Perspective on Risk - June 15, 2024 (Bank Supervision)
Has the NY Fed lost its swag?; Fintech C&D; FDIC
Sorry for the spam, but I’m trying to keep some stuff like this reasonably timely. Just a short bit.
Has the NY Fed lost its swag?
Everyone who eventually leaves the NY Fed thinks it was a fabulous institution, whose glory days were when they were there, and how now everything has deteriorated and gone to shit.
New York Fed Is Losing Talent and ‘Street Cred’ Under John Williams (Bloomberg)
Top Federal Reserve district bank has seen many senior-level departures, raising concerns about its diminished heft and “swagger”
This piece is mostly about the NY Fed’s Markets Group. The Markets Group is one key activity that differentiates the NY Fed from the other Reserve Banks. Other factors are running Fedwire, maintaining accounts for foreign central banks (including holding much of their gold), and, to a lesser extent than in the past, supervising the largest and most sophisticated financial institutions.
Diminished “heft and swagger” is exactly what the powers-that-be in Washington DC have sought since the 2007 financial crisis. I have said before that there is a three-way power struggle constantly in play in the Fed system: the DC-based “Board Staff,” the NY Fed, and the 11 other Reserve Banks as a block. Generally, the Reserve Banks are the swing as they align against whichever of DC or NY is acting to big for their britches.
It is also the case that, following the GFC, the DC folks sought to blame NY for all that was wrong (ignoring what was right) about the crisis. Blaming NY was the convenient way from having Congress come down too hard on them.
The departure of many officials since 2022 from senior roles at the bank who each had more than a decade of experience has sparked concerns over an exodus of talent since Williams took over. That’s in turn shined a brighter light on his own resume, which some ex-central bank officials and Wall Street professionals lament lacks the market experience of his predecessors.
This article is based on interviews with more than a dozen former New York Fed officials, along with longtime strategists, economists and traders at major banks and investment firms.
This is a pretty direct shot on William’s “gravitas” in the financial markets. In my time, Corrigan had it, McDonough had it, Geithner certainly earned it, and Dudley had it to a degree.
The New York Fed chief is known for his academic chops — including the co-authoring of a widely cited model of the natural rate of interest. That may be a strength in debates over economic variables and policy frameworks, but critics say it’s less well suited to a role in charge of the arm of the US central bank responsible for the mechanics of conducting policy, and being its eyes and ears on Wall Street.
Williams, like Dudley, is an economist by training. While Corrigan was technically an economist, he was much more of a market practitioner and “plumber.” Dudley came from Goldman and at least ran the Markets Group for a period.
New York Fed watchers also note that the Dallas Fed president since mid-2022 and the incoming Cleveland Fed president each have deeper backgrounds in finance, adding to a perception that New York is no longer the dominant voice on markets.
One New York-based market participant now conducts regular catch-ups with the Dallas Fed ahead of FOMC blackout periods … In terms of market intelligence gathering, discussions are much more extensive with the Dallas Fed than with New York Fed staff, the person said.
Clearly a legacy Lorrie Logan effect.
“We have an extremely deep talent pool in markets, where we are in constant conversations with market participants and doing that analysis,” Williams said
I suspect that for all of the handwringing, this is still true.
Fed Cease-and-Desist Against Evolve Bancorp
Background
This is certainly an interesting case for quite a few reasons. Evolve is a relatively small bank that in 2010 decided to become a Fed supervised bank. At this time, Evolve began to offer a range of innovative financial services marketed as Banking-as-a-Service (BaaS) and Open Banking solutions, which enable other financial and non-financial companies to offer banking services to their customers.
Evolve Bank & Trust was linked to the FTX scandal due to their indirect relationship with the now-bankrupt cryptocurrency exchange. FTX's implosion brought scrutiny to many of its partners. Evolve had a sponsorship and issuing relationship with Deserve, a company that partnered with BlockFi, which was in turn associated with FTX.
Evolve also made headlines for freezing millions of dollars linked to crypto scams and fraudulent activities. This included funds tied to money laundering schemes facilitated by companies using Evolve’s banking services.
More specifically, there are two distinct fintech/crypto issues.
