David Levy - Vice President
Published September 1, 1999 | September 1999 issue
Point man for the Fed on Y2K, Governor Edward (Mike) Kelley discusses his life at the Board of Governors, ranging from monetary policy to banking supervision to operations. His leadership roles have exposed him to nearly every facet of the Federal Reserve System, and with his lengthy tenure since 1987, he can claim the institutional memory chair of honor.
Besides all that, he is a Civil War buff.
(Executive Editor's note: In the last decade before all my cover interviews, I've read the first few lines of "The Cremation of Sam McGee" into the tape recorder to make sure it operated properly. That test was usually met with a curious smile and silence by my subjects. In Governor Kelley's case, when I had finished, he said simply, "Robert Service.")
REGION: In your 12 years at the Board, what has been the most significant change that you've noticed?
KELLEY: I would cite one internal and one external. Internally, I think the biggest change that I have seen, which is still a work in process I might add, is a broad cultural shift in response to changes in the nature of the industry that we servebankingwhich has evolved considerably over the past 12 years since I've been here. It's necessary for the Federal Reserve to evolve with it, as indeed any organization must as its customer base evolves, in order to maintain relevance to it. We've learned to act much more as a system, in a much more seamless way, both in terms of the cost structure that we incur and the services we provide, which have historically been district based and have evolved in quite district-unique ways.
We are finding that we must present a much more seamless face to the banking industry as nationwide institutions have evolved with much more sophisticated products and complex organizations. That has not been an easy process, because we are trying to maintain the vital elements of the culture that each individual Reserve bank has developed over its history. It would be highly undesirable to homogenize those away; we have to be very careful.
Externally, I think it has been our economy's evolution into a much different sort of an economic era. When I first came here, the economy was rather traditional in the sense that it was well understood and responded to traditional stimulus in fairly predictable ways. In the last several years we've evolved into a golden era that has been remarkably beneficial, but quite new and different. I think it is a fundamental and very important change.
REGION: Let's go back to the idea that the Fed's products and services have to be more unified and presented in a more consistent way. Is there a product or service that typifies what you're talking about?
KELLEY: Check processing is our largest product line and it is changing profoundly, as we now service customers in a multidistrict environment. Each district has historically done things differently, and now for both cost and service quality reasons we must rationalize that. Over the next several years we will collapse 12 distinct systems into two, or perhaps even one, common platforms, which will be a very big project for every office, and will involve large new investments. You find the same situation in the provision of cash services, that have also had substantially different configurations across the country, which multidistrict customers not surprisingly find quite unsatisfactory. Risk evaluations and credit relationships have been conducted differently in different districts and that is changing. In fact, bank supervision is being impacted by these industry developments just as profoundly as financial services and payments systems. Those are some quick ones that come to mind, and there are many others.
REGION: The Fed was founded on the notion that a decentralized system would foster independent thinking and action that, in the long run, would be healthy. In the recent past, the System has centralized a great deal, and some would argue that the independent thinking envisioned by our founders has been jeopardized as a result. Does that follow what you're saying?
KELLEY: It does indeed, and those two are very much of a piece. I think we should be, and indeed are, concerned that we must not jeopardize the critical core of the individual cultures and relationships and approaches to doing business that each bank has individually developed. But, that said, we have had to find ways within the framework to come together in a much more System-focused way. We've been at this for about a decade, and we're getting much better. We now have arrived at the point where we're comfortable with thinking in those terms, and that took a while. We are now challenged by the need to become much more efficient and effective at doing business on both an individual district basis and as a System.
REGION: What do you think is the drag on our effectiveness as a System?
KELLEY: Well, I'm not sure that I'd use the term "drag," but I think the concern that has made people hesitant has been the felt need to not lose the vital district cultures, and indeed the essence of the independence of the individual district. I fully share that concern; it's a legitimate concern. Nonetheless, we simply must proceed to do things with a System focus, or else we will lose our relevance to our marketplace.
REGION: How would we lose relevance in the marketplace?
KELLEY: Organizations exist to supply services needed by a customer base; this is true for auto manufacturers, hotel chains, school districts, HMOs, fire departments, you name it. As the needs of a customer base change, suppliers must change the product or service they provide or they will lose the productive relationship with their customers, which they previously enjoyed. They will lose relevance to those customers. In the case of the Federal Reserve, our nation's central bank, our organization exists to serve our society as the foundation of our financial system. We perform this mission through provision of three interdependent service lines: monetary policy, bank supervision and regulation, and payments system services. If we perform any of these services poorly, all will be impacted, and soon our mission performance will suffer as we lose relevance to our customer base.
