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‘Regulatory Capture’ by Wall Street Caught on Tape?

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Wall Street’s reputation, and the government’s perhaps even more, have not been enhanced by the release of secretly recorded tapes that appear to portray a supine New York Fed fearful of offending Goldman Sachs.

On Friday This American Life radio program and ProPublica jointly released an investigative report on the story of former Federal Reserve Bank of New York bank examiner Carmen Segarra, who was fired after only seven months on the job, but not before secretly recording meetings including one in which her boss persistently tried to get Segarra to back down from a negative finding about Goldman.

The investigative report provocatively commences with the conclusions of a once-secret report by a Columbia University professor, David Beim, hired by the New York Fed to help it avoid a repetition of the laxity that enabled banks under its supervision to trigger the financial crisis through their excessive leverage.

Beim had faulted the Fed for a culture of consensus and “regulatory capture,” as a result of a tendency of Fed employees to seek future high-compensation employment with the very banks they currently regulate.

The finance professor recommended the Fed hire examiners who would be unafraid to speak up and ask tough questions, as a direct result of which the New York Fed in late 2011 hired Segarra, an Ivy League and Sorbonne-educated international lawyer with 13 years of compliance experience.

In that painful back-and-forth session with the head of the Fed’s Goldman Sachs team, which lasts 40 minutes out of a total 46 hours of recordings, the investigative report says:

“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.’

In other highlights of the recordings, Segarra’s supervisor describes one Goldman deal as “legal but shady” and calls for further investigation. But the Fed’s Goldman team backs off a provision she finds that could thwart the deal, lauds Goldman for its “thoroughness” and worries aloud that too much “inquisitiveness” might discourage the bank from making voluntary disclosures.

“To Segarra, the ‘inquisitiveness’ comment represented a fear of upsetting Goldman,” the investigative report says.

In a separate exchange with her manager, Segarra is criticized for being too “transactional” and not more “relational.”

While commended for her knowledge, her manager says her colleagues on the Goldman team think she has “sharper elbows, or you’re sort of breaking eggs.”

When Segarra asks for specifics, the recording reveals she is told:

“I would ask you to think about a little bit more, in terms of, first of all, the choice of words and not being so conclusory.”

She is further told:

“You use the word ‘definitely’ a lot, too. If you use that, then you want to have a consensus view of definitely, not only your own.”

This discussion perfectly reflects the conclusions of Professor Beim’s report to the Fed, which ProPublica quotes, saying:

“Because so many seem to fear contradicting their bosses, senior managers must now repeatedly tell subordinates they have a duty to speak up even if that contradicts their bosses.” And Beim further states:

“An allied issue is that building consensus can result in a whittling down of issues or a smoothing of exam findings. Compromise often results in less forceful language and demands on the banks involved.”

Despite the Beim recommendations, Segarra’s outspokenness led to her dismissal. The Goldman team leader said, in a recorded conversation, that the Fed had “lost confidence in [her] ability to not substitute [her] own judgment for everyone else’s.”

Segarra sued the New York Fed for wrongful termination, alleging the Fed fired her for refusing to back down on her finding that Goldman lacked a conflict of interest policy, and though the case was dismissed procedurally, she is appealing.

In a lengthy statement, the New York Fed “categorically rejects the allegations being made about the integrity of its supervision of financial institutions,” but notes that “it is constrained in what it can say about matters that are the subject of a pending appeal by Carmen Segarra.”

One former New York Fed bank examiner, who spoke on condition of anonymity, made clear he did not know Segarra, worked on a different team and was highly reluctant to speak with a reporter, described the report as “embarrassing.”

Asked by ThinkAdvisor what might justify the New York Fed’s conduct to an audience hearing the tapes, the former bank examiner focused on the Goldman team leader’s “legal but shady” remark. It may be that that deal (with Spanish bank Santander) was legal and therefore the Fed team thought it should concentrate its firepower elsewhere.

The possible legality of the New York Fed’s actions did not stop Sen. Elizabeth Warren, D-Mass., from calling for congressional oversight hearings of the issues raised by the ProPublica report in a statement the Senate Banking Committee member released Friday.

And Goldman Sachs, for its part, announced a new policy on conflicts of interest, curiously or coincidentally, the very day of the ProPublica investigative report.

In a separate e-mail to ProPublica’s Jake Bernstein several days before Friday’s broadcast, Goldman spokesman David Wells affirmed it “long had a comprehensive approach for addressing potential conflicts” it said was easily discoverable via a Google search despite claims to the contrary by “Ms. Segarra, who unsuccessfully interviewed for employment at Goldman in 2007, 2008 and 2009.”

More details appear likely to be forthcoming. In an interview on NPR Wednesday, Warren opined that Segarra’s recordings portrayed a “cozy” relationship between Wall Street and regulators and suggested an investigation would not be far in the offing:

“I want to get a complete picture of what’s happened here. But we need to move on this and move quickly.”

Check out The Biggest Lie of the New Century on ThinkAdvisor.


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