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Episode 18 - The Directors

Turns out each of the twelve Federal Reserve Banks has their own board of directors. Who are these directors, and how are they chosen? We’ll use the makeup of the boards of directors as an illustration of the term “quasi-governmental”.

Intro

Welcome to The Bankster Podcast. I’m your host, Alexander Bagehot, and this is Episode 18 - The Directors. Every episode we dive into what I call The Centralverse! The incredibly fascinating and ever more consequential world of central banking.

Happy Thanksgiving to all of the listeners here in the United States and happy end of November to the rest of you in the world. On today’s episode we will discuss the Board of Directors of the Federal Reserve Banks - not to be confused with the Board of Governors in Washington DC. Also, instead of a news story today we are going to focus the first section of the podcast on a single term. So let’s jump right in.

Quasi-governmental

The term from today’s episode comes from the classic definition of the Federal Reserve: the quasi-governmental central bank of the United States. It’s a sophisticated sounding term that if you took a macroeconomics class in college you probably heard and then immediately forgot. It’s also one that sounds complex and makes you look smart if you use it with confidence. But at its core quasi-governmental is simply a term used to try to describe the interesting role that the Federal Reserve plays in the government and the economy. The central bank isn’t fully a governmental agency like the IRS for example, but neither is it fully a commercial bank like Bank of America. It’s somewhere in between. In fact when I asked one employee of the Federal Reserve what it was like to work at the country’s central bank he responded, “Well, imagine what you think it’s like to work at Goldman Sachs. Now imagine what you think it’s like to work at the IRS. The Fed is right smack dab in the middle of those two.”

You wouldn’t find that definition of the work of the central bank in a textbook, but I thought it was a fun way to describe the interesting position that the Fed is in. Imagining the bureaucratic, tax code, audit driven IRS juxtaposed with the fast paced, analysis, returns driven Goldman Sachs is probably a good way to think about the Federal Reserve. There are aspects of the work that the Federal Reserve does that are very report form and processes based, but then there are very high intensity, markets based money policy aspects as well.

The term that somebody decided best fit this type of institution was quasi-governmental. I hang out in circles where this term is thrown around pretty commonly, so the term itself has become familiar to me. However, working on this episode I realized that I needed to flush it out a little bit more. So I started by researching what “quasi” means. The second entry in Google’s dictionary seemed to match the Federal Reserve best - “being partly or almost”. So the Federal Reserve is partly governmental or almost governmental.

When the creation of a central bank for the United States was being debated following the Financial Panic of 1907 two plans emerged. One plan provided for more control in the hands of the public through the government. The other plan left more control to the hands of bankers and businesses. After being elected president in 1912 Woodrow Wilson signed a compromised act that had taken parts of both of the original plans. The new plan had a lot of aspects that gave power to the Federal Government. There were other aspects of the new act that gave power to the bankers and businesses. That’s why we use the term quasi-governmental. It’s a complicated word that describes a complicated system. As an example, we are going to spend the next portion of the episode discussing the makeup of the board of directors at the Federal Reserve Banks.

The Directors

Before we dive into what and who the board of directors are let’s establish a few things that they are not. They are not located in Washington DC. There is not just one board of directors for the whole Federal Reserve System (remember that the leadership body for the whole system is called the Board of Governors - they’re the ones in DC). They are not appointed by the President and confirmed by the Senate like the Governors are. They do not make direct decisions about monetary policy.

Section 4, subsection 6 of the Federal Reserve Act itself says, “Every Federal reserve bank shall be conducted under the supervision and control of a board of directors.” Remember that the Federal Reserve Banks are the twelve regional banks spread out through the country. Not evenly spread out, but spread out nonetheless. The act says that each of these banks will have a Board of Directors. The act goes on to say in the next subsection, “The board of directors shall perform the duties usually appertaining to the office of directors of banking associations and all such duties as are prescribed by law.”

Before we talk about what they do, let’s talk about how they are chosen. This is where I wanted to focus today’s episode because it demonstrates that interesting and unique characteristic of the quasi-governmental makeup of the Federal Reserve.

There are nine members of each board of directors at each of the twelve banks. Each nine member board is divided into three different groups called: Class A, Class B, and Class C. So there are three directors in each class. Each of the different classes is unique and I’m going to do my best to summarize their different roles on the podcast. However, for the visual learner I really recommend signing up to receive the show notes to the episode. You can sign up on my website www.thebanksterpodcast.com and I’ll send you a cool chart that I’ve created that summarizes the Board of Directors roles and responsabilities in a nice, easy to read format.

