The Banking Protection Racket

February 28th, 2015
in Op Ed

Remember When Carmen Segarra Exposed the NY Fed’s Refusal to Stop Goldman Sachs and Banco Santander’s Scam to Inflate Santander’s Capital?  How’d that Work Out?

by William K. Black, New Economic Perspectives

On September 30, 2014 I wrote an article to explain the true significance (and horrific analysis by the NY Fed and much of the media) of Carmen Segarra's key disclosure. My title was "A 'Perfectly Legal' Scam is Perfectly Unacceptable to Real Bank Supervisors." Segarra was the NY Fed examiner who was fired for her criticisms of Goldman Sachs.

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Follow up:

Segarra was part of the group of new examiners hired as a result of the NY Fed's admission that it had failed utterly under Timothy Geithner and that the failure had helped make possible the financial crisis. Segarra was part of the new crew that was supposed to radically vitalize the NY Fed's broken supervisory arm. (Notice that I did not say "revitalize" - the NY Fed has always been Wall Street's Fed bank, not America's. It has never been an effective supervisor.)

The point I made was how similar the scam that Goldman crafted to reduce Banco Santander's capital requirement was to the scam that Lehman used to reduce its capital requirement and pretend that it was healthy when it was deeply insolvent. The key thing that Segarra disclosed was that Mike Silva, her NY Fed boss, claimed that Lehman's failure caused a "Road to Damascus" conversion that transformed him from a regulatory weakling into the big banks' worst nightmare - a tough bank supervisor. I showed that, in reality, he did nothing when he learned of Goldman's scam. The pathetic scope of his conversion is that he now understood that what Goldman and Santander were doing was unethical and endangered the global financial system, but remained unwilling to stop, try to stop, or even criticize Goldman and Santander's scam.

Silva's disconnect with the real world is so total that after his incoherent non-criticism of Goldman he bragged to his staff that he had accomplished his mission of putting a "shot across the bow" of Goldman. Silva should give up his day job, because he is an invertebrate, but he should not take up a job in the Navy when he resigns from the NY Fed. The concept of firing a shot across the bow is that if the other vessel does not stop you will blow it out of the water. Goldman did not stop, Silva did not fire any kind of shot, much less an 18" gun across Goldman and Santander's bow, Goldman and Santander proceeded to accomplish their unethical and dangerous mission, and Silva did nothing to them when they didn't stop.

This column adds two points that have (mostly) become public since I wrote my prior article. I have read William Dudley's speeches on regulation and the corrupt culture on banking and examined Santander's conduct and condition since the Fed allowed it to conspire with Goldman to scam its capital requirement in a manner similar to Lehman. Dudley is the NY Fed's President. He was responsible for the NY Fed hiring new examiners like Segarra to, he claimed, end the corrupt culture of banking and the Fed's pathological failures as a regulator. Dudley talks a great show about the paramount need for far greater capital for the biggest banks, the need to never again allow accounting gimmicks that take liabilities off balance sheet and reduce capital requirements, the necessity of bank CEOs and regulators stopping lawful actions that should not be taken, and the need for consistent application of these principles of integrity by bankers and regulators. In short, he tells us Segarra was right and Goldman and Santander's senior officers were disasters waiting to happen.

Dudley bears the ultimate responsibility for firing Segarra when she made the grave mistake of believing Dudley's words and Silva's faux conversion. Segarra did not realize that Dudley and Silva were simply talking a good show as a form of dishonest window dressing akin to Santander and Goldman's accounting wind dressing scam.

The other big news is that Santander's controlling officers responded to the NY Fed's failure to block even an obvious scam by deepening their corrupt corporate culture. They have gone on to become even more unethical and dangerous to the global system. The Boston Fed has taken limited action against Santander's holding company in response to the newest misdeeds, but not the unethical Santander (USA) CEO who grew wealthy by deliberately violating the Fed's rules and orders. The Boston Fed's faux "enforcement action" is scandalous for reasons I explain at the end of this paper. I have buried the lead for the sake of maintaining chronological order, but I do ask you to read both parts of my description of the enforcement action. The sickness at the Fed is not limited to the NY Fed. Three years after Dudley refused to fix the grave problems examiners like Segarra found at Goldman and Santander and instead blessed firing Segarra the rot is still spreading through the Fed's regional banks. There are few things in life more expensive than refusing to appoint effective regulatory leaders.