REGION: There was a piece in the business press not long ago that argues the Fed has become much more transparent, that we're a lot more forthcoming about what we're doing. Do you see it that way?
KELLEY: Oh, I think over the time that I've been here, we have indeed become much more transparent. That's true not only in monetary policy, but we're also making a much stronger effort to make ourselves better understood by the public more broadly, by fostering an awareness of central banking and what the Federal Reserve does on behalf of the United States.
REGION: From your perspective, are you more or less satisfied with the way the media or Fedwatchers read and interpret what happens here at the Fed?
KELLEY: Broadly speaking they do a good job. We run into instances from time to time where there will be important misunderstandings, but I think that's probably inevitable. I think that the quality-as a broad generality-of economic reporting in the U.S. media has improved materially in recent years, both in terms of its sophistication and the extent of it. It used to be more sensationalistic, but now it is more rational and analytical, and that's very welcome.
REGION: You talk to the press on some occasions, do you have some sort of criteria as to who you'll talk to?
KELLEY: I try to be broadly available, and my relationships with the reporters who have wanted to have access to me have gone quite well. I haven't had any major problems with anyone.
REGION: Each governor assumes leadership responsibility. Which are yours?
KELLEY: I think that the most important one, and the one that takes a great deal of my time, is my role as chair of the Bank Affairs Committee, which has been designated by the Board to conduct its oversight responsibilities of the district banks, and indeed, to a broader degree, the overall relationships between the Board and the district banks. I very much enjoy this role because it combines two lifelong interests of mine, namely the effective operation of organizations on the one hand, and corporate governance on the other. Both of those are intimately involved in this assignment. My work involves extensive attention to our activities in the payment systems, both on the regulatory side and also on the operations side. The regulatory side, of course, is a pure public policy activity, whereas on the operational side, it involves providing services in a competitive arena, and that is basically what I was involved in all my life before I came to the Board of Governors.
I'm also chair of the Payments System Policy Advisory Committee, which is a joint Board-bank committee that develops payments system policies. And a very important responsibility has been to chair the Employee Benefits Committee.
REGION: In your oversight of operational areas, I'm sure you touch on many of the same questions that were raised by the Rivlin Committee on the Fed's role in the payments system. What should the Federal Reserve be doing operationally?
KELLEY: That's a fine next question. As far as the Rivlin Committee work was concerned, the primary purpose of its creation was to examine and settle the issue of whether or not the Federal Reserve should stay in the business of competitively providing financial services to the banking industry. And after a great deal of work and consideration, we came down very clearly, I hope, on the side that the Federal Reserve would indeed maintain its presence. It was important to settle that, because there was considerable concern about it both inside the Federal Reserve and in the industry generally. To the extent that there was uncertainty on this subject, it led to an inability to plan appropriately on a number of different levels. I'm glad that issue is closed. Now we are attempting to identify a proper role for the Federal Reserve in the evolution of retail payments. We are still working hard to identify what would be both useful and appropriate for the Federal Reserve to do as we move toward a more electronic environment.
REGION: Would you expand on that answer? Is the thinking starting to crystallize around certain ideas?
KELLEY: I don't think it is yet. We have all been very interested in the economics and market viability of electronic presentments, payments and imaging, and an array of different ways to try to take the paper out of the paper check, but that has not yet crystallized. We have a number of different pilot projects and studies under way and we have had a number of meetings with private-sector experts to explore what would be appropriate for the Fed to do, but my sense is that we really have not yet agreed upon a firm direction.
REGION: Among your responsibilities are banking supervision and regulation. In that area, what concerns you the most?
KELLEY: I did spend a period as chair of the Supervision and Regulation Committee and I still sit on that committee. I think there, the most important concerns are, number one, the rapid evolution of very sophisticated financial products and our ability to properly supervise them, and second would be in the international arena, where financial institutions and financial flows have become much more global. We are working hard to update the Basle Accord [international risk-based capital standards adopted by most industrialized nations in 1988] to respond to today's conditions, and hope to create a revised accord that will have ongoing relevance as we face future evolution there. So there are both domestic and international challenges.
REGION: Is training a problem, considering the rapid pace of change, electronic or otherwise?
