New York Fed Chairman’s Ties to Goldman Raise Questions

Aren’t we Canadians a bunch of total innocents? Mark Carney is such a sweet ex Goldman Sachs alumni, he would never falsify a tax leakage analysis would he?


By KATE KELLY and JON HILSENRATH
May 4, 2009
Wall Street Journal

The Federal Reserve Bank of New York shaped Washington’s response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed’s chairman, Stephen Friedman, sat on Goldman’s board and had a large holding in Goldman stock, which because of Goldman’s new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They’ve since risen $1.7 million in value.

Mr. Friedman also was overseeing the search for a new president of the New York Fed, an officer who has a critical role in setting monetary policy at the Federal Reserve. The choice was a former Goldman executive.

The case illustrates what a tangle of overlapping interests can arise at a hybrid institution like the New York Federal Reserve Bank, especially as the U.S. government, in addressing the financial and economic turmoil, grows ever more deeply enmeshed in American business and banking.

Mr. Friedman, who once ran Goldman, says none of these events involved any conflicts. He says his job as chairman of the New York Fed isn’t a policy-making one, that he didn’t consider his purchases of more Goldman shares to conflict with Fed policy, and bought shares because they were very cheap.

Last week, following questions from The Wall Street Journal, Mr. Friedman, 71 years old, disclosed he would step down from the New York Fed at year end. In an interview, he said he made the decision because the waiver letting him own Goldman stock and be a Goldman director expires at the end of the year. He added: “I see no conflict whatsoever in owning shares.”

Jerry Jordan, a former president of the Fed bank in Cleveland, says Mr. Friedman should have stepped down once Goldman became a bank holding company in September and thus fell under the Fed policy barring stock ownership by certain directors of Fed banks. “Any kind of financial transaction at all by any of the directors is always a problem,” Mr. Jordan said. “He should have resigned.”

New York Fed officials disagree. Last fall, then-New York Fed President Timothy Geithner was President-elect Barack Obama’s choice to head the Treasury, and New York Fed officials say that to have forced Mr. Friedman off the board while it sought a Geithner successor would have deprived it of two leaders at a crucial time.

“Steve Friedman is a very capable chairman,” said Tom Baxter, the New York Fed’s general counsel, “and was the kind of person who we needed to head the search” for someone to succeed Mr. Geithner.

In Washington, the Fed’s general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed’s transition. He adds that Mr. Friedman was in compliance with the Fed’s rules when he first joined the New York Fed board and was put in violation of the rules by events “outside of his control.”

Because he was wasn’t allowed to own the stock he had, the Fed doesn’t consider his additional December purchase to be at odds with its rules at the time. The Fed had no policy requiring directors to inform it of new stock purchases, and Mr. Friedman didn’t. The Federal Reserve Board is now in the process of rewriting its rules for handling situations like Mr. Friedman’s.

The 12 regional Fed banks, contrary to a common impression, aren’t government agencies. Nor are they private banks: They’re a hybrid. Each is owned by member commercial banks, which collect a 6% dividend and control six of nine board seats.

The Fed banks also have quasi-governmental roles. They conduct bank examinations, under the direction of the Federal Reserve Board. Their presidents participate in discussions of Fed monetary policy and vote on it, on a rotating basis.

The New York Fed has a strong regulatory role. Its president has a permanent vote on Fed interest-rate policy and is vice chairman of the Fed’s policy-making committee. The New York Fed has historically been deeply involved in addressing financial crises, from hedge fund Long Term Capital Management in 1998 to today’s upheaval.

There’ve long been tensions at the New York Fed between the interests of member banks and those of the rest of the economy. The aggressive federal intervention in the economy is heightening worries about conflicts.

The regional banks’ presidents aren’t subject to congressional confirmation, a feature of the 1913 Federal Reserve Act intended to give the Fed some independence from politicians.

“The Federal Reserve system was designed to be a bunch of special interests that would duel to a draw,” says Anil Kashyap, a former Fed economist who is a University of Chicago business professor and member of an advisory board to the New York Fed.

Mr. Friedman ran Goldman in the early 1990s, leaving in 1994. He joined the Bush White House in 2002 to oversee economic policy. The move required him to sell his Goldman shares and many other investments. Doing so “was very costly and a difficult thing to manage,” he recalls.

He left the White House in 2004 and later reinvested in Goldman shares, joining its board. He got involved in private-equity firm Stone Point Capital in Greenwich, Conn., where he is now chairman. In January 2008, he became a member of the New York Fed board and its chairman. In that role, he worked closely with Mr. Geithner.

The economists and directors of Fed regional banks share their views with the banks’ presidents, helping shape the ideas the presidents express in meetings with the Federal Reserve. It’s one way the Fed in Washington gets input from around the country to help it set policy. Mr. Friedman says the board has a strictly advisory role: “We don’t get involved in decisions related to supervisory issues or issues related to particular companies.”

Charles Wait, another director, says Mr. Geithner “informed us in many instances, and we informed him in others, in quite important ways.” Mr. Wait describes Mr. Friedman as a consensus-seeking chairman who encourages give-and-take and “is a listener. He solicits opinions more than gives them.” Mr. Wait is chief executive of Adirondack Trust Co. in Saratoga, N.Y.

