« links for 2010-06-19 | Main | Never Let the Threat of a Manufactured Crisis Go to Waste »

Sunday, June 20, 2010

Reducing the Influence Banks Have over Monetary Policy

I don't have anything to post, so until I do, here's something I posted at MoneyWatch a few days ago. The post addresses the latest proposal for financial reform, in particular the proposal to change the way the District Bank presidents are chosen in an attempt to reduce the power banks have over monetary policy. One part of the proposal was to have the NY Fed president chosen by the president rather than the NY Fed's Board of Directors because of the NY Fed's special role in the implementation of national monetary policy. One question I ask at the end of this post is whether the NY Fed needs to have a special role in monetary policy and be elevated above all other District Banks. Why can't the execution of monetary policy be housed in a separate agency under the control of the FOMC (or, alternatively, the Board of Governors)? There was a time when proximity to Wall Street was essential, but that has changed in the last 70 years, and, in any case, the agency could be located as close to Wall Street as needed. Communication with Washington, to the extent it's needed, could us digital technology. This would put the NY Fed on a more equal footing with the other Fed's, and solve the problem of how to represent both regional and national interests in the selection of the NY Fed president:

Reducing the Influence Banks Have over Monetary Policy: There's some news on the Dodd proposal for financial reform, something I wrote about when the details of the proposal initially came out.

First, what is the Dodd proposal? This is from the earlier post (if you are familiar with the structure of the Federal Reserve District Banks, you can skip the first part of this):

What's Wrong With the Dodd Proposal to Restructure the Fed: A proposal from Senate Banking Committee Chairman Christopher Dodd changes the selection process for key positions within the Federal Reserve system. Unfortunately, this proposal makes the selection process worse, not better. If this proposal is passed into law, it would further concentrate power within the Federal Reserve system, and it would politicize the selection process, both of which are the opposite of where reform should take the system.

The Current Structure of the Federal Reserve System

The Federal Reserve System consists of a Central Bank in Washington and twelve Federal Reserve District (or regional) Banks. The Central Bank's authority resides with the seven member Board of Governors, one of which serves as chair (currently Ben Bernanke).

Each of the District Banks has a nine member Board of Directors along with a bank President. It is the selection of the Board of Directors that is at issue. [The reason this is an issue is that the Board of Directors selects the bank president, and the bank president is a member of the monetary policy committee, the FOMC. This is of particular concern for the president of the New York Fed because the NY Fed carries out monetary policy, and, unlike other regional bank presidents who have rotating positions as voting members of the FOMC, the NY Fed president is a permanent member. In addition, the president of the NY Fed often plays a key role in brokering bailout deals with Wall Street firms during financial crises.]

Currently, the nine member Board of Directors at each of the District Banks consist of three Class A directors, three Class B directors, and three Class C directors. Class A directors are elected by member banks within the district and are professional bankers. Class B directors are also elected by member banks in the district, but these are business leaders, not bankers. Finally, Class C directors are appointed by the Board of Governors and are intended to represent the public interest.

Class B and Class C directors cannot be officers, directors, or employees of any bank, and Class C directors may not be stockholders of any bank. One Class C director is selected by the Board of Governors to serve as Chair of the Board of Directors. The Board of Directors selects the President of each District Bank, but the President must be approved by the Central Bank's Board of Governors.

What is the reasoning behind this structure? When the Fed was created in 1913, there was a concerted attempt to distribute power across geographic regions; between the public and private sectors; and across business, banking, and the public interests. The geographic distinctions were important because it's not unusual for economic conditions to differ regionally -- conditions can be booming in some places and depressed in others -- and the regions would favor different monetary policies. Thus, it's important to bring these different preferences to the table when policy is being determined so that the best overall strategy can be implemented. ...

