Strange Things Are Afoot at the Richmond Fed

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The Federal Reserve System is not an easy institution to understand, but there is an important balance between the Board of Governors of the Federal Reserve System and the 12 regional Federal Reserve banks. The reserve banks are separately incorporated entities, legally owned by commercial banks, and run by their local membership under the supervision of the Fed’s board.

Tuesday’s shocking revelation that Federal Reserve Bank of Richmond President Jeffrey Lacker had immediately resigned after admitting that he was involved in leaking confidential information to Wall Street insiders is particularly dismaying. In this time of eroding trust in government, it is especially important for the Federal Reserve System’s regional banks to be above reproach and to work on behalf of all Americans in the districts they serve.

The reserve banks appoint their own presidents, subject to relatively deferential board approval. Regional presidents are, on a rotating basis, members of the Federal Open Market Committee, which makes monetary policy.

Lacker’s actions are so clearly unacceptable that it’s difficult to say what personal consequences he should face. Tipping off banks so they can profit at the expense of the public is bad enough, but the scale of wrongdoing involved in playing favorites in a program called “large-scale asset purchases” is likely to be, well, large. Under this temporary program, which was an important contributor to the post-recession recovery, the Fed bought $40 billion in mortgage-backed securities every month. So it’s easy to see how an early tip on this program could be worth a lot to investors.

Going forward, this disclosure presents major challenges to the Federal Reserve System as a whole. The Fed’s most important macroeconomic duty is to fulfill its dual mandate of maximum employment and stable prices. The public must have confidence that Fed monetary policy is exclusively directed at fulfilling that mandate and is not compromised by officials’ connections with or bias toward financial firms. The Fed, in turn, must have confidence in its ability to use policies, such as large-scale asset purchases, without worrying about the integrity of the process.

Critics have previously pointed to close ties between some Fed staffers and the financial institutions they supervise as a possible conflict, a point amplified by multiple regional Fed bank president hires with Wall Street ties in recent years. Lacker’s disclosure strengthens their case.

After Lacker’s sudden resignation, an important first step in rebuilding confidence in the system is restoring trust in the Richmond Fed. Lacker had already planned to step down at the end of the year, and the search for his replacement is underway. Those involved in this search must now take every step possible to demonstrate that the process for finding the next Richmond Fed president is especially open and transparent. Forming a new committee and starting the process from scratch with a new search firm would be a clear way to reassure the public that this process is being performed with clean hands.

The search process should give additional weight to the importance of choosing a highly qualified candidate who represents the region’s broad economic interests and has no connection to Wall Street insiders or this scandal. Given the circumstances and the importance of improving diversity at the Fed, Richmond should also heed the success of the Atlanta Federal Reserve Bank in finding a qualified leader from beyond its district.

It is difficult to understand how one of the most senior people in the Federal Reserve System could do something that has the potential to so deeply undermine trust in one of the country’s most important economic tools. Elected officials and the broader economics community should come together to ensure that the Richmond Fed takes the right steps to rebuild trust in this vital institution.

Michael Madowitz is an Economist at the Center for American Progress.

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