Under a staggered-term theory of the Board of Governors, the number in the column to the furthest right should be 0.5 (an appointment every two years). As Table 2 illustrates, only President Kennedy’s appointment control over the Board met that standard. Although the legal mechanism was designed to prevent Presidential control of Governor appointments, the practice of frequent resignations has undermined that check completely.
The decision not to serve a full term is all the more surprising in consideration of the statutory incentive to serve the full term: Governors are precluded “during the time they are in office and for two years thereafter to hold any office, position, or employment in any member bank.”196 But there is a proviso: “except that this restriction shall not apply to a member who has served the full term for which he was appointed.”197 The opportunities to translate the benefits of Board service to personal rewards in the banking sector are probably significant. And yet, Governors much more often than not end their terms early.
The consequence here is that the extraordinary legal institution—a term of service that is more than double the norm for other independent commissions—is undermined completely by the practice of frequent resignation. Presidents can pick their Boards because Governors do not serve their full term.198 Whether because the anonymity of the “C-list political celebrity” or the lack of authority relative to the Chair, the reason is unclear.
19.Independence from the Treasury
As mentioned above, the standard story of central bank independence refers to the temptation for the political branches—usually the executive—to inflate the currency in order to buy prosperity.199 Thus, when defenders talk of the importance of central bank independence, they usually refer to government’s temptation to monetize the public debt, that is, to print money to buy government securities to keep the interest rates on those securities artificially low. This speaks directly to the relationship between the Treasury (the entity responsible for the maintenance of the public debt) and the central bank (the entity responsible for the nation’s currency). The Fed’s relationship with the Treasury is thus an important one, and indeed, could and perhaps should take its place on equal footing with the other audiences to which the Fed caters.200 And, important for understanding the institutions of Fed independence, it is significant that the relationship is governed by a strong sixty-year tradition of informal independence with essentially no foundation in law.
The history of Fed-Treasury interactions illustrates perfectly the ways that legal modifications do and do not change the ways that audiences influence the Fed. Consider one of the most striking changes wrought by the Bank Act of 1935. Under the original 1913 Act, the Secretary of the Treasury was the Chairman of the Federal Reserve Board. His presence was viewed as the means by which the Fed would be accountable to the people, and was widely opposed by the Republicans who refused to support the statute in 1913. The critics feared that the Secretary would so dominate the Fed’s affairs as to render it not only accountable, but subordinate to the government. Carter Glass, uniquely situated as the author of the House version of the bill and later President Wilson’s Secretary of the Treasury, agreed much later that the Secretary’s inclusion led to this result. In 1935, the Secretary was eliminated from the Board. The absence of that statutory mechanism of control therefore became a legal mechanism of independence.
20.In Practice: The Fed-Treasury Accord Independence
But the story of the Fed’s relationship with Treasury did not end in 1935 with the Secretary’s elimination from the Board. Instead, that relationship became dominated by non-statutory mechanisms. Under the identical statutory structure presently in place, the Federal Reserve, during World War II, was entirely subordinate to the Treasury.201 But in 1951, the Treasury granted the Fed its independence. The so-called Treasury-Fed Accord of 1951 consists of a single, characteristically (for the time and for many decades thereafter) opaque paragraph inserted into the Federal Reserve Bulletin buried between announcements of federal debt issuances:
The Treasury and the Federal Reserve System have reached full accord with respect to debt management and monetary policies to be pursued in furthering their common purpose to assure the successful financing of the Government’s requirements and, at the same time, to minimize monetization of the public debt.202
Even a reasonably well informed citizen or lawyer of the day would likely not have recognized the extraordinary import of this dense sentence. In fact, some in Congress thought very little of so informal an arrangement. In Congressional hearings after the announcement of the Accord, Senator Paul Douglas (D.—Ill., 1949-1967)—long critical of Treasury control of the Board of Governors—thought very little of the Accord and Secretary Snyder’s defense of it. In his words: “Talleyrand said that words were used to conceal thought. I have always thought that words should be used to express thought, and it is the lack of this quality which I find unsatisfactory in your testimony throughout.”203
Unclear though it may be, written with an intent to conceal though it may have been, this sentence forms the basis of the Fed’s continued independence from Treasury. The important aspect of this separation from the Treasury/President is that it is purely informal. Some within Congress thought the informality of it was extremely dangerous for the long-term prospects of an independent Fed.204 With all the care devoted to the legal mechanisms of independence to separate the Fed from the President—length of tenure, size of the Board, non-appointment of five members of the FOMC, the essence of the Compromise of 1913—the liberation of a subordinated monetary policy occurred by virtue of a handshake and an opaque sentence included in the Federal Reserve Bulletin.