All of the members of the board of directors are voted into their position. But who gets to vote depends on the Class.

Directors of Class A and Class B are voted in by member banks of that Federal Reserve District. Nationally chartered banks are required to be members of the Federal Reserve System. State chartered banks may choose to be members of the System. There’s more to membership in the Federal Reserve but we won’t cover it in this episode. Suffice it to say that these member banks choose six of the nine members of the board of directors.

Class A directors are to represent the District Banks. This means individuals that work in the banking industry. For today, we’ll take the Board of Directors of the Chicago Federal Reserve Bank as an example. Their Class A Directors include: the CEO of Urban Partnership Bank, a mid size bank in Illinois; the CEO of Discover Financial Services, widely known for their credit card business; and finally, the CEO of Ohnward Bank and Trust, a community bank in Iowa.

Class B directors are to represent the public or as the Act puts it “[They are to be chosen] with due but not exclusive consideration to the interests of agriculture, commerce, industry, services, labor and consumers”. Chicago’s Class B Directors include: the Dean of the Public Policy School at the University of Michigan; the CEO of PineGrove Holdings, a firm that invests in small to mid sized industrial companies; and finally, the President of the Chicago Federation of Labor, the umbrella organization for labor unions in Chicago.

Are you getting a sense of how this is working? So we have six directors so far that were each chosen by the member banks of the Federal Reserve, three to represent the bankers and three to represent the public. The final three members of the Board of Directors are chosen by the Board of Governors and are also required to represent the public. In Chicago they are: the CEO of ComEd, the largest electric company in Illinois; the CEO of Illinois Tool Works, a manufacturing company; and finally, the CEO of Motorola. The Chair and Deputy Chair of the Board of Directors come from among this Class C group chosen by the Board of Governors.

How would you describe the makeup of this Board of Directors so far? Bankers get to choose six of the directors, three of whom are bankers three of whom are not. The other three directors, including the Chair and Deputy Chair are chosen by the Presidentially appointed Governors in Washington DC. Hopefully you’re beginning to see why the term quasi-governmental is used to describe the Federal Reserve.

So now that we know who makes up the board of directors let’s talk a little bit about what each of the different Classes can and cannot do. Because remember that one of the responsibilities of the Fed is to regulate the banks, isn’t it strange that bankers get to choose who is on the board of directors of their regulator? Well, let me tell you what the Act sets out for dealing with some potential conflicts of interest. For today, whether it is enough or not, is up to the listener.

Let’s start with the most obvious conflicting group - Class A Directors. These are the bankers voted in by other bankers. One traditional role of a board of directors is the choosing of an executive team at the company. However, these Class A Directors cannot participate in the selection process of the Federal Reserve Bank President. They also may not participate in regulatory decisions.

All of the directors are eligible to serve two terms of three years each. They meet at the Federal Reserve Bank in person seven times a year. They also meet via teleconference every two weeks. This two week check in is required by the act so that the directors can approve the discount window loan rate. One of their most important roles is to inform the Reserve Bank President on the economy from their perspective. Remember the list of people on the Board of Directors at the Chicago Fed? All of those people are leaders of the economy. They make decisions that often create jobs or destroy jobs. Having an inside view of why they are making these decisions is helpful to the Reserve Bank President when the he or she goes to vote on the FOMC.

Conclusion

We started today’s episode with the definition of the term quasi-governmental. We then opened up the mysteries behind the board of directors at the Federal Reserve Banks to illustrate the term. You are one step closer to understanding the most important institution in the world economy. And no matter how you feel about it’s role or whether it’s powers should be changed, restricted, or expanded - the first step is always understanding how it is today.

As always, send in your comments and questions about the Centralverse or the Bankster Podcast via email (alexander@thebanksterpodcast.com) or Twitter or Facebook. Please open up your podcast app right now and give the podcast a rating and a review.

If you go to my website, www.thebanksterpodcast.com you can sign up to receive the show notes to today’s podcast and every future podcast directly in your inbox. It’s a great way to follow up on the content that we discuss and to look deeper into the Centralverse. As I mentioned earlier, the board of directors are a bit confusing, so you won’t want to miss the show notes to this episode. It will include a simple to read chart outlining the roles and responsibilities of each class of directors. I’ll also include a few excellent links that helped me to create this episode.

Today’s episode was written, edited, and produced by me, Alexander Bagehot. I dedicate this episode to my fiance, my family, and my faith - three things I’m very grateful for. And to everybody else, thanks for listening. I’m Alexander Bagehot, and I’ll see you next time on The Bankster Podcast!

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