The New York Fed: A “Captured” Regulator

The following post comes to us from Luigi Zingales, Professor of Finance at the University of Chicago, and is based on an op-ed by Mr. Zingales that was published today in Il Sole 24 Ore, which can be found here.

The world of American finance has been invested by a new scandal. At its core, there is New York’s Federal Reserve; in other words, the institution that supervises America’s main banks. The scandal exploded because of the revelations emerged in a legal lawsuit about a layoff.

Carmen Segarra, a supervision lawyer, sued after being fired only seven months into her job. The New York Fed says it fired her due to poor performance. Segarra instead maintains that she was given the pink slip because she did not adapt to ‘Fed culture’—so permissive towards banks it regulates, almost to the point of collusion.

The case would not have made the news if it weren’t for two important revelations. The first is that Ms Segarra had been hired exactly to answer an internal investigation about the prevalent culture within the New York Fed. This inquiry, that had to remain confidential, has, instead, ended up on the web, and you can find it at This should be required reading for anyone involved in supervision, audit or compliance.

It clearly states that the Fed supervision is ineffective because of the prevalent culture internal to the organization. “Many people are afraid to make mistakes or to contradict others, especially their superiors. There is not enough communication between hierarchical levels. The ‘need-to-know’ principle (in other words sharing the minimum level of necessary information) is abused.” And there is more. “The supervisors show excessive deference towards banks, and consequently they are less aggressive in identifying problems or in taking care of them effectively.”

The Fed report also speaks negatively of the culture of prevalent consensus among the supervisors, especially when—as it later happened in the Segarra case—the search for consensus at all costs leads to the “criminalization” of dissent. Consensus tends to produce group thinking—in other words, an excess of conformism on positions that are often wrong. It delays—when it does not totally eliminate—the ability to intervene. It tends to overshadow problems, rather than pointing them out.

We, the economists, define this attitude as the “capture” of the regulators by hand of the “regulated.” Instead of worrying about the integrity of the financial system (the reason why we have regulatory organisms in the first place), the supervisors care about keeping a good relationship with the banks they regulate, in order to help their own career or simply for peace and quiet. “Over the course of three weeks, after my hiring, I saw the ‘capture’ taking over,” writes a Fed employee quoted in the report. Even for those who, like me, have always believed in the ‘capture’ problem, these declarations are devastating.

But even more devastating is the second part of the revelations. As she suspected the turn the issue was taking, Ms Segarra recorded many of the conversations she had with her superiors. The 46 hours of recordings, distilled in a program I strongly recommend, at, depict a terrible picture, yet an unfortunately familiar one. Although her bosses appreciate Ms Segarra’s qualifications—a law degree from Cornell, a master’s degree in French from Columbia, and fluency in five languages—they begin to scold her for tone and attitude.

“I never question your knowledge and your judgment,” one of her superiors can be heard saying in one of the recordings, “it’s the way they see you here… many perceive you as too rigid, a pain in the neck.” Yet in a world of people who turn their head away not to see, how can you perform your duty as a supervisor without being a little rigid and sometimes even a pain in the neck?

For instance, when an employee of Goldman, the bank she supervises, says that “if a client is sufficiently rich, certain consumer protection laws do not apply,” his superiors try to convince her to forget she ever heard it. When she insists, they say that the Goldman employee “did not mean it.” After this episode the “suggestions” of her superiors begin to become not-so-implicit threats. “You have to change rapidly if you want to be successful, here.”

But Ms. Segarra did not give up. She found out that at Goldman, not only is there no policy on conflict of interest, they do not even have a definition of conflict of interest—despite all the nice sentences written on it website. Her superiors do all they can to make her change her report. In the end—almost driven to tears—she surrenders. Yet, like Galileo in front of the inquisition, she says: “between these four walls, I declare to be convinced that Goldman Sachs has no policy whatsoever.” A few days later, she was fired.

The story does not have a happy ending. Her layoff is a very strong signal to all Fed employees. Despite the suggestions contained in the internal report, who dissents gets, first, isolated, and, eventually, expelled. Only a hero would be so brave as to continue to do his or her job well. Bertolt Brecht said: “Happy is the country that does not need heroes!”. Let us hope the scandal triggered by the revelations from the conversations and the report can change the situation. At stake is the stability of the world’s financial system as a whole.

These episodes happen even though the American society encourages children to speak up when teachers are wrong, protects civil whistleblowers (in fact it generously rewards them), and creates monetary incentives to fight injustices (Ms. Segarra, for example, asked the Fed for a $7 million compensation).

In conclusion, I dare to give the Bank of Italy Governor Ignazio Visco a piece of advice. Why does he not hire Ms. Segarra? After all, she speaks Italian (as well as English French and German); she a supervising expert; and the move would send a clear signal about the fact, our culture of supervision is indeed very different.

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