Nov. 10 (Bloomberg) -- U.S. commercial banks would lose their power to appoint directors of the 12 Federal Reserve regional banks under legislation proposed by Senate Banking Committee Chairman Christopher Dodd.

Under the draft bill, directors at each regional bank would be chosen by the Fed’s Senate-confirmed governors, and each board chairman would be subject to Senate approval. Currently, two-thirds of directors are chosen by private-sector banks and one-third by the Fed’s Washington-based governors.

The changes, which would amend the 1913 law creating the Federal Reserve system, would shift some of the private sector’s power to name regional Fed presidents to elected officials and political appointees. Lawmakers say banks share blame for the financial crisis, with Dodd today calling the Fed’s regulation an “abysmal failure.”

“It’s one step removed from making the bank president a political appointee,” said Vincent Reinhart, a former Fed monetary-affairs director who is now a resident scholar at the American Enterprise Institute in Washington. “I’m sure that you’ll hear that this is an encroachment on the independence of the Federal Reserve.”

The provisions, which aren’t included in House legislation, are part of a broader reduction of the Fed’s authority and autonomy in a 1,136-page draft bill. The measure would also move bank-supervision powers from the Fed and other regulators to a new agency.

‘Not Punishment’

“It’s not designed to basically punish the Federal Reserve at all, but rather to enhance their role, and their independence,” Dodd said at a press conference today. “You start loading up the Fed with additional responsibilities, and that independence can be threatened.”

Dodd’s draft bill stops short of subjecting the regional Fed presidents to the political approval process, or otherwise altering the makeup of the Fed’s policy-setting Open Market Committee. Regional Fed presidents vote on interest-rate decisions on a rotating basis, with the New York Fed president having a permanent vote.

Under Dodd’s bill, the regional Fed boards would nominate the presidents of the Fed banks, and those presidents would continue to be subject to the Washington-based governors’ approval.

Congressional Influence

Former Fed Governor Lyle Gramley said last month that the danger of altering the selection process for Fed presidents is that Congress may gain enough influence over monetary policy to thwart the central bank’s efforts to tighten credit in coming years and keep prices from surging.

The Fed boards would still be required to have three directors representing commercial banks in each region. The difference is that the directors would be chosen by the Board of Governors in Washington instead of by the commercial banks themselves.

Similar to a House proposal, the Dodd bill would also curb the Fed’s ability to grant emergency loans to individuals or corporations, powers the Fed used in 2008 to facilitate the merger of Bear Stearns Cos. with JPMorgan Chase & Co. and bail out American International Group Inc. It would instead limit such loans to institutions that clear payments and keep the financial system functioning. The Dodd measure would not allow the Fed to bail out individual banks.

Fed Audits

The draft legislation would also allow congressional auditors to conduct reviews and onsite examinations of the accounting, financial reporting and internal controls of any Fed credit facility. Reports to Congress on each examination would be required within 90 days.

The Fed would be required to tell Congress the identities of emergency-loan recipients and the collateral they pledged, subject to a delay of up to one year. The Fed has refused to reveal which banks have borrowed emergency funds throughout the financial crisis.

The central bank has come under fire for granting a waiver allowing a former Goldman Sachs Group Inc. chairman to remain on the board of the New York Fed after the company opted to come under Fed oversight.

The official, Stephen Friedman, was also chairman of the New York Fed’s board. He resigned from the Fed in May, saying that his role was “in compliance with the rules” and his service had been “mischaracterized” as improper.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.

Last Updated: November 10, 2009 16:03 EST