News Analysis: Front-Runner For Fed Makes Banks See Red

WASHINGTON - President Clinton would probably ignite a firestorm of protest within the banking industry if he nominated Assistant Treasury Secretary Alicia Munnell for a seat on the Federal Reserve Board.

Bankers know Ms. Munnell largely because of a controversial study on lending discrimination that she wrote while director of research at the Boston Federal Reserve Bank. That study concluded that banks discriminate against minorities.

But Ms. Munnell has excited controversy in a number of other areas inwhich she has published research, particularly in the fields of pension funds and public investments.

President Clinton has not decided whether to nominate Ms. Munnell for the Fed seat, and some industry sources said this week that the White House may have chosen to cast a wider net for candidates.

However, the 20-year Boston Fed veteran emerged as the front-runner last week after former Wachovia chairman John Medlin withdrew as a candidate for the seat that was vacated by former banker John LaWare.

Bankers, who believe the Fed is already too dominated by economists, want one of their own picked to replace Mr. LaWare.

"People in the industry have a strong preference for a bona fide banker, someone with actual banking experience," said Joe Belew, president of the Consumer Bankers Association. A banker can best explain the industry's needs to the economist-dominated Fed, he said.

But the industry's dismay over Ms. Munnell goes well beyond her lack of experience in a commercial bank. Those familiar with her work are enraged by her fair-lending study.

"She'll never be confirmed," said one angry bank economist, who, like many others, asked that his name not be used in connection with a criticism of an official who could become an industry regulator.

But Ms. Munnell's strongest critics are her fellow economists, some of whom said the Harvard University PhD advocates extreme economic theories and uses overly simplistic economic models that produce misleading results.

They point to her three most well-known interests - fair-lending, pension taxes, and public investments, as evidence of her problems.

On fair-lending, Ms. Munnell almost single-handedly created a new industry - fair-housing consulting. The Boston Fed study which she directed renewed interest in the area and initiated a string of bank prosecutions by the Department of Justice.

Today, nearly every bank in the country is reviewing its operations carefully with an eye toward potential violations of the Equal Credit Opportunity Act and the Fair Housing Act.

In the study, Ms. Munnell and her three co-authors reviewed Home Mortgage Disclosure Act data and additional information collected from loan files, and concluded that Boston-area banks were discriminating on the basis of race.

Community activists are quick to praise the study. "It was an important watershed event that absolutely promoted a dramatic change in the dialogue on fair-lending," National Community Reinvestment Coalition president John Taylor said. "That was a very good thing."

But a number of economists who have reviewed the study said her conclusions are off base. They said she misinterpreted the data and failed to include key variables that would have altered her results.

"A lot of people are really starting to zero in on the Boston Fed study," said Bert Ely, an industry consultant best known for predicting both the magnitude of the thrift crisis and the speed with which the banking industry would return to health.

"It had a lot of impact, but the more people look at the methodology, the more people are questioning it," Mr. Ely added.

A number of others have raised similar questions, including Federal Deposit Insurance Corp. economist David Horne, who reported in a study last year that most of the discrimination that Ms. Munnell found disappeared once other factors were considered.

Also, Federal Reserve Board economist Glenn Canner released a study inJanuary that sought to prove discrimination by looking at default rates. He found no evidence of discrimination.

But, Mr. Taylor said these technical challenges are irrelevant because the study forced a dialogue between banks and activists. "The fact that so many people have studied it lends credence to its importance," he said.

Ms. Munnell, speaking through the Treasury Department public affairs office, refused to be interviewed for this article.

In addition to concerns about her fair-lending work, bank economists cite two other areas of Ms. Munnell's work as grounds for concern.

First, they point to her proposal to levy a 15% tax on all pension funds and then assess an additional tax on every dollar added to a fund. "It is difficult to understand why such a large source of potential revenue is allowed to go untapped," she wrote in New England Economic Review in 1989.

She later retreated on the pension tax, saying she was merely presenting it as an option. But it still shocked many economists, who said it would devastate the country's already paltry savings rate.

"That would destroy the whole pension world," said Thomas Kelly, president of the Savers and Investors League, a pro-pension fund association. "That is so far out of mainstream thinking that it is horrible."

Banking economists also point to Ms. Munnell's work on the value of public investments. A study she oversaw concluded that using taxes for public investments - such as roads and bridges - produces greater benefits then lowering taxes and allowing the private sector to spend the money.

Later studies cast doubt on her conclusions, much like later studies questioned her fair-lending results. That worries some economists.

"If somebody gets reversed a couple of times, it does make you wonder whether the next time they say something you should pay a lot of attention," said Anthony Yezer, a George Washington University economics professor.

Her supporters counter that she's imaginative and willing to challenge the status quo.

"Sure, there were a lot of flaws in the (fair-lending) study," said William Cunningham, an economist and president of the industry consulting firm Creative Investment Research & Management. "But it was a new data set and people didn't have experience with it. She was one of the first to get out there and work with the new data."

Even some of her detractors praise her risk-taking. "Her research was imaginative," said Eugene Sherman, an analyst at M.A. Shapiro & Co. "She didn't follow the conventional wisdom. She was willing to approach things unconventionally, which I admire enormously."

Also, Ms. Munnell knows the value of economic data, having supervised the government's primary economic forecasting arm at the Treasury Department.

And, she's publicly endorsed the Fed's anti-inflation policy. "I think it is a very sensible thing," she told the Bond Buyer in July 1993. "They want a level of inflation that does not interfere with decisions."

Finally, her supporters said she knows how the Fed works and what is expected from its governors.

Political observers said Ms. Munnell might be able to overcome the banking industry's objections if she didn't have to contend with the Republican-controlled Congress.

Banking committee Republicans, who must confirm any nominee, are wary about sending a liberal economists to the board because the terms of bothChairman Alan Greenspan and Vice Chairman Alan Blinder expire within the year, several observers said.

The senators may demand a package deal involving Mr. Greenspan and the other nominees, these sources said.

But, Ms. Munnell's supporters said its too early to count her out. They said she has survived tricky confirmation battles before, noting that she secured her current job despite an intense lobbying effort against her.

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