FISSURES APPEAR AT THE NEW YORK FED / THE WALL STREET JOURNAL

BUSINESS

JULY 3, 2009.

Fissures Appear at the New York Fed

By KATE KELLY


The board of the Federal Reserve Bank of New York is packed with powerful executives. But the selection process leading up to January's promotion of William Dudley to president underscored the lack of clout among the Fed's regional directors as the central bank navigated the crisis.

Mr. Dudley, a 56-year-old former Goldman Sachs Group Inc. economist who ran the New York Fed's markets division, got the top job after a two-month search, succeeding new Treasury Secretary Timothy Geithner.

Behind the scenes, the hiring process triggered concerns with some New York Fed directors, including General Electric Co. Chief Executive Jeff Immelt and PepsiCo Inc. CEO Indra Nooyi, according to people familiar with the situation. One reason: Mr. Geithner took an active role in recommending his successor, lobbying hard for Mr. Dudley and against other candidates, attendees said.

It isn't unusual for outgoing Fed presidents to provide such input. But Mr. Dudley's case is different, some observers said, because Mr. Geithner was a political nominee at the time. Injecting a White House appointee's views into the process, they suggested, may have meddled.

"The right thing for the Treasury secretary to do is to allow the central bank to be independent and not have a say in who gets chosen," said Allan Meltzer, a Fed historian.

Tom Baxter, the New York Fed's general counsel, said it made sense for Mr. Geithner to be involved because his successor "would be working closely with the new Treasury secretary." Given that, "it was seen as appropriate and consistent with good-governance principles" for the board to invite Mr. Geithner's input.

A Treasury spokesman said it is "only natural that the outgoing head of an institution would be asked to share his views on the set of candidates who may serve as his replacement."

Concerns about the selection process come at a sensitive time for the Fed, as its role in the financial crisis has been questioned by some lawmakers. The recent resignation of New York Fed board chairman Stephen Friedman after a conflict over his holdings in Goldman Sachs, a bank regulated by the Fed, sparked criticism in Washington. Some are calling for more oversight of both the reserve banks and the central bank.

Within the system, some New York Fed directors also have bristled at times at the board's rules -- which place parameters on some board members' stock holdings, affiliations with banks, and partisan activities -- and even its overarching mission, which is to act largely as an advisory board rather than a more activist, corporate board.

J.P. Morgan Chase & Co. CEO James Dimon, for instance, aired frustrations to associates that New York Fed rules curbing directors' political activities stymied his backing of Barack Obama for president.

Yet some directors have told associates their role at the New York Fed is important and their input, especially during this time of stress, is meaningful. A reserve-bank board, says former Federal Reserve Board lawyer Oliver Ireland, is "a valuable information source on the regional economy."

The nine-member panel in New York currently has three vacancies, but officials there said the successors could be named by the end of the summer.

The Federal Reserve has played a major role, influenced strongly by the New York Fed, in launching more than $2 trillion in new lending and asset-purchase programs to help revive the economy. President Obama, who recently proposed to broaden the Fed's oversight of the financial system, also asked the central bank to offer recommendations "to better align its structure and governance with its authorities and responsibilities."

The boards of the nation's 12 reserve banks were integral to the original compromise that created the Fed in 1913, which was meant to address fears that too much power would be consolidated in Washington through the Federal Reserve Board, leaving regional business voices out of the mix.
Their original task was to set local discount rates and be more engaged with regional business. Now the discount rate is effectively nationalized, and directors' role in crises is hands-off.

The lack of clout upsets some directors. Ms. Nooyi was critical during an audit-committee meeting late last year where she and other directors were briefed, after the fact, on how the New York Fed handled the bailout of American International Group Inc.

If directors couldn't have a bigger role, attendees said Ms. Nooyi asked colleagues at the meeting, "What are we doing here?" In February, she stepped down from the Fed board, citing scheduling conflicts. Mr. Baxter declined to comment on specific directors.

Selecting a new president is one of the board's most important duties. A reserve bank's president has a five-year term and, in the case of New York, a permanent seat on the Federal Open Market Committee, which sets the federal-funds rate, or the rate at which financial institutions borrow from one another. The New York Fed president's geographic perch also gives him close oversight of some of the nation's largest banks.

The search to replace Mr. Geithner began immediately after he was tapped in late November to be Treasury secretary. Mr. Friedman led it.

By early January, the list was narrowed to six, including Kevin Warsh, a member of the Federal Reserve Board in Washington; Rodgin Cohen, who specialized in banking law at Sullivan & Cromwell LLC; and Mr. Dudley, who had been head of the New York Fed's markets division since 2007.

Momentum for Messrs. Warsh and Cohen was strong, said people who were involved in the discussions, with Mr. Friedman speaking favorably about Mr. Warsh. Directors, including Mr. Dimon and Richard Carrión, CEO of Popular Inc., a banking company in Puerto Rico, advocated for Mr. Cohen, the people said.

On Jan. 10, the board convened early for a full day of interviews. The final candidates met with the board for about 45 minutes, attendees said, after which directors discussed their performances.

That afternoon, Mr. Geithner, shared his own views, attendees said. Along with Federal Reserve Chairman Ben Bernanke and Vice Chairman Donald Kohn, these people said, Mr. Geithner had been briefed privately on the list of candidates and qualifications throughout the process.

At the meeting, Mr. Geithner argued that Mr. Warsh was too large a part of the Washington establishment, an attendee said, a link that could cause tension with the New York Fed. He said Mr. Cohen, who has represented investment banks and banks in private legal matters, could be considered too close to the Wall Street establishment, the attendee said.

Mr. Geithner's preference was clear, attendees said: Mr. Dudley, with his intimate markets knowledge and home-court advantage, was the best choice. "Good decisions" and "execution" were among the economist's strong points, Mr. Geithner said, according to an attendee.

After Mr. Geithner left the room, GE's Mr. Immelt noted that an outgoing president's point of view shouldn't carry too much weight, attendees said. But during the discussion that followed, opinions seemed to be shifting toward Mr. Dudley, for some of the reasons Mr. Geithner had cited.

Ms. Nooyi, who argued for Credit Suisse Group investment-banking chief Paul Calello, appeared angry, an attendee said. She criticized the process, saying: "If a Wall Street guy presented such issues, why interview this person?" according to attendees.

Five days later, the board reconvened. The directors' recommendation, Mr. Dudley, was conveyed to the Federal Reserve Board in Washington, which has final say over such matters. He got the nod.

—Jon Hilsenrath contributed to this article.
Write to Kate Kelly at kate.kelly@wsj.com

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved