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Bill Black: Dudley Do Wrong Rejects Being a “Cop” and Embraces “Foaming the Runways”

Yves here. Bill Black’s post is an important follow-up on the New York Fed president William Dudley’s Congressional testimony on Friday. Here, Black looks at how four statements which Dudley clearly saw as defenses of the Fed are actually damning. And as usual, Black also has to debunk New York Times coverage of the hearings that attempted to position the Senators’ concerns as unwarranted.

By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Originally published at New Economic Perspectives

William Dudley, the President of the NY Fed, is not a stupid man. He is, however, wholly unfit to be a regulator. He has now admitted that publicly. It is time for him to return to Goldman Sachs so that he can be replaced by someone expressly chosen to be a vigorous regulator who will embrace the most critical function of a financial regulator – to be the tough “regulatory cop on the beat.”

The story of Dudley’s ineptness has been mirrored by the New York Times’ inept coverage of the failures of one of the reporter Peter Eavis’ favorite sons on Wall Street. Eavis is a Brit with a B.A. in international history and politics. He has also been a pastor. He co-authored the epically incoherent column on the NY Fed’s most recent scandal, the leaking of confidential information by a NY Fed employee to a former NY Fed employee who had joined Goldman Sachs. I criticized that column in my November 20, 2014 article and provided some of the key missing facts and analytics.

 

Eavis has now written what purports to be a news story, but often reads like an editorial, about the November 21 Senate hearing on a series of recent NY Fed failures. Eavis introduces his piece with this snide slam at Senator Elizabeth Warren.

William C. Dudley, the president of the New York Fed, defended the agency, but Senator Elizabeth Warren, Democrat of Massachusetts, at one point told him, “You need to fix it, Mr. Dudley, or we need to get someone who will.”

The president of the New York Fed is not chosen by Congress. And much of the stern questioning could be seen as the sort of grandstanding that plays well with those who want to limit Wall Street’s power or were harmed in the financial crisis of 2008. Even so, it will be hard for the Fed to ignore the anger directed at Mr. Dudley. The New York Fed is the public’s first line of defense against Wall Street’s excesses and abuses, and the discontent in Congress could build if more evidence emerges that suggests the New York Fed is not tough enough with the large banks it oversees.

The mendacity of these two paragraphs is a joy to dissect. First, one of the most serious problems is the fact that the “president of the New York Fed is not chosen by Congress” – or, more precisely, by the President with the “advice and consent” of the Senate. As long as our anti-regulators are chosen by industry they are supposed to regulate they will be anti-regulators and they will fail to regulate effectively.

My prior column explained this obvious conflict of interest, the fact that the identical conflict used to institutionalized into the Federal Home Loan Bank system, that Congress decided in 1989 (by enacting FIRREA) to eliminate the conflict by ensuring that regulation was done only by federal employees and stripping all governmental functions from the FHLBs, and that this was done with the support of the regulatory leaders of the FHLB of San Francisco because we agreed with the need to remove the conflict of interest even though the prior system was strongly in our self-interest. Dudley is a whole lot wealthier than we were and the fact that he continues to advocate for maximizing his self-interest by maintaining such an obvious conflict of interest, despite a record of abject regulatory failure at the regional Fed banks, demonstrates one reason he is unfit to be a regulator.

Dudley is a wealthy man, he doesn’t need the extra salary he receives because the NY Fed is exempt from federal pay caps. But then, does anyone seriously think that Dudley would take a job as a regulator subject to federal pay caps? If the President or Congress ends the conflict of interest Dudley will scurry back through the revolving door to Government Sachs before the law becomes effective.

In sum, the Senate banking committee members’ critiques and warnings to Dudley are in the core of their responsibilities as legislators, not “grandstanding.” The next strange aspect of Eavis’ article is his attempt to imply that such “grandstanding” would “play well” only with a small group of malcontents, “who want to limit Wall Street’s power or were harmed in the financial crisis of 2008.” Those two groups, of course, represent pretty much everyone except the bankers and the sycophantic financial media. Eavis’ effort to make the two groups appear to be the uncouth outliers is bizarre.

The NY Fed is not, and never has been, “the public’s first line of defense against Wall Street’s excesses and abuses. Eavis’ claim would be fabulous British irony, but alas poor Pastor Eavis: so far from British humor (and God) and so close to Wall Street.

Let us count the levels on which the statement is absurd. The first line of defense is the bank’s management. The second line of defense is the bank’s board of directors. The third line of defense is the bank’s internal audit function. The fourth line of defense is external audit. The fifth line of defense is the shareholders. The sixth line of defense is creditors, who are supposed to provide “private market discipline.” The seventh line of defense is the regulators.