KELLEY: Oh, yes indeed; this evolution of new products requires constant updating and training by our examination force. And another fact that I should mention is the evolution of very large bank holding companies that are organizationally complex; their sheer size and scope introduces challenges for supervisors in their own right. Examples would be evermore sophisticated derivative instruments on the product side, and the adoption of functional rather than business unit organization on the structure side.
REGION: This comes back to some of the earlier discussion we had about the need to centralize.
KELLEY: That's right, that is another area where we have to be able to operate effectively across districts.
REGION: Financial modernization has been on the legislative track here for some years. Is it on a proper track?
KELLEY: Fundamentally, very much so. There are a million details and a million competing special interests involved there, and it's been very difficult, obviously, to put together a package that could go all the way through the legislative process. But it's definitely trying to achieve appropriate objectives by freeing up the banking system to participate more broadly in the financial services industry. There are, however, two important issues which are very much in the balance as we speak. [Editor's note: The interview was conducted in June.] We have very different bills passed by the two houses of the Congress, and we are about to go into a conference committee to attempt their resolution.
The first is the so-called op-sub issue that involves whether or not substantial nonbanking activities can be located within a bank or must be located within a bank holding company. How this gets resolved is going to have profound implications for how banking is organized in the United States in the new century. And we can talk about the Fed's point of view on that if you want to, but it'd be a little bit of a diversion.
The other is the extent of the mixing of commerce and commercial interests with banking. For many years, they were almost completely separate one from the other. These days, that bright line has become considerably fuzzier and harder to identify, and there are strong interests that would completely obliterate any legal separation of the two. Here again, I think, how that issue is resolved is going to have a very substantial impact on the provision of financial services in our economy over the years to come.
REGION: You and Chairman Greenspan are the two remaining Reagan appointees. Any significance?
KELLEY: At the Federal Reserve I am happy to say it has no significance whatsoever. There is a long tradition herethat is in my experience scrupulously observedthat there is no politically partisan component that interjects itself into the work of this central bank. We all either arrive with or very quickly adopt the viewpoint that our sole and only constituent is the American people and their economy. You will never be able to identify a partisan consideration in the discussions around this building.
REGION: Political philosophies get checked at the door?
KELLEY: Political philosophies get checked at the door. People maintain their own personal convictions and interests and networks. That's fine and that's appropriate, but in terms of the work of the Federal Reserve, I have never seen it emerge as a factor.
KELLEY: This may be a recurring question: How is it being the only noneconomist on the Board?
KELLEY: It's not a problem at all in my view, and I hope it's not a problem in the view of the System broadly. Two sets of comments. Number one: Much of what we do here at the central bank only peripherally involves the profession of economics narrowly defined. Supervision and regulation is primarily a banking concern and requires knowledge of how financial institutions operate. The provision of financial services is a business, pure and simple. As I said earlier, the provision of services in a competitive environment involves all the considerations that I've worked with all my life in business in the private sector. Number two: The third activity, clearly economic in nature, is monetary policy, which is vitally important and the one that gets the most public attention. Here at the Fed, both at the Board and around the System, we have on the staff many of the world's best economists. I have enormous respect for them and I learn from them every day. But policy creation goes substantially beyond pure economics to consider as well a broad array of social, business and international concerns. And there I would hope that the noneconomist has something to contribute, as indeed my economist colleagues contribute to our other work in ways that are not specifically economics.
REGION: A few years ago you attended a conference on public sector competition instigated by the Minneapolis Fed-the Economic War Among the States, we called it. And the topic still generates interest and debate. How do you weigh in on the issue of states competing for private sector business? Should the federal government play a larger role in this issue?
KELLEY: First of all, I strongly support the initiative that came out of the Minneapolis bank in this area. I think it was very timely and is a very important public policy concern. I salute and encourage the continued efforts to try to make progress that Art Rolnick and Gary Stern and others there espouse. As far as the role of the federal government, I would have some hesitancy in recommending a very strong and overt presence there because I think this is appropriately a state and local consideration that probably should not involve federal intervention, except to the extent that federal tax laws might be involved.
REGION: Let's talk a little about Y2K. You have been designated as the point man at the Board on Y2K. There's an important message that we're trying to get out about Y2K. What is that?
