Banks and bank regulators have been in the news a lot
lately. You may have heard stories about how banking regulators often get too
cozy with the bankers they are supposed to keep an eye on. While this has been a
pernicious issue for years, two recently publicized scandals have brought this
problem into the news.
Both of these recent controversies surround two former
employees of Federal Reserve Bank of New York (FRBNY), and their relationships
with the megabank Goldman Sachs. These stories have revealed the blurry and often
complex nature of the relationship between regulators and powerful banks. These
stories also exemplify the persistent problem of something called “regulatory
capture”, which, while sounding like a dusty legal topic, is actually a very important
issue that can affect the whole economy.
The first of these two controversies arose in October,
when a Carmen Segarra, a former employee of the Federal Reserve Bank of New
York, released several audio clips that she had recorded while still employed
at the Fed. These tapes included conversations between Segarra and her bosses
at the FRBNY, as they discussed some controversial business practices being
made by Goldman Sachs.
Segarra was frustrated with the light treatment and relaxed
attitudes that her higher-ups had towards this behavior at Goldman, which she
perceived to be unethical and potentially dangerous. Segarra was a permanent on-site examiner at Goldman Sachs during
her brief tenure at the Fed, and claimed that the Fed's lackadaisical approach
to supervision led her to record, and later release, these conversations. These
substantial disagreements ultimately led to her dismissal from the Fed in 2012.
Then in October of this year, she released a few minutes of her tapes and sat
down for a lengthy
interview with NPR.
Recently, news broke about unethical
behavior of a former employee of the same Federal Reserve Bank of New York, who
later went on to work at Goldman Sachs. This former examiner named Rohit Bansal
was caught using data from his time as an examiner and his connections with the
FRBNY to benefit his new role at Goldman Sachs.
1)
So, what’s the problem here?
The audio
tapes that Segarra released revealed that senior staff at the FRBNY
frequently gave Goldman Sachs a lot of regulatory deference and went easy on
Goldman employees when they made questionable business decisions. The tapes
focused on conversations between Segarra and her colleagues, who were all part
of the FRBNY’s examination team stationed at Goldman. The most revealing quote
from the tapes comes from Segarra’s boss, who almost laughingly described one
business deal of Goldman’s as “legal, but shady.” Expressions like these were
exactly the reason Segarra recorded internal conversations at the FRBNY--which
ended up coming in handy once she was fired. It’s clear from the rest of these
tapes that Segarra’s willingness to stand up to Goldman’s behavior was resisted
by her superiors and likely led to her termination from the Fed.
A few weeks later the New York Times reported on yet another scandal between Goldman and the
FRBNY. The article revealed that a former FRBNY
employee Rohit Bansal had been caught using private government data at his new
job at Goldman. Bansal had worked for the FRBNY for several years, and by the
time he left the Fed, he was the central point of contact for certain banks.
Once Bansal joined Goldman, he used his expertise, along with his relationship
with a former FRBNY colleague, to illegally acquire confidential regulatory
information about a client that Goldman was doing business with.
Once this leak was discovered,
Goldman immediately fired Bansal, and FRBNY immediately fired the man who they
believed to be the leaker. The severity of these leaks became obvious when only
days after Goldman reported the breach, federal authorities, including the FBI,
FDIC, and the US Attorney for the Southern District of New York, began an
investigation into the matter to see if any crimes were committed.
2) I think I’ve heard of Goldman Sachs before, but what
exactly is it?
Goldman Sachs is one of the largest
banks that many people haven’t heard of. That’s because Goldman Sachs is not a
commercial bank like Bank of America, Wells Fargo, or Citi, that consumers can
directly do business with. Goldman is organized as something called a “bank
holding company”, which is a fancy term for financial conglomerate. Goldman
does many things, but hosting checking/savings accounts and making consumer
loans are not among them. Goldman is actually an investment bank, which means
it deals only with other companies, and not directly with consumers. Its major
business lines include giving merger
and acquisition advice, managing assets, engaging in private equity deals, and serving as a
financial broker for other corporate clients.
3)
What’s a bank examiner?
In the US, there are two major steps to regulation:
rulemaking and supervision. Regulatory agencies first have to write the
regulations for their respective industry, through a public process called “rulemaking”.
Then, once these regulations are finalized, the agencies must also make sure
that businesses are complying with them. This ongoing, complex, and often fuzzy
process of ensuring compliance is called ‘supervision’, and its where these two
recent scandals have occurred.
In general, government agencies that supervise banks,
at both the state and federal level, have employees called ‘examiners.’ These
examiners are people with expertise in accounting and regulatory compliance who
go on-site to the banks that are under their supervision and conduct bank
exams. During these exams, examiners comb through bank balance sheets, policies,
practices, and interview bank employees--all to ensure that the bank is
properly complying with regulations. Different agency examiners have different
jurisdictions and look for different things-- for example, examiners from the Consumer Financial
Protection Bureau might look to make sure a bank isn’t
unfairly charging its customers, while examiners from the Federal Reserve might
check to make sure the bank isn’t making too many risky loans.
While smaller banks might only go through exams
occasionally, megabanks like Goldman Sachs have teams of examiners on site
permanently, since their business practices and balance sheets are so large and
complex that they require constant review. Carmen Segarra and Rohit Bansal were
two such examiners.
4)
But wait, isn’t the Federal Reserve a private bank?
