SUPREME COURT V FOMC

Following President Bush's announcement of a nominee to replace Sandra Day O'Connor on the Supreme Court, camps designed to either back or bash them began to spring up. While an important office, one could argue the man stepping down in 195 days on the financial side of the world will be a much bigger deal and is much harder to replace. On January 31, 2006, FOMC Chairman Alan Greenspan ends his 18-year stewardship of the U.S. economy. As the Maestro prepares to give his semi-annual testimony to Congress today, he is foremost in our minds. With such a short time left until Greenspan steps down and the importance of his position, finding a competent replacement is critical. Most say that at this point, the White House has narrowed the list down to three candidates, each of which is highly regarded by the financial community. Of the candidates (Ben Bernanke, Martin Feldstein and Glenn Hubbard), Bernanke is the odds-on favorite at this point. Bernanke was a Princeton economist and named to the Federal Reserve in late 2001. He currently serves as Chairman of Bush's Council of Economic Advisers. The next most likely candidate, Martin Feldstein, is a professor of Economics at Harvard University and President and CEO of the National Bureau of Economic Research. From 1982 through 1984, Feldstein was Chairman of the Council of Economic Advisers and President Reagan's Chief Economic Adviser. Finally, rounding out the pack is R. Glenn Hubbard. Hubbard serves on Bush's Council of Economic Advisers, received a Ph.D. in economics from Harvard University and was a former teacher of economics at Columbia University. All of these men are qualified, so it will be interesting to watch things percolate. That, however, is not the point of this article. Rather, the transition to whoever gets the nod is what particularly interests us. You will have to go back to 1991 when the mere naming of a successor to then Chairman Paul Volcker rocked markets. Until the new chairperson has earned credibility with financial players, the markets will unquestionably be more volatile. In fact, of the last three FOMC chairmen with long terms (Burns, Volcker and Greenspan), bond market volatility was usually the most extreme during their first year in office. For Greenspan, in fact, the first year was more volatile than the remaining 17. Face it - investors do not like uncertainty. No matter who is chosen, they will be untested in their new role. This will increase uncertainty, which in turn will likely result in higher volatility, as markets have a harder time anticipating future Fed actions. No matter what, the new Fed Chairman will inherit a challenging environment, given the current economic imbalances. As you think about how to conduct a rate shock of such an event on your own bank, consider sage comments from Greenspan himself who once said "Senator, if I seem unduly clear to you, you must have misunderstood what I said." We can only hope the next FOMC Chairman is as clear in his message.