Barely a year removed from the devastation of the 2008 financial crisis, the president of the Federal Reserve Bank of New York faced a crossroads. Congress had set its sights on reform. The biggest banks in the nation had shown that their failure could threaten the entire financial system. Lawmakers wanted new safeguards.
The Federal Reserve, and, by dint of its location off Wall Street, the New York Fed, was the logical choice to head the effort. Except it had failed miserably in catching the meltdown.
New York Fed President William Dudley had to answer two questions quickly: Why had his institution blown it, and how could it do better? So he called in an outsider, a Columbia University finance professor named David Beim, and granted him unlimited access to investigate. In exchange, the results would remain secret. (William Dudley, president of the Federal Reserve Bank of New York speaks in New York in the photo below. AP Photo/Mark Lennihan, File.)
After interviews with dozens of New York Fed employees, Beim learned something that surprised even him. The most daunting obstacle the New York Fed faced in overseeing the nation’s biggest financial institutions was its own culture. The New York Fed had become too risk-averse and deferential to the banks it supervised. Its examiners feared contradicting bosses, who too often forced their findings into an institutional consensus that watered down much of what they did.
The report didn’t only highlight problems. Beim provided a path forward. He urged the New York Fed to hire expert examiners who were unafraid to speak up and then encourage them to do so. It was essential, he said, to preventing the next crisis.
A year later, Congress gave the Federal Reserve even more oversight authority. And the New York Fed started hiring specialized examiners to station inside the too-big-to fail institutions, those that posed the most risk to the financial system.
One of the expert examiners it chose was Carmen Segarra.
Segarra appeared to be exactly what Beim ordered. Passionate and direct, schooled in the Ivy League and at the Sorbonne, she was a lawyer with more than 13 years of experience in compliance – the specialty of helping banks satisfy rules and regulations. The New York Fed placed her inside one of the biggest and, at the time, most controversial banks in the country, Goldman Sachs.
It did not go well.She was fired after only seven months.
As ProPublica reported last year,Segarra sued the New York Fed and her bosses, claiming she was retaliated against for refusing to back down from a negative finding about Goldman Sachs. A judge threw out the case this year without ruling on the merits, saying the facts didn’t fit the statute under which she sued.
At the bottom of a document filed in the case, however, her lawyer disclosed a stunning fact: Segarra had made a series of audio recordings while at the New York Fed. Worried about what she was witnessing, Segarra wanted a record in case events were disputed. So she had purchased a tiny recorder at the Spy Store and began capturing what took place at Goldman and with her bosses.
Segarra ultimately recorded about 46 hours of meetings and conversations with her colleagues. Many of these events document key moments leading to her firing. But against the backdrop of the Beim report, they also offer an intimate study of the New York Fed’s culture at a pivotal moment in its effort to become a more forceful financial supervisor. Fed deliberations, confidential by regulation, rarely become public.
The recordings make clear that some of the cultural obstacles Beim outlined in his report persisted almost three years after he handed his report to Dudley. They portray a New York Fed that is at times reluctant to push hard against Goldman and struggling to define its authority while integrating Segarra and a new corps of expert examiners into a reorganized supervisory scheme.
Segarra became a polarizing personality inside the New York Fed — and a problem for her bosses — in part because she was too outspoken and direct about the issues she saw at both Goldman and the Fed. Some colleagues found her abrasive and complained. Her unwillingness to conform set her on a collision course with higher-ups at the New York Fed and, ultimately, led to her undoing.
In a tense, 40-minute meeting recorded the week before she was fired, Segarra’s boss repeatedly tries to persuade her to change her conclusion that Goldman was missing a policy to handle conflicts of interest. Segarra offered to review her evidence with higher-ups and told her boss she would accept being overruled once her findings were submitted. It wasn’t enough.
“Why do you have to say there’s no policy?” her boss said near the end of the grueling session.
“Professionally,” Segarra responded, “I cannot agree.”
The New York Fed disputes Segarra’s claim that she was fired in retaliation.
“The decision to terminate Ms. Segarra’s employment with the New York Fed was based entirely on performance grounds, not because she raised concerns as a member of any examination team about any institution,” it said in a two-page statement responding to an extensive list of questions from ProPublica and This American Life.
The statement also defends the bank’s record as regulator, saying it has taken steps to incorporate Beim’s recommendations and “provides multiple venues and layers of recourse to help ensure that its employees freely express their views and concerns.”
“The New York Fed,” the statement says, “categorically rejects the allegations being made about the integrity of its supervision of financial institutions.”
In the spring of 2009, New York Fed President William Dudley put together a team of eight senior staffers to help Beim in his inquiry. In many ways, this was familiar territory for Beim.
He had worked on Wall Street as a banker in the 1980s at Bankers Trust Company, assisting the firm through its transition from a retail to an investment bank. In 1997, the New York Fed hired Beim to study how it might improve its examination process. Beim recommended the Fed spend more time understanding the businesses it supervised. He also suggested a system of continuous monitoring rather than a single year-end examination.
Beim says his team in 2009 pursued a no-holds-barred investigation of the New York Fed. They were emboldened because the report was to remain an internal document, so there was no reason to hold back for fear of exposure. The words “Confidential Treatment Requested” ran across the bottom of the report.
“Nothing was off limits,” says Beim. “I was told I could ask anyone any question. There were no restrictions.”
In the end, his 27-page report laid bare a culture ruled by groupthink, where managers used consensus decision-making and layers of vetting to water down findings. Examiners feared to speak up lest they make a mistake or contradict higher-ups. Excessive secrecy stymied action and empowered gatekeepers, who used their authority to protect the banks they supervised.
“Our review of lessons learned from 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.”
(AP Photo/Richard Drew)
One New York Fed employee, a supervisor, described his experience in terms of “regulatory capture,” the phrase commonly used to describe a situation where banks co-opt regulators. Beim included the remark in a footnote. “Within three weeks on the job, I saw the capture set in,” the manager stated.
Confronted with the quotation, senior officers at the Fed asked the professor to remove it from the report, according to Beim. “They didn’t give an argument,” Beim said in an interview. “They were embarrassed.” He refused to change it.
The Beim report made the case that the New York Fed needed a specific kind of culture to transform itself into an institution able to monitor complex financial firms and catch the kinds of risks that were capable of torpedoing the global economy.
That meant hiring “out-of-the-box thinkers,” even at the risk of getting “disruptive personalities,” the report said. It called for expert examiners who would be contrarian, ask difficult questions and challenge the prevailing orthodoxy. Managers should add categories like “willingness to speak up” and “willingness to contradict me” to annual employee evaluations. And senior Fed managers had to take the lead.
“The top has to articulate why we’re going through this change, what the benefits are going to be and why it’s so important that we’re going to monitor everyone and make sure they stay on board,” Beim said in an interview.
Beim handed the report to Dudley. The professor kept it in draft form to help maintain secrecy and because he thought the Fed president might request changes. Instead, Dudley thanked him and that was it. Beim never heard from him again about the matter, he said.
In 2011, the Financial Crisis Inquiry Commission, created by Congress to investigate the causes behind the economic calamity, publicly released hundreds of documents. Buried among them was Beim’s report.
Because of the report’s candor, the release surprised Beim and New York Fed officials. Yet virtually no one else noticed.
Among the New York Fed employees enlisted to help Beim in his investigation was Michael Silva.
As a Fed veteran, Silva was a logical choice. A lawyer and graduate of the United States Naval Academy, he joined the bank as a law clerk in 1992. Silva had also assisted disabled veterans and had gone into Iraq after the 2003 invasion to help the country’s central bank. Prior to working on Beim’s report, he had been chief of staff to the previous New York Fed president, Timothy Geithner.
