New York Fed Didn't Want Goldman Sachs to Embarrass Itself

It's like a fire warden, for embarrassment. As opposed to a beat cop on the embarrassment beat.
Heading for the fire exit.

Here's kind of a jarring moment from today's Senate grilling of New York Fed president William Dudley about whether his staff are too cozy with the banks they supervise. It's about the Fed's review of a deal that Goldman did with Santander: 1

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’s legal department concluded that the deal was legal and judged that it would not damage Goldman’s reputation.

That last conclusion is factually debatable -- ordinarily if your transaction gets discussed at a Senate hearing, that's not great for your reputation -- but also doesn't it seem a little weird that it's the New York Fed's job to protect Goldman Sachs's reputation? 2

It seems weird, but it's not really. The Fed's job as a banking supervisor is 3 "to ensure the safety and soundness of financial institutions." It's supposed to look out for their well-being. The banks that the Fed supervises are under constant threat, mostly from themselves. They could make risky loans, or do dumb trades, or be taken by rogue traders, or lose the confidence of investors, or ruin their reputations and see their businesses dry up. Any of those things would be bad for the bank that did it. And the Fed's job is to prevent banks from doing things that are bad for themselves.

So reputational risk is just another risk that banks face, and that supervisors are supposed to guard against. Here's a handbook on Large Bank Supervision from the Office of the Comptroller of the Currency -- like the Fed, a supervisor of banks -- and page 24 covers reputational risk. "The market’s or public’s perception of the corporate citizenship, mission, culture, and risk tolerance of the bank" is very explicitly the concern of bank supervisors.

This helps explain another jarring moment from the hearing, Dudley's refusal to engage with Senator Elizabeth Warren's chosen metaphor:

Dudley took issue with Warren’s description of regulators as the “cop on the beat,” saying the Fed is concerned more with the safety and soundness of the financial system and refers potential crimes to law-enforcement agencies.

“I think of it more like a fire warden makes sure that the institution is run well so that it’s not going to catch on fire and burn down,” he said.

Now, for myself, I don't like to engage with any financial metaphors. Things are the things that they are, and if someone is pretending that they're other things, it's because she's trying to lie to you. Financial metaphors very rarely generate insights; normally they are just a way to sneak biases into an argument without actually arguing for them.

But this particular set of metaphors does seem productive. Those are two usefully distinct models of regulatory engagement. A fire warden is on your side, protective, forward-looking. A cop is antagonistic, punitive, backward-looking. The fire warden hopes you don't have a fire. The cop really hopes you committed that murder.

Those two cultures each have their own problems. The problems of cops are fairly well-understood, when they're cops. You could worry about cops viewing the communities they serve as enemies, leading to strained relations and excessive antagonism. Or you could worry about a bureaucratic bias toward easy action, leading to arrest quotas and pointless harassment, or to enforcement activities done with an eye toward revenue rather than justice.

But you get similar problems when the cops are not cops, but financial enforcers like the Department of Justice or the Securities and Exchange Commission. Alexis Goldstein wrote yesterday about the parallels between the SEC's current enforcement activities and "broken windows" policing, and it's plausible that the SEC is pursuing easy wins and low-hanging fruit at the expense of systemic problems. (Certainly that's how I view the SEC's and DOJ's obsession with insider-trading cases.) And the regulatory focus on pursuing big fines, while lucrative for the regulators, also gets a lot of criticism, both from those who think the fines are too harsh and from those who think they're too mild.

There are also enforcers who perhaps go too far in viewing finance as the enemy. Neil Barofsky, the former prosecutor who became the inspector general of Treasury's TARP program, believed that his supervision of Treasury's funds required the ability to shoot people. Honestly that seems like an overreaction, 4 but on the other hand it's hard to imagine the New York Fed showing up to its meetings with Goldman Sachs carrying guns and wearing bulletproof vests.