Well, it’s complicated. Most people know the Fed as
the organization that sets monetary policy and manages the currency, buts its
lesser-known role as a powerful bank regulator is just as important. The
Federal Reserve is actually a system, composed of 12 regional banks located in
major cities across the US, and the Board
of Governors, which is located in Washington, DC. The
Board of Governors is just that-- a board of seven men and women who write
regulations for the banking system, make policies for the 12 regional banks,
and oversee their activities. These seven governors are nominated by the US
President and confirmed by the Senate, just like the heads of other government
agencies. The Board of Governors, more than any other part of the Federal
Reserve System, most closely resembles a federal government agency. It has a “dot-gov” web address,
pays its employees on a public pay scale, and regularly reports to and testifies
before Congress.
The 12 regional banks, while they are ultimately
controlled by the Board of Governors, function more like private banks and have
their own
boards of directors. The presidents of these banks are
privately selected without input from the US President or Congress. Banks like
Goldman Sachs, which are regulated by these regional banks, are also members
of the regional banks, and have some influence into how these banks are run.
The Federal Reserve’s examiners, like Segarra and Bansal, are employees of
these regional banks.
The most powerful of the regional banks is the Federal Reserve Bank of New York (FRBNY),
where both Segarra and Bansal were employed as examiners. The FRBNY, located in
downtown Manhattan, is responsible for regulating and supervising banks in the
New York area, which is to say, many of the world’s largest and most complex banks
like Goldman Sachs.
Ultimately, the president of the FRBNY is the most
responsible for the behavior of the examiners, and the banks they regulate. The
president of the FRBNY is a very powerful position, so the person filling the
chair is usually well known around Wall Street and Washington. For example, the
last president of the FRBNY was Timothy Geithner, who went on to become
Treasury Secretary during the first four years of the Obama administration (not
surprisingly, Geithner’s predecessor at the Treasury was Hank Paulson, who had
previously been the CEO of Goldman Sachs). The current FRBNY president is a guy
named William C. Dudley, who formerly served as chief economist to….Goldman
Sachs. Not surprisingly, Mr. Dudley’s name has shown up in the news a bit
lately, and he also
appeared before Congress a few weeks ago.
5)
Is “regulatory capture” as scary as it sounds?
It can be! Regulatory capture is a term used to
describe how regulatory agencies, like the FRBNY, can be ‘captured’ by the
business that they are supposed to regulate. Capture is often demonstrated when
government regulators go easy on businesses, potentially because they may be seeking
higher-paying employment with these businesses in the future. This is a
particular problem in the world of financial regulation, because government
employees often make far less than the bankers they are regulating. It’s not
uncommon for regulators to quit their regulatory jobs and go work for a bank,
often for two or three times more than their government salary. So if
regulators are going about their jobs with future employment in mind, it can
compromise their ability to adequately enforce the laws on the books. Even the
best written laws aren’t any good if they aren’t firmly enforced, so bad
regulatory capture can put the banking system, and the entire global economy,
at risk.
6)
So what (if anything) is Congress doing about all this?
In mid-November the Senate Banking Committee held a
hearing entitled “Improving
Financial Institution Supervision: Examining and Addressing Regulatory Capture.”
This hearing featured testimony from FRBNY President William Dudley, and
lengthy questioning from several Democratic Senators. Most notably, Senator Elizabeth Warren
(D-MA) grilled Dudley about the FRBNY’s capture problem, his
role in these two scandals, and his seemingly dismissive attitude about them. Warren
and Dudley went back and forth for much of the hearing, and the conversation
got testy at times.
At the same hearing, Senator
Jack Reed (D-RI) introduced a bill that would require the president of the FRBNY to be nominated by the
President and confirmed by the Senate, much like the Fed’s Board of Governors
is currently. Reed’s legislation would also require the head of the FRBNY to
testify before the Senate Banking Committee and the House Financial Services
Committee at least once per year. Other proposals that were raised at the
hearing include removing the Fed’s regulatory and supervisory powers and giving
them to another agency like the FDIC, which is not traditionally as cozy with
the banking industry.
7)
But I thought the financial reform law was supposed to change things!
Well, the 2010 Dodd-Frank financial reform law did do
many good things. It created an entirely new and powerful agency, the Consumer
Financial Protection Bureau, to focus solely on how financial institutions
treat their customers. It also created an umbrella organization, called the Financial
Stability Oversight Council (FSOC) to oversee the federal
government's entire approach to financial regulation and coordinate activities
among the different agencies.
That being said, the Federal Reserve as a system was
not significantly modified by the Dodd-Frank law. Although the Fed was given
expanded regulatory and oversight powers under the law, its structure and
culture remain largely the same as before the financial crisis. Senator Jack Reed’s
recent proposals, which were included in early drafts of Dodd-Frank but later
removed, would allow Congress to keep a direct eye
on the FRBNY, instead of only through the Board of Governors. Although
unlikely to become law in a Republican controlled Congress, these proposals would bring a significant change to
the current relationship between Congress and the Fed.
The problem of regulatory capture clearly remains.
Even though employees of the bank regulatory agencies usually make more money
than other federal employees (because they are exempt from the traditional “GS”
pay scale), they still make far less than their counterparts in the financial
industry. The allure of lucrative post-government employment is a difficult
phenomenon to reverse, especially in the current political environment where government
agencies are subject to continuous sequesters, shutdowns, furloughs, and pay
freezes. However, perhaps more important than compensation is an agency’s culture
and understanding of its role in the economy. Segarra
herself put it best-- when asked what was ultimately lacking
at the Fed, she replied “lack of
backbone, transparency, thoroughness and perseverance.”