```

[Senate Hearing 113-570]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 113-570

 IMPROVING FINANCIAL INSTITUTION SUPERVISION: EXAMINING AND ADDRESSING 
                           REGULATORY CAPTURE

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
             FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                   ON

EXAMINING THE CAUSES, IMPLICATIONS, AND POTENTIAL METHODS OF ADDRESSING 
                           REGULATORY CAPTURE

                               __________

                           NOVEMBER 21, 2014

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

                 Available at: http: //www.fdsys.gov /

                                     ______

                      U.S. GOVERNMENT PUBLISHING OFFICE 

93-411 PDF                     WASHINGTON : 2015 
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Troy Cornell, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

     Subcommittee on Financial Institutions and Consumer Protection

                     SHERROD BROWN, Ohio, Chairman

       PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         DAVID VITTER, Louisiana
ROBERT MENENDEZ, New Jersey          MIKE JOHANNS, Nebraska
JON TESTER, Montana                  JERRY MORAN, Kansas
JEFF MERKLEY, Oregon                 DEAN HELLER, Nevada
KAY HAGAN, North Carolina            BOB CORKER, Tennessee
ELIZABETH WARREN, Massachusetts

               Graham Steele, Subcommittee Staff Director

        Geoffrey Okamoto, Republican Subcommittee Staff Director

                  Megan Cheney,  Legislative Assistant

                                  (ii)

                            C O N T E N T S

                              ----------                              

                       FRIDAY, NOVEMBER 21, 2014

                                                                   Page

Opening statement of Chairman Brown..............................     1

Opening statements, comments, or prepared statements of:
    Senator Reed.................................................     3
    Senator Merkley..............................................     3
    Senator Manchin..............................................     4
    Senator Warren...............................................     6

                               WITNESSES

William C. Dudley, President and Chief Executive Officer, Federal 
  Reserve Bank of New York.......................................     6
    Prepared statement...........................................    48
David O. Beim, Professor of Professional Practice, Columbia 
  Business School................................................    34
    Prepared statement...........................................    52
Robert C. Hockett, Edward Cornell Professor of Law, Cornell Law 
  School.........................................................    36
    Prepared statement...........................................    56
Norbert J. Michel, Research Fellow in Financial Regulations, 
  Heritage
  Foundation.....................................................    38
    Prepared statement...........................................    69

                                 (iii)

 
 IMPROVING FINANCIAL INSTITUTION SUPERVISION: EXAMINING AND ADDRESSING 
                           REGULATORY CAPTURE

                              ----------                              

                       FRIDAY, NOVEMBER 21, 2014

U.S. Senate, Subcommittee on Financial Institutions 
                           and Consumer Protection,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Sherrod Brown, Chairman of the 
Subcommittee, presiding.

          OPENING STATEMENT OF CHAIRMAN SHERROD BROWN

    Chairman Brown. The Subcommittee will come to order.
    Thank you all for joining us. Thank you to Senator Reed and 
Senator Merkley, and there will be, I believe, another couple 
of Senators that will be along.
    Six short years ago, we were in the midst of a massive 
financial crisis and the largest bailout in our country's 
history. The financial crisis was brought on as much by 
timidity and capture on the part of regulators and Congress as 
it was greed on the part of Wall Street. The Financial Crisis 
Inquiry Commission concluded that Wall Street watchdogs, quote, 
``lacked the political will in a political and ideological 
environment that constrained it as well as the fortitude to 
critically challenge the institutions and the entire system 
they were entrusted to oversee.''
    One Fed supervisor told the FDIC that the Nation's largest 
bank was, quote, ``earning four to five billion dollars a 
quarter. When that kind of money is flowing out quarter after 
quarter, it is very hard to challenge.'' And so that bank's CEO 
famously concluded, as long as the music is playing, you have 
got to get up and dance.
    If we learned anything from the financial crisis, it is 
that we all have responsibility to remain vigilant in our 
oversight of Wall Street risk taking. As we saw so clearly, 
short-term profits can quickly turn into long-term losses. The 
music stopped. The victims were, of course, not just Wall 
Street's bottom lines. The real victims were millions of 
Americans who lost their jobs, who lost their pensions, who 
lost their savings, who lost their homes.
    Four years ago, we overhauled the Nation's financial 
regulations, handing a great deal of power to the Federal 
Reserve. As one Fed official told the Subcommittee in 2011, and 
I quote, ``Improvements in the supervisory framework will lead 
to better outcomes only if day-to-day supervision is well 
executed, with risks identified early and promptly remediated. 
When we have significant concerns about risk management at 
complex firms, we raise those concerns forcefully with senior 
management at the firms, holding them accountable to respond 
and tracking their progress.''
    Six years after the crisis, 4 years after Dodd-Frank, 3 
years after those comments, troubling reports suggest that it 
is back to business as usual at the Federal Reserve Bank of New 
York. Former employees have come forward with troubling reports 
about the examination teams of JPMorgan and Goldman Sachs, two 
of the Nation's largest, most complex banks. ``Legal but shady 
transactions,'' quote-unquote; examiners engaged in an internal 
struggle; expertise that is not valued; low morale; all reports 
coming out from the examination teams; financial reform that 
ends up in a vacuum, and examiner told to ``bite her tongue;'' 
an institution that is like a giant Titanic, slow to move; a 
decision-making process that grinds everything to a halt; 
examiners being stonewalled by their supervisors, all direct 
quotes from these reports.
    Yesterday, we learned of another example of the revolving 
door at work, a New York Fed examiner leaving to work at 
Goldman Sachs, then receiving confidential information from his 
old colleague. It is no wonder that Wall Street always appears 
to stay one step ahead of the sheriff. It is bad enough when 
banks can capture the agencies that regulate them or the 
Congress, which is all too often the case, also, that oversees 
those agencies. It is worse when they do not even have to 
because the agencies handcuff themselves or public servants 
attempt to curry favor with the companies which they supervise.
    These recent reports should trouble any organization, but 
they are particularly catastrophic when the agency in question 
is responsible for four megabanks, four of the six largest 
banks in our country, four megabanks that alone account for $6 
trillion in assets in some 11,000 subsidiaries. These banks 
operate in an average of 65 countries--65 countries. And a 
recent report by the Federal Reserve's Inspector General on the 
London Whale incident reinforced risky trades in a London 
office supervised by the New York Fed can reverberate back to 
our country.
    With all of its resources and its new authority, is the 
Federal Reserve up to the task of regulating financial 
institutions that are so large and complex? That is the 
question. Or, are these Wall Street banks simply too big to 
regulate? We talk about too big to fail. Are they too big to 
manage? Are they too big to regulate? All important questions.
    I would be interested in hearing Mr. Dudley's thoughts, 
especially on the question of are they too big to regulate, 
because the damage from the failure of any of these 
institutions, as we know, is not contained to Wall Street. It 
is also felt most acutely on Main Street. That is why it is so 
important that examiners and supervisors and regulators 
remember that their job is to serve the public, to serve Main 
Street, not the banks they oversee. That is why the Fed must 
put its financial stability mission on an equal footing with 
monetary policy, which has consistently, at least from many 
observers, been the problem, that the financial stability 
mission needs to be on an equal footing with monetary policy.
    Congress and Dodd-Frank created a Vice Chair for 
Supervision at the Federal Reserve in this city, but by failing 
to even nominate someone to this position, the message that is 
sent from the President to the Board, to the supervisors, is 
that financial regulation is secondary. According to my 
research, the Reserve Banks are still dominated by monetary 
policy experts. Only two of the 12 Fed Reserve Bank presidents 
around the country--only two of the 12 have any background in 
supervision.
    We are here today because of issues raised by Carmen 
Segarra. She has done--and she is here today, welcome--and she 
has done a public service in bringing them to light. The 
question for all of us is what we are going to do about them. 
Will we simply talk and move on, or will we do something?
    I thank the witnesses for being here. I thank Senator 
Toomey, his staff. He could not join us today. I thank the 
Committee staff, other Members of the Subcommittee, for working 
with us.
    I yield to Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, Mr. Dudley, for joining us today. Let me commend the 
Chairman and the Ranking Member for holding this hearing. It is 
very important.
    In 2007, 2008, we discovered that there were systemic flaws 
in the regulatory structure of the United States and we tried 
to address those flaws in the Dodd-Frank legislation. We made 
some progress. But, one of the issues that was supported by my 
colleagues in the Senate but did not survive a conference with 
the House was requiring that the President of the New York 
Federal Reserve Bank be nominated by the President of the 
United States and confirmed by the Senate. I think that is 
appropriate and obvious. It does not have anything to do with 
personalities, because 4 years ago, I thought it was 
appropriate and responsive.
    The fact is, the New York Fed is one of the biggest 
regulators of financial institutions in the United States and 
the only one that does not directly or indirectly have the 
thoughtful review by the Congress, the Senate, and the initial 
nomination by the President of the United States, and I just do 
not think that makes sense. So, I reintroduced the legislation 
and we are going to pursue it. I hope in this context, it will 
be successful.
    And, it just strikes me, being from New England, I think 
these are lines originally attributed to Robert Frost, which is 
``Good fences make good neighbors.'' And, frankly, the 
perception today and the perception 4 years ago is there are no 
fences between the New York Fed and the banks they regulate, 
and that perception is wrong and we are here to see whether or 
not there is something we can do positively about that.
    Thank you, Mr. Chairman.
    Chairman Brown. Thank you, Senator Reed.
    Senator Merkley.

               STATEMENT OF SENATOR JEFF MERKLEY

    Senator Merkley. Thank you very much, Mr. Chairman.
    Six years ago, when I came here, we were in the middle of a 
tremendous economic collapse due to the process in which there 
had been a huge surge in teaser rates, subprime mortgages, with 
kickbacks that went to mortgage originators, sizable kickbacks 
if they would steer their customer from a prime loan they 
qualified into a subprime. The responsibility for the oversight 
of this was in the Federal Reserve, and, indeed, monetary 
policy had been put in the penthouse, consumer protection had 
been put in the basement, and it as if the doors had been 
locked and the keys had been thrown away, and the result was a 
not only enormous direct harm to millions of families across 
the country, but eventually a collapse of the entire economy.
    And, I look at various issues that keep arising, whether it 
is manipulation of LIBOR rates, or whether it is the deep 
conflict of interest in which large banks have both extensive 
commodity holdings and are able to affect the supply and demand 
of those holdings at the same time that they are making bets on 
the prices of those, and I just see a regulatory system that--I 
guess a polite version would be to say it is passive or asleep, 
but certainly we are not seeing anything close to a rigorous 
accountability for conflicts of interest and failures of 
oversight.
    And, so, I am just very interested in hearing your thoughts 
today and look forward to the important discussion that should 
follow on from that. Thank you.
    Chairman Brown. Senator Manchin, who is not a Member of the 
Subcommittee, he is a Member of the full Committee, and thank 
you for your interest in joining us.

              STATEMENT OF SENATOR JOE MANCHIN III

    Senator Manchin. Thank you, Mr. Chairman. I appreciate very 
much you giving me the opportunity and the courtesy to join 
your Subcommittee today.
    I've often said that Government needs to act as a partner, 
not an adversary, when it comes to boosting our economy. But, 
the Government also needs to protect consumers with the tools 
given to it by Congress. It is a difficult balance to strike, 
but when regulators fail to do so, we all suffer.
    In my great State of West Virginia, regulators have often 
gone too far on several issues. Too often, it fails to strike 
the proper balance, leading to a regulatory overreach that 
handcuffs industry and the people of my great State suffer. 
Today, we are discussing a failure at the opposite end of the 
spectrum, but the result is the same: Main Street suffers.
    The Federal Reserve is tasked with supervising the Nation's 
largest banks and is our first line of defense against another 
financial crisis. Yet, we have seen time and again the Fed has 
failed to strike the proper balance when regulating these large 
firms. The most obvious example is the 2008 financial crisis, 
from which we are still recovering. Their inability to properly 
regulate the banks led to an economic catastrophe. Despite 
passing Dodd-Frank and promising Americans that this would 
never happen again, can we really say we have learned our 
lesson? Have the regulators really learned their lessons?
    Recently, a former Goldman employee released secret 
recordings that confirm many of our suspicions, that the Fed is 
too cozy with the very banks where tough oversight is needed. 
Her recordings laid out how her supervisors wanted the 
employees to soften her findings for fear of disappointing the 
large bank they are supposed to oversee. The Fed Office of the 
Inspector General provided additional proof of these concerning 
relationships when it concluded that lax supervision 
contributed to the London Whale incident at JPMorgan that 
resulted in almost $6 billion in losses. Both the recordings 
and the trading losses happened in 2012, just 4 years after the 
Great Recession. It seems little has changed and few lessons 
have been learned.
    I am encouraged that the Fed announced yesterday that it 
would revise its supervisory standards and think more about how 
to deal with employees who have divergent views. That is a long 
time coming.
    But, we have an opportunity to do more. That is why I 
teamed up with my good friend, Senator Warren, in penning an 
editorial asking the President to nominate candidates to the 
Board of Governors with experience investigating big banks and 
distinguishing between the greater risk posed by the biggest 
banks relative to community banks.
    I understand the need for regulators who have industry 
experience and banking experience. New York Federal Reserve 
Governor Dudley's, qualifications are unquestioned. We know 
that, with your expertise and your background, that your 
contributions have been valuable and we appreciate that. But, 
you worked at Goldman Sachs for over 20 years, attained the 
coveted title of partner, and was its Chief Economist.
    But, Governor Dudley is not the only Goldman employee at 
the New York Fed not by a longshot. In fact, I would hazard 
that the big bank alumni network at New York Fed is quite 
extensive. When a banking regulator hires mostly people who 
work at Goldman or JPMorgan or Morgan Stanley or any of the six 
largest banks they are tasked with overseeing, is it any 
surprise that the culture at the Fed is poor at supervising 
these very institutions that they once worked for?
    As Senator Warren and I have said, the stakes could not be 
higher. With the proper supervision, we might have averted the 
2008 crisis that cost so many people on Main Street in America 
their jobs and wiped out over a decade of economic success. We 
owe it to the American people to learn from our mistakes and 
ensure we never put them in that position again.
    My little State consists mostly of community banks, as you 
know, and they are getting hit hard now by the overreach, if 
you will. All the problems started with the banks that the Fed 
is tasked to oversee, and we would hope that you would take 
that to heart and look at ways that you can find people with 
diverse, not special interests, but diverse interests to do 
that job.
    Thank you, sir.
    Chairman Brown. Thank you, Senator Manchin.
    Senator Warren.

             STATEMENT OF SENATOR ELIZABETH WARREN

    Senator Warren. Thank you, Mr. Chairman.
    We need bank regulators who work to protect the American 
people, not the profits of giant banks, and that is what this 
hearing is about today. I want to thank you, Mr. Chairman, for 
holding this hearing, and I want to thank my colleagues for 
being here. I want to thank my friend, Senator Manchin, for our 
work together on trying to focus on the Fed, the Fed nominees, 
and the role of the Fed, not just in monetary policy, but in 
supervising the largest financial institutions in this country.
    I am looking forward to our getting to the questions, so 
with that, I am going to yield back the remainder of my time.
    Chairman Brown. Thank you, Senator Warren.
    William Dudley is the tenth President and Chief Executive 
Officer of the Federal Reserve Bank of New York. Mr. Dudley 
served as the President of the Markets Group at the New York 
Fed from 2007 to 2009. Before that, as Senator Manchin said, he 
was Chief Economist at Goldman Sachs. He worked at Goldman 
Sachs for 21 years.
    President Dudley, welcome. Please proceed.

 STATEMENT OF WILLIAM C. DUDLEY, PRESIDENT AND CHIEF EXECUTIVE 
           OFFICER, FEDERAL RESERVE BANK OF NEW YORK

    Mr. Dudley. Thank you. Chairman Brown and Members of the 
Subcommittee, thank you for this opportunity to testify on the 
effectiveness of financial institution supervision and the 
issue of regulatory capture.
    In 2008 and 2009, our country faced its worst financial 
crisis since the Great Depression. At the Federal Reserve, the 
crisis raised two fundamental questions. First, how can we 
improve the stability of the financial system? And, second, how 
can we improve our supervision of financial institutions?
    Due in large part to our efforts, the financial system 
today is unquestionably much stronger and much more stable now 
than it was 5 years ago. In the area of bank capital, new 
regulations, including Basel III standards and periodic stress 
tests, such as the Comprehensive Capital Analysis and Review, 
or CCAR, have increased both the quantity and quality of equity 
capital at the largest financial institutions we regulate and 
supervise. Since these stress tests commenced in 2009, the 
largest banks have more than doubled their Tier I capital. 
Firms that fail our tests face severe consequences, including 
restrictions on the payment of dividends and share buy-backs.
    The Federal Reserve has also imposed new liquidity 
regulation and stress testing and has put more focus on 
corporate governance, not only policies and procedures, but how 
risk decisions are actually made. We have also increased public 
and nonpublic enforcement activity, including fines and 
restrictions on the growth of banks with poor risk management. 
And, we assisted in the recent criminal pleas by Credit Suisse 
and BNP Paribas, which ended the concept of ``too big to 
jail.''
    We also placed greater emphasis on the reform of banker 
conduct. I have proposed four specific reforms to curb 
incentives for illegal and unduly risky behavior. First, 
increase deferred compensation for senior managers and material 
risk takers.
    Second, impose de facto performance bond on bank employees 
for the payment of fines funded through this deferred 
compensation.
    Third, create a database of bank employees dismissed for 
bad behavior.
    And, fourth, ban any banker convicted of a crime of 
dishonesty from the financial system, both the regulated and 
shadow banking sectors.
    The process of supervision has changed in several important 
respects since the crisis. Consequential supervisor decisions 
are now made on a systemwide level through the Large 
Institutions Supervisory and Coordinating Committee, or LISCC. 
LISCC is comprised of representatives from across the Federal 
Reserve, including several other Reserve Banks and the Board of 
Governors. The New York Fed supplies only 3 of its 16 members. 
Through its Operating Committee, the LISCC coordinates the 
supervision of the largest supervised institutions. These 
committees promote objectivity by ensuring that no Reserve Bank 
and no one person has the power to make a final decision on 
important supervisory matters.
    We have also increased our use of crossfirm horizontal 
review. This technique facilitates a better assessment of the 
financial system's health and safeguards against regulatory 
capture by providing insight from examiners assigned to many 
different institutions.
    And, we reorganized the New York Fed's Supervision Group to 
enhance the effectiveness of our supervision. Many of the 
changes directly reflect the recommendations in a 2009 report 
that I commissioned from David Beim. For example, we reassigned 
senior personnel to front-line positions at the largest 
supervised institutions. We increased training for all managers 
in supervision. We hired more risk specialists and business 
line specialists. We continue to require that examiners rotate 
to another institution after 3 to 5 years. And, we have taken 
concrete steps to encourage examiners to speak up, which is now 
a factor in their annual performance reviews. We created 
programs to encourage peer recognition of innovative ideas. 
And, we require examination teams to spend more time at the New 
York Fed headquarters. This helps facilitate communication 
between our senior management and examiners.
    Before concluding, let me share my view of what we should 
expect from bank supervision. Supervision must be fair, that 
is, applied consistently across the firms we supervise. We all 
need to know the rules and follow the same rulebook. 
Supervision must be conscientious. This means we must be 
committed to sustained self-improvement. To this end, we will 
be working with the Board of Governors as it reviews whether 
the LISCC Operating Committee receives all material information 
necessary to reach sound supervisory decisions. Finally, 
supervision must be effective, which means being tough on banks 
that demonstrate illegal, unsafe, or unsound practices. A good 
measure of our effectiveness is the improved strength and 
stability of banks since the financial crisis.
    The Federal Reserve cannot prevent all illegal or otherwise 
undesirable conduct at banks, but we can help create more 
resilient, less complex, and better managed organizations and a 
more stable financial system. Of course, we are not perfect, 
but we always strive to improve and to retain your trust.
    Thank you again for this opportunity to speak with you. I 
look forward to taking your questions.
    Chairman Brown. Thank you very much, President Dudley. I 
appreciate your testimony and appreciate the discussions we 
have had over the last number of years.
    You have been in this job, more or less, for 6 years now, 
5\1/2\ years. The public confidence still--you said it has been 
put to rest, the too big to jail. I am not sure that the public 
would really believe that or agree with that. I think that I 
heard you say that all your staff, including you, go through 
annual ethics training. I hear a pretty sunny description in 
your testimony of conditions now, even though public confidence 
in Wall Street has not grown particularly since 2009, even with 
Dodd-Frank and the improvements that we have made.
    So, three stories in the last 6 weeks have laid out clear 
issues at the New York Fed, three stories in just the last 6 
weeks. They identify issues that do not appear to be isolated 
incidents. So, tell us--or, do you agree these are serious 
problems that cause troubling questions still about the New 
York Fed, about the work environment there, about its relations 
with Wall Street? Are these serious problems that raise 
troubling questions or no?
    Mr. Dudley. I think the issue of regulatory capture, 
Senator, is a serious issue and one that we always have to work 
to guard against. I think that the Federal Reserve employees at 
the Bank of New York that I have worked with for 6 years act in 
the public interest. I think that we should be judged on where 
the banking system is today compared to where it was 6 years 
ago. A lot more capital, a lot more liquidity, significant 
improvements in risk management, empowering the professionals 
in the organizations to take on the business line revenue 
producers. So, I think we have made a lot of progress.
    Does that mean that we are where I want to be? Absolutely 
not. I recently gave a speech on bank culture, and I think the 
bank culture needs to be improved significantly. I think there 
are a number of things that we can do in that space to improve 
incentives, to get the behavior that we absolutely require from 
the banking industry.
    Chairman Brown. It strikes me that when the most recent 
incident with the Goldman employee and the former employee of 
the Fed, that they pretty surely engaged in illegal activity, 
and I wonder what kind of environment, when you rightly--I 
mean, you talk about the ethics training, you talk about the 
fact that they know these things are illegal. You say that too 
big to jail is a thing of the past. It just does not seem to a 
lot of us that the environment there speaks very strongly to 
that kind of behavior.
    Let me shift to another issue quickly. In the September 
ProPublica story, you hear Mr. Silva and Ms. Segarra struggling 
to define their roles as supervisors in the Santander 
transaction. In your statement, you said effective supervision 
means tough supervision. What exactly does that mean? How do 
you define that mission for supervisors and examiners, tough 
supervision?
    Mr. Dudley. I would define tough supervision as, obviously, 
resisting any notion of regulatory capture. In the Banco 
Santander case, which was part of that story, we did a very 
detailed vetting of that issue. We followed up with the Bank of 
Spain to see what their views were on the transaction. They had 
no objection. We evaluated whether the transaction was going to 
cause significant reputational harm to Goldman Sachs, it was 
going to cause problems for them in terms of their ability to 
operate. The transaction was judged by our Legal Department to 
be legal and it was publicly disclosed. And, as a consequence 
of all those things, we did not prevent the transaction from 
going forward.
    What we did do with respect to Goldman Sachs in that case 
was we made it very clear that the implication that we were 
somehow approving the transaction was false and that they need 
to clarify with Banco Santander that in no way had we approved 
the transaction. And, we also required them to go back and 
establish clearly to us that in no other cases were they 
representing that transactions were occurring with the Fed's 
blessing. We in no way think that it is appropriate for a firm 
to imply that we are warranting what they are doing when that 
is not the case.
    Chairman Brown. Your language was not approving--you were 
not approving the transaction, but--that was your language, my 
language--but you let it go. Senator Reed in his opening 
statement said that the Federal Reserve--that the New York Fed 
is one of the most powerful regulators in the United States. I 
would amend it to say one of the most powerful regulators, 
economic regulators, in the history of the world, maybe, but 
certainly in the world.
    So, I want to go back and talk about that. A decade or so 
ago, the former head of the Fed's Banking Supervision and 
Regulation Division was testifying about Enron and they said 
that banks should not, quote, ``engage in borderline 
transactions that are likely to result in significant 
reputational or operational risk to the banks.'' That was in 
2002.
    In 2012, 10 years later, Mr. Silva described the Santander 
deal as ``legal but shady,'' his quote. The supervision team 
believed it was window dressing. The lawyer said it was not 
clearly illegal. The Bank of Spain did not object. So, there is 
nothing that they, as regulators, could do. So, while you did 
not approve it, you let it go.
    So, the question is, who is responsible for the Fed's 
deteriorating standards of, quote, ``no borderline 
transactions'' to ``legal but shady''? I mean, no borderline 
transactions is pretty clear. Legal but shady, well, then that 
is--is there--I mean, why the deterioration of that standard? 
Why the lower standard today?
    Mr. Dudley. I do not think the standard has been lowered at 
all. The transaction was fully vetted. We followed up with the 
Bank of Spain. We made an assessment of whether this posed a 
threat to Goldman Sachs' reputation and ability to operate, to 
their safety and soundness, and concluded that that did not 
reach the threshold in this particular case.
    Chairman Brown. Thank you.
    Senator Reed.
    Senator Reed. Well, thank you very much, and thank you, Mr. 
Dudley, for your testimony.
    You know, I picked up on one of your comments which you 
said, I think, completely--with complete sincerity, which is we 
have to resist any notion of regulatory capture. I would 
suggest the very definition of regulatory capture is when the 
regulated entities choose the person to regulate them, and that 
is essential what they do with you, and not just you, but your 
predecessors. And, that is why I think it is essential to do 
what we tried to do in Dodd-Frank, which is to move the 
selection of the President of the Federal Reserve Bank of New 
York out of the industry in New York and do as we do for 
Governors of the Board, make them subject to nomination and 
confirmation.
    In addition to your regulatory powers supervising these 
institutions, you are a member of the Open Markets Committee. 
You are the only member that is not nominated and confirmed, 
and yet you serve on that. You also are the Vice Chairman, 
which gives you more powers, all of that insulated from the 
review by the President and by the Congress.
    And, I think it goes to the very essence of what we are 
talking about here today and what I commend you for trying to 
change, which is the culture of the Federal Reserve Bank of New 
York. But, the culture starts at the top, and the perception is 
that you, essentially, were hired by the people you are 
regulating. I think that cultural message goes--permeates 
throughout the entire organization. I do not think it is a 
conscious excuse for people to be less than professional. In 
fact, my contact with the Federal Reserve, your colleagues, 
they are extraordinarily professional. They want to do a good 
job.
    But, this culture begins at the top and it is a culture in 
which you are perceived--and perception sometimes is more 
powerful than any reality--as essentially hired and serving at 
the, if not the will, at least with the influence of those you 
regulate. Do you have a response?
    Mr. Dudley. Yes, I do, Senator. First of all, I am 
definitely not hired and appointed by the people that I 
regulate. The Dodd-Frank Act clearly establishes that the 
selection of the President of the Federal Reserve Bank of New 
York and other Presidents in the Federal Reserve Bank System 
are done by the Class B and C directors, which exclude the bank 
directors. So, the bank directors play no role whatsoever in 
the selection----
    Senator Reed. No direct role.
    Mr. Dudley. No role.
    Senator Reed. No role.
    Mr. Dudley. No role in the selection of the Federal Reserve 
Bank President of New York.
    Senator Reed. Does any governmental entity, any 
representative of the people play a role in your selection?
    Mr. Dudley. Yes, indirectly. The Board of Governors--it is 
a two key appointment process. The Board of Governors, 
excluding the bank directors, makes a recommendation to the 
Board of Governors, and the Board of Governors, who have all 
been appointed by the President, confirmed by the Senate, 
approve the President's selection. If they do not like the list 
that the Board of Directors has sent down to them, they can 
demand a different list. So, it is a two key approach. The 
nonbank directors and the Board of Governors make the 
selection.
    Senator Reed. Well, why, if we have the authority, which we 
do, to select the Board of Governors, should we not--and, by 
the way, we essentially confirm and select every other 
regulator, the Comptroller of the Currency, the Board of the 
FDIC--why should we not have the same authority with you, in 
whom, I would argue, you have more authority, more influence, 
and more impact on every phase of the economic policy of the 
United States than any one of these other individuals?
    Mr. Dudley. Well, I think, Senator, the answer is that it 
is the prerogative of Congress to decide how the Federal 
Reserve Act is written and how the President of the Federal 
Reserve Bank of New York and other Federal Reserve Presidents 
are selected, so I----
    Senator Reed. So, you would have no objection if you were 
subject to confirmation and----
    Mr. Dudley. It is completely up to Congress to decide how 
it works.
    Senator Reed. I agree, and since you do not have any 
objection to that process, I hope you can formally endorse our 
proposal. Thank you.
    Chairman Brown. Thank you, Senator Reed.
    The Federal Reserve Board of Cleveland just chose its new 
Governor and the process, first of all, is unknown to the 
public. It is anything but a public process. It is unknown to 
the public and maybe unknowable to the public. I would guess if 
you asked the 100 members of the Senate, how is a Federal 
Governor in Kansas City or Minneapolis or Atlanta or Dallas or 
St. Louis or Cleveland or Philadelphia or anywhere else chosen, 
or Richmond, they probably would not know and understand, and 
the public input is--I mean, you said indirectly--Senator Reed.
    Senator Reed. If I may, you are selected by the Class B 
directors?
    Mr. Dudley. Class B and Class C.
    Senator Reed. And, how are they selected?
    Mr. Dudley. They are selected--the Class C are selected by 
the--approved by the Board of Governors, and the Class B are 
subject by a vote of the banking--I think of the banking 
authorities----
    Senator Reed. Of the banks.
    Mr. Dudley. But, let us talk about who those people are.
    Senator Reed. I know who they are, sir, and if you want to 
talk personalities, we can. I want to talk about reforming the 
law and the structure of governance.
    Mr. Dudley. I understand. I understand.
    Senator Reed. Your Class B directors are essentially chosen 
by the banks, and that is not lost on anyone. I just want to 
make that point. Excuse me.
    Chairman Brown. OK. I appreciate that. And, you, I am sure, 
say that Janet Yellen and a number of Fed Governors had 
something that was extraordinary in this world, a meeting with 
the public. I guess Governor Powell was there, Governor--who 
else was there--Brainard and Fischer, the new ones. Brainard 
and Fisher were also there.
    And, one of the questions that they had was they come into 
this ornate conference room at the Fed and were, I am sure, 
overwhelmed by that, and then they really expressed their 
understanding of--their lack of understanding of how all this 
comes together, and that sits with us, that responsibility, 
because we have not changed it. There are forces working in 
Congress in far too many cases resistant to that change, but 
more on that later.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair.
    Mr. Dudley, you referred to the Credit Suisse arrangement 
as ending too big to jail. Credit Suisse was involved in an 
operation that involved creating secret offshore accounts in 
the names of sham entities and foundations. How many of the 
names of the Americans who were involved in creating those 
accounts were turned over as part of that criminal prosecution?
    Mr. Dudley. I do not know the answer to that, Senator.
    Senator Merkley. You do not know the answer to that?
    Mr. Dudley. No, I do not.
    Senator Merkley. Well, the answer is none, and can you 
explain why that is?
    Mr. Dudley. I cannot explain why that is, Senator.
    Senator Merkley. That is just a fundamental fact of that 
case that you are presenting as too big to jail. How many of 
the Americans who created these secret accounts were 
prosecuted?
