June 15, 2010 / 7:20 PM / in 7 years

UPDATE 2-Fed dodges bullet as House drops audit idea

* House Democrats drop Ron Paul’s Fed audit provision

* House opposes making NY Fed chief political appointee

* Want discount window loans disclosed with lag (Recasts, adds analysts’ comments, details, background)

By Pedro Nicolaci da Costa

WASHINGTON, June 15 (Reuters) - The Federal Reserve scored a political victory on Wednesday as Democrats mulling financial reform backed off measures that would expose monetary policy to audits and make the head of the New York Fed a political appointee.

The U.S. House of Representatives had approved a bill in December that included a provision, championed by Texas Representative Ron Paul, that would have opened the Fed’s interest rate policy to congressional audits.

But in a statement on Tuesday, House Democrats participating in negotiations over a final financial reform bill signaled a willingness to live with a narrower Senate audit provision that does not cover monetary policy.

“Many politicians wanted to extract a pound of flesh from the Fed,” said Eric Lascelles, chief economics and rates strategist at TD Securities. “That seems to be cooling off now.”

The Fed, which has admitted it was too complacent about regulatory oversight in the run-up to the global financial crisis, has come under heavy fire for being too close to the banks it regulates.

The House Democrats also said they would try to defeat a plan contained in the Senate bill under debate that would allow the U.S. president to name the head of the New York Fed, a step that Fed officials have argued would undercut the central bank’s political independence.

See: FACTBOX-What U.S. financial overhaul means for the Fed [nN15152442]

“It is disappointing to see both the removal of the provision about the president picking the New York Fed president and also the prohibition of bank employees serving as Fed presidents,” said Dean Baker, co-director of the Center for Economic and Policy Research. “This would have been a big change toward taking away the banks’ control over the Fed.”

The U.S. central bank appears to be emerging largely unscathed by the regulatory reform efforts. It successfully fought off a Senate push last month that would have stripped it of its oversight of smaller banks, and is poised to emerge as the most powerful financial regulator when reforms are complete.

In the wake of the worst financial meltdown in generations, the U.S. Congress is seeking to put in place reforms to ward off future crises. House and Senate negotiators are set to take up provisions on Fed governance and audits on Wednesday.

SOME CONCESSIONS

The shift by House Democrats was not an unequivocal win for the Fed. Their counteroffer looks to broaden a proposal for a one-time Fed audit contained in the the Senate bill that would focus narrowly on the Fed’s emergency lending during the financial crisis.

House Democrats want to widen the audit to cover regular discount window lending and open market transactions, and require the Fed to publicly disclose details on these operations on an ongoing basis, albeit with a three-year lag.

Still, the push points to successful lobbying efforts by both the Fed and the financial sector, which firmly backs the U.S. central bank. Influential industry groups wrote to the Senate Banking Committee in March pleading for the Fed to retain its supervisory responsibilities.

In place of the Senate measure that would allow the president to appoint the head of the New York Fed, House Democratic negotiators said they favor a provision that would prevent the regional Fed bank directors who come from the financial sector from having a say on who will head their regional Fed bank.

That move is an attempt to ensure conflicts of interest do not arise with bankers essentially picking their regulator. The Fed had been quietly pushing for a compromise along these lines.

The dissolution of Paul’s wider Fed audit provision comforted investors who had worried that greater political influence could weaken the central bank’s resolve to fight inflation in the future.

“Anything that makes the Federal Reserve more political or subject to political review is I think a step backwards,” said Charles Lieberman, chief investment officer for money management firm Advisors Capital Management and a former New York Fed official.

Both the Fed’s Washington-based Board of Governors and the New York Fed declined to comment on the latest congressional maneuvering.

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