Washington Strips New York Fed’s Power
Secret ‘Triangle Document’ gives control of big-bank regulation to committee
By Jon Hilsenrath
March 4, 2015 10:30 p.m. ET
WASHINGTON—The Federal Reserve Bank of New York, once the most feared banking regulator on Wall Street, has lost power in a behind-the-scenes reorganization at the nation’s central bank.
The Fed’s center of regulatory authority is now a little-known committee run by Fed governor Daniel Tarullo , which is calling the shots in oversight of banking titans such as Goldman Sachs Group Inc. and Citigroup Inc .
The new structure was enshrined in a previously undisclosed paper written in 2010 known as the Triangle Document. Under the new system, Washington is at the center of bank supervision, exercising control over the Fed’s 12 reserve banks, much as the State Department exerts control over embassies.
The power shift, initiated after the financial crisis and slowly put in place over the past five years, is more than a bureaucratic change. It influences how the biggest banks on Wall Street are overseen and has begun to affect regulation in unanticipated ways across the Fed system.
During internal debates on a range of issues—including a Citigroup bid to raise its dividend a year ago and J.P. Morgan’s 2012 “London Whale” trading losses—New York Fed examiners have been challenged by Washington. At times they have been shut out of policy meetings and even openly disparaged by Mr. Tarullo for failing to stem problems at banks, according to current and former Fed officials involved the discussions.
“It was obvious that a lot in the U.S. regulatory system had not worked particularly well before the crisis,” Mr. Tarullo said in an interview. “It was equally obvious that there was going to need to be a rethink and reorganization.”
The new structure will be on display Thursday, when the Fed releases results of annual stress tests of big banks, a program run out of Washington by Mr. Tarullo’s group.
The Fed undertook the reorganization with little disclosure about what was taking place, but officials are now drawing attention to it. “The Federal Reserve is requiring more of large institutions,” Fed Chairwoman Janet Yellen said in a speech Tuesday that addressed the reorganization. “We are also requiring more of ourselves.”
The New York Fed, as it loses power, is adjusting its approach in some ways. It is pulling examiners out of offices at the banks they review and relocating them to a building near New York Fed headquarters.
Many of the firms that faced the gravest trouble in 2008—Bear Stearns, Fannie Mae, Freddie Mac, American International Group and Lehman Brothers—weren’t the responsibility of the New York Fed. But it has borne the brunt of the blame, as the central bank’s eyes and ears on Wall Street. And certain postcrisis incidents, such as the 2012 losses at J.P. Morgan Chase & Co., gave ammunition for those seeking to rein in the New York branch and its examiners.
It also came under scrutiny when a former employee, Carmen Segarra, told news organization ProPublica the New York Fed had gone easy on Goldman—and made tapes of internal discussions.
The New York Fed said the facts didn’t support her assertions. Her wrongful-dismissal suit was dismissed, a ruling she is appealing. Even so, the case has led central-bank officials to explore whether they get adequate information from district banks on financial firms.
Officials in Washington say centralizing regulatory authority in D.C. gives the Fed a broader view of risks across the whole system and a more evenhanded oversight approach. As evidence of benefits from the stress tests Washington introduced, officials say the 50 largest U.S. banks increased their capital to $1.2 trillion by the end of the 2014 third quarter from $506 billion in early 2009.
Added strains
There also have been strains. Some regulated banks say they are uncertain whether they can depend on feedback from front-line examiners. Others complain of an increase in paperwork and complexity that they doubt makes the system safer.The organizational shakeout and criticism of the New York Fed have placed its president, William Dudley , in a vise: holding less authority to regulate banks even as he faces a bigger burden to prove the New York branch is up to such work.
Under the new structure, the New York Fed president isn’t directly involved in many of the central bank’s most important supervision decisions, including stress tests. Supervisors of bank examiners often report directly to Mr. Tarullo’s group.
Still, Mr. Dudley is taking heat. At a Senate hearing in November, Sen. Elizabeth Warren (D., Mass.) suggested there was a cultural problem at the New York Fed and told Mr. Dudley he needed to fix it “or we need to get someone who will.” Sen. Jack Reed (D., R.I.) has introduced a bill to subject New York Fed presidents to Senate confirmation. Dallas Fed President Richard Fisher recently said the New York Fed should have less sway in monetary-policy decisions.
Ms. Yellen is standing behind Mr. Dudley, who won respect inside the Fed for spotting emerging problems in markets during the financial crisis and is part of Ms. Yellen’s inner circle on monetary policy. “He’s done a fine job,” Ms. Yellen said in December. In an interview, Mr. Tarullo said he had a good working relationship with Mr. Dudley.
Behind the scenes, Mr. Dudley, a former senior economist at Goldman, has been trying to restore the New York Fed’s dinged reputation.
In 2011, he began a “Listening to Our Critics” series that brought in detractors for daylong discussions. The bank screened for its staff the documentary “Inside Job,” which finds the Fed, along with others from government and Wall Street, culpable for the financial crisis. A discussion with the film’s director followed. Mr. Dudley sat in the front row.
