By Simon Johnson. This is a long blog post, about 2,800 words.
On the “PBS NewsHour” in late May, Treasury Secretary Timothy Geithner indicated that the continued presence of Jamie Dimon, the chief executive of JPMorgan Chase, on the board on the Federal Reserve Bank of New York creates a perception problem that should be addressed. He used the diplomatic language favored by finance ministers, but the message was loud and clear: Mr. Dimon should resign from the board of the New York Fed.
Mr. Dimon has been an effective opponent of financial reform over the past four years. He remains an outspoken advocate of the view that global mega-banks can manage their own risks, and he has stated publicly that the new international and national rules on capital requirements are “Anti-American.”
Mr. Dimon now finds himself at the center of a number of official investigations into how his bank could have lost so much money so quickly in its London-based trading operation – including whether adverse material information was disclosed to regulators and to markets in a timely manner.
(The Wall Street Journal reported this week that serious concerns about the London trading operation had been raised – but not made public – two years ago; the New York Times has reported similar concerns. On Wednesday, the Senate Banking Committee interviewed Mr. Dimon; the event was inconclusive, perhaps because JPMorgan Chase is a major donor to some members of the committee.)
On Monday, Lee Bollinger, chairman of the board of the New York Federal Reserve Bank and president of Columbia University, weighed in to contradict Mr. Geithner in no uncertain terms. The Wall Street Journal reported Mr. Bollinger’s view: Mr. Dimon should stay on the New York Fed’s board, and critics attacking the Fed have a “false understanding” of how it works. (Please note the correction to the original Wall Street Journal story, with an important change to the reporting of what Mr. Bollinger said.) This is a remarkable statement in part because Mr. Geithner is himself a former president of the New York Fed, so it is hard to see how he would have a false understanding of how the Fed works.
More generally, however, Mr. Bollinger’s intervention is inadvertently helpful, as it opens the door to a more productive conversation about the exact nature of the institutional weakness that lurks at the heart of the Federal Reserve System and that threatens our financial stability more broadly.
I stick up for the Federal Reserve System in many settings, including on Capitol Hill. We need a central bank that can provide emergency liquidity support when needed. That is a major lesson from the financial disaster and banking collapses that were an integral part of the Great Depression.
A significant number of Americans assert that the central bank should be abolished. With respect, I have argued elsewhere that this view is misguided. But the anti-Fed view continues to gain traction, and versions of it are increasingly manifest among mainstream Republicans (as well as some people on the left of the political spectrum).
The problem is that sensible liquidity support can easily become inappropriate subsidies, particularly when some financial institutions are considered too big to fail. Outsiders will never observe the real-time information on which central banks make decisions, so we need to be able to trust the people running our central bank, otherwise the system will go badly wrong — again.
As Esther George, president of the Kansas City Fed, put it recently, the “integrity, dignity and reputation of the Federal Reserve System” need to be preserved. As in ancient Rome, “Caesar’s wife must be above suspicion.”
Mr. Bollinger’s intervention brings a fresh spotlight to a deep governance problem at the heart of the Federal Reserve System – prominent financial sector executives and their close allies are much too involved in how the New York Fed operates. This is partly an anachronistic holdover from the original Federal Reserve Act of 1913 – and reflects the political milieu of that time, in which bankers had to be persuaded to accept a central bank (for more background and a lot of relevant technical detail, I recommend Edwin Walter Kemmerer’s “The ABC of the Federal Reserve System,” published in 1920).
But it is also an all-too-accurate reflection of where we stand today with regard to global mega-banks and the large, nontransparent and highly dangerous subsidies they extract from the rest of society by being too big to fail.
The people who run global mega-banks get the upside when things go well – they are paid based on their return on equity unadjusted for risk, so they prefer a lot of debt piled on top of very little equity. When things go badly, the downside is someone else’s problem – in the first instance, typically, the Federal Reserve’s.
The New York Fed has a special role – as the eyes and ears of the Federal Reserve System on Wall Street. It is also the repository for much of the expertise of the system on the complexities of modern capital requirements.
The board of directors of the New York Fed has, in part, the following mandate:
“In the exercise of its management oversight responsibilities, a Reserve Bank’s Board of Directors reviews and establishes with management the Bank’s annual goals and objectives, reviews and approves the budget, and conducts an independent appraisal of the performance of both the Bank (including its efficiency and productivity) and its president and first vice president. The Reserve Bank directors supervise, through a general auditor whom they appoint, and who reports directly to them, the maintenance of an effective system of internal auditing procedures.”