    Mr. Dudley. I do not know, Senator.
    Senator Merkley. Well, the answer is none, because no names 
were turned over.
    Did the information related to that prosecution, which you 
said that shows the Fed is now involved in ending too big to 
jail, did the information come from the Fed that led to that 
prosecution?
    Mr. Dudley. I do not know, Senator.
    Senator Merkley. It is hard to imagine, since the casual 
reader of the newspaper would know that it came from Senator 
Levin's hearings and the report that his committee put out that 
had extensive disclosure that led to this investigation.
    So, the basic information on that case is that hundreds of 
Credit Suisse employees were involved in the scheme to create 
these secret offshore accounts in the name of sham entities. 
So, if we have ended too big to jail, how many of those 
hundreds of the Credit Suisse employees have been indicted for 
criminal activity?
    Mr. Dudley. I do not know the answer to that.
    Senator Merkley. Would you be surprised if the answer is 
zero?
    Mr. Dudley. I would be surprised, probably.
    Senator Merkley. Well, I find it fascinating that you are 
presenting this as the end of too big to jail. How many people 
are actually in jail right now because of that investigation?
    Mr. Dudley. It is the end of too big to jail for the 
corporation, which pled guilty----
    Senator Merkley. But----
    Mr. Dudley. The corporation pled guilty----
    Senator Merkley. You do not put corporations in jail.
    Mr. Dudley. There was no--the argument that was made a year 
ago, or a year and a half ago, was that large financial 
institutions could not plead guilty to crimes because this 
could destabilize those institutions, which could lead to 
problems, and the view was that was unfair because the view 
was, why should these entities be too big to jail? Why should 
they be able to escape guilty pleas because of their size? And, 
I think we have actually set a new precedent over the last year 
where no bank is too big to be found guilty if they have 
committed a crime.
    Senator Merkley. OK, but that does not involve jail. Jail 
involves putting people in jail. I just--I think ordinary 
Americans would find it fascinating that this plea agreement, 
which basically involved a financial payment, a fine, 
constitutes somehow ending too big to jail if nobody is going 
to jail. There may have been some folks who went to jail. There 
were some eight folks 3 years earlier who were indicted. I do 
not know the outcome of those cases, but that would be a small 
touch on this.
    I just think it--is it not ironic that it took a U.S. 
Senate investigation by Carl Levin to provide the facts that 
led to this particular case getting handled?
    Mr. Dudley. I do not have a good way of judging that, 
Senator.
    Senator Merkley. But, you are the regulator. Should not the 
regulator have discovered these facts? Why did it take the U.S. 
Senate Committee to find out the facts if you are the 
regulator? Why did the regulator not find out these facts?
    Mr. Dudley. I do not know the answer----
    Senator Merkley. Does this not indicate you are just asleep 
at the switch?
    Mr. Dudley. I do not--I do not agree with that 
characterization----
    Senator Merkley. Well, then, why did you not find out these 
issues? If the U.S. Senate Committee, long, far removed could 
find out this information, and you have all kinds of people 
daily reviewing the activities, how is it possible you could 
fail to see the information that the U.S. Senate Committee came 
up with?
    Mr. Dudley. Well, for----
    Senator Merkley. Does this disturb you? Do you think there 
needs to be some change in these practices? You presented a 
very glib presentation of everything being wonderful. But, does 
not this set of facts say that maybe there is need for some 
fundamental reform?
    Mr. Dudley. We--Senator, we are continuing to try to see 
how we can do our job better. But, I think, especially for 
foreign institutions where we only have insight into the U.S. 
entity, it is very hard to know what is happening globally. So, 
I would----
    Senator Merkley. But these were activities of the U.S. 
entity. Is that really an excuse, that it is--I mean, this is a 
U.S. subsidiary of the foreign entity. Is that really an 
excuse? I mean, if the U.S. Senate can find out the activities 
of the U.S. subsidiary, can not your regulators, who are there 
on a daily basis, find it out?
    Mr. Dudley. Senator, I think that when we focus on 
supervision, our orientation is toward safety and soundness of 
the firms that we supervise and the financial stability of the 
global financial system. I do not think that we have spent--
ever spent a tremendous amount of resources on issues of tax 
evasion.
    Senator Merkley. Are you familiar with the settlement 
involved granting Credit Suisse an exemption from Federal law 
that requires the bank to hand over its investment advisor 
lists?
    Mr. Dudley. I do believe that they were granted an 
exemption.
    Senator Merkley. OK. Well, it might be an appropriate part 
of the story to present, and also that the plea agreement was 
deliberately announced when the markets were closed. There was 
an awful gentle touch in even how this plea agreement was 
handled, and I just want to have a coherent picture for the 
public to see. Those are parts of the story.
    I will conclude there. Thank you.
    Chairman Brown. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman.
    Thank you for being here, President Dudley. So, President 
Dudley, last month, you gave a speech about improving the 
culture at the big banks and you noted the long list of illegal 
and unethical behavior leading up to the financial crisis and 
its aftermath and you discussed the problem as fundamentally 
cultural. You said, and I am quoting you here, ``The problems 
originate from the culture of the firms and this culture is 
largely shaped by the firms' leadership.'' I agree with you. I 
think there is a terrible cultural problem on Wall Street.
    But, given the long list of supervisory failures at the New 
York Fed, both before and during your tenure as President, 
would you say that the New York Fed has its own cultural 
problems?
    Mr. Dudley. Well, first, I would not accept the premise 
that there has been a long list of failures by the New York Fed 
since my tenure. Our culture, we continue to strive----
    Senator Warren. I have to stop you there, Mr. Dudley. That 
is part of why we called this hearing, is the evidence of the 
failures at the Fed. So, are you saying that these are not 
true? I mean, are you denying the facts that have already been 
reported and established about this?
    Mr. Dudley. Well, first of all, I am not clear that there 
are facts. Number two, let us judge how the financial system is 
today in terms of its safety and soundness. I think you would 
admit that we are in a much better place today in terms of bank 
capital, bank liquidity, the ability of banks to resist 
stress----
    Senator Warren. Mr. Dudley, I am sorry, and I do not want 
to interrupt here, except I would like you to answer the 
question. The question is, do you think--you castigated the 
banks, and I think quite rightly so, the large financial 
institutions, for having serious cultural problems, as you put 
it, in terms of their behavior. The question I am asking you is 
do you think the New York Fed also has serious cultural 
problems?
    Mr. Dudley. I do not think we have serious cultural 
problems to the same degree, but are we perfect? Absolutely 
not. One reason why I commissioned the Beim report in 2009 is I 
thought we could improve how we conduct bank supervision.
    Senator Warren. Right. And, did you carry out the 
recommendations, all of the recommendations of the Beim report?
    Mr. Dudley. I would say that we carried out the vast 
majority of the recommendations.
    Senator Warren. Well, we will have Mr. Beim here to talk 
about how much you carried out the recommendations of the Beim 
report. But, you know, it is interesting to me that you would 
say you do not think there is a problem, because that is 
entirely consistent with where you have been before. I remember 
your immediate reaction to the release of the Segarra tapes, 
and you said, quote, ``I do not think anyone should question 
our motives or what we are trying to accomplish.''
    I want to look back at your speech on bank culture. You 
said there that because culture is largely shaped by the firm's 
leadership, the solution needs to originate from within the 
firms, from their leaders. And, you later said that as a first 
step, senior leaders need to hold up a mirror to their own 
behavior and critically examine behavioral norms at their firm.
    Now, are you holding up a mirror to your own behavior when 
you say that no one should question your motives or what you 
are trying to accomplish?
    Mr. Dudley. I commissioned the Beim report, in part because 
I thought we could do better. I--we have implemented many of 
the--most of the recommendations of the Beim report because we 
thought that would improve how supervision at the New York Fed 
is----
    Senator Warren. And that was in 2009. Here we are in 2014 
with tapes of how the New York Fed is not working. So, the 
question is, are you holding up a mirror to your own behavior?
    Mr. Dudley. I do not accept the characterization that those 
tapes show that the Fed Reserve is not working correctly. There 
are 46 hours of tapes. There was about 10 minutes of those 
tapes that were released. To say that that is sort of the 
definitive record of how the New York Fed conducts supervision, 
I think is just----
    Senator Warren. I am sorry. Surely, you are not going to 
take the position, Mr. Dudley, that if most of the time most of 
what the Fed does is boring or even does its job, that it is OK 
every now and again to throw in 10 minutes of backing people 
off their regulatory duties, of standing up for the banks, of 
overruling those who find problems and say they want to pursue 
them. You think that is not a problem if the rest of the time 
you are doing your job?
    Mr. Dudley. I have no way of assessing how accurate that 10 
minutes is because I have had no access--I have had no ability 
to listen to the full 46 hours of tapes.
    Senator Warren. It----
    Mr. Dudley. So, I have no idea of--I have no idea of 
assessing whether those 10 minutes are reflective of what is 
going on at the New York Fed or whether they are a snippet that 
distorts what is the situation at the New York Fed. That is 
point number one.
    Point number two is, look at what we did----
    Senator Warren. I am looking at what you did.
    Mr. Dudley. The allegation----
    Senator Warren. You backed up----
    Mr. Dudley. The issues raised----
    Senator Warren. When Goldman was unhappy----
    Mr. Dudley. The issues----
    Senator Warren. ----you told the lead investigator to back 
up.
    Mr. Dudley. The issues raised in those tapes that were on 
the NPR story, Banco Santander, conflicts of interest, were 
fully vetted by us. The record shows that we fully vetted those 
issues. We did not--we did not repress them. We did not table 
them. We investigated those issues.
    Senator Warren. Mr. Dudley, you castigated the large 
financial institutions for having a cultural problem, and I 
believe in your speech you described that cultural problem as 
what is wrong internally that would cause them to end up in a 
place where many of them broke the law, where many of them took 
on incredible risks that threatened to bring this economy all 
the way to its knees. And, I am asking you the same kind of 
question. You want the big financial institutions to hold up a 
mirror and look at their behavior, because, you say, otherwise, 
we are not going to get a change. You say that change has to 
start at the top, with the leaders of those institutions.
    Well, you are the leader of the New York Fed. We have here 
a description from Senator Merkley of a hearing that has been 
conducted by the Senate that manages to find serious problems 
in the large financial institutions that were not uncovered by 
the New York Fed, and the question is, why not? You had first 
supervisory responsibility. That was supposed to be the full-
time job of the New York Fed, but you gave a pass on it. We 
have got on tape higher-ups at the New York Fed calling off the 
regulators.
    And, I am just asking the same kind of question. Is there a 
cultural problem at the New York Fed? I think the evidence 
suggests that there is, and I would go to the point that you 
made when you were talking to the big financial institutions. 
Change has to come from the top and it has to go all the way 
through the institution. Without that, the Fed is not able to 
do its job.
    You know, we have to remember----
    Mr. Dudley. I agree with you. I agree with you on that.
    Senator Warren. Well, I am glad you agree with me on this--
--
    Mr. Dudley. I agree with you on that.
    Senator Warren. ----but either you need to fix it, Mr. 
Dudley, or we need to get someone who will.
    Thank you, Mr. Chairman.
    Chairman Brown. Thank you, Senator Warren. There will be at 
least another round for all of us.
    Senator Warren. Thank you.
    Chairman Brown. An interesting set of questions from all my 
colleagues. Senator Merkley mentioned a Levin hearing. I want 
to mention another Levin hearing that is actually going on 
today about commodities. Yesterday, he had people from Goldman 
in. Today, he has others concerning banks' involvement in 
commodities and infrastructure. One of the banks you regulate 
has 35 electric companies, 100 oil tankers, I believe 35 
electric companies. You are responsible at the New York Fed--
the banks that are most in commodities are, of the six largest 
banks, are pretty much concentrated in the four banks that you 
regulate in New York City, so the responsibility for day-to-day 
supervision of these holding companies that engage in the vast 
majority of these activities. Should banks be engaged in these 
activities and investments?
    Mr. Dudley. I think there are serious questions of whether 
they should be. You know, really two things that I think are 
relevant. One are--is the amount of potential risk they are 
taking. You know, an Exxon Valdez or a BP oil well blowout, if 
that were to happen where a major U.S. financial institution 
had an interest, either directly or indirectly, could lead to 
very large losses for that institution. So, that concerns me.
    And, the second thing that potentially concerns me is are 
the banks able to do this business with less capital than what 
a nonbank entity would be required to actually carry out this 
business.
    So, this is something that the Federal Reserve is looking 
at very intently. We put a comment out for--we have a proposal 
out for comment. The comments have come back, and I expect you 
will hear more from us relatively shortly.
    Chairman Brown. You said this raises serious questions. 
Were you, President Dudley, was the New York Fed raising these 
questions prior to the New York Times article of, I believe, a 
year and a half ago about Detroit Metro Aluminum? Were you 
asking those questions before they did?
    Mr. Dudley. Well, I cannot address the specific question of 
Metro Aluminum, but as you look----
    Chairman Brown. Let me back up.
    Mr. Dudley. If you----
    Chairman Brown. Not Metro Aluminum, but were you asking 
questions about any of the--the Metro Aluminum, in essence----
    Mr. Dudley. We were----
    Chairman Brown. ----published story about all the 
commodities. Were you----
    Mr. Dudley. We were looking at this commodity question----
    Chairman Brown. What questions were you asking about----
    Mr. Dudley. And, if you look at the report that came out of 
Senator Levin's committee, there are a lot of references to the 
work that was actually done by the New York Fed that was 
looking at the operations of these entities. So, this is 
something that very much has been on our radar screen.
    Chairman Brown. Yes. I am glad to hear that. But, I guess, 
maybe that is our fault, but I do not remember hearing much 
about activities of the Fed questioning or regulating or 
looking into that. It sort of begs the question--in Michael 
Silva's words, he said your examiners are reined in by Federal 
Reserve lawyers and economists. The Levin report on this 
documents an example of JPMorgan using an aggressive legal 
interpretation to allow them to exceed by more than 100 percent 
the cap on commodities exposure.
    You mentioned the capital they hold and the huge risks. 
Morgan Stanley's CEO told employees an oil tanker spill, one of 
the shipping units, is a risk we just cannot take. Some of them 
evolved into that. Some of them are digging in, and the capital 
they are holding, it is questionable whether it really is 
adequate capital, depending on the interpretation of the 
quality of the capital. We know that. You suggest that.
    But, as I said, the Levin report documents an example with 
the aggressive legal interpretation to allow them to exceed, 
dramatically exceed the cap on commodities exposure. Fed 
lawyers said that Morgan's interpretation was permissible, they 
did not object, despite the fact that JPMorgan's interpretation 
made New York Fed examiners very concerned. So, it goes back, 
perhaps, to the culture at the Fed in New York. It goes back 
to--I mean, fundamentally, the question, why are risk-averse 
lawyers who are unwilling to challenge banks' risky practices 
taking precedent over examiners who are trying to do their 
jobs.
    Mr. Dudley. I do not know the specifics in this case to be 
able to give you a good answer. Obviously, the--my personal 
view is it is not just the letter of the law, it is the spirit 
of the law that we should expect firms to conform to.
    Chairman Brown. And, from your observations, from your 
management seat at the Fed and your history there, both in your 
prior job and this job over the last 6, 7 years, from your, I 
assume--you are a very well-read man. I assume you have 
followed this pretty closely on the commodities issue. You know 
the risk on oil tankers. You know the risk on electricity 
generation. You know the risk on some of the ownership, they 
are a broad, broad ownership. Some of the banks that you 
regulate have acknowledged the risk and are starting to get out 
of it. You know what Federal law is on capital standards and 
what the cap is. So, I mean, how do you justify that these 
lawyers are overruling these examiners trying to do their jobs?
    Mr. Dudley. The point I would make is that this is 
something that the Federal Reserve is looking at very, very 
closely. That is why we went out for comment on this. And, we 
are evaluating it, evaluating some of the issues that I 
mentioned, and I would say, stay tuned.
    Chairman Brown. Does it trouble you that Goldman Sachs 
yesterday in Senator Levin's committee, when, I mean, Goldman 
Sachs was defended by some of my colleagues, as they always are 
here in some venue, but Goldman really dug in. Does it bother 
you that they dug in and perhaps doubled down on their 
ownership of these commodities?
    Mr. Dudley. I do not know. I did not hear the testimony, so 
I do not know the specifics to be able to fairly comment on 
them, Senator.
    Chairman Brown. OK. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chairman.
    Mr. Dudley, in 2009, a team of experts from across the Fed 
recommended that the New York Fed conduct a, quote, ``full 
scope examination'' of the JPMorgan unit that was later 
involved in the London Whale. When you got that recommendation 
in 2009, did you act on it?
    Mr. Dudley. First of all, that was not a recommendation 
that came up to me for my approval. In 2009, there were a lot 
of demands on the New York supervision staff at JPMorgan and 
the prioritization was--the decisions on the prioritization 
were made not to pursue the examination of the CAO because of a 
lack of resources, given all the other things that we were 
engaged in, for example, the SCAP, and in 2010, the first 
Comprehensive Capital Analysis Review process. So, a lot of 
competing ideas about what to examine. We try to prioritize 
those on the way that we think makes the most sense. After the 
fact, you know, with the benefit of hindsight, one could 
reasonably say, well, why did we not tackle that, and I think 
that is a criticism that is always going to be there when 
something goes awry.
    I would point out that the activities of the London Whale 
took place in the bank, in London. The OCC has said publicly 
that this was their primary responsibility. But, the most 
important thing I would stress is that JPMorgan had sufficient 
capital and liquidity resources, so when they announced the 
losses associated with the London Whale, there were no negative 
consequences to the bank's ability to provide credit to 
households and businesses. The bank's ability to do what it 
needs to do to support the U.S. economy was not impaired at 
all----
    Senator Merkley. That is a different question, so let us go 
forward here.
    In 2009, there was also an internal New York Fed report 
that found that supervisors at the New York Fed were too 
reluctant to criticize Wall Street, hindering its ability to 
spot and eradicate problems. Based on that internal report back 
in 2009, what actions did you take to change the culture of the 
bank?
    Mr. Dudley. We took many, many actions as a response to 
that report and also other judgments that we made. Number one, 
we dramatically upgraded the senior supervisory officers that 
interact with the bank's senior management and board of 
directors.
    Number two, we established business line specialists that 
really looked at the issue of how do these banks make money and 
what risk do they take to make the money that we do. We 
embedded the risk specialists in the examination teams so that 
they were more involved with the bank and understood the bank's 
risk taking activity on credit, liquidity, operational risk. 
There is a whole series of changes that were made, I think, to 
improve the effectiveness of supervision by the New York Fed 
and in the Federal Reserve System.
    Another big change was the creation of the LISCC, so a 
systemwide committee to review all of the big firms, looking at 
them on a crossfirm basis, so not relying just on the judgment 
of the supervisory team at one specific bank, but comparing 
their findings with the findings at other institutions. The 
stress tests that were imposed was also a very important 
crossfirm exercise to understand better how--not how is this 
firm doing absolutely, but how is it doing relative to its 
peers and where could it actually improve its performance. So, 
I think there are a lot of changes that we made in response to 
the financial crisis that have made our supervision more 
effective.
    Senator Merkley. Well, I did not actually ask the question 
you are answering. I was asking specifically about the internal 
report which says supervisors were too reluctant to criticize 
Wall Street. And, so we have a pair of bookends. We have the 
2009 report, which occurred during your first year. Now, we 
have the other end of the bookend, basically, these tapes which 
show, at least on one 10-minute instance, substantial 
supervisory input saying, go easy on the banks. It does not 
look like much changed between 2009 and 2014, but perhaps we 
will get the chance to explore that further.
    Let me turn to this fundamental question on commodities. 
The real concern here is, and you will recall the New York 
Times series that looked at the series of warehouses that 
Goldman Sachs had across the country. Is there a fundamental 
problem for a very large bank--there are few institutions in 
the world that have enough money to be able to essentially 
influence the supply and demand of products--but, is there a 
fundamental problem for banks to be able to trade on the price, 
if you will, the value of commodities at the same time that 
they own so much of the delivery system, or control so much of 
the delivery system that they can affect supply and demand? Is 
that a problem, or do you see that as simply, no, that makes 
money for the bank. Therefore, it makes it safer and sounder 
and that is a good thing. Are you arguing that that is the 
case, that that is a good thing?
    Mr. Dudley. I do not think you would ever want a situation 
where the commodity market prices was anything less than fully 
competitive. So, I do not think you would ever want a situation 
where one entity had such a big role in the market that they 
were actually influencing the price of the commodity.
    Senator Merkley. Well, this is happening regularly. We have 
banks that control pipelines. We had JPMorgan involved, and 
paid a big fine for it, for trying to control and having an 
influence over the electric markets, kind of Enron style. We 
certainly have this case of these aluminum warehouses. So, if 
you think that that is inappropriate, what are you doing to 
advocate an end to this fundamental conflict of interest?
    Mr. Dudley. Well, I think that there is no question that if 
banks are found that they are actually manipulating prices, 
they should be prosecuted for that, and the New York Fed has 
basically been shining a light on the whole commodity space 
over the last few years, doing a lot of work here to understand 
what the risks are and what the threats are to financial 
stability.
    Senator Merkley. Is it your recommendation today that the 
Fed aggressively require divestment of commodities by banks 
that are also trading in the price of those commodities?
    Mr. Dudley. Well, that is certainly not a recommendation 
for me to make. It is a decision for the Board of Governors, 
and I think you will be hearing from the Board of Governors on 
this issue relatively soon.
    Senator Merkley. But, if the Board of Governors was to ask 
your advice--I mean, you are definitely part of the Fed--what 
would you say to them? They are turning to you for advice. Is 
this a good thing that this is allowed? Because, I can tell 
you, I have had conversations with different members of the 
Board of Governors and they say, well, you know, it is kind of 
grandfathered, and, well, we do not want to get too involved in 
it----
    Mr. Dudley. Well, I would say two things----
    Senator Merkley. ----and are you saying there is no 
problem, or is there a problem?
    Mr. Dudley. I would say two things. One, we do have to be 
concerned about the commodities activities that expose the bank 
to the risk of very large losses. So, the tail risk problem, I 
think, is a completely legitimate issue that we need to care 
about. We do not want a bank to get into trouble, because they 
decided that they had to be in the physical commodities 
business. So, that is number one.
    And, number two, I do not think we want anywhere in the 
financial system, in the commodities space, be it a regulated 
bank or someone else, that has the power to actually manipulate 
commodity prices. So, I think that applies not just for banks, 
but for any entity participating in the commodity markets.
    Senator Merkley. Thank you.
    Chairman Brown. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman.
    So, I want to ask a simple question. How would you describe 
the New York Fed's supervisory responsibilities? What are you 
supposed to do and what are you not supposed to do?
    Mr. Dudley. Well, I think of it as the Fed's supervisory 
responsibilities are mainly about ensuring the safety and 
soundness of the institutions that we supervise, in other 
words, that they have sufficient capital, sufficient liquidity, 
good corporate governance, good risk management systems, that 
the risk managers are on par with the revenue generators, in 
other words, they actually have clout in their organizations--
--
    Senator Warren. Good----
    Mr. Dudley. ----that the banks have good culture----
    Senator Warren. Good, and good culture. Good. So, I just 
want to break that down a little bit about what safety and 
soundness means. Are there bank transactions that are perfectly 
legal but that could threaten the safety and soundness of a 
bank or of the broader financial institution?
    Mr. Dudley. I think that there are financial transactions 
that could pose reputational risk to the bank, that could 
damage the bank, and I think those type of transactions would 
need to be evaluated.
    Senator Warren. I am sorry, need to be evaluated. The 
question is, are there activities that are perfectly legal but 
that could pose a risk under safety and soundness and, 
therefore, should be shut down?
    Mr. Dudley. If the reputational risk were potentially large 
enough to threaten the integrity of the institution or----
    Senator Warren. That was the question, to threaten the 
safety and soundness.
    Mr. Dudley. I think--I think that is certainly a 
possibility.
    Senator Warren. OK. So, illegality is not the test. The 
test is what threatens the safety and soundness, and it is 
possible to have an activity----
    Mr. Dudley. I think it is possible.
    Senator Warren. ----that is perfectly legal----
    Mr. Dudley. I think it is possible.
    Senator Warren. ----but that threatens the safety and 
soundness, either of the financial institution or of the----
    Mr. Dudley. I think it is possible.
    Senator Warren. ----or of the larger financial system. OK. 
Good. So, what about a transaction that does not threaten the 
safety and soundness of the bank, but is arguably illegal? That 
is, the Fed would have a credible argument that the transaction 
is illegal, but the bank might be able to show in court that 
the transaction is legal. What are the Fed's obligations there?
    Mr. Dudley. Well, I think if we think a transaction may be 
illegal, it is appropriate for us to refer it to the 
enforcement authorities.
    Senator Warren. OK. So, if you think that it is arguably 
illegal, you think you should go ahead and enforce at that 
point?
    Mr. Dudley. Absolutely.
    Senator Warren. OK. And, I often describe our Federal 
regulators as the cop on the beat. That is, they are out there 
to look for illegal or unsafe conduct, try to stop that conduct 
before it happens. Is that an accurate way to describe what the 
New York Fed supervisory role is?
    Mr. Dudley. I would characterize it slightly different. Our 
main goal is to ensure the safety and soundness of the 
institutions that we supervise. If, in the process of doing 
that, we see behavior that we think is illegal, then our job is 
to refer it to the enforcement agencies. But, I do not really 
think of it as quite the way you characterize it, as cop on the 
beat. I think of it more like a fire warden. Make sure that the 
institution is run well so that, you know, it is not going to 
catch on fire and burn on, and managed in a way that if the 
institution is stressed, that it does not collapse and threaten 
the rest of the financial system.
    So, I think there is an enforcement element to it, but I do 
not think our primary purpose as supervisors is really the cop 
on the beat. Now, that does not mean that if we see something, 
we should walk by it and ignore it. I do not think that is the 
case at all----
    Senator Warren. But, you do not think you should be doing 
any investigation? You should wait to see if it jumps in front 
of you?
    Mr. Dudley. Well, because I think our primary focus on 
supervision is ensuring that the bank is safe and sound, that 
it is run well.
    Senator Warren. That means you need to know enough about 
the bank's activities, not just illegal activities, but all of 
their activities, so that you can stop any activity, illegal or 
not, that threatens the safety and soundness either of the bank 
or of the financial system. And, yet, you think you should not 
be investigating them?
    Mr. Dudley. But, I think where you----
    Senator Warren. I do not understand what the distinction is 
you are----
    Mr. Dudley. Well, I think what you are proposing is 
something that, I think, would be very difficult to do in 
practice, which is sort of evaluating every transaction that 
the bank does on a transaction-by-transaction basis, and I just 
do not think that is practical.
    Senator Warren. Look, I understand, just like any cop, you 
make decisions about when you are going to investigate more and 
what you think is suspicious and where you are going to look 
for things, and I understand that, but that is what it means to 
be a cop on the beat.
    Mr. Dudley. So, I will give you an example on reference 
rates. You know, once we became aware of the problems in LIBOR, 
we started to look at the banks' reference rate setting 
behavior more broadly. So, if there is a----
    Senator Warren. Fair enough. Do you wish you had looked a 
little earlier?
    Mr. Dudley. Well, my point is----
    Senator Warren. Excuse me. Do you wish you had looked a 
little earlier?
    Mr. Dudley. I think it is fair to say----
    Senator Warren. Maybe investigated a bit more before they 
had cheated people for years?
    Mr. Dudley. But, my point is, once we become aware of 
something, of course, we are going to investigate it.
    Senator Warren. And----
    Mr. Dudley. But, the notion that we are going to be aware 
of everything that is going on in these large institutions in 
real time, I just do not think----
    Senator Warren. I would just like to hear you say that you 
are really going to try to investigate things, though, and I 
think LIBOR is not an example that works for you. I think you 
should have been investigating a whole lot earlier.
    But, I tell you what. Let us take a look at this. We have 
got our safety and soundness. We at least can agree on that, 
that this is important. It is not just illegal behavior that 
you stop, it is any behavior that threatens safety and 
soundness of the bank, and illegal behavior, if you happen to 
stumble across it, which I think is what you said to me. So, 
let us focus----
    Mr. Dudley. I would not say stumble. I would say, see.
    Senator Warren. But you are not looking.
    Mr. Dudley. No, we are looking. Our eyes are open.
    Senator Warren. All right. So, let us take a look at the 
cases from the Segarra recordings. Let us focus on the deal 
between Goldman Sachs and this Spanish bank, Santander. Michael 
Silva was the New York Fed's head supervisor assigned to 
Goldman and he said he had concerns about the Goldman-Santander 
deal, but he was ``reined in''--this was his quote--by the New 
York Fed's General Counsel, Tom Baxter. Now, do you think it 
was appropriate for Mr. Baxter to rein in Mr. Silva?
    Mr. Dudley. Well, I am not sure that that is actually what 
happened. The way I understand it is the----
    Senator Warren. This is the quote from the person who says 
he was reined in.
    Mr. Dudley. Well, that may be the way he was experiencing 
it at the time, but let me tell you what I think actually 
happened, that the transaction went to the Legal Department of 
the Federal Reserve Bank of New York to be evaluated about 
whether it was legal or not, and the legal group of the New 
York's Federal Reserve Bank of New York determined that the 
transaction was legal.
    Now, you know, Michael may have felt that he was being 
reined in because he would have liked the transaction to be 
illegal so he had a stronger basis----
    Senator Warren. I am sorry. Let us stop right there, Mr. 
Dudley. The reason we spent all that time talking about safety 
and soundness is I thought that what we established--and, I 
thought, that part, we agreed on--is that the test for safety 
and soundness is not whether or not the activity is legal or 
illegal. The test is whether or not it might threaten the 
safety and soundness of the financial institution.
    And, I recall that when we talked about illegal behavior, 
you said just--I think it was just a couple of minutes ago--
that it was appropriate for the New York Fed to shut down 
activities that were arguably illegal, not to wait until you 
could prove they were illegal, but that were arguably illegal, 
even if the institution might be able to defend itself in 
court, indeed, if it might be able to win in court. I am pretty 
sure that was the question I asked and I am pretty sure that is 
what you said yes to.
    Mr. Dudley. We made a determination that the transaction 
was legal, so we had eliminated the issue of whether it was 
illegal or not illegal. We made a determination. Then we went 
back to the Bank of Spain and asked them what was their view of 
the transaction.
    Senator Warren. So, here is what I do not understand. You 
are supposed to be supervisors.
    Mr. Dudley. Right.
    Senator Warren. Did the General Counsel have more 
information than the lead supervisor in this case?
    Mr. Dudley. Well, I think the Legal Department has a 
better--a sense of what is legal than the lead supervisor.
    Senator Warren. I know, but we are talking about--I think 
we have been through this--about safety and soundness----
    Mr. Dudley. Right.
    Senator Warren. ----and about what is arguably illegal.
    Mr. Dudley. Right.
    Senator Warren. Is there any better information that the 
General Counsel has that was not available to the lead 
investigator? Who has the most information about the case, the 
lead investigator?
