The Journal fronts a scoop that the chairman of the New York Fed not only held Goldman Sachs shares in violation of Fed policy but loaded up on more of them while his appeal for an exemption was under way. And the story got a scalp even before it ran.

The Journal story raises the right flags here: That it illustrates Goldman’s deep entanglement with the government and its regulators and that it pulls the curtain back on the weird conflict-ridden nature of the Federal Reserve banks.

The chairman, Stephen Friedman, was himself a former head of Goldman Sachs, and owned tens of thousands of shares in his former employer. When Goldman became a bank-holding company in September, in a bid to stay afloat, it put Friedman in violation of rules that prohibit Fed board members from holding shares in banks (Goldman had been structured as an investment bank, which didn’t take deposits and were much less-regulated than regular banks).

It seems like this isn’t a huge problem since the game changed on Friedman rather than the other way around. He appealed for a waiver, which took nearly three months to come through. That said, financial institutions of all kinds are impacted by the Fed’s regulation of banks, so why should anyone with an interest be allowed on the board? And the question is whether he should have resigned during that time—a former Fed president says so.

But the real issues are that while all this was going on, Friedman led the search for a new president to replace Tim Geithner and that led—to nobody’s surprise—to an ex-Goldman guy. More damningly, while his appeal was out, Friedman bought tens of thousands more Goldman shares—and didn’t tell the Fed about it. Might he have had inside information there? It would seem unlikely that he didn’t—or else he wasn’t doing his job.

Does this make any sense?

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 Journal’s inquiry appears to have led the Fed to begin rewriting its rules on these things, which it very obviously should.

But these are not world-ending doings in the grand scheme of things. The Journal does well is show how these somewhat minor issues fit into the big picture. It ain’t pretty:

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.


And opens up a view into what the far-too-opaque Federal Reserve system actually is:

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.

That’s how Dick Fuld was on the Fed board until Lehman Brothers went down.

More good background:

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.

And good stuff on why the Goldman connections cause disquiet:

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.

Friedman says he’ll resign by the end of the year. That ought to and will probably come much sooner. Meanwhile, he’ll be all right:

Mr. Friedman’s December and January stock purchases now are showing accrued gains of $2.7 million.

Really nice digging here by the Journal.

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu.