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Fed under pressure: “Ethics must be as strong as the economy”

In the face of one of the biggest reputational crises in history, the Federal Reserve is under pressure to revise its ethical guidelines and end virtually all active trading by Federal Reserve officials.

U.S. lawmakers, former Federal Reserve officials and ethics experts are calling for tighter restrictions after it was revealed that a handful of senior policy makers were active participants in the financial markets as the central bank used its full firepower to mitigate the damage caused by the coronavirus pandemic.

Two regional Fed presidents, Robert Kaplan of Dallas and Eric Rosengren of Boston, resigned after their trading activities became known, and Elizabeth Warren, Democratic senator from Massachusetts, called on the Securities and Exchange Commission to open an investigation.

She has also questioned transactions by Richard Clarida, vice chairman of the Fed, which included the transfer of up to 5 million pandemic that hit the ground in February 2020.

The state watchdog that oversees the Board of Governors also checks the legality of trading activities.

In order for the central bank to overcome this controversy – described by a former director as “shocking and heartbreaking” – Fed monitors and former employees need to rethink the rules that govern what officials can do and how often they can do so.

We had put in place a number of investing, trading, and disclosure practices that seemed to work for a long time. Obviously it really doesn’t work now

“In its centuries of history, the Fed has never been able to publicly acknowledge the possibility that one of its top officials has broken the law,” said Andrew Levin, who served on the board for two decades and now teaches at Dartmouth University. “You have no choice – you have to restore your reputation.”

Both regional Fed presidents said their dealings were allowed under the central bank’s ethical rules. A Fed spokesman said this week that Clarida’s transaction was part of a “pre-planned rebalancing” and had previously been approved by the board’s ethics officer.

Guidelines state that central bankers should avoid any act that “might even give the appearance of a conflict between their personal interests, the interests of the system and the public interest”.

The rules restrict Fed employees from owning stocks, bonds, or funds that are specifically tied to the banking sector. Regional presidents, officers and officers may also not trade or hold securities for less than 30 days in the approximately 10 days prior to a meeting of the US federal government’s Open Markets Committee.

There are different business disclosure guidelines for officials at the 12 regional banks, which are private institutions. For example, branches do not report their trading activities to the US Office of Government Ethics. Powell, Clarida and other directors do this annually and must report all securities transactions within 30 days.

This “decentralized” structure creates challenges, said a former Fed governor, because different people have different rules.

At a congressional hearing last week before Clarida’s business became known, Powell said the reported transactions appeared to be in compliance with current ethical rules, underscoring the extent to which standards need to be improved.

“We had a number of investing, trading and disclosure practices in place that seemed to have worked for a long time,” he said. “Of course it really doesn’t work now.”

The Fed has stated that it is involved in its own “thorough and comprehensive” review of the guidelines. It declined to comment further.

“Ethics must be as strong as economics,” said Norman Eisen, who served as an ethics advisor to the Obama administration and is now a senior fellow at the Brookings Institution. “Your credibility will be at stake if you gloss over or step down. Right now, they have a chance to build their credibility by doing the right thing. “

One idea is to ban active trading, which was sponsored by Warren and Jon Ossoff, a Democratic Senator from Georgia.

“There should be no nuances, no exceptions, no lengthy rules,” said Peter Conti-Brown, professor of law and business ethics at the University of Pennsylvania. “It should just be like this, if you are a regional president of the central bank or a member of the board of governors, you cannot actively trade.”

A former employee of one of the regional banks said the rules should go further: “Anyone in the room” when discussing policy decisions or other market-sensitive information should be subject to controls that invest in passive index funds with “mechanical, pre-announced controls Rules ”how they can be managed.

Claudia Sahm, a former Fed economist and senior fellow at the Jain Family Institute, said greater restrictions were also required on the approval of transactions, especially in crisis situations like last year.

“The ethics rules were not written for a moment like in spring 2020,” she said. “There are restrictions on FOMC meetings, but it was absolutely not enough when the Fed was holding emergency meetings and the financial markets were in dire straits.”

There are also calls for the rules for regional Fed officials to be coordinated with those on the board. Levin, who served as special advisor to former chairwoman Janet Yellen, said the inspector general’s legal powers should be extended to include regional banks. Others want the Freedom of Information Act to apply to regional banks.

It is also important to act quickly, said Sarah Binder, a political scientist at George Washington University, particularly with Powell’s future at the Fed. His term expires early next year and while he is widely expected to be reappointed, the controversy has complicated matters.

Fed officials “need the support of the public, and especially politicians, in making changes that affect people’s livelihoods,” Binder said. “If there is any doubt about whose interests the central banks are working, it is not a good thing to add to the Fed’s support.”

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