    Mr. Dudley. Well, I think that the lead investigator 
probably has the most information about the case, but I think 
the General Counsel and the Legal Department has a better view 
on whether the transaction is legal or not. I mean, the key 
point here is did the transaction threaten the reputation of 
Goldman Sachs to threaten its safety and soundness, and the 
conclusion made by the supervisory team was, no, not in this 
case. Now, it could----
    Senator Warren. No, let us be clear.
    Mr. Dudley. Now, could it----
    Senator Warren. The supervisory team----
    Mr. Dudley. Could it----
    Senator Warren. No, this is not what Mr. Silva has been 
quoted as saying. He said he wanted to investigate more. He 
said he wanted to go further. He gets reined in, and he gets 
reined in by General Counsel.
    Mr. Dudley. But, I think that----
    Senator Warren. This goes back to the cultural----
    Mr. Dudley. But, I think it----
    Senator Warren. ----question we asked earlier, why it is 
that you are not trying to empower the investigators.
    Mr. Dudley. But, we did investigate.
    Senator Warren. All right----
    Mr. Dudley. We went to the Bank of Spain.
    Senator Warren. Well, you investigated----
    Mr. Dudley. We--the Bank of Spain----
    Senator Warren. So, let us talk about that.
    Mr. Dudley. OK.
    Senator Warren. You described this deal as--your team 
identified the deal as shady, right? I think this was the team 
did. And, as Michael Silva, who is the lead examiner here, 
said, the deal with Goldman was, quote, ``designed to help 
Santander artificially enhance its capital position.'' Now, 
what that means is that this shady deal was clearly intended to 
help Santander evade the regulations, in this case, capital 
standards, of the European banking authority. That was the 
intent of the deal. Once you knew about this plan, did your 
team contact the European banking authority to let them know 
what Santander and Goldman were up to?
    Mr. Dudley. I do not know the answer to that. We did 
contact the Bank of Spain to----
    Senator Warren. That was not my question, whether or not 
you contacted the Bank of Spain that was trying to evade 
capital standards. My question is, did you contact----
    Mr. Dudley. I do not know the answer to that.
    Senator Warren. ----your counterparts on the regulatory 
side?
    Mr. Dudley. I do not know the answer to that, Senator.
    Senator Warren. Is there any evidence that you ever got in 
touch with them?
    Mr. Dudley. I just do not know the answer to that question.
    Senator Warren. You know, I do not understand----
    Mr. Dudley. My point is----
    Senator Warren. ----why this would not be a priority. You 
come across a deal----
    Mr. Dudley. But----
    Senator Warren. ----where two parties are getting 
together----
    Mr. Dudley. The transaction was not a secret. It was 
disclosed. It was not a secret. It was not like this 
transaction was held in--it was in the dark. It was publicly 
disclosed.
    Senator Warren. What was not disclosed about this 
transaction is the capital standard and what the intent of this 
deal was, and that was to help Santander evade its capital 
standard, in other words, to help it evade its regulator. That 
is the European banking authority, and apparently, you did not 
inform them about what they were up to.
    You know, I just want to say on this, we have talked about 
the report that Professor Beim did, and there are two parts to 
the supervisory process, recognizing the potential problems and 
then acting on them. And, the point he makes in his report--I 
just want to quote from it--is, ``the problem of recognition is 
hard,'' but, he goes on to say, ``the problem of action is yet 
more difficult. We find that during the run-up to the recent 
crisis, many potential issues were identified, but did not ring 
alarms and were not acted upon. Action requires support from 
the highest levels of management in the interest of financial 
stability, even if this makes the banks less profitable. 
Supervisors must be willing to stand up to banks and demand 
both information and action, especially when things appear to 
be going very well.''
    Mr. Dudley. And, I agree with that.
    Senator Warren. Based on your responses today, the New York 
Fed is not there in terms of acting on the issues it 
identifies. It is not even close. What we have got here, action 
is warning a foreign regulator about a plot to evade the law 
that you have uncovered. Action is about shutting down shady 
transactions that could imperil the safety and soundness of the 
bank. And, until you are willing to take meaningful action, our 
financial system and our whole economy remain at risk.
    Sorry for going over so long, Mr. Chairman.
    Chairman Brown. Thank you, Senator Warren.
    President Dudley, your predecessor some years ago 
reportedly recognized risks bubbling up in the credit default 
swap market and learned that LIBOR was being manipulated, but 
did little at the time besides telling a few people about it. 
Examiners discussed this Santander transaction, but still no 
one seemed to try to stop it. The Inspector General's report 
summary says that examiners were concerned about JPMorgan's 
Chief Investment Office, but never got around to doing anything 
about it. Even in your initiative on bank culture, you have 
talked about the issue, but only, I guess, recently taken 
action. Low disclosure, inaction, reliance on markets to self-
correct, strike us, I think, strike me as sort of Greenspan-era 
relics. Why are we still using this same failed model?
    Mr. Dudley. We are not. We are not----
    Chairman Brown. I am not sure----
    Mr. Dudley. I mean, I have said repeatedly on the record 
that financial stability is on equal footing of monetary 
policy. Without financial stability, monetary policy cannot be 
effective. I mean, you cited some of the things that you think 
we should do that we did not do, but there are a lot of things 
that we have done. The banking system today is demonstrably 
much sounder than it was five or 6 years ago, more capital, 
more liquidity, better governance, better risk management. I 
think a lot of--all these things, I think, have been 
accomplished over the last----
    Mr. Dudley. I am not sure those words would not have been 
said by President Geithner seven or 8 years ago in front of 
this Committee, that the system is sound, that there seemed to 
be no bells going off.
    Mr. Dudley. Well, I think the fundamental difference, 
Senator, is that we spend a lot of time now on financial 
stability issues at the Federal Reserve Bank of New York, at 
the Board of Governors, at the Federal Open Market Committee. 
You know, I, for years, have rejected the Greenspan view that 
you clean up after financial bubbles only after they blow up. I 
was on record in 2006, before I joined the Federal Reserve, 
that I did not agree with that philosophy. I think you have to 
be proactive in preventing excesses in the financial system 
from developing. If you are not, you threaten the financial 
stability of the system. That impairs the ability of monetary 
policy to guide the economy. And, as we saw in the financial 
crisis, households and businesses suffer. My goal in my job is 
to make sure that we never have a financial crisis like that 
again. It is just totally unacceptable.
    Chairman Brown. Well, you claim here to be proactive, and 
there are so many examples where it seems otherwise. You know, 
the Levin reports we talked about, it seems that the ProPublica 
stories, the stories that break with Goldman the other day, the 
Segarra story, I mean, it just seems that it is reacting to 
issues that others bring forward, usually public, and then the 
reaction is there. I mean, I see the story in the paper this 
morning that yesterday, the Fed put out some statements--it 
seems like they do that often, maybe it is just coincidence--
often a day or two before either a Levin hearing or one of our 
Subcommittee hearings.
    For example, Goldman did not prohibit its investment 
bankers from an egregious practice, holding stock in companies 
involved in deals that they advise, until after the first 
ProPublica story. That was 2 years after they had a $110 
million settlement for their El Paso deal. It was done at their 
own initiative, not at your urging, apparently. I mean, what 
good is supervision if you observe but not challenge? What good 
are words if they are not backed up by actions? And, it seems 
that when bankers can crash the economy, they are not sent to 
jail, and so few have. You gave that one example, but what 
lesson--and then I look at the Goldman employee that used to be 
with you and you say you have an environment where people are 
doing the right thing and this former employee with this 
present employee can deal in inside information, knowing it is 
illegal, knowing they deserve to go to jail for something like 
that, yet those things happen. Why should we believe that 
things have changed as dramatically at the Fed in New York as 
you say they have?
    Mr. Dudley. Well, let us turn to that last example. First 
of all, we have extensive training programs, compliance 
regimes, to make it clear that confidential supervisory 
information should never leave the bank. And, if someone is a 
bad actor and does something that is inappropriate, what is the 
consequence to them? The consequence to them is we fire them 
and we refer the case to the criminal authorities. We have a 
zero tolerance policy for that sort of thing. That is all I----
    Chairman Brown. You have a zero tolerance policy, perhaps. 
I believe you. I mean, I know you say that. I believe you. But, 
there does not seem to be much fear. I mean, people enforce 
laws in different ways in countries across the board, and fear 
plays some role. If I get caught, I pay a serious price. But, 
there does not seem--if the Justice Department, if the Feds, if 
others are not really willing to send people to jail virtually 
almost ever for almost any of the most egregious practices----
    Mr. Dudley. People----
    Chairman Brown. ----they are more likely to do these 
things.
    Mr. Dudley. People who have disclosed confidential 
supervisory information have gone to jail. They have pled--have 
been found guilty----
    Chairman Brown. Occasionally. Let me----
    Mr. Dudley. So--and, I think they should. I mean, I think, 
basically, if someone willfully is disclosing confidential 
supervisory information, so not an inadvertent mistake, I think 
they--our policy would be to dismiss the employee, refer it to 
the criminal--to the enforcement agencies for criminal 
prosecution, and that would be our policy in every case.
    Chairman Brown. So, good. Thank you for that. Let me go 
back. In October, you quoted an article on corporate culture. 
It said that ethical problems in organizations originate not 
with, quote, ``a few bad apples, but with the barrel makers.'' 
Yesterday, the Times reported one of your employees was passing 
that confidential supervisory information to one of your former 
employees working at Goldman who relayed the information, what 
you were just talking about, related to investment banking 
executives to use for the benefit of their clients. When you 
were Goldman's Chief Economist almost a decade and a half ago, 
one of your employees obtained and then shared illegal insider 
information with Goldman's Treasury desk. As you suggested, he 
was sentenced to 33 months in prison.
    So, where do these ethical problems originate? Was it the 
culture at Goldman? Was it you, as the barrel maker, in that 
case? Why do these things happen? Why did it happen then if 
there are these ethics constraints in place or ethics teachings 
in place and legal constraints, and why did it happen recently 
at the Fed?
    Mr. Dudley. I cannot answer that question. What I can tell 
you is that we do everything in our power to make sure that the 
incentives are such that people will not engage in that type of 
behavior. So, that means punish, you know, very clear what the 
consequences of the actions are, and the consequences are 
severe.
    So, I mean, one of the things--one of the points I made in 
the speech on culture is that we have to get the incentives 
right so people actually have severe consequences when they 
misbehave. So, that is the one thing that we can do. And, I 
think at the Federal Reserve Bank of New York, the incentives 
are right. We will follow up. We will be severe. We will refer 
these type of cases for criminal prosecution.
    Chairman Brown. Do your public statements now, since 
yesterday, and your response to this and hearings like this put 
a little more fear of God into your employees that might be 
tempted?
    Mr. Dudley. I would hope that the consequences--we will 
have to--obviously, I cannot comment on the details of this 
particular investigation because it is ongoing. But, I would 
hope in cases of this sort that the person loses his job, the 
case is referred for criminal prosecution, the prosecution--
that the prosecutors take up the case and drive it to a 
conclusion. That is what I would hope should happen. And, I 
think, if that happens, that is a good thing, because then 
people see the consequences of their actions.
    Chairman Brown. And you will continue to make public 
statements that the era of too big to jail is behind us?
    Mr. Dudley. I think we made a lot of progress, because we 
are now finding firms guilty where we were not willing to find 
those firms guilty before because we were worried that if we 
found them guilty, that it could somehow potentially 
destabilize the financial system. We have gotten past that, and 
I think it is really important that we got past that.
    Chairman Brown. And, as Senator Merkley said, firms do not 
go to jail.
    Mr. Dudley. That is fair. But, the Federal Reserve does not 
have the enforcement powers to send people to jail. That is 
really up to the enforcement authorities. We do not have the 
ability to jail people. We do not have the ability to prosecute 
people in court, to find them guilty and send them to jail. 
That is just not within the Fed's remit.
    Chairman Brown. You certainly have an ability to----
    Mr. Dudley. We have the ability to----
    Chairman Brown. ----set the table so that law enforcement 
can and should.
    Mr. Dudley. We have the ability to cooperate with the law 
enforcement agencies, and we do.
    Chairman Brown. You, in response to a number of questions 
around the table, you spoke of the two missions that should be 
coequal. I am not sure your statements in the past have 
suggested that you believe, until recently, that they are 
coequal, monetary policy and safety and soundness. I appreciate 
your evolution, if that is right, or your acknowledgment that 
it is--that they are coequal.
    Mr. Dudley. I have said that for many years. There is a----
    Chairman Brown. Well, you say it, but let me give one 
example. About a year, a little more--last summer, the summer 
of 2013, when Chairman Bernanke was still the Chair of the Fed, 
I asked him about the higher supplemental leverage ratio for 
the eight largest U.S. banks. I think you know of Senator 
Vitter's and my efforts on higher capital standards and the 
sort of news reports and debate, heightened public debate that 
swirled around that, and then--I am not crediting Senator 
Vitter and me, but what the Fed, the FDIC, and the OCC did in 
terms of higher capital standards.
    So, I asked Chairman Bernanke about these higher leverage 
ratios for the eight largest U.S. banks, five of which you 
supervise, the four largest and Bank of New York Mellon. 
Chairman Bernanke said that we should, quote, ``do whatever we 
need to do to make sure that the U.S. financial system is 
safe.'' But, the New York Times then reported in March that you 
expressed concerns to the Board in Washington that the leverage 
ratio could inhibit the execution of monetary policy. So, how 
does that mean that you give them sort of equal standing in 
your job and equal standing from the Fed generally that 
monetary policy is important, but no more important than safety 
and soundness, that, in fact, safety and soundness is a 
coequal, if you will, with monetary policy?
    Mr. Dudley. Well, we want to balance those two goals. We 
want monetary policy to be effective and we also want to have 
financial stability. And, we want to make sure that the balance 
is struck correctly.
    Chairman Brown. So, are you saying that higher safety and 
soundness, higher capital standards mean----
    Mr. Dudley. No----
    Chairman Brown. ----would compromise monetary policy?
    Mr. Dudley. No.
    Chairman Brown. Is that what you were trying to say?
    Mr. Dudley. I am not. This is a very, very narrow issue. It 
is an issue about whether reserves held at the Federal Reserve 
by banks should be included in the leverage ratio or not. That 
is a very technical issue that I thought we should look at, 
just to understand the implications of the leverage ratio in 
terms of its effects on monetary policy. It is not in any way 
subordinating financial stability to a lower position than 
monetary policy----
    Chairman Brown. That is the way----
    Mr. Dudley. All I----
    Chairman Brown. I believe that is the way it is 
interpreted.
    Mr. Dudley. All I wanted to do was look at it. That is all 
I wanted to do, is make sure that we understand how these 
things are interconnected. That is it. Eyes open. Understanding 
how these things are interrelated. That is it.
    Chairman Brown. It would certainly appear that you 
expressed reservations----
    Mr. Dudley. I think----
    Chairman Brown. ----with capital standards----
    Mr. Dudley. I think it was--no, I really object to that 
characterization. I am completely in favor of higher capital 
standards for banks, absolutely have been supportive, supported 
the SIFI surcharge on the large complex institutions, favored 
the leverage ratio because I think the credibility of the risk-
weighted asset standards is a little bit in question, so it is 
useful to have a belt and suspenders. So, I have no objection 
to having a leverage ratio.
    Chairman Brown. Is this the first public statement you have 
made about support of higher capital standards, about these 
specific capital standards?
    Mr. Dudley. I do not recall, Senator.
    Chairman Brown. Well, I----
    Mr. Dudley. But, I do support the capital standards. There 
is no question.
    Chairman Brown. I think you would remember if you had said 
it, because it is a pretty important issue----
    Mr. Dudley. I presume--I am sure I have said it many times, 
because I very much endorse what we have done in terms of 
raising capital standards for the large complex institutions 
that we regulate. As I said in my prepared remarks today, 
absolutely in favor of it.
    Chairman Brown. I mean, you----
    Mr. Dudley. No question. This is----
    Chairman Brown. I am not asking what you say when you sit 
around the table at every FOMC meeting, but I think it would be 
important----
    Mr. Dudley. I participated in the Basel discussions, and 
very much, I was always on the side of pushing for a higher 
capital.
    Chairman Brown. OK. I hope you will continue to, then.
    Senator Merkley, this is the last round. Any other 
questions?
    Senator Merkley. Thank you.
    Professor Beim's report said that changing the culture of 
the Fed required hiring out-of-the-box thinkers, even at the 
risk of getting disruptive personalities. It called for expert 
examiners who would be contrarian and ask difficult questions 
and challenge prevailing orthodoxy.
    As I am looking at some of the commentary with Carmen 
Segarra, she took minutes from a meeting and those minutes 
reflected kind of a hesitancy to apply regulatory standards 
aggressively, and she was called into the office of Mike Silva. 
Silva had worked at the Fed for 20 years. He was now the senior 
Fed officer stationed inside Goldman. What Mike Silva said to 
Carmen made her very uncomfortable, and essentially, she was 
pressured repeatedly to not, if you will, reflect the culture 
of the Fed in these minutes that showed kind of this ``go 
easy'' situation.
    Carmen sounds like just the sort of person that Professor 
Beim's report suggested the Fed needed to kind of shake up the 
place, and yet she did not last long. Do you agree with 
Professor Beim that the Fed needs to hire people who challenge 
the institutional culture?
    Mr. Dudley. We definitely want people that speak up and 
express their views, but we also want people that are fact-
based so that if the facts point in one direction, that that is 
where their conclusion leads them.
    In the case that you are discussing, this was a question 
about whether Goldman Sachs had a conflict of interest policy 
or not, and Mike Silva and other senior people on the 
supervision side at the Federal Reserve Bank in New York, and, 
in fact, up to the Operating Committee that consists of people 
well beyond the Federal Reserve Bank of New York, concluded 
that Goldman Sachs did, in fact, have a conflict of interest 
policy, and he wanted to turn the discussion to not whether 
they have a policy or do not have a policy, but whether they 
have a good policy or not, and he was encouraging her to 
investigate whether they had a satisfactory policy or not.
    But, the debate was--you know, I think if judging from the 
tapes, which I think are a very incomplete record, there was 
this lack of willingness to agree on whether they had a 
conflict of interest policy or not, and, basically, this issue 
was vetted. I think the position of the senior supervisors was 
that there was a conflict of interest policy and that is what 
the debate was about. That----
    Senator Merkley. Let me go to a more fundamental question, 
then. I will accept that different folks have different 
opinions about what happened there. But, more fundamentally, is 
there a revolving door policy that bans people who have worked 
as regulators from then going back to work on Wall Street?
    Mr. Dudley. There are varied sets of restrictions. I would 
not say that it bans people from going to work on Wall Street. 
I can lay out what the restrictions are. So, anyone in the bank 
who leaves the bank cannot come back and lobby the bank on any 
particular matter that they worked at while they were at the 
Federal Reserve Bank of New York.
    Number two, if someone from the supervision staff or 
officer leaves the Supervision Department, they cannot come 
back and talk to the Fed about anything, any business matter, 
for a year.
    And, third, no deputy senior supervisor or officer or 
senior supervisor or officer can leave the bank and work for an 
entity that they were supervising, accept compensation from 
that firm, for over--for a year.
    In addition, if someone does leave, you know, someone who 
is on an exam team leaves the bank to go to a bank that they 
are supervising, there is a review made of their examination 
papers to make sure that there was no bias in terms of how they 
examined the banking institution.
    You know----
    Senator Merkley. Let us do this----
    Mr. Dudley. ----a legitimate question is whether, one, you 
should make these standards even higher, but there are a whole 
set of standards in place.
    The other thing I would say, if you would just give me one 
more moment, Senator, is I do not think it is a--I do not think 
revolving door is really the apt description for the Federal 
Reserve Bank of New York, because despite the fact that we have 
added a lot of people to the staff--we have grown from 520 to 
700 in the Supervision Department--the average tenure in 
supervision at the New York Fed is over 9 years. So, that does 
not strike me that a revolving door is an apt description of 
what is happening at the Federal Reserve Bank in New York.
    Senator Merkley. I think I heard from your last standard 
that if you are below a certain level in the bank, you can be 
an examiner and then go to work for the group you examined. Is 
that appropriate?
    Mr. Dudley. That is a reasonable question that, I think, 
needs to be looked at in more detail.
    Senator Merkley. Will you commit to taking a look at that 
and letting us know your opinion on it?
    Mr. Dudley. I would be worth--I would be willing to commit 
to taking a look at that.
    Senator Merkley. Thank you. I think, because there is a 
sense that at one point, the regulatory career path was over 
here and the banking world career path was over here, and there 
was a regulatory culture that was very different, but that the 
process now where people come and go in and out of Wall Street 
to the regulators creates enormous inclination toward being 
very deferential to institutions that might then pay 
substantial salaries when you go back into that world, and I 
think that that question really does need to be examined. It is 
a difficult problem. You need the expertise of people who 
really understand the system, so I understand that. But, I 
think it is something that may help explain some of the 
cultural issues that seem to be coming up time and time again.
    The last point I will make, and I am out of time, so I will 
just make the point, is that you repeatedly referred to safety 
and soundness. When we were looking back at the issue of the 
Fed's failure to regulate teaser rate mortgages and the 
kickbacks that steered people into subprimes, a lot of the, 
kind of, inclination was, well, banks were making money from 
this and that increased their safety and soundness.
    And, this is something I am very concerned about when I was 
asking the question about the ownership of assets, like 
aluminum warehouses and pipelines and power stations. Most 
entities could not hold enough to influence the supply and 
demand, but big banks can. They can put their thumb on the 
scale while they are making these bets. And, putting your thumb 
on the scale makes money. And, so, there is the apparent 
inclination to say, well, this is not a safety and soundness 
issue because it makes banks more profitable, and yet there is 
something fundamentally wrong with it, apart from safety and 
soundness, which is essentially a monopoly control or influence 
that raises the price of the end product. So, everybody buying 
a can of beer in an aluminum can is paying a little bit more 
for that beer. Folks buying power are paying a little bit more. 
People buying oil or gasoline are paying a little bit more. 
And, that, too, should be a concern.
    I was glad to hear you say you thought it was 
inappropriate, but I must say, the Fed has been completely 
absent on this, continuously referring to ``this was 
grandfathered,'' and, ``well, we will be taking a look at this 
over here,'' and never getting to the heart of saying that this 
fundamental conflict of interest should be addressed, and that 
is unfortunate, because American consumers pay a big price for 
that.
    Mr. Dudley. Senator, if I could just make one comment, I 
completely agree with you that profits do not necessarily 
ensure that an institution is safe and sound. It depends on 
what risks that the institution is taking to achieve those 
profits, both risk in the sense of credit risk, liquidity risk, 
but also reputational risk. And, we have seen firms that have 
apparently made profits and the profits have turned out to be 
illusory. So, I completely agree with your point on 
profitability.
    Chairman Brown. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. I will be quick. I 
just have one question I want to get to here.
    I am very glad that you commissioned the Beim report in 
2009, and you have discussed how seriously you took that 
report. How many times did you talk with Professor Beim in the 
5 years since the report came out?
    Mr. Dudley. I do not think I have talked to him at all. I 
thought--I got what I wanted from him. I got a report that was 
very critical of the way we were doing things, that made a very 
detailed set of recommendations, and we basically--you know, 
that is not the only input in terms of how we have revamped 
supervision over the last 5 years----
    Senator Warren. But, you never spoke to him again?
    Mr. Dudley. ----but--well, I spoke to him today.
    [Laughter.]
    Mr. Dudley. So, I did speak to him again, but----
    Senator Warren. Well, good. Let us talk about what comes 
out of today, then. So, I understand that you believe that you 
have made progress in implementing the recommendations from the 
Beim report. You have referred to it several times during this 
hearing. So, my question is, why do we not get some independent 
confirmation about that? I do not want to put Professor Beim on 
the spot here, but if he is willing to do so, would you be 
willing to have him come back to the New York Fed, do new staff 
interviews, and do a new public report on your efforts to 
implement his recommendations from 2009? I am sure it would be 
of great interest to this Subcommittee.
    Mr. Dudley. Let me put it this way, Senator. I will 
definitely think about it, recognizing in fact, though, that 
there is a number of studies that are already in train to look 
at the issue of whether the information that needs to get to 
the----
    Senator Warren. So, you already have a number of studies 
that are going to come out and be public studies evaluating 
whether or not----
    Mr. Dudley. Well, the----
    Senator Warren. ----the Beim report recommendations have 
been implemented?
    Mr. Dudley. No. The Federal Reserve Board announced that 
they are going to have two studies, an internal study and a 
study that is going to be done by the Inspector General, that 
is going to look at the issue of whether the appropriate 
information that needs to be available to make good supervisory 
decisions is available and whether the divergent viewpoints are 
also available to the senior policymakers. So, those studies 
are already underway. We are also doing a number of studies at 
the New York Fed to look at the issue of data security, to look 
at the issue of----
    Senator Warren. Well, I am glad there are other studies 
underway. I have no doubt about that. But, given the number of 
times you have turned to the Beim report and said during the 
course of this hearing that the Beim report is the evidence of 
how seriously you took the problems at the New York Fed and 
your determination to change it, and yet you have never spoken 
to Professor Beim in the 5 years since then, and I have just 
asked you, why not invite Professor Beim to come back in. You 
thought his report was really terrific in 2009. Ask him to come 
back in and do an evaluation of whether or not the 
recommendations have been implemented. I asked you for a 
``yes'' here. I would like to have a ``yes.''
    Mr. Dudley. I would like to think about it, Senator.
    Senator Warren. OK. Thank you, Mr. Chairman.
    Chairman Brown. President Dudley, thank you for joining us.
    Mr. Dudley. Thank you.
    Chairman Brown. Thanks for your public service.
    Mr. Dudley. Thank you.
    Chairman Brown. The Chair calls up the next panel, please.
    David Beim is a retired Professor of Professional Practice 
at Columbia Business School. Professor Beim worked for 24 years 
as an investment banker at First Boston, Bankers Trust, and 
Dillon Read.
    Robert Hockett is the Edward Cornell Endowed Chair in Law 
at Cornell, where he has taught since 2004. Professor Hockett 
is also a Fellow at the Century Foundation and an in-house 
finance regulatory consultant with Westwood Capital. Professor 
Hockett has spent time at the International Monetary Fund as 
well as the Federal Reserve Bank of New York.
    Norbert Michel is a Research Fellow in Financial 
Regulations at the Heritage Foundation. Prior to joining 
Heritage, Dr. Michel was a tenured professor at Nicholls State 
University College of Business in Thibodaux, Louisiana.
    So, welcome, all three of you. If you are prepared, 
Professor Beim, you are comfortable, ready to go, turn your 
microphone on and let us hear from you. And, please keep your 
remarks close to 5 minutes, all of you, and we will have 
questions.

STATEMENT OF DAVID O. BEIM, PROFESSOR OF PROFESSIONAL PRACTICE, 
                    COLUMBIA BUSINESS SCHOOL

    Mr. Beim. I know the time is short, and you have my written 
testimony, so I will just give you a quick oral summary of what 
I consider the most important points.
    First of all, I would like to emphasize that the report 
that I did in 2009 was not just me. It was not just me looking 
at the Fed and making observations. It was the Fed looking at 
itself. I was given a team of eight senior vice presidents, who 
were terrific. They were people of positions in great 
responsibility and obviously very bright, and what you see in 
the report is largely their words and the words of witnesses 
that we all called together. We worked together through the 
summer. This was very much a collective effort, and 
furthermore, it was certainly focused on culture. It was 
certainly clear to us that Mr. Dudley wanted us to focus on 
culture, and we did, because culture really does govern 
people's behavior.
    The issue that I see today as being particularly important 
is the revolving door law, and that was referred to briefly in 
the preceding testimony, but I think that this is very near the 
center of the problem, because it is not--the existing law is, 
I think, really unfortunately weak. Very few regulators go to 
work for the very bank they were regulating. The problem is not 
that. The problem is that regulators and bankers form a 
community. They know each other. They talk to each other. They 
exchange--they talk about each other. This is a community of 
people who share a common interest in banks and bank 
regulation.
    And, what I would recommend is that anyone who has been 
part of the bank regulatory world should not join any bank for 
3 years, because I think it is impossible to take out of the 
heard of someone like Mike Silva the possibility that he might 
be offered a job not by Goldman Sachs, whom he regulated, but 
by any bank. And, indeed, in the end, he was given a job by GE 
Capital, not a bank he regulated. But, the fact that you are 
likely, highly likely to get an offer, if you are as bright and 
uprising as Mike Silva, you are highly likely to get an offer 
from some bank, cannot help but govern your behavior toward the 
bank you are regulating.
    And, so, I would recommend a significant strengthening of 
the revolving door law so that regulators cannot go to work for 
any bank for 3 years, and that would force an identity 
decision, am I a banker or am I a regulator, and keep people on 
one track or the other.
    You have asked me to talk about developments since my 
report, and as Mr. Dudley just said, I have not been to the Fed 
since my report. One of the hazards of being a consultant is 
that most consultants in most cases do not get invited back and 
do not know if their recommendations ever did any good or not. 
You just hope for the best, but it is a little bit blind 
following that. So, it is not unusual that he should not have 
called me, but I really have little to add except what I see in 
the press.
    I do think it is rather striking that ProPublica and NPR 
put together a story of my report kind of side by side with 
Carmen Segarra's recordings because many of the issues that I 
was reporting in 2009 are illustrated--in technicolor, really--
in the tape recordings, and it does suggest to me that not as 
much change has happened as I would have hoped and that, 
indeed, there is a continuing cultural problem and culture is 
slow to change. You should not be surprised. Cultures do not 
change quickly. A culture takes a very, very long time to 
change and it needs a lot of incentives to change. So, I am not 
surprised that these practices continue.
    As to the other two articles, I think you see examples of 
things other than revolving door. I think you see bureaucratic 
infighting in the ProPublica piece on the London Whale. I think 
you see--in the Times piece on the Goldman leak, I think you 
see further hazards of having people in this community of 
regulators cum bankers moving so freely back and forth. I 
really think the most important step that Congress can take to 
fix this problem of excessive coziness between regulators and 
banks is to stop the revolving door. Pass something far 
stronger than what you have currently got.
    Chairman Brown. Thank you, Professor.
    Professor Hockett.

  STATEMENT OF ROBERT C. HOCKETT, EDWARD CORNELL PROFESSOR OF 
                    LAW, CORNELL LAW SCHOOL

    Mr. Hockett. Thanks for having me here, Senators. So, I 
think I am here in two capacities, on the one hand, as a 
scholar in financial law and central banking and on the other 
hand as somebody who has spent a fair bit of time over at the 
New York Fed. So, I will keep my remarks fairly brief right now 
because there is a lot more detail in the written testimony 
that I have submitted and I assume that there will be a chance 
to talk in more detail over the Q and A, as well.
    So, I have just got basically five quick points to make 
here. The first is just to remind us all that the Fed is the 
primary macroprudential or systemic risk regulator of our 
financial system now. That means the stake of its regulatory 
mandate, or, I should say, the stakes of its regulatory mandate 
are especially high. The stability of the entire financial 
system, hence, of the monetary system, and of the macroeconomy 
itself, and, hence, of employment in this country, very much 
ride on the Fed's properly executing its financial stability 
mandate.
    Second, the bank examination process is particularly 
critical in this connection. It is the clutch, you might say, 
that engages the engine of the regulatory regime, on the one 
hand, to the actual behavior of participants in the financial 
markets on the other hand.
