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Why the Fed can't rein in Wall Street

A Federal Reserve regulator who says she was fired for going aggressively after banks secretly taped more than 46 hours of her meetings with Goldman executives.
Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall on July 16, 2010.
Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall on July 16, 2010.

“Have we made the banking system safer?”

That question was asked rhetorically by Federal Reserve Bank of New York chairman William Dudley on Thursday at New York University’s Stern School of Business, before an audience who had come to hear him speak about reforming lending practices.

But Dudley wasn’t talking about lending; he was addressing a blockbuster story that’s been churning in the financial press since the previous weekend, when reporters from ProPublica and public radio’s “This American Life” teamed up to broadcast the story of former Federal Reserve regulator Carmen Segarra.

Segarra had been hired by the Fed in 2011 to make sure another financial crisis like the one that nearly crippled the global economy in 2008 could not happen again. She came to the job with more than a decade of experience under her belt as an expert in regulatory compliance and was soon assigned to monitor one of the biggest "too big to fail" banks of them all: Goldman Sachs. There, she was to keep an eye on the bank’s risk management and make sure it followed federal financial rules.

She proved to be tough minded and sharp tongued – just what the New York Fed needed, according to a report Dudley commissioned in 2009. But her supervisors saw it another way; one cautioned Segarra to be more polite and cooperative in meetings with Goldman Sachs. In response to complaints from other Fed colleagues, this supervisor said she was “arrogant” and should express “a sense of humility,” according to a recording of their conversation.

In a complaint she filed in federal court, Segarra claimed she was subsequently fired from her job at the Fed after refusing to back down from concluding that Goldman Sachs’s conflict of interest policy was not in compliance with Fed rules. But she didn’t leave William Dudley’s Federal Reserve bank empty-handed. As was first revealed in a wrongful termination lawsuit she filed against the Fed, Segarra had taped recordings of more than 46 hours of meetings between herself, her Fed colleagues, and executives at Goldman Sachs. 

The portions of those tapes that have been broadcast and published reveal that, compared to her colleagues, Segarra was -- as her metaphor-mixing supervisor said on one of those recordings -- “breaking eggs” with the “sharper elbows” they hoped she would dull.

The tapes also reveal that the regulators and examiners under Dudley’s command at the New York Fed seem to often be timid and even deferential toward Goldman Sachs executives -- an impression Dudley hoped to counter with his impromptu defense of the Fed’s record at NYU.

Under Dudley’s watch, and after the passage of new Congressional financial regulatory reform packages like Dodd-Frank, regulators were supposed to have been empowered to snuff out potential conflicts of interest and risky transactions before they had a chance to fester within a Wall Street bank and put the global economy on the brink of another 1929-like disaster. Dudley had no desire to live through the experiences of his predecessor, former Treasury Secretary Timothy Geithner, and reportedly came to the chairman’s job determined to make changes to the often-cozy relationship between the Fed and the banks it regulates.

That task is inherently difficult given that, when it was created in 1913, the Federal Reserve system was intended to be a collaborative rather than adversarial system of central bank regulation. To this day, two-thirds of the members of the board Dudley chairs are chosen by the very banks he is responsible for regulating. Dudley himself worked at Goldman Sachs for two decades, until 2007, and was the investment bank’s chief economist. Although the Fed’s Board of Governors in Washington, D.C. was partly created in 1933 to be a counterweight to the regional bank in New York, the Federal Reserve Bank of New York is nevertheless the most important of those twelve banks simply because it is located in the nation’s (and arguably the world’s) capital of capital.

Early in his tenure, in 2009, Dudley tapped a Columbia University business professor named David Beim to conduct a review studying and suggesting how the New York Fed could become a more effective regulator. The report was to be read only internally; no reporters or lawmakers would be given copies, creating room for Beim to be – in his words – “candid and self-critical.”

"A number of people believe that supervisors paid excessive deference to banks, and as a result they were less aggressive in finding issues or in following up on them in a forceful way."'

After conducting interviews with New York Fed staff, Beim and his team prepared a draft that was submitted to Dudley in August 2009. That copy can be found here, with “confidential treatment requested” at the foot of each page.

Among the flaws Beim discovered was that Fed regulators were overly reliant on banks to volunteer information and manage their own risk. Additionally, some on the Fed’s staff believed that the “deference” they showed to big banks was “excessive.” “The [New York Fed] culture is marked by insufficient individual initiative and lacks fluid communication,” Beim wrote in the report summary.

“The crisis reveals a culture that is too risk-averse to respond quickly and flexibly to new challenges," the report stated. "A number of people believe that supervisors paid excessive deference to banks, and as a result they were less aggressive in finding issues or in following up on them in a forceful way." Among the solutions offered was to hire tougher, more independent regulators – people like Carmen Segarra.

When Segarra was hired and assigned to Goldman Sachs, she was given an office inside the firm’s headquarters, a common practice in American financial regulation. Among her discoveries was that Goldman Sachs seemed to not have a single, firm-wide comprehensive conflict of interest policy in place that would comply with what the Federal Reserve expected of big banks.

Segarra maintains she was fired for pressing the issue with her superiors, despite an admission from a Goldman Sachs executive that they had “no one policy” in place. Goldman Sachs has since denied her claim. For a time the firm pointed journalists to a 2011 report on the matter. Last Friday, however, Goldman Sachs implemented more stringent rules that now bar their investment bankers and some other personnel from trading individual stocks and bonds. The new measures were announced internally and reported by numerous outlets.

NBC News has not heard the tapes, but the revelations in Segarra’s recordings have prompted senators Elizabeth Warren (D-Mass.) and Sherrod Brown (D-Ohio) to call for hearings.

They also raise deeper structural questions about the Fed’s approach to financial regulation. Under the traditional understanding of something called "regulatory capture," one of the top concerns about regulators was that they could be corrupted into aiding the firms they oversee. But the Segarra recordings don’t show Fed regulators trying to help Goldman Sachs make money. Instead, they suggest the same deference highlighted in the report David Beim authored in 2009. “Why is the Fed so wimpy?” asked one financial blogger earlier this week.

That’s a good question. Answering it is going to require a newer understanding of how regulators should be doing their jobs.