Banking

Fed regional banks seek new presidents amid calls for reform

Two Federal Reserve banks are seeking new leaders at a precarious moment, as key senators call for sweeping changes to the way regional Fed banks operate — some of which threaten their independence. 

Directors of the Federal Reserve banks of Kansas City and Chicago this year launched searches for their next presidents. Esther George, the Kansas City Fed’s current chief, and Charles Evans, who runs the Chicago Fed, turn 65 on Jan. 15 and must retire per Fed rules.

At the same time, Republicans on the Senate Banking Committee continue to hammer the Kansas City Fed over George’s handling of the master account application by the Colorado fintech Reserve Trust, and other lawmakers are pushing the central bank to address its longtime lack of racial and ethnic diversity. 

Frustrated by what he describes as the lack of transparency around Reserve Trust and instances of “mission creep” by other reserve banks, Sen. Pat Toomey of Pennsylvania, the banking committee’s ranking Republican, has floated ideas such as subjecting the Fed’s 12 regional bank presidents to Senate approval and consolidating or disbanding the regional banks altogether. 

Across the aisle, Sen. Bob Menendez, D-N.J. — also a banking committee member — has repeatedly expressed frustration that the Fed has never had a Latino reserve bank president or board governor. He and eight other senators have called on the Federal Reserve Board to change the process for hiring regional presidents to make it more public.

For the Kansas City and Chicago Fed banks — whose boards of directors are in charge of selecting candidates to fill vacancies — it is increasingly imperative that their selections assuage these lawmakers’ concerns, some experts say. Failing to do so may determine how much autonomy they have moving forward. 

“Getting it right goes beyond ensuring diversity,” said Karen Petrou, co-founder and managing partner of Federal Financial Analytics. “The Reserve Trust case for Kansas City is only one piece of a far broader set of increasingly strong demands that the Federal Reserve System as a whole — not just the board of governors — be directly part of the federal government, not the public-private hybrid created in 1913.”

Petrou pointed to the stock trading scandal that led to the resignations of Boston Fed President Eric Rosengren and Dallas Fed President Robert Kaplan last year as another controversy driving calls for reserve bank reform. She also noted more esoteric concerns about the power of the New York Fed and the governance structure of the system as a whole. If the Fed struggles to rein in inflation, she said, it could open the central bank up to a host of changes. 

“It’s too soon to say how far Congress will go down this familiar road next year because I don’t know who’ll be running what in Congress and, at least as important, whether the central bank can regain the monetary policy credibility that has so far been its bulletproof casing from these demands and even broader ones to bring it on-budget,” she said. “It’s for sure going to be tricky.”

For now, as the Fed attempts to cool down the economy without inducing a recession, Congress is unlikely to pursue sweeping reforms to the reserve bank system, Kaleb Nygaard, a senior research associate in Yale University’s Program on Financial Stability said. The approaching midterm elections in November are another deterrent to immediate action, he said.

Still, Senate pressure could lead to top-down policy changes within the Fed, Nygaard said. The board is already examining its policies for granting master accounts — which give financial institutions access to the Fed’s payment system and the ability to settle transactions with their peers — and policing stock trading by reserve officials, he said.

“General supervision of the reserve banks is increasing,” Nygaard said. “The board is realizing that they have to take more responsibility in overseeing these processes at the reserve banks.”

The Fed has taken steps to create more uniformity in how reserve bank presidents are hired and evaluated. Last year, as part of its reappointment process, which presidents and first vice presidents are subject to every five years, the board rolled out a specific and standardized rubric for assessing reserve bank leadership. It also doubled the amount of time search committees would have for finding new presidents and drew in commentary from a variety of sources about how the process could be improved.

Role of Fed bank chiefs

Each reserve bank has a board of nine directors: three Class A directors representing banks in its district, three Class B directors chosen by the banks to represent other interests in the district and three Class C directors chosen by the Fed’s board of governors in Washington. The six nonbank directors are tasked with finding presidents, though the Fed board has the final say about whether the chosen candidate is hired.

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Reserve bank presidents rotate onto the Fed’s Federal Open Market Committee in three-year cycles. George is a voting member of the FOMC this year and Evans is an alternate; whoever replaces Evans next year will get a vote on the Fed’s monetary policies.

Sen. Pat Toomey, R-Pa., has floated ideas such as subjecting the Fed’s 12 regional bank presidents to Senate approval and consolidating or disbanding the regional banks altogether. Sen. Bob Menendez, D-N.J., has expressed frustration that the Fed has never had a Latino reserve bank president or board governor.

Bloomberg

Reserve bank presidents also oversee the various functions of their respective reserve banks, which include conducting research on economic conditions within their districts, supervising member banks and facilitating payments. A key component of that is managing which institutions in their district have access to the Fed’s payment systems through a master account. 

