With independent agencies imperiled, Fed may face further pressure despite Cook win

By Howard Schneider

WASHINGTON, June 30 (Reuters) - The Supreme Court may have reaffirmed the U.S. Federal Reserve's independence, but in a pair of rulings also left the central bank isolated as possibly the last agency able to wield executive power based on expertise free of the threat of its officials being fired by the president.?

Whether Monday's rulings give the Fed a more durable status or raise further questions about why monetary policymaking deserves special treatment, they may be just a starting point for further pressure on the Fed and debate about its structure.

"Fed independence lives on but the foundation is much weaker than it has been over the past 90 years," said Columbia Law School professor Kathryn Judge, who has focused on Fed and regulatory issues.

"In a very close, 5-4 opinion, the court says the Fed is different" from other agencies whose officials can now be fired at the president's will, Judge said. "The Fed is now going to be forced to stand alone."

"It's possible for the Fed to maintain its independence as the other independent agencies disappear. But it puts far more pressure on the Fed to justify its independence in the eyes of the public," Judge said.

In that ruling, the court refused to let President Donald Trump fire Federal Reserve Governor Lisa Cook based on unproven allegations of mortgage fraud, which she denied.?

In the second ruling, the court backed Trump's firing of Federal Trade Commission member Rebecca Slaughter, expanding his powers over the government and overturning its 1935 precedent that had recognized the authority of Congress to protect leaders of certain regulatory agencies from presidential removal at will.

The Cook decision lifts a potential cloud over the head of new Fed Chairman Kevin Warsh, a Trump appointee who last month took over the reins at the central bank. Trump so far has offered hands-off comments that he trusts Warsh and wants him to pursue the policies he deems best - a shift in tone from the Republican president's steady criticism of former Fed Chair Jerome Powell, whom he nominated to the post in 2017.?

A ruling against Cook would have put Warsh and his central bank colleagues under immediate threat should Trump's tune change. That risk has now eased through Supreme Court language that said any attempt to fire a Fed governor would face a "substantial" hurdle to prove the seriousness of any alleged misconduct and a "nexus" with the person's Fed duties.?

"Without such constraints in place, any perceived or alleged misstep (past or present) could provide a ready pretext for a governor's removal," the ruling authored by conservative Chief Justice John Roberts stated. "Nothing could be more corrosive of the independence that Congress sought to preserve."

But Roberts added in the Slaughter ruling: "Subordinates who exercise the president's power are subject to removal by him."

In creating the Fed in 1913, Congress passed a law called the Federal Reserve Act that included provisions to shield it from political interference, requiring governors to be removed by a president only "for cause," though the law did not define the term nor establish procedures for removal.

AVOIDING 'CALAMITIES'

Yet in shifting the rationale for Fed independence, the court also opened new doors for potential challenges.

The advisability of central bank independence is widely embraced. Letting politicians set interest rates is linked with short-term thinking that trades a hot economy in election years with higher inflation afterward, and less overall trust from global bond markets.

But democratic societies also are supposed to ensure the exercise of power is connected to electoral outcomes, making central banks an outlier of sorts in major developed economies that have tried to insulate them from day-to-day political meddling.?

Until Monday, Fed officials had shared along with policymakers at other independent agencies like the Federal Trade Commission protection from arbitrary dismissal that was grounded in a 1935 Supreme Court precedent acknowledging the importance to government decisionmaking of expertise wielded outside the direct influence of elected officials.?

That ruling, in a case called Humphrey's Executor v. United States, was overturned by the court on Monday in the ruling backing Trump's firing of Slaughter. The Slaughter ruling expanded presidential power to remove officials who the court decided were effectively operating as part of the executive branch, headed by the president.

The Fed, however, with its different history and different structure, was given a pass from that standard in a ruling that cited the warnings of Alexander Hamilton, one of the nation's 18th-century founders, about the "calamities" of letting politicians influence monetary policy, as well as the current Fed's hybrid public-private structure.

The Fed's Washington-based Board of Governors is appointed by the president, with Senate confirmation. But the heads of its 12 regional reserve banks are hired by local boards of directors at what are ostensibly private regional institutions. The court noted as well the Fed's freedom from congressional appropriations. The conduct of monetary policy lets it earn money to fund its operations, and set its own staffing and spending levels - another sign of the Fed's unique standing.

'MAGICALLY DIFFERENT'

Taken together, Roberts wrote, that warranted a different level of protection for Fed policymakers who not only need to be independent but need to appear to be independent.

Putting the Fed on its own island, however, "will not be sustainable," former Fed vice chair for regulation Randal Quarles said in April in remarks that anticipated the court's ruling.

In tossing protections for independent federal agencies but making an exception for the Fed, Quarles said, the justices would beg the larger question of why, despite the importance of monetary policy independence, the Fed gets different treatment when it comes to oversight.?

"The Supreme Court says, 'Look, here's how the system is supposed to operate, the president has to be able to dismiss entities that execute executive power.' But the Fed - we just say it's magically different," Quarles said.?

"At some point that is an unstable solution," Quarles said, likely to face further challenge.?

Nor is Cook's case fully settled. The court did not rule on the substance of Trump's allegations of mortgage fraud, but ruled she could stay in office pending a court proceeding on the firing. Trump on Monday said he will continue to pursue the matter.

"This was never about mortgage documents signed years before I became a Federal Reserve governor. It was an attempt to remove me on a manufactured pretext because I refused to bow to political pressure and continued to set interest rates based only on what would best serve the American people," Cook said in a statement following the decision. "Today's ruling affirms a principle that has underpinned sound economic stewardship for generations."

(Reporting by Howard Schneider; Editing by Dan Burns and Will Dunham)