Yes, the US must go deeper and deeper into debt if it has to issue more and more $ as international reserve currency to the rest of the world that grows faster than itself, if for no other reason than because it is less advanced. This is clear for over 30 years already.
Yes, China – among other countries but on a different scale given it sheer size – has gamed the system in the 1990’s and 2000’s by joining the global trade system while undervaluing its currency relative to the $ and suppressing domestic consumption so as to accelerate its economic development at the expense of the US and of developed countries in general.
But if you are aiming to resolve the situation, it is critical to realize that China has done so under the intellectual authority of anglo-saxon theoricians and with the very interested complicity of Western multinational corporations and banks. US ideologues and big business interests have been China best allies in gaming the system.
You have reminded us that if China sells more goods to the US than it purchases from the US, it ends up with a credit on the US for the surplus. In other words, goods are exchanged not for other goods (via money as a medium) but for credit.
This is very directly in contradiction with the theory which has served and still serves today (you have of course used it in your article) as the justification for the push towards free trade globalisation since the 1970’s, namely David Ricardo’s theory of comparative advantage.
Ricardo’s theory of comparative advantage states that countries will mutually benefit if they exchange finished products for which they have a relative cost advantage, leading to a specialisation of said countries in the production of said finished products, leading to a rising standard of living in all participating countries. This conclusion is reached under the assumption that countries trade finished goods for finished goods, for instance Portugal sells wine to England in exchange for cloth. This goods for goods exchange means that, in Ricardo’s framework, trade balance remain balanced. Said differently, Ricardo’s theory is not supposed to be valid if a country exchange goods for IOUs issued by another country. Oops! In a monetary environment, the corresponding assumption would be that exchange rates are set at levels that, on average, makes the respective trade balance be at equilibrium. There is no doubt that this mutual benefit is the intention of the founding fathers of the GATT as it is explicitly and solemnly indicated in the preamble to the original 1947 agreement. However, to my knowledge, nowhere in the various GATT / WTO agreements that have been signed over recent decades to liberalise international trade is there any mention of the fact that exchange rates should be set at levels that make trade flows balanced across participating countries. The WTO has pushed free trade globalization without any consideration for exchange rates. As if international trade and exchange rates were two completely different things, while of course they are the two inseparable sides of the same coin. Re-oops!
Instead, Milton Friedman theory of floating exchange rates has been added to Ricardo’s theory of comparative advantages as the second intellectual backbone of the push towards trade globalisation in the post Bretton Woods world unilaterally decided by the US in 1971.
Milton Friedman’s theory states that market forces will ensure that exchange rates adjust at levels which, on average, make trade balances balance. This conclusion is reached under the assumption that there is no official intervention in FX markets. Of course, this assumption has never been valid in the real world. In practise, surplus countries recycle their accumulated monetary reserves back into the deficit countries, thereby bidding up the currency of the deficit country relative to their own, thus completely negating the adjustment envisaged by Friedman. Re-re-oops!
So, in the current system, trades flows result in large and persistent imbalances and goods are not being exchange for other goods but increasingly for credit. Like global trade has been growing faster than GDP from the early 1980’s, so has global debt. If this continues long enough, of course debtor countries will eventually reach a point where they are no longer solvent and creditor countries will eventually pay the price by holding worthless bonds. The mutually beneficial outcome initially envisaged by the theory will end up being mutually detrimental in practise. Bravo!
In the meantime, rising debt is a blessing for banks which see the cake on which they charge interest and / or trading commissions grow, further compounded by countless derivatives and repackaging opportunities on these securities. Exchange rate volatility is also a blessing for banks as it means much more commissions on FX trades and related derivatives than in a world of fixed but adjustable exchange rates like pre-1971. Financial profits as % of GDP have increased dramatically since the early 1980’s.
There is more still. Ricardo’s theory also assumes that there is no relative technological change between countries engaged in trade. But, in the current system, US firms can set up in China via FDI with their own equipment, technology and range of intermediary products. Said differently, US firms can import US relative advantage (ie. its modern production technology) to China and combine it with China relative advantage (ie. its cheap labor). At the end, the technological transfer means that the initial relative advantage between countries is altered. China ends up with both efficient production methods imported from the US – which means that its initially lower productivity can quickly catch up – and cheap labor. The overall balance of relative advantages is firmly tilted into China’s favor. Under this condition, it is no surprise that trade becomes unbalanced and that China becomes net exporter to the US. To my knowledge, nowhere in the GATT / WTO agreements is there any restrictions on cross-border investments that alter the initial conditions of production, ie. the comparative advantages in Ricardo’s sense, between participating countries. Re-re-re-oops!
