Tags: charles | plosser | fed | reforms | independence

Plosser: Reforms Could Threaten Fed's Independence

Wednesday, 21 Apr 2010 07:08 AM

The Senate's financial regulatory reform bill contains provisions that would politicize the U.S. Federal Reserve and threaten its independence, a top Fed policymaker says.

In a letter to senators, Philadelphia Federal Reserve Bank President Charles Plosser criticized a plan to make the New York Fed's president a political appointee with a five-year term.

"This proposal would gravely dilute governance structures that have sheltered the central bank from short-term political influences," Plosser wrote.

His letter comes as the Senate inches closer to a pivotal vote. U.S. President Barack Obama will take his reform push to New York on Thursday as part of his bid to tighten financial regulation and control risk taking after the global crisis.

Washington-based Fed Governors are appointed by the president and confirmed by the Senate, but for 14-year terms to keep them insulated from partisan politics.

Regional Fed bank presidents are chosen by their boards of directors — comprised mainly of local bankers and businessmen — subject to approval by the Fed's Board of Governors.

When he unveiled his plan in March, U.S. Senate Banking Committee Chairman Christopher Dodd said the provision aimed to clamp down on conflicts of interest at the New York Fed, by ensuring that the key regional Fed bank's president is not picked by banks it regulates.

"Changing the New York position to a Presidential appointee would greatly skew the center of power and influence to New York and Washington and further reduce critical input to monetary policy from the rest of our country," Plosser wrote.

The New York Fed — which acts as the Fed's arm on Wall Street — is the only one of the regional Fed banks that has a permanent seat on the Fed's policysetting panel.

Plosser warned Tuesday that the Fed could come under more political pressure to keep interest rates low to support growth at the risk of fueling inflation.

In a letter that addressed a wide range of regulatory issues, Plosser reiterated that ensuring that the Fed holds only Treasury securities — and not the mortgage-backed securities it acquired during the crisis — would promote a clearer distinction between fiscal and monetary policy.

This would "help uphold the Fed's independence, and assign fiscal decisions to the Congress where they belong," he said.

Plosser also reiterated his concern that the proposed financial reform does not adequately address the issue of banks perceived to be too big to fail. He said the best way to do so would be amending the bankruptcy code for nonbank financial firms and bank holding companies.

Stripping the Fed of oversight of all but the largest financial firms would exacerbate the problem, he said, by signaling to markets that these firms are too big to fail.

It would also "dramatically reduce" the Fed's ability to monitor the economy and financial market developments critical to its role as lender of last resort, he said.

"The financial crisis has clearly demonstrated the need for reform," Plosser wrote. "If we don't enact the right reform, we may end up sowing the seeds of another, unintended crisis."

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