If Tim Geithner says it's a problem that the CEO of America's biggest bank chairs the New York Fed board, be assured it is
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JP Morgan CEO Jamie Dimon testifying on Capitol Hill. His role as chairman of the board of the New York Federal Reserve has come under scrutiny. Photograph: Haraz N Ghanbari/AP
The Federal Reserve System was created in 1913, a late arrival to the world of central banks. The American public and banking community had long distrusted the notion that there should be one authority in charge of managing the financial system. At least since the presidency of Andrew Jackson in the 1830s, there had been aversion to giving too much power to one bank. Much of this suspicion of can be traced back to Thomas Jefferson and his belief that that a "financial aristocracy" could take over the newly independent United States.
The crisis of 1907 convinced mainstream opinion that the US needed a way to prevent severe financial instability – and European experience suggested this could be done by bestowing special powers on a legal entity that could manage the supply of credit within the then prevailing framework of the gold standard. Top Wall Street bankers of the day wanted to control such an entity. Bankers elsewhere in the country, however, resisted this centralization of power. In line with the anti-monopoly sentiment of the day, leading voices argued for a greater role of government in limiting the power of what was called the "money trust".
At inception, the Federal Reserve System comprised 12 reserve banks – each responsible for its own "district" – and a Federal Reserve Board in Washington, DC. At least initially, the Federal Reserve Bank of New Yorkproved the most powerful element of this system. Headed by Benjamin Strong, a long-time associate of the original JP Morgan, the New York Fed dominated credit and monetary policy thinking through the early 1930s.
By 1935, a string of banking crises and a prolonged slump in economic activity produced a political reassessment. Under the Banking Act of 1935, a more politically independent, seven-member board of governors of the Federal Reserve was created – and power was shifted towards these presidential appointees, particularly the chairman. With the end of the traditional gold standard in the 1930s, central banking came to take on even greater importance in the economy.
Although it is now more clearly subject to the authority of the board of governors, the Federal Reserve Bank of New York remained the most important component within this system. Partly this is because the president of the New York Fed always votes on and serves as vice-chair of the federal open market committee (FOMC), which sets monetary policy (members of the board of governors are always on the FOMC; the other regional Fed presidents all attend but voting rights rotate among them.)
The New York Fed remains important also because the country's international financial transactions run through the second district and, more broadly, because so many large banks are based in New York. In normal times, the actual implementation of monetary policy runs through the New York Fed to a significant degree. Much of the Federal Reserve System's technical expertise on derivatives and on essential regulatory details – such as capital requirements – is based in the New York Fed.
When the financial system comes under stress, as it did in 2007-2008, the New York Fed is critical as the eyes and ears of the system – and as a mechanism through which emergency funds can be provided to the market. Reflecting this, the de facto troika in charge of trying to preserve financial stability under George W Bush comprised Treasury Secretary Hank Paulson, Fed Chairman Ben Bernanke, and President of the New York Fed Tim Geithner.
Under the 1913 Act, the regional Feds each have their own boards of directors – comprising nine people, divided into three "classes" that reflect the initial compromise between powerful bankers and a skeptical public. Class A directors are elected by banks to represent banks. Class B directors are elected by banks to represent the public (at least, that is what it says in the legislation). Class C directors are appointed by the board of governors to represent the public.
Arguably, this system has always been tilted towards over-representing bankers, particularly those based on Wall Street. This issue has become particularly sensitive of late because Jamie Dimon – CEO of JP Morgan Chase, now the largest bank in the country – is a class A director of the New York Fed.
Dimon's firm bought assets from the failing Bear Stearns in spring 2007, with financing provided by the New York Fed, yet he remained on the New York Fed board. Dimon has also opposed many key elements of financial reform over the past four years, including on derivatives, the framework for capital requirements, and the current design of the Volcker Rule (intended to limit excessive risk-taking by big banks).
He has insisted that modern global megabanks can manage their own risks, but his firm is now under investigation by various authorities with regard to losses in its London-based proprietary trading operations. It's hard to see how any such investigation can be credible while Dimon holds such an influential position.
Defenders of the New York Fed counter that his board membership does not confer influence on Dimon, and Dimon himself says he has "an advisory role". But Jamie Dimon is on the board of directors, with well-defined oversight activities, not on one of the New York Fed's sevenadvisory groups.
Class A directors are kept well away from the supervision of banks. Following the 2010 Dodd-Frank financial reform act, such directors can no longer participate in the selection of regional Fed presidents. But Dimon sits on the management and budget committee, which oversees the activities of the New York Fed's research and other departments – including the promotion and compensation of top personnel. The thinking of these staff members with regard to capital requirements is absolutely critical for financial stability going forward.
Dimon's firm has also donated money to the nonprofit headed by a class C director (and current chair of the New York Fed board). The class C directors oversee, in part, the activities of the supervision department.
No one has been accused of any wrongdoing. The Fed's rules on the relationships between different types of directors seem lax. The policies of the New York Fed are not determined solely by Jamie Dimon. But, asTreasury Secretary Tim Geithner conceded recently, these governance arrangements create a perception problem that needs to be addressed.
The political legitimacy of the Federal Reserve System is at risk.
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