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New York Fed Faces Questions Over Policing Wall Street

As the Federal Reserve Bank of New York faced criticism for missing a multibillion-dollar trading loss at JPMorgan Chase, the regulator convened a town hall meeting in May to bolster employee morale.

United States Federal Reserve
Tetra Images | Getty Images
United States Federal Reserve

Two months later, the New York Fed staff huddled again, after lawmakers questioned why the regulator had failed to rein in banks that manipulated key interest rates.

"We were told to keep our heads down and stay focused," said one person present at the July meeting who requested anonymity because the gathering was not public.

The New York Fed, whose weaknesses were first exposed when the financial crisis hit, is undergoing a new trial by fire as it grapples with how to police Wall Street. While the regulator has revamped its approach to overseeing the nation's biggest banks since the crisis, recent black eyes suggest that fundamental problems persist.

Lawmakers will most likely focus on the record of the New York Fed when Timothy F. Geithner, the regulator's former president, testifies on Wednesday before the House Financial Services Committee. Mr. Geithner, now the Treasury secretary, will appear before a Senate panel on Thursday.

The regional Fed bank, by virtue of its location in Lower Manhattan, is on the front line of financial regulation. With examiners stationed inside the banks, the regulator has a wide window into the inner workings of these institutions.

But the New York Fed does not have enforcement power like many American regulators. Instead, it reports potential wrongdoing to other agencies or the central bank, the Federal Reserve , and leaves its counterparts to dole out punishments if necessary.

The New York Fed's mission, officials say, is to broadly protect the health and safety of the financial system — not to micromanage individual banks.

"They focus on safety and soundness of the banks, which ultimately means they are not particularly focused on market manipulation," said Sheila C. Bair, the former chairwoman of the Federal Deposit Insurance Corporation, another regulator.

In recent years, the New York Fed has beefed up oversight. Under the president, William C. Dudley, the regulator has increased the expertise of its examiners and hired new senior officials.

Even so, the JPMorgan debacle and the interest-rate investigation have raised questions about the New York Fed. They highlight how the regulator is hampered by its lack of enforcement authority and dogged by concerns that it is overly cozy with the banks.

Mr. Geithner is expected to face questions from lawmakers on Wednesday about the rate-rigging inquiry that has ensnared more than a dozen big banks. In June, Barclays agreed to pay $450 million to authorities for manipulating the London interbank offered rate, or Libor.

Since the settlement, Mr. Geithner has heralded his efforts to reform the rate-setting process in 2008. But the New York Fed, which knew Barclays had been reporting false rates at the time, did not stop the actions.


And when Mr. Geithner briefed other American regulators about Libor in May 2008, he did not disclose the specific wrongdoing, according to people briefed on the meeting. In later briefings, New York Fed officials did warn their counterparts about "allegations of misreporting."

"The regulator has an obligation to make a criminal referral if it suspects a crime may have occurred," said Bart Dzivi, who served as special counsel to the Federal Financial Crisis Inquiry Commission. "How this doesn't rise to that level, simply boggles the mind."

The New York Fed has been engulfed by controversy since the financial crisis. Mr. Geithner was one of many regulators who had underestimated certain risks spreading through the financial system, saying in a May 2007 speech that "financial innovation has improved the capacity to measure and manage risk" while acknowledging that threats remained. In late 2008, the system nearly collapsed after Lehman Brothers failed.

This year, the New York Fed was again caught off guard when JPMorgan disclosed the trading losses, which have already exceeded $5 billion. The regulator has assigned about 40 examiners to the bank, but none of the officials kept close tabs on the chief investment office, the powerful unit that placed the ill-fated trade.

In the case of Libor, the New York Fed took a somewhat passive approach. Despite mounting evidence of problems, the agency focused on policy solutions rather than the wrongdoing.

People close to the Fed note that, at the time, the regulator was primarily concerned with saving Wall Street from collapse. And the regulator pushed harder than its British counterparts, records show. Mr. Geithner urged British authorities to "eliminate incentive to misreport" Libor, which affects the cost of trillions of dollars in mortgages and other loans.

Some New York Fed examiners are now focused on how the Libor investigation could damage the bottom line at banks like Citigroup and JPMorgan. The examiners, people briefed on the matter say, are assessing whether banks need to build reserves against the growing threat of lawsuits.

The concerns echo the New York Fed's broader moves to enhance supervision. After the crisis, the Fed formed a special team to spot emerging risks. Mr. Dudley also appointed a new head of bank supervision, Sarah J. Dahlgren, who first joined the Fed more than two decades ago after working as a budget official at Rikers Island jail.

In recent years, the New York Fed has doubled the number of on-site examiners and dispatched some of its most senior officials to big banks. The lead supervisors at each bank are some of the most "battle tested" and sophisticated regulators who are comfortable challenging Wall Street executives, one regulator said.

The New York Fed also notes that it has delved deeper into internal bank data, focusing on business units that generate the most revenue and risk. To better prepare the industry for sudden losses, the regulator has pushed banks to build extra capital.

But there are limits to its power. Despite its leading role in policing the banks, the New York Fed cannot levy fines. When examiners do detect questionable behavior, they often push the company to adopt changes. If the wrongdoing persists, officials can pass along the case to the Federal Reserve board in Washington.

It is up to the central bank to take action. The Fed, which can impose fines and cease-and-desist orders, filed 171 enforcement actions last year. The cases are down 44 percent from the year before, but the actions have increased sharply from the precrisis era.

Some critics also contend there is a revolving door between Wall Street and the New York Fed. Mr. Dudley was formerly the chief domestic economist at Goldman Sachs, and his wife collects deferred compensation from her days at JPMorgan. After Bear Stearns collapsed in 2008, the New York Fed hired the firm's chief risk officer.

The New York Fed does limit the influence of employees who depart for a career on Wall Street. Some former senior officials cannot discuss regulatory matters with the Fed for up to a year. As an extra measure, examiners rotate between banks every three to five years to prevent a clubby culture from forming.

But some experts say the problem is not solved.

"It's a cultural problem at all the banking regulators," said Ms. Bair, who is now a senior adviser to the Pew Charitable Trusts. "There's not a healthy separation, and you can see that in their hiring practices."

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