Mike Silva's Tale of His "Road to Damascus" Conversion to Becoming a Zealous Regulator

Segarra's boss, Mike Silva, talked a great "never again" tale of redemption. Segarra's secret tape recordings disclosed that Silva told this tale to the NY Fed's supervisory staff.

Mike Silva I have to tell you that night that the reserve fund broke the buck and we got that word...

Jake Bernstein It was a moment when it looked like the financial system was going to come crashing down. Big firms were frantically calling the Fed, terrified that economic

Armageddon had arrived. When this happened, Silva was chief of staff for Tim Geithner who, at the time, was president of the New York Fed.

Mike Silva And when I realized that nobody had any idea how to respond to that, I went into the bathroom and threw up. Because I realized this is it, it's just this small group of people, and right now at this moment we have no clue. I never want to get close to that moment again.

My prior article explained the context of the events Silva was describing. When Lehman failed a large money market mutual fund that had purchased Lehman's commercial paper suffered such severe losses that an investor in the fund who put $1 in would receive less than $1 back. That is referred to as "breaking the buck." It immediately sparked the largest and quickest run in history. The run terrified the Fed and the Treasury. They realized that they were "clue[less]" about the true condition of the financial system and the spreading financial collapse and Silva felt so helpless that he puked and vowed never to fail again and even "get close to that moment again." The word "close" is the key word and it is exactly the right concept and would have represented a radical change in global regulation if it were a real conversion.

The global race to the bottom of financial regulation had produced in Europe, the City of London, and Wall Street a pernicious anti-regulatory philosophy that ignored regulatory effectiveness and instead focused on minimizing financial regulation, supervision, enforcement, and even prosecutions. The palpable hostility to regulation was extreme. The official goal was to get as close to the line of disaster as possible by minimizing financial regulation to the very boundary of producing recurrent catastrophes. The vital concept of a maintaining a protective cushion - that we desperately needed to stop bank misconduct well before it was fraudulent - was eliminated. The moral of Silva's Road to Damascus story was the need to ensure that we never again even got "close" to allowing the fraud epidemics that drove the financial crisis. In criminology jargon, Silva was calling for a "broken windows" approach to financial regulation - stressing the urgent need for regulators to end the corrupt culture of banking long before the misconduct consisted of serious felonies.

Lehman's Scams to Inflate Its Capital

Silva's morality play was all about Lehman. Lehman's controlling officers led the accounting control fraud that destroyed Lehman and helped cause the global crisis. In particular, Lehman did REPO deals with other banks to understate its liabilities and make its deeply inadequate capital appear adequate.

Banco Santander and Goldman Sachs' Scam to Inflate Santander's Capital

Santander did deals with Goldman to understate its liabilities and make its inadequate capital appear adequate.

Mike Silva It's pretty apparent when you think this thing through that it's basically window dressing that's designed to help Banco Santander artificially enhance its capital.

What Part of "Never Again" Does Silva Fail to Understand? All of It

Silva talked a good game to his staff about his Road to Damascus conversion. He remained, however, Saul and never converted to Paul. He continued to oppress the reformers like Segarra. Her tape recording reveal that Silva's specialty was delusional descriptions of his toughness combined with obsequious conduct towards even the most unethical elite bankers.

Silva admits on the tapes that he knows the Goldman deal is a scam designed to produce huge bonuses for Goldman's officers in return for entering into a deal with Santander that has no economic substance and is designed solely to overstate dramatically Santander's capital relative to its true risks. He knows that Goldman and Santander are reprising Lehman's scam deals with other banks that had no economic substance and were entered into for the sole purpose of understating Lehman's true risk and overstating the adequacy of its capital. Silva was not faced with the standard he claimed to be enforcing - ensuring that no bank was able to even "get close" to the scams Lehman's officer committed. Santander and Goldman are working the same scam that precipitated the last financial crisis.

