This American Life, Carmen Segarra, and the Federal Reserve Bank: an Episode TBTF?

by zic

The latest eposide of This American Life featured secret recordings made by Carmen Segarra, a regulator for the NY Fed who was embedded at Goldman Sachs; it seems to be causing a stir in the bubbles. I just listened, and it’s disturbing stuff.  No matter how you feel about the show, I hope you’ll take the time to listen, too.

I pretty much agree with conventional wisdom on the relationship between the Fed and the banks it regulates: it’s way too cozy. In the wake of the financial crisis, it’s obvious that the Fed showed deference to banks, not to people; banks were made whole, with individual people left holding the bag. The program to help underwater homeowners defers first to banks, and has helped a tiny proportion of people harmed through no doing of their own. But the economic destruction to American families is still a huge problem. [Note: this link goes to a journalist resource tip sheet from the Harvard Kennedy School’s Shorenstein Center on Media, politics and Public Policy.]

However.

The piece left me very unsatisfied. I had a huge question that should have been at least acknowledged. The background story says Segarra and others were preparing a finding that Goldman’s did not have a conflict-of-interest policy; she was not she alone in coming to the conclusion that there was no bank-wide policy that met federal requirements in place. She was fired before the finding was filed.

I wanted to know what would have happened to the finding. What’s the process? The relationship between Fed regulators and banks is private and confidential, but a finding is a legal result of that relationship. Does the finding become public record? If it becomes public record, is there some risk to financial markets? Because, remember, we live in a world that trembles at every whisper from the Federal Reserve, and Goldman’s actions both. If it’s not public record, what is the process for moving forward?

I would also like to have known if these types of conflict-of-interest concerns are a problem of other TBTF American banks, and if regulating by insinuation – not by stating facts – is how banking goes down? Segarra’s boss seemed to think simply raising the question of the appearance that the Fed had signed off on something it hadn’t signed off an action. This reminds me of the careful phrasing of all public Fed statements, of Janet Yellen’s early thrown-elbows that set the markets aflutter.

In a world that trembles at every whisper from the Federal Reserve, can it actually regulate the banking industry without causing financial chaos?

TBTF.

A few thoughts on Carmen Segarra. The woman’s a hero. She deserves whistle-blower protection. But she was also secretly recorded those meetings. So while I want to go all rah-rah sisboomba on her; I wonder if her decision to begin recording the meetings secretly may have changed how she performed her job. That’s an ethical nut I’m having trouble cracking. I want to give her the benefit of the doubt, particularly in a world where her bosses words so echoed the ‘you’re too abrasive’ meme women receive in job evaluations. I think that her suggesting to her boss that she was going to be fired probably opened the door to her firing. Even so, I cling to what feels like a healthy dose of skepticism.

For anyone considering such a thing, I’d advise you to talk to a lawyer before you purchase the recording devices from Spies ‘R Us. Your right to record, without whistle-blower protection, is regulated by the state in which you’re recording; particular care is required with interstate phone calls.

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34 thoughts on “This American Life, Carmen Segarra, and the Federal Reserve Bank: an Episode TBTF?

  1. FYI, my critique is one of the story leaving out important information to give context, a few lines of talk would have resolved the problem. When discussing regulatory activities, the activities happen in the context of the process, and this essential tidbit was left out. It was big enough to fire her over, so it can’t have just sat there, producing no ripples or waves in the world of high-finance banking.

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  2. Listening to it now. I like that the background music as the “background” portion ends and we move into the story itself, is HBMS’ “The Truth,” which features the chorus, “You can’t hide from the truth/Because the truth is all there is.”

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  3. Lack of conflict of interest policy is one of the reasons I recommend small time investors stay the fuck out of the market right now.

    TBTF just means “let’s break the global market! AGAIN!” Sons of bitches.

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  4. There’s another thread in that story that I’d hope, but doubt, was covered. As I’ve been saying in the threads about a US Postal Bank, giving agencies multiple, often conflicting, missions is a good route to dysfunction.

    The Fed’s primary job is to try to keep the economy steady by managing the money supply. This is demanding enough, as it has to balance keeping unemployment reasonably low with keeping inflation reasonably low while making guesses about the future.

    Asking it to also regulate the banks is adding in something that’s not really even related to that core task. And so zic asks, “In a world that trembles at every whisper from the Federal Reserve, can it actually regulate the banking industry without causing financial chaos?” And the answer is, no. Because its actions can be too powerful, because of regulatory capture (the Fed Directors are generally chosen from the regulated industry), and because it’s a distraction from its primary purpose.

    The general public–and congressional–belief that we can continually add new tasks to extant agencies because they’re already there and, hey, money, banks, that’s surely in the same ballpark, right? desperately needs a reality check that I don’t think it’s going to get.

    Businesses get bogged down by multiple tasks as well, but they have the capacity to close down, sell off, or just split up the functions (as Hewlett Packard just announced it is doing). Government agencies lack that flexibility (and it’s not clear we’d want to give them that much autonomy anyway), so it’s a much more serious, but much more neglected, issue in the public sector.