Developed countries multinational firms and their shareholders are happy as the product of this arbitrage (labor costs / productivity x exchange rate) goes straight to their profits. Like global trade has been rising faster than global GDP since the early 1980’s, so has global profits. Symmetrically, global wages have grown more slowly than GDP. Here is the source of the weak aggregate demand. Here is the source of deflationary forces. As discussed in “Economic Consequences of Income Inequality”, soaring global debt has been the price to pay for global demand to keep up with global production despite global labor share of production falling materially.
So, we see that the intellectual foundation and justification for the current international trade and monetary system in place since the 1970’s are very weak and essentially non-existent. Certainly, things have not been working according to these David Ricardo and Milton Friedman theories. They have been contradicted by the facts, either because they are wrong or because they are only correct under certain assumptions that are not met in the real world. Remember, when the theories and the facts are not in accordance, it is always the facts that are correct.
Global trade has not been mutually beneficial. Under-employment (official unemployment + part time for economic reasons + dropping out of labor force for reasons unrelated to demographics + disability) has skyrocketed in developed countries, in parallel with debt. Floating exchange rates, while they have certainly been very volatile, have not pushed trade balances any closer to equilibrium, quite the opposite.
All of this is perfectly understood by all the managers of multinational companies that evaluate precisely all these factors when they decide to set up, acquire a local company or expand in developing countries and assess the “value creation” potential of such a move. Of course, in such a system, the value creation accruing to the shareholders of the multinational companies is compensated by the value destruction for developed countries via the mutualisation and socialisation of jobs losses, salary losses and bad debts losses. That’s why profit share of GDP and total-debt-to-GDP have been rising in tandem on a global basis since the early 1980’s. The system results in private profits being funded by socialized losses. Income and wealth inequality within countries have been soaring since the early 1980’s even as the average gap between countries has been narrowing. Not quite the definition of mutually beneficial.
While all of this is very well understood by managers of large companies (who are in it big time “gaming the system” with China) it remains poorly understood or at least not publicly recognized by many economists (yourself are part of a small minority) and virtually all policymakers that continue to use Ricardo’s comparative advantage and Friedman’s freely floating exchange rate theories as justification for a system that is dangerously unbalanced and leveraged and behaving in complete contradiction to the predicted results. Whether these ideologues and policymakers are completely blind to facts, or whether they are in the pocket of big business, or both, remains a matter of speculation for the time being.
Maurice Allais was already using the prestige of his 1988 Nobel Prize to explain in the early 1990’s what you are now explaining. He was not only ignored but ridiculed despite his explanations making complete sense and never being seriously challenged. In that case, the propagandists know what to do: attack the person if you can’t attack his ideas. By the time what he had long predicted finally occurred in 2008, he was 97 years old and was no longer intervening in the public debate. He became bitter and disillusioned and concluded that “it’s impossible to make the blind see and the deaf hear”. Now, it’ your turn to try. While 2008 might have shaken a few beliefs and might have raised the critical spirit of many ordinary people towards the official party line, you can’t underestimate the interests that you are taking on. You are asking big corporations and big banks to lower their share of profit. Of course, it is in their interest to have a gradual relative drop over time rather than a complete, sudden and absolute collapse as in the early 1930’s but don’t believe that they are so reasonable.
In any case, thank you for yet another stimulating article. Beyond the very clear explanation of the mechanisms at play, what is missing in my opinion is still the same: what is the solution? I mean other than letting the system go to the wall. There is, i think, a way to keep international trade open while preventing the development of debt-funded imbalances and while closing these labor arbitrage opportunities that are eroding aggregate demand and feeding the debt snowball. It seems logical to me that this is where your so far largely descriptive work leads to.
In any case, it is very clear from the on-going response to 2008-2009 that we shouldn’t count on G20 officials to change the system. They are the system. Developing countries officials are happy as they provide jobs for their people. Developed countries officials are happy as they provide profits to their corporate and financial benefactors (who cares if they effectively let down large parts of their population as long as they can plausibly deny it and issue empty words to the contrary?). The world continues to releverage at an even steeper pace than pre-2007 (thanks to China in no small measure), which is precisely the point of the “credit easing” policy applied everywhere. Speculative bubbles are bigger and more widespread than in 2000 ad 2007. Under-employment remains unbearably high many developed countries. Profit share continues to go up. Labor share continues to go down. Income and wealth inequalities are stretched beyond merit. Social tensions are rising. Currency wars are raging. One would be forgiven to think the G20 has been actively preparing the next crisis.
