The financial crisis turned the spotlight on the Federal Reserve and its lack of transparency, oversight and accountability. That was not surprising given that one of the best books on the Fed is called “The Secrets of the Temple.” Some Fed reform was included in the Dodd-Frank Act, most notably in restricting its emergency lending authority and allowing for a one-time audit of its emergency lending programs. But pressing issues still remain.
One of the most troubling aspects is the governance at the Fed’s 12 regional banks. Thankfully, the Dodd-Frank Act also called for a General Accountability Office study to determine whether the current system for appointing directors at Federal Reserve Banks is riddled with conflicts of interest and represents the public interest.
The GAO’s 108-page report paints a picture of a comfy club of bank executives and their allies in the directorships across the 12 regional banks. The system is designed disproportionately to give banks greater influence as the three Class A directors are selected by member banks to represent their interests. Three Class B directors are selected by member banks to represent the public, leaving only three Class C directors are appointed by the Federal Reserve Board to represent the public, a wide-ranging category that includes agriculture, commerce, industry, services, labor, and consumer representation.
The GAO looked at the period from 2006-2010 and not surprisingly noted: “labor and consumer groups had less representation than other industries.” The office recommended the Fed board find ways to make these directorships more diverse.
It also recommended improvements to deter conflicts of interest. This was especially troubling during the crisis when the New York Fed played a role in emergency lending decisions to institutions whose executives were directors on the regional bank’s board. The most egregious case was of that of Stephen Friedman, who was chairman of the New York Fed in 2008 while also serving on the board of Goldman Sachs. During the crisis, Goldman became a bank holding company to access the Fed’s discount window. But that move should have made Friedman ineligible from serving as a Class C director because he was a director and stockholder in a bank holding company – and Class C seats have to go to those outside the banking industry. But without any public announcement nor consultation from the full New York Fed board, high-ranking officials from the regional bank sought a waiver for Friedman in October 2008. The waiver was not granted until January 2009, and during those three months Friedman continued purchasing Goldman stock.
The GAO found the bylaws at most Fed regional banks don’t document the board’s role in supervision and regulation. The office recommended the banks establish a formal process for requesting waivers for directors and make it publicly available when they are granted. It also recommended Fed regional banks make key governance documents such as bylaws, ethics policies and committee assignments available on their websites.