Again... The Question Of Effective Wall Street Regulation

Elizabeth Warren and Joe Manchin, Senate Banking Committee

Monday evening, the Wall Street Journal published an OpEd by two members of the Senate Banking Committee, the most conservative Senate Democrat, Joe Manchin (D-WV) and one of the most progressive, Elizabeth Warren (D-MA), The Fed Needs Governors Who Aren't Wall Street Insiders. Wall Street banksters were petrified and furious when Warren was put on the Banking Committee, but Manchin's appointment to the same committee helped calm them down a bit. They expected him to balance out her populism. The OpEd may worry them. She's pretty persuasive and he's not as Wall Street-oriented as they had hoped he would be.

We joined the Senate Banking Committee to try to make the banking system work better for American families. That's why we're concerned that the Federal Reserve-- our first line of defense against another financial crisis-- seems more worried about protecting Wall Street than protecting Main Street. Fortunately, this is one problem the Obama administration can start fixing today by nominating the right people to fill the two vacancies on the Fed's Board of Governors.

The Board of Governors is responsible for supervising the country's biggest banks. It's also responsible for overseeing the regional Federal Reserve banks, including the Federal Reserve Bank of New York. For decades, the Board of Governors and the New York Fed have been responsible for supervising Wall Street banks, but after the 2008 crisis and the regulatory lapses it revealed, Congress gave the Fed even more oversight authority. According to the new chair of the Board of Governors, Janet Yellen, the Fed's obligation to supervise the big banks is now "just as important" as its better-known obligation to set interest rates and conduct the country's monetary policy.

Two recent reports highlight that the Fed isn't very good at supervising certain banks. In September, Carmen Segarra, a former bank examiner at the Federal Reserve Bank of New York, released secret recordings she had made of meetings at the New York Fed in 2012. The recordings revealed that New York Fed employees had identified concerns with a proposed Goldman Sachs deal with Banco Santander, calling it "legal but shady." The New York Fed didn't attempt to make Goldman address these concerns. The recordings also showed Ms. Segarra's superiors pressuring her to soften her finding that Goldman did not comply with federal regulations on conflicts of interest. While the recordings offered important new insights, they ultimately confirmed the old suspicion that the Fed is too cozy with big banks to provide the kind of tough oversight that's needed.

An October report from the Fed's Office of Inspector General provided additional confirmation that the Fed is failing to oversee the big banks. The report found that the New York Fed had failed to examine J.P. Morgan Chase 's Chief Investment Office-the office that incurred over $6 billion in losses in the infamous 2012 "London Whale" incident-despite a recommendation to do so in 2009 from another Federal Reserve System team. The report concluded that the New York Fed needed to improve its supervision of the biggest, most complex banks.

Lax supervision isn't an abstract or academic problem. The stakes couldn't be higher. Just this summer, the Fed and the Federal Deposit Insurance Corp. determined that 11 of the country's biggest banks had no credible plan for being resolved in bankruptcy. That means that if any one of these banks makes more wild bets and loses, the taxpayers would have to bail it out to prevent the economy from crashing again. We're all counting on the Fed to monitor the big banks and stop them from taking on too much risk, but evidence is mounting that this faith in the Fed is misplaced.

While there will be a congressional hearing this week to examine what's wrong at the Fed and to consider changes in the law, the administration shouldn't wait for Congress to act. The president is responsible for nominating people to serve on the Fed's seven-member Board of Governors. Currently, two of the seven seats on the board are vacant. The president has the opportunity to move the board in a new direction-and to make that change for the long haul, since governors can end up serving terms of 14 years or more.

The president should use that opportunity to address the Fed's supervisory problem. The five sitting governors have a variety of academic and industry experience, but not one came to the Fed with a meaningful background in overseeing or investigating big banks or any experience distinguishing between the greater risks posed by the biggest banks relative to community banks. By nominating people who have a strong track record in these areas and who have a demonstrated commitment to not backing down when they find problems, the administration can show that it is taking the Fed's supervision problem seriously. Nominating Wall Street insiders for the Board of Governors would send the opposite message.

If regulators had been more willing to protect Main Street over Wall Street before 2008, they might have averted the financial crisis and the Great Recession that hurt millions of American families. So long as the Fed and other regulators are unwilling or unable to dig deeply into dangerous bank practices and hold the banks accountable, our economy-and our country-remains at risk. The administration has a chance to protect the families that are still struggling to recover from the last financial crisis. It should not pass it up.

This morning, Matt Stoller laughed in the face of claims of sacrosanct Fed independence, pointing out that the Fed is stuffed to the gills with industry lapdogs. And with bankster-lackey Jeb Hensarling just reelected as Chairman of the powerful-- and lucrative-- House Financial Services Committee, Stoller points out that "defenders of the banking industry's culture of corruption aren't going down without a fight. It's not just Republican politicians."

Now that the Republicans control Congress, get ready for more. Don't take my word for it: listen to Alvarez, who said at that same conference that "there’s certainly things we think could be revisited in Dodd-Frank," before bitterly adding, "as perfect as it was." This is remarkable, a public servant at an institution created by Congress opining on what Congress should be doing.

That just doesn't happen-- except at the Fed. Democrats allow this to occur because of their childish presumption that the Fed should be ''independent" of politics. What this in fact means is that the Fed is accountable to bankers rather than voters.

So what, specifically, does Alvarez want to change?

Let's go down the list. He said he wants to take a de-regulatory posture for smaller institutions, which is fine until you realize that "small" at the Fed can mean institutions with billions of dollars in assets.

Alvarez is also seeking to gut derivatives regulation. During the passage of Dodd-Frank, one particularly controversial measure was called the "swaps pushout rule." This provision bans banks from gambling on exotic derivatives using taxpayer dollars. Alvarez doesn't like it, saying, "You can tell that was written at 2:30 in the morning and so that needs to be, I think, revisited just to make sense of it." This is a typical posture by legal advocates, pretending something they don't want to enforce is poorly written. It's not. Alvarez is just a Greenspan guy, a believer in deregulation.

Then there are the new rules on credit rating agencies like Moody's and Standard & Poor's. These institutions were so corrupt that, at the height of the crisis, their employees joked that they would slap AAA on securities structured "by cows." Well, restrictions on those agencies, according to Alvarez, "really did not work and it doesn't work and it’s more constraining than I think it is helpful." It's good to know that Alvarez doesn't think that laws passed by Congress are helpful, and that they should be repealed. It seems, though, that such behavior is best conducted by bank lobbyists rather than the head lawyer of the Fed.

One wonders why Fed Chair Janet Yellen allows this kind of behavior to go on within her institution. While it's true that regulatory agencies can't regulate the behavior of every single employee at every single bank, the culture on Wall Street is something that is definitively set by public servants and private leaders throughout the banking world.

When a whistle-blower shows evidence of embarrassingly weak regulators currying favor with predatory sharks, the reaction is important.

Yellen and Dudley might proudly bleat that malfeasance will not be tolerated. But if they allow subordinates to go to banking conferences and tell the lawyers who represent banks that the Fed doesn't want to regulate, that is a cultural signal. It says to insiders that they can go along, ignoring what is clearly only meant for public consumption and PR purposes. The only way to counteract this signal would be to fire Alvarez. And the only way for Democrats to credibly argue they have reigned in Wall Street is to drop their silly pretense that the Fed should be "independent." They must reread the Constitution, and recognize that monetary policy is clearly within Congress' purview.

It's an open debate whether regulators can change the culture on Wall Street. But one thing is not open for debate. Regulators who don't want to change the culture on Wall Street, won't.