Follow the Money with Bergman: Eyeing Green Eyeshades- Part III
14 August 2011
Fed Governance – Accountable Independence, or a Spider’s Web?
On the heels of the worst financial crisis since the Great Depression, financial reform legislation passed last year
directed the Congress’ General Accountability Office (GAO) to examine Fed emergency lending in the crisis, and also to
review the Fed’s governance. Last month, the GAO issued its first report. This report documented how the Fed extended
over $1 trillion of various forms of emergency lending, and politely identified room for improvement in management
procedures administering this kind of aid in the future. The second report, with broader implications for the future of
our central bank, will likely be issued in October.
To help set the stage for that second report, here’s a review of the basic framework for Federal Reserve governance, and
a brief introduction to some of the topics relevant for that second report:
The Federal Reserve System, “the Fed,” has a lot of moving, interconnected parts. The two basic components are the
Federal Reserve Board of Governors, and the collection of 12 Federal Reserve Banks. In turn, the Federal Open Market
Committee (FOMC) melds those two parts to make the Fed’s main monetary policymaking body.
The Board of Governors is a government agency, an independent regulatory commission like the SEC. The Board has 7 seats
which are (normally) filled by Presidential appointment, subject to Senate confirmation. (Two of those seats have been
vacant for some time.) The Board appointments are for 14 year terms, and they are ‘staggered’ (the individual terms do
not coincide with one another). The long, staggered terms are asserted to promote a valuable independence from
nearsighted political influence. By law, one of those seven members is appointed by the President to serve as Chairman.
Ben Bernanke was first appointed to that post in 2006 by George Bush, and he was reappointed to that role by President
Obama in 2010.
The Board of Governors is primarily a policymaking and oversight body, while the day-to-day operations, supervisory and
examination roles, and economic reconnaissance are the main province of the 12 Reserve Banks around the country. The
banks are separately chartered government corporations. The Federal Reserve Act stipulates that they are to be
“conducted under the supervision and control of a board of directors.” But Reserve Bank operations are also subject to
supervision and regulation from the Board of Governors and Congressional oversight lies behind the scenes as well, at
least in theory. In another melding of authority, Federal Reserve supervisory authority for private financial
institutions is rooted in the Board of Governors, but much of that authority is delegated by the Board of Governors to
the Reserve banks, with the Board retaining oversight authority after that delegation.
Each of the 12 Reserve Banks is led by a president, whose appointment by the Reserve Banks’ board of directors is
subject to the approval of the Board of Governors in Washington. Each of the 12 Reserve Banks is governed by their own
board of directors, with the boards holding 9 members grouped in three classes. The 3 Class A directors in each Reserve
Bank board are elected by member banks in the district, and ‘represent’ those member banks. The three Class B directors
are also elected by member banks, but ‘represent’ the public, at least in theory. The three Class C directors are
appointed by the Federal Reserve Board of Governors, and they ‘represent’ the public as well.
The Federal Open Market Committee, or FOMC, is the main monetary policymaking body in the Fed. It melds the Reserve
Banks and the Board of Governors. The FOMC includes the seven (currently five) members of the Board of Governors, as
well as the 12 Reserve Bank presidents. But only five of the presidents hold a vote at one point in time. The president
of the Federal Reserve Bank of New York holds a permanent seat on the FOMC, and by law, also serves as the Vice Chair of
that body. The other four Reserve Bank seats on the FOMC are filled on a rotating basis.
That’s the basic structure. What, then, did Dodd-Frank call for in the GAO audit of Fed governance?
Dodd-Frank’s Fed Governance Audit Provisions
The “Dodd-Frank” bill passed in 2010 had two main ‘audit the Fed’ elements. (The scope of those provisions fell short of
what advocates were calling for, but those drums are still beating
.) The first provision called for a one-time audit of Fed emergency lending in recent years, while the second audit
called for would include a more comprehensive review of “Federal Reserve Bank Governance.” This second provision
directed the GAO to examine:
• whether the current system of appointing Reserve Bank directors meets statutory goals for “public”
• whether the election of Reserve Bank board directors by member banks set up “actual or potential conflicts of
interest” as those Banks execute supervisory functions delegated by the Board of Governors,
• emergency facilities that were the topic of the most recent GAO audit, and
• to identify changes to Reserve Bank board selection or other governance procedures that could improve public
representation, reduce conflict of interest problems, increase information for monetary policy, or “in other ways
increase the effectiveness or efficiency of reserve banks.”