The relationship between the Secretary of the Treasury and the Chair is an important one for the pursuit of coherent national economic policies. But because the interactions between the two are governed entirely outside of the legal framework, the extent of Treasury influence over Fed policy is dependent on traditions of independence post-1951, and on the personal relationship between the two individuals who occupy that space. For example, some have questioned the Bernanke Fed’s independence, in light of the close presumed connection between Bernanke and Treasury Secretary Timothy Geithner.205 The net effect in this context, as with the Chair’s relationship with the President, is that personalities matter much more than law.
21.Implications: Presidential Control of the Federal Reserve
As mentioned, the President has long been the primary focus for previous analyses of agency independence generally and central bank independence specifically. Part III has shown that this view is not without justification: the ways in which the Fed has and can interact with the President are sundry, some of which involve law, some convention and environment, and some a combination.
What does the reappointment of Chairs across Administrations, the President’s ability to choose his Board through frequent Governor resignation, and the fragile relationship between the Fed and Treasury all mean for the Fed’s relationship with the President? Only that Fed independence is a constantly evolving, and evolvable, phenomenon. As in the case of the Fed’s relationship with the Treasury, it took no legislative enactment to render the Fed completely subservient to the Treasury’s debt monetization, nor to liberate the Fed from that subordination thereafter. Those who would influence the Fed’s independence from the President, in either direction, can do so outside of the legal mechanisms specified by statute. Thus, when discussions focus on Fed independence or accountability something more is needed. Proposals to adjust that independence should be mindful of legal and non-legal institutions and the net effect that the interaction of these will create.
As with the Fed’s relationship with Congress,206 there are more aspects of the President’s relationship with the Fed worthy of note. And in fact, the article has delved very little into the main event for administrative law: the Appointments Clause, and any constitutional defects associated with the structure of the Fed and FOMC.207 The features here, though, are sufficient to demonstrate how the institutions of the Federal Reserve independence function in practice, especially as the legal and non-legal institutions interact with each other.
22.Private Banks and the Federal Reserve
The inclusion of private banks in an analysis of Fed independence is a departure from the usual approach to assessments of agency or central bank independence. This departure is a self-conscious effort to incorporate, following Barkow,208 the inquiries from one strain of public choice scholarship into the broader inquiry into agency (here, Federal Reserve) independence. The government focus that academics have taken in the last decades stands in marked contrast to the contours of the original debate over the founding of the Fed, and indeed the place of banking in the United States generally. Part IV therefore looks closely at why private banks are essential to the Fed independence inquiry, and then catalogues some of the legal and non-legal institutions by which private banking influence is and is not manifest in Fed decision-making.
Despite their exclusion from the usual CBI inquiry, suspicions about the role that bankers play in central banking animate much of the critique of the Fed throughout history, including to the present. As Allan Sproul—one of the most influential Reserve Bank Presidents in history—described it, “[t]he possibility that there might be a ‘money power’ able and willing to flout the economic policies of elected Government, or exposed to the coercion of special private interests, disturbs many men and attracts demagogic assault.”209 Such has been the sentiment since the beginning of the Republic. Thomas Jefferson and Andrew Jackson, with their supporters, hated government-sponsored banks210; Alexander Hamilton and Henry Clay,211 with their followers, loved them. Indeed, it is not a stretch to say that partisan politics in the United States were birthed by a government-bank midwife, as the question of government banking created coalitions that endured even during periods when the existence of a government bank was not in controversy. As the eminent 19th century financial historian Albert Bolles put it, “[w]hen the smoke of the contest [over government banks] had cleared away, two political parties might be seen, whose opposition, though varying much in conviction, power, and earnestness, has never ceased.”212 And as seen in Part II, the debates about private-bank participation in the Federal Reserve System were at the heart of the Compromise of 1913. To exclude private banks from the analysis of Fed independence is ahistorical.
The starting point, then, following the Compromise of 1913, is appropriately the structure of the quasi-public, quasi-private Reserve Banks. These much misunderstood features of the System wield considerably less influence today than they did prior to the Fed’s reorganization in 1935. But they cannot be discounted. In the most recent 2010 reorganization of the Fed, the Reserve Banks are likely responsible for the System’s continued role as the nation’s preeminent banking regulator.