KELLEY: That people should use common sense and maintain a calm and rational approach to it. That there is extensive and quite effective preparation being made, and there is every prospect that we will be able to get across the millennium quite successfully. But no one can guarantee that there won't be isolated disruptions of one sort or another that could occur as a result of this very comprehensive challenge that we must meet. I think that's the message that we'd like to project.
REGION: The appliances, generally speaking, are probably going to work, right?
KELLEY: Yes. We live in a world that is incredibly interactive and interdependent; one in which complex series of relationships could, somewhere along the chain, involve a problem that could cause an inconvenience of one sort or another. In the case of financial institutions, over the past two years the industry and its regulators have done a very effective job of preparing for this, and I do not anticipate financial sector disruptions.
REGION: Is there more that we need to say, or is that the main message?
KELLEY: That's the message.
REGION: Sometime ago you made a speech about the surprising resilience of our national economy. This is also a theme that Minneapolis Fed President Gary Stern has also been sounding. We don't seem to get knocked off course. To what do you attribute this economic momentum?
KELLEY: Well, I am delighted you have resurrected that. I think that we are blessed in many, many ways. I will identify four separate categories. The first is simple geography. We are placed on the globe with three excellent coastlines that have excellent harbors that face effectively in the direction of all the rest of the world's economies. We have comprehensive inland water resources and several different moderate climates. Our natural resource base is very, very broad and extensive. So in many ways we are incredibly blessed by the very structure of nature that we have inherited here in our particular piece of the world.
Second, the way this country has been historically populated and continues to be populated. The whole melting pot phenomenon has been enormously important in creating our national attitude toward improving our lives. People have come to the United States by the million in an attempt to better themselves, and that ethic is still very much alive and well in this country. It continues to drive us forward and is the key to the third factor, which is that uniquely in the world, to my knowledge, Americans are willing to move.
We move! Our people are ready to go to better themselves. We're always looking for a better home, a better school, a better job or a better vacation. Our capital base is always seeking the most economically attractive place to invest, which leads to progress. The entire American society is open to the idea of movement, both personally and financially. This enables us to maintain a continual freshness in our economic activity.
Finally, our legal structure has been created over the years to facilitate this. Even our tax laws, imperfect though they are, facilitate the movement of capital and the movement of people. The way we set up our social safety net contributes to that. State laws make it very easy for people to move from one area to another and so forth. Our entire institutional structure has evolved in a way that is supportive of this flexibility. And all of this works together to create our ability to maintain a continual refreshing of our economy.
We go through a series of rolling recessions in different sections of the country. Different important industries will get in trouble for one or another reason, and they have to go through a very painful period of restructuring to renew themselves. But in the United States, where we have such a broadly diversified economy, individual regions or industries are able to do that beneath an umbrella of continuing overall prosperity, which enables them to complete this process expeditiously and soon themselves become part of the umbrella of support for wherever the next problems appear. So we never ossify. We constantly renew ourselves. All these things work together to create the dynamic that so blesses us here and amazes the world.
REGION: What are your personal interests outside the Fed?
KELLEY: A major interest is in opera and art, and my wife, Janet, and I spend a good deal of time in those areas. When we travel we always try to incorporate the artistic features and offerings in the area we're visiting.
I must mention that we are together, heroically but sporadically, trying to learn to play golfwith great enthusiasm but limited progress. It is a game that takes a good deal of time in order to be able to improve, and time is probably the most precious commodity in our lives.
Janet and I are very interested in educational travel. We like to find places to go where we can learn something that requires a visit to absorb. For instance, last summer we took a long trip along the inland waterways of Russia's hinterlands and saw parts of the country, away from Moscow, that are difficult to access. Not too many people, I think, have been there. In recent years, we've been to places like the Galapagos Islands; we toured all over the country of Morocco, and we spent 10 days in Florence, Italy. There are lots of other places we would like to go, time permitting, in the future.
Part of our educational travel has been to this area's Civil War sites. I've long been a Civil War buff, and Washington is an absolutely ideal place from which to visit Civil War locations. We have visited virtually every significant site in the eastern theater and are now trying to find time to become more familiar with the western sector of the war.
REGION: And that interest developed because you came to Washington, D.C.?
KELLEY: I've had that interest for a long time, but it was rather dormant through my middle years. Then when I found myself in Washington, D.C., I fairly quickly realized that it all happened right here at my doorstep and it's been great fun to reconnect. We have enormously enjoyed visiting all these different spots.
REGION: Thank you, Mr. Kelley.
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