The Fed's stuck in the penalty box

By Colin Barr, senior writer

NEW YORK (Fortune) -- The Federal Reserve has enough problems without having to play shorthanded.

The Fed's vice chairman, Donald Kohn, said Monday he'll retire in June after eight years on the board. Kohn's departure will open a third vacancy on the Fed's seven-member Board of Governors.

Federal Reserve vice chairman Donald Kohn is retiring in June. His departure will create three vacancies on the Fed's seven-member Board of Governors.

Empty seats at the Fed's offices in Washington are nothing new. There have been vacancies since the late George W. Bush years, and the Obama administration hasn't exactly fallen over itself to appoint new governors.

But in the aftermath of the financial meltdown of 2008, the Fed's juggling more balls than ever. In addition to overseeing banks and setting interest rates, the Fed is trying to gently extricate itself from a massive, multifaceted bailout operation.

Expecting it to do so successfully without a full complement of governors may be asking too much.

"Operating with five governors is a problem," said Susan Phillips, a former Fed governor who is now dean of the business school at George Washington University. "But when you get down to four, then it's time to get moving."

The Obama administration said it would nominate a replacement for Kohn "quickly" in hopes of a fast congressional confirmation. The White House didn't say who it would nominate.

Bank of America economist Ethan Harris wrote in a note to clients Monday that top candidates might include National Economic Council director Larry Summers and two members of the president's Council of Economic Advisers: chair Christina Romer and member Austan Goolsbee.

But a quick turnaround may be wishful thinking. The administration has been in office for more than a year, a span over which the Fed has had at least two vacancies. During that period the White House has only nominated one person. Daniel Tarullo, a former Georgetown professor and banking regulation expert, was sworn in as a Fed governor Jan. 28, 2009.

The administration's failure to stay ahead of the curve on Fed staffing hasn't impressed onlookers.

"They may say they've been busy fighting the financial crisis, but you'd have to say this has been a major shortfall in terms of policy planning," said Michael Brandl, an economics lecturer at the University of Texas. "The timing for this couldn't be worse."

That's because the role the Fed will play in the future is very much part of the debate in Congress over financial reform. The House passed a reform bill in December, but senators continue to dicker over the shape of banking regulation and how the Fed will fit in.

Nominating governors at a time when the financial reform debate is still going on is far from ideal, Phillips said, because of the tough questioning candidates can expect in Congress.

And though the "fight-the-Fed" movement that bubbled up in January during Fed chief Ben Bernanke's reconfirmation appears to have lost some momentum, there is still anger over the bailouts -- something members of Congress won't forget in an election year.

"It's a difficult time to come up for nomination," Phillips said.

Yet the administration may have no choice. There have been reports in recent days of some progress on a possible compromise between Senate banking panel leaders. But unless an agreement is reached quickly, the White House runs the risk of letting more time slip away, putting the Fed in an even tighter corner come June.

"This is a great opportunity for everyone to put aside their politics and focus on getting good governors," said Brandl. "If we let this one pass, we could end up looking like Japan when it comes to policy paralysis." To top of page

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