GAO Fears Conflicts of Interest at Fed

WASHINGTON — The Federal Reserve Board must step up efforts to avoid possible conflicts of interest that result from how board members at the 12 regional banks are selected, the Government Accountability Office said in a report issued Wednesday.

The report is likely to provide more ammunition to central bank critics who have long raised concerns about how bank directors are chosen. Fed-member banks are permitted to elect six of the nine board members at each regional bank — effectively giving the regulated some oversight over the regulator.

"Clearly it is unacceptable for so few people to wield so much unchecked power," said Sen. Bernie Sanders, I-Vt., who pushed for a GAO study of the situation as part of the Dodd-Frank Act. "Not only do they run the banks, they run the institutions that regulate the banks."

While the GAO found cause for concern, however, it did not find evidence of wrongdoing. Instead, it suggested the situation creates the "appearance" of conflicts of interest, and said the Fed must do more to avoid giving off such appearances.

Failure to do so, the GAO said, could call into question the independence of the central bank from those institutions it regulates. "Although directors' affiliations with financial firms do not necessarily create conflicts of interest, they may complicate the directors' relationships with the Reserve Banks and increase public scrutiny of them," its report said. This was especially true during the financial crisis when the Fed created a number of emergency lending programs to help buoy the system as the lender of last resort, spotlighting the issue of how involved board members at the banks were in crafting such programs.

"Questions were raised as to whether the directors representing member banks had any involvement in the Reserve Banks' role in supervising member banks," the report says.

The GAO identified 18 former and current directors from nine Fed regional banks who were affiliated with institutions that used at least one of the Fed's emergency lending programs. The report did not name them, but it described a few in enough detail to make it clear who the agency was talking about. One such example, cited by the GAO, was former Federal Reserve Bank of New York Chairman Stephen Friedman, who had been director of Goldman Sachs and held stock with the company.

At the time of his election, Goldman was an investment company and Friedman's position as director was a nonissue. But once Goldman became a bank holding company in September 2008, Friedman was no longer eligible to serve as director.

Instead of removing him from the board, however, the New York Fed sought a waiver to allow Friedman to continue to serve. One bank official explained it would have been difficult to find a replacement during the middle of a crisis, and there was already another vacancy on the board at the time.

But the fact the decision was not made public at the time worried the GAO. "These situations have raised questions as to whether directors have greater access to Reserve bank officials than other financial institution officials and whether they have influence over matters that may affect banks or institutions with which they are affiliated," the report says.

Similarly, former Lehman Brothers CEO Richard Fuld served as a director at the New York Fed at the same time the bank was discussing possible participation in one of the Fed's emergency lending programs. Typically, directors affiliated with troubled financial institutions are encouraged to resign from the board. In this case Fuld stayed on as director, but voluntarily resigned before Lehman filed for bankruptcy.

JPMorgan Chase CEO Jamie Dimon was another example. He was on the board of the New York Fed the same time his company was participating in several emergency programs.

Even so, the GAO did not find evidence that the boards of the Reserve banks "participated directly in making any decisions about authorizing, setting the terms of, or approving a borrower's participation in the emergency programs." That conclusion was supported by Fed Chairman Ben Bernanke, who wrote a letter in response to the GAO report.

"The report also confirms that the Federal Reserve Board and Reserve Bank have in place a number of policies and procedures to address both potential and perceived conflicts of interest associated with a governance structure that includes bankers on the boards of Reserve Banks," Bernanke wrote. He noted the GAO found no evidence of "special treatment" of firms with director representation in any discount window lending decision or regarding the emergency lending facilities the Fed established during the crisis.

Also, the report found no instance where a Reserve bank director was involved in any supervisory matter involving an institution with which the director was affiliated.

Still, the GAO said more must be done to combat the potential appearance of impropriety.

"While these relationships may not give rise to actual conflicts of interest, they can create the appearance of a conflict as illustrated by the participation of director-affiliated institutions in the Federal Reserve System's emergency programs," the report says. "Most Reserve Banks' bylaws do not document the role of the board in supervision and regulation. To increase transparency, GAO recommends that all Reserve Banks clearly document the directors' role in supervision and regulation activities in their bylaws."