The NY Fed, however, has never served as an effective “line of defense” for the “public.” It was never designed to do so. It was designed to serve the interests of Wall Street and it functions as it was designed. This is why the NY Fed was designed with an obvious, acute conflict of interest so that it could be relied upon to serve the interests of Wall Street. NY Fed employees are not government employees. The board of directors that selects their boss is controlled by Wall Street.

The NY Fed has a long track record as the anti-regulator. As I explained in prior columns, and as is repeatedly documented in the Financial Crisis Inquiry Commission’s report, the regional Fed banks were terrible regulators that repeatedly weakened vitally needed supervisory actions. The NY Fed, under Timothy Geithner, was the worst of the worst. It is isn’t simply that the NY Fed does not protect the public against Wall Street – the NY Fed is Wall Street and has a long history of aiding the bankers’ actions that harm the public.

Notice that even in the midst of spinning this fiction of the valiant NY Fed as the guardians of the public from Wall Street, Eavis cannot bring himself to use the “f” word – fraud. After all of the Wall Street frauds – the largest and most destructive in history, the best that the mealy-mouthed Pastor Eavis can come up with is “excesses and abuses.” We’ll see why Eavis is so unwilling to use the “f” word as we explore other aspects of his embarrassing editorial posing as a straight news story. There is a senior financial regulator who has decried the unethical nature of Wall Street bankers in blunter terms in a November 7, 2013 speech.

Some argue that what I have proposed—higher capital requirements and better incentives that reduce the probability of failure combined with a resolution regime that makes the prospect of failure fully credible—are insufficient.  Perhaps, this is correct.  After all, collectively these enhancements to our current regime may not solve another important problem evident within some large financial institutions—the apparent lack of respect for law, regulation and the public trust.  There is evidence of deep-seated cultural and ethical failures at many large financial institutions.  Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed.  Tough enforcement and high penalties will certainly help focus management’s attention on this issue.

Eavis is nearly as unintentionally funny is his concluding clause “discontent in Congress could build if more evidence emerges that suggests the New York Fed is not tough enough with the large banks it oversees.” “If?” “Suggests?” We just ran a series of real world tests that demonstrate that using the word “tough” and the phrase “the New York Fed” in the same sentence is hilarious. The NY Fed was a total failure as a supervisor and regulator. No one seriously doubts that. The financial crisis would not have occurred had the NY Fed been a real, competent regulator. Since the crisis, the NY Fed has continued to be an embarrassing failure.

Four “Ill-Advised” Statements by Dudley to the Senate

Eavis editorializes that the “hard questioning did not provoke the New York Fed president, a former economist at Goldman Sachs, into any ill-advised comments.” It is hard to know what “provokes” an “ill-advised comment,” but it’s not hard to figure out that Eavis’ column reports at least three “ill-advised comments” that Dudley made at the Senate hearing. The fact that Eavis considers each of the statements to be well-advised demonstrates that his moral and regulatory compasses are equally bent. A Huffington Post article reveals a fourth “ill-advised comment” that Dudley made at the hearing.

One,

On the audio recording, a New York Fed examiner said that the Goldman deal with Santander looked ‘legal but shady.’ But on Friday, Mr. Dudley said that the New York Fed had concluded that the deal did not pose any risks to Goldman’s reputation.

Let’s recall what Goldman’s deal with Santander was. It was a pure accounting scam designed to change nothing of substance but to reduce Santander’s (already grossly inadequate) capital requirement. Goldman would earn a major fee for helping another “systemically dangerous institution” (SDI) scam its regulatory requirement in a way that would leave the global financial system more exposed to catastrophic failure because it increased the risk that an SDI (Santander) would fail. Lehman engaged in a similar scam for the same purpose that increased its exposure to a catastrophic failure. Goldman did a variant on the same scam in connection with Greece that helped produce its crisis. There was nothing good about the Goldman/Santander deal – it was designed solely as a scam. The deal was an outrageously “unsafe and unsound” practice by Santander and Goldman was to profit by aiding and abetting Santander’s indefensible practices.

Three Facets of the Scam: Dudley’s concerns re Wall Street’s Corrupt “Culture”

It is important to consider three facets of the context of this scam. I explained that Dudley has warned of Wall Street’s corrupt “culture.” “Shady” acts produce corrupt cultures. Anyone serious about stopping a corrupt culture would look for opportunities like the corrupt Goldman/Santander scam to start ending that corrupt culture.

On October 20, 2014, a senior financial regulator gave a powerful speech attacking that corrupt culture.

