New York Fed Chair Stephen Friedman Resigns: About Time

The chairman of the board of the Federal Reserve of New York, Stephen Friedman, resigned today — a resignation doubtlessly timed to coincide with the much bigger news of the day, the release of the stress test results.  (I’ll get back to those in a bit).  Though he had earlier announced his intention to resign at the end of the year, he moved the date up as criticisms of his overlapping role at the Fed and on the board of Goldman Sachs have mounted.

The Wall Street Journal ran an A-1 story this week that started thus:

The Federal Reserve Bank of New York shaped Washington’s response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed’s chairman, Stephen Friedman, sat on Goldman’s board and had a large holding in Goldman stock, which because of Goldman’s new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They’ve since risen $1.7 million in value.

Mr. Friedman also was overseeing the search for a new president of the New York Fed, an officer who has a critical role in setting monetary policy at the Federal Reserve. The choice was a former Goldman executive.

The WSJ has been putting up new pieces every day as criticism of Friedman’s moves has mounted.  He’s not a bad target.  He’s purchased more than 50,000 new shares in Goldman since the bank came under Fed regulation last fall, and never mentioned any of those purchases to the NYFed.  His claims that he saw “no conflict whatsoever in owning shares” is at best self-deluding and more likely disingenuous.  Whether or not Friedman was involved in day-to-day decision making at the Fed — and his spear-heading of the search for a new president certainly makes him seem very involved — as a Class C director, appointed to represent the public, holding shares in any bank or bank holding company seems like a dangerous contradiction.

Now, it’s true that Friedman wasn’t initially in conflict with Fed policy — only when Goldman became a bank-holding company, instead of an investment bank, did he come into explicit conflict with the rules, and at that point the NYFed lawyers sought a waiver.  In January, they concluded he hadn’t broken any internal rules — and even in the statement released by the NYFed, the general counsel says “these purchases did not violate any Federal Reserve statute, rule or policy.”

Which makes it seem all the more important that those statutes, rules, and policies get changed. 

Though Friedman showed some terrible judgment here, the other villain of this story is whoever in the Washington, D.C. Fed offices decided to grant the waiver that allowed Friedman to continue in his conflicting role.  The defense that the NYFed has mustered so far for keeping Friedman around is that his leadership was necessary because the NYFed was already functioning without a president, after Tim Geithner became the Treasury nominee in November.  If that was true — if Friedman was so valuable to the company — then the company should have worked harder to convince Friedman to sell of his shares and resign from Goldman.  Instead, they chose to grant a waiver to a rule that, really, is a pretty reasonable rule, one that’s built to arm against exactly the kinds of conflicted decisions that seem to have been made here.

The WSJ reports that many of the other 11 regional Fed banks already have or are supportive of changing and clarifying the rules.  I hope that’s true.  Until then, it falls upon the Wall Street Journals of the world to find this stuff out and push for change — and we may be destined to see the resolution of the problem coming, as it did in this case, too late.

Gov’t for Grown-ups: I have Federal Reservations for 3

I’ve neglected this series for a long time.  Not for very good reasons — it can mostly be summed up by “writer’s block,” having to do with a precipitous drop in my ability to write about Congress in an informative manner instead of one laced with profanity.  So I’m back, and I’m refocusing my attention, at least for now, on institutions, instead of political positions.  If I’m going to want to burn something down, better it be an entire building constructed from marble than a man in a suit.

So, let’s talk The Fed.

This is going to be a long talk, so I’m breaking it into three tasty pieces: A Brief History of U.S. Banking (1790-1930ish); The Federal Reserve, from Depression to Inflation (1930ish to 1980ish); and The Post-Modern Fed (1980ish to current) — if the TALF is still alive by then.

There will be a one-week guacamole intermission between posts.  Guacamole making and consumption is also encouraged while reading — if you need to step away, I’ll still be here.  Take your time.

A Brief History of U.S. Banking.

At the same time America became a country, it was also, in the great American tradition, broke.  A debate ensued about what to do — pay off the debts incurred by states before they were even states?  Say “screw it” and move on?  It was hard to decide what to do — individual states, and sometimes even individual cities and banks, were using different notes to denote debts, so it was hard to say what was even owed.

Enter Alexander Hamilton.  I should at this point again disclose a fascination and admiration for Hamilton, the father of the U.S. banking system and probably a total jerk to hang out with.  In 1791, Hamilton, the first Secretary of the Treasury, convinced Congress to create the First Bank of the United States, arguing in part that a strong financial institution would benefit everyone by making the nation itself stronger and more certain to survive:

[A]n attentive consideration of the tendency of an institution immediately connected with the national government which will interweave itself into the monied interest of every state, which will by its notes insinuate itself into every branch of industry and will affect the interests of all classes of the community, ought to produce strong prepossessions in its favor in all who consider the firm establishment of the national government as necessary to the safety & happiness of the country, and who at the same time believe that it stands in need of additional props.

