By Mark Felsenthal and Pedro da Costa
WASHINGTON (Reuters) - Treasury Secretary Timothy Geithner, while head of the New York Federal Reserve Bank, granted a waiver that allowed a senior New York Fed official to hold on to investments in firms getting emergency help, a congressional watchdog agency said on Thursday.
Senator Bernie Sanders' office identified the official as the current head of the New York Fed, William Dudley, who at the time ran the regional central bank's powerful markets desk. Sanders called the finding by the Government Accountability Office (GAO)("disturbing.")
Sanders, a persistent critic of financial firm bailouts, is concerned a high-ranking Fed official was allowed to retain investments in a company he helped rescue. The GAO, however, said the Fed followed procedures aimed at preventing conflicts of interest in such cases.
"(Three) days after the Federal Reserve Board authorized FRBNY (the Federal Reserve Bank of New York) to assist AIG -- the then-FRBNY President granted ... a waiver to a senior management official with financial interests in AIG and GE (General Electric) who was involved in decision making related to these two companies," the investigative agency said.
The GAO said the Fed could strengthen policies to prevent conflicts of interest, in particular in instances of emergency lending.
The New York Fed justified the waiver on the grounds that the official in question was critical to emergency operations, that the value of his investment in AIG was worth less than $15,000, and that divesting might violate laws on insider trading, according to the report.
Further, the regional Fed bank said divestiture might have created the appearance of a conflict of interest.
"William Dudley, who was then head of the Markets Group at the New York Fed, held shares in these companies as part of his personal portfolio that predated his service at the New York Fed," a New York Fed spokesperson said.
"A waiver was granted allowing him to hold these shares based in part on the judgment that had he sold these shares immediately after the interventions it would have the appearance of a conflict," the spokesperson said.
Dudley has since disposed of the shares.
The Treasury declined to comment on Geithner's role in granting the waiver.
The disclosure comes as GAO prepares another study on the governance of the regional Fed banks that, together with the Fed's Board of Governors in Washington, form the U.S. central bank system. That study is due out this fall.
Among the 12 regional Fed banks, the New York institution is first among peers because of its location on the doorstep of financial markets. Its president has a permanent vote on the Fed's interest-rate setting panel and it manages the Fed's all-important market operations.
The Fed's aggressive rescue efforts during the 2007-2009 financial crisis are viewed by many as having prevented an even deeper economic downturn. Officials were confronted with fast-moving crisis that required quick responses.
The extraordinary efforts threw a spotlight on the central bank's power and raised questions about the close connections between the Fed and the financial institutions it oversees.
The Fed was embarrassed in early 2009 when it became public that New York Fed Board Chairman Stephen Friedman, a member of Goldman Sachs' board, held a substantial amount of stock in that company when it was allowed to come under the Fed's protection during the crisis.
Friedman defended the holding, for which he received a waiver, but resigned from his position to spare the Fed the controversy.
Last year's Dodd-Frank financial reform legislation, which mandated the GAO study, made some changes to the powers of regional Fed board members, including taking away the right of some of them to vote for the regional bank presidents. Regional presidents participate in meetings of the Fed's influential policy committee and get to vote on interest rate decisions.
The GAO also recommended that the Fed strengthen policies for awarding contracts to carry out emergency activities.
The Fed awarded contracts worth $660 billion to carry out emergency efforts during the crisis, and eight out of the 10 highest-value contracts were awarded without a bidding process, the report said.
Many of the firms picked to run emergency programs were themselves getting Fed loans at rock bottom interest rates, Sanders said. Firms included JPMorgan Chase, Morgan Stanley, and Wells Fargo.