The Federal Reserve Needs to Get Its Ethics Straight

(Bloomberg Opinion) -- The Federal Reserve is scrambling to deal with an urgent question: Should its officials be allowed to trade in the securities of companies and other issuers that their decisions might affect? The answer ought to be obvious. No, they shouldn’t.

The central bank’s conflict-of-interest rules have come under scrutiny because of the uproar over the trading activity of two officials, Dallas Fed President Robert Kaplan and Boston Fed President Eric Rosengren. Last year, as the Fed took extraordinary action to support everything from individual companies to entire markets, Kaplan moved millions of dollars in and out of myriad investments including shares of Amazon and Johnson & Johnson, a bond fund and S&P 500 index futures. Rosengren bought and sold shares in four real-estate investment trusts, among other trades.

Both announced their resignations this week, while insisting they’d complied with the relevant codes of conduct. Strictly speaking, that might be true. The codes explicitly exclude only a narrow range of activities: investing in certain financial companies, and, for those with access to certain materials for meetings of the Federal Open Market Committee, short-term trading and trading any security during a brief period before those meetings. (Kaplan and Rosengren had such access.)

However, the codes also prohibit any activity “which might result in a question being raised regarding the independence of the employee’s judgment.” This formula left officials, so they thought, a degree of discretion. Such vagueness was always unwise — and the risks have only grown more serious with time.

Successive crises have expanded the central bank’s financial-market activities. Nowadays, its actions can directly affect the of just about any U.S. security. Last year, the Fed bought and sold bond ETFs similar to one Kaplan traded, and it spent $40 billion each month on mortgage-backed securities like those held in one of Rosengren’s REITs. Relying on officials to use their discretion wisely isn’t good enough. The rules need tightening up.

Fed Chair Jerome Powell has ordered a review. Here’s a suggestion: The central bank’s top officials should not be allowed to trade or hold securities, with only rare exceptions — such as long-term holdings in the broadest of mutual funds, like those offered by the Fed’s Thrift Plan.

The legitimacy and effectiveness of any government institution depends on trust. Officials should avoid not just actual conflicts of interest but also any plausible suspicion of them. This goes for judges, legislators and anyone in power who claims to act on behalf of the public. And it certainly goes for the Fed.

Editorials are written by the Bloomberg Opinion editorial board.

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