Do regional bank directors, such as the president of the New York Fed, have any power in a financial crisis?
And what does it mean when the media describe presidential candidate Herman Cain as having “served on the Federal Reserve Board”?
These are two of the good questions about the Federal Reserve system raised recently by readers.
The first issue is important, especially because the president of the New York Fed nominally reports to a board of directors that always includes some prominent Wall Street executives. Does their presence affect what actions get taken in a financial crisis? Can the directors order that some financial firm be bailed out?
The second is less critical, but points up some common confusion about the way the Fed is organized.
First, a quick review:
The Board of Governors of the Federal Reserve System, with its ability to control the country’s money supply, is an important institution and wields great power, at least within its scope of operation as a central bank. These governors are appointed by the nation’s president and confirmed by the Senate.
The individual boards of directors of each of the 12 Federal Reserve District Banks, in contrast, have little power. They play a useful advisory and administrative role within the system. But they have minuscule influence on national policy.
That is important to remember when evaluating news or arguments about the role of the boards of directors of the regional banks. They don’t run the Fed in any important way.
Some might wonder how we ended up with regional banks in the first place. Because of the political compromises necessary to bring it into being in 1913, the Federal Reserve was established as a decentralized system of 12 privately owned corporations spread from Boston to San Francisco. The stockholders were and are the ordinary commercial banks that chose to join the system.
As with any other private corporation, each district bank has a board of directors. The board ostensibly hires and oversees each bank’s day-to-day management, while representing the interests of the shareholders. That is the theory, at least.
In practice, commercial banks have little say in the decisions of the boards that ostensibly represent them.
There are no annual meetings of a district bank’s shareholders. All shareholder banks, regardless of the number of shares owned, are equal in their impotence. In theory, they vote to choose six of the nine directors, but in practice this is a pro-forma ratification of the slate put forward by the existing board. And three of the nine are named by the Fed Governors in Washington, D.C.
These district bank boards themselves serve primarily to channel information about local economies to the presidents of their respective banks. This may influence the arguments that such presidents make and the votes they cast in meetings of the Federal Open-Market Committee, the Fed’s policy-making body. But in the end, presidents make up their own minds.
The boards do cast periodic votes about their district’s “discount rate,” the interest rate charged on direct loans to banks. This is largely symbolic, however. The rate only actually changes when the Fed’s Board of Governors approves a change for the nation as a whole. And, except during emergency bailouts, such direct lending has almost disappeared as a tool of monetary policy.
So in terms of influencing monetary policy, the district boards have no power other than to express their opinion to their presidents. They cannot tell them what to say or how to vote at the FOMC. In practice, they cannot fire their presidents or even determine their salaries. The presidents’ pay is set by the Board of Governors on a scale that varies with the earnings of financial professionals in the city where the district bank is located.
In concrete terms, this means that the directors of the New York Fed, even though some work for big Wall Street firms, cannot tell their president how to act in a financial crisis, including whom to bail out or not. Yes, there may be excessive coziness that skews the perceptions of the president, but his directors have no practical power to compel him to do anything.
It also means that, while Herman Cain’s service on the board of directors of the Kansas City Federal Reserve Bank shows public recognition of his abilities, he did not serve on the Fed’s Board of Governors. Nor did he play more than a peripheral role in setting monetary policy. And it certainly does not mean that he has any expertise in monetary policy.
All that said, there is one way in which district directors influence history. They do choose their bank’s new president whenever a vacancy arises. Yes, their choice is subject to the veto of the Board of Governors in Washington.
So, in 2003, when the nine directors of the New York Fed selected Timothy Geithner as their new president, they influenced history. But we will never know in what direction.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.