Fed Risks Credibility Over Bank Ties, Report Says

By:  By MICHAEL R. CRITTENDEN
Wall Street Jounral

WASHINGTON-The Federal Reserve faces a risk to its credibility because of the banking industry's role in choosing board members at the 12 regional Fed banks, a congressional watchdog said Wednesday.

The Government Accountability Office, a nonpartisan research arm of Congress, called on the U.S. central bank to take additional steps to prevent potential conflicts of interest, as well as to boost disclosures to the public. Without such steps, the agency said, public skepticism about the Fed could increase.

"Failing to make the process and decisions more transparent can decrease confidence in the Federal Reserve System and has resulted in questions about the integrity of Reserve Banks' operations and the appearance of conflicts of interest," the GAO said in a report.

Public anger with the banking industry is already high, as evidenced by the Occupy Wall Street movement in a number of U.S. cities. The Fed also has come under attack from the public and politicians for its role in responding to the financial crisis, and the GAO's findings provided fresh fodder for critics.

"Clearly it is unacceptable for so few people to wield so much unchecked power," Sen. Bernie Sanders (I., Vt.) said in a statement. "Not only do they run the banks, they run the institutions that regulate the banks."

At issue is banks' role in appointing members to the board of directors for the 12 regional Fed banks, which work with Fed officials in Washington to provide oversight of the banking industry and region-focused information on the state of the economy. Banks elect six of the nine board members at each of the regional banks, three of which are given the task of representing the interests of the banking industry.

The GAO said this creates the risk of conflicts of interest. Even with specific policies in place to mitigate against such risks, the appearance alone can have negative consequences for the central bank, GAO auditors found. This was particularly true at the height of the financial crisis, when the companies of executives serving on regional-Fed-bank boards were occasionally consulted by Fed policy makers on the creation of emergency lending programs.

The report cited, among others, former Federal Reserve Bank of New York Chairman Stephen Friedman, who was a director of Goldman Sachs Group Inc. and held company stock. When the investment bank applied to the Fed to become a bank-holding company at the height of the crisis, Mr. Friedman should have been ineligible to continue to serve on the New York Fed's board of directors. New York Fed officials, without consulting their full board, sought a waiver for Mr. Friedman, which was granted but which wasn't made public.

The GAO said such situations raise questions about whether bank-affiliated directors "have influence over matters that may affect banks or institutions" with which they are connected.

"As demonstrated during the recent financial crisis and the waiver request for the then-FRBNY chairman, a lack of transparency around the waiver request process and outcome contributed to greater distrust of Reserve Bank governance," the report said.

Mr. Sanders said the report highlights "exactly the kind of outrageous behavior by the big banks and Wall Street that is infuriating so many Americans." He said he plans to develop legislation to restructure the Fed and eliminate the role of banks in choosing directors for the regional Fed banks.

 He isn't alone. Rep. Barney Frank (D., Mass.), the ranking member of the House Financial Services Committee, has been pushing to take away regional Fed officials' power to shape monetary policy. While Republican opposition to either a Sanders or Frank measure means they are unlikely to become law, it underscores the growing sense of frustration with the central bank on Capitol Hill.