The case of the missing Federal Reserve Board members

The Board of Governors is supposed to have seven members. It currently has only five. The Senate has been sitting on two nominations, of Elizabeth Duke and Larry Klane.

On Thursday February 7, 2008 President Bush complained about the failure of the Senate to proceed with the confirmation of three nominees – the two still waiting for Godot and Randall Kroszner, who has since been confirmed (Kroszner first took office on March 1, 2006, to fill an unexpired term ending January 31, 2008.). The nominations of Duke and Klane were sent to the Senate on 16 May 2007. It is a scandal that the Senate has not been able or willing to find the time to hold confirmation hearings for these two new Board members. The main guilty parties are the US Senate Committee on Banking, Housing, and Urban Affairs and its Democratic Chairman, Christopher Dodd.

It is quite irresponsible to let these two positions remain vacant for this long. We are not talking about a couple of dog catchers in Willimantic, Connecticut, but about two out of seven members of the Board of Governors and two out of twelve voting members of the FOMC, the policy making body of the most important central bank in the world. Is Dodd playing silly politics? Does he hope to drag the nomination process out for another year, so a Democratic President can make different nominations? Duke has a banking background and Klane is a senior executive at Capital One Financial Corp. Both nominees therefore have experience and knowledge that would actually be useful in the current crisis. Even Dodd must have noticed by now that there is a financial crisis on.

The failure of the Senate to confirm the two nominees for the Board is directly relevant to the question of whether the Board acted properly (in a legal, technical sense) when it authorised the indirect collateralised loan to Bear Stearns, through the intermediary of J P Morgan (which has since bought Bear Stearns). As I pointed out in an earlier blog, Bear Stearns, which was not a deposit-taking institution but an investment bank, could not access the Fed’s discount window, unless the Board of Governors of the Federal Reserve System determined that there were “unusual and exigent circumstances” and at least five (out of seven) governors voted to authorize lending under Section 13(3) of the Federal Reserve Act.

We know only four Governors of the Fed were present when the decision to lend to Bear Stearns was taken. The fifth Governor was abroad and unavailable. The vote of the four available Governors was unanimous, but clearly, four ain’t five. Also, the Fed’s public statement said nothing about “unusual and exigent circumstances”.

I interpreted this as meaning that the Board had not declared that “unusual and exigent circumstances” prevailed, and that the decision to channel the loan through JP Morgan was a subterfuge to get around the problem that, because “unusual and exigent circumstances” had not been declared to exist, Bear Stearns could not borrow from the Fed directly.

I have since been informed by several commentators on that earlier blog, that the Fed may in fact have declared “unusual and exigent circumstances”, although I have not yet seen a public official statement by the Fed to that effect. David Cahagnes’s comment deserves citing in full:

“Section 13(3) of the Federal Reserve Act (which contains the basic precondition of a determination of unusual and exigent circumstances) should be read in conjunction with section 11(r)(2)(A) of the same Act which provides that:

“[a]ny action that the Board is otherwise authorized to take under section 13(3) may be taken upon the unanimous vote of all available members then in office, if—
(i) at least 2 members are available and all available members participate in the action;
(ii) the available members unanimously determine that—
unusual and exigent circumstances exist and the borrower is unable to secure adequate credit accommodations from other sources;
(II) action on the matter is necessary to prevent, correct, or mitigate serious harm to the economy or the stability of the financial system of the United States;
(III) despite the use of all means available (including all available telephonic, telegraphic, and other electronic means), the other members of the Board have not been able to be contacted on the matter; and
(IV) action on the matter is required before the number of Board members otherwise required to vote on the matter can be contacted through any available means (including all available telephonic, telegraphic, and other electronic means); and
(iii) any credit extended by a Federal reserve bank pursuant to such action is payable upon demand of the Board.” (italics added).

According to the Wall Street Journal, Fed officials have indicated that four “available” Fed governors did in fact determine unanimously that there existed “unusual and exigent circumstances” – and that the fifth governor was abroad and unavailable. CNBC has reported that the latter claim – and the legality of the loan to Bear – has been contested by the Inner City Press Community on the Move, a “housing and fair lending activist group” in a complaint filed with the Fed on Saturday.”

If the Board in fact determined that “unusual and exigent circumstances” existed with only four members voting, this would only be a proper decision according to the Act, if the fifth member, abroad and unavailable, could not “ contacted through any available means (including all available telephonic, telegraphic, and other electronic means)”. Possible, but not likely in this age of cell phones, Blackberries, e-mail, instant messaging and all the traditional methods of communication from fixed-line phones, satellite phones, telegraph, radio, tv and postal pigeon.

It beats me how a Governor could simply not be contactable, unless he (all five current Governors are men) were dead, injured and in hospital or in a ditch somewhere, suffering from amnesia or doing a Spitzer or engaging in some other undercover activity and did not want to be found. It also is hard to understand how a Governor could decide to go abroad to a place where he would be hard/impossible to reach, when massive stresses were building up in Wall street and the need for a Board quorum was no longer a theoretical curiosum. And why did his colleagues not point out the error of his ways to him before he disappeared?

Whichever way this plays out, it was not the finest our of Senator Dodd or the existing Board members.

Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website