Any chance of resolving this peacefully now rest on people like you with a clear grasp of what’s going on, an understanding of the lessons of history, a passion and a talent for explaining it and the great ability to get an audience.
Inside the New York Fed: Secret Recordings and a Culture Clash
A confidential report and a fired examiner’s hidden recorder penetrate the cloistered world of Wall Street’s top regulator—and its history of deference to banks.
Carmen Segarra joined the New York Fed in late 2011 as part of a new wave of bank examiners. Seven months later, she was fired amid differences about her negative examination of Goldman Sachs. A supervisor told her, “I'm here to change the definition of what a good job is.” (Adam Lerner/AP for ProPublica)
Barely a year removed from the devastation of the 2008 financial crisis, the president of the Federal Reserve Bank of New York faced a crossroads. Congress had set its sights on reform. The biggest banks in the nation had shown that their failure could threaten the entire financial system. Lawmakers wanted new safeguards.
The Federal Reserve, and, by dint of its location off Wall Street, the New York Fed, was the logical choice to head the effort. Except it had failed miserably in catching the meltdown.
New York Fed President William Dudley had to answer two questions quickly: Why had his institution blown it, and how could it do better? So he called in an outsider, a Columbia University finance professor named David Beim, and granted him unlimited access to investigate. In exchange, the results would remain secret.
After interviews with dozens of New York Fed employees, Beim learned something that surprised even him. 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.
The report didn't only highlight problems. Beim provided a path forward. He urged the New York Fed to hire expert examiners who were unafraid to speak up and then encourage them to do so. It was essential, he said, to preventing the next crisis.
A year later, Congress gave the Federal Reserve even more oversight authority. And the New York Fed started hiring specialized examiners to station inside the too-big-to fail institutions, those that posed the most risk to the financial system.
One of the expert examiners it chose was Carmen Segarra.
Segarra appeared to be exactly what Beim ordered. Passionate and direct, schooled in the Ivy League and at the Sorbonne, she was a lawyer with more than 13 years of experience in compliance – the specialty of helping banks satisfy rules and regulations. The New York Fed placed her inside one of the biggest and, at the time, most controversial banks in the country, Goldman Sachs.
It did not go well. She was fired after only seven months.
As ProPublica reported last year, Segarra sued the New York Fed and her bosses, claiming she was retaliated against for refusing to back down from a negative finding about Goldman Sachs. A judge threw out the case this year without ruling on the merits, saying the facts didn't fit the statute under which she sued.
At the bottom of a document filed in the case, however, her lawyer disclosed a stunning fact: Segarra had made a series of audio recordings while at the New York Fed. Worried about what she was witnessing, Segarra wanted a record in case events were disputed. So she had purchased a tiny recorder at the Spy Store and began capturing what took place at Goldman and with her bosses.
Segarra ultimately recorded about 46 hours of meetings and conversations with her colleagues. Many of these events document key moments leading to her firing. But against the backdrop of the Beim report, they also offer an intimate study of the New York Fed's culture at a pivotal moment in its effort to become a more forceful financial supervisor. Fed deliberations, confidential by regulation, rarely become public.
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. They portray a New York Fed that is at times reluctant to push hard against Goldman and struggling to define its authority while integrating Segarra and a new corps of expert examiners into a reorganized supervisory scheme.
Segarra became a polarizing personality inside the New York Fed — and a problem for her bosses — in part because she was too outspoken and direct about the issues she saw at both Goldman and the Fed. Some colleagues found her abrasive and complained. Her unwillingness to conform set her on a collision course with higher-ups at the New York Fed and, ultimately, led to her undoing.
In a tense, 40-minute meeting recorded the week before she was fired, Segarra's boss repeatedly tries to persuade her to change her conclusion that Goldman was missing a policy to handle conflicts of interest. Segarra offered to review her evidence with higher-ups and told her boss she would accept being overruled once her findings were submitted. It wasn't enough.
"Why do you have to say there's no policy?" her boss said near the end of the grueling session.
"Professionally," Segarra responded, "I cannot agree."
The New York Fed disputes Segarra's claim that she was fired in retaliation.
"The decision to terminate Ms. Segarra's employment with the New York Fed was based entirely on performance grounds, not because she raised concerns as a member of any examination team about any institution," it said in a two-page statement responding to an extensive list of questions from ProPublica and This American Life.
The statement also defends the bank's record as regulator, saying it has taken steps to incorporate Beim's recommendations and "provides multiple venues and layers of recourse to help ensure that its employees freely express their views and concerns."
"The New York Fed," the statement says, "categorically rejects the allegations being made about the integrity of its supervision of financial institutions."
