The Federal Reserve's independence is dangerous, undemocratic, and a boon to Wall Street

A few months ago, a former employee at the secretive Federal Reserve Bank of New York named Carmen Segarra came forward and blew a big fat whistle. She alleged that she had witnessed regulators, and specifically her boss Mike Silva, act unethically and deferentially towards an entity they were supposed to regulate, Goldman Sachs.

The specifics of the allegation were as follows. Silva had allowed Goldman to do a deal with the Spanish banking giant Santander, a deal which amounted to being paid to help Santander manipulate accounting standards. Goldman had received $40 million to hold some Santander assets on its books to fool Spanish banking regulators, an icky deal that should have been stopped. At the meeting where Silva was supposed to confront Goldman, he instead did the regulatory equivalent of rolling over and letting Goldman scratch his belly.

Segarra also saw rank pressure on employees of the New York Fed to cover up Goldman's lack of a conflict-of-interest policy, which had allowed Goldman insiders to take advantage of their clients by taking both sides of a deal.

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But unlike normal allegations of wrongdoing, her complaints came equipped with audio. Segarra had the New York Fed cold, because she had taped the meetings in which Fed employees discussed how important it was to let large banks do whatever they wanted.

This has had significant consequences. The head of the New York Fed, Bill Dudley, has threatened large banks with dismemberment if they don't shape up. And Democrats in the Senate, in one of their last moves prior to handing over the majority to the Republicans, will hold a hearing on these audio tapes.

This is a start. But defenders of the banking industry's culture of corruption aren't going down without a fight.

It's not just Republican politicians. The head of the Federal Reserve's legal department, Scott Alvarez, is the main ideological roadblock to better policy. At an American Bar Association Conference a few weeks ago, he said that "from our perspective, culture is not something that we feel we can regulate." He was joined by Amy Friend, the chief counsel of the Office of Comptroller of the Currency. Conferences like this are where insider lawyers, those who pull the levers of power and represent banks and financial titans in their dealings with regulators, learn the real rules of the game. And what they are hearing is very different from what Dudley is saying in public.

Alvarez is one of the most powerful people in the country, an Alan Greenspan holdover who supervises the 50 some lawyers at the Fed that make supervisory, legal, and legislative determinations for the Fed. The public doesn't pay much attention to what he says. That is a mistake. Because Alvarez moves policy.

Take an episode we all remember: the bailout of AIG. One of the few successful legislative initiatives of the last several years was a move to have the Federal Reserve supervise large insurance companies, such as AIG, that took down the global financial system. This measure, part of the 2010 Dodd-Frank Act, passed because the administration wanted to ensure that entities like insurance companies would not be able to hide risk on their balance sheet without regulatory awareness.

Yet Alvarez sought legislative changes to allow the Fed to go lax on these companies. This measure passed both chambers of Congress largely unnoticed.

Now that the Republicans control Congress, get ready for more. Don't take my word for it: listen to Alvarez, who said at that same conference that "there’s certainly things we think could be revisited in Dodd-Frank," before bitterly adding, "as perfect as it was." This is remarkable, a public servant at an institution created by Congress opining on what Congress should be doing.

That just doesn't happen — except at the Fed. Democrats allow this to occur because of their childish presumption that the Fed should be ''independent" of politics. What this in fact means is that the Fed is accountable to bankers rather than voters.

So what, specifically, does Alvarez want to change?

Let's go down the list. He said he wants to take a de-regulatory posture for smaller institutions, which is fine until you realize that "small" at the Fed can mean institutions with billions of dollars in assets.

Alvarez is also seeking to gut derivatives regulation. During the passage of Dodd-Frank, one particularly controversial measure was called the "swaps pushout rule." This provision bans banks from gambling on exotic derivatives using taxpayer dollars. Alvarez doesn't like it, saying, "You can tell that was written at 2:30 in the morning and so that needs to be, I think, revisited just to make sense of it." This is a typical posture by legal advocates, pretending something they don't want to enforce is poorly written. It's not. Alvarez is just a Greenspan guy, a believer in deregulation.

Then there are the new rules on credit rating agencies like Moody's and Standard & Poor's. These institutions were so corrupt that, at the height of the crisis, their employees joked that they would slap AAA on securities structured "by cows." Well, restrictions on those agencies, according to Alvarez, "really did not work and it doesn't work and it’s more constraining than I think it is helpful." It's good to know that Alvarez doesn't think that laws passed by Congress are helpful, and that they should be repealed. It seems, though, that such behavior is best conducted by bank lobbyists rather than the head lawyer of the Fed.

One wonders why Fed Chair Janet Yellen allows this kind of behavior to go on within her institution. While it's true that regulatory agencies can't regulate the behavior of every single employee at every single bank, the culture on Wall Street is something that is definitively set by public servants and private leaders throughout the banking world.

When a whistle-blower shows evidence of embarrassingly weak regulators currying favor with predatory sharks, the reaction is important.

Yellen and Dudley might proudly bleat that malfeasance will not be tolerated. But if they allow subordinates to go to banking conferences and tell the lawyers who represent banks that the Fed doesn't want to regulate, that is a cultural signal. It says to insiders that they can go along, ignoring what is clearly only meant for public consumption and PR purposes. The only way to counteract this signal would be to fire Alvarez. And the only way for Democrats to credibly argue they have reigned in Wall Street is to drop their silly pretense that the Fed should be "independent." They must reread the Constitution, and recognize that monetary policy is clearly within Congress' purview.

It's an open debate whether regulators can change the culture on Wall Street. But one thing is not open for debate. Regulators who don't want to change the culture on Wall Street, won't.