Mr. Geithner declined to discuss his interaction with the New York Fed board or Mr. Friedman.

Amid the crisis, Goldman has been a lightning rod for criticism because a number of its executives hold or have held powerful government positions, including ex-Treasury secretary Henry Paulson, who like Mr. Friedman once led Goldman.

Goldman was one of nine big banks the Treasury aided with capital injections in early October. The prior month, the government decided, partly at the urging of New York Fed officials, to bail out insurer American International Group Inc. The initial $85 billion provided to AIG enabled it to pay a portion of $8.1 billion it owed to Goldman, stemming from past trading agreements. By the end of the year, Goldman had gotten all of the $8.1 billion as AIG received more government aid.

Mr. Friedman says that although directors were briefed occasionally on the actions the New York Fed took regarding AIG, that was just a courtesy. “The New York Fed board was not involved in the decisions to take any actions related to AIG,” he said.

As Goldman’s stock slid last fall and some wondered if the remaining big investment banks would survive, the Fed, in close consultation with Mr. Geithner, hurriedly approved applications from Goldman and Morgan Stanley to be commercial banks instead of investment banks. The goal was to show investors the institutions were under the closer watch of a national regulator, had access to emergency loans and could broaden their funding by taking deposits. Goldman and Morgan Stanley converted to bank holding companies.

Mr. Friedman says Goldman’s regulatory-status change was “certainly not something that was brought to the [New York Fed] board for consideration.”

The change created a problem. The Federal Reserve Act bars directors representing the public interest from owning bank stocks or being bank directors or officers. Because Goldman had always been an investment bank, Mr. Friedman’s board membership there and his ownership of about 46,000 Goldman shares, at that time, hadn’t run afoul of this rule. Now it did.

The regional Fed banks have three classes of directors: Class A, elected by member banks and representing them; Class B, elected by banks but representing the public; and Class C, representing the public but picked by the Fed. Under law, directors in Class C, including Mr. Friedman, and Class B can’t be officers or directors of banks, and Class C directors like Mr. Friedman also can’t own shares of banks. This means not of bank holding companies, either, by the Fed’s interpretation of the 1913 law.

Mr. Baxter, the New York Fed general counsel, realized that the bank’s chairman was now in violation of the Fed rules. But the institution had just lost another director, Richard Fuld Jr., a few days before the September collapse of the firm he led, Lehman Brothers Holdings Inc. So on Oct. 6, at the urging of New York Fed lawyers, Mr. Geithner asked the Federal Reserve Board for a waiver enabling Mr. Friedman to continue owning Goldman stock and serving on Goldman’s board.

While Fed officials in Washington weighed the request, Mr. Baxter stayed in touch with a senior lawyer there, pushing for a decision, says a New York Fed official. This official says that in conversations with Mr. Friedman, who began voicing concern about the delays in December, Mr. Baxter suggested that the Fed policy should be considered to be in abeyance until the waiver came through.

Mr. Friedman’s role grew more prominent in November after Mr. Geithner became the pick for Treasury secretary. Mr. Friedman got the board started seeking a successor. There were two leading candidates: Federal Reserve Board member Kevin Warsh, who had worked with Mr. Friedman at the White House, and William Dudley, a former Goldman economist who ran the New York Fed’s markets desk.

Mr. Friedman saw that Goldman’s battered stock was trading below book value, or assets minus liabilities. On Dec. 17, he bought 37,300 Goldman shares at an average price of $80.78, a $3 million purchase, according to regulatory filings.

He says he checked with a Goldman lawyer to make sure there was no timing issue with such a purchase. He says he didn’t check with the Fed. New York Fed lawyers say they didn’t learn about his share purchases until the Journal raised questions about them in April.

By mid-January, the New York Fed board had settled the Geithner-succession question, picking Mr. Dudley. On Jan. 21, Fed Vice Chairman Donald Kohn granted a waiver, until the end of 2009, of the rule barring Mr. Friedman from being a Goldman stockholder or director.

The next day, Mr. Friedman purchased 15,300 more Goldman shares in two slugs, at average prices of $66.19 and $67.12, according to regulatory filings. That million-dollar purchase brought his holdings to 98,600 shares, according to filings.

Class C directors from a handful of other regional Fed banks have also sought waivers of Fed policy on stock ownership in recent months. As the Fed reviews its policy on the matter, one revision under consideration would bar directors from adding to or reducing their positions when they get temporary waivers.

Meanwhile, Goldman’s stock has rallied strongly. Investors liked the bank’s announcement in early February that it hoped to repay its $10 billion federal capital injection, freeing it from pay and other restrictions. Then, after a surprisingly strong first-quarter earnings report in mid-April, Goldman raised about $5 billion in a public offering.

Mr. Friedman has benefited from those events. On Friday, Goldman stock closed late in New York Stock Exchange trading at $127.08 a share. Mr. Friedman’s December and January stock purchases now are showing accrued gains of $2.7 million.

Write to Kate Kelly at kate.kelly@wsj.com and Jon Hilsenrath at jon.hilsenrath@wsj.com