Part II.A. discusses the modern System, and the ways in which the private banks participate through the Reserve Banks as a matter of law. Part II.B. then looks at the informal institutions of independence, and focuses on the relationship between the Reserve Banks and the private banks informally. Special consideration is given to the Federal Reserve Bank of New York. Part II.B. also discusses the role of the Reserve Banks and the private banks in maintaining the System’s role as the primary regulator of thousands of smaller banks, even as the Board of Governors and the Senate sought to relinquish that authority in the Dodd-Frank negotiations. Because of the unique institutional arrangements that undergird the Reserve Banks’ continued existence, they are situated to exert considerable influence outside of the Fed and, indeed, without coordination of the Board of Governors.
The Legal Institutions of Fed-Bank Independence
While the Banking Act of 1935 significantly curtailed the Reserve Banks’ role in the System, as discussed in Part II, the Act did not destroy the Reserve Banks, despite the wish of Marriner Eccles—the father of the 1935 Act—that it would. Today private banks still maintain their primary interface with the Federal Reserve System through the Reserve Banks. The legal mechanisms of Fed-Bank independence start with those unusual institutions. If the Federal Reserve System has been neglected by legal scholars, the Reserve Banks have been even more neglected: there is virtually nothing written about Reserve Banks’ legal structure.213
The primary way that private banks exercise influence over the affairs of Reserve Banks is through the appointment procedure of directors and, in turn, the executive employees of the Banks. Under the Federal Reserve Act, “[e]very Federal reserve bank shall be conducted under the supervision and control of a board of directors.”214 The member banks play an important role in the oversight of the Reserve Banks through the selection of two-thirds of the Reserve Banks’ boards of directors. Each Reserve Bank’s board is divided, by statute, into three classes, each with three directors. Class A Directors are “chosen by and [shall] be representative of the stockholding banks.”215 Class B Directors are selected by the stockholding banks216 “with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor, and consumers.”217 And Class C Directors are “designated by the Board of Governors of the Federal Reserve System” under the same “due but not exclusive consideration” to the factors listed for Class B Directors.
While regulated banks participate in the selection of Reserve Bank directors, the more important question is the legal obligations of those directors. These are few, and have changed under Dodd-Frank. The directors select the Reserve Banks’ “president, vice presidents, and such officers and employees as are not otherwise provided for in” the Federal Reserve Act.218 But Dodd-Frank made an important change in that selection process. Before 2010, all three classes of Reserve Bank directors selected the President of each Reserve Bank, subject to approval by the Board of Governors.219 Dodd-Frank inserted the clause “and shall be appointed by the Class B and Class C directors of the bank” to preclude member banks’ representatives serving as Class A directors from that selection process.220
Another significant legal mechanism of private bank influence is the bankers’ access, through the Reserve Bank board and through the Reserve Bank presidents, to the Federal Open Market Committee. This access is, to be sure, circuitous. But all twelve Reserve Bank Presidents participate in each of the eight annual FOMC meetings; the New York Fed President on a permanent voting basis; and four others by statutory rotation for annual terms. If bankers want messages transmitted to the FOMC, they need only pass that message to their Reserve Bank president.
The structure of the Federal Reserve Act, then, creates a formal, legal proximity between the regulated and regulator that does not exist anywhere else among the federal agencies. And while the Dodd-Frank changes insulate the Reserve Bank presidents further from the private banks, the remnants of the Compromise of 1913 have left a structure that places private banks in close legal proximity to their regulators.
That is not to say that the banks are unencumbered in their legal access to the Reserve Banks. For example, the Chairman of each Reserve Bank must be a Class C director—that is, one not chosen by the member banks.221 And at the Board of Governors level, Governors are “ineligible during the time they are in office and for two years thereafter to hold any office, position, or employment in any member bank.”222 But the legal structure of the Reserve Banks—even as it has grown increasingly restrictive to private banks over the last eighty years—does provide a clear path of access for the private banks to the FOMC and, consequently, the Board of Governors.
23.The Non-Legal Institutions of Fed-Bank Independence
The legal mechanisms of bank-Fed interaction are present, but do little more than create a means of communication. It is the informal institutional mechanisms that determine what kinds of communication actually occur.
New York Fed and the FOMC
The permanent presence of the president of the New York Fed is a departure from the original vision of the 1935 FOMC. That permanence was not added until 1942.223 But the permanent vote might only be that—a vote, the same as the other rather anonymous permanent votes of the non-Chair Governors. It would be a legal mechanism that allowed private banks to express themselves to the FOMC, but not much more.