In recent years, there have been ongoing occurrences of serious professional misbehavior, ethical lapses and compliance failures at financial institutions.  This has resulted in a long list of large fines and penalties, and, to a lesser degree than I would have desired employee dismissals and punishment.  Since 2008, fines imposed on the nation’s largest banks have far exceeded $100 billion.  The pattern of bad behavior did not end with the financial crisis, but continued despite the considerable public sector intervention that was necessary to stabilize the financial system.

The senior financial regulator went on to emphasize that the banks’ corrupt culture “is largely shaped by the firms’ leadership.” The Goldman/Santander scam was a manifestation of two corrupt cultures shaped by their leaders.

Santander’s Capital Was Already Inadequate Before the Scam

Another facet of the context was that European and U.S. regulators had become convinced that the banks had inadequate capital and that the SDIs in particular needed much higher capital. The purpose of the Goldman/Santander scam was to allow Santander to scam that requirement. A senior financial regulator explained in a November 7, 2013 speech that the need for higher capital for SDIs like Santander was particularly acute. (Note that the current crew of regulators lack the candor to call such banks “systemically dangerous” and instead spread the fiction that they are “systemically important” (as if they deserve a gold star for putting the global financial system at risk).

A number of steps have already been taken along these lines that further reduce default risk.  The Basel III framework significantly raises both the quantity and quality of capital required of internationally active bank holding companies.  This risk-weighted capital standard is also being augmented by a higher leverage ratio requirement. The Basel framework will also require SIFIs to hold additional capital due to their complexity (more commonly referred to as the SIFI surcharge).  As a result, the capital buffer for the more systemic firms should be higher based on size, complexity, interconnectedness, global exposure and substitutability, so that their expected probability of failure will be lower than for less systemic firms.

A senior financial regulator gave a speech on November 7, 2013 explaining why it was essential that bank corrective actions to increase capital be implemented as rapidly as possible.

We also need to create new mechanisms and incentives for bank management to act early, well before resolution becomes necessary.  Early intervention is likely to be much more successful in preventing failure as compared to last-ditch efforts. These actions can take many forms—cutting capital distributions earlier, raising new capital faster, restructuring businesses sooner, and reorganizing senior management and boards of directors more radically when the firm is not performing well.

In this regard, the Comprehensive Capital Analysis and Review (CCAR) should bolster the incentives for early action.

The Santander scam, by materially understating the bank’s capital requirement necessarily delays corrective actions. Indeed, Santander’s purpose in entering into the scam was to reduce the capital it would otherwise have been required to have.

A senior financial regulator gave a speech on March 6, 2009 in which he raised a similar concern.

Another bad dynamic that exacerbated the crisis has been the reluctance of some banks to raise the additional capital they might need should the economic outlook deteriorate sharply. Repeatedly over the past 18 months we have heard—from the GSEs, from the investment banks, from the commercial banks—now is not a good time to raise capital. This desire to postpone capital raising stems, in part, to the fact that bank executives often do not want to dilute the existing shareholders (which, of course, include themselves).

Santander was willing to engage in an expensive scam for the sole purpose of avoiding “rais[ing] the additional capital they might need.”

In that same speech, the senior financial regulator emphasized the critical need to stop accounting scams.

We need an accounting and disclosure regime that allows investors to meaningfully ascertain the risks they are taking. For example, the same assets are often carried on different bank books at different prices. If you can’t trust the valuation marks on the assets, how robust can confidence be in the ability of the financial system to withstand stormy weather?

In that same speech, the senior financial regulator stressed the terrible harm caused when these scams ruined trust among financial institutions.

The complete breakdown in trust across markets has been remarkable. Essentially, it has gone like this: Even if I think you are a good credit, I am not going to lend to you, because others may not share the same opinion. The problem is if no one else thinks you are good, I may not be able to get my money back if I need it. Conversely, others are not willing to lend to you, even though they think you are a good credit, because they are not convinced that I will do so. The result is that no one lends, financial conditions tighten and this exacerbates the downward pressure on the economy. As economic conditions deteriorate, this undermines the financial strength of the major financial institutions, further reinforcing the downward spiral in confidence.

A senior financial regulator gave a speech on October 13, 2009 blasting precisely the kind of scam deal that Goldman and Santander did. His language makes clear that he was excoriating precisely the illicit purpose that Santander intended to achieve through its sham deal with Goldman.

Another example of a reinforcing mechanism is a situation in which firms have incentives to structure activities to minimize regulatory capital or other requirements without transferring risk. Creation of off-balance sheet funding vehicles, structured products and complex corporate structures to minimize regulatory requirements and tax obligations reduces transparency, introduces new risks and limits the effectiveness of resolution regimes.

