond rate in the neighborhood of 3 percent, if that's not a time to invest in repairing our infrastructure, I can't imagine when there would be a better time," Summers said in January 2011.
"The main thing we have to do to accelerate the process of job creation is to accelerate economic growth," Summers said. "The most important thing we can do is to raise the demand, the level of demand in our economy, so as to create more output. That's what's most important in the short run."
Since then, Summers has tried to convince policymakers to not reduce government spending for fear of hobbling the recovery. Spending, not deficit reduction, should be the priority, he has repeatedly intoned.
Instead, the White House and Congress have increased taxes and reduced government expenditures.
Summers’ warnings proved prescient. Fiscal policy is among the biggest barriers to growth, Bernanke has said.
For some Democrats, the choice of Summers, who was forced out as president of Harvard for offensive comments about women he made in a speech, would reopen fresh wounds between Summers and leading women economists who clashed with him in the Obama administration.
"Larry had a reputation as having horrible working relationships with women at the White House," said one former administration official. "This wasn’t just about something he said in a speech 10 years ago, it was about his operating style with his colleagues. It showed up in everything from how he reacts to comments from women colleagues in meetings to how he tried to control access to the president. It'd be a real problem at the Federal Reserve because it saps morale and reduces productivity."
Summers notoriously clashed with Christina Romer, former chair of the president's Council of Economic Advisers, over the appropriate size and scope of Obama's economic stimulus package. Summers insisted on lower stimulus numbers, and working with other male staffers to prevent Romer from presenting the economic case for a bigger bill to Obama.
Sources told National Journal that Romer resigned frustrated that Summers was blocking her from giving advice directly to the president.
"I have no idea what the president’s decision will be, but I do think it’s a real test for Valerie Jarrett and her influence. Valerie protects the president from making bad decisions, and she can and should play a real role here," said the former administration official. "The idea that the president wouldn’t nominate Janet Yellen would be an insult to a lot of people on its own, but the idea that he would hire Larry Summers instead would be a serious problem."
"They were mean to her. They were like schoolboys," said a different former White House official, talking about Summers and former Treasury Secretary Tim Geithner.
Because Yellen is more focused on the real economy than Wall Street, she has been able to see soft spots and risks in the economy where other policymakers have seen only rosy futures. As early as 2005, Yellen was sounding the alarm about a housing "bubble" -- specifically using the term -- that could pop and drag the broader economy down. She warned in December 2007 that the "shadow banking sector" was shutting down and had become a threat, employing a term not yet in common usage. (A board member later in the meeting referred to "what Janet calls the shadow banking sector.")
Before the term was in circulation, Yellen warned in 2007 that credit default swaps were a major threat. "CDS spreads from major financial institutions with significant mortgage exposure, including Freddie and Fannie, have risen appreciably," she warned. "Although I don’t foresee conditions in the banking sector getting as bleak as during the credit crunch of the early 1990s, the parallels to those events are striking. Back then, we saw a large number of bank failures in the contraction of the savings and loan sector. In the current situation, most banks are still in pretty good shape. Instead, it is the shadow banking sector -- that is, the set of markets in which a variety of securitized assets are financed by the issuance of commercial paper -- that is where the failures have occurred. This sector is all but shut for new business."
Those failures, she noted, were drifting into the official banking sector. "Until the securitization of nonconforming mortgage lending reemerges, financing will depend on the willingness and ability of banks, thrifts, and the GSEs" -- Fannie and Freddie -- "to step in to fill the breach...Several developments suggest to me that this situation could worsen."
"The possibilities of a credit crunch developing and of the economy slipping into a recession seem all too real," she said, urging aggressive action to soften the landing.
Yellen also took a stand against Alan Greenspan in the 1990s, arguing against his effort to drive inflation to zero. Doing so, she argued, would hurt workers, depress wages and make the severity of recessions greater. She persuaded him, and the Fed now aims for around 2 percent inflation.
Former President Bill Clinton, asked in a 2010 interview about the deregulatory advice given him by Summers and Rubin, conceded he had been wrong.
"On derivatives, yeah I think they were wrong and I think I was wrong to take [their advice] because the argument on derivatives was that these things are expensive and sophisticated and only a handful of investors will buy them and they don't need any extra protection, and any extra transparency," Clinton said.
"And the flaw in that argument,” Clinton added, “was that first of all sometimes people with a lot of money make stupid decisions and make it without transparency.”
The problem for Yellen is that Washington places little value in being right over the course of a career.
This article has been updated to include a former White House official's comment about Summers' treatment of Christina Romer.
Shahien Nasiripour contributed to this report.