In declining through his lawyer to comment for this story, Silva cited the appeal of Segarra’s lawsuit and a prohibition on disclosing unpublished supervisory material. The rule allows regulators to monitor banks without having to worry about the release of information that could alarm customers and create a run on a bank that’s under scrutiny.
Silva had been in the room with Geithner in September 2008 during a seminal moment of the financial crisis. Shares in a large money market fund – the Reserve Primary Fund – had fallen below the standard price of $1, “breaking the buck” and threatening to touch off a run by investors. The investment firm Lehman Brothers had entered bankruptcy, and the financial system appeared in danger of collapse.
In Segarra’s recordings, Silva tells his team how, at least initially, no one in the war room at the New York Fed knew how to respond. He went into the bathroom, sick to his stomach, and vomited.
“I never want to get close to that moment again, but maybe I’m too close to that moment,” Silva told his New York Fed team at Goldman Sachs in a meeting one day.
Despite his years at the New York Fed, Silva was new to the institution’s supervisory side. He had never been an examiner or participated as part of a team inside a regulated bank until being appointed to lead the team at Goldman Sachs. Silva prefaced his financial crisis anecdote by saying the team needed to understand his motivations, “so you can perhaps push back on these things.”
In the recordings, Silva then offered a second anecdote. This one involved the moments before the Lehman bankruptcy.
Silva related how the top bankers in the nation were asked to contribute money to save Lehman. He described his disappointment when Goldman executives initially balked. Silva acknowledged that it might have been a hard sell to shareholders, but added that “if Goldman had stepped up with a big number, that would have encouraged the others.”
“It was extraordinarily disappointing to me that they weren’t thinking as Americans,” Silva says in the recording. “Those two things are very powerful experiences that, I will admit, influence my thinking.”
(AP Photo/Jacquelyn Martin)
Silva’s stories help explain his approach to a controversial deal that came to the New York Fed team’s attention in January 2012, two months after Segarra arrived. She said the Fed’s handling of the deal demonstrated its timidity whenever questions arose about Goldman’s actions. Debate about the deal runs through many of Segarra’s recordings.
On Friday, Jan. 6, 2012, at 3:54 p.m., a senior Goldman official sent an email to the on-site Fed regulators – including Silva, Segarra and Segarra’s legal and compliance manager, Johnathon Kim. Goldman wanted to notify them about a fast-moving transaction with a large Spanish bank, Banco Santander. Spanish regulators had signed off on the deal, but Goldman was reaching out to its own regulators to see whether they had any questions.
At the time, European banks were shaky, particularly the Spanish ones. To shore up confidence, the European Banking Authority was demanding that banks hold more capital to offset potential future losses. Meeting these capital requirements was at the heart of the Goldman-Santander transaction.
Under the deal, Santander transferred some of the shares it held in its Brazilian subsidiary to Goldman. This effectively reduced the amount of capital Santander needed. In exchange for a fee from Santander, Goldman would hold on to the shares for a few years and then return them. The deal would help Santander announce that it had reached its proper capital ratio six months ahead of the deadline.
In the recordings, one New York Fed employee compared it to Goldman “getting paid to watch a briefcase.” Silva states that the fee was $40 million and that potentially hundreds of millions more could be made from trading on the large number of shares Goldman would hold.
Santander and Goldman declined to respond to detailed questions about the deal.
Silva did not like the transaction. He acknowledged it appeared to be “perfectly legal” but thought it was bad to help Santander appear healthier than it might actually be.
“It’s pretty apparent when you think this thing through that it’s basically window dressing that’s designed to help Banco Santander artificially enhance its capital position,” he told his team before a big meeting on the topic with Goldman executives.
The deal closed the Sunday after the Friday email. The following week, Silva spoke with top Goldman people about it and told his team he had asked why the bank “should” do the deal. As Silva described it, there was a divide between the Fed’s view of the deal and Goldman’s.
“[Goldman executives] responded with a bunch of explanations that all relate to, ‘We can do this,’ ” Silva told his team.
