Is the Federal Reserve too close to Wall Street banks? On friday, November 21, the president of the Federal Reserve Bank of New York, William Dudley, had to answer the barrage of questions from US senators at a hearing in Washington. The day before, the Fed announced the launch of monitoring procedures for evaluation of its major banks. On the same day, we learned that Goldman Sachs recently fired one of its employees, former employee of the Fed, for relaying confidential information from the Central Bank of New York.
“Is there an ethical problem with the New York Fed? I think the evidence suggests that this is the case.” At the hearing of Mr. Dudley, Democratic Senator from Massachusetts, Elizabeth Warren, was tempted to make both the questions and the answers. “Either you need to adjust to that, Mr. Dudley, or we need someone who will do it,” she told him.
This hearing was triggered by revelations of the site ProPublica.org, which published the records of a former employee of the New York Fed, Carmen Segarra. In these documents, we discover the reluctance with which the institution’s teams conducted the supervision of a suspicious transaction between Goldman Sachs and Santander in January 2012. As part of the sale of a subsidiary of the Spanish bank to its American counterpart, Ms. Segarra had alerted his superiors on porting suspicions. But it was not acted upon.
A regulator is not there to “act as police”
“I do not accept the suggested description of these records, that the Fed is not doing its job properly. (…) We have not postponed decisions. We investigated these issues,” retorted Mr. Dudley, rejecting “the premise that there was a long list of errors at the New York Fed under my mandate.” He also challenged the description that Ms. Warren has made of the supposed role of the Fed. A regulator is not there to “act as police”, but to ensure the safety and soundness of the financial system by reporting potential crimes to the authorities responsible for the enforcement of the law, he insisted. “I think it’s more of a role for fire safety that ensures that the institutions work well and that they will not catch fire,” he says.
It is precisely this role that was recently challenged by a report from the Office of the Inspector General for the Federal Reserve (OIG) published on 21 October. This document indeed deplores the lack of vigilance on the New York Fed on the risks taken by JPMorgan Chase in the case of the “London Whale”, which erupted in 2012. A team of experts within the reserve Federal had recommended in 2009 at the New York branch conduct of “a thorough and comprehensive review” of the London unit of JPMorgan questioned. A job that ultimately was never undertaken, the report said.
To explain this inertia, the Inspector General points to several factors. Congestion control procedures, lack of resources, “weakness in the planning procedures” and finally loss of “institutional knowledge” in 2011 after an internal reorganization of the team that was responsible for the supervision of JPMorgan. But to overcome these shortcomings, the New York Fed was at fault by not sharing the information with the Office of the Comptroller of the Currency (OCC), another regulator that could support it in its task.
Also at the heart of the criticisms of the Fed there is porosity between the institution and the major banks in terms of recruitment. Reproaches that have taken a little more acute tone in recent days, after the revelation of dismissal in September by Goldman Sachs of one of its employees, passed on by the Fed. The latter,with his old network had succeeded in transmitting confidential information relating to the regulation of the US bank by the New York Fed.
Ms. Warren has called for the placing locks on the revolving doors that allow passage from one world to another. “We cannot build a reliable control system if the revolving doors let in former leaders in the role of temporary cops,” she said. The monitoring service “rose from 520 to 700 persons and the average length of holding a position is nine years. So I do not think the revolving door is what characterizes what is happening on the New York Fed,” said Mr Dudley in his defense, who is himself a former head of Goldman Sachs.
Will the General Inspectorate announced by the Fed to control its bank supervisory procedures be enough to silence critics? In any case, they may keep it down, while the Republican Party has won a majority in the Senate during the midterm elections. During Friday’s hearing, no Republican senator attended the hearing and the “Grand Old Party” has already proposed to pass a law to curb the Fed’s operating margins on supervision of banks.
Banks pinned by the Senate
The US Senate accused, Wednesday, November 19, Goldman Sachs, JPMorgan Chase and Morgan Stanley on having “potentially” manipulated the prices of raw materials. These three banks “are engaged since 2008 in multi-billion dollar business for physical commodities, controlling or owning vast stocks,” said a report of the Permanent Subcommittee in charge of investigations. It denounces a crossover between their banking business and trade, which creates unfair competition with industrial institutions. A new stone in the shoe of the Fed, which, among others (with the Commodity Futures Trading Commission, the regulator of US derivatives markets) is responsible for monitoring the activities of banks in the commodities market.