Dean Baker, co-director of the Center for Economic and Policy Research, hit the nail on the head on the Federal Reserve in saying that the report's findings reflected "an institutionalized conflict of interest" within the Fed. “We don't let Comcast appoint people to the FCC. We don't let Pfizer appoint people to the Food and Drug Administration,” he noted. The degree to which bankers, on the other hand, can assume regulatory responsibility for their own industry through their connections at the Fed is "without precedent." Considering the impact of systemic risk in the financial system over the entire economy—indeed, over the global economy—banking ought to be the last industry where a structural or institutional conflict of interest is tacitly permitted that can compromise the regulatory function. In other words, regulatory capture, wherein the regulated industries capture their regulatory agency, is particularly dangerous in banking, and yet there it is, right under our noses!
Alexander Eichler provides a specific example in reporting that “the Fed agreed in 2008 to bring Goldman Sachs under its supervisory authority, thereby making it easier for Goldman to get billions in Federal Reserve loans. At the time, Stephen Friedman—then the chairman of the New York Fed—sat on Goldman's board of directors and owned stock in the company. Friedman received a waiver that allowed him to remain at the New York Fed, but the waiver was never made public, and Friedman continued to buy Goldman stock—unbeknown to his colleagues at the Fed, according to the report—until his resignation from the Fed several months later.” Even if Friedman had not been instrumental in Goldman Sachs being allowed to become a commercial bank, the combination of a chairman’s vested interests and consequence-free largess is a red flag. Indeed, the vastness alone of Goldman’s network of alums in government suggests that the bank may be open to far more conflicts of interest than Friedman.
In terms of the Federal Reserve, Eichler reports that, “All in all, the [GAO] found 18 current or former Federal Reserve board members who had ties to institutions that benefited from the Fed's emergency lending, including directors and executives from General Electric, JPMorgan Chase and Lehman Brothers.” Even if those members were not active in securing “consequence-free” loans for “their” institutions, even the appearance of impropriety or favoritism could hurt the Fed. According to Sen. Bernie Sanders, the GAO report indicates that “(t)he corporate affiliations of Fed directors from such banking and industry giants as [GE, Chase, and Lehman] pose ‘reputational risks’ to the Federal Reserve System . . . Giving the banking industry the power to both elect and serve as Fed directors creates ‘an appearance of a conflict of interest’.” Even the appearance constitutes a wrong because it compromises or thwarts trust. The diminishing of trust constitutes a sort of harm to the otherwise-trusting parties, who do not deserve such harm. So even if the Fed could not obviate even the appearance, it still constitutes a wrong and the Fed is blameworthy. Accordingly, actual favoritism by any of those 18 board members is not necessary for us to reach this moral determination, though any such favors justifies even more moral condemnation for those parties who were involved as well as for the Fed and the banking industry overall because they permitted the relationships in which the corruption actualized. In other words, the Fed and the bankers should have known better than to permit the sort of conditions that are ripe for manipulation for one’s friends.
Sen. Sanders notes from the GAO report that “many directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. The rules, which the Fed has kept secret, let directors tied to banks participate in decisions involving how much interest to charge financial institutions and how much credit to provide healthy banks and institutions in ‘hazardous’ condition.” The rules make it so tempting for directors to enrich themselves or their favored banks that disclosure is not sufficient; the rules themselves should never have been promulgated and should not be allowed to remain in effect. Yet the GAO Report’s recommendations highlight disclosure, as if transparency were sufficient to obviate questionable policy or particular deals favoring specific banks.
1. The Chairman of the Federal Reserve Board should encourage all Reserve Banks to consider ways to broaden their pools of potential candidates for directors.
2. The Chairman of the Federal Reserve Board should direct all Reserve Banks to clearly document the roles and responsibilities of the directors, including restrictions on their involvement in supervision and regulation activities, in their bylaws.
3. The Chairman of the Federal Reserve Board should direct the Reserve Banks to make key governance documents, such as such as board of director bylaws, committee charters and membership, and Federal Reserve Board director eligibility policy and ethics policy, available on their websites or otherwise easily accessible to the public.
Transparency can give the illusion of probity. For example, the pools of potential candidates for directors can be broadened while people for the same clique are disproportionately selected. Also, formally restricting a director’s involvement in regulation activities will not necessarily stop the said director from informally influencing those directors involved in the activities related to the particular bank tied to the director. What is needed is to forestall the hiring of that director in the first place, or to remove him or her forthwith once any ties are discovered. In other words, broadening the pool is not sufficient; the candidates themselves should not have any ties to the institutions being regulated.
It might be counter-argued that no bankers, or even business practitioners, could serve as directors if any substantive tie or relationship to a bank were sufficient to disqualify a potential candidate. The point that the Fed itself would be deprived of expertise in banking is specious, for there would still presumably be a bureaucracy of underlings at the central bank more than willing to apply their technical skills. At the upper echelons, the perspective needed is different—broader. So, for example, academic economists (and finance scholars) could be called on to serve at the Fed even though their only tie with a particular bank is in going in to their local bank for help on how to use their debit card. Perhaps other such “broadening but in the neighborhood” pools could be found as well. Besides the conflict-of-interest problem, Fed policy should not be arrived at through the prism of technical banking. Just as members of Congress need (and should) not all be lawyers, Fed directors need (and should) not all be former bankers. Having some is fine as long as they have moved to a regulatory mindset and no longer have ties, but the nepotistic practice of having former bankers regulate current bankers is not wise, given that even the appearance of a conflict of interest is immoral.
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Alexander Eichler, “Conflicts of Interest Abound at The Federal Reserve, Report Finds,” The Huffington Post, October 19, 2011. http://www.huffingtonpost.com/2011/10/19/federal-reserve-banks-links-finance-industry-conflict-interest_n_1019703.html
Bernie Sanders, “GAO Finds Serious Conflicts at the Fed,” Website of Sen. Bernie Sanders, October 19, 2011. http://sanders.senate.gov/newsroom/news/?id=70c40aba-736c-4716-97d1-45f1a1af10a0
GAO, “Federal Reserve Bank Governance: Opportunities Exist to Broaden Director Recruitment Efforts and Increase Transparency,” October 19, 2011. http://www.gao.gov/products/GAO-12-18