The senior financial regulator went on to warn that the “collective impact on the system as a whole [of the “reinforcing mechanism[s]”] can be disastrous.”

Dudley Knew NY Fed Regulation Needed Toughening: Then Fired the Tougher Examiner

The third facet, which even Eavis reports, is that Dudley had supposedly become convinced that the NY Fed’s regulation was systematically inadequate and needed to be fixed urgently through an infusion of far tougher supervisors who had the guts to take on the SDIs’ corrupt cultures.” I quoted the regulator’s speech above about this corrupt “culture” and the need for “tough enforcement” to end that culture.

A senior financial regulator stated in an October 20, 2014 speech that for financial regulators “improving culture in the financial services industry is an imperative.” He also termed the “measurement and accountability for progress in developing a healthier culture across the industry” our “paramount” task “as supervisors and central bankers.”

Dudley’s refusal to act against Santander and Goldman’s “shady” acts demonstrates that he does not – in practice – treat improving banking culture as even a minor priority, much less an “imperative” or “paramount” duty of financial supervisors.

Santander’s actions were intended to deceive the public and the Spanish regulators. Any competent regulator, much less one who’s leader prates about the corrupt “culture” of Wall Street, would have forced Goldman to unwind the indefensible scam and would have immediately notified the Spanish regulators of Santander’s scam. As financial regulators we have broad authority to ban actions that are “legal but shady.” To state the obvious, Goldman and Santander should never do “shady” deals. The fact that the top leaders of both banks were eager to do a “shady” deal should have led the NY Fed and Spanish regulators to act urgently to remove them from running two SDIs that endanger the global economy. As the senior financial regulator stressed in his October 20, 2014 speech: “Culture relates to what ‘should’ I do, and not to what ‘can’ I do.”  That senior financial regulator (correctly) stated that what matters is not what bankers say about their commitment to honesty, but rather that they demonstrate through their actions the “consistent application of ‘should we’ versus ‘could we in business decisions, rigor in identifying and controlling of conduct risk, and how compliance breaches factor into compensation.” To state what should be obvious, Goldman and Santander’s controlling officers showed consistently that they would take actions they knew they should not take and they took these “shady” actions with no effective barriers from their compliance staffs and in order to boost the executives compensation because the banks’ compensation systems were designed by their controlling officers to create perverse incentives that encourage officers to act unethically.

In his October 20, 2014 speech, the senior financial regulator states that in order to end the corrupt culture of Wall Street a bank officer “who violates a firm’s code of conduct would need to face the risk of being permanently denied employment in the financial industry.” The dual problem is that “shady” deals are not treated by Goldman Sachs or Santander as violations of their “code of conduct” and the officers involved got bonuses for creating their scam rather than “being permanently denied employment in the financial industry.”

The same senior financial regulator concluded his speech with this warning to his audience of senior bank officers running the SDIs about just how seriously they had better take their adherence to the highest level of ethics.

In conclusion, if those of you here today as stewards of these large financial institutions do not do your part in pushing forcefully for change across the industry, then bad behavior will undoubtedly persist.  If that were to occur, the inevitable conclusion will be reached that your firms are too big and complex to manage effectively.  In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.  It is up to you to address this cultural and ethical challenge.  The consequences of inaction seem obvious to me—they are both fully appropriate and unattractive—compared to the alternative of improving the culture at the large financial firms and the behavior that stems from it.  So let’s get on with it.

Goldman and Santander, however, heard a more convincing message. Under Dudley, the “shady” deal got done, the NY Fed examiner who objected to giving the sleazy deal a pass was fired, and the Goldman and Santander officers got bonuses for acting for closing a shady deal that increased the risk of a global financial crisis.

A regulator intent on ending a corrupt banking culture would not ask only whether a bank’s leaders were acting in a manner that was “legal,” but whether they were acting in a manner that they “should” be acting. By definition, they should not do things that are “shady.” That is, of course, precisely what the senior financial regulator told the industry in his October 20, 2014 speech.

Note that this point – obvious to any competent regulator – totally escaped the attention of the NY Fed during its non-regulation of Goldman, Dudley at the Senate hearing, and Eavis. Instead, we get Dudley’s crazed testimony that the deal was fine because it “did not pose any risks to Goldman’s reputation.” The obvious point, except to these ethical and regulatory failures, is “who the *** cares what effect the scam has on Goldman’s “reputation.” First, that isn’t the issue. Second, Goldman already has a despicable reputation for its unethical behavior. Matt Taibbi’s famous metaphor captures its reputation: “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” Third, Goldman loves having its dual reputation as the “vampire squid” and “Government Sachs.” By allowing Goldman to aid and abet a “shady” deal and firing the examiner who fought against that treatment Dudley burnished Goldman’s “Government Sachs” reputation – the firm so well connected with the U.S. government that its depredations as the global “vampire squid” go unpunished and even rewarded by anti-regulators like Dudley. Indeed, since Dudley was Goldman’s chief economist before coming to the NY Fed, he personally exemplifies “Government Sachs” and how the firm achieves the ability to do “shady” deals with impunity.