But the role of the New York Fed on the FOMC is more than that vote. As the Fed states in its official publication, “[t]he FOMC, under law, determines its own internal organization and by tradition elects the Chairman of the Board of Governors as its chairman and the president of the Federal Reserve Bank of New York as its vice chairman.”224 The legal basis for the Fed’s claim is somewhat opaque. After listing the statutorily-prescribed method of selected Reserve Bank representatives on a specific rotating basis, Section 12A provides that “the details of such elections may be governed by regulations prescribed by the committee, which may be amended from time to time.”225 The meaning of “such elections” is the key to determining whether the FOMC actually does have the authority to choose its own Chair and Vice Chair. If “such elections” refers to the means by which Reserve Bank representatives are selected to join, in the first instance, the FOMC, then the ability to then designate the Chair and Vice Chair seems a bridge too far. But if the election is in reference to the process by which the FOMC is constituted, the legal position seems more defensible.226
This question bears on more than legal arcana. The influence of the New York Fed president on Board matters is sizeable, given not only his permanence but also his status as the Vice Chair of the FOMC. This status may well have been the reason why New York Fed President Timothy Geithner was the third in the trio of crisis responders that included the Treasury Secretary Henry Paulson and Fed Chair Ben Bernanke. Board Vice Chair Donald Kohn, Vice Chair from 2006 through 2010, was nowhere near as prominent as Geithner, despite the coincidence of his tenure with the most active part of the Fed’s intervention during the financial crisis. What this informal mechanism gives the New York banks is direct access to the FOMC that it otherwise would not have, amplified beyond the vote on the FOMC to the higher stature of the Vice Chairmanship of that committee.
Regulatory capture is another kind of non-legal dynamic—if not institution in the sense North means—mechanism of Fed-bank interaction. And as with the New York Fed’s Vice Chairmanship on the FOMC, the significance is the amplification of influence. If the New York Fed President—and directors and other employees—are “captured,” the banks’ interests are amplified in monetary policy and bank regulation. Claims of regulatory capture are frequently made against the Fed generally and New York Fed specifically.227 The academic questions, then, are three: what does capture mean, has it occurred at the Fed, and what is the effect?
These are very difficult questions to answer, and provide promising veins of future research. Carpenter’s recent treatment of the problems of measuring capture suggests both under- and overspecification in much of the work on the subject: underspecification in, for example, the failure to determine whether a “captured” result occurred via faithful implementation of a statute itself produced by a captured legislative process;228 overspecification because frequent critics of captured agencies do not, as they must, put forward “some notion of the public interest in mind as a counterfactual,”229 a counterfactual essential to determine whether, indeed, the captured result is inconsistent with the public interest.
To be sure, critics of the Fed’s relationships with the banking industry are more engaged in a conceptual effort than an empirical one,230 and there are empirical efforts that seek to map the extent of Fed-institutional relationships.231 The point, again, is that capture represents an informal magnification of the statutory proximity that the banks already experience with the Fed through the Reserve Banks.
24.Political Power of the Reserve Banks
The last informal mechanism of Fed-bank dependence may also be the most important in terms of the Fed’s own ability to sustain its unique structure. While the boards of directors of the Reserve Banks play mostly a selection role that is itself checked by Board approval of their choices, they have been astonishingly successful in deploying of political resources to preserve themselves. There is much about the Reserve Bank System that is anachronistic yet persistent. The former role of providing, with haste and in armored cars, the currency needed to stave off bank runs is no longer necessary in a world of FDIC insurance and, more importantly, electronic transfers.232 And the very locations of the twelve reserve banks reflect political compromises concerning an America that no longer exists: a new Reserve System with twelve banks created in 2013 would certainly include New York, Chicago, and San Francisco; would probably include Philadelphia, Boston, and Atlanta; might include Minneapolis, Dallas, and St. Louis; and would probably not include Cleveland, Kansas City, and Richmond.
And yet the Reserve System as constituted in 1913 persists. Whatever else may influence that persistence, the presence of teams of prominent Reserve Bank Presidents and directors who can influence legislation when the Reserve System is challenged can be the System’s ace in the hole. This was certainly the case in the recent lead-up to Dodd-Frank. Senator Dodd sought to remove bank supervision from the purview of the System for the majority of banks, and included that provision in the version of the bill reported out of committee.233 The Board of Governors was indifferent as to the continuing regulation of the smaller banks.234 But in time, the effect of the Reserve Banks—and the banks they regulated—made their presence felt. The final version of the bill, while it limited some of the Fed’s authority to make emergency lending decisions,235 left the supervisory bailiwicks of the Reserve Banks in tact while it massively expanded the authority of the Board of Governors.236 The amendment that restored that supervision, sponsored by Texas Republican Kay Hutchinson and Minnesota Democrat Amy Klobuchar, passed 91 to 8, just barely less popular than an amendment that eliminated what Republicans had characterized as a permanent bailout fund.237