Historically, determining which institutions could have master accounts was straightforward, as most applicants were primarily banks or similar institutions. The rise of financial technology companies that partake in banklike activities without being regulated in the same fashion has made the task more difficult.

Flaps over master accounts, public information

Questions about Reserve Trust’s master account at the Kansas City Fed have been a focal point for Toomey and other Senate Republicans since the confirmation hearing in February for the Biden administration’s then-nominee for Fed vice chair for supervision, Sarah Bloom Raskin. 

Republicans have sought answers from both the Kansas City Fed and Raskin about why Reserve Trust, which had its initial application for a master account denied in 2017, was granted one in 2018 after Raskin joined the company’s board of directors. During her hearing, Republicans asked Raskin if she discussed the Reserve Trust application during an August 2017 phone call with the Kansas City Fed. She testified that she did not recall. 

Republicans on the committee refused to allow a vote on any of Biden’s Fed nominees until more information about the Reserve Trust application process was provided. Raskin eventually withdrew from consideration so the other nominations could move forward.

In February, the Kansas City Fed defended its decision to grant Reserve Trust a master account, noting that the company met the eligibility requirements. Sometime thereafter, however, the reserve bank revoked Reserve Trust’s account, drawing a fresh round of inquiries from Toomey about the reason for the reversal. George denied the request, citing confidential supervisory information, a classification that academics and policy experts found dubious

In his latest correspondence, which accused George of misleading and obstructing Congress, Toomey was joined by three other senators, suggesting the matter will not go away when Toomey leaves office at the end of the year. 

Should George’s successor also choose to continue the fight, it could put the Kansas City Fed in a position that other reserve banks have gone to great lengths to avoid: having its disclosure obligations codified by law or court ruling, said Jeff Lacker, a former president of the Richmond Fed.

Typically, reserve banks have opted to follow “the spirit of” freedom of information laws, Lacker said. They will respond to certain requests but maintain that they do so voluntarily because they are private institutions. That rationale is murky, as the reserve banks, while not technically government entities, do government work by implementing Fed monetary policy.

“The reserve banks and the board have always tried to avoid ever having the question of whether the reserve banks are subject to [the Freedom of Information Act] go to court and be resolved in court,” Lacker said. “They’ve tried to settle and divulge enough to satisfy the interest of whoever’s asking for information without admitting or denying that FOIA applied. They keep asserting that it doesn’t apply, but they’re not willing to test it in court.”

Similarly, Lacker said, the reserve banks have made an effort to broadly comply with congressional inquiries to avoid spurring legislation that would make such disclosures mandatory. One of Toomey’s proposals would do just that.

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Lacker said there have been several questionable decisions around master accounts in recent years. Along with fintechs like Reserve Trust, banks that cater to legal cannabis industries and even more typical financial institutions with novel business plans have had their applications denied or tabled indefinitely. Lacker said if the Fed does not provide additional clarity to this process itself, Congress should take on the issue.

“For them to kind of have some more scrutiny thrown on this process would be good for the system,” he said. “I’m hoping Congress would either encourage the Fed to adopt a more rational and transparent system or legislate to make them do that.”

Reform proposals

One drastic solution has already been brought forward in the Senate. A comprehensive digital-asset bill introduced in early June by Sens. Cynthia Lummis, R-Wyo., and Kirsten Gillibrand, D-N.Y., includes a provision that would remove the reserve banks’ discretion over master accounts completely by guaranteeing every state-chartered institution access to the Fed’s payment system. 

Meanwhile, the Fed board has already set to work on standards for granting master accounts, presenting two proposals for public comment. Its latest suggested framework breaks applicants into three tiers. Banks that are federally insured and supervised would have the easiest path to access; financial firms without deposit insurance that are supervised by prudential regulators would face slightly more scrutiny; and institutions that are not federally insured or supervised would face the strictest scrutiny. 

The proposal still gives individual reserve banks latitude in how they assess applicants within each tier. The biggest question is the handling of the third tier, which would include applicants that do not fit within federal regulatory frameworks. Because of this, the Kansas City Fed’s district is likely to remain ground zero for establishing precedent on dealing with so-called novel charters, said Aaron Klein, senior fellow in the Brookings Institutions.

“The Kansas City Fed is likely to be at the forefront of the master account issue, in part because of crypto’s presence in Wyoming, in part because of their reactionary and adversarial position to cannabis banking, vis-a-vis Colorado,” Klein said.

The Kansas City Fed’s district includes Colorado, Kansas, Nebraska, Oklahoma and Wyoming as well as parts of western Missouri and northern New Mexico. It is the second-largest district by geography and among the most rural. 

Spotlight on K.C. Fed search

The ongoing controversy with Reserve Trust could take some Kansas City Fed officials out of the running to replace George, Nygaard said. Typically, the first vice president, the director of research and the general counsel are given strong consideration in these searches, he said. 

But, if the bank or the Fed board want to distance themselves from the scandal, some of those individuals could be seen as too close to the master account process. 