And the fire-warden approach to finance has its problems too. 5 If your aim is to protect banks from themselves, umm, doesn't that sound easy? And cozy, and collaborative? Banks don't really want to hurt themselves. All you have to do is hang out with them, make friends, gain their trust and occasionally gently remind them, "Hey, this trade you want to do, it's going to be a huge embarrassment for you, maybe cut it out." It's easy to think that protecting smart people from doing dumb things would be a low-touch endeavor.

The criticism of the New York Fed that I've found most compelling is this, from ProPublica's story on Carmen Segarra:

Segarra had worked previously at Citigroup, MBNA and Société Générale. She was accustomed to meetings that ended with specific action items.

At the Fed, simply having a meeting was often seen as akin to action, she said in an interview. "It's like the information is discussed, and then it just ends up in like a vacuum, floating on air, not acted upon."

Remember, the Fed's role is not to enforce, it's to supervise, literally to look over. You go look over what a bank is doing, you look over it for a while, and you go home, exhausted from all that looking. You're done! "Boy we did a lot of supervising today," you think. What more is there to do? Your job is not to make trouble, or at least, your job is not measured in units of how much trouble you make. Cops (and prosecutors) are measured on the trouble they make -- arrests, prosecutions, convictions -- but supervisors are not.

The measure of a supervisor's job is, did your bank blow up today? And the success rate is almost 100 percent. Every day that your bank doesn't blow up, you have more evidence that you're doing a great job, honestly too good a job, you could probably dial it back a bit. Of course some days your bank does blow up, and those days are uncomfortable, but, really, that was a while ago, things are probably better now. 6

There is an obvious antagonism between these cultures, but it's a mistake to think that you have to choose one. In the world of the metaphor, and also in the real world, you need cops and fire wardens. The New York Fed probably lets banks get away with too much. Barofsky would probably let them get away with too little. The Justice Department's institutional goals are to ferret out wrongdoing and seek crippling punishments to deter future misbehavior. 7 The Fed's institutional goals are to make sure that banks are safe and sound and not, you know, crippled.

In the long run those goals roughly coincide: Misbehavior is bad, and you should prevent it both with careful supervision and with strict deterrence. But in the short run they can conflict, and that conflict needs to be resolved somehow, and it's not obvious that it should always be resolved one way or the other. Shutting down every bank that ever does anything wrong would leave you with no banks; tiptoeing around all wrongdoing would leave you with too much wrongdoing. And the way to resolve the conflict is, pretty much: You negotiate. You have some regulators/supervisors who are institutionally set up as fire wardens, and other regulators/enforcers who are institutionally set up as cops, and you let them discuss and fight it out and try to get to the right answer. But for that discussion to work, you need both sides. And when everyone is angry and demanding more cops, that's when fire wardens are particularly important.

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  1. Which we previously discussed here.

  2. Disclooooooooooooooooosure. I still used to work at Goldman. I still own a little restricted stock. There won't be much more Goldman in this post, I hope.

  3. As opposed to its job doing monetary policy, etc. It has other jobs. Incidentally here is what is purportedly a short film about the Fed, by the director of the "Twilight" movies. I cannot vouch for it, but the synopsis is "When Federal Reserve Chairman Rob Rafaelson awakes with amnesia only moments before a big press conference, his children, maid and intern must explain the Fed to him using the only thing handy: the children’s toys." So you should probably watch it.

  4. To me, but also to Tim Geithner, Barofsky's boss at the time, who came from more of a fire-warden culture (both in his Treasury background and as a former New York Fed president himself).

  5. I should say, here I have left behind the world of the metaphor, and have no idea whatsoever whether these criticisms also apply to actual fire wardens.

  6. I exaggerate for sarcastic effect. Things definitely are better now, in real concrete ways that grow out of lessons learned by the Fed during the financial crisis.

  7. I know that there is a contrary view, that the Justice Department has incentives to minimize financial wrongdoing, and that federal prosecutors are actually milquetoasts who are afraid to bring charges because they worry it might hurt their careers. I think that this view is insane, and that every white-collar prosecutor dreams every night about arresting Lloyd Blankfein.

To contact the author on this story:
Matthew S Levine at

To contact the editor on this story:
Zara Kessler at

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