    So, third, for this reason, recent allegations of Fed, and 
especially FRBNY, or New York Fed capture, where this function 
is concerned, where the examination function is concerned, are 
particularly seriously, right, particularly troubling, 
particularly potentially problematic.
    Fourth, then, when I read and reflect on these allegations 
as they have appeared in the press and, of course, here today, 
I actually, quite candidly, find myself confronted with a bit 
of a paradox. On the one hand, I had not directly experienced 
anything like capture over at the FRBNY myself, right.
    Indeed, Tom Baxter, the General Counsel of the New York 
Fed, when he brought me on, referred to the Beim report over 
and over and over again, and in particular, referred to the so-
called group think problem, and he acknowledged that that had, 
indeed, been a problem, and said that one of the reasons that 
he was bringing me on board for a bit was because he thought I 
would be something of a contrarian or something of an out-of-
the-box type. I suppose that is sort of a backhanded 
compliment, or maybe a two-sided compliment, but in any event, 
I took that to mean that he was actually being serious or 
taking seriously the group think claims.
    Moreover, a lot of the projects that I was assigned to work 
on over at the New York Fed were themselves sort of out-of-the-
box programs, or, I am sorry, projects, and anything but group 
think thought projects.
    And then, finally, third, just as one sort of particularly 
dramatic example, some of you here know that I have been 
pushing for some years now an eminent domain solution to the 
ongoing underwater mortgage loan problem in this country, and 
as you know, also, the financial services industry and the 
banking industry have been particularly hostile, to say the 
least, to that plan, and yet the New York Fed asked me to do a 
write-up on the plan and then they published it, actually, in 
their own flagship journal. And, indeed, the week that it came 
out, there were two in a row, actually, two op-eds in the Wall 
Street Journal's particularly atavistic op-ed page, attacking 
the Fed and me, by name.
    So, all of that, on the one hand, makes one think, well, 
they cannot be that captured, right? On the other hand, 
militating in the other direction, my auspices at the New York 
Fed were, of course, somewhat unique, somewhat different, 
right. I was brought in as an outsider, as an academic who was 
independent, and the expectations of me, accordingly, were much 
different than, I suppose, the expectations of regular Fed 
employees are.
    Second, I was not in examination at all. I did not spend 
any time in the Supervision Department or conducting bank 
examinations or accompanying examiners. So, it could be that 
there are problems in that department that are not in other 
departments.
    And then, finally, third, I have to say that I have heard 
multiple stories from others, from friends and colleagues, both 
at the FRBNY and at the Fed Board here in D.C., that sound 
remarkably like Ms. Segarra's. The same pattern, essentially, 
characterizes all of these stories, which, of course, is at 
least potentially concerning.
    So, then, finally, fifth, then, what do I conclude from 
this, what are my provisional conclusions, well, first, I think 
that the stories that I just mentioned of other examiners and 
other employees that have been similar to Ms. Segarra's ought 
to be followed up on. I think it would be very much worthwhile 
to speak with the other Carmen Segarras, so to speak, to find 
out what their stories actually are and to go into detail on 
those, just to see how pervasive or otherwise the apparent or 
possible problem might be.
    Second, I think that putting in place some kind of 
contrarian thinking department, or institutionalizing 
contrarian thinking over at the New York Fed in the way that 
Professor Beim suggested might be a good idea. Indeed, Tom 
Baxter, the General Counsel of the New York Fed, when he 
brought me on, he was the first one who brought to my attention 
the idea that they were actually thinking about putting in 
place some kind of a contrarian thinking department and 
actually suggested that one of the projects that he might put 
me on would be to sort of help maybe start setting something 
like that up. That did not end up happening, but I do not think 
that that is necessarily because they do not want to do it. It 
might be that they have just been distracted because there is 
so much else that they have been doing, in particular, 
implementing a lot of the Dodd-Frank provisions. So, it might 
be that they have just been sort of busy and distracted, but I 
think they ought to be encouraged, probably, to go ahead and 
set that up.
    Another possibility would be to go something like the route 
that I take, I think that Walter Wriston did at Citi at one 
point, where there were sort of parallel departments that were 
established and they were sort of encouraged to be in 
competition with one another. So, you had the contrarian 
counterpart to each sort of substantive department. Maybe 
something a bit like that would be in order or possibly be 
helpful at the New York Fed.
    Finally, and sort of relatedly, it is sort of tempting to 
think in terms of maybe setting up--putting in place two, say, 
general counsels at most regulatory agents, one of whom is much 
more concerned with zealously pursuing the affirmative 
regulatory mission of the regulatory agency in question, and 
the other of whom is concerned with sort of covering the back 
side, as it were, of the agency in question, making sure that 
it is complying with law, that it is not getting into trouble, 
because the latter role is an inherently risk averse or 
cautious one. The former role, on the other hand, is an 
inherently proactive one that is apt to be best pursued by 
somebody who is zealous and trying to push the envelope and 
trying to sort of lean forward.
    So, those are just sort of some provisional thoughts about 
what we might do going forward, but again, more in the Q and A, 
I am sure, and more in the written testimony. Thanks much.
    Chairman Brown. Thank you, Mr. Hockett.
    Dr. Michel.

 STATEMENT OF NORBERT J. MICHEL, RESEARCH FELLOW IN FINANCIAL 
                REGULATIONS, HERITAGE FOUNDATION

    Mr. Michel. Thank you. Good morning, Chairman Brown, 
Members of the Subcommittee. Thank you for the opportunity to 
testify here at today's hearing. My name is Norbert Michel. I 
am a Research Fellow in Financial Regulations at the Heritage 
Foundation, and the views that I express in my testimony today 
are my own. They should not be construed as representing any 
official position of the Heritage Foundation.
    The aim of my testimony this morning is to argue that 
Congress should end the Federal Reserve's role as a regulator. 
There are three main issues I would like to address today.
    First, regulatory capture at the Fed is actually nothing 
new. The recent stories in ProPublica and This American Life 
did provide valuable insight because they brought greater 
attention to regulatory capture, an issue that most nonpolicy 
wonks probably do not hear very much about. But, these stories 
reveal nothing surprising to anyone who has studied either the 
history of the Federal Reserve or, more broadly, market 
regulation.
    The Fed was literally captured at birth by Wall Street 
icons such as J.P. Morgan and Henry Goldman and the revolving 
door sort of started right away. This is a perfectly natural 
outcome, though, because regulators have to know something 
about the industry that they are supervising, and on the other 
side, industry employees have to know something about the 
regulatory process that they are required to follow. The 
reality is that potential conflicts and outright capture do 
arise from this symbiotic relationship, and really, the only 
way to mitigate these problems is to reduce the level and 
complexity of regulation.
    The excellent report by Professor Beim takes a different 
view and essentially argues that more properly trained 
regulators with a better focus will overcome the capture 
problem. But with all due respect, Professor, that is an 
ineffective approach that has not really worked well in the 
past and there is no reason to expect that it is going to work 
any better this time.
    That brings me to my second issue, which is that these new 
macroprudential safeguards mandated by Dodd-Frank will be 
ineffective. History simply does not bode well for the 
macroprudential concept. We do tend to have short memories, so 
it is worth pointing out that the Federal Reserve System was 
created in 1913 with nothing like a micro focus. The main focus 
has always been macro from the outset. It was to prevent 
banking panics from doing damage to the broader economy. That 
is a macro concept. There was nothing about individual bank 
safety, per se.
    The more recent past also seems to have sort of slipped 
away. In 1996, the Fed changed the rating system it was using 
to gauge banks' financial health. It was previously the CAMEL 
rating, an acronym for Capital Adequacy, Asset Quality, 
Management Administration, Earnings, and Liquidity. It became 
the CAMELS rating. The letter ``S'' stood for--anybody know 
that one?--sensitivity to market risk, a macro concept.
    Aside from regulators' long history of being concerned with 
much more than just micro risk, no empirical evidence shows 
that any of these new macrofocused tools will prevent financial 
crises any better than the old ones did. In fact, one of the 
only countries that had fully implemented these types of 
regulations prior to the subprime crisis, which was Spain in 
the year 2000, suffered through at least as severe a crisis as 
everybody else.
    Furthermore, the new rules did not do anything to one of 
the old rules that we know failed spectacularly. The Fannie and 
Freddie issued mortgage-backed securities and foreign and 
sovereign debt are still given preferential capital treatment 
under the new rules. Regulators were clearly wrong about those 
risks in the beginning and we have done nothing to correct that 
mistake.
    And, that brings me to my third and final point, which is 
that ending the Fed's role as a regulator is long overdue. 
Regrettably, Dodd-Frank took us in the opposite direction and 
expanded the Fed's role. This is something that can only lead 
to more capture problems.
    Interestingly enough, expanding the central bank's 
regulatory power is counter to the international trend. More 
than a dozen developed countries prior to the subprime crisis, 
including the UK and Sweden, had already removed regulatory 
functions from their central banks, and that is exactly what we 
should do in the U.S.
    The current structure that we have jeopardizes the long-
term price stability goal of monetary policy, but it simply 
does not have to be this way, because financial regulations and 
monetary policy are completely separate functions. Congress can 
strengthen financial markets and reduce political pressure in 
the Fed by transferring the Fed's regulatory authority to 
either the FDIC and/or the Office of the Comptroller.
    Thank you for your consideration.
    Chairman Brown. Thank you very much, Dr. Michel, and thanks 
to all of you.
    I was a little disappointed that as soon as the Fed panel--
as soon as President Dudley concluded his testimony, that all 
of the Fed employees left. I think that they might want to hear 
from the three of you, all knowledgeable people that might not 
see the world quite the way they do, and it is--I am just 
disappointed. I hope that somebody from the Fed is at least 
monitoring this and will hear the comments of all three of you.
    Mr. Michel. Everybody is watching online.
    Chairman Brown. Well, yeah, as they head to the train 
station for their one o'clock train, they are watching online.
    [Laughter.]
    Chairman Brown. Anyway, Professor Beim, I very much 
appreciate your line to not take it out of his head that he 
might join some bank at some point. I think that is precisely 
right and the conflicts of interest.
    Let me ask just a couple of questions and have all three of 
you answer them. We will wrap up fairly quickly, because you 
have been patient. This hearing has gone on 2 hours, and you 
have sat and waited.
    President Dudley said that the LISCC Operating Committee, 
quote, ``provides an important safeguard against regulatory 
capture by ensuring that no one person or Reserve Bank has the 
power to make a final decision on a matter of significance.'' 
Do you agree with this diagnosis of and prescription for 
addressing regulatory capture?
    Mr. Beim. I do not think that is a particularly effective 
approach. I think what you, in my opinion, what you need is not 
more vetting and more people bringing their ideas together, you 
need more independent thinkers. I have long believed that the 
big problem within the Fed is that the people march like an 
army. There is this huge tendency to defer to authority, to 
defer to supervisors, to defer to banks. I mean, there is very 
little independence of judgment by independent individual 
regulators.
    And, so, my prescriptions come in that direction. I think 
one needs to look at the incentives of individuals, and that is 
why I focus on the revolving door rules. If a regulator is 
constantly thinking, one of these days, I hope I am going to 
get one of these jobs that pays a lot more than what I have 
got, it cannot help but affect his judgment or her judgment in 
the way that they handle particular cases. They are human 
beings. They respond to ordinary incentives. I would change 
those incentives by typing the revolving door.
    Chairman Brown. Professor Hockett.
    Mr. Hockett. Yes. So, I am in agreement with Dr. Beim. I 
think that what President Dudley suggests could be helpful, but 
I think it is only going to be marginally so in the sense that, 
well, sure, not all of the Regional Reserve Banks have the same 
opinions and the same perspectives, and so if you get more 
perspectives in there, that is going to be all to the good.
    I also agree that the revolving door can be a problem, but 
I tend to think that probably what is most important is another 
suggestion that Professor Beim made in his report in 2009, and 
that is that you not only have to have some kind of contrarian 
thinking department or contrarian thinkers there, but they have 
to have somebody who is their sort of ultimate superior who has 
the same status as all of the other sort of sub-Presidential 
top deputies over at the Fed. The department has to have a 
certain sort of prestige attached to it. It cannot be viewed as 
a sort of a passel of lovable eccentrics, right. They have got 
to be taken seriously, right. They have got to be--they have 
got to have the same kind of status and respect at the 
institution that others have, and that is partly a cultural 
matter, but it is partly an institutional or structural matter 
and I think we have to treat it that way.
    Chairman Brown. Dr. Michel.
    Mr. Michel. I think that if you increase the number of 
years that somebody has to stay out of the industry, you come 
up with a new set of incentive problems, somebody who is never 
going to want to leave and then you have sort of a permanent 
bureaucracy mentality, which probably does not get you what you 
want, either. Essentially, we are saying, fix the bureaucracy 
by making it a bigger bureaucracy. I do not think that anybody 
should be surprised that you have an enormous number of complex 
rules and somebody could leave a regulatory agency after 
writing and enforcing those rules and make a lot of money in a 
private industry that is regulated by those complex rules. I 
mean, you have to change that structure.
    Chairman Brown. My second question. I will start with you, 
Dr. Beim. ProPublica described the experience of two different 
examiners. Ms. Dobbeck was lead examiner at Citigroup when it 
required billions of dollars in bailout funds, and she was an 
examiner at JPMorgan during the London Whale. She was described 
as stonewalling her own examiners. She is now the head of the 
New York Fed's supervisory policy. Ms. Segarra was a forceful 
examiner. She questioned her institution and her supervisors. 
She spoke her mind. She was fired.
    What do these cases say about the Fed, about the attributes 
rewarded or punished at the Fed? Your thoughts.
    Mr. Beim. I think the question answers itself. I think the 
fact is that people who fall in line and do what their bosses 
want generally get ahead at the Fed, and people who speak out 
are frequently hammered down. And, so, it just has not changed 
very much. From what I have seen in 2009 to what I hear today, 
it sounds like the same.
    Chairman Brown. Professor Hockett.
    Mr. Hockett. Yes. A similar impression at my end. I tended 
to sort of gravitate toward and befriend and spend time with 
those who were probably the most contrarian thinking over there 
when I was there, and likewise with the Fed Board. I think I 
mentioned in my written testimony that I was here in D.C. for 
the year of 2012-2013 during my sabbatical, working over at the 
IMF, again, my first gig, and I spent a good bit of time with 
Fed Board employees, as well. And, there, too, I sort of 
gravitated toward and ended up becoming friends with the more 
contrarian thinkers, and it seems to be not to be without 
significance that most of those folk have since left, and I do 
not think that they left simply, you know, sort of happily, 
but, again, you would have to talk with them to get the fuller 
details.
    Chairman Brown. Dr. Michel.
    Mr. Michel. I think it highlights a bigger issue, which is 
that you have these rules, and if a bank is following the rules 
and they are legal, should a regulator or any other authority 
have the ability to arbitrarily say, no, we do not think that 
is a good idea, you cannot do it, even though you are following 
the rules. And, I do not know the merits of her case, so I am 
not commenting on those specifically, but in the broader 
picture, it is a very good question. Should there be an 
arbitrary power to do something like that? What does that mean 
for any company?
    Chairman Brown. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair.
    I wanted to go back to the challenge of regulatory capture. 
Professor Beim, you note that there are kind of three factors 
that contribute to, I think what you describe as the weak form 
of regulatory capture.
    Mr. Beim. Right.
    Senator Merkley. One is how you will be treated by your 
supervisors and how you will fit into the agency. Certainly, 
that affects your career path within the agency.
    The second is the possibility of being hired by regulated 
companies who pay a lot more than the Government does as a way 
to pursue a career path.
    And, the third is that in your role as a regulator, you 
need not just information, as you put it, but insight----
    Mr. Beim. Right.
    Senator Merkley. ----and that being handed stacks of 
numbers will not give you that insight, so that you are 
compelled to have a collaborative rather than a confrontational 
relationship.
    Mr. Beim. That is correct.
    Senator Merkley. And, it seems to me on that third point 
that the best--the very good examiners are going to need that, 
and that is a challenge for everyone, regardless of whether 
they are thinking about offending their supervisors or the 
prospects for a job outside.
    And, you also note in your testimony that one thing that 
would help create a regulatory frame of mind would be a 3-year 
period before moving into regulated companies. I was struck--I 
have here the Federal Deposit Insurance Act rules over whether 
or not you can go to work immediately, and only certain 
officers are affected by this, the current 1-year gap----
    Mr. Beim. Mm-hmm.
    Senator Merkley. ----and it only affects being hired by a 
group you directly regulated, is my understanding from looking 
at this. And, then I also--there is a waiver process where even 
that minor ability can be waived by the head of the Federal 
Reserve by signing a statement that they do not see an inherent 
conflict of interest.
    Mr. Beim. Right. Yes.
    Senator Merkley. Do you have any idea how much that waiver 
process is used to get rid of even that 1-year restriction?
    Mr. Beim. I do not have knowledge of how frequently the 
waiver provision is used, but I think that you correctly frame 
a situation that is ridiculously easy to avoid, that it is 
simply too easy to get around the current legal restrictions we 
have. Even as mild as they are, people get around them. They do 
not seem to be effective. I think the current law is not 
effective in accomplishing what it set out to accomplish. I 
think it needs to be much, much more tightly written.
    Senator Merkley. We had just here a moment ago the head of 
the New York Fed----
    Mr. Beim. Right.
    Senator Merkley. ----and he cited this provision, these 
revolving door provisions.
    Mr. Beim. Yes.
    Senator Merkley. And, it sounded like from his description 
like he is pretty much following what is in the statute----
    Mr. Beim. Yes.
    Senator Merkley. ----but, would he have the power to 
internally set much stronger restrictions as a matter of policy 
for the New York Fed if he wanted to take on this issue?
    Mr. Beim. I am not sure he has the legal ability to 
restrict the movement of his employees after they leave him. I 
think it takes Congress to do something like that.
    Senator Merkley. OK. Well, that is an interesting point to 
look at.
    Now, I know in your recommendation for this 3-year break--
--
    Mr. Beim. Right.
    Senator Merkley. ----and Mr. Michel has noted that he 
thinks that would cause other problems in terms of, I am not 
sure exactly. Do you want to repeat your concern?
    Mr. Michel. Different incentive problem.
    Senator Merkley. Which----
    Mr. Michel. Different incentive problems. I could 
elaborate, if you would like.
    Senator Merkley. Please, yes. Go ahead. Medium length.
    Mr. Michel. So, the longer you make the period that they 
cannot go back--let us just say they can never, go to the 
extreme. So, once you are a regulator, you can never go work 
for the private firm you were regulating. Well, now the only 
way you are going to get competent people in that position is 
to pay them a lot of money, and once you have got them inside 
the OCC or the Fed making an enormous amount of money, they 
really do not have very much incentive to care about much of 
anything except that they have a lifetime job. So, that is a 
different incentive structure there.
    Senator Merkley. OK. Thank you.
    And, I think--my impression is that we have a challenge 
that has been created by the increasing complexity of the 
financial world. If we turn the clock back 30 years ago, the 
banking system was a much simpler organization to understand. 
The transactions were much simpler to understand.
    Mr. Beim. Right.
    Senator Merkley. Now, we have this complexity, and I think 
in your own testimony, you talk about how the regulators came 
to get coached on what a swap was----
    Mr. Beim. Yes, exactly.
    Senator Merkley. ----and that even after you had walked 
them through it, they clearly only had a basic elementary 
understanding.
    Mr. Beim. You can visualize the scene.
    Senator Merkley. Yes. You were probably drawing little 
pictures for them and so forth.
    Mr. Beim. Yes, right. Arrows.
    Senator Merkley. Yes. And, so, how do we solve that 
problem? If we need the expertise that comes from having been 
in these sophisticated transactions in order to understand and 
regulate them, how do you pull people--would you be able to 
recruit the expertise needed if you had a 3-year restriction on 
returning to the private world?
    Mr. Beim. I think you would have--if you did this, I think 
you would have to have some way of weeding out people who are 
not effective and rewarding people who were effective in the 
direction you wanted to go. People really respond to 
incentives, and so one of the problems of Government service in 
an agency like the Federal Reserve is frequently that you get 
paid by grade and time served and not by your performance.
    If, in addition to this kind of restriction, regulators 
could pay for performance, you could reward the kind of 
behavior you wanted to reward and punish the kind of behavior 
you wanted to suppress, and people who simply got to be stale 
old bureaucrats would sort of fade into less significance. You 
do not easily have that freedom of managing people, but I think 
you should. I think that would be another way to approach the 
problem, is not to allow people to revolve back and forth, 
which creates all kinds of incentive issues. I would rather see 
a class of professional regulators very well trained and very 
well incentivized to do that which is right rather than just be 
paid on time and grade.
    Senator Merkley. And, you feel that that training and those 
incentives could overcome the challenge of not, if you will, 
having had the years within kind of the banking side of these 
complex transactions?
    Mr. Beim. It will never be perfect, but I think that you 
can go a very long ways. It is possible--I mean, the executive 
training today is really good. We have a big program at 
Columbia, and so does every university. You get state-of-the-
art transactions forward in front of executives so that they 
see what is going on. If you are willing to invest the time and 
effort, you can get excellent training for people. And, then, 
if you have a rewards system that rewards them for getting well 
trained and using their training in an effective way to counter 
things that they see need countering in their supervised 
institutions, I think you could have a regulatory system that 
works.
    Senator Merkley. Today, the--I will ask this last question, 
then I will----
    Senator Warren. That is fine.
    Senator Merkley. The testimony we had was that after the 
2009 report that you prepared, that all kinds of changes have 
happened within the Fed to respond to this problem of 
regulatory capture and to exercise regulatory provisions in an 
aggressive manner. Do you agree that the New York Fed has gone 
through a transformational reorganization that has solved this 
problem?
    Mr. Beim. Well, they certainly have gone through some 
reorganization. They certainly have done their best to make 
some changes. But, it looks like that is just not enough and 
that further change is required. So, yes, I think Mr. Dudley 
was being honest in saying that he had made a lot of changes. 
He really wanted to have these changes work. I do not doubt his 
good will and good intentions. It is just that when you look at 
the outcomes, such as we have seen in three recent stories, it 
has not gone far enough.
    Senator Merkley. It has----
    Mr. Beim. And, again, culture is slow to change. It does 
not change quickly. It takes a constant, determined effort and 
very careful attention to incentives.
    Senator Merkley. Thank you very much, all of you.
    Chairman Brown. Thanks, Senator Merkley.
    I was interested--and then I will turn it to Senator Warren 
for the last round of questions--Dr. Michel, you pretty much 
said that if we followed Professor Beim, we would not attract 
good people because they could not make the kind of money that 
a regulator who moves to a Wall Street Bank can make.
    And I am reminded--I am a bit incredulous that the number 
of my colleagues when I was in the House were--I do not hear it 
as much in the Senate--that say--that are making as Members of 
Congress, making in those days $150,000, $160,000, say, 10 
years ago, and the number of them that say, ``I am leaving 
Congress so I can go out and make money.'' You know, $160,000 
is not bad in this society, but I just am always kind of 
troubled by this attitude that you just cannot--you know, some 
people actually choose to be public servants because they 
believe in a public mission----
    Mr. Beim. Sure. Sure.
    Chairman Brown. ----and I look at the people sitting back 
here----
    Mr. Beim. But that is----
    Chairman Brown. ----most of whom will not become bank 
lobbyists, frankly. They love what they do and want to protect 
the public and want to work, but, I am sorry----
    Senator Warren. ----at that point.
    [Laughter.]
    Mr. Michel. No, and that is fine, but that is still an 
incentive structure that you have to overcome. That is still a 
basic----
    Chairman Brown. Fair enough, and I do not want to start 
that, because it is not my turn to ask questions.
    Senator Warren, wrap it up.
    Senator Warren. Thank you, Mr. Chairman. I will.
    Thank you all for being here today. Professor Beim, let me 
start where I left off with Mr. Dudley. Would you be open to 
returning to the New York Fed and producing a follow-up report 
on how well it has done at implementing your recommendations?
    Mr. Beim. Yes, of course. I would be flattered and 
delighted to do that.
    Senator Warren. Good. You might also be very helpful. All 
right. That is terrific.
    You know, we need to put a lock on the revolving door. The 
hard question is exactly how to do it, and I appreciate the 
recommendations. My colleagues have already asked the 
appropriate questions around this. I just want to point out one 
other part to this, and that is we should remember that the 
revolving door spins in both directions.
    We need to ensure that regulators are not captured by the 
big banks in exchange for the hope of future jobs, but we also 
need to ensure that we do not give a lot of key regulatory 
positions to Wall Street insiders. You know, appointing bank 
executives to regulate their former coworkers did not work in 
the past, and, in fact, it has led to the kind of passive and 
timid supervision that brought down our financial system 6 
years ago. We cannot build a strong, reliable bank oversight 
system so long as the revolving door keeps putting bank 
executives in the role of temporary cops. We need real cops on 
the beat, not rent-a-cops on temporary leave from their high-
paying banking jobs.
    So, I do not have to pursue more. I just want to make that 
point, that we have got to worry about this revolving door both 
ways.
    Mr. Beim. Yes. I would like----
    Senator Warren. You wanted to add something, Professor 
Beim?
    Mr. Beim. I would just like to add that we are almost 
unique among developed countries in the extent of our revolving 
door practices that we tolerate. I mean, in most countries, you 
have got a professional class of civil servants who do very 
conscientious jobs in just the way that you were describing, 
and it works. Those systems work.
    Mr. Michel. And virtually every one of those Nations had a 
financial crisis just like we did----
    Mr. Beim. And----
    Mr. Michel. We are overselling----
    Mr. Beim. Well, Professor----
    Mr. Michel. We are overselling the ability that we have to 
prevent a financial crisis by doing these window dressing-type 
things.
    Mr. Beim. It may be we do not prevent another financial 
crisis. That is incredibly hard to do. There is just a lot that 
goes into that besides revolving door----
    Mr. Hockett. Can I just add one quick point----
    Mr. Beim. There are other goals, absolutely.
    Mr. Hockett. So, one of the--the main argument that is made 
in favor of the revolving door is the complexity argument, 
right. It is very difficult to sort of make sense of the 
transactions and of the institutions in question without 
somebody who has actually experienced them. One thing we ought 
to consider, it seems to me, given that commonly heard 
justification, is whether the complexity itself out there in 
the financial world is not, in many ways, gratuitous, right.
    I think a lot of it has to do with the creation of 
artificial rent-grabbing opportunities, and we ought, then, to 
think about a product approval regime for complex derivatives, 
kind of an FDA-type regime for derivatives, and maybe look back 
at the institutions themselves and ask ourselves whether it 
really makes sense to keep the institutions as complex as we 
have. And, of course, it also makes sense to raise the salaries 
of the people who are regulating them, but----
    Senator Warren. All right, Mr. Hockett. Since you stepped 
in and it is still in my time period, I am going to say this is 
part of the reason we need a 21st century Glass-Steagall law. 
If banking were boring, if banking were just about banking, 
then we would not have so much complexity in the system and it 
would be far easier to regulate the banks themselves. As for 
the nonbank financial institutions, then we could have people 
who specialize in that kind of expertise.
    Listen to the rest of this panel. The notion that we are 
asking bank regulators to be able to evaluate the risk 
associated with trading in aluminum warehousing, to trade in 
oil tankers on the Straits of Hormuz and what kind of reserves 
you need against that is crazy. It helps put our system at 
greater risk and it increases the likelihood of regulatory 
capture all at the same time, so----
    Mr. Hockett. From your mouth to Congress's ears.
    Senator Warren. Yes.
    Chairman Brown. Thank you all. Thanks very much for joining 
us. Committee Members may have written questions. Please get 
back to us within a week on those questions and answer, and if 
you have additional statements you want to make, certainly do 
that.
    A special thanks to the Committee staff that has been so 
helpful for the last 2 years, and especially on this very 
complicated hearing with very complex issues, Laura Swanson, 
Elisha Tuku, Phil Rudd, and Casey Scott, and special thanks to 
my two staff people who have been dogged and incredible in 
this, Graham Steele and Megan Cheney.
    The Subcommittee is adjourned.
    [Whereupon, at 12:19 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                PREPARED STATEMENT OF WILLIAM C. DUDLEY
President and Chief Executive Officer, Federal Reserve Bank of New York
                           November 21, 2014
Introduction
    Chairman Brown, Ranking Member Toomey, and Members of the 
Subcommittee, thank you for this opportunity to testify on the 
effectiveness of financial institution supervision and the issue of 
regulatory capture.
    In 2008 and 2009 our country faced its worst financial crisis since 
the Great Depression. I mention those years as a touchstone for my 
remarks today. Despite the passage of time and an economy that is 
steadily improving, the financial crisis is hardly something that 
happened in the remote past. For the too many people who are still 
unemployed or underemployed, or who otherwise continue to struggle 
financially, it is living history.
    While the causes of the crisis remain subject to debate, it is 
undeniable that banking supervisors could have done better in their 
prudential oversight of the financial system. This conclusion raises 
two fundamental questions:

    First, how can we improve the stability of the financial 
        system? In other words, how can we make the financial system 
        more resilient and productive?

    Second, how can we improve our supervision of financial 
        institutions?

    The Federal Reserve is working diligently to improve both stability 
and supervision. The two concepts are linked. Since the financial 
crisis, the Federal Reserve has made significant changes to the 
substance and process of supervision. As a result, the financial system 
is unquestionably much stronger and much more stable now than it was 5 
years ago.
Substantive Changes
    Since the financial crisis, the Federal Reserve has redoubled its 
attention to bank capital. Capital is the financial cushion that banks 
hold to absorb loss. \1\ It provides an economic firebreak that helps 
prevent systemic stress from turning into a full blown crisis.
---------------------------------------------------------------------------
     \1\ I use the terms ``bank'' and ``financial institution'' 
interchangeably, but note that the two terms are not synonymous in 
Federal regulation.
---------------------------------------------------------------------------
    Before the crisis, capital requirements were too low and 
inconsistent across jurisdictions. Moreover, too much of the capital 
held by banks was of poor quality, and their internal capital 
assessments were not forward looking. \2\ Since the crisis, new 
regulation and heightened supervision have increased both the quantity 
and the quality of equity capital at the largest financial institutions 
that we regulate and supervise. The Federal Reserve and other Federal 
banking regulators implemented so called ``Basel III'' international 
capital standards in July 2013, which raised the minimum ratio of 
common equity Tier 1 capital to risk-weighted assets. Federal 
regulation also now requires stricter criteria for instruments to 
qualify as regulatory capital and higher risk weights for many classes 
of assets. And the Federal Reserve mandated a new minimum supplementary 
leverage ratio that includes off balance sheet exposures for the 
largest, most internationally active banking organizations and a 
leverage surcharge for large U.S. banking organizations.
---------------------------------------------------------------------------
     \2\ See generally Joint Notice of Proposed Rulemaking, 
``Regulatory Capital Rules: Regulatory Capital, Implementation of Basel 
III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition 
Provisions, and Prompt Corrective Action'', June 12, 2012, at 32, 
available at https://www.fdic.gov/news/board/2012/
20120612_notice_disb.pdf.