The similarity of the scams and Silva's supposed conversion to "never again" should have led Silva to come down on Goldman and Santander like an Old Testament biblical prophet. Segarra's tapes allow us to know exactly how fully he embraced the zealotry of the converted. He bragged to the NY Fed's supervisors in advance of the key meeting with Goldman about how he would put the fear of G-D (and the NY Fed) in Goldman's leaders. (Of course, Lloyd Blankfein had assured us all that Goldman was "doing God's work.")

Iceland just convicted the CEO, chairman of the board, controlling officer of a major subsidiary, and the second largest shareholder of Kaupthing bank for their scheme to overstate the bank's capital. Silva decided - without any real investigation - that Goldman and Santander's scam was "perfectly legal." Still, in the NY Fed strategy session to prepare for the meeting with Goldman, Silva bragged about how he would "put a big shot across their bow." His next sentence, however, made clear that he did not understand the concept he announced.

Mike Silva My own personal thinking right now is that we're looking at a transaction that's legal but shady. I want to put a big shot across their bow on that.

Poking at it, maybe we find something even shadier than we already know. So let's poke at this thing, let's poke at it with our usual poker faces, you know. I'd like these guys to come away from this meeting confused as to what we think about it. I want to keep then nervous.

Silva's "Big Shot Across Their Bow" (Steel yourself for the Terror)

Jake Bernstein. Silva wasn't satisfied. Finally, after more than an hour he went for it. It's the only time in the whole meeting he brings it up. We play it now, not because this is an important piece of financial policy, but to give you a chance to hear what it sounds like - at least on this one day - when the top Fed official onsite at Goldman Sachs questions Goldman Sachs.

Mike Silva 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...?

When you fire an 18 inch shell across a vessel's bow it sounds to the recipient like an impossibly fast, flying freight train has raced only feet over your head. The noise is deafening and the wind generated is fierce. The shell can cause water to fountain scores of feet in the air. The old line about the prospect of being hung in a fortnight focusing one's mind is as nothing compared to the prospect that within 90 seconds an entire barrage will bracket your vessel and turn it into flotsam if you do not heel to for boarding. Silva will never develop the spine to supervise banks.

Silva's Delusional Self-Evaluation of His "Big Shot Across [Goldman's] Bow"

Mike Silva At a minimum, we made them, I guarantee they'll think twice about the next one, because by putting them through their paces and having that large fed crowd come in. You know we fussed at 'em pretty good.

Silva's self-described "Road to Damascus" conversion did not "take." His every instinct ensures that he is incapable of being a supervisor. That, of course, raises the question of why Dudley would put someone as feckless as Silva in charge of what was supposedly a key aspect of the supposedly radical transformation of the feckless and failed NY Fed supervision that contributed so much to the global financial crisis.

What Dudley Claimed the NY Fed's Position Was on Scams

In his Senate testimony several months ago, Dudley emphasized three points that Segarra tried to make real and Silva ensured would not be made real. First, adequate capital is essential. Second, "off-balance sheet exposures" by the systemically dangerous institutions (SDIs) such as Goldman and Santander must be accurately recognized to ensure that capital is in fact adequate. The Goldman deal with Santander was designed to falsely take liabilities off-balance sheet for the purpose of allowing Santander to have inadequate capital. Third, it was vital to end the corrupt culture of banking. Dudley threatened to end the SDIs' existence if they failed to end their corrupt cultures.

Testimony by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, before the Senate Committee on Banking, Housing, and Urban Affairs Financial Institutions and Consumer Protection Subcommittee, Washington DC, 21 November 2014.

"Since the financial crisis, the Federal Reserve has redoubled its attention to bank capital. Capital is the financial cushion that banks hold to absorb loss. It provides an economic firebreak that helps prevent systemic stress from turning into a full-blown crisis.