In the first audit report released last month
, the GAO identified one topic it would be examining in its study of Reserve Bank governance. After describing the
structure of Reserve Bank boards, that first audit report took note of the creation of the emergency lending programs by
the Federal Reserve Board and the FOMC, and stated that board of directors of the Federal Reserve Bank of New York
“assisted the Reserve Bank in helping to ensure risks were managed through FRBNY’s Audit and Operational Risk
Committee,” and, “… according to FRBNY officials, FRBNY’s Reserve Bank Directors’ limited role in assessing the
effectiveness of the Bank’s management of operational risk for the emergency programs gave rise to limited waiver
requests or recusals.” The GAO will be looking at this and related aspects in its upcoming second report. The question
whether FRBNY officials’ assertion that the board’s oversight role was limited to operational risks could be part of
that appraisal, along with an examination of conflict of interest issues more generally.
The FRBNY – Who Was Running the Show?
As the GAO’s recent report documents, the Fed’s emergency lending during the crisis was focused on the largest financial
institutions in the United States and Europe. The largest financial institutions in the US are based in New York City,
and the Federal Reserve Bank of New York was responsible for supervising bank holding companies and state-chartered
member banks that proved disastrously exposed to the crisis – directly, and indirectly through their exposure to large
‘nonbank’ financial institutions (like AIG).
From 2003 to 2009 (leading up to and including the crisis), Timothy Geithner was the president of the Federal Reserve
Bank of New York. Geithner’s departure was not the result of a weak performance review, but his appointment by President
Barack Obama to the post of Secretary of the Treasury of the United States of America.
Of course, one person is not ‘running the show’ at a large, complex institution like the FRBNY. A legion of officers
shared supervisory authority (and responsibility for the crisis), together with the underlying regulatory responsibility
and oversight theoretically provided by the Federal Reserve Board of Governors in Washington. And given that the Federal
Reserve Act provides that the Reserve Bank operations are “conducted under the supervision and control of a board of
directors,” those individuals are accountable as well.
Now that the GAO will be examining Reserve Bank governance in its upcoming audit report, here are a few of the people
who were occupying positions in the systems it will be reviewing.
From 2004 to 2006, the Chair of the FRBNY Board (a Class C director, appointed by the Federal Reserve Board of
Governors) was John Sexton, president of New York University. The Vice Chair of the Board (also a Class C director, and
appointed by the Board of Governors) over that time was Jerry Speyer, President and CEO of Tishman Speyer Properties,
one of the largest real estate firms in the country. Like many large real estate firms, Tishman Speyer proved a source of distress in the crisis
. Speyer first started serving on the board of the FRBNY in 2001, not as a Class C director, but as a Class B director,
elected by the member banks (and again, like the Class C directors, theoretically to represent ‘the public.’)
In 2007, the year of the onset of the crisis, the Federal Reserve Board of Governors reappointed Speyer as a Class C
director for the FRBNY, and also designated him as Chair of the FRBNY board. The Board’s choice for Vice Chair was Denis
Hughes, president of the New York State AFL-CIO.
In 2008, the FRBNY had a new chairman, as the Board of Governors appointed Stephen Friedman as a Class C director
(again, to represent the public), and designated him Chair of the board. Friedman was the Chairman of Stone Point
Capital, and had been leader at Goldman Sachs, one of the largest investment firms in the world. Goldman was a heavy
borrower from the Fed in 2008 and 2009, after it proved nearly-disastrously exposed to the crisis. Friedman resigned his
post as Chair of the board of the New York Fed in 2009, following a bit of a firestorm
Some Preliminary Observations
I’ll be taking a closer look at the composition of Federal Reserve Bank boards before the GAO issues its October report
on Reserve Bank governance. But our experience in recent years suggests at least one valuable lesson in light of
Congress’ directive that the GAO examine whether election of Reserve Bank directors by member banks sets up “actual or
potential conflicts of interest” in the exercise of supervisory authority. “Privately” elected or “publicly” appointed,
well, it seems like conflict of interest problems can arise either way. More generally, regulators charged with serving
the public are always exposed to corruption from special interest group forces. Character, not process or structure,