The Regional Feds Need More Independence

June 14 (Bloomberg) -- All the fuss about whether Jamie Dimon, the chief executive officer of JPMorgan Chase & Co., should remain on the New York Federal Reserve Bank board is missing a larger issue. The entire board is connected to the banking industry and needs reform.

It is imperative that the board include some directors who are independent of the banking industry because it performs many vital public functions, including selecting the president of the New York Fed, who also serves as vice chairman of the policy-making Federal Open Market Committee. Yet none of the current directors is entirely independent, not even the six who by law should represent the public.

Here’s how the board is supposed to be structured: The nine directors are divided into three classes, each containing three people. Class A directors are bankers, elected by the member banks. Dimon is one of these. Classes B and C are designated to represent the public and are specifically not allowed to be bankers.

Nevertheless, Class B directors are also elected by the member banks. And this raises the question, whose interests are they likely to represent -- the public or the banks? Their independence would be enhanced if they were chosen in a different manner.

In testimony before Congress last week, Fed Chairman Ben S. Bernanke agreed with Senator Bernie Sanders’s statement that six of the nine directors of each regional Fed bank are actually from the banking industry. Bernanke also stated that fixing the problem would take an act of Congress to change the way the Class B directors are chosen. He is right about this. Such an act is needed.

Bernanke seems unaware, however, that the Class C directors are a problem, too. And he has the power to fix this one. Class C directors are appointed by the Fed governors, who could be careful to select independent people. Yet the three Class C directors now at the New York Fed are presidents of Columbia University, the Metropolitan Museum of Art and the Partnership for New York City. All three head nonprofit organizations that rely on contributions from financial corporations or their executives. They all report to boards partially occupied by financiers such as Jamie Dimon; Lloyd Blankfein, the CEO of Goldman Sachs Group Inc.; and Vikram Pandit, the CEO of Citigroup Inc.

To preserve their independence, the directors are not allowed to own a single share of bank stock, but apparently it is fine for them to accept millions in contributions from bankers on behalf of the institutions they run.

Perhaps these contributions don’t influence the directors. There has been no hint of corruption or quid pro quos. But is it smart to have a system whose independence relies on directors being immune to incentives? The very existence of the incentives diminishes the New York Fed’s credibility.

There is no restriction on how the governors recruit directors, but the New York Fed recommends two candidates for open Class C seats and the governors pick one. The Government Accountability Office studied the lack of diversity of the bank boards and reported that the regional banks have had difficulty finding good candidates.

This problem is not hard to fix. Bernanke and the other six Fed governors can simply select more diverse and representative directors. If they have had trouble finding good candidates, a public call for nominations would be helpful. A Class C seat expires at the end of this year, so now is a perfect time to do so.

And to increase the independence of the Class B directors, Congress should amend the law so that they are appointed not by the banks but by the Fed governors. Together, these changes would ensure that the spirit of the law governing the New York Fed board and the other regional Federal Reserve banks is fulfilled.

(Jonathan Reiss, former head of international bonds for Sanford C. Bernstein & Co., is the founder of Analytical Synthesis LLC. The opinions expressed are his own.)

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Today’s highlights: The editors on measuring methane leaks and Putin’s attack helicopters in Syria; Caroline Baum on the Federal Reserve’s next move; Michael Kinsley on why you’re even poorer than you thought; William D. Cohan on Jamie Dimon’s day in Congress; Ezra Klein on Venture For America; Nicholas Polson on recognizing smart money; Amar Bhide and Christopher Papagianis on fixing money-market mutual funds.

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