---------------------------------------------------------------------------
    In support of these new regulations, capital assessment has become 
a focus of supervision since the financial crisis. Examiners monitor 
capital reserves and put banks through periodic stress tests that are 
evaluated on a crossfirm basis. This has been one of the great 
advancements of bank oversight following the crisis. These evaluations 
enable supervisors to assemble a composite assessment of the Nation's 
banking sector, which materially assists the Federal Reserve in its 
statutory mandate to promote financial stability. \3\
---------------------------------------------------------------------------
     \3\ See, e.g., 12 U.S.C. 5365(a)(1).
---------------------------------------------------------------------------
    The Dodd-Frank Act mandates supervisory stress tests that assess 
whether large bank holding companies have a sufficient level of capital 
to absorb losses during adverse economic conditions. \4\ The Federal 
Reserve also conducts a capital planning exercise, called the 
Comprehensive Capital Analysis and Review or ``CCAR.'' This evaluation 
combines the quantitative results from the Dodd-Frank Act stress tests 
with a qualitative assessment of whether the largest bank holding 
companies have vigorous, ``forward looking capital planning processes 
that account for their unique risks.'' \5\ The criteria for both sets 
of stress tests are dynamic and change in response to evolving risks. 
For example, past tests have assumed a sharp, sudden, and widespread 
drop in markets triggered by, say, a large Eurozone shock. The tests 
also evaluate market interconnectedness, including the risk of major 
counterparty default.
---------------------------------------------------------------------------
     \4\ See 12 U.S.C. 5365(i).
     \5\ Board of Governors of the Federal Reserve System, Press 
Release, October 23, 2014, available at http://www.federalreserve.gov/
newsevents/press/bcreg/20141023a.htm.
---------------------------------------------------------------------------
    To increase public transparency, the Federal Reserve now publishes 
the overall results of its stress tests. This helps rebuild confidence 
in the strength of the financial system. The most recent round of 
stress tests concluded in the first quarter of this year. In my view, 
the results were encouraging, although not uniformly satisfying. In 
general, ``firms participating in CCAR have more than doubled their 
Tier 1 common capital since 2009, an increase of $500 billion of 
additional, high-quality capital in the U.S. financial system.'' \6\ 
This impressive statistic notwithstanding, the Federal Reserve objected 
to capital plans from 5 of the 30 participating firms. Four of those 
five firms submitted plans that raised firm specific, qualitative 
concerns. The remaining firm failed to meet a minimum quantitative 
requirement. \7\
---------------------------------------------------------------------------
     \6\ Daniel Tarullo, ``Stress Testing After Five Years'', Remarks 
at the Federal Reserve Third Annual Stress Test Modeling Symposium, 
Boston, Massachusetts, June 25, 2014, available at http://
www.federalreserve.gov/newsevents/speech/tarullo20140625a.htm.
     \7\ See Board of Governors of the Federal Reserve System, 
``Comprehensive Capital Analysis and Review 2014: Assessment Framework 
and Results'', March 2014, at 78, available at http://
www.federalreserve.gov/newsevents/press/bcreg/ccar_20140326.pdf.
---------------------------------------------------------------------------
    The consequences of failing to pass a stress test can be severe. If 
its capital plan has been rejected, the Federal Reserve may, among 
other things, restrict a bank holding company from paying or increasing 
dividends on its common stock or increasing any repurchase of its 
common stock, or both. \8\ For example, as a result of this year's 
CCAR, Citigroup was not permitted to begin a new common stock 
repurchase program or to increase its quarterly common stock dividend. 
\9\
---------------------------------------------------------------------------
     \8\ See 12 CFR 225.8(c)(2) and (e)(2)(iv).
     \9\ See Citigroup, Inc., ``Citi Statement on 2014 CCAR Results'', 
March 26, 2014, available at http://www.citigroup.com/citi/news/2014/
140326b.htm.
---------------------------------------------------------------------------
    As a companion to improved capital, the Federal Reserve also 
assesses liquidity--that is, how quickly a bank can convert its assets 
into cash. Prior to the crisis, liquidity practices did not generally 
anticipate the possibility of severe drops in the prices of saleable 
assets. Following the crisis, the Federal Reserve imposed new liquidity 
regulations, including the Basel III Liquidity Coverage Ratio. The 
objective of these new regulations is to require large firms to hold 
levels of liquid assets sufficient to protect against constraints on 
their funding during times of financial turmoil. We have also 
implemented liquidity stress test assessments for systemically 
important financial institutions. These assessments provide important 
insight into the adequacy of liquidity positions and bank preparedness 
for upcoming regulatory standards.
    Beyond capital and liquidity, the Federal Reserve has increased its 
focus on risk management practices at the largest and most systemically 
important financial institutions. We learned from the crisis that risk 
management in the financial services industry had not always kept pace 
with changing market practices. We have responded in several ways.
    For example, we have paid greater supervisory attention to 
corporate governance. We significantly increased the depth and 
frequency of interaction between senior supervisors from the Federal 
Reserve and directors and executives at banks. This supplements our 
ongoing assessment of management's oversight of risk. Our review 
entails a critical analysis not only of firm policies, procedures, and 
limits, but also of the quality of the risk reports escalated to senior 
management, the capabilities of the firm's risk monitoring program, and 
the adequacy of control functions.
    We have also increased our enforcement activity for violations of 
law or unsafe or unsound conduct. Since 2009 the Federal Reserve has 
taken 36 public enforcement actions against institutions supervised by 
the New York Fed, which included $1.2 billion in fines. On top of this, 
five firms supervised by the New York Fed paid $1.3 billion into a 
qualified settlement fund for mortgage borrowers, and the same five 
institutions were required to provide over $2 billion in other 
foreclosure prevention assistance. These statistics do not include 
nonpublic enforcement actions, including restrictions on the further 
growth of banks that do not have satisfactory risk management regimes. 
And, earlier this year, we assisted in consigning the concept of ``too 
big to jail'' to history when Credit Suisse and BNP Paribas pleaded 
guilty to criminal charges. I am gratified that the Attorney General 
and the United States Attorney for the Southern District of New York 
have acknowledged the work of the Federal Reserve in supporting our law 
enforcement partners. \10\
---------------------------------------------------------------------------
     \10\ See U.S. Department of Justice, ``BNP Paribas Agrees To Plead 
Guilty To Conspiring To Process Transactions Through the U.S. Financial 
System for Sudanese, Iranian, and Cuban Entities Subject to U.S. 
Economic Sanctions'', June 30, 2014, available at http://
www.justice.gov/usao/nys/pressreleases/June14/BNPParibasPlea.php.
---------------------------------------------------------------------------
    The New York Fed has also devoted significant resources and 
attention to the reform of bank culture and conduct. Increased capital 
and liquidity are important tools to promote financial stability, but 
in the end a bank is only as trustworthy as the people who work within 
it. I have personally delivered a strong message that the culture of 
Wall Street is unacceptable. \11\ Bad conduct by bankers damages the 
public trust placed in banks. In my view, this loss of trust is so 
severe that it has become a financial stability concern. If bad 
behavior persists, it would not be unreasonable--and may even be 
inevitable--for one to conclude that large firms are too big and 
complex to manage effectively.
---------------------------------------------------------------------------
     \11\ See William Dudley, ``Ending Too Big to Fail'', Remarks at 
the Global Economic Policy Forum, New York City, November 7, 2013, 
available at http://www.newyorkfed.org/newsevents/speeches/2013/
dud131107.html; William Dudley, ``Enhancing Financial Stability by 
Improving Culture in the Financial Services Industry'', Remarks at the 
Workshop on Reforming Culture and Behavior in the Financial Services 
Industry, Federal Reserve Bank of New York, New York City, October 20, 
2014, available at http://www.newyorkfed.org/newsevents/speeches/2014/
dud141020a.html.
---------------------------------------------------------------------------
    Our Nation's largest financial institutions need to repair the loss 
of public trust in banks. This means a back-to-basics assessment of the 
purpose of banking, including duties owed to the public in exchange for 
the privileges banks receive through their bank charters and other 
functions of law. Among these privileges are deposit insurance and 
access to a lender of last resort.
    As part of this effort, I have proposed four specific reforms to 
curb incentives for illegal and unduly risky conduct at banks. First, 
banks should extend the deferral period for compensation to match the 
timeframe for legal liabilities to materialize--perhaps as long as a 
decade. Second, banks should create de facto performance bonds wherein 
deferred compensation for senior managers and material risk takers 
could be used to satisfy fines against the firm for banker misbehavior. 
Third, I have urged Congress to enact new Federal legislation creating 
a database that tracks employees dismissed for illegal or unethical 
behavior. Fourth, I have requested that Congress amend the Federal 
Deposit Insurance Act to impose a mandatory ban from the financial 
system--that is, both the regulated and shadow banking sectors--for any 
person convicted of a crime of dishonesty while employed at a financial 
institution.
Supervisory Process
    In tandem with our attention to capital, liquidity, and risk 
management, we have made important changes to the process of 
supervision.
    For starters, the Federal Reserve now makes its most consequential 
supervisory decisions on a systemwide level through the Large 
Institution Supervision Coordinating Committee or ``LISCC.'' The 
committee comprises representatives across professional disciplines 
from several Reserve Banks and the Board of Governors. The New York Fed 
supplies only three of its 16 members. LISCC sets supervisory policy 
for the 15 largest, most systemically important financial institutions 
in our country and develops innovative, objective, and quantitative 
methods for assessing these firms on a comparative basis. LISCC also 
coordinates the supervision of the largest supervised institutions 
through its Operating Committee, which reviews and approves supervisory 
plans for exams, receives regular updates on major supervisory issues, 
and makes material supervisory decisions regarding matters that affect 
the firms' safety and soundness. In this respect, the Operating 
Committee provides an important safeguard against regulatory capture by 
ensuring that no one person or Reserve Bank has the power to make a 
final decision on a matter of significance.
    Another procedural change is our increased application of 
crossfirm, horizontal review. This technique enables peer-to-peer 
comparison of banks, facilitates a better assessment of the overall 
health of the financial system, and safeguards against regulatory 
capture by providing insight from across the Federal Reserve System. 
The analysis is done not only at the level of the Board of Governors--
for example, through CCAR and Dodd-Frank stress testing--but also 
within the New York Fed. We hold weekly discussions among senior 
supervisory and risk officers to identify developing concerns that may 
pose a systemic risk. A current subject of horizontal analysis is 
leveraged loans--specifically, whether lax underwriting practices for 
such loans could pose a significant risk to financial stability.
    In addition, we have reorganized the supervision group at the New 
York Fed in a number of ways that promote unbiased analysis and 
professional objectivity. Many of these changes directly reflect the 
recommendations in a 2009 report that I commissioned from David Beim, 
which was featured in the recent This American Life program about 
supervision at the New York Fed. For example:

    Over the last 5 years, we have reassigned some of our most 
        senior personnel to front-line positions at the largest 
        supervised institutions. We also recruited experienced 
        executives with financial backgrounds from outside the New York 
        Fed. The purpose of these personnel changes was to position 
        leaders with the confidence and depth of professional 
        experience necessary to challenge the leadership of supervised 
        financial institutions.

    We increased training, especially for more senior 
        examiners. Since 2011, we have required enhanced training for 
        senior supervisory officers on corporate governance, business 
        strategies, and risks. Our goal is to deliver stronger and 
        clearer supervisory views to boards of directors and senior 
        management. Also since that year, we have offered a customized 
        management development program for managers in the supervision 
        group.

    We hired more risk specialists and created the role of 
        business-line specialist to assess the risks and 
        vulnerabilities in firms' business models.

    We continue to require that examiners rotate to another 
        institution after 3 to 5 years. This tenure allows enough time 
        to gain an understanding of a firm without sacrificing examiner 
        independence.

    We have taken concrete steps to encourage examiners to 
        speak up, which we view as a core competency. For example, we 
        evaluate examiners on their level of engagement with colleagues 
        and their willingness to share insights.

    We created programs to encourage peer recognition of good 
        ideas, including funding for new supervision ideas proposed and 
        voted on by supervisory staff.

    We increased the opportunities for feedback to senior 
        managers, including the head of supervision, in addition to 
        other channels already provided by the New York Fed. Among 
        other improvements, we conduct regular town halls and provide a 
        standing, online forum as a device to funnel questions to group 
        leaders. In both settings, questions and answers are offered in 
        an open, transparent manner.

    And we require examination teams to spend more time at New 
        York Fed headquarters and less time ``in the field.'' 
        Additional time at headquarters promotes crossfirm discussion 
        and direct communication between senior managers and examiners. 
        For example, we offer a seminar series at which group leaders 
        discuss key issues in supervision with our supervision staff.

    Each and together, these improvements to the substance and process 
of supervision contribute to financial stability by providing greater 
insight into bank resiliency and risk. But these enhancements are not 
self-executing. They depend on the hundreds of examiners who are 
dedicated professionals working in the public interest. Our examiners 
fulfill their obligations with considerable care, mindful of the stakes 
to Main Street when something goes wrong on Wall Street. I am grateful 
for their efforts.
Reasonable Expectations
    Before concluding, let me offer a broader view of what we at the 
Federal Reserve expect from prudential supervision. Very briefly, I 
submit that supervision should be fair, conscientious, and effective.
    Fair supervision means that the rules are applied consistently 
across the firms we supervise. We all need to know the rules and follow 
the same rule book. It also entails a commitment to independence from 
business or political influence, as envisioned by the Federal Reserve 
Act 100 years ago.
    Conscientious supervision means we must be committed to sustained 
and, if necessary, radical self-improvement. The Beim report is an 
example of our willingness to commission and accept self-critical 
analysis and our commitment to improve. But we cannot stop there. To 
this end, we will be working with the Board of Governors on its 
upcoming review of whether the LISCC Operating Committee receives 
information that is sufficient to reach sound supervisory decisions. 
One subset of this systemwide inquiry will analyze regulatory capture--
specifically, how divergent views are presented to decision makers at 
the Board. The review is expected to take several months.
    Effective supervision means tough supervision and demands a focus 
on large banks that pose systemic risk. Bank supervisors cannot prevent 
all fraud or illegal conduct or forestall all undesirable behavior in 
large, complex financial institutions. But we can help create more 
resilient, less complex, and better managed organizations that promote, 
rather than undermine, financial stability.
Conclusion
    The Federal Reserve will continue to improve its supervision and 
regulation of financial institutions. We understand the risks of doing 
our job poorly and of becoming too close to the firms we supervise. We 
work hard to avoid these risks and to be as fair, conscientious, and 
effective as possible. Of course, we are not perfect. We cannot catch 
or correct every error by a financial institution, and we sometimes 
make mistakes. But in my view, a good measure of the effectiveness of 
supervision is the improved strength and stability of banks since the 
financial crisis. Thanks in part to enhanced supervision and 
regulation, banks ``have the ability to meet their financial 
obligations and continue to make a broad variety of financial products 
and services available to households and businesses even in times of 
economic difficulty.'' \12\ I can promise you that we will always 
strive to improve and that we will work hard to earn and retain your 
trust.
---------------------------------------------------------------------------
     \12\ Scott G. Alvarez, Testimony before the Committee on Financial 
Services, United States House of Representatives, April 8, 2014, 
available at http://www.federalreserve.gov/newsevents/testimony/
alvarez20140408a.htm.
---------------------------------------------------------------------------
    I look forward to taking questions.
                                 ______
                                 
                  PREPARED STATEMENT OF DAVID O. BEIM
      Professor of Professional Practice, Columbia Business School
                           November 21, 2014
Introduction
    My name is David Beim. From 1966 to 1990 I worked as an investment 
banker for The First Boston Corporation, Bankers Trust Company and 
Dillon Read & Co, with 2 years (1975-77) as Executive Vice President of 
the Export-Import Bank of the United States. In 1989 I began to teach 
as an adjunct at Columbia Business School, and in 1991 joined the 
faculty of that school as a Professor of Professional Practice.
    At Columbia Business School I taught a number of MBA courses 
including Banking Fundamentals, International Business, Emerging 
Financial Markets, Corporate Finance, Business Ethics and Corporate 
Governance over the 25-year period 1989-2014. In addition I taught in a 
wide range of executive education programs. I retired from Columbia on 
June 30 of this year.
    In 1997 I performed a consultancy study for the Federal Reserve 
Bank of New York (NY Fed) regarding the effectiveness of its bank 
examination procedures. In that connection I interviewed a number of 
bank CEOs and senior NY Fed officials. My overall conclusion was that 
the NY Fed's examinations were too low-level, too bottom-up. I 
recommended that each examination should begin top-down, with a view of 
each bank's strategy for making money and the risks such a strategy 
would likely entail. That would provide a context for seeing whether 
such risks were indeed a problem for the particular bank. I believe 
that this study was well received and significantly affected the way 
examinations have since been conducted.
    In the late spring of 2009 I received a call from Bill Dudley, 
President of the NY Fed, inviting me to conduct a new consultancy 
project, this one about systemic risk. The United States, like all 
other countries, has had numerous banking failures over many years. But 
the events of 2008 were unlike ordinary bank failures--they represented 
a systemic financial collapse, in which the capital of almost all major 
financial institutions was exhausted simultaneously. We have not had a 
systemic financial collapse in the United States since 1931, and most 
people thought we would never have another.
    The Federal Reserve had not seen these events coming, but neither 
had almost anyone else. Mr. Dudley wanted me to sit down with eight of 
his top Senior Vice Presidents and work together through the summer to 
determine what lessons had been learned, and what changes the NY Fed 
needed to make in its procedures or in its culture to better understand 
and foresee systemic problems, i.e., problems affecting not just one 
bank but all banks jointly. He emphasized that he wanted complete 
candor so that genuine reforms could be initiated.
    The summary of our findings is as follows: ``Our review of lessons 
learned from the crisis reveals a culture that is too risk-averse to 
respond quickly and flexibly to new challenges. Officers are intensely 
deferential to their superiors, similar to an army. Knowledge is too 
often hoarded in silos. Business organizations including banks have 
moved away from structured hierarchies in favor of more modern, 
flexible organizational forms, and [the NY Fed] needs to adopt some of 
these attributes to be effective in grasping and acting on systemic 
issues. This requires a significant degree of cultural change and has 
implications for human resources and management.''
    We found that NY Fed officers were excessively deferential to their 
superiors and that the entire organization was excessively deferential 
to the banks being supervised. There was huge emphasis on consensus. 
This is in sharp contrast to academic culture, for example, where 
disagreement and vigorous debate are highly valued. Among our 
recommendations was one giving officers more incentives for 
disagreement and contrarian thinking.
    I delivered the final draft of our report in late summer, and Mr. 
Dudley seemed very pleased. The report was of course highly 
confidential and never intended for public distribution. However in 
2010 the Congress created the Financial Crisis Investigative Commission 
(FCIC) to investigate the causes of the crisis. The FCIC subpoenaed a 
large number of documents from many agencies including the Federal 
Reserve, and ended by posting these on its Web site. In this way my 
confidential report was made public.
    Last June I was called by a producer from National Public Radio, 
who said that its highly regarded program ``This American Life'' wanted 
to interview me about the report. I agreed, since the document was 
already in the public domain, but said I would have to stay within the 
four corners of the document, which I did. Their story, which aired in 
late September, connected my report to the story of Carmen Segarra, a 
NY Fed examiner who was indeed contrarian and outspoken, but who was 
soon dismissed. At the time of the interview I knew nothing of Carmen 
Segarra. The program received a great deal of attention, and the 
present hearings reflect the high level of public interest in this 
subject.
Regulatory Capture
    ``Regulatory capture'' is a provocative phrase describing an 
excessively close relationship between a regulator and the companies it 
regulates. But we need to be careful, since the phrase is used to 
describe two quite different situations:

  1.  In what I call the ``strong form'' of regulatory capture, 
        regulation confers an economic benefit that companies actively 
        want, for example by keeping prices high or restricting 
        competition, and the regulator agrees to supply it to them.

  2.  In what I call the ``weak form'' of regulatory capture, 
        regulation is negative for the companies, but the regulator 
        does not strictly enforce the rules, and fails to control 
        company behavior in the way intended by the law.

    There is a large academic literature on the strong form of 
regulatory capture, dating from the 1970s. \1\ The financial bailouts 
of 2008-9, which were undoubtedly a great benefit to the banks, have 
sometimes been called an example of regulatory capture of the Federal 
Reserve by the banks. I do not share this view, as the bailouts were an 
action of the entire U.S. Government and not just one agency. They were 
an emergency action to prevent the U.S. financial system from total 
collapse, an event that could have brought us back to the 1930s. In my 
view this action was entirely in the public interest. If one bank fails 
it should be closed, but if all banks fail simultaneously the system 
needs to be rescued. All relevant modern Governments believe the same 
and did the same. My 2009 report found no evidence that the NY Fed was 
putting the interests of banks ahead of the public interest.
---------------------------------------------------------------------------
     \1\ The seminal article is George Stigler, 1971, ``The Theory of 
Economic Regulation'', Bell Journal of Economics and Management Science 
2:3-21.
---------------------------------------------------------------------------
    We did, however, find a great deal of the weak form of regulatory 
capture, an obvious pattern of timidity toward the banks being 
regulated: ``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 . . . A very frequent theme in our reviews 
was a fear of speaking up . . . Ideas get vetted to death.''
    No one should imagine that the Federal Reserve is unusual in this 
respect. All bank regulators face the same issue, as indeed do all 
regulators of economic activity. What causes this timidity? It seems to 
make a mockery of regulation. Why aren't regulators tougher?
    I believe the answer is connected with the general insight, also 
first explored by economists in the 1970s, that both companies and 
Government agencies are operated by individuals who have private 
interests, and that these private interests may drive institutional 
behavior in unexpected ways. For example, bribery happens to some 
degree in all countries and is an obvious example of the private goals 
of Government officials undermining public goals.
    But short of bribery, which is everywhere illegal, private goals of 
Government officials can and do undermine public goals in dozens of 
subtle and legal ways. An individual bank regulator is a human being 
with ambitions and needs. First, of course, he or she wants to get 
ahead in the organization, and this generally means agreeing with 
bosses and colleagues--hence the emphasis on consensus. When an 
individual regulator disagrees with the position his agency is taking, 
shutting up and avoiding conflict probably serves his general goal of 
being well regarded by his colleagues.
    More importantly, I believe that bright regulators in mid-career 
all harbor some hope that they will be offered a good job with one of 
the regulated companies. Large banks, like other large companies, pay 
higher salaries than Government agencies, and this creates a powerful 
incentive for regulators to behave in a deferential manner toward such 
banks, so that he or she might be well regarded enough to be offered a 
job.
    The NPR broadcast on the NY Fed played detailed recordings of 
conversations among NY Fed officials about regulating Goldman Sachs, in 
which the lead regulator, a man named Mike Silva, tells his colleagues 
that he is going to press Goldman hard but at the moment of truth 
behaves in a very timid manner toward that bank. Mr. Silva was actually 
part of the team of eight SVPs with whom I worked in producing my 
report. He is a bright, articulate man, and like most NY Fed officials 
is hard working and conscientious. However, in 2013 he left the NY Fed 
to join GE Capital. How could the possibility of an opportunity like 
this not have been in the back of his mind when he was making decisions 
about how tough to be with banks?
Information Asymmetry
    Another factor that helps to explain the weak form of regulatory 
capture is information asymmetry: companies being regulated know a lot 
more about their businesses than the regulators who are supposed to 
control them. I witnessed this in my own career when I was the head of 
investment banking for Bankers Trust Company, which was regulated by NY 
Fed.
    In 1979 I became very interested in swaps, a basic kind of 
derivative, when they were new and not well understood. I began to 
build a capacity in my department to offer swaps and we rapidly found 
our volume increasing. About a year later I got a polite call from the 
NY Fed asking if they could bring a team over to our bank so that we 
could explain swaps to them. I readily agreed, and spent several hours 
explaining swaps to them. However, even after this candid presentation, 
the officials had only an elementary understanding of swaps compared to 
the bankers who had been working with them full time. In short, the 
regulators often struggle to catch up with banks that are innovating 
and figure out what they are doing.
    Information asymmetry puzzles many observers, including the NPR 
journalists who interviewed me about my NY Fed report. ``Can't a 
regulator just demand the information, and don't the banks have to 
supply it?'' they asked. Well yes, I would answer, but there is a 
difference between information and insight.
    Banks supply great quantities of data to regulators, but what do 
the data mean? What strategy is being pursued and how do these 
transactions contribute to the strategic goals? Real understanding 
requires more than numbers. You have to talk to the people involved to 
understand the meaning of the data.
    I believe that regulators are deferential to banks in part because 
they need banks to share insights into the strategy and meaning of 
their transactions. Such insights can only be gained if the working 
relationship is collaborative, not confrontational. Confrontation 
usually leads to delivering the facts but not more.
    I have not visited the NY Fed since my 2009 project, so I know 
little about what has happened there since, except for articles in the 
public press. The NPR broadcast about Carmen Segarra in September and 
the related story in ProPublica \2\ seem to confirm that the Fed is 
still surprisingly bland in enforcing its rules against big banks.
---------------------------------------------------------------------------
     \2\ http://www.propublica.org/article/carmen-segarras-secret-
recordings-from-inside-new-york-fed
---------------------------------------------------------------------------
    A subsequent article in ProPublica concerning JPMorgan Chase \3\ 
seems to show that the problems of effective regulation by the NY Fed 
have not yet been solved. The villain in this story is Dianne Dobbeck, 
who is portrayed as authoritarian and negative, blocking the NY Fed's 
own risk team from investigating the ``London Whale'' trading losses. 
The story claims that Ms. Dobbeck had her mind made up and did not want 
to hear negative information about the bank. This sounds like another 
example of weak-form regulatory capture.
---------------------------------------------------------------------------
     \3\ http://www.propublica.org/article/secret-tapes-hint-at-
turmoil-in-new-york-fed-team-monitoring-jpmorgan
---------------------------------------------------------------------------
What Can Be Done?
    Regulatory capture, particularly in its weak form, is a widespread 
problem that goes way beyond banking and undermines much of our 
regulatory system. So let me come to the bottom line: what can be done 
about it?
    There is quite a lot that the NY Fed and other regulatory agencies 
can do on their own, with no need for new legislation, many of them 
detailed in my report.
    Informational asymmetry can never be fully solved, but it can be 
alleviated by upgrading the staff, hiring bright and independent-minded 
people, giving them extensive opportunities to upgrade their skills and 
providing more explicit incentives for them to act in independent ways.
    This means doing what the big banks have done: decentralize 
authority and give more responsibility for problem solving to lower-
level officers. The culture should be less like an army and more open 
to questioning and challenging. I understand that the Federal Reserve 
is in fact moving in the opposite direction, centralizing more 
regulatory authority in Washington, which in my view is a mistake.
    But the most important step to control regulatory capture is one 
that Congress can and should do: strengthen the ``revolving door'' laws 
by prohibiting all regulators from working in the regulated industry 
for fully 3 years after leaving Government.
    The United States has a number of ethics laws that try to restrict 
various classes of Government employees from moving to private sector 
companies with whom they have conducted Government work for 1 year. 
However, these rules are usually narrowly written and have dozens of 
easy loopholes, so that in practice they seem to have little effect.
    I am not an expert in such laws, but I quote the following from a 
Congressional Research Service publication: \4\
---------------------------------------------------------------------------
     \4\ ``Post-Employment, `Revolving Door', Laws for Federal 
Personnel'', by Jack Maskell, Legislative Attorney, January 7, 2014.

        Under amendments to the Federal Deposit Insurance Act, certain 
        officers and employees of a ``Federal banking agency or a 
        Federal reserve bank,'' who are involved in bank examinations 
        or inspections, are restricted from any compensated employment 
        with those private depository institutions for a period of 1 
        year after leaving Federal service. This restriction applies to 
        employees who served for at least 2 months during their last 
        year of Federal service as ``the senior examiner (or a 
        functionally equivalent position),'' and who exercised 
        ``continuing, broad responsibility for the examination (or 
        inspection)'' of a depository institution or depository 
        institution holding company. These former employees are barred 
        for 1 year from receiving any compensation as an ``employee, 
        officer, director, or consultant'' from the depository 
        institution, the depository institution holding company that 
        controls such depository institution, or any other company that 
        controls the depository institution, or from the depository 
        institution holding company or any depository institution that 
        is controlled by that the depository institution holding 
---------------------------------------------------------------------------
        company.

    This is narrowly written and restricts only the senior examiner 
from working for the very bank he examined. If you really want to push 
back against regulatory capture, the law needs to be greatly broadened: 
it should apply to all officers of a bank regulator working for any 
bank for a period of 3 years.
    Few bank regulators are offered jobs by the very bank they were 
regulating, but bank regulators as a group form a kind of community 
with all regulated banks, where many people know each other. No one can 
predict which individual will be offered a job by which bank, but it is 
highly predictable that some regulators will be offered a job by some 
banks. This likelihood affects the way all regulators deal with all 
banks--how could it not?
    To reduce regulatory capture and stiffen the backbones of 
individual regulators, this easy revolving door must be stopped. This 
would force more individuals to make an identity decision early in 
their careers: am I a regulator for the long term or am I a banker?
    Ethics laws in general and revolving door laws in particular tend 
to be unpopular with the people they affect, since they reduce choices. 
But the long-term effect would be a stronger boundary between the 
regulators and the banks. It would be a major step toward better 
regulation of banks, and I recommend it to you as the most important 
step you could take to reduce regulatory capture.
                                 ______
                                 
                PREPARED STATEMENT OF ROBERT C. HOCKETT
          Edward Cornell Professor of Law, Cornell Law School
                           November 21, 2014
Introductory Remarks: Qualifications and Scope of Testimony
    Thank you for inviting me to speak with you here today. My 
understanding is that you would like my testimony to discuss the role 
of supervision and examination of financial institutions, particularly 
the largest such institutions that the Federal Reserve \1\ has a 
prominent hand in overseeing, in protecting (a) consumers of financial 
services, (b) participants (including savers and other investors) in 
the banking and broader financial markets, and especially (c) the 
integrity and stability of the financial system as a whole. I believe 
that you would like me to address in particular the danger of what 
often is called ``regulatory capture'' in this connection--the danger 
that excessive influence by or deference to regulated entities might 
pose to the supervisory task. This is of course a matter that has 
acquired renewed public salience of late in virtue not only of the 
financial dramas of 2008-09, but also of (a) certain regulatory reform 
recommendations made by experts in the wake of those dramas, \2\ and 
(b) certain revelations of possible shortcomings in actually 
implementing the mentioned recommendations, as recently reported 
through media outlets including ProPublica and This American Life. \3\
---------------------------------------------------------------------------
     \1\ Also ``Fed,'' ``Board,'' ``FRB.''
     \2\ See, e.g., David Beim, ``Report on Systemic Risk and Bank 
Supervision'', Federal Reserve Bank of New York, Discussion Draft, 
September 10, 2009, available at http://www.propublica.org/documents/
item/1303305-2009-08-18-frbny-report-on-systemic-risk-and.html. 
Hereinafter ``Beim Report''.
