In my last column, I wrote about how the New York Federal Reserve Bank, the most powerful financial institution in America after the national Fed, has been entirely dominated by Wall Street bankers, without any meaningful public input. In this column, I want to suggest how this governance crisis could be remedied.
Steve Friedman quickly resigned as New York Fed board chair two weeks ago, when it came out that he bought Goldman Sachs stock while the Fed was dealing with Goldman's regulatory issues. The New York Fed would have us believe that his resignation clears up any potential conflict at the institution. But the fact that Friedman, a former Goldman chairman, was on the board as a "public" representative requires us to look at the possible intersections between the Fed's actions and the business interests of the Fed's other "public " representatives.
Of the New York Fed's nine board members, six are chosen to represent the public. Three of these six are picked by member banks; the other three are selected by the Fed's board of governors in Washington, D.C. The member banks somehow have been able to fill only one of the three "public" board positions, so the public voice is limited to Jeff Immelt, the chairman of GE. Yes, that's right: The chair of GE, one of the nation's largest finance companies, is the only public voice on the New York Fed chosen by the member banks.
One might fairly presume that the public representative on the board and the company he chaired would not be a direct beneficiary of Fed policies and bailouts. Such connections would, of course, be contrary to the ideal of bringing the independent, nonbanking perspective of the public to the board. But GE has gained hugely from Fed policies. It has been a significant beneficiary of the Commercial Paper Funding Facility, created by the Fed in October 2008 to insure liquidity in the commercial paper market. By putting a federal guarantee behind GE's issuance of commercial paper, GE saves very significantly on its cost of capital, thereby increasing its margins. * A back-of-the-envelope estimate of the value of these federal guarantees on the $80 billion in commercial paper that GE has issued with CPFF support: roughly $2.5 billion per year.
Now, the fact that the Fed reinforced the commercial paper market and that GE therefore got these guarantees may be wholly justifiable as a matter of policy. But why is it that GE, unlike virtually every bank that got bailout funds, did not give warrants to the government to provide for some potential return of value to the taxpayer? That question remains to be answered.
Immelt is a good and honorable man, and I do not mean to suggest that he has abused his position as a New York Fed board member for personal advantage. But I do wonder whether the board has the breadth of vision that it's supposed to have, given that two-thirds of board members are supposed to represent the public. Despite a year of financial crisis and bailouts, Wall Street still doesn't seem to acknowledge that its insular, self-dealing structure has not only destroyed public trust but undermined financial institutions. There is still a fundamental misunderstanding at the Wall Street level about the propriety of board members benefitting personally from corporate activity, about the true meaning of "public" board member, and about the nature of the fiduciary duty that public board members owe to the public.
The structure of the New York Fed can be fixed, if the member banks take their responsibility to the public seriously. Instead of stocking the board with insiders such as Immelt, the banks should pick truly independent voices. Here are a few obvious choices: Jack Bogle, the brilliant founder of the Vanguard funds, now retired, and an essential voice on the nature of fiduciary obligations in the capital markets; Barbara Roper, the sophisticated director of investor protection at the Consumer Federation of America; Harvey Goldschmid, formerly an SEC commissioner and general counsel and currently a Columbia law professor whose writings about the capital markets are astute and prescient; Arthur Levitt, the former SEC chair, whose reformist tendencies were real and often at odds with the Wall Street's desires; and Joseph Stiglitz, a Nobel laureate who has been remarkably accurate in his macroeconomic analysis.
The Fed has been absent as a meaningful Wall Street regulator for too long. The reform process can start if the existing board vacancies are filled with genuine public voices, not Wall Street-ers who masquerade as public representatives.
Correction, May 20, 2009: The article originally implied that GE is currently saving on its cost of capital by using the Commercial Paper Funding Facility. According to GE, it has not used the CPFF since February. (Return to the corrected sentence.)