Over time, however, power has been increasingly concentrated in Washington. So how would the Dodd proposal have changed this structure? Continuing:

Under the proposal, the Board of Directors for each District Bank would be chosen by the Central Bank's Board of Governors (who are themselves chosen by the President with the advice and consent of the Senate). The chair of the Board of Directors at each District Bank would be chosen by the President and confirmed by the Senate. ...

Here's what I didn't like about this proposal:

This means that the key figures within each District Bank would be chosen by Washington, and unlike the present system, there is no attempt at all to represent geographic, business, banking, and public interests explicitly in this arrangement. In addition, it no longer has the explicit safeguards contained in the current rules to prevent bankers from dominating the directorships (e.g. under the new rules the Chair of the Board of Directors could be a banker, currently that can't happen). Given that the appointments are coming from Washington (as opposed to a vote of banks within the District for six of the nine positions on the Board like we have now), there is no guarantee that the District bank Boards won't be stacked with one special interest or another. Thus one of the main reasons given by Dodd for the change in the selection process -- to remove the influence of bankers -- is actually undermined by his proposal because it removes the safeguards against the Board being dominated by banking interests. ...

However, that's not to say that the present system is fully satisfactory:

I fully agree that the selection process for the Directors and the District Bank Presidents could and should be changed (that includes redrawing geographic districts). It's not clear that the present system does the best possible job of representing the array of interests that have a stake in the outcome of policy decisions. But concentrating power in Washington is not the way to solve this problem.

So what is the proposed change in the way bank presidents are chosen?:

Lawmakers Agree to Limit Banks' Influence on Regional Fed Presidents, by Michael Crittenden, RTE: U.S. House and Senate negotiators finalizing financial-overhaul legislation agreed Wednesday on a proposal to reduce the influence of commercial banks on the appointment of regional Federal Reserve bank presidents.

Senate lawmakers on the financial overhaul “conference committee” moved toward accepting a House proposal that would eliminate the vote of “class A” directors in picking regional Fed bank presidents... Directors deemed “class A” are elected by banks to represent the interests of the industry, as opposed to the public.

The agreement between the two sides would also eliminate a Senate proposal that called for the president of the Federal Reserve Bank of New York to be presidentially appointed. Critics of the proposal said it would have politicized the position. ...

Senate conference members still need to vote on the agreement... Sen. Christopher Dodd (D., Conn.) ... put off a vote until Thursday morning because of concerns raised by Sen. Jack Reed (D., R.I.), who ... still favors having the head of the New York Fed be a presidential appointee.

If this passes, I don't have any particular objection to it. If anything, it improves the balance of interests in picking the regional bank presidents. Currently, banks elect six of the nine Board members in their districts, so they essentially control six of the nine Board votes. This proposal would change the composition to three and three with the added restriction on Type B directors outlined above. i.e. they cannot be bankers.

As for the proposal that the NY Fed presidentially appointed, there is an argument that points in this direction. The NY Fed has a larger influence over monetary policy than the other regional banks for the reasons outlined above, and hence national interests ought to be represented in the selection of the NY Fed president. One way to do that is to give the president control over the decision. However, there are also regional interests to consider, and there is also the problem that this makes the NY Fed president beholden to the president who made the selection further politicizing the Fed.

For this reason, it would be better to reduce the influence of the NY Fed over monetary policy, i.e. to leave the selection process as it is and put the NY Fed on more equal footing with the other regional banks. This would require administrative changes that put control over the day to day execution of monetary policy (i.e. the buying and selling of financial assets as directed by the monetary policy decisions) into the hands of the Board of Governors, or some other agency within the Fed, and those would be big changes. But given the present ability to do much of this electronically (though not all) from Washington, or to locate an agency of the Board of Governors proximate to Wall Street, it is within the realm of possibility.

    Posted by on Sunday, June 20, 2010 at 11:07 AM in Economics, Monetary Policy, MoneyWatch, Politics | Permalink  Comments (3)


    Feed You can follow this conversation by subscribing to the comment feed for this post.