The Federal Reserve Board prefers to operate in a shroud of secrecy, and its officials really don’t like having to answer to anybody. So it was fascinating to learn last week that the Fed is embarking on a soul-searching campaign. Its inspector general will take up the astonishing questions of whether the Fed’s big-bank examiners have what they need to do their jobs and whether they receive the support of their superiors when they challenge bank practices. Or, as the Fed put it, whether “channels exist for decision-makers to be aware of divergent views” among the Fed’s bank examination teams. Asking such questions is an about-face for the Fed, whose officials have long maintained that it is the most sophisticated and enlightened of financial regulators. And given that the Fed received extensive new regulatory powers under the Dodd-Frank financial reform law, it is troubling indeed that it may not be certain that its bank examiners have what they need to do their jobs. The Fed announcement looks an awful lot like damage control. It came late Thursday afternoon, directly after one Senate hearing that was critical of Fed practices and before another on Friday. It also came after a bill proposed by Senator Jack Reed, a Rhode Island Democrat, that would change the way the head of the most powerful of the 12 district banks — the Federal Reserve Bank of New York — is appointed. Currently, the president of the New York Fed is selected by its so-called public board members — those not affiliated with financial institutions. Senator Reed’s proposal would give the president of the United States, with Senate approval, responsibility for naming the president of the New York Fed. Clearly, last week was not a good one for the Fed. But it was a good week for anyone interested in understanding how this secretive institution works. Or doesn’t. Let’s start with the Senate Permanent Subcommittee on Investigations hearings on Thursday and Friday. Sponsored by Senators Carl Levin, the Michigan Democrat, and John McCain, the Arizona Republican, they capped a two-year investigation into the role of Wall Street banks in the commodities markets. Participants included officials from Goldman Sachs, Morgan Stanley and JPMorgan Chase. Daniel K. Tarullo, a Fed governor, also testified. A 400-page report by the subcommittee concluded that Wall Street’s significant physical commodities operations — metals warehouses, mines, oil tankers — were enormously risky, gave the banks unfair information advantages, raised the potential for manipulation and added to end users’ costs. Some of this ground was previously covered by The New York Times and other news outlets. What’s the Fed’s role in all this? It has allowed the big banks to own commodities operations even though regulations have traditionally prohibited banks from doing so. And it has opened the door to the banks, the report concluded, knowing that the risks of catastrophe were considerable. “The Federal Reserve’s failure to resolve key issues related to bank involvement with physical commodities has weakened longstanding American barriers against the mixing of banking and commerce,” the report concluded, “as well as longstanding safeguards protecting the U.S. financial system and economy against undue risk.” The Senate Banking Committee, meanwhile, heard testimony on Friday about the New York Fed and whether it was unduly influenced by the banks it is supposed to oversee — a phenomenon known as “regulatory capture.” Senator Sherrod Brown, the Ohio Democrat who oversaw those hearings, said in an interview that he was concerned about regulatory capture at the Fed because it could imperil bank examiners’ ability to monitor the safety and soundness of major financial institutions. “It’s clear that the Fed historically has cared way more about monetary policy than they do about supervision,” Mr. Brown said. “That’s why we’re shining a light on what they’re doing and their inadequacies.” Mr. Brown’s hearings explored the travails of Carmen M. Segarra, a former New York Fed examiner. Ms. Segarra encountered objections from her superiors — and was ultimately fired — after she questioned her bosses’ approval of a dubious transaction Goldman Sachs had structured for a client. Ms. Segarra’s story appeared on the ProPublica website and on “This American Life” two months ago, complete with tapes she had secretly made of internal Fed meetings. Ms. Segarra’s damaging account is clearly driving the Fed’s internal investigation into whether “divergent views” can be heard at the institution. Increasing scrutiny of the Fed, and the New York Fed in particular, is absolutely justified, given the immense powers they enjoy. Lest we forget, it was the New York Fed, under Timothy F. Geithner, that let Citibank increase its risky assets in the years leading up to the crisis. And it was the same New York Fed that seemed more interested in bailing out the big-bank trading partners of the American International Group than in rescuing the insurer itself. With the Fed under the microscope, now is also a good time to question some of its secrecy around bank examinations. The Fed’s examiners are supposed to monitor bank practices, looking for outsize risks or other problems. They are based inside banks and are bound by confidentiality rules. This secrecy protects the banks, but it disadvantages investors who try to understand the banks’ financial standing. Beyond that, regulators including the Fed give banks much leeway in keeping information confidential that would otherwise be public. Henry Hu, a professor at the University of Texas School of Law in Austin, explored the secrecy problem in a paper in the most recent Yale Journal on Regulation. In the paper, Professor Hu argues that the full-disclosure philosophy that has prevailed in our markets since the Securities and Exchange Commission was founded is being superseded by the parallel disclosure system developed by the Fed. The heightened bank disclosures are required as part of the Fed’s safety-and-soundness mission as specified under Dodd-Frank. But because the Fed is interested in the well-being of individual banks and not in the S.E.C. goals of investor protection and market efficiency, a conflict is emerging, Professor Hu said. The problem for investors, in his view, is that while they can rely on S.E.C. disclosures of bank operations, they get much less from the detailed submissions provided to the Fed. “We have two systems of disclosure, and one is not directed to investors and transparency,” he said in an interview last week. “With the Fed, you really do have regulators wanting to protect banks and willing to sacrifice investors to do so.” The Fed’s disclosure system, of course, is intended to minimize risks to the economy posed by financial institutions. Obviously, the Fed has no interest in disclosing information about a bank that might cause a run by investors or depositors. Still, investors would benefit from greater disclosures by the Fed, Professor Hu said. The Fed, for example, reveals only final results of its “stress tests” that measure banks’ health. “Right now the Fed does not disclose the precise mathematical models it uses in the stress tests,” he said. “If we required it to disclose those models, you would facilitate cross-bank comparisons in a way you can’t do right now. You’d also create incentives for the banks to disclose more about their own models.” There is another benefit to increasing transparency at the Fed. It could be a singularly powerful force against regulatory capture.
Posted on: Fri, 05 Dec 2014 15:00:01 +0000
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