Sen. Pat Toomey, R-Pa., wants to reform the Federal Reserve Banks if it’s the last thing he does as an elected official. And he very well may succeed.
The ranking member on the Senate Banking Committee, who will not seek reelection this fall, has made it a priority for his final months in office to
To counter what he and other conservatives see as a budding partisan streak among reserve bank presidents and researchers, Toomey has called for Congress to consider several changes to how the institutions operate and how their leaders are chosen. He outlined his grievances and proposed solutions earlier this month, even floating the idea of doing away with the regional banks altogether.
“The regional Fed banks’ growing politicization puts both the Fed’s independence and its effectiveness at risk," Toomey told American Banker in a statement. "Congress granted the Fed operational independence to insulate monetary policy from politics. But if the Fed is going to stray from its statutory mandate and become a political actor, it’s impossible for it to maintain its independence."
Toomey has not introduced legislation on the issue, but the senator is intent on pushing the effort to bring greater accountability to the reserves banks as far as he can, a congressional aide familiar with his thinking told American Banker.
“It’s one of his top priorities before leaving Congress,” the aide said.
Toomey is not the first legislator to call for changes to the Fed system. Sen. Jack Reed, D-R.I., has advocated making the president of the New York Fed a presidentially appointed and Senate-confirmed position for more than a decade. More recently, Sen. Elizabeth Warren, D-Mass., called for greater transparency around investments made by reserve bank presidents after scandals led to the resignations of the Dallas and Boston Feds. Sherrod Brown, D-Ohio, chair of the Senate Banking Committee, authored a bill banning Fed leaders from stock picking.
While these lawmakers all agree that the regional Fed banks could benefit from reform, they differ dramatically on the nature of the problem that needs solving. Toomey wants the reserve banks to steer clear of topics that are in any way political, while Warren wants the Fed to play an active role in addressing economic inequality. Yet, there is enough agreement on specific elements, such as enhanced disclosure requirements, that a narrow reform bill is within the realm of possibility, advocates and analysts say.
Even the threat of being hemmed in by legislation could be enough to spur policy changes within the Fed system, Jeffrey Lacker, former president of the Richmond Fed, said in an interview.
“A threat to legislatively alter [the Fed system] in a way that reduces the independence of the reserve banks and thus the Federal Reserve System, is a standard tool in the toolkit of a legislator that wants to get the attention of the Federal Reserve,” Lacker said. “It’s the equivalent of smacking them over the forehead with a two-by-four.”
Lacker said adherence to Freedom of Information Act, or FOIA, rules varies across the reserve bank system, with some institutions following the spirit of the law more closely than others. The lack of consistency and transparency on this front is a legitimate gripe for Congress, he said, but one that is within the Fed’s power to address.
“I hope this difference of views and the tug of war over disclosure can be resolved without it coming to legislative blows,” he said.
Crossing the Rubicon
Toomey and other conservatives say the reserve banks have taken an activist bent in their research and, in the case of Minneapolis Fed President Neel Kashkari, gone so far as to use the Fed’s resources and status to promote liberal causes.
Kashkari, in partnership with former Minnesota Supreme Court Justice Alan Page, has helped craft a proposed amendment to the Minnesota Constitution that would codify a “quality” education as a civil right in the state. He has used Fed research to argue in favor of the initiative, dubbed the Page amendment, and has promoted it on the Minneapolis Fed website.
While it is common for reserve banks to identify disparities through their research, Kashkari’s open embrace of a policy remedy to such an issue goes beyond the pale, one banking industry advocate, who requested anonymity to discuss Fed policy, said.
“Kashkari has crossed a Rubicon that I don’t think anyone imagined.”
After brewing for more than a year, Toomey’s frustration with the reserve banks, and Kashkari in particular boiled over this month. Toomey penned
“A Federal Reserve Bank engaging in an aggressive campaign to amend a state’s constitution regarding primary and secondary education clearly does not fall within [the Fed's] mandate,” Toomey wrote. “Instead of engaging in mission creep, the Minneapolis Fed should focus on its day job of fighting the runaway 40-year-high inflation that the Federal Reserve has allowed to spiral out of control.”
The Page amendment aims to address educational disparities between different racial and socioeconomic groups in the state. Minnesota’s current public school system “systematically” underserved children of color, Indigenous children and low-income children, according to research from the Minneapolis Fed. Just 69% and 70% of Black and Latino students, respectively, graduate high school within four years, compared with 84% overall. Among students from low-income homes, only 57% were involved in post-secondary education within 16 months of graduating, compared with 76% overall.
By throwing the Fed’s research and platform behind the Page amendment, Toomey wrote, Kashkari undermined the central bank’s independence and credibility. If enacted, the amendment could tilt budget negotiations in the state in favor of public school advocates or give precedent to “activist judges,” putting the Fed in choppy political waters, Toomey argued.
“Historically, the Federal Reserve’s independence and careful adherence to nonpartisanship have allowed it to avoid being seen as a politicized body,” Toomey wrote. “However, the Minnesota Fed’s fervent political lobbying efforts have had the opposite effect.”
