Fed Faces Biggest Blow to Independence, Powers in Dodd Proposal

By Scott Lanman and Craig Torres

Nov. 11 (Bloomberg) -- The Federal Reserve faces the biggest blows to its authority and independence in five decades under legislation championed by its lead overseer in the U.S. Senate.

The financial-regulation overhaul proposed yesterday by Senator Christopher Dodd would strip the Fed of its role as a bank supervisor and give Congress a greater voice in naming the officials who set interest rates. The measure opens the door to interference from politicians who might disagree with any move by the Fed to raise rates from record lows, former central bank officials said.

“If you were worried that the Fed will be pressured to remove its accommodation while the unemployment rate is still very high, you’ve got to look for leverage,” Vincent Reinhart, a former director of the Fed’s Monetary Affairs Division, said in an interview. Dodd is aiming for “some political reach into all the voters” on the Fed’s Open Market Committee, which decides the benchmark U.S. interest rate, added Reinhart, now a resident scholar at the American Enterprise Institute.

U.S. stocks, bonds and the dollar would collapse if investors perceive Congress violating the independence of the policy-setting panel, former Fed Governor Laurence Meyer, now vice chairman of Macroeconomic Advisers LLC, said last month.

The Dodd measure would also curb the Fed’s ability to make emergency loans to individual companies. The Fed’s response to the financial crisis prompted increased scrutiny of the central bank, especially after it used its emergency powers to bail out Bear Stearns Cos. and American International Group Inc.

Confirmation Hearings

The proposal comes as Fed Chairman Ben S. Bernanke, 55, awaits confirmation to a second term. The hearings will be held some time after the Nov. 26 Thanksgiving holiday by Dodd, the Connecticut Democrat who chairs the banking committee.

Dodd said yesterday that Bernanke is “doing a terrific job,” and that his proposal is “not about individuals and personalities. It’s about putting together an architecture that makes sense.”

Under the 1,136-page proposal, the Fed would lose its bank- supervision role to a new Financial Institutions Regulatory Administration. Its consumer oversight duties would go to a new Consumer Financial Protection Agency. An Agency for Financial Stability would have broad powers to protect the economy from financial risks, with the Fed chairman holding one of nine seats.

Dodd would leave the Fed with monetary policy as it main responsibility. The White House and Congress would gain sway over the private-sector directors who choose regional Fed presidents, who vote on interest rates.

‘Abysmal Failure’

The Fed’s regulation of banks has been an “abysmal failure,” said Dodd, who has blamed it for not preventing the practices that contributed to the financial crisis and led to taxpayer bailouts of firms including Bank of America Corp. and Citigroup Inc.

Dodd, 65, faces re-election to a sixth term next year. A Quinnipiac University poll of Connecticut voters conducted Sept. 10-14 showed Dodd’s disapproval rating at 49 percent, down nine points from April. The poll had a margin of error of plus or minus 3.2 percentage points.

The bill is “not designed to basically punish the Federal Reserve at all, but rather to enhance their role, and their independence,” Dodd said at a press conference yesterday. “You start loading up the Fed with additional responsibilities, and that independence can be threatened.”

Fed Mandate

“It is hard to imagine monetary policy being conducted effectively in an environment where financial stability is lacking from the Fed’s mandate,” J. Alfred Broaddus Jr., a former president of the Richmond Fed, said in an interview.

A Fed official said the agency will review the Dodd plan guided by whether it maintains the Fed’s independence and its ability to set monetary policy as well as promote financial stability.

“The Fed should have a particularly important role in supervising institutions that create systemic risk,” Janet Yellen, president of the San Francisco Fed, told reporters yesterday after a speech in Phoenix.

Under the proposal, commercial banks would lose their power to appoint directors of the 12 regional Fed banks. Instead, directors would be chosen by the Fed’s Senate-confirmed governors, and each board chairman would be subject to Senate approval. Currently, two-thirds of directors are chosen by private-sector banks and one-third by the Washington-based governors.

Commercial banks’ power to appoint regional Fed directors dates to the 1913 law that created the central bank. In 1951, the Fed won the right to conduct monetary policy without Treasury Department approval. The Fed was charged with supervising bank holding companies in 1956.

Single Regulator

In creating a single U.S. bank regulator, Dodd would combine parts of the Fed, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency and the Office of Thrift Supervision. The legislation also creates a mechanism for the FDIC to unwind failing “systemically significant” financial firms.

The bill must be approved by the Senate, reconciled with the House version and signed by President Barack Obama to become law. It goes beyond proposals from the Obama administration and House Financial Services Committee Chairman Barney Frank, who would expand the Fed’s bank-supervision role.

Frank, whose bill doesn’t address the central bank’s governance, said in a statement that “we are moving in the same direction.”

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net.