How to Limit Personal Trading at the Federal Reserve

(Bloomberg Opinion) -- The Federal Reserve System is remarkably complex. It’s designed, in its own words, with “a blend of private and governmental characteristics.” It has 12 regional banks, many with multiple branches, where the majority of directors are elected by member banks in the district. Then there’s the Fed’s board of governors in Washington, whose members are selected by the president, approved by the Senate and are permanent voters on the policy-setting Federal Open Market Committee.

This is no excuse for questionable trading among the central bank’s most senior leaders. Two regional bank presidents decided to step down after their 2020 financial disclosures revealed that they bought and sold financial assets that were sensitive to monetary policy. Boston Fed President Eric Rosengren retired early last week, citing health reasons, and Dallas Fed President Robert Kaplan will depart Friday. Meanwhile, Vice Chair Richard Clarida is taking heat for shifting from bonds to stocks mere days before the start of sweeping central bank actions to combat the Covid-19 pandemic. Collectively, it’s a terrible look.

However, the construction of the Fed and the current rules across the system are important to understand before jumping to conclusions. Democratic Senator Elizabeth Warren of Massachusetts, who is no fan of Chair Jerome Powell, has rushed to link the transactions to insider trading and has called on the Securities and Exchange Commission to investigate. Never mind that a spokesman has said Clarida’s move was a “pre-planned rebalancing to his accounts” and there’s no reason to think otherwise.  

Instead of making accusations about an institution already prone to baseless conspiracy theories, how about a solution? Here’s an easy one: All “senior officials” at the Fed should be required to put their assets in a blind trust.

Fortunately, the Fed already specifies what constitutes a senior official: members of the board of governors, as well as presidents and first vice presidents of the regional Fed banks. In a document titled “ETHICS — Voluntary Guide to Conduct for Senior Officials,” it lays out the guidelines that Warren and others have quoted. These 31 leaders “have a special responsibility for maintaining the integrity, dignity, and reputation of the System.” Specifically, “their personal financial dealings should be above reproach, and information obtained by them as officials of the System should never be used for personal gain.”

As was made clear recently, the current approach falls short. After all, the public was made aware of Clarida’s February 2020 shift with a 19-month lag, while Kaplan last year traded more than a dozen stocks and exchange-traded funds in chunks of more than $1 million without any sort of accountability.

The solution should go beyond just a regular blind trust. These officials should be required to hold what’s known in Washington as a qualified blind trust, which mandates they select legitimate third parties (not spouses or friends) to control their portfolios. Trustees are responsible for divesting each asset (save for $1,000 or less) and then repurchasing new securities. 

While it may sound onerous, qualified blind trusts make the most sense given the outsized influence the Fed has on today’s markets and the economy. Virtually every asset class moves on its policies. At other government agencies, it’s clearer what kinds of holdings could pose a conflict of interest — for instance, the head of the Health and Human Services Department shouldn’t buy and sell health-care stocks. But for central bankers, even trading the broad S&P 500 Index (which Kaplan did) could create the appearance of skewing monetary policy to bolster risky assets. 

Mandating qualified blind trusts would restore public faith that officials are truly in the dark about their holdings and not making trades that could ultimately benefit them. And such a trust is less harsh than an outright ban on buying or trading individual stocks. This way, a Fed official could still theoretically own an individual stock in her portfolio — she just would have no idea about it. 

Some may argue that those with sizable portfolios shouldn’t be leading the Fed in the first place. That seems like a step too far. It’s not a bad thing to have those with real-world experience and financial success making policy decisions in Washington and across the country. But the nation needs a better system to ensure an end to conflicts or even the appearance of them.  

In addition to requiring blind trusts, there has to be better enforcement and ways to penalize those who don’t comply. Currently, the main agency responsible for overseeing conflicts of interest for senior government officials, the U.S. Office of Government Ethics, serves more of an advisory role than a policing one.

As it stands, the Fed also has guidance for the scores of directors of regional Fed banks and branches across the country. It uses much of the same language: Among other things, they should avoid any action “that might result in or create the appearance of using their position as directors, including their access to Federal Reserve officials, for private gain.”

It would be overkill to subject this group to the same blind-trust standard. The decentralized nature of the system seems destined to create headaches. Here’s a summary of how the director process works:

Each of the 12 Reserve Banks is subject to the supervision of a nine-member board of directors. Six of the directors are elected by the member banks of the respective Federal Reserve District, and three of the directors are appointed by the Board of Governors. Most Reserve Banks have at least one Branch, and each Branch has its own board of directors. A majority of the directors on a Branch board are appointed by the Reserve Bank, and the remaining Branch directors are appointed by the Board of Governors. 

So a minority share of directors are picked by officials on the Fed board in Washington, who were themselves selected by the president and approved by the Senate. The rest are out of their control. “The framers of the Federal Reserve Act purposely rejected the concept of a single central bank,” notes a manual on the roles and responsibilities of Fed directors. An edict from the federal government on trading activity would run counter to that vision. At this level, the central bank’s current guidelines are appropriate.

But the Fed needs to do more for senior officials. It’s a bit unnerving that in a statement last month the central bank noted that its rules on the personal financial practices of Fed officials are the same as those for other government agencies, and it also has a set of supplemental rules “that are stricter than those that apply to Congress.” It’s worth adding more restrictions on members of Congress from trading stocks, too — that’s hardly a defense that the Fed’s policies are adequate.

Insisting upon qualified blind trusts for Fed leaders would firmly put this embarrassing episode in the rearview mirror. Given the rapidly evolving economic outlook, it will be crucial for the public to have confidence that policy makers entrusted with promoting maximum employment and stable prices are making decisions without considering what it might mean for their portfolios. If handing off control of their assets is too unbearable, then perhaps a job at the Fed isn’t right for them.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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