****
In the spring of 2009, New York Fed President William Dudley put together a team of eight senior staffers to help Beim in his inquiry. In many ways, this was familiar territory for Beim.
He had worked on Wall Street as a banker in the 1980s at Bankers Trust Company, assisting the firm through its transition from a retail to an investment bank. In 1997, the New York Fed hired Beim to study how it might improve its examination process. Beim recommended the Fed spend more time understanding the businesses it supervised. He also suggested a system of continuous monitoring rather than a single year-end examination.
Beim says his team in 2009 pursued a no-holds-barred investigation of the New York Fed. They were emboldened because the report was to remain an internal document, so there was no reason to hold back for fear of exposure. The words "Confidential Treatment Requested" ran across the bottom of the report.
"Nothing was off limits," says Beim. "I was told I could ask anyone any question. There were no restrictions."
In the end, his 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.
"Our review of lessons learned from the crisis reveals a culture that is too risk-averse to respond quickly and flexibly to new challenges," the report stated. "A number of people believe that supervisors paid excessive deference to banks, and as a result they were less aggressive in finding issues or in following up on them in a forceful way."
One New York Fed employee, a supervisor, described his experience in terms of "regulatory capture," the phrase commonly used to describe a situation where banks co-opt regulators. Beim included the remark in a footnote. "Within three weeks on the job, I saw the capture set in," the manager stated.
Confronted with the quotation, senior officers at the Fed asked the professor to remove it from the report, according to Beim. "They didn't give an argument," Beim said in an interview. "They were embarrassed." He refused to change it.
The Beim report made the case that the New York Fed needed a specific kind of culture to transform itself into an institution able to monitor complex financial firms and catch the kinds of risks that were capable of torpedoing the global economy.
That meant hiring "out-of-the-box thinkers," even at the risk of getting "disruptive personalities," the report said. It called for expert examiners who would be contrarian, ask difficult questions and challenge the prevailing orthodoxy. Managers should add categories like "willingness to speak up" and "willingness to contradict me" to annual employee evaluations. And senior Fed managers had to take the lead.
"The top has to articulate why we're going through this change, what the benefits are going to be and why it's so important that we're going to monitor everyone and make sure they stay on board," Beim said in an interview.
Beim handed the report to Dudley. The professor kept it in draft form to help maintain secrecy and because he thought the Fed president might request changes. Instead, Dudley thanked him and that was it. Beim never heard from him again about the matter, he said.
In 2011, the Financial Crisis Inquiry Commission, created by Congress to investigate the causes behind the economic calamity, publicly released hundreds of documents. Buried among them was Beim's report.
Because of the report's candor, the release surprised Beim and New York Fed officials. Yet virtually no one else noticed.
*****
Among the New York Fed employees enlisted to help Beim in his investigation was Michael Silva.
As a Fed veteran, Silva was a logical choice. A lawyer and graduate of the United States Naval Academy, he joined the bank as a law clerk in 1992. Silva had also assisted disabled veterans and had gone into Iraq after the 2003 invasion to help the country's central bank. Prior to working on Beim's report, he had been chief of staff to the previous New York Fed president, Timothy Geithner.
In declining through his lawyer to comment for this story, Silva cited the appeal of Segarra's lawsuit and a prohibition on disclosing unpublished supervisory material. The rule allows regulators to monitor banks without having to worry about the release of information that could alarm customers and create a run on a bank that's under scrutiny.
Silva had been in the room with Geithner in September 2008 during a seminal moment of the financial crisis. Shares in a large money market fund – the Reserve Primary Fund – had fallen below the standard price of $1, "breaking the buck" and threatening to touch off a run by investors. The investment firm Lehman Brothers had entered bankruptcy, and the financial system appeared in danger of collapse.
In Segarra's recordings, Silva tells his team how, at least initially, no one in the war room at the New York Fed knew how to respond. He went into the bathroom, sick to his stomach, and vomited.
"I never want to get close to that moment again, but maybe I'm too close to that moment," Silva told his New York Fed team at Goldman Sachs in a meeting one day.
Despite his years at the New York Fed, Silva was new to the institution's supervisory side. He had never been an examiner or participated as part of a team inside a regulated bank until being appointed to lead the team at Goldman Sachs. Silva prefaced his financial crisis anecdote by saying the team needed to understand his motivations, "so you can perhaps push back on these things."
In the recordings, Silva then offered a second anecdote. This one involved the moments before the Lehman bankruptcy.
Silva related how the top bankers in the nation were asked to contribute money to save Lehman. He described his disappointment when Goldman executives initially balked. Silva acknowledged that it might have been a hard sell to shareholders, but added that "if Goldman had stepped up with a big number, that would have encouraged the others."
