Fed Reviews Bank Supervision as Senate Panel Begins Hearings

On the eve of a Senate hearing today into whether the Federal Reserve has been “captured” by the institutions it is supposed to regulate, the Fed announced a broad review of its supervision of the largest banks, and a top official acknowledged there’s a danger that examiners could be too easy on them.

“We understand the risks of doing our job poorly and of becoming too close” to banks, New York Fed President William C. Dudley said in testimony to a Senate panel. “We cannot catch or correct every error by a financial institution, and we sometimes make mistakes.”

The hearing was prompted by allegations leveled against the New York Fed by a former supervisor who said her colleagues were too deferential to Goldman Sachs Group Inc., the Wall Street bank where Dudley once worked. Fresh reports this week of improper ties between employees of the two institutions are providing ammunition to congressional critics, some of whom want to limit the central bank’s authority and autonomy.

“More than six years ago, when regulators got too cozy with the banks they were regulating, we saw the cost in lost jobs, retirement savings, and homes,” Sherrod Brown, the Ohio Democrat who will lead today’s hearing, said in a reference to the financial crisis. “It’s past time that the Federal Reserve shows -- with actions, not words -- that it will protect consumers rather than Wall Street.”

The Fed Board said yesterday it had asked Inspector General Mark Bialek in a Nov. 17 letter to review examinations of bank holding companies with assets exceeding $50 billion.

Divergent Views

The Fed asked Bialek to determine if examinations obtain “all material information” and whether there are ways “for decision-makers to be aware of divergent views about material issues regarding large banking organizations.”

“The Fed review of how it supervises banks is very serious and very real,” said Joseph Engelhard, a former Treasury Department official who is now senior vice president at Washington-based consultant Capital Alpha Partners LLC.

The watchdog will also examine whether supervisors at the 12 regional reserve banks are aware of disagreements on their teams.

That’s the issue that led to today’s hearing, which Brown called in response to secret recordings made by Carmen Segarra, a New York Fed examiner posted at Goldman Sachs who said she was fired because she refused to go easy on the firm, a charge the New York Fed has denied. Segarra attended today’s hearing.

The Segarra allegations are “part of a much bigger issue than simply a dispute with the New York Fed,” said Peter J. Wallison, a senior fellow in financial policy studies at the American Enterprise Institute in Washington.

‘Very Uncomfortable’

“Congress is very uncomfortable with the fact there’s this body out there that has all this power and they, who are constitutionally entitled to exercise that power, have very little say about how it is exercised,” said Wallison, a former Treasury Department general counsel.

Brown and fellow Banking Committee Democrat Elizabeth Warren of Massachusetts have called the Segarra report “disturbing.”

In a testy exchange during today’s hearing, Warren said the recordings made by Segarra are evidence of a “long list of supervisory failures” at the New York Fed.

“I wouldn’t accept the premise that there’s been a long list of failures during my tenure at the New York Fed,” Dudley said.

Reed Bill

Another Senate Democrat, Jack Reed of Rhode Island, introduced a bill this week that would add the New York Fed chief to the list of central bank officials who must be nominated by the president and confirmed by the Senate.

“Every day the Fed drives another nail in their coffin,” said Camden Fine, who heads the Independent Community Bankers of America, which represents 6,500 lenders. “There’s been general concern on the part of Congress that in the early days of the crisis up to recent months that the Fed overreached and began to intrude on what Congress perceives as being their prerogatives.”

The group, which previously defended the Fed from congressional efforts to curb its powers, said yesterday it supports Reed’s bill.

Permanent Vote

The New York Fed chief has a permanent vote on the policy-setting Federal Open Market Committee, while the heads of the other 11 district banks rotate into voting seats. District bank presidents are selected by their boards of directors and approved by the Fed Board of Governors in Washington. Fed governors already must gain Senate approval.

Republicans, who are poised to control the Senate next year in addition to the House, have proposed legislation to curb Fed discretion on monetary policy and bank supervision.

Representatives Scott Garrett of New Jersey and Bill Huizenga of Michigan, for example, were co-sponsors of a House bill that would have required the central bank to describe a rule for how it would adjust interest rates.

Today’s Senate hearing follows reports that Goldman Sachs fired two bankers after one of them allegedly shared confidential documents from the New York Fed within the firm.

A junior banker, who had joined the company in July from the New York Fed, was dismissed a week after the discovery in late September along with another employee who failed to escalate the issue, according to an internal memo obtained by Bloomberg News. Jake Siewert, a bank spokesman, confirmed the contents of the memo.

Confidential Information

The banker forwarded an e-mail from a Fed employee that contained confidential supervisory information to members of his team on Sept. 26, according to a person briefed on the matter. The New York Fed dismissed an employee for sharing the information, according to two people briefed on the matter.

The incident is a fresh embarrassment for Dudley, who has carried on a campaign to overhaul what he calls an errant banking “culture” of misdeeds that has led to more than $100 billion of fines.

Bad conduct “damages the public trust placed in banks,” Dudley said in his testimony. “This loss of trust is so severe that it has become a financial stability concern,” Dudley said.

London Whale

The central bank’s internal watchdog last month said the New York Fed botched oversight of the JPMorgan unit that suffered $6.2 billion in trading losses, attributed to the so-called London Whale, when it missed opportunities to uncover problems in 2008, 2009 and 2010.

Dudley defended his organization in his testimony, saying it has made “significant changes” since the crisis, holding banks to higher capital and liquidity requirements and conducting stress tests to determine if they can survive shocks.

Examinations have been changed to reduce the chance for regulatory capture by ensuring that one person can’t make “final decisions on matters of significance,” Dudley said. The bank also reorganized its supervision group to support “unbiased analysis and professional objectivity.”

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