Monday, November 24, 2014

Banks Too Big To Jail: A Systemic Conflict of Interest

When a blatant conflict of interest is ensconced in a regulatory system, the public can expect to be insufficiently protected from being harmed. Such a people is probably too tolerant of such conflicts, or else too weak to effectively counter the concentrated power of the vested interests benefitting from the sordid design. I submit that the relationship between U.S. banks and the Federal Reserve is plagued by a clear conflict of interest, and furthermore that the refusal of the Fed and the U.S. Justice Department to go after fraud committed at the big banks is a direct result.

In mid-November 2014, an official at the U.S. Federal Reserve Bank acknowledged that federal prosecutors had not pursued criminal charges against banks—in spite of evidence of laundering money for suspected criminals, manipulating interest-rate benchmarks, rigging commodity markets, misleading investors purchasing mortgage-based securities and homeowners taking out large mortgages, manipulating municipal debt markets, and breaking state and federal laws in attempting to seize houses (i.e., “robosigning”).[1] At a U.S. Senate Banking Committee hearing, William Dudley, president of the Federal Reserve Bank of New York, admitted, “We were not willing to find those firms guilty before, because we were worried that if we found them guilty, that could somehow potentially destabilize the financial system.”[2] He went on to say that he and his colleagues had “gotten past” that way of thinking.

I contend that relying on Dudley and his colleagues to recognize for themselves that enabling criminal conduct orchestrated in large U.S. banks is not a good thing is problematic. Doing so is tantamount to relying on the wolves guarding the hen house to come to the opinion that eating all the hens is not such a good thing for the wolves (or society) after all. That is to say, the sordid mentality at the New York Fed and the U.S. Department of Justice stems at least in part from a structural, or institutional conflict of interest.

At the congressional hearing, Senator Jack Reed (D-R.I.) too issue with the amount of influence that the big banks have over who oversees them.  According to The Huffington Post, “Each regional fed board has three classes of directors -- one selected by banks, another headed by corporate leaders selected by banks, and a third that is supposed to represent other public interests. The corporate and public interest directors choose the Fed president. Since big banks like Goldman Sachs and JPMorgan Chase select the corporate directors in the New York region, they exercise a great deal of influence over the process. Dudley himself is a former Goldman Sachs banker.”[3] Although Dudley insisted that he had changed the culture at the New York Fed, the fact that he has been socialized in a banker’s perspective points to an underlying problem—one admittedly subtle but too large to be swayed by a leader’s attempts to change organizational culture from enabling to regulating.

A glaring structural conflict-of-interest exists in the bankers having a say in who regulates them and their respective institutions. The banks essentially control two of the three classes of directors, and through their corporate picks, the banks can stop any nominee for NY Fed president put forward by the public interest directors. Hence, the system is rigged, in its very design, against a president inclined to hold the banks and their employees accountable to the law. The only way out of this mire is for the system to be redesigned, and such a feat presumably requires visionary and ethical leadership rather than incremental and political leadership.

As one instance of how the system as it stands works, Tim Geithner was supported by Citigroup (and in particular its largest individual stockholder) to be president of the New York Fed. In his tenure there, he went along with U.S. Treasury Secretary Henry Paulson, a former CEO of Goldman Sachs, in not stipulating that banks being bailed out use the funds to increase lending and limit bonuses. The stated reason given was that the bankers might not go along with the bailout—as if they would have preferred facing the short-sellers on their own. A few years later as the Secretary of the U.S. Treasury himself, Geithner went along with the Dodd-Frank financial reform law not including a clause giving the U.S. Government the authority to break up banks that have such systemic risk that a collapse could cause the financial system to “freeze up,” creditwise (e.g., commercial paper). Given the role of the banks at the Federal Reserve, it is truly remarkable that Paul Volker, who was Reagan’s first Chairman of the Federal Reserve, advocated for such authority. From his advice, we can measure the fallout from the systemic conflict-of-interest.

In general terms, for the regulated to have any say in who regulates them, and for the top regulators to come from the ranks of the regulated are such glaring “red flags” that it is astounding to come across a people who tolerate them in how their banking regulators are selected. Perhaps the gap between the political and business classes on the one hand and the popular sovereign (i.e., the People) on the other is so wide that the wolves guarding the chickens can afford to be blatant as to their system. Moreover, the tolerance in a societal culture for institutional conflicts of interest must be huge to allow such a conflict-of-interest not only to exist, but to sustained such that it has become well-ensconced in the existing system of public governance. It is in precisely such an atmosphere that a plutocracy—the rule of private wealth—can flourish openly on the subterfuge of democracy.



[1] Zack Carter and Shahien Nasiripour, “The Fed Just Acknowledged Its Too Big to Jail Policy,” The Huffington Post, November 21, 2014.
[2] Ibid.
[3] Ibid.