Bernanke's Job Is Done. Now the Fed Needs a Jobs Creator
While Bernanke's decision to avoid the mistakes of the 1930s was bold and will be judged by history to have been correct, the need for those skills is past. Given America's need for Fed chairman who can figure out how to contribute to job growth, one name that comes to mind is Paul Romer (pictured) of the University of California at Berkeley and of Stanford's Hoover Institute who has developed New Growth Theory (NGT).
New Ideas Attract Capital
NGT's central claim is that new ideas, embedded in technological change, generate economic growth. These new ideas also allow us to escape the dark future economists have so often imagined that results from the growing scarcity of physical resources. NGT imagines a world where new ideas attract capital and fuel the growth of job-creating enterprises. And jobs are certainly what America needs now.
And Romer has some intriguing ideas about what ought to happen in response to the financial crisis. In a recent New York Times interview he said Congress should use the financial equivalent of the National Transportation Safety Board to investigate the causes of the financial crisis. Romer believes that such an investigation in the wake of the savings and loan crisis would have helped us avoid future financial crises. (While individual S&L collapses were investigated, there was no comprehensive examination of the reasons for the S&L debacle.)
Romer's idea appears to differ substantially from the current Financial Crisis Inquiry Commission (FCIC). He's calling for a detailed analysis of the most significant money-losing transactions that led to the financial crisis. Such an investigation would uncover who participated in these deals, what motivated the transactions, what went wrong and how they fell apart. By contrast, the FCIC hearings are more of a public theater for politicians to look tough while making Wall Street CEOs squirm.
Create a New Kind of Bank
Romer also advocated a clever way to get new loans into the hands of business. Starting in October 2008, I repeatedly suggested -- here, here, here and here -- that the U.S. could get money to business by creating new banks unencumbered by toxic assets. In February 2009, Romer wrote an editorial in The Wall Street Journal in which he also advocated creating new banks.
Sure, conventional thinking says it's foolish to appoint someone who isn't a monetary economist to lead the Fed. The traditional economic approach to job creation is that Congress can help through government spending on the right projects -- so-called fiscal policy -- and that the Fed has only a limited role in job creation.
Such thinking leads to the conclusion that the Fed has done all it can by keeping interest rates near zero, and that it's up to Congress to come up with fiscal policy aimed at creating jobs.
But more of the same isn't what the Fed needs now. My concern with the status quo is that it would allow bank to keep using low-cost capital from the Fed to trade for their own accounts instead of lending it out to companies that would create jobs.
Debt Versus Equity
Here's a different idea: What if we thought of the Fed as having a very important part to play in encouraging job creation? As I see it, the central bank has a huge role in deciding whether investors prefer to use debt or equity to finance new ventures. And investors make that choice based on which costs them more.
That's where the Fed comes in. It sets the price of debt by determining the fed funds rate, which is now zero. And that choice by the Fed makes debt the preferred way to finance investments because the cost of equity is so much higher than zero. If technology-based ventures could finance themselves with debt, there would be no problem.
But so far, nobody has figured out how to provide the bulk of a start-up's capital through debt. In order to get investment capital into such start-ups, either the cost of equity needs to drop, the cost of debt needs to rise or a combination of the two must occur.
In the last decade, however, that trend has been going in the wrong direction. According to the National Venture Capital Association, in 1999 the typical venture capital fund had generated a 10-year return of 83.4%. But that rate has declined steadily, and when the NVCA tabulates the June 2010 statistics, VCs' 10-year returns are expected to average a negative 5.2%.
Banks Will Have Little Reason to Change
Someone like Romer might be able to reverse this trend by making the Fed an active participant in boosting investment into new ideas. As long as Bernanke is in charge, there's a good chance that the cost of debt will be so much lower than the cost of equity that the returns to equity will remain highly unattractive.
While those equity returns stay low, the odds of getting equity investment into growth-producing new ideas will become even more difficult than they already are. That would mean that the banks will keep making huge profits from cheap capital without investing in job-creating businesses.
I think Romer -- with the creative thinking manifest in his proposals to investigate deeply the sources of the financial crisis and to create new banks -- would be far more likely to change this than Bernanke.