Jamie Dimon And The Legitimacy Of The Federal Reserve System

Ethical Markets Reforming Global Finance, SRI/ESG News

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Posted: 24 May 2012 05:13 AM PDT

By Simon Johnson

There are two diametrically opposed views of how the largest financial companies in our economy operate. On the one hand, there are those like Charles Ferguson, director of the Academy Award-winning documentary “Inside Job” and author of the new book, “Predator Nation.” Mr. Ferguson takes the view that greed and immorality now prevail to an excessive degree at the heart of Wall Street.

Academics and other experts have become corrupted, the responsible regulators have been intellectually captured, and law enforcement officials refuse to act – despite the accumulation of evidence before their eyes.

“Inside Job” was gripping and emotional; “Predator Nation” contains many more specific details and evidence, as this excerpt dealing with academics (one Republican and one Democrat) makes clear.

The second view is that the people in charge of large banks and bank holding companies have done nothing wrong. To see this view in action, look no further than this week’s debate about whether Jamie Dimon, chief executive of JPMorgan Chase, should resign from the board of the Federal Reserve Bank of New York. The New York Fed oversees his organization, including assessing whether it is taking dangerous risks, so there are reasonable questions about whether this creates a potential conflict of interest.

A balanced account of this debate appeared in American Banker, which kindly agreed to bring the entire article out from behind its paywall. The strongest statement from the pro-Dimon corner comes from Ernest Patrikis, a partner with White & Case L.L.P. and former general counsel of the New York Federal Reserve:

“I don’t see Jamie Dimon’s conflict of interest. What’s the conflict? He’s expected to represent the banks’ view, the lenders’ view.”

Yet even people who are generally sympathetic to banks feel that there is a perception problem with Mr. Dimon’s position. Treasury Secretary Timothy Geithner said exactly that to the “PBS NewsHour” last week.

Kenneth Guenther, the former head of the Independent Community Bankers of America, told American Banker:

“I do think there is a public perception problem when the head of the largest bank gets into a massive highly publicized trading loss, which he articulately condemns, when he’s tied to the Federal Reserve Bank of New York, and the president of the Federal Reserve Bank is vice chair of the Federal Open Market Committee. There is a perception problem. I don’t think there’s any way around it.”

What exactly is a conflict of interest? Narrowly defined, an actual conflict of interest would involve using public office for personal financial gain – and would be a matter for criminal prosecution.

There is only one case that I am aware of in which a director of the New York Fed went to prison for such a violation – Robert A. Rough was indicted in December 1988, on charges that he leaked sensitive interest-rate information to a brokerage firm. He was sentenced to six months in prison.

More broadly, however, in modern America we use the term “conflict of interest” when we believe someone may be promoting private interests while acting in a public role.

Allowing big bankers to become too influential is an important part of what Mr. Ferguson writes about. If you don’t understand the channels through which influence actually works in the United States today, you need to see “Inside Job,” which touched a nerve and won an Oscar precisely because it is profoundly undemocratic when powerful people are able behave in this way.

Elizabeth Warren, a Democratic candidate for the Senate in Massachusetts, said Mr. Dimon should resign from the board of the New York Fed. The recent spectacular trading losses at his company require a full investigation, which should include an examination of how the supervision process broke down. How can this be anything other than awkward for the New York Fed while Mr. Dimon – hardly known as a shrinking violet – sits on its board?

Senator Bernie Sanders, independent of Vermont, would go further, proposing legislation that would remove any bankers from the boards of Federal Reserve banks. For more background, you may want to consult Page 65 and other parts of this report from the Government Accountability Office, which deal with potential conflicts of interest in the Federal Reserve System, or at least read Senator Sanders’s summary of the report.

To be clear, directors of the New York Fed are in principle kept away from bank-supervision matters – a point that was codified in December 2010, following the passage of the Dodd-Frank financial reform legislation.

Under the current bylaws, directors are not involved in appointing, monitoring or compensating the head of supervision, although they have input into the selection and remuneration of the head of research (an important position, as this person helps to shape the Fed’s view on bank capital and all technical matters relative to risk management), and they oversee other management issues. Bill Dudley, the president of the New York Fed, interacts with the board at least several times a month, as you can see from his schedule.

Mr. Dudley, a former Goldman Sachs executive, was originally appointed president of the New York Fed by a board that included Mr. Dimon as a voting member.  The Dodd-Frank legislation stripped so-called “Class A” directors, of which Mr. Dimon is one, from voting on such appointments.  Mr. Dudley was subsequently reappointed by the Class B and Class C directors of the board.  (For more on the different classes of directors, see this page)

Mr. Dimon has also been an outspoken opponent of financial reform of late – including the Volcker Rule (on proprietary trading) and attempts to strengthen capital requirements. He is an intensely political figure, despite the fact that an important footnote in the Board of Governors’ policy on political activity by Reserve Bank Directors says,

In all instances, directors should avoid any political activity that would publicly identify the director as being associated with the Federal Reserve System or would embarrass the System or raise questions about the independence of the director or the ability to perform Federal Reserve duties.

Directors are allowed to lobby and engage in other specific activities. The issue is whether these actions undermine the effectiveness of the New York Fed.

There is recent precedent for New York Fed board members resigning when there is a perceived conflict of interest – and when the legitimacy of the Federal Reserve System would undoubtedly have been undermined if they had refused to resign.

Dick Fuld, the chief executive of Lehman Brothers, resigned (on Thursday, September 11, 2008) shortly before his firm collapsed (on September 15, but its last day of business was Friday, September 12) – and presumably because the New York Fed was at the center of intense discussions about who should suffer what kind of losses or get rescued. Did he resign of his own volition or was he encouraged to resign?

Stephen Friedman, then the former chief executive of Goldman Sachs, resigned in early 2009 when it became clear that he had bought Goldman stock after Goldman became a bank and therefore fell under the supervision of the New York Fed.

Mr. Friedman was chairman of the New York Fed at that time. (To be clear, Mr. Friedman was not involved in any of the decisions that saved Goldman in fall 2008, and I am not accusing him of using his public position for personal financial gain.)

For those of you keeping score at home, Mr. Fuld was a Class B director and Mr. Friedman was a Class C director.

If you think Mr. Dimon should resign from the New York Fed, you can express your opinion by signing this on-line petition, which I drafted. (For more background on why he should resign, see this blog post.)

If Mr. Dimon refuses to resign – as seems likely – he can removed by the Board of Governors of the Federal Reserve System (not by his fellow directors at the New York Fed). The petition is therefore addressed to the Board of Governors.

There is an undeniable perception problem. It is damaging the legitimacy of the Federal Reserve. As Treasury Secretary Geithner implied, this must be “addressed” – a great Washington euphemism – by Mr. Dimon leaving the board of the New York Fed.

An edited version of this blog post appeared this morning on the NYT.com’s Economix; it is used here with permission.  If you would like to reproduce the entire column, please contact the New York Times.