Fed Governance and Market Trust: The Erosion of Confidence Through Repeated Ethics Violations

The Federal Reserve's role as a guardian of economic stability hinges on public trust. Yet, repeated ethics violations by senior officials between 2020 and 2025 have chipped away at this foundation, creating ripples of uncertainty in financial markets. From stock trading controversies to internal probes, these incidents have exposed vulnerabilities in the Fed's governance framework, raising critical questions about how such breaches impact investor confidence and market stability.

The Ethics Violations and Their Immediate Fallout

The cracks first appeared in 2020 when it was revealed that Robert Kaplan, then-president of the Dallas Fed, had engaged in extensive stock trading, including positions in tech giants like Apple and Amazon. Similarly, Eric Rosengren, the Boston Fed's former leader, faced scrutiny for trading in real estate investment trusts. These actions, while not explicitly violating existing rules, sparked public outrage and drew sharp criticism from lawmakers like Senator Elizabeth Warren, who called for a ban on stock ownership by senior officials.

The Federal Reserve responded by commissioning a review of its ethics policies, led by Chair Jerome Powell. While the Inspector General ultimately cleared officials of rule violations, the report acknowledged that their investment practices "failed to maintain public confidence". This admission underscored a critical truth: the perception of impropriety can be as damaging as the act itself.

Measuring the Impact on Investor Confidence

The erosion of trust is not merely anecdotal. A groundbreaking study by the Centre for Economic Policy Research analyzed over 4 million tweets to quantify public sentiment toward the Fed. The results were stark: ethics scandals acted as "exogenous shocks" that significantly reduced trust in the central bank. For instance, the 2020 revelations coincided with a sharp decline in net trust, which only partially recovered in 2021 before being dented again by inflationary pressures and further governance issues.

This decline in trust has tangible consequences. Central banks rely on credibility to anchor inflation expectations and stabilize markets. When confidence wanes, monetary policy becomes less effective. As the CEPR analysis notes, a one-standard-deviation increase in the Fed funds rate-often a tool to restore stability-can paradoxically reduce net trust by 11 percentage points. This creates a vicious cycle: policy interventions aimed at restoring order may inadvertently deepen skepticism.

Market Volatility and the Fed's Policy Challenges

The connection between ethics scandals and market volatility is less direct but no less significant. In April 2025, a tariff announcement by President Trump triggered a 30.8-basis-point surge in the VIX (the "fear gauge") within a week. While this spike was primarily driven by trade policy uncertainty, the broader context of Fed governance issues likely amplified market sensitivity. Investors, already wary of the Fed's credibility, reacted more sharply to external shocks, compounding volatility.

Similarly, November 2025 saw renewed turbulence as delayed economic data and shifting sentiment around the AI sector created uncertainty about Fed policy. Large-cap growth stocks, particularly AI-linked firms, plummeted despite the S&P 500's overall gains. This divergence highlights how governance-related doubts can fragment investor behavior, with some sectors retreating while others advance-a sign of a market struggling to find consensus.

The Path Forward: Rebuilding Trust in a Post-Scandal Era

The Fed's revised ethics rules, which now restrict officials from holding certain financial assets, represent a step toward transparency. However, as the CEPR study emphasizes, institutional credibility is fragile and slow to rebuild. For investors, this means remaining vigilant about how governance issues might influence policy outcomes and market reactions.

In the short term, markets may continue to oscillate between confidence and skepticism, particularly as the Fed navigates complex economic signals. The Bloomberg analysis of late 2025 volatility noted that "investor confidence in market resilience" helped stabilize conditions by December, suggesting that trust can rebound-if reinforced by consistent, transparent actions.

Conclusion

The Federal Reserve's governance challenges over the past five years offer a cautionary tale for investors. Ethics violations, even when not legally binding, have demonstrably weakened public trust and complicated the Fed's ability to manage economic stability. As markets look ahead, the key question remains: Can the Fed restore its credibility through policy consistency and stricter governance, or will lingering doubts continue to fuel volatility? For now, the answer lies in the delicate interplay between institutional reform and investor psychology-a dynamic that will shape financial markets for years to come.