What banks — and fintechs — can expect from N.Y. Fed's new chief

April 5, 2018 12:22 PM

The selection of John C. Williams as the next president of the Federal Reserve Bank of New York could have a ripple effect that spreads far beyond lower Manhattan.

The New York Fed has always played an outsized role within the Federal Reserve System, owing in part to its association with the nation's financial center and as the home jurisdiction of many of the largest financial firms. It also plays a key functional role conducting the open market operations directed by the Federal Open Market Committee. Unique among regional banks, the New York is a permanent FOMC member.

But the ascension of Williams — now the head of the Federal Reserve Bank of San Francisco — to what is often considered one of the most influential leadership positions with the Fed system, along with the Fed board chair and vice chair, could change the direction of the central bank itself.

Part of that is the longevity of the term. The Fed chairman and vice chair each serve four-year, renewable terms. The New York Fed president’s term, meanwhile, is effectively a 10-year term. And unlike Federal Reserve Board governors, most New York Fed presidents serve out the majority of their term. There have only been 10 since the passage of the Federal Reserve Act in 1913.

Williams is poised to wield a lot of influence in part because the Federal Reserve’s Board of Governors is so historically short-handed. The voting members of the FOMC, for example, are composed of the seven members of the board and a rotating selection of five regional bank presidents. Those include the New York Fed as a permanent voting member, the Chicago and Cleveland Fed bank presidents on a biennial rotation, and the remaining Fed bank chiefs on a triennial rotation, making a total of five regional bank votes.

With only three Fed Governors currently serving — and with the president’s only other nominee facing a tough confirmation fight — Williams and the other regional bank presidents will outnumber the Fed board, at least for the time being.

Here is what Williams’ selection could mean for the Federal Reserve and the banks it supervises?

Federal Reserve Bank President John Williams

John Williams, president of the Federal Reserve Bank of San Francisco, listens during a Hutchins Center on Fiscal and Monetary Policy panel discussion at the Brookings Institution in Washington, D.C., U.S., on Monday, Jan. 8, 2018. The event was entitled Should the Fed Stick with the 2 Percent Inflation Target or Rethink It. Photographer: Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

Why John Williams’ selection to lead the New York Fed matters

The selection of John C. Williams as the next president of the Federal Reserve Bank of New York could have a ripple effect that spreads far beyond lower Manhattan.

The New York Fed has always played an outsized role within the Federal Reserve System, owing in part to its association with the nation's financial center and as the home jurisdiction of many of the largest financial firms. It also plays a key functional role conducting the open market operations directed by the Federal Open Market Committee. Unique among regional banks, the New York is a permanent FOMC member.

But the ascension of Williams — now the head of the Federal Reserve Bank of San Francisco — to what is often considered one of the most influential leadership positions with the Fed system, along with the Fed board chair and vice chair, could change the direction of the central bank itself.

Part of that is the longevity of the term. The Fed chairman and vice chair each serve four-year, renewable terms. The New York Fed president’s term, meanwhile, is effectively a 10-year term. And unlike Federal Reserve Board governors, most New York Fed presidents serve out the majority of their term. There have only been 10 since the passage of the Federal Reserve Act in 1913.

Williams is poised to wield a lot of influence in part because the Federal Reserve’s Board of Governors is so historically short-handed. The voting members of the FOMC, for example, are composed of the seven members of the board and a rotating selection of five regional bank presidents. Those include the New York Fed as a permanent voting member, the Chicago and Cleveland Fed bank presidents on a biennial rotation, and the remaining Fed bank chiefs on a triennial rotation, making a total of five regional bank votes.

With only three Fed Governors currently serving — and with the president’s only other nominee facing a tough confirmation fight — Williams and the other regional bank presidents will outnumber the Fed board, at least for the time being.

Here is what Williams’ selection could mean for the Federal Reserve and the banks it supervises?

A critic of Wall Street culture

When Williams’ status as front-runner for the job of New York Fed president was reported late last month, he was criticized on a number of fronts. Some public advocacy groups were disappointed in the nomination of yet another white man to a powerful position.

Others — notably Sen. Elizabeth Warren, D-Mass. — were critical of his role in failing to uncover wrongdoing at Wells Fargo, which is headquartered in San Francisco. Warren said in a statement that Williams and the co-chairs of the New York Fed’s board of directors should testify before the Senate Banking Committee about his selection, though it remains unclear whether they will do so.