"It was extraordinarily disappointing to me that they weren't thinking as Americans," Silva says in the recording. "Those two things are very powerful experiences that, I will admit, influence my thinking."
*****
Silva's stories help explain his approach to a controversial deal that came to the New York Fed team's attention in January 2012, two months after Segarra arrived. She said the Fed's handling of the deal demonstrated its timidity whenever questions arose about Goldman's actions. Debate about the deal runs through many of Segarra's recordings.
On Friday, Jan. 6, 2012, at 3:54 p.m., a senior Goldman official sent an email to the on-site Fed regulators – including Silva, Segarra and Segarra's legal and compliance manager, Johnathon Kim. Goldman wanted to notify them about a fast-moving transaction with a large Spanish bank, Banco Santander. Spanish regulators had signed off on the deal, but Goldman was reaching out to its own regulators to see whether they had any questions.
At the time, European banks were shaky, particularly the Spanish ones. To shore up confidence, the European Banking Authority was demanding that banks hold more capital to offset potential future losses. Meeting these capital requirements was at the heart of the Goldman-Santander transaction.
Under the deal, Santander transferred some of the shares it held in its Brazilian subsidiary to Goldman. This effectively reduced the amount of capital Santander needed. In exchange for a fee from Santander, Goldman would hold on to the shares for a few years and then return them. The deal would help Santander announce that it had reached its proper capital ratio six months ahead of the deadline.
In the recordings, one New York Fed employee compared it to Goldman "getting paid to watch a briefcase." Silva states that the fee was $40 million and that potentially hundreds of millions more could be made from trading on the large number of shares Goldman would hold.
Santander and Goldman declined to respond to detailed questions about the deal.
Silva did not like the transaction. He acknowledged it appeared to be "perfectly legal" but thought it was bad to help Santander appear healthier than it might actually be.
"It's pretty apparent when you think this thing through that it's basically window dressing that's designed to help Banco Santander artificially enhance its capital position," he told his team before a big meeting on the topic with Goldman executives.
The deal closed the Sunday after the Friday email. The following week, Silva spoke with top Goldman people about it and told his team he had asked why the bank "should" do the deal. As Silva described it, there was a divide between the Fed's view of the deal and Goldman's.
"[Goldman executives] responded with a bunch of explanations that all relate to, 'We can do this,' " Silva told his team.
Privately, Segarra saw little sense in Silva's preoccupation with the question of whether "should" applied to the Santander deal. In an interview, she said it seemed to her that Silva and the other examiners who worked under him tended to focus on abstract issues that were "fuzzy" and "esoteric" like "should" and "repetitional risk."
Segarra believed that Goldman had more pressing compliance issues – such as whether executives had checked the backgrounds of the parties to the deal in the way required by anti-money laundering regulations.
*****
Segarra had joined the New York Fed on Oct. 31, 2011, as it was gearing up for its new era overseeing the biggest and riskiest banks. She was part of a reorganization meant to put more expert examiners to the task.
In the past, examiners known as "relationship managers" had been stationed inside the banks. When they needed an in-depth review in a particular area, they would often call a risk specialist from that area to come do the examination for them.
In the new system, relationship managers would be redubbed "business-line specialists." They would spend more time trying to understand how the banks made money. The business-line specialists would report to the senior New York Fed person stationed inside the bank.
The risk specialists like Segarra would no longer be called in from outside. They, too, would be embedded inside the banks, with an open mandate to do continuous examinations in their particular area of expertise, everything from credit risk to Segarra's specialty of legal and compliance. They would have their own risk-specialist bosses but would also be expected to answer to the person in charge at the bank, the same manager of the business-line specialists.
In Goldman's case, that was Silva.
Shortly after the Santander transaction closed, Segarra notified her own risk-specialist bosses that Silva was concerned. They told her to look into the deal. She met with Silva to tell him the news, but he had some of his own. The general counsel of the New York Fed had "reined me in," he told Segarra. Silva did not refer by name to Tom Baxter, the New York Fed's general counsel, but said: "I was all fired up, and he doesn't want me getting the Fed to assert powers it doesn't have."
This conversation occurred the day before the New York Fed team met with Goldman officials to learn about the inner workings of the deal.
From the recordings, it's not spelled out exactly what troubled the general counsel. But they make clear that higher-ups felt they had no authority to nix the Santander deal simply because Fed officials didn't think Goldman "should" do it.
Segarra told Silva she understood but felt that if they looked, they'd likely find holes. Silva repeated himself. "Well, yes, but it is actually also the case that the general counsel reined me in a bit on that," he reminded Segarra.
