The Federal Reserve’s burgeoning ethics scandal, with two regional bank presidents and now Vice Chair Richard Clarida caught trading stocks while the central bank was creating its COVID response policies, should trigger a re-examination of who really controls the institution. The tug-of-war over whether Governor Lael Brainard’s position overseeing regional banks should have caught the ethical lapses, or whether Chair Jerome Powell has the responsibility, misses the point of where the power actually lies.
For one, it is literally a matter of statute that at the Fed, the chair controls almost everything: The Federal Reserve Act specifies in Section 10.2 that “the chairman of the Board, subject to its supervision, shall be its active executive officer” (emphasis added). (An executive officer is the general legal term for someone who oversees the day-to-day operations of an institution.) No other board members are ever referred to as executive officers. The sentence uses the singular “officer.”
This is important, because the cloistered, out-of-touch nature of Fed leadership derives mostly from its obscure senior staff members. And if one asks who sets the direction for them, one finds a fascinatingly top-heavy organizational structure.
Powell’s chief of staff is a woman named Michelle Smith, who has served every Fed Chair of the last 30 years in some capacity—Powell, Janet Yellen, Ben Bernanke, and Alan Greenspan. Prior to that, as a spokeswoman in Bill Clinton’s Treasury Department, she worked with the entire Rubinite gang that dominated economic policy in the Democratic Party for decades. This unappointed, rarely discussed figure is the point person for most of the Fed’s day-to-day activity, giving her extraordinary power over the actual operations of the most powerful central bank on Earth.
The proof is in the org chart. As of February 2018 (the last time the Fed’s org chart was updated), Smith is both the chair’s chief of staff and the director of the Division of Board Affairs. Several departments report to her, three of which are especially notable: public affairs, the congressional liaison office, and general program support.
Public affairs includes the board’s press relations team, which is how Smith got to where she is. As a press aide to Larry Summers at Treasury, she befriended Tim Geithner and Summers chief of staff Sheryl Sandberg, and reportedly helped to pitch the fateful Time magazine story that named Summers, Greenspan, and Robert Rubin as “The Committee to Save the World.”
After the Clinton years, Greenspan recruited her to run his own press shop at the Fed, where she revolutionized how the chairman interacts with the media. As The Washington Post wrote, “Greenspan was famous for talking in circles. Privately, though, he was more direct with reporters, hoping to influence market expectations so that Fed policy pronouncements wouldn’t cause massive dislocations. Greenspan was almost never quoted on the record, but a few economics reporters had access to him. He didn’t tell them exactly what he planned to do, but the reporters combined what they could learn from him and from other Fed officials to make educated inferences about the direction of Fed policy—a pattern that continues today.”
This approach to media relations helped to prevent market fluctuations. (Ever wonder why so much Fed reporting has unsourced speculations about what a statement by the chair “seems to signal”?) But it also sent a clear message to the Fed press: Don’t cross Michelle Smith, or you’ll lose your access to the chair.
One reporter famously learned this the hard way. In March 2015, The Wall Street Journal’s Pedro da Costa asked then-Chair Yellen for the names of Federal Open Market Committee members who’d struck down an internal investigation into a 2012 leak of market-moving information. Yellen refused to answer. Two weeks later, when da Costa got back from paternity leave, his editor at the Journal informed him he’d no longer be covering Fed press conferences. As da Costa writes, he has no reason to think he was “banned” from the press conferences “because the central bank let me back in as soon as I changed news organizations,” and he still covers the Fed today. But merely asking a question that painted the Fed in a bad light was evidently enough to rattle the most famous financial newspaper in America, which regularly engages in unsourced Fed prediction in its stories.
Smith still runs the Fed’s press shop, even as she simultaneously serves as Powell’s chief of staff. Meanwhile, the Division of Board Affairs, which she directs, also includes the Fed’s Congressional Liaison Office. In 2018, Linda Robertson supervised this office, but reported to Smith. Robertson now runs legislative affairs at the Treasury Department, according to the Prospect. That leaves Smith singularly in charge of the Fed’s relationships with both the press and Congress—and Smith herself answers to Powell, since she is his chief of staff.
But there’s one other key department that Smith oversees: the General Program Support Division—in other words, the staff economists.
“General program support” encompasses all aides to the governors, from clerical typists to their closest policy advisers. Anytime a Fed governor asks for an aide, they have to go through Smith, who scours the other departments and divisions to find someone who can be taken off of their current duties. In effect, that means that Smith gets sign-off on which economists end up advising which governors, and what work gets put on the back burner to attend to their needs. Former Fed staff tell us that the social and power dynamics of the Fed make it too awkward for a governor to theoretically say no to whoever is chosen.
By statute, the Fed chair is the only person in the Fed system who can set its governance policies, and has power over its day-to-day operations. Right now, most of that power gets delegated to one person, who is simultaneously the Fed chair’s closest personal aide, the head of the Fed’s communications office, the chief strategist for the Fed’s relationship with Congress, and the person who hand-chooses which economists get to work with which governors.
That is more power in the hands of one bureaucrat than exists in any other part of the federal government that I know of. It’s an extraordinary way to run an organization—imagine if, say, Amazon’s press secretary, top lobbyist, chief operations officer, and CEO’s secretary were all one person.
This delegation of enormous responsibility to staffers is built into the structure of the Fed. For decades, a sole staffer, general counsel Scott Alvarez, exercised control over regulatory policy, aligned with the laissez-faire direction of the man who hired him, Alan Greenspan. Alvarez, who helped draft the repeal of Glass-Steagall’s separation between investment and commercial banking and warded off any examination of mortgage fraud during the housing bubble, actively undermined the Dodd-Frank financial reform after it passed, pointing out to bank lawyers which parts he wanted to see weakened or repealed (which they promptly were).
Alvarez finally retired in 2017; his replacement, Mark Van der Weide, is another Fed lifer, with 23 years at the central bank. The Legal Division, which the general counsel heads, serves the Board of Governors directly, and the chair directs day-to-day operations for that board.
This kind of power concentration is a recipe for generating yes-men, rather than independent and critical thinking. It helps explain why anyone outside of the central bank who wants to maintain a positive relationship with those inside of it—reporters, ex-staffers, congressional staff, and so on—can tend toward so much deference to the chair. When almost all of the practical power in an institution is concentrated in one person, and that person serves the leader, it becomes extremely dangerous to say what the leader doesn’t want to hear.
Smith herself clearly recognizes the power of her job. The Post reports that she left the private sector almost as soon as she entered it in the mid-aughts. She also appears to be setting up a potential dynasty. Her daughter, Maddie Smith, is now a special assistant in the Treasury Department, following one of Smith’s old bosses, Yellen. The younger Smith joined the government from a communications consultancy, implying that she might foresee a similar career path to her mother: talking to reporters on behalf of top economic policymakers.
Institutions like the Fed, with this much centralization of power, and this much momentum to downplay dissent, are ripe for ethical lapses and scandals. There’s an active debate about reappointing Chair Powell. But until we address the way that people who are unrecognizable to the public also set and entrench Fed policy, we simply shouldn’t expect it to be fully responsive to public needs.