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    • I think the interesting thing with the TAL story is that almost everyone agree that the relationship between the Fed and the Banks is too cozy but there is probably substantial disagreement on what to do about this too cozy relationship.

      I imagine that Zic and I would have preferred solutions very different from someone on the right-wing. Stories like this seem to exist to be all things to all people. The right listens to them and gets confirmation about the folly of regulation. The left listens to them and gets confirmation about the need for good government, tighter regulations, and finding ways to end the private-public revolving door.

      FWIW Felix Salmon’s take away from the TAL story was regulatory capture is hear to stay and I generally respect his work as a financial and economics journalist.

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      • As a side-note… the right wing and radical left have some alignment on economic issues… I think it is the Pragmatic Establishment Center with whom you have the greatest potential disagreement.

        We fight on so many other fronts… let us enjoy our bonhomie where we can.

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      • I agree with your assessment. I often think politics acts more like a circle than a line and both the radical-right and radical-left have strong utopian and pastoralist streaks which I find damgerous and unrealistic.

        You are right that the greatest disagreement probably exists within the cofines of the light and right wings are the “pragmatic establishment center.”

        Though I wonder if Hanley likes being considered part of the establishment :)

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      • Oh… we almost had a moment there. And, you have strange notions of danger.

        Libertarians… putting the Classical back into Liberal for over a century – can’t get more establishment than that. It is the rest of us who are the dirty splitters of one stripe or another.

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      • Saul,

        I am a straight white middle-aged property-owning male. How much more establishment can one get?

        The weird thing about libertarianism, though, is that while it appears establishment in being pro-market, it’s actually both anti-corporate and anti-businesses, and quite satisfied with seeing both be continually challenged by upstarts. While the left wants to lock in a permanent revolution, and the right wants to lock in the ancien regime, libertarians root for those who can successfully uproot established structures by offering people something more attractive.

        Of course if, like me, one is a Burkean as well as a libertarian, that creates a hell of a lot of cognitive dissonance.

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      • It was just a little joke. :)

        And I am a welfare state social democracy kind of liberal, not a leftist. I don’t believe in permanent revolution because that just leads to misery and suffering for the masses. I believe in protecting people from the slings and arrows of outrageous fortune as much as possible. I am also skeptical of the cult of disruption as Tech 2.0 likes to call it.

        :)

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    • The Fed is charged with pursuing a tripartate goal: low interest rates, maximization of employment, and stable prices. It has, in essence, three tools available to it to pursue these goals: setting the required reserve ratio for various institutions, controlling the prime interest rate, and managing debt instruments. That’s what the Fed does.

      The Fed is interested in Goldman Sachs to the extent that Goldman Sachs’ activities affect M1 and M2. Which an entity of the size and pervasiveness of Goldman Sachs is going to do. She’s necessarily going to be principally interested in monitoring the entity’s capital reserves and liquidity, and to a lesser extent the entity’s investment in government debt (which in the case of Goldman Sachs, is going to be an objectively large amount but a relatively small percentage of its activity).

      So we ought not be surprised to find that the Fed collaborates as much as conflicts with a large institution: Goldman Sachs, not the Fed, is an actual engine of money creation; it is through the activities of banks and brokerages and investment houses responding to its that the Fed implements its desire to expand or contract the supply (and thus the value) of money. To the extent that a regulator for an agency that is charged with encouraging banks creating money does something that obstructs the creation of money, friction is an expected outcome.

      The kind of regulation that the OP seems to call for — what kinds of investments a brokerage makes, who is involved in making those decisions, and whether they are prudent and wise and beneficial to the economy as a whole — seems to fall within the jurisdiction of the SEC (or maybe the FTC and the CFPA, although to my understanding Goldman operates at the wholesale, institutional level for the most part so individual consumers aren’t really on the radar).

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      • “So we ought not be surprised to find that the Fed collaborates as much as conflicts with a large institution: Goldman Sachs, not the Fed, is an actual engine of money creation…”

        It’s sort of like how, when I step on the accelerator pedal, we don’t describe it as “the driver and the engine conspiring to make the car go faster so that they can arrive at their destination faster than they deserve”.

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  5. I listened to this story last week and read the Pro Publica reporting on it as well. I used to work for the Federal government in one of the agencies relevant to this conversation, although I was not a regulator, and I now work in the private sector for a company regulated by the Fed, although I am not in compliance. This ongoing conversation about financial regulation, however, is very relevant to what I do.

    A few random thoughts:

    -It would be a bit much to expect the Fed folks to agree to openly engage on this issue. Despite that, the piece was relatively well-balanced, despite the fact that it is only presenting Segarra’s side of the story. There were a few attempts at smoking gun moments that don’t quite work if you are someone with more than a casual knowledge of banking supervision and financial regulation.

    -As points out, the Fed’s primary responsibility is to the economy and to the banking system as a whole. The NPR piece did make a point of mentioning that they regularly call the Fed a regulator when it is a supervisor; they could have done a better job at bringing some precision to those terms. There are bunch of other agencies that are explicitly responsible for regulating banks and financial services companies.

