- Key insight: Supreme Court rulings have made the Federal Reserve the last remaining independent regulator in Washington. The durability of that independence remains to be seen and could shape the Fed's approach to bank oversight.
- Expert quote: "The reason for the creation of the Fed was really to provide liquidity to the banking system in times of stress. That's really hard to do effectively if the provider of liquidity is not also supervising the institutions. Monetary policy, to a significant extent, is a job that the central banks made up over the course of the last century." —Former Fed Vice Chair for Supervision Randal Quarles
- Forward Look: Fed Chair Kevin Warsh said the central bank does not intend to test the limits of its regulatory supervision, but the gaps between the two recent Supreme Court rulings sets the stage for challenges down the road.
After a set of recent Supreme Court decisions, the Federal Reserve finds itself as the lone independent regulator in Washington. The question is whether that status is a source of strength for the central bank or a vulnerability.
For years, the high court has been chipping away at the ability of federal agencies to insulate themselves from presidential influence. In a decision issued last month —
Yet, in a separate opinion issued on the same day —
In its opinion on Cook, the Supreme Court took a narrow approach, ruling only on the immediate question of what President Donald Trump must do to legally fire Fed Gov. Lisa Cook. The court did not weigh in on the independence of the Fed's various functions or where the overlap between monetary policy and regulatory policy begins and ends.
Rather than clarify the issue of Fed independence, the court's rulings deepened the uncertainty, said Kathryn Judge, a professor of constitutional and administrative law at Columbia University.
"The combination of Slaughter and Cook protects Fed independence in the short run, but leaves it on a much shakier foundation, raising the possibility of a meaningful lack of independence, depending on how things play out," Judge said. "That's true both as a legal matter, but also as a matter of political and democratic legitimacy."
A new equilibrium
One outcome in the wake of Cook and Slaughter is that the president could cite regulatory or supervisory differences in an attempt to fire a Fed board member. The specific conditions that would allow for such an outcome are hazy, but legal scholars say it cannot be ruled out.
Former Fed Gov. Daniel Tarullo — who spearheaded regulatory and supervisory reforms at the central bank after the 2008 financial crisis — discussed such a scenario in a
One is the status quo: supervision and regulation continue to enjoy the same independence as monetary policy. Another is that the executive control over regulation and supervision supersedes any claims of monetary independence, giving the president power over the Fed. The final option is a structural separation of the Fed's bank oversight function from its monetary functions.
Tarullo's preferred outcome is a court ruling explicitly confirming that Fed governors have for-cause removal protections in all their roles. Absent that, he said policymakers should stand ready to partition the function of the central bank.
"[P]reservation of the Fed's monetary policy independence may require Congress to remove its regulatory functions from the control of the for-cause-protected Board of Governors," he wrote. "Whatever the policy merits or demerits of that change, it would stand as a stark example of Congress being effectively forced into a policy change by the aggressive separation of powers doctrines of the current Supreme Court."
The logical gaps between the Cook and Slaughter decisions create a clear path for further litigation over the bounds of the Fed's independence. Settling them will require the right challenge from the right plaintiff in the right court at the right time. Those stars could align in a few years or several decades or not at all.
In the meantime, Judge said the nature and effectiveness of the Fed's independence — and therefore its credibility — will ultimately be determined by public perceptions of the way the institution conducts itself and engages with other parts of the government.
"It's going to be some period of time before we actually get to a new stable equilibrium, where there is a collective understanding, both as a legal matter and in a way that's consistent with democratic legitimacy, over where power lies," she said. "That might shape the way the public perceives and understands the administrative state, and that's going to have spillover effects for the Federal Reserve."
History and politics
Some critics say the opinions did little to justify their core assertion about the Fed: that it is unique and worthy of special treatment. Former Fed Vice Chair for Supervision Randal Quarles said the court's idea that the Fed derives its monetary policy independence from the history and tradition of central banking in the U.S. is a weak leg to stand on. If anything, he said, the history reveals how central supervision and regulation are to the Fed's founding principles.
"The reason for the creation of the Fed was really to provide liquidity to the banking system in times of stress. That's really hard to do effectively if the provider of liquidity is not also supervising the institutions," Quarles said. "Monetary policy, to a significant extent, is a job that the central banks made up over the course of the last century."
The Federal Reserve is more than just a bank, it's an entire system. The Board of Governors is a seven-members body based in Washington, D.C. Governors are nominated by the president and confirmed by the Senate. Then there are the 12 regional reserve banks, each independently incorporated with its own board. Commercial banks are members of this system through their regional Fed banks. All seven board members and a rotating group of five reserve bank presidents sit on the Federal Open Market Committee and vote on monetary policy actions.
The current fight for control centers around the Board of Governors.
Because bank regulation and supervision are at the core of its mission, Quarles said, the Fed's board members in Washington should be fireable by the president at will. He noted that the structure of the Federal Open Market Committee and the appointment mechanics of the Fed Board of Governors are already sufficient protections for monetary independence.
To stack the committee with enough board members to outvote these five presidents, Quarles said, the president would need at least six like-minded governors on the board. Applying the Slaughter ruling to Fed governors would make it easier for the president to fire them, but would not change the process for installing replacements. Nominees would still have to be confirmed by the Senate — no small task, Quarles noted, pointing to the
Beyond that, Quarles said, if a president is able to command enough congressional support for his preferred policy outcome, that Fed should not be able to insulate itself from that level of popular sentiment.
"At the end of the day, the country is filled with adults who vote and should have the ability to make that decision," Quarles said. "It shouldn't be something that can switch with the wind, but if you had that degree of agreement, you shouldn't have an institution that could ignore it."
Others are less comforted by the Fed's appointment mechanisms. Todd Baker, a senior fellow at Columbia University and managing principal of Broadmoor Consulting, said loyalists and partisans could still make their way onto the board by saying the right things.
"While the firings and the confirmation process for any replacements would be politically fraught, so long as the GOP retains control of the Senate in the fall elections there is every chance that Trump's nominees — chosen with the expectation that they would be dovish in the FOMC but without any public commitment to cut rates — would be confirmed," Baker said. "Wall Street funders may complain, but they are too committed to Trump's other policies to burn their bridges with him as long as the form if not the substance of Fed independence — what I call 'Potemkin independence' — is preserved."
Fed just wants to get along for now
Based on the court's decisions, the Fed could use its monetary policy independence as a shield to chart its own course on bank oversight. Or, the Fed's role as a regulator could create a backdoor for the president to exert control over the agency's leadership.
For now, the Fed is opting not to test the limits of its non-monetary independence. In a hearing in front of the
"Independence is at its peak in the conduct of monetary policy," Warsh said. , adding: "My general view is we should be working with … the other bank regulators, the OCC and the FDIC, see if we can't put out our rules together."
In this regard, Warsh's view of Fed independence mirrors that of his predecessor, Jerome Powell. During his time at the helm of the central bank, Powell was adamant about the central bank's monetary independence but, on matters of regulation, he emphasized the importance of collaborating with other bank regulators. Amid the
Still, the Fed has at times deviated from the other regulators. One much critiqued example is its refusal to set
As a result of this go-along-to-get-along approach, the Fed has minimized the legal challenges to its regulatory independence. The Supreme Court's recent rulings, however, show how tenuous that independence might be.