In his letter, Toomey calls for Congress to explore three potential changes to the Fed system: subjecting reserve banks to FOIA, requiring the Fed president to be presidentially nominated and congressionally confirmed, and consolidating or disbanding the reserve banks altogether.
A strange position
Toomey’s frustration with the reserve banks, which he shares with Warren, Reed and others, is their lack of transparency and oversight.
Regional Fed presidents are selected by the boards of directors of each reserve bank. The Board of Governors gets to weigh in and ultimately approve the selection, but the hiring process is done largely away from public view.
The same can be said for much of the activity that goes on within the reserve banks. Toomey’s office found this out firsthand this past year, as it repeatedly requested documents on research activity from Minneapolis, San Francisco, Boston, Atlanta and Kansas City Feds, an aide told American Banker. It has come up empty on all fronts.
The reserve banks have been able to skirt FOIA requirements because they are not technically government agencies, even though they carry out monetary policy on behalf of the Fed Board of Governors. Shares of the reserve banks are held by their member institutions. The system was designed this way to ensure monetary policy was not controlled exclusively by politicians in Washington or bankers in New York, Julie Hill, a professor at the University of Alabama Law School, said.
“They’re not wholly public and they’re not wholly private,” Hill said. “It’s really a strange position to be in.”
Setting the agenda
Over the decades, many of the original duties of the regional banks have been eroded by market evolutions, technological advancements or the consolidation of power within the Board of Governors.
Each reserve bank still plays a role in executing the day-to-day operations of the monetary system and supervises banks in its region. Otherwise, it is largely up to the individual reserve presidents to set their own policy agendas.
Kashkari, a former Treasury official and onetime Republican gubernatorial candidate in California, argues that education often dictates job attainment and income, putting the issue squarely in the Fed’s mandate to achieve maximum employment.
“The Minneapolis Fed, we don’t set education policy, but we care a lot about it because it directly affects how competitive our region is and how competitive our country is,” Kashkari said during a public appearance in March. “If we want our economy to grow, if we want Minnesota’s economy to grow, then we need to educate all Minnesotans.”
Examining local economies from as many angles as possible is a key duty for regional reserve banks, former New York Fed President William Dudley said in an interview. Doing so effectively, he added, means granting staffers the freedom to research as they please.
“If you want to have high-quality people doing research at the reserve banks, you've got to give them some freedom to work on a wide range of issues,” Dudley said. “It’s important to have a broad range of expertise, because you never know what the issues are going to be.”
Still, conservatives argue that reserve bank research has taken on a more political flavor. Indeed, hot-button issues, such as climate change and economic disparities between racial groups and genders are on the rise, according to a report released this month by the Mercatus Center at George Mason University, a market-centered research nonprofit.
More than 20% of reserve bank papers published in 2021 were focused on one or more of those “activist” topics, per the report, up from between 4% and 8% annually for reports published between 2006 and 2013.
The report also notes that certain reserve banks have taken on leading roles in specific areas. The Minneapolis, Cleveland and Boston Feds led the pack in terms of inequality-focused reports, while San Francisco and Chicago were the forerunners on climate issues. Atlanta was number one in gender-based reports and Dallas was the leader for race-based studies.
One of the authors of the Mercatus report, Christina Skinner, a professor of legal studies and business ethics at the University of Pennsylvania’s Wharton School of Business, said there is no inherent issue with the reserve banks studying such topics. But, she noted, research tends to guide policymaking either directly or indirectly, and the more research done outside the Fed’s core mandates of maintaining price stability and full employment, the greater risk that the central bank deviates from those missions.
“The reserve banks don't really have mandates per se; they're just responsible for operationalizing monetary policy. But what they have done is use their general stature within the Federal Reserve, in some cases, as more of a podium to try and push or advance policy goals that are outside the mandate of the Fed board,” Skinner said in an interview. “It’s using the imprimatur of the reserve banks to suggest that A, this is something that a central bank can and should do and B, to perhaps influence in, soft law terms, the policy trajectory of the Federal Reserve Board.”
‘Can of worms’
Frustrations with the reserve banks are evident on both ends of the political spectrum and there is near- unanimity that the system’s structure is antiquated.
The clearest example of this is the location of the 12 regional banks, which reflect the population centers of a century ago, Karen Petrou, co-founder and managing partner of Federal Financial Analytics, said. There are two reserve banks in Missouri and only one west of the Rocky Mountains.
With so many of the reserve banks’ original duties able to be carried out digitally, Petrou said the best justification for keeping regional locations is to monitor the economy in different parts of the country. To that end, a reworking of the system would be best served by focusing on the locations and issues prevalent today, she said.
“To the extent that the reserve banks do what they say they still have a mission to do — which is to reflect the national voice in economic policy — then they need to better represent the nation,” she said. “And that's true not only in the diversity with the heads of banks … but also in the nature of their mission.”
Therein lies the problem for reserve bank proponents who would like to see incremental improvements to the system, Lacker said. Once the reform process starts, it can balloon into something much bigger.
“Within the system, there's always going to be the can-of-worms fear,” he said. “If you open up the reserve banks, you'll get changes you like, but you might get changes you don't like. That's always going to be a clear and present danger.”
