

AP Photo/Mark Lennihan)

The problem with Wall Street's cops is that, before the crisis, they didn't actually fall asleep on the job.

Regulators knew the big banks were taking big risks, and had the power to do something about it. But they didn't. It's worse than outright neglect, since it's not as obvious how to fix it. And now, thanks to 46 hours of secret audio tapes from inside the New York Federal Reserve, we can hear that they're still having trouble fixing it. The problem isn't that regulators don't have the tools they need. It's that they won't use the tools they have, because they respect the bankers too much.

It's not regulatory capture. It's regulatory deference.

Now, after the financial debris had settled in 2009, the New York Fed, which supervises Wall Street banks in addition to helping set monetary policy, asked itself why it hadn't done more—or anything—to avert the crisis. It brought in Columbia University professor David Beim to figure that out, and his answer was stark: The New York Fed needed more people who were willing to speak their minds, even if they thought their bosses (or the bankers they were regulating) didn't want to hear it. Too often, bank supervisers buried their concerns, because they knew those concerns weren't welcome higher up. The New York Fed, to its credit, listened to this, and decided it needed to start looking for regulators who wouldn't just go along to get along. Carmen Segarra, a former bank lawyer, was one of this new breed who came aboard in 2011.

But old culture dies hard. Segarra found that when she joined the New York Fed's team at Goldman Sachs, which is quite literally at Goldman Sachs. Bank regulators, you see, actually work in the banks they're regulating. The idea is that being on-site makes it easier for them to scrutinize anything that seems questionable. But in Segarra's experience, it only made it harder for them to stand up to the bankers at all. It's just human nature. You try to make friends with the people in your office, and avoid confrontation. But Segarra didn't. And for that, she got into trouble with her bosses. They told her she had to worry about her "credibility," which was more about "perceptions, as opposed to reality." They even told her to change her official minutes of a meeting with a Goldman executive, because she had supposedly misheard them. So, in response, she went to a Spy Store, bought a miniature recorder, and started documenting everything that happened with her bosses and the bankers they were supposed to be regulating.

This is where you need to go to This American Life, who, in conjunction with Jake Bernstein of ProPublica, put together the highlights of Segarra's 46 hours of audio recordings. You have to hear how obsequious the supervisors sound when they talk to Goldman's executives, almost apologetic for not-quite doing their jobs. The best example of this came during a deal between Goldman and the Spanish banking behemoth Banco Santander in 2012. "We're looking at a transaction that's legal but shady," Segarra's boss Mike Silva said, and "I want to put a big shot across their bow on that." Specifically, Goldman was making it look like it was taking assets from Santander without really doing so — for a fee, of course — all so Santader could avoid having to raise more capital. This was regulatory arbitrage of the worst kind: It was potentially destabilizing. But the term sheet said the deal wouldn't go ahead unless the New York Fed explicitly signed off on it. Until, that is, Goldman just went ahead without it.

Silva told his charges that he was really going to let Goldman have it for that. This is what he said to the bankers:

Just to button up one point. I know the term sheet called for a notice to your regulator. The original term sheet also called for expression of non-objection, sounds like that dropped out at some point, or ...?

And that was that. Well, aside from the letter. Silva's team decided to get really tough by maybe sending Goldman a letter with their concerns, because, as one supervisor put it, "the only downside risk is that they choose to ignore us." But either way, Silva thought they'd "fussed at 'em pretty good," and that "at a minimum, we made them, I guarantee they'll think twice about the next one."

Meanwhile, Segarra continued to clash with her superiors. She thought Goldman's conflict-of-interest policy, which is critical at an institution that's involved in so many different businesses, was so vague as to be nonexistent. Silva disagreed. He said that she "needed to come off the view that Goldman doesn't have any kind of conflict-of-interest policy" though she could say that "they need to improve it" and "maybe they have to improve it a lot."

But these skirmishes soon cost Segarra her job. She sued the New York Fed, saying she was fired for refusing to change her findings on Goldman's conflict-of-interest policies, but the case was thrown out. She's now appealing. The New York Fed can't talk about ongoing litigation, but it has responded by saying its "examiners are required to be independent, critical, and analytical thinkers" and that it's working "diligently to execute its supervisory authority." Goldman, for its part, points out that Segarra unsuccessfully interviewed for a job with them in 2007, 2008 and 2009, and that it does, in fact, have a conflict-of-interest policy.

But forget this he-said, she-said, and just listen to the tapes. They show regulators who think "that having a meeting is the same as taking action," as Marcus Stanley, the policy director at Americans for Financial Reform, told me. The bad news is there's no easy answer here, because culture is a lot harder to change than regulations. And that's why we need regulations that don't depend — or at least depend less — on uninhibited regulators. Things like tougher capital requirements might be smarter policy.

Otherwise, it might not be long until the big banks fuss up the economy again.