Dudley’s Second Ill-Advised Statement to the Senate

Two, Eavis reports that Dudley slammed the fired NY Fed examiner – rather than Goldman and Santander.

But in what appeared to be a comment on Ms. Segarra’s actions, Mr. Dudley said: “We definitely want people who speak up and express their views. But we also want people who are fact-based.”

As I have explained in detail with supporting quotations from four different speeches given by a senior financial regulator over the course of six years, the NY Fed examiner that Dudley’s bank fired was (1) indisputably right on the facts of the Goldman/Santander scam and (2) those facts indisputably fit within the core of the concerns that the senior financial regulator said must be “paramount” for financial regulators because they demonstrated the existence of a corrupt culture at both Goldman and Santander that threatened the stability of the global financial system. As the reader may well have already figured out, William Dudley is the “senior financial regulator” whose speeches I have quoted. So, the person who demonstrated that she was “fact-based” was the examiner whose Dudley’s bank fired and the person who demonstrated he has no respect for the facts and the person who engaged in wholesale hypocrisy is Dudley. He should resign and return through the Revolving Door to Government Sachs.

Note that Dudley’s other beef with the examiner is about Goldman’s approach to conflicts of interest. Dudley is notorious for claiming that the blatant, institutional conflict of Wall Street’s domination of the NY Fed does not exist. He, as befits a Government Sachs product, lacks the gene for being able to spot or be embarrassed by even the most obvious of conflicts of interest. Goldman made clear to the Congress in its testimony about the Abacus/Goldman/John Paulson scandal that its view was that clients existed to be sucked dry by Goldman’s “blood funnel.” There was no “conflict of interest” because every customer should have known that Goldman was a vampire squid.

Dudley’s Third Ill-Advised Statement to the Senate

Third,

“Many of the senators’ questions centered on whether the New York Fed should have done more to pass on information to law enforcement officials to help detect crimes, like tax evasion. Senator Jeff Merkley, Democrat of Oregon, for instance, homed in on a case in which Credit Suisse, a Swiss bank, helped Americans dodge United States taxes. He asserted that the information for that case had come largely from a Senate investigation, not from information provided by regulators like the New York Fed.

‘Our orientation is the safety and soundness of the firms we supervise,’ Mr. Dudley said. He also disputed the notion that the New York Fed’s mission should be that of a police force. “It is not like a cop on the beat,” he said. ‘It’s more like a fire warden.’”

I have spent seven years trying to get journalists and members of Congress to demand to know how many criminal referrals each of the federal financial regulatory agencies made, by year, how many of those referrals named the SDIs, and how many of those referrals involved “C Suite” officers/directors of financial institutions (and how many are C Suite officers/directors of SDIs). I have spent seven years trying to get journalists and members of Congress to demand to know when the position of criminal referral coordinator was eliminated at the various agencies and when (if) it was reestablished. Please demand the documents demonstrating the facts, because the Department of Justice’s internal auditor’s study found that DOJ knowingly lied about its number of mortgage fraud prosecutions – and that those lies dramatically overstated reality.

Dudley’s excuse for not making criminal referrals is pathetic. “Our orientation is the safety and soundness of the firms we supervise.” First, that is not true. The NY Fed’s orientation is protecting the elite banks and bankers from accountability for their crimes and unsafe and unsound practices. Even when Goldman was known to be aiding and abetting (and richly profiting from) a clearly unsafe and unsound practice by Santander the NY Fed’s reaction was to fire the examiner who was most critical of Goldman. The FCIC report excoriates the NY Fed for its abject regulatory failures.

The failure of the NY Fed to act on Citi’s best known whistleblower (Richard Bowen’s) warnings of endemic fraud in Citi’s sale of fraudulently originated mortgages through fraudulent reps and warranties is inexcusable. Indeed, it raises an obvious question – why didn’t the NY Fed hire Richard Bowen. He had the relevant expertise, experience, analytical abilities, and proven integrity. But my question, of course, answers itself. If Dudley had actually undergone a “Road to Damascus” conversion and become a vigorous regulator he would have reached out to people like Bowen, Mike Patriarca, Chris Seefer, Dick Newsom, and me and we would have cleaned up Wall Street’s corrupt culture. I guarantee that Dudley never emulated Ed Gray and went out and found out who had a reputation as the most effective regulators in America and personally recruited them for the toughest jobs.