     \3\ See, e.g., Jake Bernstein, ``Secret Tapes Hint at Turmoil in 
New York Fed Team Monitoring JPMorgan'', ProPublica, November 17, 2014, 
available at http://www.propublica.org/article/secret-tapes-hint-at-
turmoil-in-new-york-fed-team-monitoring-jpmorgan; Jake Bernstein, 
``Inside the New York Fed: Secret Recordings and a Culture Clash'', 
ProPublica, September 26, 2014, available at http://www.propublica.org/
article/carmen-segarras-secret-recordings-from-inside-new-york-fed; Ira 
Glass, ``The Secret Recordings of Carmen Segarra'', This American Life, 
September 26, 2014, available at http://www.thisamericanlife.org/radio-
archives/episode/536/the-secret-recordings-of-carmen-segarra.
---------------------------------------------------------------------------
    My understanding is that you have invited my testimony on these 
matters in light of two sets of qualifications that might suit me to 
the task. The first is my academic and related professional expertise 
as a specialist in finance and its regulation. The second is my recent 
role as a Legal Department counterpart to the ``Visiting Scholar'' 
economists who regularly share expertise in pursuit of various projects 
while in residence at the Federal Reserve Bank of New York's \4\ 
Research and Statistics Group. Because recent allegations concerning 
the FRBNY figured prominently in three of the recent media reports 
referenced above, \5\ and because they concerned, moreover, events 
thought to have occurred while I was in residence there, I gather that 
you also are interested in my impressions of capture's presence or 
absence at this institution--the FRBNY--in particular.
---------------------------------------------------------------------------
     \4\ Also ``New York Fed's,'' ``FRBNY's,'' ``the Bank's.''
     \5\ Sources cited supra, n. 3.
---------------------------------------------------------------------------
    As to the first set of qualifications, I hold the Edward Cornell 
Endowed Chair in Law at Cornell University, \6\ where I have taught 
since 2004; and am a Fellow of The Century Foundation, \7\ a long-
established public policy institute with which I have been associated 
for nearly 3 years. I also am Chair of the Association of American Law 
Schools' Section on Financial Institutions and Consumer Financial 
Services, \8\ a Member of the New York City Bar Association's Committee 
on Banking Law, \9\ and in-house finance-regulatory consultant with 
Westwood Capital Group in New York. \10\
---------------------------------------------------------------------------
     \6\ Web page available at http://www.lawschool.cornell.edu/
faculty/bio_robert_hockett.cfm.
     \7\ Web page available at http://tcf.org/experts/detail/robert-c.-
hockett.
     \8\ Web page available at http://memberaccess.aals.org/eWeb/
dynamicpage.aspx?webcode=ChpDetail&chp_cst_key=a99dc504-4ef4-43e4-bd35-
7f0eb1083b7b.
     \9\ Web page available at http://www.nycbar.org/banking-law.
     \10\ Web page available at http://www.westwoodcapital.com/
ourpeople/robert-hockett/. 
---------------------------------------------------------------------------
    My principal fields of research, writing, teaching, and practical 
expertise lie in the realms of enterprise-organizational, finance-
regulatory, and monetary law. Central banks like the Fed and their 
functions figure importantly in much of what I do in these connections. 
I am also the author of what soon will be the sole American law school 
coursebook that treats financial regulation in a comprehensive and 
integrated fashion, \11\ while most of my other academic writing since 
2008 has been on (a) the causes of our recent financial difficulties 
and (b) cures to the ills that have occasioned them. \12\ Prior to 
entering the legal academy and then again during my sabbatical year of 
2012-13, I worked at the International Monetary Fund, \13\ the closest 
thing we have to a global central bank. \14\ During my first stint 
there in 1999-2000, my work was on corporate- and finance-regulatory 
reform proposals under consideration in connection with the Asian, 
Russian, and Argentine financial difficulties of the era. \15\ During 
my second stint in 2012-13, my work was primarily on how best to 
implement, through law, certain new proactively bubble-preemptive, 
``macroprudential'' approaches to financial regulation under 
consideration or in process of implementation in the U.S., the UK, the 
E.U., and other jurisdictions. \16\
---------------------------------------------------------------------------
     \11\ Robert Hockett, ``Cases and Materials on Finance and Its 
Regulation'' (West, 2014) (forthcoming).
     \12\ See, e.g., Robert Hockett, ``A Fixer-Upper for Finance'', 87 
Wash. U. L. Rev. 1213 (2010), available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1367278; Robert Hockett, ``The Macroprudential 
Turn: From Institutional `Safety and Soundness' to `Systemic Stability' 
in Financial Supervision'', 9 VA. L. and Bus. Rev. 1 (2014) 
(forthcoming), available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2206189.
     \13\ Also ``IMF,'' ``the Fund.''
     \14\ See Robert Hockett, ``Bretton Woods 1.0: A Constructive 
Retrieval'', 16 N.Y.U. J. Legis. and Pub. Pol'y 1 (2013), available at 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1805962.
     \15\ See, e.g., Robert Hockett and Barry A.K. Rider, ``The 
Regulation of Insider Dealing'', IMF White Paper, March 2000 (available 
on request).
     \16\ See, e.g., Robert Hockett et al., ``Implementing 
Macroprudential Finance-Oversight Policy: Legal Considerations'', Draft 
IMF White Paper, February 2013, available at http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=2340316; also Robert Hockett et al., 
``Implementing Macroprudential Policy--Selected Legal Issues'', IMF 
Board Paper, June 17, 2013, available at http://www.imf.org/external/
np/pp/eng/2013/061713.pdf; and Robert Hockett, ``Practical Guidance on 
Macroprudential Finance-Regulatory Reform'', Harvard Law School Forum 
on Corporate Governance and Financial Regulation, November 22, 2013, 
available at http://blogs.law.harvard.edu/corpgov/2013/11/22/practical-
guidance-on-macroprudential-finance-regulatory-reform/.
---------------------------------------------------------------------------
    With respect to my second set of qualifications noted above, from 
the early summer of 2011 to the early autumn of 2012, I worked in a 
consultative capacity at the FRBNY, primarily in the Legal Department 
but in a sizable number of cases also with economist colleagues in the 
Research and Statistics Group. I was at the Bank more or less daily 
during the summers of 2011 and 2012, and during the long academic 
winter break of 2011-12. I was also there during all or nearly all 
Fridays and many Thursdays, as well as during all days of the long 
autumn and spring breaks, while school was in session at Cornell. The 
projects on which I worked at the Bank were numerous and fell under a 
variety of categorical headings, from helping to draft formal Comment 
Letters in connection with proposed rulemakings by other finance-
regulatory agencies, through legal analyses tracing and assessing the 
likely domestic consequences of possible currency regime changes 
abroad, through helping to identify existing statutory and regulatory 
avenues through which to implement new macroprudential finance-
regulatory tools here in the U.S., to topic suggestions for inclusion 
in policy speeches, preparing a seminar on the role of corporate 
governance in big bank risk-taking, and numerous legal analyses of 
possible reforms to the Nation's secondary mortgage markets.
    Before proceeding to the principal substance of my testimony, I 
should emphasize three final points about my role with the FRBNY. The 
first is that some of the work that I did at the Bank was confidential 
in character, and I will of course be taking care not to violate any 
such confidences in my testimony. The second is that I do not believe 
that you wish me to do otherwise, \17\ and do not believe in any event 
that many, if any, of the matters about which I shall be maintaining 
confidence are within the scope of that about which you wish me to 
testify. Finally the third is that, notwithstanding various accusations 
or criticisms of the FRBNY, the FRB, or the Federal Reserve System more 
generally that one sometimes encounters from the ``left'' or the 
``right,'' I have found those with whom I have worked or become 
acquainted in the Federal Reserve System to be serious, conscientious, 
and able public servants. Some of them, though, do think the 
institution can be improved, and have sometimes reported discouragement 
as to how seriously or otherwise their suggestions are taken.
---------------------------------------------------------------------------
     \17\ Do please of course let me know if I'm wrong in assuming 
this.
---------------------------------------------------------------------------
    Insofar as there are improvements that might be made to the FRBNY 
or the Fed more broadly in their regulatory capacities, then--and I'll 
urge below that there are--these opportunities for improvement are not, 
so far as I can tell, rooted in any lack of integrity or raw ability on 
the part of Fed personnel. They seem to have much more to do with the 
internal structure of institutional decision making. My proposed 
avenues for possible reform are accordingly structural rather than 
personal in character.
Background to Today's Hearings: Supervisory Role of the Fed, Post-
        Crisis Reform Proposals, and Recent Allegations of Inadequate 
        Reform Implementation
    As many of you here today know, the U.S. is more or less unique 
among comparable jurisdictions in the number of distinct financial 
regulators that oversee its complex and sprawling financial system. At 
least three distinct regulatory agencies (the Fed, FDIC, and OCC \18\) 
oversee federally chartered or insured commercial banks, for example, 
while State regulators supervise State-chartered commercial banks 
alongside those banks' Federal insurer, the FDIC. Other regulators 
(primarily the NCUA and, until 2011, the OTS \19\) have, along with the 
Fed in the case of some holding companies, \20\ helped supervise some 
of the Nation's noncommercial (``thrift'' and ``credit union'') banking 
institutions, while still others (FHA and FHFA \21\) oversee the 
Nation's system of home mortgage finance. Meanwhile, another regulator 
(the SEC \22\) has primary responsibility for overseeing the Nation's 
securities markets and the firms, including broker-dealers (investment 
banks) and investment companies (``mutual'' and ``closed-end'' funds) 
that operate therein. And yet another regulator (the CFTC \23\) 
oversees the derivatives markets. Finally, under the McCarran-Ferguson 
Act of 1945, State insurance commissioners take primary responsibility 
for regulating the Nation's (since 2010, non-SIFI \24\) insurance 
firms, including the actions they take in their capacities as financial 
intermediaries.
---------------------------------------------------------------------------
     \18\ The FDIC is the Federal Deposit Insurance Corporation, which 
insures all federally chartered and nearly all State chartered 
depository institutions. The OCC is the Office of the Comptroller of 
the Currency, housed in the Department of Treasury, which charters 
national banks and administers the lending-limit and other portfolio-
shaping regimes to which those banks are subject, among other things. 
Its counterpart in the case of State-chartered banks is typically 
called the State ``banking commissioner.''
     \19\ The NCUA is the National Credit Union Administration, charged 
with regulating that form of noncommercial (i.e., non-shareholder-
owned) depository institution known as the ``credit union.'' The OTS 
was the Office of Thrift Supervision, which used to regulate other 
forms of noncommercial (thrift) institutions, and whose former duties 
since 2011 have been parceled out among the other depository 
institution regulators.
     \20\ See below for more on the Fed's supervisory role vis-a-vis 
holding companies that own depository institutions of various stripes--
commercial banks, thrifts, etc.
     \21\ FHA is the Federal Housing Authority, which since 1934 has 
provided default insurance on qualifying mortgages (the now familiar 
30-year fixed rate was its invention) and assisted with home refinance 
and home borrower education. FHFA is the Federal Housing Finance 
Agency, which primarily regulates such secondary mortgage market makers 
as Fannie Mae.
     \22\ The SEC is the Securities and Exchange Commission, which 
since 1934 has regulated the securities markets, the broker-dealer 
firms that operate in those markets, and the investment companies, 
including mutual funds, that specialize in investing in those markets. 
It also regulates those who serve as investment advisors to such 
companies, as defined by the Investment Advisors Act of 1940.
     \23\ The CFTC is the Commodity Futures Trading Commission, which 
is the SEC's counterpart in the derivatives markets.
     \24\ SIFIs are ``Systemically Important Financial Institutions,'' 
a category that embraces two subcategories of institution defined under 
the Dodd-Frank Act, more on which infra.
---------------------------------------------------------------------------
    Although it is simply one among the many aforementioned financial 
regulators, the Fed has long stood apart as a sort of ``first among 
equals'' among them, and the New York Fed in particular has stood out 
in turn as a sort of ``first among equals'' among the regional Fed 
banks themselves--the entities that all jointly constitute, along with 
the Board, the Federal Reserve System itself. The reasons for this 
``first among equals'' character are not difficult to appreciate. As 
the primary agent of the Nation's monetary policy, the Fed has long had 
to concern itself with the financial system as a whole in view of the 
dollar's role as principal reserve asset and purest form of liquidity 
in that system. Activity in the financial markets bears directly upon 
demand for, and the consequent relative value of, the dollar. An agency 
charged with maintaining ``stable prices''--i.e., a nonfluctuating 
dollar--then, as is the Fed, \25\ cannot but concern itself with events 
in financial markets. Effectively maintaining price stability requires 
among other things that one safeguard financial stability.
---------------------------------------------------------------------------
     \25\ See 12 U.S.C. 223a.
---------------------------------------------------------------------------
    These same considerations account for the New York Fed's special 
role within the Federal Reserve System itself. For one thing, the 
``financial system'' is primarily headquartered in, and conducts most 
of its business in, Manhattan, while the New York Fed is that 
instrumentality of the Federal Reserve System with jurisdiction over 
the Fed's Second District which includes New York. For another thing, 
the Fed conducts much of its monetary policy through so-called ``open 
market operations,'' pursuant to which it acts to maintain price 
stability by purchasing and selling securities--primarily Government 
securities--with a view to increasing or decreasing the supply of 
dollars in private banking institutions' reserve accounts day by day. 
The New York Fed in turn is that instrumentality of the Federal Reserve 
System which conducts these trades, which it does with private ``dealer 
banks'' operating primarily nearby in lower Manhattan.
    It is for all of these reasons, along with some others, that the 
Fed is often thought to be charged with an ``unwritten third'' mandate 
sounding in ``financial stability,'' along with its express ``stable 
prices'' and ``maximum employment'' mandates. \26\ It is probably 
likewise at least partly for these reasons that the Fed has possessed, 
since 1956, another role that lends it yet more systemic importance: 
that is its role, under the Bank Holding Company Act signed into law 
that year, as the ``umbrella'' regulator of large financial firms that 
own commercial banks and other species of financial firm.
---------------------------------------------------------------------------
     \26\ See, e.g., Chair Janet Yellen, ``Semiannual Monetary Policy 
Report to Congress'', July 15, 2014, available at http://
www.federalreserve.gov/newsevents/testimony/yellen20140715a.htm; also 
Christian Ackman, ``The Unwritten Mandate: Is Financial Stability Worth 
the Fed's Time?'' Seeking Alpha, November 4, 2014, available at http://
www.nasdaq.com/article/the-unwritten-mandate-is-financial-stability-
worth-the-feds-time-cm409827. Note that this is the case even post-
instituting of the Financial Stability Oversight Council (FSOC) under 
Dodd-Frank.
---------------------------------------------------------------------------
    The associated macroprudential and ``umbrella''-regulatory roles 
had grown quite systemically significant already by 1999, when the 
Graham-Leach-Bliley Act (GLBA) partially repealed the longstanding 
Glass-Steagall restrictions on commercial bank affiliation with 
investment banks and thereby opened the door to a new form of financial 
conglomerate--the ``Financial Holding Company''--operating 
simultaneously in the banking, securities, insurance, and other 
financial markets. The Fed's role became all the more systemically 
significant thereafter, once GLBA assigned it ``umbrella'' regulator 
status vis-a-vis not only traditional bank holding companies, but also 
these inherently systemically significant, multiple-subsector-
straddling conglomerates themselves. Here too, moreover, the New York 
Fed in particular was bound to emerge as a ``first among equals'' among 
the Fed regional banks, since the principal financial conglomerates in 
question--the likes of JPMorgan Chase, Goldman Sachs, and Morgan 
Stanly--are, yet again, headquartered primarily in Manhattan.
    A final systemically important role that the Fed plays, now largely 
though not solely in virtue of its role as umbrella regulator of 
banking and other financial conglomerates, has to do with consumer 
protection and fair access to banking services. Until the Dodd-Frank 
Act of 2010 instituted a new, independent Consumer Financial Protection 
Bureau (CFPB) housed in the Fed, the Fed was the principal Federal 
guarantor of various forms of consumer protection afforded clients of 
the financial services industry. While the new CFPB has taken over much 
of this mandate over the past several years, the Fed continues to 
exercise jurisdiction over certain spheres of concern that either 
overlap with or rest adjacent to traditional consumer protection. Among 
these are equal credit opportunity, \27\ home mortgage disclosure, \28\ 
electronic fund transfers, \29\ certain aspects of Community 
Reinvestment Act (CRA) compliance, \30\ consumer leasing, \31\ fair 
credit reporting, \32\ and truth in lending. \33\
---------------------------------------------------------------------------
     \27\ See 12 CFR 202.
     \28\ See 12 CFR 203.
     \29\ See 12 CFR 205.
     \30\ See 12 CFR 207 and 12 CFR 228.
     \31\ See 12 CFR 213.
     \32\ See 12 CFR 222.
     \33\ See 12 CFR 226.
---------------------------------------------------------------------------
    The specific statutory and regulatory channels through which the 
Fed has pursued its systemic stability and related mandates are many. 
Prior to the crisis of 2008-09, the principal regulatory functions that 
still are in place to this day were these: first, administration of the 
reserve requirement, \34\ interbank liability limit, \35\ interbank 
``managerial-interlock'' limit, \36\ ``insider'' lending limit, \37\ 
holding company capital adequacy requirement, \38\ broker-dealer and 
margin credit limit, \39\ and affiliated lending limit regimes; \40\ 
second, regulation of savings and loan, mutual, and (optionally) 
securities holding companies; \41\ third, oversight and enforcement of 
the ``international operations'' \42\ and ``changes in bank control'' 
regulatory regimes; \43\ and fourth, enforcement of the aforementioned 
consumer protection and community reinvestment regimes. All of these 
channels have obvious systemic stability significance, but also can be 
viewed as having individual institutional ``safety and soundness'' 
significance--which the Beim Report that I'll discuss below, as well I 
myself and others back in the early months of the crisis, feared to 
have constituted the Fed's primary understanding of these powers' 
significance prior to the crisis. \44\
---------------------------------------------------------------------------
     \34\ See 12 CFR 204.
     \35\ See 12 CFR 206.
     \36\ See 12 CFR 212.
     \37\ See 12 CFR 215.
     \38\ See 12 CFR 217.
     \39\ See 12 CFR 220-221.
     \40\ See 12 CFR 223.
     \41\ See 12 CFR 238, 12 CFR 239, and 12 CFR 241.
     \42\ See 12 CFR 211, and 12 CFR 214.
     \43\ See 12 CFR 225.
     \44\ ``Safety and soundness'' is a phrase-of-art that figures into 
many bank-regulatory provisions of Title 12 of the U.S. Code and rules 
promulgated thereunder, referring to individual banking institutions' 
robustness to various risks that financial institutions typically face 
over their life cycles.
---------------------------------------------------------------------------
    Post-crisis, the Fed has emerged more explicitly and self-
consciously as a macroprudential, or ``systemic risk'' regulator. This 
change is manifest in the fact that under Dodd-Frank it's been given 
additional regulatory functions rooted in its early role as an emergent 
but not quite yet fully emerged systemic risk regulator. These new 
functions bear a more unambiguously macroprudential significance, with 
less in the way of individual-institutional ``safety and soundness'' 
importance than had its regulatory functions of pre- Dodd-Frank 
vintage. These functions include, among others: the regulation of 
systemically important financial market utilities as defined under 
Dodd-Frank; \45\ the promulgation and administration of a margin and 
capital requirement regime for swap dealers and participants as defined 
under Dodd-Frank; \46\ administration of the orderly liquidation plan 
regime for systemically significant financial institutions (SIFIs) per 
Dodd-Frank; \47\ administration of the credit-risk retention regime 
applicable to asset-backed securities (ABS) sponsors established by 
Dodd-Frank; \48\ administration of the proprietary trading (Volcker 
Rule) regulatory regime established under Dodd-Frank; \49\ and the 
development and application of enhanced prudential standards for SIFIS 
under Dodd-Frank. \50\
---------------------------------------------------------------------------
     \45\ See 12 CFR 234.
     \46\ See 12 CFR 237.
     \47\ See 12 CFR 243.
     \48\ See 12 CFR 244.
     \49\ See 12 CFR 248.
     \50\ See 12 CFR 252.
---------------------------------------------------------------------------
    In carrying out these functions, of course, a critical tool at the 
Fed's disposal is the system of regular, ongoing bank examinations 
carried out in the FRBNY's case by its Financial Institution 
Supervision unit. The examination process is the crucial ``interface'' 
between the content of the Fed's regulatory mandate, on the one hand, 
and the actual behavior of those institutions the Fed regulates, on the 
other hand. Members of the New York Fed's Supervision unit, who now 
number in the hundreds, are accordingly charged with continuous 
monitoring of regulated entities' activities on-site, and are 
authorized to demand all manner of evidence necessary to the task of 
ensuring that financial institutions' day-to-day activities comport 
fully with the sundry rules the Fed promulgates and enforces under its 
statutory authority in the name of systemic financial stability.
    To facilitate continuity in monitoring, acquisition of relevant 
information, and follow-up with regulated entity personnel when 
acquired information raises ``red'' (or even ``yellow'') flags, the 
examination regime actually houses examiners on the premises of the 
regulated entities themselves. This of course brings obvious advantages 
to the supervision process. But it also raises systematic 
vulnerabilities on the part of examination staff to ``cultural'' or 
attitudinal ``capture'' by the supervised entities. This is, of course, 
precisely what some recent news reports mentioned above suggest has 
happened at FRBNY, so I'll return to the matter further on in my 
testimony.
    To sum up, then, what all of the aforementioned Fed roles and 
enforcement powers have in common for present purposes is their 
capitalizing in varying degree upon the Fed's potential, de facto, and 
de jure roles as a systemic risk--or, again, macroprudential--regulator 
of the financial system considered as a whole. This systemic-risk-
regulatory common denominator is important to highlight in the present 
context for at least three reasons.
    First are two implications it carries. One of these is that the Fed 
must, in this capacity, virtually by regulatory definition be 
``contrarian''-minded. The macroprudential or systemic risk-regulatory 
task is a countercyclical task; in the oft quoted words of the late 
great Fed Chairman of the 1950s to the early 1970s, William McChesney 
Martin, the role of the Fed is to ``lean against the wind,'' or to 
``take away the punch bowl just as the party is getting started.'' \51\ 
But a countercyclical role is a countermajoritarian role. It is an 
inherently unpopular, ``wet blanket'' role. Those who discharge the 
role are accordingly apt to be resented rather as children resent 
parents who tell them it's bed time. Fed personnel must accordingly be 
endowed with either the psychological or the institutional capacity to 
``hold firm.'' In view of the challenges to relying on personalities 
alone in this context, however, I will argue below that internal 
structural reforms are apt to bear most fruit in the present 
connection.
---------------------------------------------------------------------------
     \51\ See, e.g., sources cited supra, n. 12; also Robert Hockett, 
``Recursive Collective Action Problems: The Structure of Procyclicality 
in Financial Markets, Macroeconomies, and Formally Similar Contexts'', 
2 J. Fin. Persp. (2015) (forthcoming), available at http://
papers.ssrn.com/sol3/papers.cfm?abstract_id=2239849.
---------------------------------------------------------------------------
    The second implication entailed by the Fed's long implicit and now 
explicit macroprudential role is that any deficiency in the manners in 
which the Fed or the New York Fed in particular carry out their 
regulatory mission is at least potentially a deficiency that places the 
financial system itself, not merely particular institutions therein or 
their clients, at risk. The regulatory regimes that the Fed and the 
FRBNY administer all are now aimed, among other things, at preventing a 
repeat performance of the catastrophic events of 2008-2009 and their 
debt-deflationary sequelae. Deficiencies in that administration 
accordingly should be, and are, viewed as deficiencies that invite 
precisely this danger. The only real question is whether there have 
been, or still are, any such deficiencies to rectify.
    The third and related reason for highlighting the Fed's 
macroprudential role here is that the recent allegations concerning the 
Fed and the FRBNY that have occasioned today's hearing all ultimately 
sound in this same, macroprudential concern. They are all to the effect 
that these institutions first failed to prevent the 2008-09 market 
calamity in the manner they could have and should have done, and now 
are placing the system at risk of a repeat performance, owing to laxity 
in the manner with which they have pursued their systemic stability 
mandates via the bank examination process. The truth or falsity of 
these allegations is accordingly of the utmost importance, and I will 
accordingly be offering my own observations both on the allegations and 
on what seems to me to be warranted by way of follow-up as I proceed.
    The critique of the pre-2008 performance that has drawn most 
attention of late is the internal report for the New York Fed produced 
by Professor David Beim of the Columbia Business School. \52\ One 
reason that this report has drawn the attention it has, I suspect, is 
that it quite simply and compellingly, in my view, lays the New York 
Fed's pre-2008 failures at the door of two basic shortcomings. The 
first is the intellectual shortcoming of simple failure to appreciate 
and act upon the role of the FRB and FRBNY as systemic risk--i.e., what 
I also am calling ``macroprudential''--regulators as elaborated above. 
\53\ This shortcoming would have led the Bank both (a) to fail to seek 
certain systemic-stability-relevant categories of information in the 
examination process conducted pursuant to the Fed's regulatory 
mandates, and (b) to miss certain systemically significant implications 
carried by such information as it did manage to accumulate.
---------------------------------------------------------------------------
     \52\ See Beim Report, supra, n. 2.
     \53\ For what this might be worth, I have long been told by 
colleagues at the FRBNY that during the Greenspan era there was little 
tolerance at FRB for dissent at FRBNY. I suppose it is possible, then, 
that some at FRBNY might not have suffered the intellectual blindspot 
identified by Professor Beim, but rather were stymied by the ``higher-
up'' in Washington who notoriously denied central banks' capacity to 
spot bubbles before they had burst.
---------------------------------------------------------------------------
    The second shortcoming that Professor Beim highlighted was a 
tendency on the part of FRBNY's bank examiners to defer to regulated 
entities in their information-gathering tasks, hence to refrain from 
following up even on the comparatively small number of ``red flags'' 
that their nonsystemically focused attentions permitted them to notice. 
Professor Beim found this shortcoming to have been reinforced, 
moreover, by certain structural proclivities toward excessive risk-
aversion and ``groupthink'' within the institution--proclivities that 
tended to squelch, Professor Beim found, the ``hard questions'' and 
``follow-up'' that the Bank's few contrarian examiners wanted to pose 
and conduct.
    My firm impression is that both the Fed and the FRBNY have made 
significant strides in addressing the first shortcoming identified by 
Professor Beim. And I say this as one who himself long decried the 
Greenspan-associated orthodoxy of the late 1980s, 1990s, and early 
2000s, to the effect that the Fed could neither spot, nor, therefore, 
preempt asset price bubbles of the kind that imperiled financial 
stability. In light of both (a) the routinely non-Greenspanian policy 
pronouncements we now hear from both Fed and FRBNY officials, and (b) 
the research agendas well underway in most of the regional Fed Banks, I 
think it probably fair to say that the Fed has done best where 
Professor Beim's--along with my and others'--first criticism is 
concerned. The old ``lean versus clean'' debate seems largely to have 
been won, at the Fed and the FRBNY as well as in their peers and 
counterparts abroad, by the ``leaners.'' \54\
---------------------------------------------------------------------------
     \54\ See, e.g., Hockett, ``Macroprudential Turn'', supra, n. 12; 
also Robert Hockett, ``Leaning, Cleaning, and Macroprudence'', Harvard 
Law School Forum on Corporate Governance and Financial Regulation, 
March 27, 2013, available at http://blogs.law.harvard.edu/corpgov/2013/
03/27/leaning-cleaning-and-macroprudence/.
---------------------------------------------------------------------------
    With respect to Professor Beim's second criticism, however, things 
look less favorable for the Fed and the FRBNY. And this itself seems to 
constitute a second reason that Professor Beim's report has drawn so 
much attention of late. In short, the aforementioned ProPublica, This 
American Life, and other news accounts all highlight recent anecdotal 
reports tending to show both a continuing pattern of deference to 
regulated entities--i.e., of a species of ``capture''--and a 
``groupthink''-style quashing of regulatory zeal on the part of those 
few ``contrarian'' bank examiners and others who work at the Fed or the 
FRBNY, all notwithstanding the recommendations for counteracting such 
tendencies made in Professor Beim's FRBNY-internal Report.
    What, then, to make of these charges? At this point it will be 
instructive for me to shift into at least partly personal anecdote 
mode, in that much of my own experience at FRBNY seems to have bearing 
both upon Professor Beim's findings and recommendations, and upon the 
aforementioned tales recently told by the media. As a specialist on 
central banking and financial regulation, of course, I tended to 
reflect on these experiences even while experiencing them, and I have 
continued thus to reflect ever since. I will therefore regularly 
``hook'' the experiences that I turn now to recounting back ``up'' with 
the legal and policy considerations elaborated above.
    The most salient feature of my experiences with the Fed, against 
the backdrop of the foregoing remarks, is a certain paradoxical 
character that they all jointly share as a set. On the one hand, I 
never personally experienced anything like the internal pressures that 
Professor Beim and recent reports identify as mechanisms tending toward 
groupthink and reinforcing habits of deference to regulated entities. 
Indeed, as I'll elaborate, my personal experience has been by and large 
quite dramatically to the contrary. On the other hand, I was no regular 
employee subject to the usual pressures associated with the employment 
relation, nor did I work in the FRBNY's Supervision unit as 
distinguished from its Legal and Research and Statistics units. I also, 
it must be said, did sometimes hear stories from colleagues who spoke 
with concern of precisely such mechanisms and tendencies as Professor 
Beim's Report highlights and as the recent media accounts suggest.
    My attempt to explain this contradiction to myself and, now, to 
others here present leads me to certain provisional hypotheses 
concerning how (some degree of) regulatory capture might be subtly and 
subconsciously at work at the Fed, the FRBNY, and perhaps other 
agencies. It also leads me to thoughts about how we might counteract 
it--means that focus on institutional structure rather than 
personality.
    Here, then, is my own New York Fed story in a bit more detail. Both 
my background at the IMF and my scholarly work on the causes of the 
2008-09 crisis had led me by autumn of 2008 to become convinced that 
central banks are the key agents able to spot and preempt asset price 
bubbles, busts, and associated financial instability. This in turn led 
me both (a) to seek to determine how the Fed and other central banks 
had managed to fail to ``see it coming'' or prevent ``its'' coming in 
the lead-up to 2008, and (b) to think-up means by which the Fed and 
other central banks might do better in future. The tentative 
conclusions to which I was coming by late 2008 and early 2009 were by 
and large those that Professor Beim reached, at least with respect to 
the first failing he identified at FRBNY--the failure to appreciate the 
essentially systemic role that the Fed and other central banks are both 
able and, in the Fed's case at least, statutorily required to play.
    This in turn led me to seek means of involving myself in the 
mission of the New York Fed, which seemed to me not only conveniently 
located in relation to my school, but also optimally situated to 
commence the project of developing means of ``macroprudentially'' 
overseeing the U.S. financial system. Because I tended to seek 
practical work during summers between school years already (in order to 
avoid losing touch with the realities of finance and the law thereof), 
I decided simply to find a way to do such practical work within the 
FRBNY by the next summer's academic break.
    Not long after arriving at the aforementioned decision I met Tom 
Baxter, the General Counsel \55\ of FRBNY, at a conference to which we 
had both been invited. We had heard about one another from mutual 
friends and former colleagues, and seemed immediately to form a rapport 
at this conference. I spoke to him about the idea of perhaps starting 
something like the FRBNY Research and Statistics Group's Visiting 
Scholar program within the Legal Department, and he seemed intrigued. 
