Inside the New York Fed: Secret Recordings and a Culture Clash
by Jake Bernstein ProPublica, Sep. 26, 2014, 5 a.m.
Barely a year removed from the devastation of the 2008 financial crisis, the president of the Federal Reserve Bank of New York faced a crossroads. Congress had set its sights on reform. The biggest banks in the nation had shown that their failure could threaten the entire financial system. Lawmakers wanted new safeguards.
On April 9th 2021, Bruce Greenwald, the founding director of the Heilbrunn Center for Graham and Dodd Investing at Columbia Business School, sat down for a Fireside Chat with Li Lu, the founder and chairman of Himalaya Capital as part of the 13th Columbia China Business Conference. Q1 2021 hedge fund letters, conferences and more Read More
This story was co-published with This American Life, from WBEZ Chicago.
The Federal Reserve, and, by dint of its location off Wall Street, the New York Fed, was the logical choice to head the effort. Except it had failed miserably in catching the meltdown.
New York Fed President William Dudley had to answer two questions quickly: Why had his institution blown it, and how could it do better? So he called in an outsider, a Columbia University finance professor named David Beim, and granted him unlimited access to investigate. In exchange, the results would remain secret.
After interviews with dozens of New York Fed employees, Beim learned something that surprised even him. The most daunting obstacle the New York Fed faced in overseeing the nation’s biggest financial institutions was its own culture. The New York Fed had become too risk-averse and deferential to the banks it supervised. Its examiners feared contradicting bosses, who too often forced their findings into an institutional consensus that watered down much of what they did.
The report didn’t only highlight problems. Beim provided a path forward. He urged the New York Fed to hire expert examiners who were unafraid to speak up and then encourage them to do so. It was essential, he said, to preventing the next crisis.
A year later, Congress gave the Federal Reserve even more oversight authority. And the New York Fed started hiring specialized examiners to station inside the too-big-to fail institutions, those that posed the most risk to the financial system.
One of the expert examiners it chose was Carmen Segarra.
Segarra appeared to be exactly what Beim ordered. Passionate and direct, schooled in the Ivy League and at the Sorbonne, she was a lawyer with more than 13 years of experience in compliance 2013 the specialty of helping banks satisfy rules and regulations. The New York Fed placed her inside one of the biggest and, at the time, most controversial banks in the country, Goldman Sachs.
It did not go well. She was fired after only seven months.
As ProPublica reported last year, Segarra sued the New York Fed and her bosses, claiming she was retaliated against for refusing to back down from a negative finding about Goldman Sachs. A judge threw out the case this year without ruling on the merits, saying the facts didn’t fit the statute under which she sued.
At the bottom of a document filed in the case, however, her lawyer disclosed a stunning fact: Segarra had made a series of audio recordings while at the New York Fed. Worried about what she was witnessing, Segarra wanted a record in case events were disputed. So she had purchased a tiny recorder at the Spy Store and began capturing what took place at Goldman and with her bosses.
Segarra ultimately recorded about 46 hours of meetings and conversations with her colleagues. Many of these events document key moments leading to her firing. But against the backdrop of the Beim report, they also offer an intimate study of the New York Fed’s culture at a pivotal moment in its effort to become a more forceful financial supervisor. Fed deliberations, confidential by regulation, rarely become public.
The recordings make clear that some of the cultural obstacles Beim outlined in his report persisted almost three years after he handed his report to Dudley. They portray a New York Fed that is at times reluctant to push hard against Goldman and struggling to define its authority while integrating Segarra and a new corps of expert examiners into a reorganized supervisory scheme.
Segarra became a polarizing personality inside the New York Fed 2014 and a problem for her bosses 2014 in part because she was too outspoken and direct about the issues she saw at both Goldman and the Fed. Some colleagues found her abrasive and complained. Her unwillingness to conform set her on a collision course with higher-ups at the New York Fed and, ultimately, led to her undoing.
In a tense, 40-minute meeting recorded the week before she was fired, Segarra’s boss repeatedly tries to persuade her to change her conclusion that Goldman was missing a policy to handle conflicts of interest. Segarra offered to review her evidence with higher-ups and told her boss she would accept being overruled once her findings were submitted. It wasn’t enough.
“Why do you have to say there’s no policy?” her boss said near the end of the grueling session.
“Professionally,” Segarra responded, “I cannot agree.”
The New York Fed disputes Segarra’s claim that she was fired in retaliation.
“The decision to terminate Ms. Segarra’s employment with the New York Fed was based entirely on performance grounds, not because she raised concerns as a member of any examination team about any institution,” it said in a two-page statement responding to an extensive list of questions from ProPublica and This American Life.
The statement also defends the bank’s record as regulator, saying it has taken steps to incorporate Beim’s recommendations and “provides multiple venues and layers of recourse to help ensure that its employees freely express their views and concerns.”
“The New York Fed,” the statement says, “categorically rejects the allegations being made about the integrity of its supervision of financial institutions.”
In the spring of 2009, New York Fed President William Dudley put together a team of eight senior staffers to help Beim in his inquiry. In many ways, this was familiar territory for Beim.
He had worked on Wall Street as a banker in the 1980s at Bankers Trust Company, assisting the firm through its transition from a retail to an investment bank. In 1997, the New York Fed hired Beim to study how it might improve its examination process. Beim recommended the Fed spend more time understanding the businesses it supervised. He also suggested a system of continuous monitoring rather than a single year-end examination.
Beim says his team in 2009 pursued a no-holds-barred investigation of the New York Fed. They were emboldened because the report was to remain an internal document, so there was no reason to hold back for fear of exposure. The words “Confidential Treatment Requested” ran across the bottom of the report.