Dudley’s response to Senator Merkley is a non sequitur. Deterring, identifying, investigating, and removing from power through receiverships bank officers that lead fraud schemes is our paramount responsibility as financial regulators. Our next highest priority is assisting DOJ and the FBI, and then sanctioning through civil and administrative measures bank officers leading fraud schemes. Nothing is more destructive of “safety and soundness” than criminal conduct by elite bank officers, particularly at the largest banks. When the officers leading the fraud scheme control the bank the losses are often catastrophic.

Each of our modern financial crises was driven by epidemics of accounting control fraud. The current crisis was driven by the three most destructive epidemics of financial fraud in history (appraisal fraud, liar’s loans, and the sale of fraudulently originated loans through fraudulent reps and warranties). In addition to those frauds, the elite bankers led the two largest frauds in history – rigging Libor and FX plus a series of other massive frauds. I know that Dudley pretends to be clueless about elite financial fraud, but his implication that he ignored these crimes because he was focused on “safety and soundness” should have led to his being asked to resign by the President.

But Dudley did not stop there. He went on to make the related “ill-advised” statement.

He also disputed the notion that the New York Fed’s mission should be that of a police force. “It is not like a cop on the beat,” he said. ‘It’s more like a fire warden.’

Well, we can all agree with his statement of how the NY Fed actually operates. Its refusal to act as the essential “regulatory cops on the beat” means that fraud has become endemic at our most elite financial institutions. This means that the CEOs leading the control frauds have been able to generate the multiple “Gresham’s” dynamics that cause “bad ethics to drive good ethics” out of the markets and professions. It is also true, as Geithner admitted, that the Bush and Obama administration used the misleading excuse of supposedly bailing out distressed homeowners overwhelmingly for the real purpose of “foaming the runways” to provide a soft landing to the distressed banks. The fact that Dudley would openly reject taking on the felons that drive our recurrent, intensifying financial crises and to adopt the “foaming the runways” metaphor inherent in his “fire warden” claim simply confirms what we have long known about Dudley. No one has to “capture” him. He was chosen by Wall Street to serve Wall Street. Regulatory failure is a self-fulfilling prophecy in such cases. No wonder he can rarely bring himself to use the “f” word.

Dudley’s Fourth Ill-Advised Statement to the Senate

Eavis’ column does not report this admission by Dudley, but it is reported in the Huffington Post, which made it the lead.

“We were not willing to find those firms guilty before, because we were worried that if we found them guilty, that could somehow potentially destabilize the financial system” Dudley said. “We’ve gotten past that and I think it’s really important that we got past that.”

Dudley’s admission was just one of several cringe-worthy exchanges during an hour-long appearance before a committee intent on holding him accountable for regulatory lapses.

Apparently, Eavis attended a different hearing. He didn’t bury the lead, he cremated it and scattered its ashes. As the Huffington Post authors explain, I and many others have been saying that the administration refused to prosecute for precisely this (purported) reason – and the administration’s most senior officials have repeatedly lied by denying it. But I have a special bone in this controversy because in December 2012, Geithner’s minions got NPR to censor and remove my (accurate) comments explaining what Dudley has finally admitted. The NYT then compounded the error with a column supporting Treasury’s successful effort to censor my criticism of Geithner.   I explained this sordid saga in a detailed article. I stress that I was one of dozens of people making the same (accurate) point. But it’s still nice that we were all proven correct, though the NYT doesn’t find the fact that the administration finally admits that it decided to suspend the rule of law to allow the world’s largest banks and bankers to commit massive felonies with impunity from criminal prosecution.

President Obama Could Fix the Fed’s Broken Examination & Supervision System

The media tell all of us repeatedly that President Obama is looking for actions he can take that make the point that he is still the president and an active shaper of policy. The president could end this indefensible conflict of interest by requiring all examiners and supervisors to be government employees who did not work for the regional Fed banks. Such an action would be praised by Americans of nearly all political views – and would be bitterly opposed by Wall Street, the regional Fed banks, and the Federal Reserve. Does any reader believe that Obama would even consider taking such a desirable act?

I want to be clear that ending the regional Fed banks’ conflict of interest is not sufficient to produce effective examination, supervision, regulation, and criminal referrals. FIRREA created the Office of Thrift Supervision (OTS), which had a different institutional conflict of interest “baked” into its system by its funding. That conflict encouraged the exceptionally poor OTS leaders appointed by President Clinton and Bush to engage in (and “win”) a “race to the bottom” with other regulators to attract financial firms to their competing “charters.” Washington Mutual (WaMu) and Countrywide were such large sources of OTS’ income that if OTS had placed them into receivership it would have had to fire over one-third of OTS’ employees. Countrywide changed its charter from that of a bank to an S&L in order to be regulated by the OTS for the purpose of assuring pathetically weak regulation.