Privately, Segarra saw little sense in Silva’s preoccupation with the question of whether “should” applied to the Santander deal. In an interview, she said it seemed to her that Silva and the other examiners who worked under him tended to focus on abstract issues that were “fuzzy” and “esoteric” like “should” and “reputational risk.”
Segarra believed that Goldman had more pressing compliance issues – such as whether executives had checked the backgrounds of the parties to the deal in the way required by anti-money laundering regulations.
Segarra had joined the New York Fed on Oct. 31, 2011, as it was gearing up for its new era overseeing the biggest and riskiest banks. She was part of a reorganization meant to put more expert examiners to the task.
In the past, examiners known as “relationship managers” had been stationed inside the banks. When they needed an in-depth review in a particular area, they would often call a risk specialist from that area to come do the examination for them.
In the new system, relationship managers would be redubbed “business-line specialists.” They would spend more time trying to understand how the banks made money. The business-line specialists would report to the senior New York Fed person stationed inside the bank.
The risk specialists like Segarra would no longer be called in from outside. They, too, would be embedded inside the banks, with an open mandate to do continuous examinations in their particular area of expertise, everything from credit risk to Segarra’s specialty of legal and compliance. They would have their own risk-specialist bosses but would also be expected to answer to the person in charge at the bank, the same manager of the business-line specialists.
In Goldman’s case, that was Silva.
(AP Photo/Manu Fernandez)
Shortly after the Santander transaction closed, Segarra notified her own risk-specialist bosses that Silva was concerned. They told her to look into the deal. She met with Silva to tell him the news, but he had some of his own. The general counsel of the New York Fed had “reined me in,” he told Segarra. Silva did not refer by name to Tom Baxter (photo), the New York Fed’s general counsel, but said: “I was all fired up, and he doesn’t want me getting the Fed to assert powers it doesn’t have.”
This conversation occurred the day before the New York Fed team met with Goldman officials to learn about the inner workings of the deal.
From the recordings, it’s not spelled out exactly what troubled the general counsel. But they make clear that higher-ups felt they had no authority to nix the Santander deal simply because Fed officials didn’t think Goldman “should” do it.
Segarra told Silva she understood but felt that if they looked, they’d likely find holes. Silva repeated himself. “Well, yes, but it is actually also the case that the general counsel reined me in a bit on that,” he reminded Segarra.
The following day, the New York Fed team gathered before their meeting with Goldman. Silva outlined his concerns without mentioning the general counsel’s admonishment. He said he thought the deal was “legal but shady.”
“I’d like these guys to come away from this meeting confused as to what we think about it,” he told the team. “I want to keep them nervous.”
As requested, Segarra had dug further into the transaction and found something unusual: a clause that seemed to require Goldman to alert the New York Fed about the terms and receive a “no objection.”
This appeared to pique Silva’s interest. “The one thing I know as a lawyer that they never got from me was a no objection,” he said at the pre-meeting. He rallied his team to look into all aspects of the deal. If they would “poke with our usual poker faces,” Silva said, maybe they would “find something even shadier.”
But what loomed as a showdown ended up fizzling. In the meeting with Goldman, an executive said the “no objection” clause was for the firm’s benefit and not meant to obligate Goldman to get approval. Rather than press the point, regulators moved on.
Afterward, the New York Fed staffers huddled again on their floor at the bank. The fact-finding process had only just started. In the meeting, Goldman had promised to get back to the regulators with more information to answer some of their questions. Still, one of the Fed lawyers present at the post-meeting lauded Goldman’s “thoroughness.”
Another examiner said he worried that the team was pushing Goldman too hard.
“I think we don’t want to discourage Goldman from disclosing these types of things in the future,” he said. Instead, he suggested telling the bank, “Don’t mistake our inquisitiveness, and our desire to understand more about the marketplace in general, as a criticism of you as a firm necessarily.”
To Segarra, the “inquisitiveness” comment represented a fear of upsetting Goldman.