Not only did they go native, they were hand picked by the same bank CEO’s that sit on the Federal Reserve board of directors. This is great article of how that works from Prof William K. Black, associate professor of economics and law at the University of Missouri-Kansas City, who explains some more of the reasons the TBTF banks need to be broken into smaller pieces.
Embedded Examiners always married the Natives, but now their Bosses Do Hook Ups
Jessica Silver-Greenberg and Ben Protess have written an extraordinarily important column for the New York Times about embedded examiners at JPMorgan.
Embedded examiners’ are federal regulators whose normal work station is a desk at the bank. We only embed examiners for systemically dangerous institutions (SDIs) – banks so large that they pose a systemic risk to global economy.
Embedded examiners do not work. They get too close to the bank officers and employees. In the regulatory ranks we called this “marrying the natives.” Nothing works with SDIs – they are too big to manage, too big to fail, and too big to regulate. A conventional bank examination, scaled up to size to fit an SDI the size of JPMorgan would have 500 examiners and take 18 months to “complete.” (Obviously, when it takes that long to complete an examination it is impossible to “complete” an examination in any meaningful sense – by the time you’ve spent 18 months examining an SDI it can be a radically different bank.) One cannot conduct an effective conventional bank examination of even a medium-sized bank on a “real time” basis because of the amount of new information pouring in every minute. Conventional examinations examine a bank’s records and operations “as of” some date (typically the last quarter-end for which reports have been filed). Embedding examiners is an effort at achieving an “early warning” system. It has one virtue – it indicates that some senior regulator(s) recognized that they cannot rely on the bank’s own reports to determine whether it is steering toward trouble.
In fairness, twenty-five years ago the proponents of embedding recognize the severity of the “marrying the natives” problem. They simply viewed embedding as the least bad manner of attempting the impossible – effectively regulating SDIs. Here is the key passage of the NYT column.
Roughly 40 examiners from the Federal Reserve Bank of New York and 70 staff members from the Office of the Comptroller of the Currency are embedded in the nation’s largest bank. They are typically assigned to the departments undertaking the greatest risks, like the structured products trading desk. Even as the chief investment office swelled in size and made increasingly large bets, regulators did not put any examiners in the unit’s offices in London or New York, according to current and former regulators who spoke only on condition of anonymity.
Senior JPMorgan executives assured the bank’s watchdogs after the financial crisis that the chief investment office, with hundreds of billions in investments, was not taking risks that would be a cause for concern, people briefed on the matter said. Just weeks before the trading losses became public, bank officials also dismissed the worry of a senior New York Fed examiner about the mounting size of the bets, according to current Fed officials.
The authors of the article frame the issue as whether Jamie Dimon’s role as Director of the Federal Reserve Bank of New York poses a conflict of interest and could have led to the regulatory failure to place any examiners in the chief investment office (CIO). The CIO appears to be the largest de facto hedge fund in the world. (Note: “hedge fund” is a deliberately misleading term. Entities called hedge funds typically speculate rather than hedge. When I call the CIO a “hedge fund” I mean that it largely speculates and disingenuously calls its bets “hedges.”) [..]
SDIs are not simply dangerous, they are also inefficient. Shrinking the SDIs to the point where they no longer posed a systemic risk would also increase their efficiency, make them small enough to regulate, and help recover our democracy.
SDIs that function as banks pose intolerable risks to the global economy. SDIs that function as (thinly disguised) hedge funds should be far beyond the pale. Conservative and libertarian philosophy rightly condemn providing enormous federal subsidies to a private entity whose senior officers claim any wins and socialize any severe losses.
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