Centralizing power at the Fed in Washington, D.C., one stone at a time. (Library of Congress/Harris & Ewing)
“Washington Strips New York Fed’s Power” heralded an eye-opening Wall Street Journal article last week that detailed changes underway at the Federal Reserve. Typically, the Fed’s Board of Governors in Washington delegates authority to the New York Fed to supervise financial institutions on Wall Street. But the board in recent years — only now apparently coming to light — has centralized bank supervision in Washington, presumably out of concern that the New York Fed suffers from severe regulatory capture. In short, the New York Fed appears to be more loyal to bank interests than to the public’s interest.
How should we understand this move to undermine the most powerful of the Fed’s regional reserve banks? There is of course an exhaustive literature on regulatory capture in political science and economics, with excellent new work on regulatory capture in the financial sector published by the Tobin Project. Here, I want to narrow my focus to the political import of the board’s move.
First, charges of regulatory capture at the New York Fed are endemic to the governance of the Fed. Prospects for capture were arguably written into the Federal Reserve Act in 1913. The 12 regional reserve banks are roughly akin to private corporations: member banks are required to hold stock in their respective reserve bank. Moreover, most of the directors of the reserve banks (most of whom are selected by member bankers) choose the president of the reserve bank. In other words, the regulated choose their regulator. (The head of J.P. Morgan Chase, for example, formerly sat on the board of the New York Fed, the reserve bank charged with supervising J.P. Morgan Chase.) Bloomberg columnist Justin Fox last week argued that “The Fed is Weird. Get Over It.” But there is an inherent and troubling conflict of interest between the reserve bank’s public function and their private governance, exacerbated by the board’s practice of delegating supervisory authority to the regional banks. (Potential conflicts were explored here in 2011 by the Government Accountability Office and more recently in a Brookings paper.)
Second, the WSJ revelation that William Dudley, president of the New York Fed, has lost most of his supervisory authority to the Fed’s Board of Governors raises doubts about how forthcoming the board has been to Congress about reforming its regulatory processes in the wake of the financial crisis. Indeed, Democratic senators have recently accused the New York Fed of being endemically captured by Wall Street banks: Senator Elizabeth Warren (D-Mass.) warned Dudley last fall that “You need to fix it, Mr. Dudley, or we need to get someone who will.” Apparently, the Board of Governors had already taken steps several years ago to attempt to fix the problem. Had the board really not informed Congress, as we might infer from the WSJ article? To be sure, Fed officials had previously mentioned in congressional testimony and posted on their website details about the new supervisory committee highlighted in the WSJ article, known as the Large Institution Supervision Coordinating Committee (LISCC). In other words, the board’s new arrangement seems to have been hiding in plain sight. Still, one wonders why the institutional makeover of the Fed’s supervisory powers had not been more widely known, especially to its congressional overseers.
Third, the board’s move to recoup its supervisory powers fits readily into the history of the Fed’s development over its first century. Centralizing power in the hands of the Washington-based board has been a recurring dynamic throughout Fed history. A decentralized system of reserve banks largely controlled by bankers was the price that President Woodrow Wilson paid when he pushed Congress to create the Fed in 1913, undermining the concept of a “central” bank. Ever since, lawmakers have repeatedly pushed (often succeeding) in unraveling the original compromises that empowered the privately-controlled regional reserve banks. The goal has been to concentrate power in the hands of president-appointed, Senate-confirmed board of governors in Washington at the expense of the reserve banks. Granted, in this case, undercutting the supervisory and regulatory influence of the New York Fed appears to have been instigated by the board, not by Congress. But the move is consistent with the broader arc of the Fed’s institutional evolution.
Frustration with the power and performance of the New York Fed is an old theme for critics in and outside of the Fed. Indeed, holding the New York Fed accountable for its pre- and post-crisis performance currently seems popular with both Democratic and Republican senators on the Senate’s banking panel. Still, partisan and bicameral hurdles to legislating in today’s Congress raise doubts about the ease of reforming the Fed. I suspect that the board preferred to move internally to recoup the New York Fed’s supervisory and regulatory authority than to wait for Congress to act — especially given House Republicans’ support for imposing new audits on the Fed. Ultimately, whether the board’s move proves effective– in limiting regulatory capture of the New York Fed or in forestalling congressional interest in reform — remains to be seen.