The criticism has baffled some New York Fed examiners and left them feeling under assault. “Why do we get blamed for everything?” one New York Fed employee asked Sheila Bair , the former head of the Federal Deposit Insurance Corp., at one of Mr. Dudley’s events, according to her.
“I do think they are trying to effectuate culture change,” said Ms. Bair, who often sparred with Mr. Dudley’s predecessor, Timothy Geithner .
The New York Fed’s move to base bank examiners in New York instead of at banks helps them compare notes, officials of the regional bank said. Other Fed officials said it lowers the risk of examiners becoming loyal to banks they review.
The regulatory changes mark a sharp turn in the central bank’s 100-year history. The New York Fed once towered over the system, with New York Fed President Benjamin Strong the dominant figure.
The Fed board had regulatory power but delegated many decisions to the 12 reserve banks.
After the Depression, the New York Fed lost power to dictate short-term interest rates but retained great sway as the regulator of Wall Street banks. “Heads of the New York Fed really were dominant figures,” said Liaquat Ahamed, author of the book “Lords of Finance” about central banking in the 1930s. “Their closeness to Wall Street was viewed as an asset and not as a liability.”
The Dodd-Frank law in 2010 instructed the White House to name a Fed vice chairman for bank supervision, a step it has never taken. It declined to comment on why. In the absence of a nomination, Mr. Tarullo filled the void.
He hatched the regulatory shift with the approval of former Fed Chairman Ben Bernanke, who put Mr. Tarullo in charge of a post-financial-crisis overhaul.
“The precrisis situation was one that relied too much on the on-site people and did not provide enough perspective on correlated risks and how things could be problematic at multiple institutions,” Mr. Tarullo said.
Chewed out supervisors
He was hard on New York’s team of examiners from the start. He chewed out their supervisors during discussions in late 2009 of a plan by Citigroup to repay its $45 billion federal bailout, said people involved in the discussions.New York Fed supervisors doubted Citigroup could raise as much money as Washington wanted it to raise before starting repayment. Mr. Tarullo said New York wasn’t pushing Citigroup hard enough. One person involved in the talks said Mr. Tarullo’s message to New York officials was that he was tired of cleaning up their messes.
The six-page document placed a new panel called the Large Institution Supervision Coordinating Committee, overseen by Mr. Tarullo, at the center of Fed supervision of banks. Supervisors at the 12 reserve banks operate under the “guidance and supervision” of the LISCC (pronounced “lissick”).
Nine of the Federal Reserve Board’s members are on the 16-person committee; the New York Fed has three representatives, and they answer to Washington. Mr. Dudley isn’t on it.
“This reserve bank doesn’t breathe any more without asking Washington if it can inhale or exhale,” said one person prominent in the banking community.
Mr. Tarullo has empowered economists in both New York and Washington, while weakening examination teams. His top lieutenant, economist Michael Gibson, and Mr. Gibson’s deputy, Timothy Clark, have central roles at the LISCC and in running the Fed’s current stress tests of the largest 31 U.S. banks.
The LISCC also oversees the 16 financial firms the Fed believes would pose the biggest risks to financial stability if they failed. It includes a “vetting committee” to oversee the Fed’s internal bank ratings and a Risk Secretariat that runs specialized “risk teams” watching for problems across a broad swath of banking.
Before the financial crisis, New York Fed officials regularly took part in Washington-run meetings on regulatory policy, such as rules for derivatives oversight or capital. Mr. Tarullo ended the practice of including New York officials in these high-level meetings—a source of frustration for New York officials, they said privately.
Eugene Ludwig, the CEO of Promontory Financial Group, said banks now must navigate three layers of Fed supervision: examiners from the regional Fed banks, the committee Mr. Tarullo heads plus the risk teams. “It makes getting an approval or an issue rectified a more complex undertaking,” he said.
Tensions accompanying the reorganization became apparent in 2012 when J.P. Morgan’s London large trading losses came to light. In a conference call, Mr. Tarullo pressed New York Fed supervisors to explain how the matter slipped through regulatory cracks and asked whether it was their responsibility, according to people on the call.
New York had its own frustrations. Employees there complained that the emphasis on stress tests of banks drained resources and was at odds with the New York Fed’s ability to attend to individual institutions, said a report by the Fed inspector general. Mr. Gibson told the IG the tests shouldn’t strain New York examiners because they didn’t have to do much work on them.
Stress tests became a source of friction again in March 2014, when the Fed rejected a Citigroup plan for its capital that included a dividend increase. Citi had been assured by New York Fed examiners that it had until 2015 to correct shortcomings found in an earlier stress test, according to people familiar with the matter. The LISCC committee believed Citi hadn’t made enough progress and rejected its capital plan, a decision ratified by the Fed board.
Several New York Fed supervisors have left—stung, some said, by lost power, low morale and pay freezes imposed after the financial crisis.
At times, New York has recommended tougher treatment of banks—but still lost out to Washington.
In one round of stress tests, Michael Silva, the New York Fed’s former point person on Goldman Sachs, recommended penalizing the bank for not adequately calculating potential losses in a downturn. (Goldman declined to comment.)
But, said a person familiar with the tests, Mr. Tarullo’s committee judged that all of the big banks needed more time to address the same problem, and rejected the New York Fed’s recommendation.
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