While it is not sufficient to remove regulatory conflicts of interest, it is necessary to do so to achieve longer run regulatory success. Individual banks at particular times can have strong supervision despite the conflict of interest due to exceptional leadership, but on a system-basis over longer time periods conflicts of interest are certain to prove devastating.

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17 comments

  1. Ben Johannson

    Like Bill, I don’t understand how Dudley’s claim that the Santander deal was kosher is anything other than an off-the-cuff screwup. Admittedly I haven’t looked that closely at the details, but it appears equivalent in goals to a tobashi scheme.

  2. PaulArt

    I think Bill Black is possibly the last known resource we have here in this corrupt nation to keep speaking truth to power. I have read Black and have listened to him many times on the Real News Network. I admire him but have one piece of advice to Bill – please don’t let your emotions get the better of you when you write. Your writing becomes incoherent interspersed with long winded ponderous sentence formation which reduces clarity. Keep it simple, use short pithy sentences and most of all please please do not resort to too much sarcasm because it again reduces clarity for your readers. Finally, don’t try too hard to prove your theses – that is not necessary. You tie yourself into knots trying to quote this passage here and that passage there and take us on a long journey through the mines of Moria that when we finally come to the destination we know not where we are. Keep your emotion under check as you write.

    1. GuyFawkesLives

      The only honest man in America, yet you want to reign in his righteous anger? That’s so fucked up.

      Bill, spew away. We love you.

      1. susan the other

        What choices do we have left when the ministry of propaganda ignores the truth? We are left to compare their disingenuousness with various colorful, salient metaphors – bringing the point home. The point is the thing. And when you live in an empire run by an obama and you are confronted with None Dare Call It Fraud – you make your verbal choices for the most return. My choices are mostly given to me by Prof. Black. He’s a genius. With a good sense of humor. Aka – outrage.

  3. fresno dan

    Great article. It is amazing to me how people defend the FED when it is obviously of the banks, by the banks, for the banks, and that they have blinders on that make them think what is terrific for banks isn’t too bad for the rest of us.
    However, I don’t know if this follows:
    “The NY Fed is not, and never has been, “the public’s first line of defense against Wall Street’s excesses and abuses. Eavis’ claim would be fabulous British irony, but alas poor Pastor Eavis: so far from British humor (and God) and so close to Wall Street.

    “Let us count the levels on which the statement is absurd. The first line of defense is the bank’s management. The second line of defense is the bank’s board of directors. The third line of defense is the bank’s internal audit function. The fourth line of defense is external audit. The fifth line of defense is the shareholders. The sixth line of defense is creditors, who are supposed to provide “private market discipline.” The seventh line of defense is the regulators.”

    I think in trying to critique the author of the article, Mr. Black attributes many mechanisms of good oversight to how banks are run. It seems to me those board of directors were either part of the scam, or were designed to be useless….(who has been fired??? and management is the problem, and will of course neuter any audit function) And well….considering the Great Depression, the Saving and Loan scandal, and this recent disaster, it seems to me that what has been proven is that the “free market” internal control mechanisms in banking, when left alone is just a hot bed of corruption, incompetence, and disaster. Goldman Sachs BRAGS about how they screw their own muppets….uh, customers, and the customers keep coming back.

    The only line of defense of the public is law, impartially and rigorously enforced. The problem is that government has become corrupt, and until that is fixed, any fixing of the FED will be designed to fail. Indeed, we have laws now, but if Mr. Holder, undoubtedly instructed not to enforce them, well yeah, we’re gonna have banksters running wild.

    1. cnchal

      Goldman Sachs BRAGS about how they screw their own muppets….uh, customers, and the customers keep coming back.

      That is a mystery. Why would anyone deal with a known criminal organization? My best guess is that Goldman’s customers are playing with someone else’s money and in on the scams.

      1. GuyFawkesLives

        “Why would anyone deal with a known criminal organization?”

        Do you see how many ignorant Americans line up to continue to bank with JPMorgan Chase, Bank of America, Wells Fargo and US Bank? These RICO offenders are known criminal organizations, yet constantly many Americans willingly deposit their paychecks.

        1. not_me

          Give us a real alternative to banks and credit unions such as a Postal Savings Service that makes no loans nor even pays interest, announce that government-deposit insurance would soon be ended and you’d see a MASSIVE run on the banks as people fled them to the PSS.

