Federal Reserve chair Ben Bernanke acknowledged yesterday that the central bank may need to do a better job dealing with asset bubbles. I think I just heard Dean Baker’s head explode. Specifically, Bernanke said that he would move to use interest rate policy and not just regulatory tools to head off bubbles.

“In the decades prior to the crisis, monetary policy had come to be viewed as the principal function of central banks,” Bernanke said at a conference sponsored by the Federal Reserve Bank of Boston, according to a prepared text. “Their role in preserving financial stability was not ignored, but it was downplayed to some extent. The financial crisis has changed all that. Policies to enhance financial stability and monetary policy are now seen as coequal responsibilities of central banks.”

Bernanke is basically engaging in the polar opposite approach of Alan Greenspan – and himself, at the end – during the housing bubble. Greenspan said that the adjustable rate mortgage was an exciting product for consumers to use. Bernanke is saying that he would consider using interest rates to stop the so-called “irrational exuberance” in a particular market. That’s a sea change.

But I doubt it will go beyond the theoretical stage unless you do something about the massive conflict of interest at work in the Federal Reserve. Banks don’t like “oppressive” regulation constricting their profit-making abilities. They don’t like using interest rate policy to tamp down bubbles, which on the way up are quite the cash cow for them. They think they can manage their own risk and don’t want the oppressive arm of government stepping in to force them to do more. The problem is, as a stunning new GAO report unearthed by Bernie Sanders shows, there’s not much distance between the big financial institutions on Wall Street and the Federal Reserve system, particularly when it comes to the directors of the regional banks.

“The most powerful entity in the United States is riddled with conflicts of interest,” Sen. Bernie Sanders (I-Vt.) said after reviewing the Government Accountability Office report. The study required by a Sanders Amendment to last year’s Wall Street reform law examined Fed practices never before subjected to such independent, expert scrutiny.

The GAO detailed instance after instance of top executives of corporations and financial institutions using their influence as Federal Reserve directors to financially benefit their firms, and, in at least one instance, themselves. “Clearly it is unacceptable for so few people to wield so much unchecked power,” Sanders said. “Not only do they run the banks, they run the institutions that regulate the banks.” [...]

The corporate affiliations of Fed directors from such banking and industry giants as General Electric, JP Morgan Chase, and Lehman Brothers pose “reputational risks” to the Federal Reserve System, the report said. Giving the banking industry the power to both elect and serve as Fed directors creates “an appearance of a conflict of interest,” the report added.

Maybe you could add Godfather’s Pizza to that, since one of these Federal Reserve directors was, in fact, Herman Cain, a director at the Kansas City Fed from 1992 to 1996.

The report is here. In 18 different instances, current and former board members of the Fed regional banks, the ones who pick the Presidents who then sit on the Federal Open Market Committee, “were affiliated with banks and companies who received emergency loans from the Federal Reserve during the financial crisis,” according to the report. There is no restriction on this conflict of interest, or really any, for that matter. And there’s certainly no transparency on how the boards of directors handle conflict of interest. Here are just a couple examples:

Stephen Friedman In 2008, the New York Fed approved an application from Goldman Sachs to become a bank holding company giving it access to cheap Fed loans. During the same period, Friedman, chairman of the New York Fed, sat on the Goldman Sachs board of directors and owned Goldman stock, something the Fed’s rules prohibited. He received a waiver in late 2008 that was not made public. After Friedman received the waiver, he continued to purchase stock in Goldman from November 2008 through January of 2009 unbeknownst to the Fed, according to the GAO.

Jeffrey Immelt The Federal Reserve Bank of New York consulted with General Electric on the creation of the Commercial Paper Funding Facility. The Fed later provided $16 billion in financing for GE under the emergency lending program while Immelt, GE’s CEO, served as a director on the board of the Federal Reserve Bank of New York.

Jamie Dimon The CEO of JP Morgan Chase served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and was used by the Fed as a clearing bank for the Fed’s emergency lending programs.

Until you get the bankers out of the business of picking a substantial chunk of Fed policymakers, you will never, ever have a Fed working in the interests of financial stability, let alone working to pierce asset bubbles. You will have a Fed working for the banks. Because they’re practically one and the same.

…Incidentally, the GAO made a series of recommendations on how to strengthen conflict of interest policies and create transparency. The Federal Reserve Board “agreed with GAO’s recommendations and said that it believes all have merit and will work to implement them. The Reserve Banks also said that they will give serious consideration to implementing the recommendations,” according to the report.

Of course they did. The GAO recommendations are the least you can do. The proper policy is to end the practice of having bankers pick policymakers at the Fed.