Election year Fed bashing sometimes has merit

Federal Reserve building

Election year often means it is time to bash the Federal Reserve. After all, Congress created an independent central bank in order to allow it to make politically unpopular — but economically prudent — decisions. Because the Fed becomes a convenient political punching bag during election time, it can easy to disregard political criticisms of the central bank emerging from party platforms. Reflexively defending the Fed’s independence from politics is usually a good heuristic to employ to make sure that serious permanent damage is not inflicted on a critical government agency. However, there is a new and growing criticism of the Federal Reserve, embraced in the Democratic Party’s platform, that does merit serious attention: the lack of diversity among leadership at the Federal Reserve’s twelve Regional Banks.

Diversity matters. Bank Presidents vote on monetary policy, regulate banks, operate the nation’s payment systems, and direct large economic research operations. Diverse leadership can improve decision making, highlight different areas to focus, direct research into new fields, and raise new thoughts and issues before the Fed and the general public. Diversity strengthens the institution’s legitimacy, which is necessary for the Federal Reserve System, given its inherent need to take politically unpopular actions. Ensuring diversity of background was a main goal of creating the Fed system in the first place, so that monetary policy and bank regulation would not be set only by politically appointed officials in Washington, but rather that voices across the country would be heard.

First the facts. There are 12 regional Federal Reserve Banks, each headed by a Bank president who is selected by a subset of that Bank’s board of directors and approved by the Federal Reserve’s Board of Governors. Unlike the Bank presidents, the Governors are appointed by the President and confirmed by the Senate. Since the Fed’s founding in 1913, there have been 134 regional Bank presidents. None have been African American. None have been Latino. In fact, until 2009, there had never been any non-white Federal Reserve regional Bank presidents. Since then, there have been two, both Asian Americans, and both Presidents of the Minneapolis Federal Reserve. That means the other 11 regional banks have never had a non-white president.

There have only been six women to ever serve as President of a regional bank. The first woman, Karen Horn, was appointed in 1982 as president of the Cleveland Fed. In fact, half of the women to ever head a regional Fed have been from the Cleveland Fed. Eight of the 12 regional banks have never had a woman serve as president in their history.

The Fed’s Board of Governors has had a better track record on diversity. The first African American to serve as a Governor of the Fed was appointed in 1966. The number two job as Vice-Chairman has been held by an African American who was appointed to that position by a Democratic President (Clinton) and reappointed by a Republican (George W. Bush), evidence that support for qualified diverse individuals are bipartisan values. There have been nine women to serve as Fed Governors, out of the 94 Governors we’ve had. But at one point a few years ago, the majority of sitting Governors were women.

Now the hard part, how do we fix this?

We need to focus on the selection process of regional bank presidents — selected by their own bank’s board of directors. GAO studied Federal Reserve Regional Bank Boards and concluded that they themselves lack diversity. The Dodd-Frank Act made one small change trying to improve the regional bank selection process: it prohibited bankers who serve on regional bank boards from being involved in the president’s selection process. Instead the Regional Bank Boards non-bank directors are in charge.

However, the law still allows sitting bank board members to select themselves. This was the case in the selection process in Philadelphia when the bank selected its own Board member, even after that board member served on the search committee and interviewed other candidates. One simple suggestion is to prohibit the selection of existing search committee members from selecting themselves. Congress could do this by law, or the Fed’s Board of Governors could do this by practice as they have veto authority over any final selection.

Making the selection process itself more transparent, with clear selection criteria, greater public input, and enhanced oversight by the Fed’s Board of Governors are steps in the right direction that could be taken without a new law. The last time Congress changed the rules for who serves on the Fed, it did so to ensure greater banking representation by instituting a quota for someone with small bank experience. It is somewhat ironic to see a quota-based solution for industry representation while the problem of diversity goes unsolved.

Editor’s note: This piece originally appeared in Real Clear Markets.