The US Federal Reserve is one of the most important and powerful US institutions shaping US and global economic health. The Fed is supposed to supervise the big banks and, in a vacuum of leadership in Congress, gets to push the levers on the economy too. So how it reaches its decisions really matters. This makes a recent Propublica story especially interesting. It asks why the Fed did not see the 2008 financial crisis coming – and why Fed staff who did spot some worrying signs, ultimately did nothing about them.
The story draws on two main sources: First, the “culture” exposed in 40 something hours of recordings of Fed meetings done covertly by a former Fed examiner Carmen Segarra, stationed inside Goldman Sachs.
The second main source is a report by Columbia finance professor David Beim who was commissioned by NY Fed President William Dudley right after the financial crisis to look at why the Fed didn't see it coming:
“In the end, his [Beim’s] 27-page report laid bare a culture ruled by groupthink, where managers used consensus decision-making and layers of vetting to water down findings. Examiners feared to speak up lest they make a mistake or contradict higher-ups. Excessive secrecy stymied action and empowered gatekeepers, who used their authority to protect the banks they supervised…
At the Fed, simply having a meeting was often seen as akin to action, she [Segarra] said in an interview. “It’s like the information is discussed, and then it just ends up in like a vacuum, floating on air, not acted upon.”
Beim said he found the same dynamic at work in the lead up to the financial crisis. Fed officials noticed the accumulating risk in the system. “There were lengthy presentations on subjects like that,” Beim said. “It’s just that none of those meetings ever ended with anyone saying, ‘And therefore let’s take the following steps right now.”
The Beim report makes very interesting reading. I was reminded of a quote by Tim Geithner, the former Treasury Secretary and former head of the New York Federal Reserve during the crisis, who said in his book "Stress Test" that when he walked into meetings at the Treasury he would ask "Is this a fake meeting or a real meeting?" Segarra, it's important to add, was fired by the Fed 7 months into her job. She had been hired to be assertive and help overcome the regulatory capture identified in the Beim report. She says her firing was precipitated by arguments over whether Goldman Sachs had a conflict of interest policy that complied with Fed requirements. She said it didn't. Interestingly Goldman Sachs published a new policy on the day the Propublica story was published.
The IMF did a similar naval gazing exercise as the Beim report right after the crisis and came to much the same conclusions about its own culture. I think it's a problem with large one-of-kind bureaucracies that are constantly in the limelight.
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