Fed, Heal Thyself

It is breathtaking to read about Federal Reserve Chairwoman Janet Yellen berating Wall Street banks, as reported by Victoria McGrane in today’s Wall Street Journal, “to follow the law and to operate in an ethical manner.”  Ms. Yellen’s speech to the Citizens Budget Commission in New York City is an apparent reference to the various probes of banks’ misdeeds around interest-rate manipulation, tax avoidance and other unnamed sins.

The audacity of Federal Reserve officials Yellen and William Dudley, president of the Federal Reserve Bank of New York, to point fingers at others for ethical and legal lapses is clearly an effort to divert attention from the Federal Reserve’s own failings and their deep disinterest in addressing them seriously.

The problems of regulatory capture at the Fed are now well documented, between a confidential study commissioned by the Fed and recently-released tape recordings of Fed agency staff interactions. As reported by Jake Bernstein of Pro Publica, Columbia University professor David Beim found that:

“The most daunting obstacle the New York Fed faced in overseeing the nation’s biggest financial institutions was its own culture. The New York Fed had become too risk-averse and deferential to the banks it supervised. Its examiners feared contradicting bosses, who too often forced their findings into an institutional consensus that watered down much of what they did.”

Knowledge of these ethical lapses wasn’t intended for public consumption. Beim was hired to produce a confidential report to New York Fed President Dudley. Three years after the Beim report, it was clear little has changed at the Fed.  An examiner hired to keep an eye on large banks was fired when she questioned the behavior of her colleagues. The examiner was so alarmed by what she observed that she recorded 46 hours of conversations. Bernstein explains that, “The recordings make clear that some of the cultural obstacles Beim outlined in his report persisted almost three years after he handed his report to Dudley.”

It’s not surprising that a large, powerful, independent government agency that faces little oversight would suffer from deep ethical problems. What’s so galling is the anemic response of top Federal Reserve leaders to address them.

Yellen’s response to the Fed’s ethical failings is to point to a committee of Fed insiders, the Large Institution Supervision Coordinating Committee.  The suggestion that a Fed committee can effectively oversee Fed behavior is either dangerously naïve for someone of Ms. Yellen’s responsibilities or cynical in the extreme. At the very least an inter-agency group of financial regulators should be established to monitor each other.

The cultural problems across the Fed system Chairwoman Yellen inherited have built up over years. She can’t fix them alone or quickly. But if she wants to have the moral standing to lecture others on institutional ethics, she will need to do more to put the Fed’s own house in order.