Tags: Fed | Conflicts | Interest | banks

Watchdog Warns Fed on Apparent Conflicts of Interest

Thursday, 20 Oct 2011 12:27 PM

 

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The Federal Reserve needs to work harder to fight the perception that bankers on the boards of its regional branches benefit from their roles, a congressional watchdog agency said on Wednesday.

The Fed's 12 regional banks need to make clear that board members, most of whom have ties to financial firms, are not involved in regulatory decisions and do not benefit from special treatment, the Government Accountability Office said.

"While these relationships may not give rise to actual conflicts of interest, they can create the appearance of a conflict," the GAO warned.
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The agency, the investigative arm of Congress, pointed to a number of instances where problems of perception arose, although it did not say anyone abused their position.

Many institutions linked to directors of regional Fed banks took advantage of the central bank's emergency lending programs during the 2007-2009 financial crisis, underscoring the potential for conflicts, GAO said. At least 18 directors at 9 regional Fed banks were linked to firms that got emergency support from the central bank, the report said.

The report was mandated by the Dodd-Frank overhaul of financial rules that was put in place last July in an attempt to prevent future crises.

Fed Chairman Ben Bernanke said in a letter included with the report that the U.S. central bank agreed with GAO's recommendations and would implement them.

"GUILD SOCIALISM"

The report focused squarely on governance and board diversity issues, offering little fodder for Democrats who had hoped it might find that cozy ties with banks impacted regulatory policy, including decisions on bank bailouts, or led to a heavier focus on price stability at the expense of the central bank's full employment mandate.

Even so, a leading critic of the regional Fed system said the report merely confirmed that financial institutions have privileged status in making monetary policy.

"The financial community should certainly have a voice, but they shouldn't be picking voting members of a government agency. It's a kind of guild socialism," Representative Barney Frank told Reuters.

Frank wants the presidents of the 12 regional Fed banks, who vote on interest rate decisions, to be appointed by the White House and subject to Senate confirmation, as members of the central bank's Washington-based board are. He sees the regional bank presidents as more hawkish on inflation.

But such a change seems unlikely. Republicans who control the House of Representatives have been sympathetic to the regional Fed banks, which they view as a bulwark against the more interventionist policies favored by the Washington board.

CONNECTIONS

The GAO credited the Fed for managing and tamping down actual conflicts of interest, and its recommendations centered on protecting the Fed's reputation.

Although the boards of Fed banks are supposed to have directors representing a range of groups, in practice many directors have ties to the financial industry, the report said. Labor and consumer groups tended to be less represented than other industry groups, it added.

GAO urged the regional Fed banks to clearly document directors' roles in bank regulation, and it recommended they create a process for letting directors step aside from dealing with matters where they might face a conflict of interest.

Stephen Friedman, a former Goldman Sachs chairman, was forced to step down as chairman of the New York Federal Reserve Bank's board when it emerged he bought shares in Goldman after it had won the right to borrow at the Fed's emergency lending window in September 2008. He was still on Goldman's board at the time.

That incident was one factor that prompted lawmakers to call for the GAO study.

Critics contend the extensive ties between the financial industry and the Fed fostered a culture of hands-off oversight that helped lay the groundwork for the financial crisis.

The study said that in actual practice, regional Fed directors have limited roles in supervision, regulation, and budgetary and personnel actions.

However, GAO warned that ties between the regional Fed banks and current and former directors connected to financial firms risk undermining the central bank's reputation.

"Without more complete documentation of the directors' roles and responsibilities with regard to supervision and regulation functions ... questions about reserve bank governance will remain," the report said.

© 2014 Thomson/Reuters. All rights reserved.

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