He then mentioned that a recent internal report--presumably Professor 
Beim's--had singled out ``groupthink'' as a principal cause of the 
FRBNY's failure to have ``seen it coming'' and failure to have acted to 
head ``it'' off in the leadup to 2008. \56\ Perhaps I, he said, could 
help set up some sort of internal ``contrarian thinking'' office at 
FRBNY. As an academic, he continued, I might be particularly well 
suited to doing that. This prospect excited me very much--indeed it 
seemed right up my alley--and within a few months we'd arrived at an 
arrangement pursuant to which I would begin working at the Bank at the 
end of the then-current academic year.
---------------------------------------------------------------------------
     \55\ Also ``GC.''
     \56\ This was in late 2010, so one supposes that Professor Beim's 
report would still have been fresh in FRBNY officials' minds.
---------------------------------------------------------------------------
    Almost immediately upon my arrival at FRBNY the following summer, I 
was given a marvelous variety of ``out of the box'' tasks. Tom and one 
or two of his Deputies quickly undertook to introduce me to various 
people in various FRBNY departments, including many economists in 
Research and Statistics, with the advertisement that I was there to 
help with ``pushing the envelope'' type projects. I also was introduced 
all around the Legal Department with the same description. In the first 
week, then, I was introduced to, among others, Meg McConnell from 
Research and Statistics, who I gather was one of those who assisted 
Professor Beim in the work that culminated in his report. Meg suggested 
that I help a team she was heading to develop metrics the Bank might 
employ with a view to determining when leverage buildups within the 
financial system were reaching systemically dangerous levels. This was 
exactly the sort of thing I thought that macroprudentially serious 
central banks ought to be doing, so I was very excited about this 
suggestion. Meg also later (in November or December of 2011, I think) 
solicited my suggestions for ``out of the box'' research and policy 
proposals both (a) to put on the Bank's research agenda and (b) even 
mention in speeches by high level Bank officials.
    I was also given a sizable number of mortgage market related 
projects while at the Bank. Some of these, too, were ``envelope-
pushing'' or ``out of the box.'' Tom, for example, was intrigued by the 
prospect of developing an electronic mortgage registry system that 
might more effectively provide certainty of title than MERS as then 
constituted. \57\ One of Tom's Deputies, for her part, was interested 
in possibly developing an official FRBNY position concerning reform of 
certain articles of the Uniform Commercial Code, uncertainties in 
connection with which seemed likewise to have played some role in 
rendering titles in real estate uncertain. Another Bank Legal officer 
asked for my help in developing a mortgage bridge loan assistance 
program akin to Pennsylvania's HEMAP program geared to keeping 
distressed mortgagors in their homes, \58\ while two other Deputy GCs 
asked me to trace in advance the likely legal consequences of certain 
possible fundamental currency regime changes abroad and another asked 
me to help design a seminar on the role of internal governance in 
generating or tolerating excessive risk-taking by financial 
institutions.
---------------------------------------------------------------------------
     \57\ MERS is the privately owned Mortgage Electronic Registration 
System, more information on which is available at https://
www.mersinc.org/about-us/about-us.
     \58\ HEMAP is the Home Emergency Mortgage Assistance Program, more 
information on which is available at http://www.phfa.org/consumers/
homeowners/hemap.aspx. For the plan that we ultimately came up with, 
see Robert Hockett and Michael Campbell, ``The Home Mortgage Bridge 
Loan Assistance Act of 2012'', available at http://papers.ssrn.com/
sol3/papers.cfm?abstract_id=1987093; also Robert Hockett and Michael 
Campbell, ``White Paper in Support of the Home Mortgage Bridge Loan 
Assistance Act of 2012'', New York City Bar Association, available at 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1987159. The bill 
has been taken up for consideration in the New York State Senate. See 
New York State Senate, Bill S5035A-2013, available at http://
open.nysenate.gov/legislation/bill/S5035A-2013.
---------------------------------------------------------------------------
    Most of the mentioned law-related projects were at least somewhat 
unorthodox relative to the usual fare of the Legal Department. Projects 
conducted with economists in Research and Statistics, for their part, 
were certainly unorthodox relative to the Greenspan era systemic risk 
orthodoxy that had prevailed up to the time of the Beim Report. 
Moreover, at least one Deputy General Counsel with whom I worked 
enthusiastically shared my view, somewhat unorthodox at the time but 
since seemingly embraced by the Fed Board itself, that Dodd-Frank's 
Title 8 offered all the legal authority necessary for the Fed to 
regulate the repo markets and other critical components of the ``shadow 
banking'' sector--effectively disagreeing with those who have 
criticized Dodd-Frank for not addressing that critical piece of the 
landscape that ultimately brought us the 2008-09 crisis. \59\
---------------------------------------------------------------------------
     \59\ See, e.g., Viral Acharya et al., ``Restoring Financial 
Stability: How To Repair a Failed System'' (2009).
---------------------------------------------------------------------------
    In view of all of this, I found myself quite impressed, again and 
again, by what struck me as the fresh, independent-minded quality of 
the people with whom I worked at the Bank. Indeed it seemed to me that 
mindsets here were at least as free as many of those I encounter 
regularly within the academy. As if to top off these impressions, two 
somewhat controversial extracurricular initiatives in connection with 
which I was a central character received a great deal of media 
attention during my time at FRBNY, and in both cases the Bank was 
effectively encouraging--or at the very least not discouraging.
    The first of these extracurricular projects was the ``Way Forward'' 
white paper that Daniel Alpert, Nouriel Roubini, and I, ``mavericks'' 
all, authored for the New America Foundation in October 2011. \60\ As 
some here might recall, this drew a great deal of media and legislative 
attention for several months, \61\ during all of which time my FRBNY 
colleagues to a person were congratulatory, encouraging, and even a bit 
seemingly proud. The second such project was the eminent domain plan 
for underwater PLS mortgage debt that I and colleagues ``went public'' 
with 6 months later in the spring of 2012. \62\ This one, as some here 
will recall, elicited a veritable firestorm of objections, primarily 
from banking and other concerns that the FRBNY itself regulates. \63\ 
And yet here, too, my FRBNY colleagues seemed untroubled and 
unembarrassed. Indeed, FRBNY even published a brief article I wrote on 
the plan in its flagship journal, Current Issues in Economics and 
Finance. \64\ That brought, among other things, two attack pieces in 
the same week, singling out both the Bank and myself by name, on the 
Wall Street Journal's notoriously ugly op-ed pages. \65\ And yet here, 
too, the Bank and its personnel seemed unapologetic, in effect rolling 
their eyes at the frivolity and gratuitous snark of at least one of the 
pieces--though it might bear noting that by this point (June of 2013) I 
had long since commenced my sabbatical back at the Fund in DC, and 
might accordingly have been simply unaware of other, less favorable 
internal reactions at FRBNY.
---------------------------------------------------------------------------
     \60\ See Daniel Alpert, Robert Hockett, and Nouriel Roubini, ``The 
Way Forward: Moving From the Post-Bubble, Post-Bust Economy to Renewed 
Growth and Competitiveness'', New America Foundation, October 11, 2011, 
available at http://newamerica.net/publications/policy/the_way_forward.
     \61\ See, e.g., media collected at this Web page: http://
www.lawschool.cornell.edu/spotlights/Robert-Hockett-Co-Authors-The-Way-
Forward.cfm.
     \62\ See, e.g., media collected at this Web page: http://
www.lawschool.cornell.edu/spotlights/Hockett-Reveals-Plan-to-Address-
Underwater-Mortgage-Loans.cfm.
     \63\ Id. Also media collected at this Web page: http://
www.lawschool.cornell.edu/spotlights/Cities-Begin-Moving-on-Hockett-
Municipal-Plan.cfm.
     \64\ See Robert Hockett, ``Paying Paul and Robbing No One: An 
Eminent Domain Solution for Underwater Mortgage Debt'', 19(5) Current 
Issues in Economics and Finance 1 (2013), available at http://
www.newyorkfed.org/research/current_issues/ci19-5.html.
     \65\ Both op-eds are available, along with other coverage of the 
Current Issues paper, at http://www.lawschool.cornell.edu/spotlights/
NY-Fed-Report-by-Hockett-Revives-Discussion-of-His-Municipal-Plan.cfm.
---------------------------------------------------------------------------
    Perhaps needless to say, none of these experiences seems itself to 
support the proposition that the FRBNY is a zombified groupthink-
plagued institution prone to rolling over in the face of actual or 
likely anger from the financial services industry. Nor, of course, do 
Chairmen Bernanke and Yellen's, or other Fed Board members', or 
President Dudley's and other FRBNY officials', regular public 
pronouncements concerning the dangers of widening economic inequality 
or the need to reduce principal on still-underwater mortgage loans 
suggest any such thing. \66\ And this is all notwithstanding that 
nearly all such pronouncements appear to draw ire from self-described 
``conservatives,'' ``liberals,'' ``libertarians,'' and ``progressives'' 
alike--as well as their representatives in Congress. For all of these 
reasons, then, some of what I have recently read and heard about 
goings-on at the Fed and the FRBNY have surprised me.
---------------------------------------------------------------------------
     \66\ See, e.g., speeches collected at these Web sites: http://
www.federalreserve.gov/newsevents/speech/2014speech.htm; http://
www.newyorkfed.org/newsevents/speeches/.
---------------------------------------------------------------------------
    But now for the other limb of the ``paradox.'' First off, it seems 
to me to bear repeating that I was different from others at FRBNY in a 
crucial respect: my livelihood did not ride on the Bank's approval of 
what I thought or did, and I was brought in expressly as an independent 
academic meant to help counteract possible ``groupthink.'' Those with 
whom I worked, then, including those ``higher up,'' accordingly would 
have had different expectations of me than they had of regular 
employees, while I for my part was bound to feel more free to express 
my opinions and make my suggestions than regular employees presumably 
would have felt. \67\
---------------------------------------------------------------------------
     \67\ I think it would still, in this case, be impressive that they 
brought me in at all under such auspices, and indeed one set of 
suggestions I'll make below aim to institutionalize this form of 
impressiveness.
---------------------------------------------------------------------------
    Second, I cannot deny having been told by some with whom I worked 
both at FRBNY and, later, at FRB, that they themselves had experienced 
pressures of the kind that are described in the recent reports 
mentioned above, and that they knew nontrivial numbers of others who 
had experienced the same. Indeed these colleagues in effect suggested 
that Carmen Segarra's story is but the tip of a possibly deep iceberg. 
Moreover all such cases, it seems, shared a common pattern: A report 
would be sought by ``higher ups.'' The report would be drafted. The 
report then would be sent back with requests that particular 
conclusions that seemed a bit hard on either the regulated entity or 
the Fed or FRBNY be ``toned down.'' The drafter would then agree to do 
the toning down, but would make clear that in doing so s/he would not 
then be honestly reporting his or her actual beliefs but rather those 
of the ``higher ups.'' The response from the latter then would in some 
cases be some form or other of ``passive aggression,'' resulting 
ultimately in demoralization or even exit. \68\ This pattern is of 
course striking in light of Carmen Segarra's story, as well as in light 
of the 2009 Beim Report. Again, I must emphasize that I never 
personally experienced anything like this; quite the contrary, in fact. 
But I've heard enough stories from or about people who say that they 
have to feel warranted in offering some suggestions below.
---------------------------------------------------------------------------
     \68\ See Beim Report, supra, n. 2. See also, e.g., Shahien 
Nasiripour, ``Federal Reserve Employees Afraid To Speak Put Financial 
System at Risk'', Huffington Post, August 28, 2013, available at http:/
/www.huffingtonpost.com/2013/08/28/federal-reserve-employees-
survey_n_3826165.html?utm_source=Alert-
blogger&utm_medium=email&utm_campaign=Email%2BNotifications.
---------------------------------------------------------------------------
    What, then, to make of all this? How to reconcile my own experience 
with some of the experiences reported by others whose perceptions, 
memories, and general integrity I trust? Part of the answer might lie 
in that different status I held as just mentioned. But this seems 
unlikely to be all of it, given how many at both FRB and FRBNY openly 
congratulated me for, and even expressed pride in, some of the ``out of 
the box'' projects with which I was both internally and externally 
associated while I was there. Even these people's being vicariously 
``out of the box'' in this manner seems to suggest that there is no 
more ``zombification'' on the part of regular staff than there was of 
myself.
    I am tempted provisionally to conclude, then, that there must 
certain structural circumstances that account for the ``disconnect'' 
between my experiences with the Fed on the one hand, and those reported 
by others at the Fed on the other hand. There must be some feature of 
the institution that encourages or permits ``groupthink'' in some 
contexts while not doing so in other contexts. I'll turn now to 
elaborating my best guesses at present, along with associated proposals 
for possible reform.
Possible Structural Dangers of FRB/FRBNY ``Capture'' and Their Possible 
        Cures
    There seem to me to be at least three mutually complementary 
reasons that some of my colleagues' and recent media reports might be 
right in ascribing ``capture'' to the FRB and FRBNY in some contexts, 
even while my own experiences have been quite the contrary in other 
contexts. One stems from the inherently ``countermajoritarian'' 
character of a countercyclical mandate, which is bound to elicit some 
sense of worry on the part of the countercyclical regulator at least in 
contexts where the proverbial ``rubber'' meets the proverbial ``road'' 
as it does in the context of bank-examining. Another reason stems from 
the deeply ingrained, perhaps even ``hard-wired,'' human tendency to 
want things to go smoothly between ourselves and those with whom we are 
in close contact on a daily basis, as examiners are with the personnel 
of the institutions that they examine--particularly when they are 
continuously in residence at the regulated entities themselves. Finally 
the third reason stems, I suggest, from the inherently ``dual,'' 
``public-private'' character of the FRBNY itself--a duality which might 
sometimes find its way into the person of one or another of the Bank's 
General Counsels.
    The imperatives at work in the Bank's public and private roles are 
sometimes at odds with each other, which yields two important 
entailments: first, that expectations and behaviors in contexts more 
closely associated with the one character of the FRBNY might well be 
radically different from those in contexts more closely associated with 
the other character of the institution; and second, that anyone charged 
with responsibility for activities in both spheres--as are, for 
example, the General Counsel of the Fed Board itself and those of the 
regional Fed banks--might at least sometimes be subject to certain 
internal cognitive or attitudinal conflicts that can lead him or her to 
be quite ``out of the box'' in some cases while being quite 
temperamentally ``conservative'' or ``risk-averse'' in other cases.
    I turn now turn to briefly elaborating a bit on all three of the 
factors that I've just identified, then suggest structural means by 
which we might mitigate their occasional possibly detrimental effects.
    With respect first to the countermajoritarian character of the 
Fed's countercyclical risk-regulatory role, then, Fed Chairmen 
themselves are notoriously unpopular when they act to rein-in loose 
money or credit conditions during times of boom that appear headed 
toward ultimate bust. If that is the case even in respect of figures so 
powerful as Fed Chairman faced with diffuse public and political 
criticism, how much more must it be true in the case of lower-ranked 
officials faced with the concentrated rancor of testosterone-poisoned 
Wall Street bankers each day? For reasons rooted in such considerations 
it seems to be the case that the best Fed Chairmen and best bank 
examiners are those with stiff backbones. Indeed I have often 
suggested, and heard verified by Fed colleagues, that Fed Board members 
and bank examiners really should be ``professional jerks,'' or 
``boors,'' who either are shameless or afflicted by something like 
Asperger's Syndrome. This is of course somewhat to overstate the case, 
but the point still remains.
    The problem, however, is that people of the mentioned sort tend to 
impose costs on the places at which they work in addition to providing 
what ever benefits they do. \69\ Moreover, simple reliance on hiring by 
``personality type'' seems a thin reed on which to rest effective 
countercyclical finance-regulatory policy. Better, I'll suggest 
presently, would be some means of institutionalizing and insulating the 
``professional boor'' role--preferably in a manner that does not 
require the ``boors'' actually being boors.
---------------------------------------------------------------------------
     \69\ See, e.g., Robert Sutton, ``The No A-Hole Rule: Building a 
Civilized Workplace and Surviving One That Isn't'' (2010).
---------------------------------------------------------------------------
    Complementing the pressures of unpopularity that the Fed's 
countercyclical role places upon its personnel at all levels is the 
general human tendency to want to ``go along to get along'' in 
relations with others, whether the ``others'' be one's colleagues or 
one's adversaries or ``regulatees.'' Stockholm Syndrome, one might say, 
tends in the long run to counteract Asperger's Syndrome. This bears at 
least two salient implications. First, those who have regular day-to-
day contact with regulated entities are going in general to tend, over 
time, to want to ``go easy on'' if not indeed ``identify with'' those 
whom they regulate. And second, even those who do not find themselves 
all that tempted to go easy on or identify with those whom they 
regulate might nevertheless find themselves longing to get on well at 
least with their colleagues and their ``superiors'' up the chain of 
command. Add to all this the natural tendency to hope that a regulated 
entity will be more forthcoming with requested data if one is but 
``friendly'' with them, and you have yet another recipe for systematic 
tendencies toward deference.
    Here, too, in the absence of certain neutralizing structural 
measures, it would seem to require a rare personality type to avoid 
falling into the pitfalls of ``going along to get along.'' One would 
have to be capable of being firm on the one hand, while being courteous 
or even courtly on the other. Many of us strive to be that kind of 
person, but few seem entirely to succeed, and in any event here again 
it seems foolish to rest all of one's macroprudential hopes on the thin 
reed of seeking out ideal personalities. There just aren't enough 
George Washingtons out there to count on.
    Finally, with respect to the Fed's--and especially the regional Fed 
banks'--dual role as a manner of private-public partnership, here is a 
possible source of inadvertent ``capture'' that seems to have drawn 
very little attention yet likely is very important. First, then, recall 
that the New York Fed conducts monetary policy through open market 
operations by trading in securities with various designated ``dealer 
banks.'' Relatedly, during the immediate post-crisis period the FRBNY 
also ran funds--the ``Maiden Lane'' entities--that purchased mortgage-
backed securities (MBS) with a view to stabilizing the secondary 
mortgage markets. In all such capacities, the Bank acts as a bank among 
banks, in effect acting as a sort of colleague or peer to those (other) 
banks. This doubtless encourages attitudes of reciprocity, 
collegiality, perhaps even equality toward those institutions. Those 
attitudes then might spill over into excess ``politeness'' even in 
regulatory contexts.
    On the other hand, of course, the FRBNY also is the Fed's primary 
regulatory ``interface'' with the most systemically important financial 
institutions that it supervises. In this capacity it is an authority, 
an enforcement agency, a kind of ``policeman'' or ``night watchman.'' 
The attitudes appropriate to this role sound more in vigilance and even 
suspicion than they do in collegiality or reciprocity. Yet in the FRBNY 
we seem to want one institution to perform functions that encourage 
both sets of mutually contrasting attitudes.
    This duality problem might also afflict some highly placed 
personnel within the institution who effectively embody in their 
persons the very duality that characterizes the FRBNY itself. And this 
might in turn account for the stark differences between my own 
experiences with such ``higher ups'' on the one hand, and those of some 
of my colleagues on the other hand.
    Consider the role of the General Counsel, for example. On the one 
hand, the GC is like any in-house counsel at any private firm, 
including any financial firm. A critical part of her role will be 
``keeping the firm out of trouble,'' and she will accordingly--and 
indeed appropriately--be prone to adopting an attitude of caution where 
setting firm policy and advising firm action are concerned. When that 
happens in ways that yield consequences we do not like, we will be 
tempted to call it ``risk-aversion,'' even morbid risk-aversion. When 
it happens in ways that yield consequences we do like, we'll call it 
``prudence'' or ``appropriate caution.''
    On the other hand, another part of the role of an FRBNY GC--or 
indeed any regulator's GC--is more proactive. For inasmuch as the 
institution is itself meant to be proactive--as is the FRBNY in its ex 
ante bubble-preemptive, macroprudential regulatory role--its GC's job 
will be to facilitate its thus acting, by identifying the legal 
authority for and legal means by which to act in the context in 
question. Here, then, we will want the GC to be somewhat less risk-
averse and rather more ``forward-leaning.'' She should be confident and 
forthright about the institution's--now in its public rather than 
private role--mission, which is meant to safeguard the full general 
public rather than just the institution itself or the sectional 
interests it's charged with supervising.
    Yet this attitude is of course at odds with the other one, and this 
might yield either of several upshots: (a) the GC might be continually 
conflicted and accordingly appear to be acting ``erratically'' at 
times; (b) the GC might ultimately resolve the unremitting conflict by 
allowing one of the conflicted attitudes finally to gain the upper 
hand, and from then on tend to give short shrift to which ever 
institutional role is associated with the discarded attitude; or (c) 
the GC might simply seem to some people in some contexts to be ``risk-
averse,'' while appearing to other people in other contexts to be 
``proactive.''
    When I reflect on my own experience at the New York Fed on the one 
hand and the tales told me by others there on the other hand, I am 
tempted to think that at least option (c) might be sometimes at work. 
It would account at least in part for the much more ``positive'' 
experiences I've had at FRBNY than have some others. I am less certain 
about options (a) and (b), however, as I simply lack any data that 
would clarify whether either of those have occurred. For present 
purposes I'll accordingly think of them simply as structural tendencies 
one might expect to be present.
    What I do feel confident about, then, is the advisability of 
certain structural reforms at FRBNY that might mitigate all three of 
the vulnerabilities just elaborated--those associated with a 
macroprudential regulator's inevitable unpopularity, with its 
personnel's natural tendency to want to avoid conflict, and with its 
dual role as a simultaneously public and private actor. I've got two 
principal suggestions here, each of which warrants some elaboration.
    My first suggestion is very much in keeping both with Professor 
Beim's suggestions of 2009 and with ideas that Tom Baxter himself 
broached enthusiastically at FRBNY when I first arrived there. The 
contrarian role must be permanently institutionalized in some manner, I 
believe, both at FRBNY and probably at many other regulatory agencies 
as well. The institution requires some permanent means of self-
evaluation and self-criticism much as our society itself has in the 
institutions of the press and the academy. This can be done in a 
variety of ways, of course; but key to any particular method adopted, I 
think, will be the establishment of some unit or department explicitly 
charged with the ``skeptical'' or self-critical task. Any such unit or 
department then should have the following basic characteristics.
    First, deliberate, explicit, self-conscious identification on the 
part of the department itself and of the Bank as a whole of the 
department as precisely what it is--a mode of institutional self-
evaluation and self-criticism. This self-understanding should 
ultimately determine the criteria by which the department's actions are 
evaluated and by which its hiring and promoting policies are developed.
    Second, sufficiently many personnel within the department or unit 
in question as to enable an ``esprit de corps'' to develop within it--
perhaps something a bit like what the Rangers are to the U.S. Army, or 
what the Marines are to ground forces more generally. The goal must be, 
not to establish a unit with a few lovable or barely tolerated token 
eccentrics, but to put in place a bona fide institutional unit on par 
with all the others, whose successes or otherwise are determined by all 
in the full institution as riding on how good they prove ultimately to 
be in ferreting out problems and developing successful solutions to 
them.
    In a sense, what we want is for personnel in this department to be 
simultaneously admired (perhaps even envied) and perhaps even mildly 
feared by others in the institution (in the sense of fearing to miss 
red flags that the contrarians later find), such that some others might 
in time even ask to be transferred to the department in question. 
Success here, it bears noting, will not only boost the likelihood of 
errors' being spotted or avoided by department personnel themselves. It 
also will likely, over time, work to encourage heightened vigilance by 
others in the institution, who either ``want to be like'' those in the 
department in question, ``want to avoid being shown up'' by the same, 
or both.
    Finally third, it probably goes without saying that whoever leads 
the group or department in question should be possessed of a status 
equivalent to that of other top level FRBNY personnel. This person, in 
other words, should command the same respect in the institution as do 
the GC, the head of Research and Statistics, the head of Supervision, 
and so on. This status and respect should, in turn, effectively carry 
over to the department or unit itself. Those who work within it should 
have ``cover'' from their department head and the FRBNY as a whole 
when, inevitably, they raise hackles among regulated entities and even 
among some in other units of FRBNY itself.
    There is some irony in this set of suggestions. The reason is that 
helping to envisage or even begin the process of setting up some such 
department was among the first possible projects that Tom Baxter 
suggested when we first spoke of my possibly taking up residence there. 
I am told by other colleagues, moreover, that prospects of this sort 
have been under occasional discussion at FRBNY ever since the Beim 
Report was completed. I think, then, that there is already significant 
willingness on the part of key FRBNY personnel to explore and then 
tentatively begin the process of constructing some such department or 
unit. Given how enthusiastic Tom seemed to be, my guess is that others 
would be as well.
    That this has not happened yet, then, I suspect is rooted less in 
lingering skepticism or ambivalence about the idea than it is in sheer 
busyness on the part of FRBNY staff. The Dodd-Frank mandated tasks of 
new regulatory rulemaking and ``living will'' drafting and improving, 
among other things, have had many FRBNY staff running a bit ragged in 
recent years, and it is accordingly understandable that something as 
fundamental as adding and constructing an entirely new unit has not yet 
been effected. I nevertheless believe that this project should be 
resumed at the earliest feasible opportunity. It would serve to 
counteract both the inherent unpopularity and ``Stockholm Syndrome'' 
vulnerabilities noted above.
    My second principal suggestion is somewhat more ``out of the box'' 
and perhaps speculative than the first. It is that the Fed itself begin 
a process of considering whether it might be advisable and feasible to 
bifurcate Fed legal departments, and perhaps even the role of the 
General Council itself, at the regional Fed banks if not at the Fed 
Board itself. My reasons stem from the reflections above concerning the 
dual role that the GC and his or her staff play when the institution 
itself plays a dual role as do the regional Fed banks and as does the 
New York Fed in particular.
    My impression, on the basis of both direct and reported experience, 
is that Fed and Fed Bank GCs--not to mention the GCs at other 
regulatory agencies like the FDIC and FHFA, for example--tend to become 
enormously influential figures within their institutions. \70\ This is 
partly because they are in most cases the most highly placed officials 
without term limits, meaning that more transitory ``higher ups'' tend 
to rely on them heavily as high level repositories of institutional 
memory.
---------------------------------------------------------------------------
     \70\ For more on this phenomenon, see, e.g., Jesse Eisinger, ``The 
Power Behind the Throne at the Federal Reserve'', New York Times 
Dealbook, July 31, 2013, available at http://dealbook.nytimes.com/2013/
07/31/the-power-behind-the-throne-at-the-federal-reserve/?_r=0.
---------------------------------------------------------------------------
    It is also, of course, because all institutional decision makers 
know that they must comport with the law, while their GCs are in most 
cases their principal if not sole authoritative expositors of what the 
law actually permits or requires. Deference of the sort highlighted by 
Professor Beim and other recent reports, then, tends to be especially 
strong where the GC is the person deferred to. And this means that how 
ever the GC resolves the internal ambivalence mentioned above is apt to 
become internal institutional orthodoxy.
    The ``contrary thinking'' unit considered a moment ago might, of 
course, serve partly to mitigate any such problem. But it will be 
inherently limited no matter how well insulated or respected it is. For 
again, everything done by or in the institution in question is subject 
to law, and the GC at present is the sole final ``oracle'' reporting to 
all what the law actually is in a given situation.
    How, then, to address the risks that inhere in this situation? One 
way would be to ensure that at least one subunit within any legal 
department be charged solely and uniquely with performing the functions 
associated with the Bank's public (regulatory) aspect on the one hand, 
and those associated with its more private (internal compliance) aspect 
on the other hand. The head of each such subunit, in turn, would be of 
equal status and only one hierarchical step below the GC him or 
herself. In cases where these two heads counseled irreconcilable 
actions (or inaction), the GC would then make the final call, perhaps 
with the assistance of other highly placed members of the legal staff 
or even outside counsel retained on a limited basis for the purpose. 
(Academics like myself might even be briefly retained or invited in.)
    To some extent, of course, legal departmental divisions already 
feature variations on this form of bifurcation. The problem as I see 
it, however, is that these departments are typically divided into more 
than two parts, and the inherently dual public-private, proactive-
reactive nature of the institution and its GC's roles accordingly goes 
underappreciated. Appropriate focus on ``leaning forward'' where 
regulation is concerned even while maintaining caution where compliance 
with Fed-binding law is concerned might accordingly be muddled or 
missing.
    Another, slightly more radical approach to our dilemma, then, would 
be to bifurcate the role of the GC itself, with one GC charged 
primarily with helping to craft means of proactively enforcing that 
institution's regulatory mandate, and the other charged primarily with 
taking care to ``cover the institution's backside'' by ensuring that it 
is in compliance with other laws applicable to it rather than to the 
firms and markets it regulates. This possibility might initially appear 
to be only superficially different from that of bifurcating the 
department while retaining the unitary GC as final arbiter. I think 
that the difference is apt to be more than superficial, however, in 
view of the institutionally wide ``authoritative'' character of the 
GC's final pronouncements on what the law says, permits, and prohibits.
    Allowing for the possibility of two ``authoritative'' 
pronouncements rather than one is accordingly apt, I suspect, to be 
salutary in cases where there is disagreement between counsel. For it 
will serve to remind staffers throughout the institution that the law 
often features enough play in the joints to allow for attempting a 
novel and possibly in the end successful argument in favor of some 
proactive regulatory measure even when somewhat more risk-averse 
lawyers might incline to ``playing it safe'' by doing nothing. 
Moreover, even the one potential disadvantage I can see as possibly 
being raised by the bifurcation option--institutional impasse wrought 
by a ``push-me, pull-you'' dispute between the two general counsels--
would seem readily resolvable by, once again, bringing in outside 
counsel to assist the Bank's Board and/or President in making the final 
call.
    I think, then, that this option ought to be fully considered and 
vetted. I do not yet commit myself to it, but I do think it to warrant 
full inclusion on the agenda of options to consider as we all decide 
where we're to go from here.
Conclusion
    I hope that the foregoing written testimony serves as a useful 
supplement to my oral testimony before you today. Please do not 
hesitate to let me know if I might be of further assistance. I am happy 
to elaborate further on anything said orally or written above in this 
supplement, as I have tried to keep myself as brief as possible in 
both. Thank you again for inviting my thoughts and recollections on the 
matters under discussion.
                                 ______
                                 
                PREPARED STATEMENT OF NORBERT J. MICHEL
     Research Fellow in Financial Regulations, Heritage Foundation
                           November 21, 2014
        A critical lesson from the Fed's first 100 years is that an 
        overly broad interpretation of the Fed's role in financial 
        stability in fact undermines financial stability, contributing 
        to a cycle of moral hazard, financial failures, and rescues. 
        The Fed already has the tools and mandate it requires to 
        provide monetary stability, which is its best contribution to 
        financial stability.

        ----Renee Haltom and Jeffrey M. Lacker, ``Should the Fed Have a 
Financial Stability Mandate? Lessons from the Fed's First 100 Years'', 
Federal Reserve Bank of Richmond 2013 Annual Report (2014)

    Chairman Brown, Ranking Member Toomey, and Members of the 
Subcommittee, thank you for the opportunity to testify at today's 
hearing. My name is Norbert Michel and I am a Research Fellow in 
Financial Regulations at The Heritage Foundation. The views I express 
in this testimony are my own, and should not be construed as 
representing any official position of The Heritage Foundation. In my 
testimony I will argue that the Federal Reserve is not, and can never 
be, immune from the potential conflicts and capture problems that exist 
throughout U.S. regulatory agencies. I will also maintain that the 
supposedly new ``macroprudential'' regulations are new only in the 
narrowest sense, and that we should not expect them to make financial 
markets any safer than they were prior to the subprime crisis. All 
reform proposals should include at least one major change to U.S. 
financial market regulation: transferring all regulatory authority from 
the Federal Reserve to the Federal Deposit Insurance Corporation (FDIC) 
and/or the Office of the Comptroller of the Currency (OCC).