“Nothing was off limits,” says Beim. “I was told I could ask anyone any question. There were no restrictions.”
In the end, his 27-page report laid bare a culture ruled by groupthink, where managers used consensus decision-making and layers of vetting to water down findings. Examiners feared to speak up lest they make a mistake or contradict higher-ups. Excessive secrecy stymied action and empowered gatekeepers, who used their authority to protect the banks they supervised.
“Our review of lessons learned from the crisis reveals a culture that is too risk-averse to respond quickly and flexibly to new challenges,” the report stated. “A number of people believe that supervisors paid excessive deference to banks, and as a result they were less aggressive in finding issues or in following up on them in a forceful way.”
One New York Fed employee, a supervisor, described his experience in terms of “regulatory capture,” the phrase commonly used to describe a situation where banks co-opt regulators. Beim included the remark in a footnote. “Within three weeks on the job, I saw the capture set in,” the manager stated.
Confronted with the quotation, senior officers at the Fed asked the professor to remove it from the report, according to Beim. “They didn’t give an argument,” Beim said in an interview. “They were embarrassed.” He refused to change it.
The Beim report made the case that the New York Fed needed a specific kind of culture to transform itself into an institution able to monitor complex financial firms and catch the kinds of risks that were capable of torpedoing the global economy.
That meant hiring “out-of-the-box thinkers,” even at the risk of getting “disruptive personalities,” the report said. It called for expert examiners who would be contrarian, ask difficult questions and challenge the prevailing orthodoxy. Managers should add categories like “willingness to speak up” and “willingness to contradict me” to annual employee evaluations. And senior Fed managers had to take the lead.
“The top has to articulate why we’re going through this change, what the benefits are going to be and why it’s so important that we’re going to monitor everyone and make sure they stay on board,” Beim said in an interview.
Beim handed the report to Dudley. The professor kept it in draft form to help maintain secrecy and because he thought the Fed president might request changes. Instead, Dudley thanked him and that was it. Beim never heard from him again about the matter, he said.
In 2011, the Financial Crisis Inquiry Commission, created by Congress to investigate the causes behind the economic calamity, publicly released hundreds of documents. Buried among them was Beim’s report.
Because of the report’s candor, the release surprised Beim and New York Fed officials. Yet virtually no one else noticed.
Among the New York Fed employees enlisted to help Beim in his investigation was Michael Silva.
As a Fed veteran, Silva was a logical choice. A lawyer and graduate of the United States Naval Academy, he joined the bank as a law clerk in 1992. Silva had also assisted disabled veterans and had gone into Iraq after the 2003 invasion to help the country’s central bank. Prior to working on Beim’s report, he had been chief of staff to the previous New York Fed president, Timothy Geithner.
In declining through his lawyer to comment for this story, Silva cited the appeal of Segarra’s lawsuit and a prohibition on disclosing unpublished supervisory material. The rule allows regulators to monitor banks without having to worry about the release of information that could alarm customers and create a run on a bank that’s under scrutiny.
Silva had been in the room with Geithner in September 2008 during a seminal moment of the financial crisis. Shares in a large money market fund 2013 the Reserve Primary Fund 2013 had fallen below the standard price of $1, “breaking the buck” and threatening to touch off a run by investors. The investment firm Lehman Brothers had entered bankruptcy, and the financial system appeared in danger of collapse.
In Segarra’s recordings, Silva tells his team how, at least initially, no one in the war room at the New York Fed knew how to respond. He went into the bathroom, sick to his stomach, and vomited.
“I never want to get close to that moment again, but maybe I’m too close to that moment,” Silva told his New York Fed team at Goldman Sachs in a meeting one day.
Despite his years at the New York Fed, Silva was new to the institution’s supervisory side. He had never been an examiner or participated as part of a team inside a regulated bank until being appointed to lead the team at Goldman Sachs. Silva prefaced his financial crisis anecdote by saying the team needed to understand his motivations, “so you can perhaps push back on these things.”
In the recordings, Silva then offered a second anecdote. This one involved the moments before the Lehman bankruptcy.
Silva related how the top bankers in the nation were asked to contribute money to save Lehman. He described his disappointment when Goldman executives initially balked. Silva acknowledged that it might have been a hard sell to shareholders, but added that “if Goldman had stepped up with a big number, that would have encouraged the others.”
“It was extraordinarily disappointing to me that they weren’t thinking as Americans,” Silva says in the recording. “Those two things are very powerful experiences that, I will admit, influence my thinking.”
Silva’s stories help explain his approach to a controversial deal that came to the New York Fed team’s attention in January 2012, two months after Segarra arrived. She said the Fed’s handling of the deal demonstrated its timidity whenever questions arose about Goldman’s actions. Debate about the deal runs through many of Segarra’s recordings.
On Friday, Jan. 6, 2012, at 3:54 p.m., a senior Goldman official sent an email to the on-site Fed regulators 2013 including Silva, Segarra and Segarra’s legal and compliance manager, Johnathon Kim. Goldman wanted to notify them about a fast-moving transaction with a large Spanish bank, Banco Santander. Spanish regulators had signed off on the deal, but Goldman was reaching out to its own regulators to see whether they had any questions.
At the time, European banks were shaky, particularly the Spanish ones. To shore up confidence, the European Banking Authority was demanding that banks hold more capital to offset potential future losses. Meeting these capital requirements was at the heart of the Goldman-Santander transaction.
Under the deal, Santander transferred some of the shares it held in its Brazilian subsidiary to Goldman. This effectively reduced the amount of capital Santander needed. In exchange for a fee from Santander, Goldman would hold on to the shares for a few years and then return them. The deal would help Santander announce that it had reached its proper capital ratio