In the run-up to 2007, the complacency of the entire Fed System can be traced in part to the cozy relationship between the New York Fed (headed then by Mr. Geithner) and the Wall Street elite. We cannot let this happen again. Yet all too often with regard to financial reform today, we find the Fed lagging rather than leading the thinking and the implementation that Dodd-Frank calls for on many issues.
A version of the pre-2007 governance problem is playing out in full view, this time through interactions between different “classes” of directors at regional Feds. There are three directors in each “class”; nine directors in all at each regional Fed (the Federal Reserve provides this primer on its structure).
Class A directors are elected by member banks to represent banks. As a matter of practice, bankers have taken these positions – although there is no presumption that any of them should head a too-big-to-fail institution and no legal requirement that any should actually be bankers.
An elegant solution to the current problem would be to replace Mr. Dimon with a distinguished former banker, for example John Reed – previously chief executive of Citigroup and more recently a critic of very large banks. (Mr. Reed and I are both on the new systemic risk council created by Sheila Bair, the former chairman of the Federal Deposit Insurance Corporation. This general idea, but not Mr. Reed’s name, was suggested to me by a leading financial journalist.)
The awkwardness raised by the existence of Class A directors was recognized most recently by Congress during the debate on the Dodd-Frank financial reform legislation, as a result of which such directors are no longer involved in selecting the heads of the regional Federal Reserve Banks. They are also not allowed to be engaged in the selection and oversight of supervisory personnel. But this just shifts the exact locus of the problem.
Class B directors are elected by member banks “to represent the public.” This is a very strange concept; it’s hard to understand how it made sense even in 1913.
The heart of the matter is Class C directors, who are appointed directly by the Board of Governors also “to represent the public.” At most regional Feds today, these directors are typically the chief executive or chief financial officer of a significant regional business). At the New York Fed, however, the three Class C directors are all heads of nonprofits, at least two of which – Columbia University and the Metropolitan Museum of Art – have high-profile fund-raising efforts.
Only Class C directors (and Class B directors, if they are not involved in running a savings institution supervised by the Fed) are involved in the selection, appointment and compensation of Reserve Bank officers involved in supervision.
The Federal Reserve – both at the Board of Governors level and in New York — sets high ethical standards for its directors in generally. But there are apparently no rules that effectively constrain the nature of interaction among directors.
According to a statement reported on Tuesday by The Guardian, a British newspaper, the JPMorgan Chase Foundation donated about $2 million to Columbia University in recent years. (I’m not sure this includes pledges and continuing support; we may learn more about this in the days ahead.)
There are many problematic issues associated with Mr. Dimon’s position on the board of the New York Fed, but he is kept well away from supervision. However, he is allowed to give money to Mr. Bollinger’s university. (I understand that the New York Fed allows a Class C director to solicit donations from a Class A director only in his “professional role” as president of Columbia University, not as a fellow board member. This strikes me as a meaningless distinction.)
If they saw such an arrangement at work in any other country, American officials would recoil in horror – as they did, for example, when the inner workings of countries such as Indonesia and Russia came into sharper focus during the 1990s and when the nature of governance in Greece became more widely appreciated recently.
Why then is such behavior tolerated not just in the United States, within the inner sanctum of arguably the single most powerful institution in the country?
To anyone who does not work at the Federal Reserve, this kind of monetary transfer to an organization run by a Class C director is obviously inappropriate. I’m surprised it is allowed under the ethics rules of Columbia University. (When I asked to put questions to Mr. Bollinger, I was told that he was traveling and unable to talk with me directly.) However, through a representative, he did email a statement, part of which reads:
“The Federal Reserve Act embodies the policy judgment by Congress that by creating distinct classes of directors selected from different constituencies and diverse parts of the economy, and with different degrees of association with the financial industry, the Board will be constituted in a manner that allows it to effectively serve the public’s interest in expressing views on the state of the economy. Significantly, neither the Board nor any of its individual members have any involvement in the Fed’s supervisory responsibilities over financial institutions, nor does the Board have any authority over supervised institutions such as JPMorgan. Supervisory responsibilities are conducted by New York Fed officials under authority provided by the Federal Reserve Board. Prior board chairs to have been drawn from New York’s major business, civic, cultural and educational institutions. As required by statute, the chair is selected from among the Board’s Class C directors, appointed by the Board of Governors to represent the public.”
