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Fed says it needs to review its bank review process, yet again

Senator Sherrod Brown Holds Hearing On "Regulatory Capture" With New York Fed's DudleySenator Sherrod Brown Holds Hearing On "Regulatory Capture" With New York Fed's Dudley
William C. Dudley, president and chief executive officer of the Federal Reserve Bank of New YorkPhotograph by Andrew Harrer — Bloomberg via Getty Images

Step No. 1 in bureaucratic crisis management: announce a study. The Federal Reserve is back to step No. 1.

In 2009, after the dust had cleared from the financial crisis, the New York Fed called in an outside expert, a Columbia University professor, to review why the regulator had so miserably failed at detecting the problems—the loose lending and dangerous derivatives—at the banks that had culminated in the financial crisis.

Professor David Beim concluded that the Fed, specifically the New York Fed, didn’t really know what was going on at the banks it was supposed to be regulating. His prescription, which the New York Fed followed, was to hire hundreds of examiners who would be stationed at the individual banks so they could get a closer look at what the firms were doing.

On Thursday, facing new criticism, the New York Fed announced a new study. This time, the study is going to be done by the Fed’s inspector general. The focus: Are bank examiners really telling regulators at the Fed everything they are finding out? In short, are the bank examiners too close to the banks they regulate?

You can imagine how we got here. According to a ProPublica story, former New York Fed bank examiner Carmen Segarra was told to stand down, and eventually fired, when she raised questions about a Goldman Sachs loan deal. The implication was that her superiors, also embedded at Goldman, were too close to the bank, which wanted to do the deal. But over the past few years, the back and forth on the proper role of bank examiners has made for an odd tale.

In a Senate hearing on Friday, Elizabeth Warren grilled New York Fed President William Dudley about Segarra . Dudley’s answer was basically, “Meh.” The Goldman loan wasn’t going to put Goldman out of business. So, Segarra’s examiners were right to tell her to lay off, even if the loan in question might put another bank—in this case, Santander, which was borrowing from Goldman—and therefore other parts of the financial system, at risk, which was Segarra’s point in the first place.

So, Segarra’s message may have made it back to the home office of the New York Fed on Maiden Lane. But even if it had made it all the way up to Dudley, he still may have told Segarra or an examiner like her, “Well, will the loan put Goldman out of business. Nope. Leave it alone.”

But that seems like a weird metric for a bank regulator. The mega banks are huge. (They are called mega banks.) It’s hard to imagine any one trade or loan that would risk the “safety and soundness” of Goldman, or any of its rivals. So, it seems like a waste of taxpayer money to have bank examiners just doing that. What regulators should really be doing, and what the examiners should be doing at the banks, is flag behavior that suggests banks are making decisions that might not be in the best interests of the banking system. It’s about connecting the dots when the information gets relayed back to the central regulators at the Fed.

But in his response to Warren, Dudley seems to be saying, “that’s not our job,” or at least not the bank examiners’ job. That’s a problem. And I’m not sure yet another study is going to change that.