Abrupt ousters, public missteps sink morale inside New York Federal Reserve

[NEW YORK] As the financial world watches the White House turn up the heat on the Federal Reserve in Washington, another Fed drama has been playing out right on Wall Street's doorstep.

An unusual level of internal tension broke out in recent weeks at the fortress-like Federal Reserve Bank of New York in lower Manhattan.

The sudden departure of two longtime officials shook staff, sank morale and drew attention to the leadership of the New York Fed under John Williams as he enters his second year at the helm. On Wall Street, questions arose again a couple of weeks ago when a speech he gave inadvertently whipsawed markets.

The story involves Simon Potter, who ran the all-important markets desk, and Richard Dzina, head of the financial services group. Both were abruptly relieved of their roles in late May by Mr Williams. Little explanation was given, but according to current and former New York Fed employees, as well as those close to the bank, the nature of the exits, by fault or design, seemed to be a warning: fall in line.

A spokesman for the New York Fed declined to discuss the circumstances surrounding the departures. When reached by phone, Mr Potter referred questions to the bank, while Mr Dzina didn't respond to multiple requests for comment.

The New York Fed plays a powerful role. It is the central bank's eyes and ears on Wall Street. And as the only regional bank with a permanent vote on rate decisions, it has outsize influence in the financial system. The selection of Mr Williams, a widely respected and oft-cited monetary economist who ran the San Francisco Fed for seven years, for the top job in New York raised eyebrows from the outset. A finance-industry background has traditionally been seen as a key qualification, something he lacked.

Mr Williams, who during his San Francisco Fed days often mentioned his reluctance to pay too much attention to short-term swings in the markets, came under fire on July 18 after saying in a speech that central banks should act quickly "at the first sign of economic distress."

With the remarks coming just a day before Fed officials entered a quiet period prior to their July 30-31 policy meeting, traders immediately took his comments to mean a more-aggressive rate cut was in store. The New York Fed issued a rare clarification walking back his comments later that day, causing another sharp move in the opposite direction.

New York Fed presidents often circulate advance drafts of speeches to members of the markets desk, who advise them on how certain words might be interpreted by traders, according to people familiar with the process. It's unclear whether that happened this time, but the practice is meant to prevent episodes like the one on July 18, they said.

The kerfuffle prompted Ward McCarthy, chief financial economist at Jefferies, to say in a July 22 note to clients that "until proven otherwise, President Williams will remain a communication liability and a probable source of market volatility."

It also caught the attention of President Donald Trump, who has been openly critical of Fed policy. He tweeted, "I like New York Fed President John Williams first statement much better than his second."

Granted, some close to the Fed downplayed the recent upheaval - emphasising it is Mr Williams' prerogative, as the bank's incoming leader, to pick his team with a free hand and run the institution as he sees fit. And nobody disputes Mr Williams' monetary policy or economic research chops, nor that the New York Fed has a deep bench of experts. If anything, his decades of experience are seen as complementing Fed Chairman Jerome Powell, who himself is a lawyer by training.

Whatever the case, this much is clear: As Mr Williams reorganises the leadership ranks and puts his stamp on the New York Fed, the ousters of Mr Potter and Mr Dzina leave the reserve bank without two of its most experienced hands.

Mr Potter, who holds a Ph.D. in economics from University of Wisconsin-Madison, started at the New York Fed in 1998. As head of the markets desk, he oversaw the end of the Fed's massive bond-buying programme known as quantitative easing, as well as the unwind that began in October 2017.

Mr Potter was also responsible for briefing policy makers on the state of financial markets at the Fed's rate-setting meetings. He met with Mr Powell about three weeks after he was relieved of his duties, according to the chairman's calendar. A Fed spokesman declined to comment on the reason for the meeting or what was discussed.

Mr Dzina, a former Army officer, began his career at the Fed as a bank examiner in 1991 before working his way up the ranks. In addition to leading the financial services group, he also managed a key network central to the US payments system called Fedwire. He's been described in conversations with those who know him as a steady hand who projected confidence and a team-first attitude. His oft-repeated credo was, "Mission First, People Always."

It's still unclear whether any specific disagreements prompted the removals. But those close to the New York Fed say Mr Potter and Mr Dzina, who were known for being strong-minded, did not align with Mr Williams on issues related to managerial strategy. In any event, there's little doubt many were surprised by how it all went down.

"Until proven otherwise, President Williams will remain a communication liability"

When the New York Fed announced the departures on May 28, it said both would be stepping down from their roles at the end of that week. Mr Williams told Mr Potter of the decision over the phone while the latter was out of town and was scheduled to travel to Hong Kong for a speech on regulatory reform, according to people with direct knowledge of the situation, who aren't authorized to speak publicly.

Employees put questions to Mr Williams at a town hall-style meeting in June, two weeks after the departures, expressing their frustration over the message Mr Williams seemed to be sending, according to people familiar with the matter. Mr Williams responded by talking about the need for a cohesive vision among the bank's top executives, without elaborating on the specifics of the decision.

The bank has yet to announce who will succeed Mr Potter and Mr Dzina on a permanent basis. In the meantime, Michael Strine, the institution's first vice-president and Mr Williams' second-in-command, is managing Fedwire. Traditionally, the network is overseen by the first vice-president, but was instead delegated to Mr Dzina by Mr Williams' predecessor, William Dudley, when Mr Strine was promoted to the role in 2015.

Whoever replaces Mr Potter and Mr Dzina will have plenty to contend with. On Wednesday, the Fed reduced its benchmark interest rate for the first time in over a decade and signaled more cuts may be in store later this year. New York Fed staffers have also been charged with looking into a new repurchase-agreement facility to provide liquidity to the banking system as cash becomes increasingly scarce. No less important are efforts to modernise Fedwire, which suffered a rare outage this year.

Subadra Rajappa, Societe Generale's head of US rates strategy, says that while the personnel changes may be unsettling, the New York Fed will ultimately adjust and move on.

"That's how life goes," she said. "Institutions like this are designed to function with change."

Nevertheless, things may not have blown over just yet.

At an official send-off for Mr Potter and Mr Dzina at the New York Fed's downtown headquarters one day before Mr Williams' public flub, staffers and guests indicated the affection in which they held the two men by giving a drawn-out ovation after they spoke. That kept Mr Strine waiting at the podium to introduce Mr Williams for a few awkward moments.

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