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01.11.13

Is Lew a Financial Regulator?

The next Treasury secretary is no expert when it comes to financial regulation. Does that matter?

Jack Lew certainly fits the mold for a high-level Obama appointee. He’s been in the administration since the beginning—deputy secretary at the State Department, head of the Office of Management and Budget, and White House chief of staff. Lew also served in the Clinton White House, where he also headed up OMB. Like Gene Sperling, the head of the National Economic Council, Larry Summers, the former head of the NEC, and Peter Orszag, who preceded him at OMB, Lew has spent some time in the financial sector. He worked at Citigroup from 2006 to 2009.

No one doubts Lew’s expertise and experience when it comes to budget crunching and legislative dealmaking, the earliest criticism of him. But he doesn’t have the experience at the heights of industry and finance that’s considered typical of Treasury secretaries. Meanwhile, the job requirements have changed in recent years—the Treasury secretary is now one of the nation’s most important financial regulators. And Lew doesn’t have much regulatory experience.

If Lew is confirmed, he will be following up two of the most consequential Treasury secretaries with extensive, but different, backgrounds in finance. Hank Paulson, who served from 2006 to the end of the Bush administration, was the CEO of Goldman Sachs, while Tim Geithner, a career public servant, worked as a financial crisis firefighter at Treasury in the Clinton administration, at the International Monetary Fund from 2001 to 2003, and was the head the New York branch of the Federal Reserve. Paulson’s predecessors, Paul O’Neill and John Snow, were CEOs of aluminum and railroad companies respectively. James Baker, who served as secretary under President Reagan from 1985 to 1988 was previously Reagan’s chief of staff; Lloyd Bentsen, Clinton’s first Treasury secretary, was a longtime Democratic senator from Texas; Larry Summers had no private-sector experience before he was secretary at the end of Clinton’s second term.

Robert Rubin, of course, spent 25 years at Goldman Sachs before he came into the Clinton administration and ascended to Treasury secretary in 1995. Andrew Mellon served for more than 10 years, from 1921 to 1932, and was perhaps the most significant banker-industrialist of his era. But some of the most consequential Treasury secretaries had little to no private-sector experience at all, let alone banking experience. Salmon P. Chase, who under Lincoln introduced government-backed paper money and financed the Civil War, was the abolitionist governor of Ohio before he came to Washington. “You can’t take Jack Lew and say he is totally different. If you went back to all Treasury secretaries, there were more guys like Jack Lew than guys from Wall Street,” said Richard Sylla, a financial historian at New York University.

But Lew is going to have to learn on the job. Until the passage of the Dodd-Frank financial regulatory reform bill in 2010, the Treasury secretary had little formal regulatory power. He did (and it’s always been a he) always have a good deal of informal power to influence financial policy. In response to the 1987 stock market crash, President Reagan issued an executive order creating an interagency group called the “President’s Working Group for Financial Markets,” which also included the Federal Reserve chair and the chairs of the Securities and Exchange Commission and the Commodities Futures and Trading Commission. “Since the market crash of 1987, the Treasury secretary has been, by executive order and now by statute, the quarterback for the federal regulators to respond to crises that are systemic for the economic system,” explained Michael Greenberger, who served as the director of the Division of Trading and Markets at the CFTC and is now a professor at the University of Maryland.

“It’s a different time, a time for fiscal policy—that’s why Lew was chosen.”

The Dodd-Frank financial regulatory reform bill made the secretary of the Treasury’s role as the response coordinator for financial crises permanent with the creation of the Financial Stability Oversight Council (FSOC). The Treasury secretary chairs the council, and eight regulators serve as voting members.

The FSOC has the ability to recommend that an independent regulator, like the SEC, act on a certain issue, and if it refuses the FSOC can designate a group of financial institutions as “systemically important” and kick the issue to the Federal Reserve: “If FSOC’s unhappy with a regulator’s failure to act it can re-jigger jurisdiction through the Fed. That’s a pretty powerful tool,” explained Aaron Klein, a former Treasury official who is now the director of the Financial Regulatory Reform Initiative at the Bipartisan Policy Center in Washington, D.C. “The Treasury secretary has the responsibility to look over financial markets and the entire economic system to see if there’s going to be a failure that will trigger a cascading set of events that will bring down our and the world economy,” explained Greenberger.

Geithner exercised a mild version of this power in November when, as head of FSOC, he approved a set of recommendations for money-market mutual funds in order to encourage the SEC to write its own rules after the SEC had failed to act. The council also has the power to designate companies that aren’t banks, but whose failure might cause a crisis, as “systemically important,” thus subjecting them to regulation similar to those imposed on the largest banks. Since October it has been reported that the insurance firm A.I.G. is likely the first company to receive this particular designation.

The Treasury secretary is also responsible for coordinating the work of five separate regulators in writing and implementing the Volcker Rule. Named for the former Federal Reserve chair, the rule is supposed to limit or ban risky trading by federally supported banks with their own money.  “A good secretary of the Treasury will be overseeing implementation of Dodd-Frank and serving as honest broker between his advisers,” said Greenberger.

By his own admission, Lew is no expert when it comes to financial regulation. Many observers interpreted Obama’s pick as a sign that the focus has shifted from cleaning up and reforming the financial system to dealing with long-term tax and spending policy, an area where Lew has nearly unmatched experience. “Now you have a huge fiscal challenge. Jack has expertise in how to balance the budget,” Aaron Klein said. “It’s a different time, a time for fiscal policy. That’s why Lew was chosen,” said Phillip Swagel, who served as assistant secretary for Economic Policy in the Bush administration. “This is not nuclear physics. Lew will learn and get to speed. I don’t think anyone is worried that the job is beyond him,” said Swagel. 

Lew will be buttressed by the Treasury’s staff, as well as by Mary J. Miller, the undersecretary of Domestic Finance and one the Treasury’s top financial markets officials, who Swagel, a Republican, described as “excellent.” Swagel said that “having a strong supporting staff is always important, but more important when the secretary doesn’t have the background.” Beyond Miller, the Treasury has devoted more resources and staff toward financial markets since 2008, and Dodd-Frank created the Office of Financial Research, an independent entity housed within Treasury whose job it is to let the FSOC know where potential financial crises may arise. “Treasury’s capacity to understand instability is significantly better that it was in 2008,” said Michael Barr, a University of Michigan law professor who served under Geithner as assistant secretary for Financial Institutions and helped write Dodd-Frank.

“Lew is a very bright, nice person who will want to do the right things. It’s just a question of what will he do in a crisis of worldwide proportions that could happen next week,” Greenberger said.