One of the most troubling aspects of the financial crisis was that government regulators let it happen in the first place. And the most compelling explanation is also the most disturbing: regulators were unduly influenced or even controlled ("captured" is the term of art) by the very banks and financial firms they were meant to rein in. This argument, popularized most notably by MIT economist Simon Johnson, has strong circumstantial evidence supporting it, but concrete proof from within regulatory agencies has, understandably, been hard to come by.

On Friday, This American Life and ProPublica announced they had found such proof. A joint report produced by ProPublica reporter Jake Bernstein (who previously won a Pulitzer for his investigative reporting on Wall Street for the two outlets) revealed the existence of 46 hours of audio recordings made inside the Federal Reserve Bank of New York, which, as the Fed's interface with the financial sector, serves as one of country's most powerful bank regulators. Taken by former Fed bank examiner Carmen Segarra, the recordings suggest a culture within the Fed that was at best overly cautious in confronting bank wrongdoing, and at worst in bed with the banks it was regulating.

The TAL episode is worth listening to in full, and the ProPublica report is worth reading in full, but here are the very basics of what they found in case you're in a rush.

First off, what's a bank examiner?

A bank examiner is a New York Fed employee who actually works out of the offices of the bank they're supposed to oversee. "Like, you have a desk there, and your own phone," as Bernstein explains in the TAL episode. Before the financial meltdown, these staffers typically lacked specific area knowledge and had to call on experts in the Fed headquarters if they had questions about the bank's business practices. One of the reforms the bank adopted after the crash was to hire more experts and place them in bank examiner roles.

Who is Carmen Segarra?

Segarra is a veteran of the financial industry who, after working for firms like Citigroup and Société Générale, joined the New York Fed as an expert bank examiner on October 31st, 2011. Her specialty, Bernstein says, was "helping big banks with the procedures and systems they need to comply with the many rules and regulations they face, here and overseas."

The Fed assigned her to embed within Goldman Sachs. She worked as an examiner at Goldman for seven months before she was fired. She claims that she was let go for refusing to change certain findings about Goldman's practices; in April a judge dismissed her wrongful termination lawsuit against the NY Fed and two former supervisors. In a particularly vivid illustration of the coziness the TAL/ProPublica report exposes, the judge's husband was representing Goldman Sachs at the time she dismissed the suit. The case is currently under appeal.

What did Segarra find?

Segarra found three clear cases where Goldman appeared to be engaged in wrongdoing, but where Fed staff pushed back at her attempts to correct it. The latter two incidents have audio evidence from Segarra's recordings corroborating them.

The wealthy clients incident

A senior Goldman executive, at a meeting with Fed officials early in Segarra's tenure, expressed the view that "once clients were wealthy enough, certain consumer laws didn’t apply to them," in Bernstein's words; this is corroborated by minutes from the meeting in questions. When Segarra tried to look into the issue further, a Fed colleague protested, saying the executive didn't say that, or if he did, that he didn't mean it.

The Santander incident

In early January, Goldman was closing a deal with the Spanish bank Santander, the point of which, Fed regulators discerned, was to take risky assets off of Santander's hands so as to increase its ratio of capital to assets so as to comply with European regulators. The deal required Goldman to notify the Fed about the deal and get it to sign off, which Goldman hadn't done.

While Fed officials, including Michael Silva, initially sounded outraged, in the end Silva only brought it up once, at the very end of a meeting with Goldman officials, and in a tone that Segarra found overly deferential. She thought the debrief from the meeting with other Fed officials suggested the Fed feared Goldman retaliation if they were too aggressive. This was despite the fact that Goldman was required to hand over information and the Fed could punish it, including criminally, if it failed to comply.

The most forceful action they considered taking against Goldman for the deal was sending them a letter; Bernstein couldn't confirm that one was ever sent.

The conflict of interest policy incident

The Fed requires banks like Goldman to have firmwide conflict of interest policies that fit certain requirements. Segarra concluded that Goldman lacked such a policy, not least because Goldman's staffer in charge of managing conflicts of interest told her the firm's policy had no definition of "conflict of interest."