    2. susan the other

      The levels of defense paragraph got me too. It was amazing. The art of obfuscation and appropriation while nobody’s looking.

  4. down2long

    I have made it one of my missions to comment in the NY Times and bring the perspective of a victim of serial bank fraud to the attention of the readers, to offer a perspective that the victims of “errors and omissions” of the banksters that the Times always obliquely refers to actually existed, they there were actual VICTIMS. (You all know my story several banks/servicers (Ocwen/Deutsche Bank, Wells, Chase/B of A refusing my court ordered payments to in order to foreclose, Wells trying to collect, then foreclose on a property they foreclosed on on the first mortgage) Chase foreclosing on a current mortgage.

    My posts usually put me in the top three readers recommendations. Almost all of my posts to Peter Eavis’ nonsense are usually deleted, especially if they question his “reporting.” One gets the impression the reporters are consulted on particularly thorny comments.

    Anyhow, this is a great piece by Bill Black, one of my heroes. It also explains a lot about Mr. Eavis’ “reporting.” Mr. Dudley is a disgrace, and I hope he keeps blabbing away, digging the hole deeper. I think the most jaw dropping thing Dudley said, besides what the HP reported (and Eavis ignored) is that the Santander deal did not affect Goldman’s reputation. I did not know the Fed’s portfolio consisted primarily of protecting banks’ reputations. I think we can all agree that if that is the case, given the dismal reputation of the criminal Wall Street banks, the Fed is totally useless and should be dissolved. On the other hand, the banks’ reputations could not sink any lower, so any further transgressions will clearly not effect their reputations since.their reputations are lower than the Mafia. Of course, that may have been the Fed’s point all along: Continue screwing everyone and raping the country guys. No one trusts you and everyone hates you, so you have nothing to lose, and a lot of money to gain.”

  5. Tim

    One thing that should be pointed out is the NY Fed like other regional Fed banks operates on a one bank one vote system for electing directors. So the real power base at the NY Fed in a technical sense are the large number of small and medium size banks based on Long Island and Upstate NY. I have no doubt Wall Street has a lot of influence at the NY Fed but I also think a lot of blame has to be placed the shoulders of NY State community banks like Valley National, Solvay, and Adirondack Trust whose CEO’s have served on the NY Fed board.

    http://www.newyorkfed.org/aboutthefed/orgchart/board/mello.html

    http://www.newyorkfed.org/aboutthefed/orgchart/board/lipkin.html

    1. Yves Smith Post author

      *Sigh

      We’ve addressed this issue repeatedly in comments. The regional Fed boards do not have any governance role. The one thing they do do, which is nominate Fed presidents, which then go to the Board of Governors for approval, is done by the regional Fed directors who are NOT bank employees or directors. There are three classes of directors on Fed regional boards. Only one is made of bank members.

      1. Tim

        Yes, you are correct in terms of the formal nominating process by the regional Fed directors that the three Class A directors(the aforementioned CEOs of Valley National, Adirondack etc) don’t have a formal role in nominating Dudley. However, the three Class B “independent” directors are elected by the member banks on a one bank one vote do play a role in Dudley’s nomination. Now again I am not saying the small and medium sized NY State Fed member banks are totally responsible for Dudley but they do play a role that is often overlooked.

        Second even if the NY Fed President’s job became subject to Presidential appointment it would in all likelihood became subject to the Senate’s “Blue Slip” procedures. Thus someone like Elizabeth Warren by means of not representing NY State would actually have little say in who runs the NY Fed just as she has little say in who is the US Attorney or US Marshall are for any part of NY State.

        *The truth of the matter is many NY State politicians along with their community banking colleagues even those who live upstate and call themselves Democrats don’t dare kill what they perceive as the Golden Goose, Wall Street.

  6. Clifford Johnson

    A key observation is this: “As long as our anti-regulators are chosen by industry they are supposed to regulate they will be anti-regulators and they will fail to regulate effectively.” This matter-of-fact circumstance is what renders moot and trumps prior comments in NC re Dudley’s testimony, as to the stock-ownership-without-governing-powers of the NY Fed’s member banks.

  7. susan the other

    The solution, one obvious solution, to the self-interest of the Federal Reserve Banks is to remove their incentive. Pass laws that restrict them from profiting in any way whatsoever from any transactions above a minimum interest rate. Say one quarter of one percent. Then prevent them from making it up in massive volume HFTs that scoop the market. Just put them in a cage, where they belong. And if they don’t like it, kill them.

  8. Jay M

    Foaming the runways is higher tech than flashing the prep-school all purpose smile at the little senator.

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