The following day, the New York Fed team gathered before their meeting with Goldman. Silva outlined his concerns without mentioning the general counsel's admonishment. He said he thought the deal was "legal but shady."
"I'd like these guys to come away from this meeting confused as to what we think about it," he told the team. "I want to keep them nervous."
As requested, Segarra had dug further into the transaction and found something unusual: a clause that seemed to require Goldman to alert the New York Fed about the terms and receive a "no objection."
This appeared to pique Silva's interest. "The one thing I know as a lawyer that they never got from me was a no objection," he said at the pre-meeting. He rallied his team to look into all aspects of the deal. If they would "poke with our usual poker faces," Silva said, maybe they would "find something even shadier."
But what loomed as a showdown ended up fizzling. In the meeting with Goldman, an executive said the "no objection" clause was for the firm's benefit and not meant to obligate Goldman to get approval. Rather than press the point, regulators moved on.
Afterward, the New York Fed staffers huddled again on their floor at the bank. The fact-finding process had only just started. In the meeting, Goldman had promised to get back to the regulators with more information to answer some of their questions. Still, one of the Fed lawyers present at the post-meeting lauded Goldman's "thoroughness."
Another examiner said he worried that the team was pushing Goldman too hard.
"I think we don't want to discourage Goldman from disclosing these types of things in the future," he said. Instead, he suggested telling the bank, "Don't mistake our inquisitiveness, and our desire to understand more about the marketplace in general, as a criticism of you as a firm necessarily."
*****
To Segarra, the "inquisitiveness" comment represented a fear of upsetting Goldman.
By law, the banks are required to provide information if the New York Fed asks for it. Moreover, Goldman itself had brought the Santander deal to the regulators' attention.
Beim's report identified deference as a serious problem. In an interview, he explained that some of this behavior could be chalked up to a natural tendency to want to maintain good relations with people you see every day. The danger, Beim noted, is that it can morph into regulatory capture. To prevent it, the New York Fed typically tries to move examiners every few years.
Over the ensuing months, the Fed team at Goldman debated how to demonstrate their displeasure with Goldman over the Santander deal. The option with the most interest was to send a letter saying the Fed had concerns, but without forcing Goldman to do anything about them.
The only downside, said one Fed official on a recording in late January 2012, was that Goldman would just ignore them.
"We're not obligating them to do anything necessarily, but it could very effectively get a reaction and change some behavior for future transactions," one team member said.
In the same recorded meeting, Segarra pointed out that Goldman might not have done the anti-money laundering checks that Fed guidance outlines for deals like these. If so, the team might be able to do more than just send a letter, she said. The group ignored her.
It's not clear from the recordings if the letter was ever sent.
Silva took an optimistic view in the meeting. The Fed's interest got the bank's attention, he said, and senior Goldman executives had apologized to him for the way the Fed had learned about the deal. "I guarantee they'll think twice about the next one, because by putting them through their paces, and having that large Fed crowd come in, you know we, I fussed at 'em pretty good," he said. "They were very, very nervous."
Segarra had worked previously at Citigroup, MBNA and Société Générale. She was accustomed to meetings that ended with specific action items.
At the Fed, simply having a meeting was often seen as akin to action, she 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 New York Fed's post-crisis reorganization didn't resolve longstanding tensions between its examiner corps. In fact, by empowering risk specialists, it may have exacerbated them.
Beim had highlighted conflicts between the two examiner groups in his report. "Risk teams ... often feel that the Relationship teams become gatekeepers at their banks, seeking to control access to their institutions," he wrote. Other examiners complained in the report that relationship managers "were too deferential to bank management."
In the new order, risk specialists were now responsible for their own examinations. No longer would the business-line specialists control the process. What Segarra discovered, however, was that the roles had not been clearly defined, allowing the tensions Beim had detailed to fester.
Segarra said she began to experience pushback from the business-line specialists within a month of starting her job. Some of these incidents are detailed in her lawsuit, recorded in notes she took at the time and corroborated by another examiner who was present.
Business-line specialists questioned her meeting minutes; one challenged whether she had accurately heard comments by a Goldman executive at a meeting. It created problems, Segarra said, when she drew on her experiences at other banks to contradict rosy assessments the business-line specialists had of Goldman's compliance programs. In the recordings, she is forceful in expressing her opinions.
ProPublica and This American Life reached out to four of the business-line specialists who were on the Goldman team while Segarra was there to try and get their side of the story. Only one responded, and that person declined a request for comment. In the recordings, it's clear from her interactions with managers that Segarra found the situation upsetting, and she did not hide her displeasure. She repeatedly complains about the business-line specialists to Kim, her legal and compliance manager, and other supervisors.
