The Libor scandal has not generated the amount of interest in the U.S. as it has in the U.K. and Europe. And yet it may presage similar investigations closer to home, involving the Federal Reserve.
A GAO study of Federal Reserve Bank Governance in October 2011 found shortcomings in the Federal Reserve’s governance of outside directors in the Reserve Banks. The report raised questions about outside directors’ involvement in the emergency programs authorized by the Federal Reserve Board during the financial crisis, generating the appearance of conflicts of interest.
From the creation of the Federal Reserve System, the Federal Reserve Act has required the Reserve Banks to include directors on their boards to be representatives of the member banks. As the GAO study pointed out, this requirement creates an appearance of a conflict of interest because the Federal Reserve System has supervisory authority over the banks.
The GAO study went on to find current Federal Reserve compliance practices to be inadequate: “However, without more complete documentation of the directors’ roles and responsibilities with regard to the supervision and regulation functions, as well as increased public disclosure on governance practices to enhance accountability and transparency, questions about Reserve Bank governance will remain.”
The report noted that there are no restrictions in Fed rules on directors lobbying the Fed on behalf of their banks. The rules also allow directors tied to outside banks to participate in decisions involving how much interest to charge financial institutions and how much credit to provide healthy banks and institutions in “hazardous” condition. When situations arise that run afoul of Fed’s conflict rules and waivers are granted, the GAO said the waivers are kept hidden from the public.
The 108-page report found that at least 18 specific current and former Fed board members were affiliated with banks and corporations that received emergency loans from the Federal Reserve during the financial crisis, including ties to Goldman Sachs, JP Morgan and General Electric.
In 2008, the New York Fed approved an application from Goldman Sachs to become a bank holding company giving it access to cheap Fed loans. During the same period, Stephen Friedman, chairman of the New York Fed, sat on the Goldman Sachs board of directors and owned Goldman stock, something the Fed’s rules prohibited. He received a waiver in late 2008 that was not made public. After Friedman received the waiver, he continued to purchase stock in Goldman from November 2008 through January of 2009 unbeknownst to the Fed, according to the GAO.
The Federal Reserve Bank of New York consulted with General Electric on the creation of the Commercial Paper Funding Facility. The Fed later provided $16 billion in financing for GE under the emergency lending program while Jeffrey Immelt, GE’s CEO, served as a director on the board of the Federal Reserve Bank of New York.
The report also noted Jamie Dimon’s apparent conflicts while serving on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs. In 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns. At the time, Dimon persuaded the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. He also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank.
No one has suggested that outside directors in the Fed Reserve system exert the same influence that Barclays and other banks had on Libor. However, the 2011 GAO study strongly suggests that Federal Reserve governance controls on outside directors are inadequate. If true, it gives the opportunity for enterprising journalists or politicians to generate a U.S. version of the Libor scandal.