Do regional bank directors, such as the president of the New York Fed, have any power in a financial crisis?
And what did it mean when the media described candidate Herman Cain as having “served on the Federal Reserve Board”?
These are two good questions raised by readers.
First, a quick review:
The Board of Governors of the Federal Reserve System, with its ability to control the country’s money supply, is an important institution. They are appointed by the president and confirmed by the Senate.
The individual boards of directors of each of the 12 Federal Reserve District Banks, in contrast, have little power. They play a useful advisory and administrative role but have minuscule influence on national policy.
Some might wonder how we ended up with regional banks. Because of the political compromises necessary to bring it into being in 1913, the Federal Reserve was established as a decentralized system of 12 privately owned corporations. The stockholders were and are the commercial banks that chose to join the system.
Each district bank has a board of directors. These district bank boards serve primarily to channel information to the presidents of their respective banks.
This may influence the arguments that such presidents make and the votes they cast in meetings of the Federal Open Market Committee, the policy-making body. But in the end, they make up their own minds.
A district board does cast periodic votes about its district’s “discount rate,” the interest rate charged on direct loans to banks. But this is largely symbolic. The rate actually changes only when the Fed’s Board of Governors approves a change for the nation as a whole. And, except during emergency bailouts like those in 2008-09, such direct lending has almost disappeared as a tool of monetary policy.
So in terms of influencing monetary policy, the district boards have no power other than to express their opinion to their presidents. In practice, they cannot fire their presidents or even determine their salaries. The presidents’ pay is set by the Board of Governors on a scale that varies with the earnings of financial professionals in the city where the district bank is located.
This means that the directors of the New York Fed, even though some work for big Wall Street firms, cannot tell their president how to act in a financial crisis, including whom to bail out or not. Yes, there may be excessive coziness that skews the perceptions of the president, but his directors have no practical power to compel him to do anything.
It also means that, while Cain’s service on the board of directors of the Kansas City Federal Reserve Bank shows public recognition of his abilities, he did not serve on the Fed’s Board of Governors. Nor did he play more than a peripheral role in setting monetary policy.
All that said, there is one way in which district directors influence history. They do choose their bank’s new president whenever a vacancy arises. Yes, their choice is subject to the veto of the Board of Governors in Washington.
So, in 2003, when the nine directors of the New York Fed selected Timothy Geithner as their new president, they influenced what would happen at the end of the decade. We will never know how history might have unfolded differently if someone else had been named to the post, even though historians will speculate about it.
Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.
