Paulson, not Bernanke, is the Most Powerful Man in Washington

It used to be said the Federal Reserve Chairman is the most powerful man in Washington. He could make or break presidents. As Bob Dylan said quite a few years ago, “the times they are a- changin’.” Former Federal Reserve Chairman Greenspan had a powerful enough public aura to transcend both Democratic and Republican administrations. While in office, the maestro could do no wrong. No president was willing to endure the potential political backlash of firing him.

Former Treasury Secretary Rubin made great progress in enhancing the strength of his position, but the public never considered him Greenspan’s equal. During the O’Neill and Snow periods of the Bush II administration, Treasury appeared weak and disorganized. With academic Bernanke in charge of the Fed, a power vacuum was left for the new Treasury Secretary to fill. Paulson did just that.

Paulson was a bit timid at first interacting with the media. He had to balance pragmatism with the Bush “free market” doctrine. But, the Bear Stearns (BSC) meltdown gave him the opportunity to break out. I believe he directed the Fed’s actions every step of the way, and later justified shifting from free market to government intervention when necessary. Over the last two weeks Paulson, rather than Bernanke, handled all of the public relations. That’s a clear shift in power.

Paulson and Bernanke clearly disagree on the remedy for the mortgage/housing crisis. In "Bernanke’s Harsh Warning", I wrote that Bernanke wants to trade mortgage principal write downs for government guarantees. Then in “Treasury Sec. Paulson Rejects Systemic Approach to Foreclosures”, I wrote that Paulson called this type of approach “not yet ready for the starting gate.”

The New York Times published Paulson’s “Treasury’s Summary of Regulatory Proposal.” The essence of this executive summary is to create a Federal Reserve with limitless power to react in times of crisis. But, the Fed should not interfere too much when markets are stable. Paulson is justifying the Fed’s recent actions retroactively. With a weak Fed Chairman, this power would indirectly be assumed be Treasury. Paulson would continue to pull all the strings.

The beneficial aspect of Paulson’s proposal is the separation of the solvency regulators from the consumer protection regulators. All federally chartered financial institutions would have to be chartered by both. While he does consolidate the solvency regulation of all federally chartered insured deposit institutions, and creates the new opportunity for federally charted insurance companies; his organizational chart is almost as complicated as Hillary-care One.

While Paulson has consolidated his power over both the Treasury and the Federal Reserve, he is heading for a clash with Congress. The President wants consumers to be taught moral hazard and Congress wants Wall Street to take a larger hit in favor of consumers. How well Paulson soothes these conflicting constituencies will determine his staying power.

I believe the big surprise is that Paulson is becoming the new Greenspan. A new Democratic administration may be forced to keep Paulson at Treasury to maintain stability in the markets.

Disclosure: Author is long BSC.

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