This was a hard argument to make to a country skeptical of any broad central grant of power.  Yet Hamilton, who also established the U.S. Mint, managed to win a 20-year guarantee for the First Bank.  Sadly, it outlived him, then lost its own duel with Congress — by one vote, the bank wasn’t renewed in 1811.

Yet by 1816, the U.S. was hungry for some central, organizing force to look over banks, bankers, and monetary policy.  So the Second Bank of the U.S. came to life.  You probably know how this story ends, but let’s let the White House history of President Andrew Jackson tell it:

The greatest party battle centered around the Second Bank of the United
States, a private corporation but virtually a Government-sponsored monopoly. When Jackson appeared hostile toward it, the Bank threw its power against him.

Clay and Webster, who had acted as attorneys for the Bank, led the fight for its recharter in Congress. “The bank,” Jackson told Martin Van Buren, “is trying to kill me, but I will kill it!” Jackson, in vetoing the recharter bill, charged the Bank with undue economic privilege.

So, back to no bank.  Ho-hum.  The U.S. muddled on with no national currency until the National Banking Act of 1863 essentially black-mailed people into adopting national notes, by a) creating them and then b) establishing a tax on state-issued notes, but not federal notes, which were backed by treasury securities.  Yes, yes, they had securities back then, too.  People still traded in state-based notes, because people are irrational, but the spread of national currency gained some footing.

Yet this “national banking system” had its own snags [.pdf]:

Under this system, “country banks” were required to hold reserves at larger banks as well as in the form of cash. ”Reserve city banks” were required to hold reserves in cash and as deposits in “central reserve city banks.” Central reserve city banks were required to hold their reserves in cash. The Treasury Department altered reserve levels by adding or draining funds that it kept on deposit at central reserve city banks. The large city banks were unable to respond adequately to seasonal and cyclical variations in the cash and credit requirements of the economy. The years were marked by periodic financial crises that were resolved primarily through emergency actions of private bankers.

Those “bankers” we led by J.P. Morgan, who was kind enough to bail out the system in 1893 when panic ensued.  In 1907, he did it again — and public opinion, long opposed to the very idea of a central bank, suddenly swung more decisively toward desirous.

But hey, this is government — why rush into anything?  Congress, being Congress, appointed a commission to look into the best way to tackle the banking problem.  Meanwhile, William Jennings Bryan stormed the country cheering for the Silver Standard (and was immortalized as the Cowardly Lion in “The Wizard of Oz” for his efforts).  Finally, President Wilson leaned on Congressman Carter Glass to get something done, and in 1913 the Glass-Willis bill, known as the Federal Reserve Act, birthed the modern Fed, a bouncing several-million-dollars baby.  It established:

• Twelve regional bank districts
• That all national banks had to buy into the Fed at a rate of six percent of the bank’s current capital stock, in exchange for voting rights
• That should the Fed not have sufficient money through bank and personal buy-ins, the Treasury Department would buy in.
• The Federal Reserve Board’s power to examine “accounts, books, and affairs” of member banks
• Individual regional boards’ power to set Discount Rates — the interest rates at which banks could borrow from the Fed.
• The Federal Reserve as the “lender of last resort,” where banks could turn when they faced a panic.
• The Federal Reserve as the primary issuer of Federal Reserve Notes — what we now know as “dollars.”  A sample from the first run, Series 1914, is seen above, starring Grover Cleaveland.

The four big provisions that came out of the Fed’s charter were “to
provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”

Ta-Da!  A Central Bank at last.  The actual responsibilities of the bank, other than to provide stability to the system, were somewhat undefined for the next two decades, however.  The bank dabbled in the 1920s with some Open Market interventions, but with little success — though aware of the speculation bubble of the late 20s, it did little (and some might argue it could do little) to stop it; it did even less to alleviate the stress on banks as the downturn turned into a full-blown Depression.  In fact, the Reserve Board and the governors raised some rates in the early 30s and wanted to raise rates further, through a sell-off of treasury securities, even as things got bad again in 1932.

Which takes us to the fall of the first Fed system, with the introduction of Franklin D. Roosevelt’s financial policies and politics.  But if you’ve made it this far, I’d guess you’re as ready for a guacamole break as I am.  So we’ll pick up here next time — though in the interim, if things are unclear above, throw me questions in the comments.  I’m trying to compress many sources into one long explanation, so I may have made things blurrier — and I’m happy to help clarify, as I can. Likewise, if I’ve skipped something vital — well, you’ll tell me, right?

Till next time, then.