The professional and financial ties between the directors of the 12 regional Federal Reserve Banks and Fed-supervised firms have created a "reputational risk" for the Federal Reserve System, and the Reserve Banks have not given the public access to key governance documents, according to a report issued today by the Government Accountability Office(GAO).
This is one of several GAO audits of the Fed required under the Dodd-Frank financial reform law. An audit released a few months ago examined the emergency actions taken by the Fed in response to the financial crisis. Today’s report provides a unique glimpse at governance and conflict-of-interest issues at the 12 regional Reserve Banks.
Each Reserve Bank is governed by a nine-member board—three Class A directors elected by member banks to represent their interests, three Class B directors elected by member banks to represent the public, and three Class C directors appointed by the central Federal Reserve Board to represent the public:
The GAO found that “directors of all three classes can have ties to the financial sector.” These ties create potential conflicts of interest because the Fed has supervisory authority over state-chartered member banks and bank holding companies. Class A and B directors can own stock in these firms, and Class A directors can work directly for them. And there are no restrictions on directors communicating with Reserve Bank staff even when the directors are acting in their capacity as officials of a bank or holding company.
The financial crisis illustrated the serious potential for conflicts of interest involving Reserve Bank directors. The GAO identified at least 18 former and current directors who were affiliated with institutions that used at least one of the Fed’s emergency assistance programs. The report also provided some specific examples of apparent conflicts involving Reserve Bank directors and Fed-supervised firms. The GAO didn’t name the specific individuals involved, but they have been identified by Senator Bernie Sanders (I-VT), whose Dodd-Frank amendment required the GAO to conduct this study.
- In September 2008, the Federal Reserve Bank of New York approved an application that allowed Goldman Sachs to become a bank holding company, which gave the firm access to the Fed’s cheap credit. The New York Fed’s Chairman at the time, Stephen Friedman, also sat on Goldman’s board of directors and owned shares in Goldman’s stock. Under a Federal Reserve Board policy, once Goldman Sachs fell under the Fed’s supervisory authority, Friedman’s connections to the firm should have disqualified him from serving as a Class C director. However, the New York Fed requested and received a waiver allowing Friedman to continue serving on the board. The Federal Reserve Board granted the waiver, but was unaware that Friedman had purchased additional shares in Goldman Sachs during this period. Friedman ultimately resigned amid heightened public scrutiny of his Goldman connections.
- New York Fed staff consulted with General Electric on the design of a program to assist with the commercial paper market at a time when GE’s CEO, Jeffrey Immelt, served as a Class B director on the New York Fed’s board. Senator Sanders pointed out that the Fed ultimately provided GE with $16 billion in assistance under this program, the Commercial Paper Funding Facility.
- Jamie Dimon, the CEO of JP Morgan Chase, served on the New York Fed’s board at a time when JP Morgan participated in several emergency assistance programs. For instance, the New York Fed provided a $30 billion loan and other assistance to facilitate JP Morgan’s acquisition of Bear Stearns.
These potential conflicts of interest are obviously a source of concern—Senator Sanders stated that “it is unacceptable for so few people to wield so much unchecked power…Not only do they run the banks, they run the institutions that regulate the banks.” But to make matters worse, the Reserve Banks also do not disclose enough information regarding their governance and conflict-of-interest policies, according to the GAO.
Specifically, the GAO found that most Reserve Banks’ bylaws do not document the board’s role in supervisory and regulatory activities; most Reserve Banks do not have a process for formally requesting conflict-of-interest waivers; and, in contrast to other comparable institutions surveyed by the GAO, most Reserve Banks do not make key information about their board committees and ethics policies available online.
The GAO described several existing policies that are aimed at mitigating potential conflicts of interest at the Reserve Banks. For instance, federal conflict-of-interest restrictions generally prohibit directors from participating personally and substantially on any matter in which they have a financial interest (however, Office of Government Ethics regulations allow directors to participate in certain matters, such as monetary policy and the approval of credit extensions, even when the directors have a disqualifying financial interest). In addition, there are Federal Reserve-wide policies and internal controls at the Reserve Banks that are designed to prevent or mitigate potential conflicts. It is standing practice, for example, that Reserve Bank directors generally do not vote on institution-specific supervisory matters.
There have also been several reforms enacted since the onset of the financial crisis. Under a provision of the Dodd-Frank Act, Class A directors are no longer involved in the appointment of Reserve Bank presidents and vice-presidents. And the Federal Reserve Board recently approved several new policies--one that addresses situations in which the stockholdings of Class B and C directors unexpectedly become impermissible, and another that requires Reserve Banks to adopt policies governing directors’ involvement in procurement decisions.
The GAO called on the Chairman of the Federal Reserve Board to pursue additional reforms such as directing Reserve Banks to document the roles and responsibilities of directors, requiring Reserve Banks to adopt a process for requesting waivers from the Board and publicly disclosing waivers that are granted, and directing the Reserve Banks to make key governance documents available online. The Federal Reserve Board stated that the recommendations “all have merit” and that it will work to implement them.
During the Dodd-Frank debate, POGO supported an additional reform that would have prohibited Fed-supervised firms from electing Reserve Bank directors, and also would have prohibited past and present officers, directors, and employees of these firms from serving as directors. This provision was omitted from the final legislation, but Senator Sanders has indicated he is working on similar legislation to prevent the banking industry from selecting Reserve Bank directors. In addition, House Financial Services Committee Ranking Member Barney Frank (D-MA) has introduced separate legislation to remove Reserve Bank representatives from the Federal Open Market Committee, which controls monetary policy.
We hope the GAO’s latest report will convince Congress of the need to further reduce the banking industry’s influence on the Federal Reserve System. Today's report also demonstrates why the GAO should have the authority to conduct complete and ongoing audits of the Federal Reserve, as has been proposed in legislation introduced by Representative Ron Paul (R-TX) and Senator Rand Paul (R-KY).