The Fed Just Acknowledged Its Too Big To Jail Policy

11/21/2014 06:11 pm ET | Updated Nov 22, 2014

WASHINGTON -- The federal government until recently shielded big banks from criminal prosecution out of concern that convictions may damage the financial system, a top Federal Reserve official said Friday, explicitly acknowledging a policy long denied by the Obama administration.

The admission came during a tense exchange between William Dudley, president of the Federal Reserve Bank of New York, and Sen. Sherrod Brown (D-Ohio) at a Senate Banking Committee hearing meant to explore the cozy relations between federal regulators and the banks they supervise.

Until May, large financial institutions investigated for wrongdoing had dodged criminal prosecution under the Obama administration, despite evidence from federal regulators and prosecutors showing that big banks had, for instance, laundered money for suspected terrorists and drug cartels; manipulated interest rate benchmarks; rigged various commodities markets; mislead investors in mortgage-linked securities; duped homeowners into taking out expensive mortgages; manipulated municipal debt markets; and broke state and federal rules when attempting to seize homes after borrowers fell behind on their payments, a scandal that became known as "robosigning."

Both Republican and Democratic lawmakers have long suspected that federal prosecutors didn’t pursue guilty pleas because they were afraid the consequences -- a potential unraveling of a giant bank -- would endanger the global economy. Attorney General Eric Holder suggested that was the case in March 2013, but quickly walked back his comments after a public outcry.

It wasn’t until May that years of persistent criticism eventually gave way to a guilty plea by Credit Suisse, the giant Swiss bank, to allegations it helped thousands of Americans hide their wealth to evade U.S. taxes.

But until Friday, no senior federal official had acknowledged this was explicit U.S. policy.

“We were not willing to find those firms guilty before, because we were worried that if we found them guilty, that could somehow potentially destabilize the financial system,” Dudley said. “We've gotten past that and I think it's really important that we got past that.”

Dudley’s admission was just one of several cringe-worthy exchanges during an hour-long appearance before a committee intent on holding him accountable for regulatory lapses.

Senate Democrats seized on recent news media and government reports that found widespread regulatory failures at the Federal Reserve, specifically at Dudley’s branch in New York. A recent report from the central bank's inspector general found that the Fed dropped the ball on JPMorgan's London Whale debacle, which lead to $6.2 billion in losses for the bank. Former New York Fed employee Carmen Segarra also released tapes showing higher-ups at the New York Fed ordering lower-level regulators to go easy on Goldman Sachs.

Sen. Elizabeth Warren (D-Mass.) tore into Dudley over a risky transaction between Goldman and a Spanish bank, Santander, which was designed to help Santander dodge European capital rules. Dudley claimed that he did not know whether he or anyone at the New York Fed had contacted European authorities to inform them of the deal's intent after waving it through.

WATCH Warren's exchanges with Dudley in the video above.

Sen. Jeff Merkley (D-Ore.) aggressively questioned Dudley's claim that the New York Fed had helped end too big to jail with the Credit Suisse case. No human beings are actually in jail for Credit Suisse's tax evasion scheme -- either the Americans who stashed cash in secret, illegal offshore accounts, or the Credit Suisse employees who executed the scheme. The criminal investigation into Credit Suisse, Merkley emphasized, was spurred by a report from Sen. Carl Levin (D-Mich.), not the Fed.

"You're the regulator," Merkley said. "Doesn't that mean you're asleep at the switch?"

Republicans made things hard on Dudley by not showing up. Only five senators attended the hearing, and one, Sen. Joe Manchin (D-W.Va.), asked no questions. The others -- Sens. Brown, Warren, Merkley and Jack Reed (D-R.I.) are bank reform hawks who have long been critical of the Fed's weak oversight.

Reed opened his questioning by taking issue with the way regional Fed presidents like Dudley are elected, noting that banks have a big say in who ultimately oversees them. Each regional fed board has three classes of directors -- one selected by banks, another headed by corporate leaders selected by banks, and a third that is supposed to represent other public interests. The corporate and public interest directors choose the Fed president. Since big banks like Goldman Sachs and JPMorgan Chase select the corporate directors in the New York region, they exercise a great deal of influence over the process. Dudley himself is a former Goldman Sachs banker.

And while Dudley insisted that he had changed the culture of the New York Fed for the better since succeeding Timothy Geithner, who left to serve as treasury secretary, he also pushed back against calls for more aggressive oversight of the banking system. He rejected Warren's suggestion that the Fed's bank regulators should function as "the cop on the beat" looking out for misconduct.

"There is an enforcement element to it, but I don't think our primary purpose as supervisors is really the cop on the beat," Dudley said. "Now that doesn't mean that if we see something, we should walk by and ignore it. I don't think that's the case at all."

"You don't think you should be doing any investigations?" replied an incredulous Warren. "You should wait to see if it jumps in front of you?"

"Because I think our primary focus on supervision is ensuring that the bank is safe and sound, that it's run well," Dudley said.

After 90 grueling minutes, the committee let Dudley go.

"Is there a cultural problem at the New York Fed?" Warren asked earlier in the hearing. "I think the evidence suggests that there is. ... Either you need to fix it, Mr. Dudley, or we need to get someone who will."

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