"It's like even when I try to explain to them what my evidence is, they won't even listen," she told Kim in a recording from Jan. 6, 2012. "I think that management needs to do a better job of managing those people."
Kim let her know in the meeting that he did not expect such help from the Fed's top management. "I just want to manage your expectations for our purposes," he told Segarra. "Let's pretend that it's not going to happen."
Instead, Kim advised Segarra "to be patient" and "bite her tongue." The New York Fed was trying to change, he counseled, but it was "this giant Titanic, slow to move."
Three days later, Segarra met with her fellow legal and compliance risk specialists stationed at the other banks. In the recording, the meeting turns into a gripe session about the business-line specialists. Other risk specialists were jockeying over control of examinations, too, it turned out.
"It has been a struggle for me as to who really has the final say about recommendations," said one.
"If we can't feel that we'll have management support or that our expertise per se is not valued, it causes a low morale to us," said another.
*****
On Feb. 21, 2012, Segarra met with her manager, Kim, for their weekly meeting. After covering some process issues with her examinations, the recordings show, they again discussed the tensions between the two camps of specialists.
Kim shifted some of the blame for those tensions onto Segarra, and specifically onto her personality: "There are opinions that are coming in," he began.
First he complimented her: "I think you do a good job of looking at issues and identifying what the gaps are and you know determining what you want to do as the next steps. And I think you do a lot of hard work, so I'm thankful," Kim said. But there had been complaints.
She was too "transactional," Kim said, and needed to be more "relational."
"I'm never questioning about the knowledge base or assessments or those things; it's really about how you are perceived," Kim said. People thought she had "sharper elbows, or you're sort of breaking eggs. And obviously I don't know what the right word is."
Segarra asked for specifics. Kim demurred, describing it as "general feedback."
In the conversation that followed, Kim offered Segarra pointed advice about behaviors that would make her a better examiner at the New York Fed. But his suggestions, delivered in a well-meaning tone, tracked with the very cultural handicaps that Beim said needed to change.
Kim: "I would ask you to think about a little bit more, in terms of, first of all, the choice of words and not being so conclusory."
Beim report: "Because so many seem to fear contradicting their bosses, senior managers must now repeatedly tell subordinates they have a duty to speak up even if that contradicts their bosses."
Kim: "You use the word 'definitely' a lot, too. If you use that, then you want to have a consensus view of definitely, not only your own."
Beim report: "An allied issue is that building consensus can result in a whittling down of issues or a smoothing of exam findings. Compromise often results in less forceful language and demands on the banks involved."
In Segarra's recordings, there is some evidence to back Kim's critique. Sometimes she cuts people off, including her bosses. And she could be brusque or blunt.
A colleague who worked with Segarra at the New York Fed, who does not have permission from their employer to be identified, told ProPublica that Segarra often asked direct questions. Sometimes they were embarrassingly direct, this former examiner said, but they were all questions that needed to be asked. This person characterized Segarra's behavior at the New York Fed as "a breath of fresh air."
ProPublica also reached out to three people who worked with Segarra at two other firms. All three praised her attitude at work and said she never acted unprofessionally.
In the meeting with Kim, Segarra observed that the skills that made her successful in the private sector did not seem to be the ones that necessarily worked at the New York Fed.
Kim said that she needed to make changes quickly in order to succeed.
"You mean, not fired?" Segarra said.
"I don't want to even get there," Kim responded.
It would be unfair to fire her, Segarra offered, since she was doing a good job.
"I'm here to change the definition of what a good job is," Kim said. "There are two parts it: Actually producing the results, which I think you're very capable of producing the results. But also be mindful of enfolding people and defusing situations, making sure that people feel like they're heard and respected."
Segarra had thought her job was simple: Follow the evidence wherever it led. Now she was being told she had to "enfold" business-line specialists and "defuse" their objections.
"What does this have to do with bank examinations," Segarra wondered to herself, "or Goldman Sachs?"
*****
Segarra worked on her examination of Goldman's conflict-of-interest policies for nearly seven months. Her mandate was to determine whether Goldman had a comprehensive, firm-wide conflicts-of-interest policy as of Nov. 1, 2011.
Segarra has records showing that there were at least 15 meetings on the topic. Silva or Kim attended the majority. At an impromptu gathering of regulators after one such meeting early that December, her contemporaneous notes indicate Silva was distressed by how Goldman was dealing with conflicts of interest.
By the spring of 2012, Segarra believed her bosses agreed with her conclusion that Goldman did not have a policy sufficient to meet Fed guidance.
