By MICHAEL SMALLBERG
The Federal Reserve has made headlines recently for its efforts to be more transparent, as illustrated by its recent decision to start publishing the predictions of senior officials regarding short-term interest rates.
As the Fed tries to be more open about its decision-making, it should also consider providing more information to the public about its policies for handling potential conflicts of interest.
In September 2008, for example, as the country faced a severe economic crisis, two members of the Fed's Board of Governors received waivers so they could work on the central bank's emergency bailout programs, despite their ongoing financial stake in firms that would go on to receive substantial assistance from the Fed.
The waivers, signed by Fed Chairman Ben Bernanke, were granted to Board members Kevin M. Warsh and Elizabeth A. Duke, who had previously worked at Morgan Stanley and Wachovia, respectively. POGO obtained the waivers in response to a Freedom of Information Act (FOIA) request.
Even though Warsh and Duke’s financial stake in their former employers was relatively minor, we think the public has a right to see these waivers, which were granted at a time when the Fed was contemplating providing billions of dollars in emergency loans to Morgan Stanley, Wachovia, and other banks on the brink of collapse.
Federal ethics laws state that an executive branch employee cannot work closely on a matter in which she has a financial interest unless she “makes full disclosure of the financial interest and receives in advance a written determination…that the interest is not so substantial as to be deemed likely to affect the integrity of the services which the Government may expect from such officer or employee.” Warsh and Duke received waivers under this provision related to their vested interest in pension plans provided by Morgan Stanley and Wachovia.
Duke was an executive vice president at Wachovia before she joined the Fed Board as a Senate-confirmed nominee of President Bush. According to her public financial disclosure report, Duke will receive around $1,000 a month from Wachovia starting in 2017 under the company’s defined benefit pension plan. Chairman Bernanke granted Duke a waiver in September 2008 as the Fed contemplated taking extraordinary action to rescue Wachovia and other firms:
Wachovia is experiencing serious liquidity problems, as have other financial institutions over the past several months, and the Federal Reserve may be called upon at any time in the very near future to take emergency action to ensure the continued viability of the bank…Such action, depending on the circumstances, could have a direct and predictable effect on Wachovia’s ability to meet its pension obligation to Governor Duke, and therefore could affect her financial interests within the meeting [sic] of 18 U.S.C. § 208.
The Fed decided that Duke’s participation in decisions affecting Wachovia was “of critical importance” because the Board—which had two vacancies the time—might not have enough members to take official action if she recused herself. The waiver also points out that “Governor Duke and her husband have a substantial number of assets and sources of income relative to which the monthly pension she will begin receiving in 2017 is insignificant.”
Thanks to data released by the Fed under the Dodd-Frank financial reform law, records obtained by Bloomberg in FOIA litigation, and a Dodd-Frank-mandated audit of the Fed conducted by the Government Accountability Office (GAO), we now have a clearer picture of the assistance that was ultimately provided to Wachovia and other firms under the Fed’s emergency bailout programs. According to Bloomberg, which did a tremendous job of combining and presenting the data from these various sources, Wachovia’s peak level of debt to the Fed totaled $50 billion in October 2008:
Wachovia Corp., which almost collapsed in September 2008 because of a deposit run, floated itself with Federal Reserve funds the following month after becoming the object of a takeover battle between Citigroup Inc. and Wells Fargo & Co. Fed assistance for Charlotte, North Carolina-based Wachovia included a $29 billion loan on Oct. 6, 2008, from the discount window, the biggest of any U.S. bank during the crisis from the central bank’s 97-year-old lender-of-last-resort program. Wachovia also borrowed from the Term Auction Facility, bringing total Fed liquidity to $50 billion.
Warsh, another Bush nominee, joined the Fed Board in early 2006, having previously served as a vice president and executive director of Morgan Stanley’s Mergers & Acquisitions Department. According to his public financial disclosure report, Warsh will receive $563 a month from Morgan Stanley when he turns 65 under the firm’s defined benefit pension plan.
Chairman Bernanke granted Warsh a waiver in September 2008 to account for the “very unlikely event that Morgan Stanley experiences the kind of difficulties encountered by other investment banks,” in which case “it may become necessary for the Federal Reserve to take action to lend to, or otherwise provide support to the company.” The waiver also notes that Warsh’s financial stake in Morgan Stanley was relatively minor compared to the substantial assets held by him and his wife, and that Warsh’s participation in the Fed’s decision-making was essential “in light of his financial expertise and his knowledge of financial markets.”
Even though Chairman Bernanke claimed it was “very unlikely” that Morgan Stanley would require emergency assistance, the Fed allowed Morgan Stanley to become a bank holding company the day after Warsh received his waiver, making the firm eligible to receive assistance through the Fed’s discount window. Morgan Stanley also received assistance through Fed programs such as the Primary Dealer Credit Facility.
According to Bloomberg, by the end of September, Morgan Stanley reached its peak level of debt to the Fed, totaling over $100 billion. Bloomberg noted that Morgan Stanley had borrowed nearly three times the firm’s total profits over the past decade, making the firm one of the largest recipients of the Fed’s emergency assistance. Morgan Stanley was also awarded a non-competitive contract by the Federal Reserve Bank of New York to help manage the AIG bailout, in exchange for which Morgan Stanley has received over $100 million in fees.
Dean Baker, the co-director of the Center for Economic and Policy Research and a longtime Fed critic, told POGO that even though Warsh and Duke’s waivers do not indicate a serious conflict of interest, there is no reason why the Fed shouldn’t be posting these waivers online:
The sums involved are not very large and since both are pension obligations, they would likely be insured in any case, so they had comparatively little at risk if these institutions went under. Still, as a matter of policy it seems to me that any waiver should be disclosed and available on the Fed’s website. There is no obvious reason to be concealing that board members have a financial relationship with firms that the Fed is assisting.
The GAO recently recommended that Chairman Bernanke require the regional Fed banks to publicly disclose ethics waivers granted to their directors. Although the GAO was focusing on the regional banks, we believe the same recommendation should apply to the central Fed Board.
POGO has generally urged federal agencies to post more ethics documents online, including waivers, financial disclosure forms, recusals, Office of Government Ethics (OGE) reviews, Office of Inspector General (OIG) reports, and revolving door records. There also may be an opportunity for OGE to create a central repository of waivers granted to senior officials at the Fed and other agencies. Along these lines, OGE recently started accepting online requests for public financial disclosure reports filed by officials throughout the executive branch. And thanks to the STOCK Act, which President Obama recently signed into law, agencies are now required to post the actual disclosure reports online, and OGE will eventually be posting the reports in a centralized, searchable database on its website. We urge OGE to ensure that the enhanced disclosure requirements will also apply to reports filed by officials at the Federal Reserve.
Providing online access to waivers and other ethics documents would enable the public to monitor how the Fed and other agencies handle potential conflicts of interest, including conflicts that arose during the bailout.
Michael Smallberg is a POGO investigator.
Image via DonkeyHotey.