Federal Reserve audit highlights possible conflicts of interest

July 21, 2011

When the Federal Reserve launched an unprecedented series of interventions in the financial system in 2008, it often moved so quickly that the usual practices for preventing conflicts of interest couldn’t keep up, according to a new report.

An audit of the Fed’s emergency lending programs by the Government Accountability Office, ordered by the financial reform law passed last year and released Thursday, reports generally sound financial management by the central bank as it undertook programs that deployed trillions of dollars to backstop a faltering financial system. But it brings to light difficult issues that arose when the Fed undertook actions that its rules never envisioned.

For instance, William C. Dudley, the president of the Federal Reserve Bank of New York who was a senior official there in 2008, owned stock of American International Group before the Fed bailed out the giant insurance firm. The GAO report did not mention him by name, but Sen. Bernie Sanders (I-Vt.), who spearheaded the audit, identified Dudley as the unnamed official described in the report.

Lawyers at the New York Fed allowed Dudley to continue owning the shares while working on issues relating to the bailout. They concluded that for him to sell the shares immediately after the central bank bailed out the firm would be more ethically problematic than simply holding onto them and selling at a later date.

Dudley “held shares in these companies as part of his personal portfolio that predated his service at the New York Fed,” a spokesman for the central bank said. “A waiver was granted allowing him to hold these shares based in part on the judgement that had he sold these shares immediately after the interventions it would have the appearance of a conflict.”

The GAO report did not condemn the Fed’s actions, it simply illuminated them. Dudley has subsequently sold all the shares on dates agreed to with the bank’s ethics officers, the spokesman said.

The GAO also recommended that the Fed make clearer and more rigorous its policies for hiring independent contractors to manage investment programs. During the crisis, the New York Fed hired outside firms to manage many of its special lending programs, such as one designed to backstop the market for short-term corporate loans, without holding a normal bidding process for the contracts.

The report also found that lines of authority between the Fed’s Board of Governors in Washington and the 12 regional Fed banks around the country were sometimes muddled during the crisis. For example, it was not always clear where authority resided on questions of what collateral would be adequate for an emergency loan.

The report was the latest to detail aspects of the Fed’s actions during the financial crisis that were shrouded in mystery at the time. Another provision in last year’s Dodd-Frank Wall Street regulatory overhaul, also instigated by Sanders, required the disclosure of what individual banks and other entities received loans from the Fed.

“As a result of this audit, we now know that the Federal Reserve provided more than $16 trillion in total financial assistance to some of the largest financial institutions and corporations in the United States and throughout the world,” Sanders said in a statement. “This is a clear case of socialism for the rich and rugged, you’re-on-your-own individualism for everyone else.”

The Fed’s general counsel, Scott Alvarez, said in a letter responding to the GAO’s audit that officials will “strongly consider” the recommendations.

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