“The Fed's Board of Governors and the New York Fed should go out of their way to solicit and consider public input when selecting a new president who will have so much influence over interest rates and Wall Street supervision,” Warren said. “Instead, they turned the process over to a handful of private individuals and ignored calls to choose one of many qualified alternatives who might have brought a new perspective.”

But Williams has been critical of those Wall Street banks and their practices in the past. In an interview with American Banker in March 2016 — before Wells Fargo’s cross-selling scandal broke — Williams said that he was worried that banks had not learned their lessons from the financial crisis and had not adjusted their attitudes accordingly.

“I think the events of the last eight years have taught a lot of leaders in banks that reputation, which has always been highly valuable, is something that you can lose quickly when you find out that people are doing things that aren't consistent with your vision and your mission,” Williams said. “That leads to a lot of public recognition of that, and obviously huge fines. Hopefully the lesson learned is to recognize that the long-run health and reputation actually matters a lot more than short-term gains. That's still a question mark, though, how much that has stuck.”

He also said that continued failures at the big banks to prioritize long-term health and enforcing the law over short-term profits is a troubling sign of a degraded culture in the banking industry, and one that has drawn his attention.

“What worries me the most is all these anti-money-laundering and [Bank Secrecy Act] failures at the biggest banks in the world,” Williams said. “They pay huge fees, they clearly have not had adequate control over this, and when you read the stories, it sounds like [the bankers think], ‘Well, this sounds like a profitable business, so let's not ask questions.’ That's what worries me, is the kind of culture that doesn't worry as much about reputation, about the long-term health of the organization.”

But some still express concern that the Fed system continues to be led by officials without a strong regulatory background.

Mayra Rodríguez Valladares, managing partner at MRV Associates, said the idea that Williams provides much-needed economic expertise is somewhat misplaced, since many of the members of the FOMC — particularly the regional bank presidents — are also Ph.D. economists. The problem is that he lacks specialized supervisory experience, as do many others in key Fed positions.

“To be honest, the Fed doesn’t have a shortage of expertise in economics. My concern is how much does he bring to the table in terms of expertise in bank supervision,” Valladares said. “That’s been a problem at the Fed, frankly. With [former Fed Gov. Daniel] Tarullo gone, we don’t have anybody with that level [of expertise], and the New York Fed … needs somebody with expertise in bank supervision.”

New thinking on monetary policy

Williams’ specialty within economics is monetary policy, particularly how central banks set monetary policy with uncertain or imperfect information.

In a speech last year, Williams addressed precisely that problem: how the Fed should think about its monetary policy in an era where the neutral rate of interest is lower than it has ever been before. That low neutral rate, known as “R-star,” should spur central banks around the world into looking beyond the economic indicators of the past and toward a new and more beneficial set of indicators, particularly something called “flexible price-level targeting.”

When the Fed decides whether or not to raise interest rates, it has two goals: to keep prices stable and to minimize unemployment. The FOMC members look to certain indicators to assess where the economy is — the nominal unemployment rate, the rate of inflation, the growth of the economy, and others.

But Williams argued in this speech that using inflation as an indicator may be less effective, especially in uncertain times, than simply assessing the prices of things relative to a price target that implies a certain rate of inflation.

“In a nutshell, the big advantage of this approach is that any surges or drops in the inflation rate need to be made up in the future,” Williams said. “This assures that, over the medium term, inflation stays on track, even if policymakers have a very imperfect understanding of the levels of natural rates or other structural changes affecting the economy.”

Karen Shaw Petrou, managing partner at Federal Financial Analytics, said that if Williams takes this idea to the FOMC and tries to sell it, he may find some willing buyers. The Fed’s inflation targets have been stubbornly hard to meet, she said, and if the FOMC members buy in to the idea of flexible price-level targeting, it could change monetary policy dramatically.

“It’s really a very strong statement about what’s wrong with the way the Fed is working now,” Petrou said. “As president of the New York Fed … he could be really important in really forcing the Fed to rethink its monetary policy. And I hope he does.”

A backlash against the regional Fed banks?

While the backlash over a lack of diversity and the supervision of Wells Fargo did not prevent Williams' appointment, that controversy could lead to greater scrutiny of regional Fed banks and how they are selected.

“Williams' appointment is just the latest example of an opaque process that has routinely resulted in the selection of individuals who fail to represent the public, and generally come from either the financial sector, within the Fed, or both,” said Jordan Haedtler, the campaign manager for the Fed Up Campaign, which opposed Williams’ appointment. “I hope and expect that this will renew the momentum in Congress to reform this process.”