Silva agreed with her. But after he got pushback from another Fed examiner, he changed his view, just as Segarra was about to take regulatory action to force Goldman to adopt a real policy. Silva protested that the bank had a conflict of interest policy, but Bernstein notes that it was "just a few paragraphs long and very general .… We showed it to two experts: former Fed examiners familiar with the Fed’s guidance on this issue. They both said it wouldn’t qualify as a policy."

Silva urged her to recant her statement that there was no policy, despite the fact that he could have easily overridden her. Segarra suggests this was because, to quote Bernstein, "if she submitted her conclusions, it would create a formal record that her bosses didn’t want." Eventually, Segarra agreed to say there was was a policy, albeit a "very poor policy," but privately insisted to Silva that there was "no way this is a policy." A week later, she was fired.

Did Segarra find other evidence of regulatory capture?

Yes. Apart from cases involving specific Goldman wrongdoing, there were a few cases where Fed employees appeared to be pressuring her to avoid offending Goldman. The last incident has audio evidence corroborating it, while the first two occurred before she acquired a recorder:

In December, less than two months after Segarra joined, a Fed colleague, one of the pre-reform generalist bank examiners, claimed that her minutes of a meeting with Goldman officials were wrong, and that some of the officials didn't say what she quoted them saying. He pressured her to change them, which she didn't.

The same day in December, Mike Silva, then the top Fed official within Goldman, called Segarra into his office. "He wanted to give me some mentoring feedback," Segarra told Bernstein. "And then he started talking about the importance of credibility. And he said, you know, credibility at the Fed is about subtleties and about perceptions, as opposed to reality." While Segarra isn't explicit in her TAL interview about what she drew from this, the implication is she interpreted it as an encouragement to bend the truth to preserve the Fed's credibility with Goldman.

In late February, Johnathan Kim, Segarra's direct supervisor, pulled her into a meeting and told her that he had received feedback from "not only one person, it’s not only two persons, but many more people who are perceiving that you’re — um, you have more sharper elbows, right?" Segarra, perceiving that she was being punished for pursuing wrongdoing aggressively, protested that it would be "unfair to fire me when I am, at the end of the day, doing a good job." Kim replied, "I’m here to change sort of the definition of what a good job is, right?"

How did Goldman and the Fed respond?

Goldman issued a three-paragraph response to Bernstein, in which they reiterated Silva's statements that they did in fact have a conflict of interest policy and noted that "Ms. Segarra … unsuccessfully interviewed for employment at Goldman in 2007, 2008, and 2009." They did not comment on the statement on wealthy clients or the Santander deal. On the TAL broadcast, Bernstein notes that the three paragraphs came after he sent them "ten pages of detailed questions."

The NY Fed did little better. In response to thirteen pages of questions from Bernstein, and after listening to her recordings at the This American Life offices, they sent a two-page statement, now available on its website as well, saying the Fed "categorically rejects the allegations being made about the integrity of its supervision of financial institutions." It notes that Segarra had "no previous experience as an examiner," that her "concerns regarding the supervised firm's conflict of interest policy were taken seriously and escalated by senior members of the team as evidenced by her own filings to the Court," and that "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 an examination team about any institution." Again, the wealthy clients and Santander incidents are not mentioned.

Silva and Kim both declined to comment for the story. Silva cited both Segarra's lawsuit and the confidentiality of Fed dealings with Goldman. He has since moved on to GE Capital, while Kim is still at the Fed.

What should I take away from this?

It would be a mistake to make the revelations all about the specific cases of Santander or the Goldman official claiming wealthy clients were exempt from rules or the Goldman conflict of interest policy. Those are all damning, to be sure, but the wrongdoing in question is, if anything, milder than some of the stuff Goldman has been caught doing in the past.

The scandal is less about Goldman's behavior and more about the Fed's inability or unwillingness to uphold the rule of law. Reasonable people can debate whether specific regulations are necessary, but even the best set of rules is totally insufficient if paired with an enforcement system that applies them inconsistently or not at all. Fair and consistent application of regulations is a prerequisite for having a regulatory regime of any kind. When regulators act the way the TAL/ProPublica report show New York Fed regulators acting, it suggests that we need to reform or revamp regulatory institutions before we can expect any new rules they're charged with enforcing to do much of anything.

Also, again, be sure to listen to the full episode and read the full article. They're really worth your time.