During her examination, she regularly talked about her findings with fellow legal and compliance risk specialists from other banks. In April, they all came together for a vetting session to report conclusions about their respective institutions. After a brief presentation by Segarra, the team agreed that Goldman's conflict-of-interest policies didn't measure up, according to Segarra and one other examiner who was present.
In May, members of the New York Fed team at Goldman met to discuss plans for their annual assessment of the bank. Segarra was sick and not present. Silva recounts in an email that he was considering informing Goldman that it did not have a policy when a business-line specialist interjected and said Goldman did have a conflict-of-interest policy – right on the bank's website.
In a follow-up email to Segarra, Silva wrote: "In light of your repeated and adamant assertions that Goldman has no written conflicts of interest policy, you can understand why I was surprised to find a "Conflicts of Interests Section" in Goldman's Code of Conduct that seemed to me to define, prohibit and instruct employees what to do about it."
But in Segarra's view, the code fell far short of the Fed's official guidance, which calls for a policy that encompasses the entire bank and provides a framework for "assessing, controlling, measuring, monitoring and reporting" conflicts.
ProPublica sent a copy of Goldman's Code of Conduct to two legal and compliance experts familiar with the Fed's guidance on the topic. Both did not want be quoted by name, either because they were not authorized by their employer or because they did not want to publicly criticize Goldman Sachs. Both have experience as bank examiners in the area of legal and compliance. Each said Goldman's Code of Conduct would not qualify as a firm-wide conflicts of interest policy as set out by the Fed's guidance.
In the recordings, Segarra asks Gwen Libstag, the executive at Goldman who is responsible for managing conflicts, whether the bank has "a definition of a conflict of interest, what that is and what that means?"
"No," Libstag replied at the meeting in April.
Back in December, according to meeting minutes, a Goldman executive told Segarra and other regulators that Goldman did not have a single policy: "It's probably more than one document – there is no one policy per se."
Early in her examination, Segarra had asked for all the conflict-of-interest policies for each of Goldman's divisions as of Nov. 1, 2011. It took months and two requests, Segarra said, to get the documents. They arrived in March. According to the documents, two of the divisions state that the first policy dates to December 2011. The documents also indicate that policies for another division were incomplete.
ProPublica and This American Life sent Goldman Sachs detailed questions about the bank's conflict-of-interest policies, Segarra and events in the meetings she recorded.
In a three-paragraph response, the bank said, "Goldman Sachs has long had a comprehensive approach for addressing potential conflicts." It also cited Silva's email about the Code of Conduct in the statement, saying: "To get a balanced view of her claims, you should read what her supervisor wrote after discovering that what she had said about Goldman was just plain wrong."
Goldman's statement also said Segarra had unsuccessfully interviewed for jobs at Goldman three times. Segarra said that she recalls interviewing with the bank four times, but that it shouldn't be surprising. She has applied for jobs at most of the top banks on Wall Street multiple times over the course of her career, she said.
*****
The audio is muddy but the words are distinct. So is the tension. Segarra is in Silva's small office at Goldman Sachs with his deputy. The two are trying to persuade her to change her view about Goldman's conflicts policy.
"You have to come off the view that Goldman doesn't have any kind of conflict-of- interest policy," are the first words Silva says to her. Fed officials didn't believe her conclusion — that Goldman lacked a policy — was "credible."
Segarra tells him she has been writing bank compliance policies for a living since she graduated from law school in 1998. She has asked Goldman for the bank's policies, and what they provided did not comply with Fed guidance.
"I'm going to lose this entire case," Silva says, "because of your fixation on whether they do or don't have a policy. Why can't we just say they have basic pieces of a policy but they have to dramatically improve it?"
It's not like Goldman doesn't know what an adequate policy contains, she says. They have proper policies in other areas.
"But can't we say they have a policy?" Silva says, a question he asks repeatedly in various forms during the meeting.
Segarra offers to meet with anyone to go over the evidence collected from dozens of meetings and hundreds of documents. She says it's OK if higher-ups want to change her conclusions after she submits them.
But Silva says the lawyers at the Fed have determined Goldman has a policy. As a comparison, he brings up the Santander deal. He had thought the deal was improper, but the general counsel reined him.
"I lost the Santander transaction in large part because I insisted that it was fraudulent, which they insisted is patently absurd," Silva said, "and as a result of that, I didn't get taken seriously."
Now, the same thing was happening with conflicts, he said.
A week later, Silva called Segarra into a conference room and fired her. The New York Fed, he told Segarra, who was recording the conversation, had "lost confidence in [her] ability to not substitute [her] own judgment for everyone else's."