Feds Freeze $5m At Evolve in “Pig Butchering” Crypto Fraud, Money Laundering Case (Fintech Business Weekly)
Per newly discovered court documents obtained exclusively by Fintech Business Weekly, a US Secret Service investigation linked Evolve and its fintech clients, including Wise, Airwallex, Solid, Mercury & Relay, to a "large fraud conspiracy ring."
The funds, held in the name of Bytechip LLC d/b/a Qbit and Gatcha Pictures LLC, the beneficial owners of which are both Chinese nationals, are the proceeds of various frauds, including crypto “pig butchering” scams, the US government’s filing says.
Per Wikipedia:
A pig butchering scam is a type of long-term scam and investment fraud in which the victim is gradually lured into making increasing contributions, usually in the form of cryptocurrency, to a fraudulent cryptocurrency scheme.
Evolve also had a relationship with Synapse Financial. This partnership involved Evolve providing sponsor bank services to Synapse’s fintech customers, facilitating various banking services including deposit accounts and payment processing.
In the summer of 2022 when Evolve announced its intention to end its sponsorship of Synapse. Evolve withheld a $17 million payment to Synapse to cover what it described as a $14 million discrepancy in one of the For Benefit Of (FBO) accounts managed by Synapse. The disputes had a substantial impact on Synapse’s fintech customers. Evolve’s move to withhold funds and Synapse’s inability to reconcile accounts caused significant customer dissatisfaction and financial instability for account holders. Synapse subsequently filed for bankruptcy.
Enforcement Action
My first reaction is that this is an extremely comprehensive order. While many elements of the enforcement action are standard in terms of addressing risk management, BSA/AML compliance, and board oversight, the emphasis on fintech partnerships and the comprehensive nature of the required remedial actions make this order particularly robust.
The order includes very detailed and granular requirements, such as the need for a comprehensive risk assessment, enhanced training programs, and specific customer due diligence procedures. These seem more detailed than what one would usually see.
In particular, the Fed is requiring the bank to obtain an external validation of its Transaction Monitoring System.
The Transaction Monitoring System Validation shall include the following three items:
(a) evaluation of the appropriateness of filtering criteria and thresholds used in the Bank’s transaction monitoring system;
(b) testing of the Bank’s transaction monitoring system to ensure that intended information is accurately captured; and
(c) assessment of controls to ensure that the Bank’s transaction monitoring system and associated processes are subject to periodic reviews and timely updates.
This is an order that the Fed wants other market participants to read and follow. It is outlining the Fed’s expectations for banking firms that have fintech businesses and clients.
There are also some language on Cash Flow and Capital Conservation that are pretty uncommon in these orders, and are quite restrictive.
More On The FDIC Culture
As expected, the Biden administration is expected to nominate a woman to head up the FDIC. Given the nature of the findings, this symbolic move is more than warranted. The nominee, Christy Goldsmith Romero, certainly seems qualified, although my preferred choice was still Sarah Dahlgren (!). DOJ, SEC, SIGTARP, CFTC. No direct banking experience, which is a shame.
Prior to the nomination, the House Financial Services Committee held a hearing; I read Hsu’s prepared remarks and was a bit underwhelmed.
Currently, the agency is taking action on all three fronts, following through on recommendations in the Report. More specifically, the FDIC is in the process of:
Replacing the broken internal process for fielding and responding to reports of harassment with a new structure that will bypass management hierarchies and utilize third party investigators, hold wrongdoers accountable, and report directly to the Board in order to credibly mitigate the risk of retaliation.
Hiring a third-party expert to bring an independent, outside perspective on what’s needed to ensure cultural and structural transformation, including augmenting the agency’s Action Plan as necessary,
Hiring an independent transformation monitor to hold the agency accountable for following through on its commitments and taking the necessary actions in a timely manner.
I guess it’s something, but not what is needed to fix a broken culture.
Brian,
Thanks so much. Awesome analysis, as per usual.
Curious what you would add to address FDIC people issues. I will share some thoughts separately.
Related, did you notice JPMC added an employee oversight role of sorts? I have not seen details but think independent oversight of how employees are managed would be welcome. Another ex fed colleague mentioned the now defunct GE capital had leading practices on managing employee base, which intrigued me.