U.S. Fed: Help wanted

Why are there vacancies at the U.S. Fed Reserve Board?

Senator Chris Dodd probably doesn’t ring the recognition bell of many Canadians. If known at all, it is probably as white male roadkill in the Democratic Party’s presidential nomination race. But unlike Hillary Clinton or Barack Obama, he already holds considerable power over the world. Indeed, as chairman of the Senate Banking Committee, Dodd is the boss of Federal Reserve head Ben Bernanke. And if his critics are right, he is using his supervisor role to keep Fed management understaffed when Big Ben needs all the help he can get.

There are supposed to be seven members of the Fed’s Board of Governors, appointed for staggered 14-year terms to distance board nominations from the political election cycle. But there are currently two vacancies nobody expects to be filled any time soon. The Bush administration nominated Virginia banker Betsy Duke, and Larry Klane, a Capital One executive, to the board almost a year ago. But Dodd is sitting on the nominations while also holding up a vote on existing Fed governor Randall Kroszne, who was nominated for another term last year.

Last year, Dodd called the need to fully staff the Fed a low priority. This year, as markets were freezing, a Dodd spokeswoman said the banking committee is “fulfilling its responsibility to carefully…evaluate whether these nominees are qualified to help protect consumers from predatory lending and set monetary policy during a time of significant economic turmoil.”

But critics insist Dodd is playing a very dangerous political game, hoping to give a Democratic president the chance to stack the Fed. They are not just worried about who ends up on the board. As a safeguard, law requires at least five governors to support emergency measures. Normally, with seven members, that would just be a so-called super majority of governors. Today, however, everyone on the board, including one lame duck, must agree before any financial firefighting can be done.

An “emergency action now requires 100% unanimity,” U.S. fund manager David Kotok recently ranted in a client commentary. “We do not know how many decisions are not made because only four of the existing five members agree. We do not know if this construction puts Bernanke in a hampered position as he and his colleagues try to deal with dysfunctional credit markets.” Kotok, CEO of Cumberland Advisors in New Jersey, says Dodd “directly threatens the actions and independence of the central bank at the very time it needs to be able to act with a full board complement and quickly.”

Fed historian Allan Meltzer isn’t convinced having a fully staffed board would have altered recent central bank policy; the chairman generally runs the show. But he does note that having just five governors highlights the ridiculous nature of the bank’s so-called sunshine restrictions — which force Bernanke to declare an official meeting whenever a majority of Fed governors happen to be in the same place at the same time. Since unscheduled official meetings spook markets, informal gatherings are key to effective policy-making. But with only five sitting governors, sunshine restrictions do not allow Bernanke to brainstorm with more than one key adviser at the same time. He can’t even ride an elevator with two other board members.

Meltzer also agrees that the Fed has lost a significant amount of independence since Sir Alan Greenspan was the chief monetary dragon slayer. The Carnegie Mellon professor says Bernanke has caved to political pressures and taken his eye off inflation to fight a sub-prime loan crisis that has been overblown by Depression-era comparisons. “Mortgage defaults were 50% during the Great Depression,” he told Canadian Business, noting that they have yet to hit 10% today.

According to Meltzer, lowering interest rates to negative levels (accounting for inflation) will not help the economy since institutional lenders, not borrowers, are the current problem. As a result, when the Fed eventually decides to reverse course, putting the brakes on U.S. market liquidity will be harder and take longer than warranted.

In other words, with Benanke at the helm of the central bank, maybe Dodd is doing the current Fed board nominees a favour.