Bankers committed massive fraud leading to the financial crash of 2008, which then caused cataclysmic job loss, foreclosures and more than a $12 trillion drain on the economy. Where were the law enforcers? Bankers captured them, metaphorically.
More than 10,000 member of Public Citizen petitioned Congress to hold hearings on regulatory capture following the September release of tapes made by a regulator named Carmen Segarra. She resisted following the instructions of apparently captured regulators who were her supervisors, and was fired for it. On Nov. 21, a Senate banking subcommittee will open those hearings. New York Federal Reserve Bank President William Dudley will testify. Segarra worked as an examiner for his agency.
Here are a few questions
Q. According to Carmen Segarra, she was fired for trying to do her job. She was told to tone down her criticism of banks, but declined. How many examiners are terminated each year by the New York Fed? Former counsel to the Financial Crisis Inquiry Commission Bart Dzivi said Dianne Dobbeck, one of the most senior supervisors at the New York Fed, is “completely the wrong type” of person for the job. Is an examiner ever terminated for failing to detect a problem with a bank early enough? Does the New York Fed have a system to reward diligent examiners?
Q. The Segarra tapes cover an 8 month period three years after the crisis. If the crisis itself constituted a “teachable moment,” then must we assume that the problem of regulatory capture is only getting worse?
Follow on Twitter
The Roman army responded to desertion by randomly executing a tenth of those soldiers remaining. They called it decimation, derived from the Latin word for “tenth.” This discipline, of course, prompted all soldiers to police against desertion so as to save their own skins.
New York Federal Reserve Bank President William Dudley seems to have borrowed a piece of this incentive structure for a current financial situation. In a speech on October 20, this key regulator of the nation’s largest banks proposed that a major chunk of pay for all senior executives at a particular bank be forfeited when the bank violates the law.
Specifically, Dudley proposes that part of senior bankers’ pay be sequestered in a “performance bond.” If the bank must pay a large fine, this bond is forfeited and paid as part of the fine. “This would increase the financial incentive of those individuals who are best placed to identify bad activities at an early stage, or prevent them from occurring in the first place.”
Making bankers pay for fraud may stifle a replay of one of the glaring judicial miscarriages following the response to the financial crisis of 2008. Despite the massive frauds subsequently documented by the Department of Justice, no senior executives faced penalties. The billion-dollar fines meted out by the DOJ were, in fact, borne by shareholders innocent of any conspiracy.
Prosecutors have offered varying reasons for this indefensible result, including the recent excuse offered by James Cole, who just retired as deputy attorney general at the DOJ: the fraudsters were “rocket scientists” who simply outsmarted the prosecutors. Under the Dudley scheme, even if the DOJ failed to track down some of the guilty individuals, all the senior bankers at a firm would nevertheless suffer at least some financial pain.
The bank gambling trade association and its regulators are giving each other high-fives over an agreement that supposedly makes it easier to bail out a failed mega-bank. Progress? If viewed from the vantage of an average taxpayer who finances bank bailouts, the progress is miniscule. And the circumstances that put this agreement barely into the “progress” column beg for far more ambitious reform.
Specifically, 18 of the largest global banks just agreed to wait about a day when one of them fails before pocketing the winnings from bets made with each other. Exactly how long the waiting period will be isn’t clear. These bets are called swaps. The agreement about how bets are settled is governed by a master contract of the International Swaps and Derivatives Association (ISDA), which is the industry trade association.
Originally conceived as hedges (the way farmers lock in a price for commodities such as corn that hasn’t yet been grown, harvested and sold) swaps have now been perverted into a $700 trillion racket largely patronized by banks. This high-stakes game primarily plays out in what’s called the over-the-counter (OTC) market. Ninety percent of the OTC bets are between banks themselves. In fact, four banks account for most of the bets in the US banking industry. Real economy companies such as airlines or car manufacturers account for only about 10 percent of the OTC casino. Even mega-bank Wells Fargo, currently the most valuable bank on the US stock market, doesn’t gamble nearly at the scale of its peers JPMorgan Chase, Citigroup and Bank of America.
In other words, if swaps are so useful to the economy, why doesn’t Main Street account for most of them? And how can Wells Fargo be so successful a bank without a swaps portfolio that matches Citi’s?