By Pam Martens and Russ Martens: March 11, 2015
Results of the first leg of this year’s Federal Reserve stress tests, which measured capital adequacy of 31 of the most systemically important banks under a hypothetical market crash and deep recession, were released on March 5. Every institution passed that phase of the tests. At 4:30 p.m. today, the Federal Reserve will release its findings on the second leg of the tests: risk management capability, corporate governance and internal controls. Wall Street calls this element the “culture” test.
For those who have been reading our columns since 2008, when the culture of Wall Street brought about the greatest U.S. economic collapse since the Great Depression of the 1930s, you might be thinking that the Fed’s concern over the culture on Wall Street is a day late and $14 trillion short. (The $14 trillion figure is the amount of secret loans the Fed sluiced into the mega banks between 2007 and 2010 to keep the financial system from completely collapsing. Many of those loans were made at less than 1 percent interest.)
Then there is the $4.5 trillion that sits on the Federal Reserve’s balance sheet today. Prior to the crisis in 2008 and its ensuing asset purchases to prop up Wall Street, called Quantitative Easing, the Fed had a balance sheet of approximately $870 billion. To keep Wall Street, and its culture alive, it has ballooned its balance sheet by $3.6 trillion with no exit strategy in sight.
Prior to the Wall Street induced economic collapse in 2008, the U.S. Government had a national debt of $9 trillion, as of the end of its 2007 fiscal period. Today, the national debt stands at $18.1 trillion as a result of the unprecedented stimulus programs needed to offset the economic collapse. Thanks to Wall Street’s culture, our national debt has doubled in less than eight years.
For reasons that can only be viewed as specious, the Federal Reserve was given a far greater supervisory role over Wall Street under the Dodd-Frank financial reform legislation that was passed in 2010 – despite the fact that it had worn blinders during the reckless buildup to the 2008 crash.
This is a small sampling of what the Financial Crisis Inquiry Report tells us about the Federal Reserve’s failed role as a supervisor of Wall Street in the lead up to the greatest financial collapse in the last 80 years:
“…there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner. The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not…
“The Federal Reserve Bank of New York and other regulators could have clamped down on Citigroup’s excesses in the run-up to the crisis. They did not… [See As Citigroup Spun Toward Insolvency in ’07-’08, Its Regulator Was Dining and Schmoozing With Citi Execs.]
“…just a month before Lehman’s collapse, the Federal Reserve Bank of New York was still seeking information on the exposures created by Lehman’s more than 900,000 derivatives contracts…
“As irresponsible lending, including predatory and fraudulent practices, became more prevalent, the Federal Reserve and other regulators and authorities heard warnings from many quarters. Yet the Federal Reserve neglected its mission ‘to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.’ It failed to build the retaining wall before it was too late.”
Why would Congress endow a regulator with that horrific record with greater authority over Wall Street under legislation that dared to call itself “Wall Street Reform”? The only possible answer is because of pressure from Wall Street. That is also likely the explanation for why Congress and the President have failed to enforce a key provision of the Dodd-Frank financial reform legislation. Under its statutory mandate, President Obama was required to appoint, subject to Senate confirmation, a Vice Chairman for Supervision at the Federal Reserve Board of Governors.
Section 1108 of Dodd-Frank states: “The Vice Chairman for Supervision shall develop policy recommendations for the Board regarding supervision and regulation of depository institution holding companies and other financial firms supervised by the Board, and shall oversee the supervision and regulation of such firms.” President Obama was statutorily required to nominate a person to fill this position once the Dodd-Frank Wall Street Reform and Consumer Protection Act became effective on July 21, 2010. That statutory mandate has just fallen by the wayside despite serial charges of new securities fraud and collusive cartel activity filling newspaper columns.
There are now growing, and accurate, fears in the Senate Banking Committee, on both sides of the aisle, that Wall Street’s culture is getting worse because the culture of its key supervisor, the Federal Reserve Bank of New York, is that of coddler and enabler rather than fearsome cop on the beat.
The culture at the New York Fed is so compromised that even after a widely disseminated report from Wall Street On Parade that the wife of the President of the New York Fed, William Dudley, was receiving $190,000 annually in deferred compensation payouts from JPMorgan Chase, a bank serially in trouble with the law and under its supervision, the practice continued. This occurred while Jamie Dimon, the CEO of JPMorgan, was sitting on the Board of Directors of his regulator, the New York Fed.
More public outrage came last September when ProPublica and public radio’s This American Life released portions of internal tape recordings made inside the New York Fed by Carmen Segarra, a former bank examiner who says she was fired by the New York Fed in retaliation for refusing to change her negative examination of Goldman Sachs. The reports revealed a lap dog regulator, eagerly willing to sacrifice a bank examiner to shelter a powerful Wall Street bank.
Those revelations spawned a Senate hearing on November 21, 2014. The Senate Subcommittee on Financial Institutions and Consumer Protection, then chaired by Senator Sherrod Brown, invited Dudley, the President of the New York Fed to testify.
Senator Jeff Merkley grilled Dudley on the tax scam crimes by Credit Suisse, asking if the New York Fed had turned over the names of the individuals involved to authorities. Dudley said he didn’t know. Senator Merkley then asked Dudley how many Americans who created those secret tax evasion accounts with Credit Suisse were prosecuted. Dudley again had to admit that he was unaware. Merkley asked how many of the hundreds of Credit Suisse employees that set up these sham accounts were indicted. Dudley, again, could provide no information. Merkley said the answer to all of these questions was “none.”
At the same hearing, Senator Elizabeth Warren sought to have Dudley explain exactly how he viewed his role as a Wall Street regulator. Dudley said he saw his role “more of a fire warden” to make sure the banks were well run so that they didn’t catch fire and burn down.
Warren responded: “But you don’t think you should be doing any investigation; you should wait and see if it jumps in front of you.” Warren also centered on the fact that even when the New York Fed became aware that Goldman Sachs had structured a deal for a Spanish bank, Banco Santander, to dress up its capital, which a New York Fed employee called “legal but shady,” the New York Fed failed to bring the activity to Banco Santander’s European banking regulators.
Following the release of portions of the Carmen Segarra tapes, more unsettling news about the New York Fed came to light. The Federal Reserve’s Inspector General released a report in October that documented that the New York Fed had been apprised on multiple occasions by its staff of potential trouble in the Chief Investment Office of JPMorgan Chase but failed to conduct a comprehensive examination. Those lapses led to an eventual investigation by the U.S. Senate’s Permanent Subcommittee on Investigations which found that JPMorgan “piled on risk, hid losses, disregarded risk limits, manipulated risk models, dodged oversight, and misinformed the public.”
That investigation was known as the London Whale matter, where under the nose of the New York Fed in 2012, JPMorgan was gambling with hundreds of billions of dollars of its bank depositors’ money – not its own capital – in exotic, high risk derivatives trading in London, and lost at least $6.2 billion of that money.
Another regulator, the Office of the Comptroller of the Currency stated the following regarding what JPMorgan had done: “The credit derivatives trading activity constituted recklessly unsafe and unsound practices, was part of a pattern of misconduct and resulted in more than minimal loss, all within the meaning of 12 U.S.C. § 1818(i)(2)(B)”; and “The Bank failed to ensure that significant information related to the credit derivatives trading strategy and deficiencies identified in risk management systems and controls was provided in a timely and appropriate manner to OCC examiners.”
There is now a movement to strip power away from the New York Fed. If that exercise results in anything less than stripping supervision of Wall Street away from the Federal Reserve, it will be as impotent an exercise as the Dodd-Frank legislation.