This is the first of three posts on recent developments in the governance of the Fed.
My apologies to any regular readers—who might consist only of my wife and mother—for the long break from blogging. To compensate, I’m going to write a three-post series on some recent discussions of the Fed and its governance. Today, I want to talk about some arguments I made at Brookings and in Senate testimony this week about the governance structure of the Fed and why I think it warrants reform.
Anyone interested in the Fed should watch both the Brookings event and the Senate hearing. The Brookings event, called “The Fed in the 21st century: Independence, governance, and accountability,” featured papers from me and NYU finance professor Viral Acharya, with responses from former Philadelphia Fed President Charles Plosser and Harvard professor/former member of the Fed’s Board of Governors Jeremy Stein, respectively. And then we heard a panel discussion with GW Professor (and leading Fed expert) Sarah Binder, Ben Bernanke, Barney Frank, and Morgan Stanley CFO Ruth Porat, all moderated by the inimitable David Wessel, currently at Brookings and formerly and still occasionally of the Wall Street Journal (also, the author of perhaps the best book reporting on the financial crisis, In Fed We Trust). It was a wonderful event.
The Senate Banking Committee hearing was on Fed reform proposals, with witness testimony from John Taylor, Allan Meltzer, Paul Kupiec, and me. As an aside, I will say that with all the talk of gridlock and partisanship and hostility, etc., the hearing was remarkably substantive, cordial, and serious, from both Senators and witnesses. I was the only Democratic witness on a four-person panel before a Republican Senate, and feared things would get a bit unwieldy. Nothing like it.
My paper at Brookings, also the basis of my testimony, offers a historical and legal analysis of the Fed’s governance structure, focusing on the twelve Federal Reserve Banks, sometimes called the “regional Feds.” The Presidents of these Reserve Banks sit on the Federal Open Market Committee on a partially rotating basis, and have a lot of influence over the implementation of bank supervision and regulation. Problem is, these presidents are appointed by part of their boards of directors, who are in turn appointed in part by the bankers they regulate.
I don’t favor these structures, for two reasons. First, it takes no great theorist of governance and incentives to see the conflict of interest in placing the appointment and removal authority for regulators in the hands of the entities they regulate. I especially worry about situations where banking regulation becomes zero sum between the interests of financial institutions and the interests of the rest of the economy, and worry that in those situations regulators appointed in this way will see more immediately the interests of the regulated entities and less the interests of the broader economy.
But second—and, I’d argue, even more important to the long-term viability of the Fed as an independent central bank—governance at the Fed is an opaque mess and fertile ground for conspiracy theories and failures of public accountability. One of the most enduring critiques of the Fed from both the left and the right is that the Fed is owned by the banks it regulates. This dramatically overstates the actual nature of the legal relationship between the member banks (who are, yes, a sort of “shareholder” of the Reserve Banks) and the Fed. But this kind of critique can’t be dismissed as crank conspiracy theory when we look at the appointments and removals of Reserve Bank presidents. It’s baked into the Federal Reserve Act itself.
In its place, I considered three alternatives. First, make the President of the New York Fed subject to the Constitution’s Appointments Clause—that is, appointed by the President and confirmed by the Senate. I like but don’t love this proposals. I like it because it takes the appointment/removal authority away from private actors and puts it in the hands of public institutions. I don’t love this because, ironically, it could make the New York Fed President even more prominent within the System, and subject that appointment process to even more pressure from the industry to get someone they like. Also, what about the other eleven?
Second, then, make all twelve Reserve Bank presidents subject to the same process. I like this more than the first, but still have problems with it. Do we really want 19 presidential appointments vying to cultivate their political constituencies as they navigate the arcana of monetary and financial regulatory policy? Again, I’m more comfortable with that structure than I am with the status quo, but ultimately not persuaded this is the right approach.
Best of all, I think, would be to turn the Reserve Bank presidents appointments (removable at will) by the Board of Governors in Washington. The Board could then create more of them, or uncreate some of them, so that they no longer reflect the political deals of a century ago—there are two Reserve Banks in Missouri, and only one west of Dallas, for example. And then we could know, definitively, where the power stood: at the Board of Governors. Love the Fed for what it did during the crisis? You can express that view through the regular political process and get more of the same. Hate the Fed for what it did during the crisis? You can express that view through the regular political process and get nothing like the same. But under the current situation, no such luck—most people don’t even understand the Fed’s governance, let alone who is pulling which levers and how the political process can influence their appointment.
Whatever the solution, I fear that the current governance structure favors the banks at the expense of the rest of the economy, but also that it gives a lot of wind in the sails of Fed critics who would love to see the whole democratic experiment in independent central banking dismantles (to be very clear, I am not in that camp). Sen. Rand Paul recently asked at a pre-campaign even, “Anybody feel like the Fed’s out to get us?” But he wasn’t asking a group of bankers, who almost certainly don’t feel this way. He was asking a group of Iowans. Reforming the Reserve Banks’ conflicted and opaque governance structure would make Sen. Paul’s question much harder to take seriously.
My respondent, former Philadelphia Fed President Charlie Plosser, wasn’t impressed by these proposals. I’ll get to his and some press critiques in the next post, and conclude with commentary on the WSJ article yesterday about a sub rosa governance change that occurred five years ago.