Regulatory Capture, the Beim Report, and Recent FRBNY Issues
    It has long been recognized that, over time, Government regulatory 
agencies tend to be ``captured'' by the firms they supervise. \1\ The 
term regulatory capture simply reflects that individuals who serve as 
regulators come to identify with the firms they are regulating at least 
as much as the agencies for which they are employed. Two sources of 
regulatory capture are (1) individual regulators are often drawn from 
regulated industries precisely because the supervisory agencies value 
their experience, and (2) regulated firms often hire individual 
regulators precisely because they value regulators' experience. Working 
for either the regulatory agency or the regulated firm enhances 
employees' value for the other, and individuals tend to move back and 
forth between Government and private-sector jobs so much so that the 
process is characterized as a revolving door. A recent Federal Reserve 
Bank of New York (FRBNY) paper suggests that the increasingly complex 
nature of financial regulations only compounds this problem. The paper 
argues that bank regulators ``have an incentive to favor complex rules 
because `schooling' in these regulations enhance regulators' future 
earnings, should they transition to the private sector.'' \2\ To 
completely stop this process in any given regulated industry--even if 
it could be done--would not necessarily produce superior outcomes 
because doing so would build regulatory agencies with very little 
knowledge of the industries they supervise. \3\ A decline in overall 
regulation and complexity of rules, on the other hand, would 
necessarily reduce the extent of regulatory capture.
---------------------------------------------------------------------------
     \1\ See Roger Sherman, ``Market Regulation'' (Boston, MA: Pearson, 
2008), and Richard A. Posner, ``The Concept of Regulatory Capture: A 
Short, Inglorious History'', in Daniel Carpenter and David Moss, eds., 
Preventing Regulatory Capture: Special Interest Influence and How To 
Limit It, The Tobin Project, 2013, http://www.tobinproject.org/sites/
tobinproject.org/files/assets/
Posner%20The%20Concept%20of%20Regulatory%20Capture%20(1-16-13).pdf 
(accessed November 18, 2014). The capture theory was originally 
developed in the seminal work of George Stigler, ``The Theory of 
Economic Regulation'', Bell Journal of Economics and Management 
Science, Vol. 2 (Spring 1971), pp. 3-21. Stigler argued that 
Governments stifle competition because they end up regulating at the 
behest of firms who capture regulatory agencies.
     \2\ See David Lucca, Amit Seru, and Francesco Trebbi, ``The 
Revolving Door and Worker Flows in Banking Regulation'', Federal 
Reserve Bank of New York Staff Report No. 678, June 2014, p. 4, http://
www.newyorkfed.org/research/staff_reports/sr678.pdf (accessed November 
18, 2014).
     \3\ There is at least some evidence that ``revolving door laws,'' 
though designed to mitigate regulatory capture, produce little benefit 
for consumers. See, for example, Mark Law and Cheryl Long, ``What Do 
Revolving Door Laws Do?'' The Journal of Law & Economics, Vol. 55, No. 
2 (2012), pp. 421-436.
---------------------------------------------------------------------------
    Without reducing regulation, we should never expect any outcome 
other than regulatory capture because, as public choice economics has 
demonstrated, all individuals tend to act in their own self-interests 
so as to make their lives easier. \4\ This principle applies equally to 
private and Government-sector employees. Indeed, none of the recent 
revelations regarding questionable relationships between FRBNY 
regulators and Goldman Sachs employees are surprising to anyone who has 
studied regulation. \5\ In 2011, as just one recent example in 
financial markets, the Government Accountability Office (GAO) 
identified a number of potential conflicts between the Federal Reserve 
and the firms they were supervising. The report pointed out that the 
CEOs of both JPMorgan Chase and Lehman Brothers were FRBNY Class A 
directors prior to the crisis, and that there were ``at least 18 former 
and current Class A, B, and C directors from 9 Reserve banks who were 
affiliated with institutions that used at least one emergency [lending] 
program.'' \6\ Additionally, a former FRBNY chairman, Stephen Friedman, 
previously served as the head of the risk committee for Goldman Sach's 
board of directors, and current FRBNY president William Dudley is a 
former Goldman partner.
---------------------------------------------------------------------------
     \4\ Essentially, this principle is also rooted in the U.S. 
Constitution. As noted by James Madison in the Federalist No. 10, ``It 
is in vain to say that enlightened statesmen will be able to adjust 
these clashing interests, and render all subservient to the public 
good. Enlightened statesmen will not always be at the helm. Nor, in 
many cases, can such an adjustment be made at all without taking into 
view indirect and remote considerations, which will rarely prevail over 
the immediate interest which one party may find in disregarding the 
rights of another or the good of the whole.''
     \5\ See Jake Bernstein, ``Inside the New York Fed: Secret 
Recordings and a Culture Clash'', ProPublica, September 26, 2014, 
http://www.propublica.org/article/carmen-segarras-secret-recordings-
from-inside-new-york-fed (accessed November 18, 2014).
     \6\ See Government Accountability Office, ``Federal Reserve Bank 
Governance: Opportunities Exist To Broaden Director Recruitment Efforts 
and Increase Transparency'', October 2011, GAO-12-18, p. 39.
---------------------------------------------------------------------------
    A second GAO report from 2011 shows the FRBNY designed emergency 
lending programs only after it consulted with the intended 
beneficiaries. The report states that ``FRBNY's Capital Markets Group 
contacted representatives from primary dealers, and commercial paper 
issuers, and other institutions to gain a sense of how to design and 
calibrate some of its emergency programs.'' \7\ While these issues 
raise concerns about potential conflicts of interest, such 
relationships are hardly new. However, recent empirical evidence 
suggests regulatory capture has higher costs than previously believed 
via insider trading. One particular study argues that ``the presumed 
protectors of the shareholders and the general public interests appear 
to be using their positions to their advantage.'' \8\ These findings, 
as well as the fundamental principles of public choice economics, 
suggest that the recent growth of Federal regulatory power in the 
financial industry will expand the regulatory capture problem.
---------------------------------------------------------------------------
     \7\ See Government Accountability Office, ``Federal Reserve System 
Opportunities Exist To Strengthen Policies and Processes for Managing 
Emergency Assistance'', July 2011, GAO-11-696, p. 80.
     \8\ See D. Reeb, Y. Zhang, and W. Zhao, ``Insider Trading in 
Supervised Industries'', Journal of Law and Economics, Vol. 57 (August 
2014). The study's findings suggest regulators are the source of 
information leakage; compared to nonsupervised firms, the paper finds 
more trading based on insider information in general, and also to an 
even greater degree in industries which exhibit higher regulatory 
capture.
---------------------------------------------------------------------------
    The 2009 Beim report fails to adequately acknowledge the causes of 
the capture problem, and instead treats capture as a managerial 
problem. As a result, the Beim report places entirely too much faith in 
regulators' ability to understand and forecast future financial crises. 
For instance, the report notes: ``Assuming that systemic risk above 
some level should be controlled, the regulator has two problems: 
recognition and action.'' \9\ The real problem, though, is that these 
difficulties are all but insurmountable because of basic incentive and 
knowledge problems. Market participants have much stronger incentives--
a profit-loss motive--than regulators to discipline inefficient and/or 
overly risky firms. Additionally, no individual, whether a regulator or 
an industry employee, has any particular advantage over any other 
individual at identifying specific systemic risk episodes ex ante. Put 
differently, it is unreasonable to expect that any regulator or 
financial-industry employee could have identified exactly when short-
term credit markets would freeze due to overly risky activity in the 
asset-backed securities markets. The Beim report mistakenly attributes 
this lack of foresight to the fact that ``virtually no one imagined 
that such a collapse could happen in 21st century America.'' \10\ In 
fact, many people had warned of the potential problems that a failure 
in these markets could cause. A 2003 report by the Office of Federal 
Housing Enterprise Oversight, for example, warned: ``Recent analyses of 
systemic risk have concluded that some nonbank financial institutions 
are now so large and integral to the financial sector as a whole that 
their failure could lead to a systemic event.'' \11\ Furthermore, in 
the 2 years leading up to the meltdown, markets undoubtedly recognized 
the growing risk of a financial crisis; the ratio of market-value to 
book-value equity for the largest U.S. financial institutions declined 
steadily. \12\
---------------------------------------------------------------------------
     \9\ David Beim and Christopher McCurdy, ``Federal Reserve Bank of 
New York Report on Systemic Risk and Bank Supervision'', August 18, 
2009, discussion draft, p. 1.
     \10\ Ibid., p. 14.
     \11\ See ``Systemic Risk: Fannie Mae, Freddie Mac and the Role of 
OFHEO'', Office of Federal Housing Enterprise Oversight, February 2003, 
p. 5, http://www.fhfa.gov/PolicyProgramsResearch/Research/
PaperDocuments/SYSTEMIC%20RISK.pdf (accessed November 18, 2014).
     \12\ See Charles Calomiris and Richard Herring, ``Why and How To 
Design a Contingent Convertible Debt Requirement'', in Y. Fuchita, R. 
Herring, and R. Litan, eds., ``Rocky Times: New Perspectives on 
Financial Stability'' (Washington, DC: Brookings Institution Press, 
2012), pp. 117-162.
---------------------------------------------------------------------------
    For all of these reasons, and more, the Beim report's 
recommendations for future supervisory policy are misguided. Even 
though the Federal Reserve was responsible for safety and soundness of 
all bank holding companies prior to the crisis, the Beim report 
suggests that future crises can be avoided if we simply improve the 
Federal Reserve's culture and focus. The report acknowledges that the 
``recent systemic collapse is the greatest departure from bank safety 
and soundness in our lifetimes,'' but then argues that ``[f]rom now on 
systemic risk must be the most important single issue in bank 
supervision.'' \13\ Essentially, these recommendations amount to the 
utopian fantasy that we can avoid future crises if we simply design 
more appropriate regulations and a better organization, one that cannot 
be captured. Aside from the fact that changing the culture of the 
regulators to prevent capture requires reversing basic tendencies in 
human nature, there is no reason to believe that relying on these 
supposedly new ``systemic risk'' regulations will prevent future 
crises. It is far more likely, in fact, that the new Dodd-Frank 
framework increases the likelihood of future crises.
---------------------------------------------------------------------------
     \13\ Beim and McCurdy, p. 14.
---------------------------------------------------------------------------
History Casts a Long Shadow Over Macropru
    The 2010 Dodd-Frank Act, among other things, effectively mandated 
the type of systemic risk regulations called for in the Beim report. 
These so-called macroprudential regulations (implemented largely via 
the Basel III capital requirements) are supposed to be an improvement 
because they are tailored to prevent financial difficulties at any one 
institution from carrying over into the broader economy. Older 
(microprudential) regulations, supposedly, were too focused on 
maintaining the safety and soundness of individual banks. This 
ostensible improvement should be viewed with extreme caution for 
several reasons.
    First, this claim ignores that Congress created the Federal Reserve 
in 1913 to prevent banking crises from causing widespread economic 
harm, not simply to save a few individual banks. Further, the Fed, 
Congress, and the U.S. Treasury have openly discussed their roles in 
stemming economywide systemic risk and financial stability for decades. 
For instance, systemic-risk concerns were mentioned in Federal Reserve 
testimony before the House Subcommittee on Economic Stabilization in 
1991, shortly after the Basel I accords were accepted. \14\ 
Additionally, in 1996, the Fed specifically accounted for systemwide 
risk in its new rating system for financial institutions known as the 
CAMELS rating. Prior to this change, the Fed used a CAMEL rating; the 
1996 change merely added the ``S'' which stood for ``sensitivity to 
market risk.'' \15\ Aside from these issues, no empirical evidence 
shows that any of the new Basel III regulations will prevent financial 
crises any better than the old rules did, and at least some evidence 
suggests they definitely will not. \16\ In reference to these new 
macroprudential policies, Columbia Professor Charles Calomiris notes 
that ``there is no agreement about precisely what objectives will 
motivate policy, what indicators will be relied upon to achieve those 
objectives, or what changes in capital requirements or other measures 
will be undertaken in response to changes in those yet-to-be-defined, 
multiple, and hard-to-observe indicators.'' \17\ Perhaps more 
troublesome is the fact that some of the most glaring weaknesses of the 
previous Basel framework remain unchanged in the new rules.
---------------------------------------------------------------------------
     \14\ See John P. LaWare, testimony before the Subcommittee on 
Economic Stabilization, Committee on Banking, Finance, and Urban 
Affairs, U.S. House of Representatives, May 9, 1991, https://
fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/
bog_members_statements/laware_19910509.pdf (accessed November 18, 
2014).
     \15\ The remaining letters of the acronym are as follows: Capital 
adequacy, Asset quality, Management administration, Earnings, and 
Liquidity. See press release, Federal Reserve Board of Governors, 
December 24, 1996, http://www.federalreserve.gov/BoardDocs/press/
general/1996/19961224/default.htm (accessed November 18, 2014).
     \16\ See Paul H. Kupiec, ``Basel III: Some Costs Will Outweigh the 
Benefits'', American Enterprise Institute for Public Policy Research 
Financial Services Outlook, November 2013, http://www.aei.org/outlook/
economics/financial-services/banking/basel-iii-some-costs-will-
outweigh-the-benefits/ (accessed November 18, 2014). See also Charles 
Calomiris, ``The Unlikely Return to `Normalcy' in U.S. Monetary 
Policy'', Shadow Open Market Committee, November 20, 2012, http://
shadowfed.org/wp-content/uploads/2012/11/Calomiris-SOMC-Nov2012.pdf 
(accessed November 18, 2014).
     \17\ See Calomiris, ``The Unlikely Return to `Normalcy' in U.S. 
Monetary Policy'', p. 3.
---------------------------------------------------------------------------
    In recognition of the high cost and inherent agency problems 
associated with equity capital, the original Basel accords sought to 
better match capital requirements to the risk level of banks' assets. 
That is, the rules sought to effectively lower the amount of capital 
banks held based on the perceived riskiness of specific bank assets. 
Not only were these rules crafted based on the ``risk bucket'' approach 
developed by the Federal Reserve in the 1950s, but the Fed (jointly 
with the FDIC and OCC) amended these rules in 2001 so that banks could 
hold even less capital for highly rated (privately issued) mortgage-
backed securities. \18\ After the 2001 rule change, known as the 
recourse rule, certain AA- and AAA-rated asset-backed securities were 
given the same low-risk weight (20 percent) as agency-issued mortgage-
backed securities. While much has been made of the ``reach for yield'' 
leading up to the crisis, evidence clearly shows that the 10 largest 
U.S. banks expanded their purchases of these private-label mortgage-
backed securities and collateralized debt obligation bonds as soon as 
the rule was changed. Even though these banks' assets doubled from 2001 
to 2007, their risk-weight-adjusted assets barely increased. \19\ These 
facts provide clear evidence that these purchases (as sanctioned by 
Federal regulators) were made for capital relief and safety first, and 
yield last.
---------------------------------------------------------------------------
     \18\ For more on the risk-bucket approach, see Howard D. Crosse, 
``Management Policies for Commercial Banks'' (Englewood Cliffs, NJ: 
Prentice Hall, 1962), pp. 169-172. The later amendment regarding the 
lower weight for highly rated private-label mortgage securities was 
known as the recourse rule. See J. Friedman, and K. Wladmir, 
``Engineering the Financial Crisis: Systemic Risk and the Failure of 
Regulation'' (Philadelphia, PA: University of Pennsylvania Press, 
2011), ch. 2, p. 69.
     \19\ Friedman and Wladmir, p. 81.
---------------------------------------------------------------------------
    Aside from the fact that the Federal Reserve--as well as other 
regulatory agencies--mistakenly endorsed these assets as low risk, 
there is an even more fundamental problem with statutorily required 
minimum capital ratios. Such rules are viewed as providing a capital 
cushion to absorb losses, but when banks fail to meet the minimum 
required they are penalized. Thus, regulatory capital ratios do not 
represent usable capital cushions because banks can only breach them if 
their regulator provides forbearance. \20\ When regulators allow such 
forgiveness, of course, the statutory capital requirements no longer 
represent a binding constraint on firms. Yet another core problem with 
statutory capital ratios is that they are arbitrarily determined 
outside any market-based system. For all of these reasons, the public 
should be wary of the notion that these rules will actually help to 
stem future crises.
---------------------------------------------------------------------------
     \20\ For this reason it is not surprising that many banks hold a 
buffer slightly above the minimum required, and this was even the case 
leading up to the 2008 crisis; according to the FDIC, U.S. commercial 
banks exceeded their minimum capital requirements by 2 to 3 percentage 
points (on average) for 6 years leading up to the crisis. Juliusz 
Jablecki and Mateusz Machaj, ``The Regulated Meltdown of 2008'', 
Critical Review Vol. 21, Nos. 2-3 (2009), pp. 306-307.
---------------------------------------------------------------------------
    It is also true that once statutory capital requirements are in 
place, purchasing specific assets to lower required capital can in no 
way represent ``gaming'' the system. Banks that simply followed the 
established rules by purchasing more mortgage-backed securities, for 
instance, cannot legitimately be accused of doing anything nefarious. 
There is very little reason, in fact, to believe that banks thought the 
securities they were buying after 2001 would lose value in the manner 
they eventually did--bank managers tend to prefer staying in business, 
after all. Regardless, the Basel requirements were--and still are--a 
system designed to match lower capital requirements against lower risk 
assets, and it is this part of the rules that were--and are--always 
destined to break down. Regulators failed to measure mortgage-security 
risk properly in this particular case, but such a problem will always 
exist because the true risk of any financial asset can never be known 
with certainty ex ante. Therefore, we should not expect the new 
regulations promulgated via the 2010 Dodd-Frank Wall Street Reform and 
Consumer Protection Act to perform any better than the previous 
regulatory framework. While Dodd-Frank did not explicitly require 
adoption of the Basel III rules, the bill included language--mostly in 
Sections 165 and 171--that effectively directed Federal banking 
agencies to implement the Basel III proposals. Under these proposals, 
with some exceptions for the smallest banks, U.S. depository 
institutions will need to adhere to higher risk-based capital, leverage 
(overall debt), and liquidity (short-term debt) standards as well as to 
a new countercyclical capital conservation buffer. This capital 
conservation buffer is supposed to maintain credit availability by 
increasing banks' capital when economic conditions improve and 
decreasing it when economic conditions worsen. \21\ The new Basel III 
rules are supposed to be an improvement over earlier versions because--
via the Federal Reserve's new ``stress tests''--they apply a ``macro'' 
regulatory view as opposed to microlevel scrutiny. We should put very 
little faith in this tool to make markets safer for several reasons.
---------------------------------------------------------------------------
     \21\ One other downside is that the new regulations appear to be 
at least partly responsible for a drop in the number of new banks 
created and for increased concentration in the industry--a risk not 
addressed in Basel III. The number of banking institutions in the U.S. 
is now at its lowest level since the Great Depression. See Ryan Tracy, 
``Tally of U.S. Banks Sinks to Record Low: Small Lenders Are Having the 
Hardest Time With New Rules, Weak Economy and Low Interest Rates'', The 
Wall Street Journal, December 3, 2013, http://online.wsj.com/news/
articles/
SB10001424052702304579404579232343313671258?mod=WSJ_hps_LEFTTopStories 
(accessed November 18, 2014).
---------------------------------------------------------------------------
    First, as mentioned previously, the general concept of focusing on 
macro risks versus micro risks is not new at all. Second, these stress 
tests, though technically different than the tools previously used, 
fail to overcome the basic problems of statutory capital minimums 
because they are merely a new arbitrary method for determining capital 
requirements. The Fed conducts stress tests by running a mathematical 
model to estimate how much capital banks need to remain solvent under 
``stressed'' economic conditions. But these models necessarily rely on 
imperfect assumptions and data to forecast capital needs, and all such 
modeling depends on the naive belief that the macroeconomy can be 
precisely explained with mathematical equations. The Fed had no 
particularly credible track record of forecasting prior to Dodd-Frank, 
and there is no reason to believe it will improve now that it has a 
more expansive forecasting mandate. The Federal Reserve's Open Market 
Committee meeting minutes clearly show that Fed officials failed to 
forecast the 2008 crisis, yet the Fed now has the responsibility to 
tell large financial firms how to forecast their own financial risks. 
At best, this exercise is futile, at worst, it exemplifies the ultimate 
version of what Nobel Laureate F.A. Hayek termed a fatal conceit. \22\
---------------------------------------------------------------------------
     \22\ See Kevin Dowd, ``Math Gone Mad: Regulatory Risk Modeling by 
the Federal Reserve'', Cato Institute Policy Analysis No. 754, 
September 3, 2014, http://www.cato.org/publications/policy-analysis/
math-gone-mad (accessed November 18, 2014).
---------------------------------------------------------------------------
Conflicts Compounded Because the Fed ``Prints'' the Money
    The Fed's shortcomings as a forecaster and regulator are compounded 
by the fact that the central bank serves as the financial system's 
lender of last resort (LLR). Though the Fed can regularly provide 
liquidity to the entire market by purchasing Treasury securities (open-
market operations), even during a financial crises, the Fed has a long 
history of providing credit directly to insolvent institutions. \23\ 
For example, as of August 31, 1925, 593 member banks had borrowed 
continuously from the Fed for at least 1 year as opposed to on a short-
term basis. \24\ Research also shows that at least 80 percent of the 
259 member banks that failed between 1920 and 1925 were habitual 
borrowers at the discount window prior to their failure, and evidence 
suggests that the Fed was continuously providing capital loans to more 
than 400 insolvent banks during the late 1980s and early 1990s. \25\ 
The Fed is even responsible for what monetary scholar Anna Schwartz 
called ``the `too-big-to-fail' doctrine in embryo'' in the 1970s. In 
this particular instance, ostensibly worried about fallout from Penn 
Central's bankruptcy, the Fed announced that it would provide discount 
window lending to banks to assist in meeting the needs of all 
businesses that could not issue new commercial paper. \26\
---------------------------------------------------------------------------
     \23\ More generally, the Fed has never consistently adhered to the 
classic prescription for a LLR: provide temporary liquidity to solvent 
institutions, against good collateral, at penalty rates. See Norbert J. 
Michel, ``The Fed's Failure as a Lender of Last Resort: What To Do 
About It'', Heritage Foundation Backgrounder No. 2943, August 20, 2014, 
http://www.heritage.org/research/reports/2014/08/the-feds-failure-as-a-
lender-of-last-resort-what-to-do-about-it?ac=1 (accessed November 18, 
2014).
     \24\ For a complete history of the Fed's overly generous lending 
policies, see Anna Schwartz, ``The Misuse of the Fed's Discount 
Window'', Federal Reserve Bank of St. Louis Review, Vol. 74, No. 5 
(September/October 1992), p. 58, http://research.stlouisfed.org/
publications/review/article/2582 (accessed November 18, 2014).
     \25\ Schwartz, ``The Misuse of the Fed's Discount Window'', pp. 
58-59.
     \26\ Ibid., p. 62.
---------------------------------------------------------------------------
    Thus the Fed showed it would go to great lengths to stem a 
financial crisis in the event a large firm--one that was not even a 
financial firm--might fail. This action, of course, implied that the 
bankruptcy of a large firm would cause a financial crisis (the so-
called contagion effect), although no analysis, only conjecture, 
establishes such a position. Yet, there is still not a single example 
of contagion causing a solvent financial firm to collapse. Furthermore, 
evidence suggests that no amount of Fed lending will stem a crisis 
because these systemic events are caused by solvency problems as 
opposed to liquidity problems. \27\ Regardless, the fact that the Fed 
used its Section 13(3) lending authority to allocate more than $16 
trillion in credit to several financial firms during the subprime 
crisis--at approximately $13 billion below market rates--should come as 
no surprise because it merely reflects the continuation of a long-term 
trend. \28\ The fact that Dodd-Frank has given the Fed even more 
regulatory responsibility, with a nebulous mandate of maintaining 
financial stability, while not stripping the Fed of emergency lending 
authority, all but guarantees future bailouts of failing firms and/or 
their creditors. Historically unable to restrain from allocating so-
called emergency credit to failing firms, the Fed now has even more 
incentive to prop up insolvent financial institutions because it is all 
but guaranteeing firms' safety and soundness. U.S. markets are now 
structured with a captured regulatory system where the primary 
regulator can create as much money as it wants to provide credit to 
financial firms and/or their creditors.
---------------------------------------------------------------------------
     \27\ See N. Boyson, J. Helwege, and J. Jindra, ``Crises, Liquidity 
Shocks, and Fire Sales at Commercial Banks'', Financial Management, 
January 30, 2014, http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2021386 (accessed November 18, 2014). Using data 
from 1980 to 2008, the study shows that funding does not typically dry 
up in a crisis (even the recent subprime crisis) but weak banks do, in 
fact, face declines in capital market borrowing.
     \28\ The U.S. Government Accountability Office (GAO) estimates 
that from December 1, 2007, through July 21, 2010, the Federal Reserve 
lent financial firms more than $16 trillion through its Broad-Based 
Emergency Programs. See U.S. Government Accountability Office, 
``Federal Reserve System: Opportunities Exist To Strengthen Policies 
and Processes for Managing Emergency Assistance'', Report to 
Congressional Addressees, July 2011, GAO-11-696, p. 131, http://
www.gao.gov/new.items/d11696.pdf (accessed November 18, 2014). Subsidy 
figures are taken from Bob Ivry, Bradley Keoun, and Phil Kuntz, 
``Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress'', 
Bloomberg Markets Magazine, November 27, 2011, http://
www.bloomberg.com/news/print/2011-11-28/secret-fed-loans-undisclosed-
to-congress-gave-banks-13-billion-in-income.html (accessed November 18, 
2014).
---------------------------------------------------------------------------
End the Fed's Role as a Regulator
    Some momentum to strip the Federal Reserve of its regulatory 
functions did exist prior to the 2008 crisis. Under the direction of 
former Treasury Secretary Henry Paulson, for instance, a special task 
force recommended that most of the Fed's regulatory authority be 
dramatically reduced and/or transferred to other agencies. \29\ Such a 
shift in policy would have been counter to the historical trend in the 
U.S. The 1999 Gramm-Leach-Bliley Act (GLBA), for instance, expanded the 
Fed's authority to define financial activities, and also widened the 
central bank's authority to allow mergers and acquisitions. However, 
stripping the Fed of regulatory authority would have been entirely 
consistent with the international trend during the last few decades of 
the 20th century, whereby roughly a dozen developed countries took 
regulatory authority away from their central banks. \30\ While critics 
of this type of policy change argue the Federal Reserve needs 
information to make better decisions during a financial crisis, access 
to information is very different from the authority to write (and 
enforce) rules and regulations.
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     \29\ See U.S. Department Of The Treasury, ``Blueprint for a 
Modernized Financial Regulatory Structure'', March 2008, (accessed 
November 18, 2014).
     \30\ See Charles Calomiris, ``Alan Greenspan's Legacy: An Early 
Look; The Regulatory Record Of The Greenspan Fed'', American Economic 
Association Papers and Proceedings, 2006, 96, pp. 170-173, https://
www0.gsb.columbia.edu/mygsb/faculty/research/pubfiles/4435/
Greenspan_Fed.pdf (accessed November 18, 2014).
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    In reality, removing regulatory functions from the Federal Reserve 
is long past due. Policymakers should not leave the Fed--with its 
history of regulatory capture and credit allocation to failing firms 
(and their creditors)--in charge of regulating financial markets and 
providing emergency lending, while simultaneously being responsible for 
conducting the Nation's monetary policy. Beyond the basic temptation to 
provide so-called emergency funds to failing firms it regulates, the 
Fed also faces the incentive to use monetary policy actions to counter 
any regulatory failings. This combination further reduces the ability 
of markets to discipline poorly managed firms, injects even more 
politics into central banking, and jeopardizes the long-term price 
stability goal of monetary policy. As pointed out by Federal Reserve 
researchers M. Goodfriend and R. King, though, a central bank does not 
need to function as a regulator in order to conduct monetary policy. 
\31\ It makes sense to strip the Federal Reserve of its regulatory 
authority so that the central bank can, instead, focus on monetary 
policy. In fact, evidence supports the notion that separating a central 
bank from its regulatory role is beneficial. For example, one recent 
National Bureau of Economic Research (NBER) study, using data for 140 
countries from 1998 through 2010, reports the following:
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     \31\ See M. Goodfriend and R. King, ``Financial Deregulation, 
Monetary Policy, and Central Banking'', Federal Reserve Bank of 
Richmond Economic Review (May/June 1988), https://www.richmondfed.org/
publications/research/working_papers/1988/wp_88-1.cfm (accessed 
November 18, 2014).

        Countries with independent supervisors other than the central 
        bank have fewer nonperforming loans as a share of GDP [gross 
        domestic product] even after controlling for inflation, per 
        capita income, and country and/or year fixed effects. Their 
        banks are required to hold less capital against assets, 
        presumably because they have less need to protect against loan 
        losses. Savers in such countries enjoy higher deposit rates. 
        There is some evidence, albeit more tentative, that countries 
        with these arrangements are less prone to systemic banking 
        crises. \32\
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     \32\ See Barry Eichengreen and Nergiz Dincer, ``Who Should 
Supervise? The Structure of Bank Supervision and the Performance of the 
Financial System'', NBER Working Paper No. 17401, September 2011, 
http://www.nber.org/papers/w17401 (accessed November 18, 2014).

    Put differently, the best way for the Fed to contribute to 
financial stability is for it to focus on monetary stability. If the 
Federal Reserve is stripped of its regulatory authority, no less than 
six Federal agencies--the FDIC, the OCC, the Securities and Exchange 
Commission, the Federal Housing Finance Agency, the Consumer Financial 
Protection Bureau, and the Commodity Futures Trading Commission--as 
well as State regulatory agencies, would still serve financial markets 
in supervisory roles. There simply is no evidence that the Fed has any 
competitive advantage over either the FDIC or the OCC in terms of 
regulating depository institutions, or over any of the other agencies 
in regulating financial markets.
Conclusion
    The Federal Reserve will never be immune from potential conflicts 
and capture problems as long as it serves as a financial market 
regulator. All potential problems are compounded by the fact that the 
Federal Reserve is responsible for the Nation's monetary policy. The 
broad new stability mandate Dodd-Frank granted the Fed has only made 
matters worse because the Fed may be even more tempted to give greater 
weight to its financial stability goals than to its monetary policy 
goal of price stability. Given the Fed's long history of allocating 
credit directly to insolvent firms, it makes even less sense to leave 
the Fed in charge of both monetary policy and supervising the Nation's 
largest financial institutions. The 100-year anniversary of the Federal 
Reserve System is the perfect time to reform the Nation's central bank, 
and a key improvement would be to transfer all of the Fed's regulatory 
authority to the FDIC and/or the OCC.
```