Congress has toyed with the idea of reforming the regional bank president selection process for decades. Former House Banking Committee Chairman Henry Gonzalez, D-Texas, introduced a bill in 1993 that would have made each of the regional Fed bank presidents presidentially appointed and require confirmation by the Senate.

More recently, a financial reform bill introduced by then-Senate Banking Committee chairman Richard Shelby, R-Ala., would have required presidential appointment and Senate confirmation for the New York Fed Bank president — a measure initially introduced by Sen. Jack Reed, D-R.I.

Those measures have thus far failed to gain enough steam to be passed into law or even foster broad support. But continued distrust of the Fed among some lawmakers and the insulated selection process for regional bank presidents could change that.

“I think the controversy surrounding this nomination will re-engage [lawmakers] on that, and this has been from both Republicans and Democrats,” Petrou said.

Perhaps one of the main things holding Congress back is a lack of viable alternatives, according to Aaron Klein, policy director at the Center on Regulation and Markets at the Brookings Institution. Presidential appointments have the effect of bringing some transparency and accountability to the selection process, but also bring inefficiency.

“I think it should change, but if I had a solution I would have published it,” Klein said. “The selection process produces the same results over and over again, which is insider selections. That being said, President Trump has failed to nominate people to serve on the board of governors, so the presidential selection process produces vacancies. The regional bank process does not produce vacancies.”

Rodriguez said the other problem with making regional bank presidents political appointees is that they then become even more entrenched with the political winds of the moment, which is precisely why the Federal Reserve was established with such a byzantine structure in the first place.

“I am very much for central bank independence,” Rodriguez said. “The real job of a legislator is getting reelected. They want to make sure that while they’re in office, the economy is as good as possible, because it will help them get reelected. Somebody who is appointed to the Fed as a regional president needs to be … working independently from any administration.”

Isaac Boltansky, an analyst with Compass Point LLC, said he thought the chances of a legislative change to the regional Fed bank nomination process was a long shot given the lack of cohesion around the issue and the challenges that Congress faces in passing even routine bills.

“There are undeniably substantive Federal Reserve reforms that should be considered by Congress — just look at a map of the regional bank locations — but Congress appears neither capable nor willing to wade into the Federal Reserve governance reform debate,” Boltansky said. “I just don’t see it.”

No free pass for fintech

As president of the San Francisco Fed, Williams has had ample opportunity to be won over by the technology sector's promise of revolutionizing financial services, but he has still been critical of fintech firms.

In his 2016 interview with American Banker, Williams said new entrants to the financial services market brought a valuable source of competition and could potentially spur innovation. But he also said that they might be either intentionally or inadvertently skirting fair lending laws meant to require that credit is extended to everyone.

“A lot of our regulation is based on real problems that needed to be addressed through regulatory or legal ways,” Williams said. “I'm thinking of things like redlining way back, or underprivileged communities not getting credit — that was a problem in our society and there were laws written to try and better address that.

“I worry about that with fintech, to make sure that, if we're going to bring technology in … that we remember the lessons from the past and demand of them that they extend credit to all parts of our community,” Williams said.

Regulators have been grappling with how and whether to integrate fintech companies into the banking industry. Former Comptroller of the Currency Thomas Curry proposed a specially designed fintech charter that his successor, Joseph Otting, is also exploring. Jelena McWilliams, president Trump’s nominee to chair the Federal Deposit Insurance Corp., has also expressed a willingness to grant charters to industrial loan companies — essentially allowing commercial companies to maintain a banking arm.

But Williams’ role as president of the New York Fed will be more indirect as it pertains to those kinds of policy decisions. The New York Fed supervises the largest banks, but regulatory policy remains the purview of the Fed board in Washington and other bank regulators.

He could still weigh in on those matters either publicly or informally, but Haedtler said it remains unclear whether he is actually moving in a different direction than other Fed leaders.

Haedltler was especially uneasy with Williams’ characterization of redlining as a long-ago practice, despite evidence that people of color continue to struggle to obtain credit.

“I'm glad that he's thinking about it, but there are a few issues that he raised where the Fed and other regulators are moving in the opposite direction, and I hope he will use his new stature as a regulator in New York to push back forcefully against those efforts,” Haedtler said. “Does he agree with Chair Powell that [the Senate Dodd-Frank bill] is basically a good bill, even though it includes language that will weaken regulators' ability to identify and respond to discriminatory lending? Does he agree with the effort announced by Gov. Quarles last week to open up and potentially weaken the Community Reinvestment Act?”