    -The Fed’s role in supervising the systemically important financial institutions (SIFIs) is to avert another global financial crisis. An agency like the SEC is there, in part, to police the reputation of the securities industry and convince the world that market participants are playing by the rules. What the Fed cares about is systemic risk. Going after one-off instances of questionable behavior by Goldman Sachs, and other banks, is much less important to the Fed than looking for and repairing systemically important fault lines. Whether that is right or not, I don’t know. I merely state it as a fact.

    -To say that the Fed is a regulator is to imply that there is some defined body of law that the Fed is measuring the banks against, which isn’t really how it works. If you talk to anyone whose job it is to make sure that the banks are complying with the Fed, the one thing that they are likely to complain about is that the Fed does not really know what it wants. Compliance with the Fed is often a moving target.*

    -The conflict of interest discussion is interesting in that the whole thing seems to hinge on whether GS had a written policy and not whether they were honoring the idea of avoiding conflicts of interest. Goldman is an interesting animal in that it is an institution that appears to have evolved solely for the purpose of making as much money as possible in any and all environments. Everyone who does business with GS knows, or should know, what they are about. And despite the fact that they don’t have a particularly good reputation for putting their clients’ interest above their own, there does not seem to be any shortage of people willing to hire GS or to be counterparties with them in various transactions. I don’t know why this is the case, but I’m not sure that it’s something that a written conflict of interest policy would solve.

    *In certain areas, like regulatory capital, where the Fed has been doing this for a while, compliance folks know what they need to do. In other areas, however, the the Fed is basically surveying the field, finding the institution with the best practices, and telling everyone else to catch up.

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    • I don’t know why this is the case, but I’m not sure that it’s something that a written conflict of interest policy would solve.

      This aspect of it surprised me. I would have expected GS to always have all of the written policies and documentation the regulators wanted and just cleverly dance around them any time they got in the way. Isn’t conforming to the letter of the law and completely ignoring the spirit of the law one of the key competencies of the financial industry as a whole?

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    • Goldman is an interesting animal in that it is an institution that appears to have evolved solely for the purpose of making as much money as possible in any and all environments.

      When I worked there, we were representing sell-side clients while offering financing options to any prospective buyers of the deal. There was always the potential for conflict. No one seemed to care.

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      • “The good part, ah-heh, is that no matter whether our clients make money or lose money, Duke and Duke get their commission.”
        “So it seems to me y’all just a couplea bookies.”
        “See, Randolph, I told you he’d understand!”

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      • Why is this?

        Is it that people trust the Chinese walls supposedly in place? Or is it just that people think that the benefits of doing business with Goldman outweigh the risk that Goldman is going to get over playing both sides of the deal for their own benefit?

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      • Exactly!

        I would say that given the transparency of real estate transactions, the odds of us being able to steer a client towards a potential buyer based on the fact that we could get the financing business was very low, especially because other lenders in the market were offering loans at terms far more aggressive than what Goldman was willing to offer.

        If the financing was aggressive enough to push the pricing of a deal upward, then it would have been a win-win for everyone.

        Please keep in mind that my role was not within investment banking. I think to the extent there’s a transaction between two firms that have a relationship with the same bank, outside banks are brought in on both sides of the deal.

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  6. So I wanted to address your specific question:
    “I wanted to know what would have happened to the finding. What’s the process? …If it’s not public record, what is the process for moving forward?”

    The typical process is that after each examination, the findings of the examiners who conducted the exam get vetted, both by more senior specialists (who would have been Segarra’s direct manager) and the Senior Supervisory Officer for the institution (Silva in this case). Much of the selected excerpts heard may have been part of this process. A lot of time is spent “getting the findings right” – that is treating firms equally, making sure of the details, making sure there is supervisory guidance to “hang your hat on.” Imagine a world full of Beim-style examiner each of whom has liscense to tell a bank how to run their business without oversight.

    Once the findings have been agreed, a letter will be sent to the institution conveying the findings and categorizing them as Matters Requiring Attention, Matters Requiring Immediate Attention, or Observations. Silva would be very involved because his name will typically co-sign the letter. He is responsible for prioritizing the issues of concern with the organization – every examiner tends to think their issue is the most important in the world.

    These letters are confidential. If something truly egregious is happening, the Fed will enter into a public Written Agreement with the firm. This is what the Fed did when they found porr mortgage processes at the banks.

    “I would also like to have known if these types of conflict-of-interest concerns are a problem of other TBTF American banks, and if regulating by insinuation – not by stating facts – is how banking goes down? ”

    This strikes me as a pretty routine interaction, but with an inexperienced examiner who became wedded to her position and thought her issue was the most important in the world. I’m sure if more tapes were released there would be a more balanced picture.

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  7. I wanted to further comment on this:
    “A few thoughts on Carmen Segarra. The woman’s a hero. She deserves whistle-blower protection.”

    It is extremely rare for the Fed to fire anyone in anything less than a year-or-two. That she was fired so quickly is a red flag. Those who support her will say it was to silence her, but in my experience she must have been causing lots of turmoil within the Fed to warrant such speedy dismissal – it’s not like she was very senior.

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