If the board and its search firm, Egon Zehnder, want to look outside for a candidate, Nygaard said, they might give greater consideration to someone with experience in the fintech sector as a way of smoothing things over with the industry.

“The odds of the Kansas City Fed at least including in their list of candidates somebody in the technology world, the fintech world, is slightly more likely than it was before, if that’s the direction the board wants to take it, to show that not only are we doing things above board but we’re at least considering somebody that has experience in this field,” he said.

Klein said even if the Kansas City Fed’s board of directors chooses an outside candidate, it likely would not stray very far. 

“If I’m trying to figure out who’s going to be the next president of a Federal Reserve bank, the first place I’m going to look is inside the Federal Reserve System, the second place is inside the Fed, and the third place is inside the Fed,” Klein said. “Federal Reserve bank presidents are largely an insular group, stemming from current and prior Federal Reserve employees.”

Neel Kashkari, president of the Minneapolis Fed, is the only sitting reserve bank president to not have worked as a staffer or director for a reserve bank before being appointed. He worked for Goldman Sachs and was in the Treasury Department during the George W. Bush administration.

Should the Chicago or Kansas City Fed boards look for an outsider to take the reins, opting for someone who fits the Kashkari mold might not be the best way to endear themselves to Congress. Toomey has singled out Kashkari as one of main contributors to “mission creep” because of his advocacy work for an amendment to the Minnesota state constitution related to educational access. 

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The opportunity to be at the heart of the master account debate could make the Kansas City Fed opening more attractive to candidates inclined to leave their mark, Lacker said, but he expects the board in Washington will be sure that whoever is put in the position shares its view of how master accounts should be meted out.

“I’d be really surprised if somebody gets chosen that has any inclination toward rocking the boat on issues like this with the board,” Lacker said.

Pressure for racial, gender diversity

The Kansas City and Chicago Feds will also be under pressure to attract a diverse pool of applicants. Fed Chair Jerome Powell has spoken repeatedly about the need to better diversify the central bank’s staff and leadership in terms of both race and gender. 

The Fed board has had some success on this front. Women and minority men make up 83% of Class C directors at regional banks, up from 58% in 2018, and 67% of Class B directors, up from 61%. Class A directors — those representing member banks — are only 44% diverse, but that is double the rate of 2018. 

Yet, board diversity does not always correlate with diverse presidential hires, Nygaard said, pointing to the example of the Cleveland Fed, which was the last reserve bank to have a female director but the first to appoint a female president in Karen Horn.

“You’ve had very nondiverse boards select the first diverse presidents, and then you’ve had it the other way where you’ve had diverse boards selecting white male Fed insiders,” he said. 

The Kansas City Fed’s search committee is headed by a Hispanic woman, Maria Grigo-Raby, and includes a Black man, Edmond Johnson. It also includes Patrick A. Dujakovich, president of the Greater Kansas City AFL-CIO trade union, the first reserve bank director in decades without a college degree, Nygaard said. 

“This is a diverse board,” he said. “It’s a diverse board, in large part due to the actions of the board of governors, but that certainly doesn’t guarantee the final person will be of a diverse background.”

Still, Menendez has said the Fed system has a long way to go before it adequately represents the broader society. While more women and minorities have been added to reserve bank boards, some groups, such as Latinos, remain underrepresented. He said this lack of representation is why there has never been a Hispanic president or board governor in the 108-year history of the Fed. 

The New Jersey Democrat raised this issue with Michael Barr, Biden’s current pick for vice chair for supervision, during his confirmation hearing in May and secured a promise from the former Treasury official that he would work to address the racial disparities within the Fed system. In June, Menendez sought a similar commitment from Powell. The chair said he would have a “frank discussion” with the senator but noted the board had already made strides where it could. 

“We’re open to ideas of how to improve as you point out in your letter. It’s not like we haven’t made tremendous strides as it relates to the B and C directors in the course of the last 10 years,” Powell said during testimony in front of the Senate Banking Committee on June 22. “We really have, and the diversity numbers are, I think, quite impressive for the B and C directors.”

Currently, there are three nonwhite reserve bank presidents: Kashkari, the son of Indian immigrants; the Atlanta Fed’s Raphael Bostic, who became the first African American to lead a reserve bank in 2017; and newly installed Boston Fed President Susan Collins, the first woman of color to lead a reserve bank. Male presidents outnumber females five to seven.

Menendez is not alone in calling for more diversity within the Fed’s highest ranks. Advocacy groups such as the Fed Up Campaign have also urged the central bank to better reflect the communities it serves. 

Klein said these calls to continue until the two vacancies are filled, but ultimately he does not foresee them compelling the Fed to appoint anyone purely on the basis of race.

“I expect there will be pressure from Congress and external groups to diversify, and the Fed will go full steam ahead with whom the Fed wants,” he said.

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