The board of the New York Fed may well express “views on the state of the economy.” But it is also formally in charge of the organization in many respects. If it were not, it could have been changed to a purely advisory group long ago. Mr. Bollinger chairs not just the board but also its management and budget committee (MBC), which has specific oversight functions that are made quite clear on the New York Fed’s website). Mr. Dimon is also a member of this committee. Section 4 of the Committee’s charter reads in part:
“Except as otherwise prohibited in the Bank’s bylaws, the MBC is responsible for reviewing and endorsing the Bank’s strategic plan, the framework forcompensation of the Bank’s senior executives (Senior Vice President and above) and any policies regarding such compensation, the budget and self-evaluation of the Bank’s performance prepared by Bank management, prior to submission to the Board of Governors of the Federal Reserve System for action.”
And either the Class C directors of the New York Fed oversee the “selection, appointment, or compensation of Reserve Bank officers whose primary duties involve supervisory matters” or they do not. This is not a question to which a satisfactory answer can be, “only a little bit.” The fact that the Board of Governors is also involved is somewhat reassuring but not decisive – how on the outside are we to know who makes which final decision and what basis?
The good news is that the sum of donations from Jamie Dimon’s firm is small relative to the total fund-raising of Columbia University. A representative emailed me that, “regarding JPMorgan Chase and Columbia, it might be helpful to know that placed in the context of the $4.9 billion raised by the University since 2004, JPMorgan Chase is not one of Columbia’s major donors. Specifically, over the eight-year period, JPMorgan has given $845,000, as well as $989,000 from its corporate foundation and $121,000 from employee matching gifts to support the university’s mission of scholarship, teaching and research. This total represents .04% of overall university fundraising during this period.” That should make it easy for them to return the money to the JPMorgan Chase Foundation. In fact, I don’t think that should even be a long or difficult conversation for the trustees of Columbia, which includes Vikram Pandit, the chief executive of Citigroup. Avoiding even the appearance of a conflict of interest is most important for all involved.
To be clear, I am not accusing Mr. Bollinger of any wrongdoing. Mr. Bollinger is a leading legal scholar and one of the top thinkers on and defenders of the First Amendment. (I particularly recommend his “Uninhibited, Robust and Wide Open: A Free Press for a New Century,” published in 2010.) I also understand that Mr. Bollinger has not personally solicited any donations from Jamie Dimon or JP Morgan Chase.
Of course, the question of who donates how much to elected officials permeates all of lobbying and modern American election campaigns – and it is an important theme in the commentary on Mr. Dimon’s gentle treatment by the Senate Banking Committee on Wednesday. But just because bankers are powerful in general does not excuse the specific governance weaknesses within the Federal Reserve System – unless we are resigning ourselves to no longer be a serious country.
The fault here lies with the rules and expectations set by the Board of Governors of the Federal Reserve System. (I have for several weeks been seeking a meeting with any governor of the Federal Reserve, to present a petition I organized seeking Mr. Dimon’s removal from the board of the New York Fed. I am currently confident that I will be offered the opportunity to meet soon with senior staff; I will report on that conversation in this space.)
More broadly and with regard to the substance of the matter, Mr. Bollinger’s choice of words was unfortunate. No one has a false understanding of the situation. He has his understanding of how the New York Fed works within the Federal Reserve System. The rest of us, looking in, have a different understanding of the role of the Fed in the boom-bust-bailout cycle that has dominated the last decade or so.
The prevailing view at the top of Federal Reserve remains indifferent to how the rest of us view their legitimacy; they live in a bubble – in the old, pre-Greenspan meaning of the expression. And the Board of Governors is making a serious mistake in perpetuating this indifference (and borderline arrogance, in my experience) – jeopardizing, through inaction, the political future of the institution.
For Ben Bernanke, the chairman of the Federal Reserve, to attempt to shift the blame entirely onto Congress last week is, at best, disingenuous. The Fed Board of Governors has plenty of power to tighten governance at regional Feds, even within the framework provided by existing legislation – a point made in an important Op-Ed by Jonathan Reiss, an experienced financial services industry executive, which appeared last night on Bloomberg View.
In addition, the Federal Reserve Act should be amended. The boards of regional federal reserves should become advisory groups. If local boards are retained in any fashion, they should be filled with distinguished experts toward the end of their careers – as is the case at the National Transportation Safety Board. (Mr. Reiss also has some very constructive suggestions.)
Columbia University should return the donations it received from JP Morgan and the JPMorgan Chase Foundation while Mr. Bollinger was a Class C director. And Mr. Dimon should resign from the board of the New York Fed.
An edited version of this post appears this morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire column, please contact the New York Times.