The big financial news story tonight is the unexpected resignation of Richmond Fed president Jeffrey Lacker, only six months before his term was due to end. Despite headlines like the one at the Wall Street Journal, Fed’s Lacker Resigns Over Leak, Dealing Blow to Bank’s Credibility, putting the damage to the bank’s reputation front and center, it looks as if the central bank and outside investigators have not come close to getting to the bottom of the matter.
The background is that, Medley Global Advisors, a firm that had its origins as a distressed debt investor but whose research unit is now owned by the Financial Times,1 published a note in 2012 that made no bones about being based on extensive inside information from the Fed. We’ve embedded it at the end of the post. It described what September Fed open market committee meeting minutes said, stating that they were not to be released until the next day, at 2:00 PM.
From a trading perspective, the big news was at the top: “The minutes will show…it will be unlikely that the labor market improvement will be substantial enough to stave off new Treasury purchases into 2013.” And in the sixth paragraph it describes how the Fed was likely to vote as early as December to stop the part of its MBS buying designed to counter the bonds being paid off (due to foreclosures, home sales, refis) and buy roughly $45 billion a month of Treasuries instead.
The amount of granular detail was stunning. For instance:
The committee will attach a predictive timetable outlining the duration of these purchases…The monthly MBS purchases of around $40 billion will continue along side the new program…Tomorrow’s minutes will reference a staff paper…The minutes will show the dovish majority was ready….[to make] open ended MBS and Treasury purchases as early as last month.
This is so specific that it comes of as if Medley either got its hands on an advance draft of the FOMC minutes or someone read it to her.
The report also describes, again in depth, how the decision process prior to the September meeting departed from established norms as well as voyeristic tidbits, such as that finalizing the text of the policy recommendations kept staffers up until after midnight.
Given how extraordinarily revealing this note was, Lacker’s departure is unsatisfactory. Specifically:
Either Lacker lied or the investigators aren’t even close to getting to the bottom of this. Lacker has admitted only to taking a call from the Medley analyst, supposedly having her run insider detail by him, and indirectly confirming it by not getting off the phone. From his resignation letter, which was released by law firm McGuireWoods, not the Richmond Fed:
During that October 2, 2012 discussion, the [Medley] Analyst introduced into the conversation an important non-public detail about one of the policy options considered by participants prior to the meeting. Due to the highly confidential and sensitive nature of this information, I should have declined to comment and perhaps have ended the phone call. Instead, I did not refuse or express my inability to comment and the interview continued. Additionally, after that phone call, I did not, as required by the Information Security Policy, report to any FOMC personnel that the Analyst was in possession of confidential FOMC information. When Medley published a report by the Analyst the following day, October 3, 2012, it contained this important detail about one of the policy options and I realized that my failure to decline comment on the information could have been taken by the Analyst, in the context of the conversation, as an acknowledgment or confirmation of the information.
This reads like the equivalent of a plea bargain, that Lacker and his lawyers negotiated him to ‘fess up to the most minimal breach possible provided he resign.
Alternatively, if Lacker is being truthful, it means that one or more additional people provided the information to the Medley analyst, Regina Schleiger.
The Fed appears to have engaged in coverup. From CNBC:
The Fed was criticized for not referring the leak to the Securities and Exchange Commission or the FBI. Instead, Fed General Counsel Scott Alvarez lead a Fed probe into the matter from October 2012 until March of 2013.
We’ve written before about Scott Alvarez, who lied shamelessly to the court in the AIG bailout trial. Lacker apparently felt he was at no risk in keeping mum during Alvarez’s internal investigation. That also suggests that it was unserious, as in Alvarez didn’t seek phone records. There could only have been a comparatively small number of people who would have had enough knowledge to provide the information to Medley, and if none of them admitted to the breach after being asked politely, the next response should have been to try to ferret out what had happened by other means. Alvarez and Lacker apparently hoped this would blow over.
Using new rules under Dodd Frank, the CFTC investigated and made a criminal referral to Department of Justice, which took it up. It was only when Federal investigators came calling and Lacker was at risk of prosecution for lying to Federal investigators that he admitted to speaking to Medley.
The Fed allowing staff, particularly members of the Board of Governors, to speak to hedgies and people who sell research to them is barmy. The Fed guidelines on staff contacts with the public kinda-sorta say that this sort of thing isn’t on. See, for instance, Item 6:
Staff will strive to ensure that their contacts with members of the public do not pro vide any profit-making person, firm, or organization with a prestige advantage over its competitors. They will consider this principle carefully and rigorously in considering invitations to speak at meetings sponsored by profit- making organizations and in scheduling meet- ings with anyone who might benefit financially from apparently-exclusive contacts with Federal Reserve staff.
But let us not forget that Yellen herself met twice with Medley, in person, in 2011 and 2012. But the central bank said that was OK…because the last meeting was in June, well before the leaked decisions took place in September and October, so she couldn’t be blamed for it.
The 2105 Wall Street Journal story discussing these incidents cited analysts trying to defend the practice:
Stephen Stanley, chief economist with Amherst Pierpont, has met with Fed officials and said they tend to say as little as possible. “It’s usually 95% someone like me talking and maybe 5% them, and most of their input is asking questions,” he said. “Usually the folks at the Fed, when they have those sorts of meetings, they have to be careful not to reveal too much.”
Let us not kid ourselves. The Fed gets top economics graduates for its research staff. They are perfectly capable of digesting data and also have access to the intelligence of the New York Fed trading desk. The idea that Fed governors have anything substantive to gain via these meetings, save a perverse idea that this amounts to some sort of transparency, is misguided. The analysts hope to gain a scintilla of insight that they can use to gain actual or apparent insight. The same Journal story showed that Medley treated this sort of access as a selling point:
Medley makes money by providing clients with information about policy developments in areas including central banks, energy markets and geopolitics. The firm says on its website it does this “by cultivating relationships with senior policy makers around the globe.”
And as a mere management consultant (at that point the blog didn’t have all that much traffic), back in 2007, a senior person at Medley, who was also a consultant to the Treasury for terrorist financing and mentioned he could get the ECB’s president Jean-Claude Trichet on the phone, was astonishingly gossipy the few times I saw him for drinks when there was no obvious commercial benefit, and a fair bit of was inside information. I wrote some of it up in late 2007. An astute reader recognized some of it as intel from the Fed, shorted Fed futures based on it and rode them all the way down through the Lehman phase of the crisis, making a six figure profit. So if someone who was merely in Medley’s outer circle was getting tradeable information, what have the clients been getting? In other words, the gaffe appears to have been that the Medley analyst and her boss had the bad judgment to give away so much detail in writing, as opposed to, say, in a conference call.
When the Europeans do this sort of thing, they are much more efficient. From a 2015 Wall Street Journal article:
Investors at a select dinner at a five-star London hotel on Monday were handed a roughly 12-hour head start over the rest of the market when a top European Central Bank official presented them with fresh details of the bank’s bond-buying program.
Fewer than 100 diners, including hedge-fund managers and other investors, heard ECB board member Benoît Coeuré explain that the bank would speed up the pace of bond purchases before the summer.
When the ECB made Mr. Coeuré’s comments public Tuesday morning, the euro tumbled while stocks and bonds soared.
Back to the US. It’s widely believed among finance professionals that the Fed is way too close to certain major institutions, such as Pimco, and they do, as one would expect, get an information advantage. However, given that l’affaire Medley was not with an institutional investor, those cozy arrangements appear to be under no threat.
1 Update. The original version of the post didn’t clarify that the Medley investing business continued to operate as Medley Capital after the research group was sold to the Financial Times. See here and here for more detail.