[T]he Federal Reserve mandated a new minimum supplementary leverage ratio that includes off-balance sheet exposures for the largest, most internationally active banking organizations and a leverage surcharge for large U.S. banking organizations. In support of these new regulations, capital assessment has become a focus of supervision since the financial crisis. Examiners monitor capital reserves and put banks through periodic stress tests that are evaluated on a cross-firm basis. This has been one of the great advancements of bank oversight following the crisis.

The New York Fed has also devoted significant resources and attention to the reform of bank culture and conduct. Increased capital and liquidity are important tools to promote financial stability, but in the end a bank is only as trustworthy as the people who work within it. I have personally delivered a strong message that the culture of Wall Street is unacceptable. Bad conduct by bankers damages the public trust placed in banks. In my view, this loss of trust is so severe that it has become a financial stability concern. If bad behavior persists, it would not be unreasonable - and may even be inevitable - for one to conclude that large firms are too big and complex to manage effectively. Our nation's largest financial institutions need to repair the loss of public trust in banks. This means a back-to-basics assessment of the purpose of banking, including duties owed to the public in exchange for the privileges banks receive through their bank charters and other functions of law. Among these privileges are deposit insurance and access to a lender of last resort."

One month before his Senate testimony, Dudley gave a speech on banking's corrupt culture entitled "Enhancing Financial Stability by Improving Culture in the Financial Services Industry" (October 20, 2014). Dudley expressed his disgust that even after fraud drove the crisis and the massive bailouts banking's corrupt culture continued.

"The pattern of bad behavior did not end with the financial crisis, but continued despite the considerable public sector intervention that was necessary to stabilize the financial system. As a consequence, the financial industry has largely lost the public trust."

Dudley emphasized that the problem was not rogue bankers but a corrupt culture set from the top.

"I reject the narrative that the current state of affairs is simply the result of the actions of isolated rogue traders or a few bad actors within these firms. As James O'Toole and Warren Bennis observed in their Harvard Business Review article about corporate culture: 'Ethical problems in organizations originate not with 'a few bad apples' but with the 'barrel makers'.' That is, the problems originate from the culture of the firms, and this culture is largely shaped by the firms' leadership. This means that the solution needs to originate from within the firms, from their leaders."

Dudley stressed that it was not sufficient that a bank action not be criminal - it was essential to act against conduct that was "grey." The key question was not "can" I do it, but "should" I do it.

"Culture reflects the prevailing attitudes and behaviors within a firm. It is how people react not only to black and white, but to all of the shades of grey. Culture relates to what 'should' I do, and not to what 'can' I do."

Dudley explained the need to take the profit out of unethical conduct and that financial fraud and misconduct is particularly easy to commit because its impersonal nature makes it easier for bank officials to rationalize away their guilt.

"In general, interactions became more depersonalized, making it easier to rationalize away bad behavior, and more difficult to identify who would be harmed by any unethical actions.

High-powered pay incentives linked to short-term profits, combined with a flexible and fluid job market, have also contributed to a lessening of firm loyalty-and, sometimes, to a disregard for the law-in an effort to generate larger bonuses."

Dudley told his audience of top bankers that they were the keys to restoring integrity to banking.

The Key Role for Senior Leadership
Correcting this problem must start with senior leadership of the firm. The "tone at the top" and the example that senior leaders set is critical to an institution's culture-it largely determines the "quality of the barrel." As a first step, senior leaders need to hold up a mirror to their own behavior and critically examine behavioral norms at their firm. Sustainable change at any firm will take time. Turning around a firm's culture is a marathon not a sprint. Senior leaders must take responsibility for the solution and communicate frequently, credibly and consistently about the importance of culture. Boards of directors have a critical role to play in setting the tone and holding senior leaders accountable for delivering sustainable change. A healthy culture must be carefully nurtured for it to have any chance of becoming self-sustaining.

"Consistent," "carefully nurtured," and "accountable" are the essential concepts Dudley identified as crucial to achieve a culture of integrity. A regulator that believed that would, of course, have ordered Goldman to unwind the scam deal with Santander, refund the huge fees it got for doing the deal, and hold the senior officers who led the scam accountable for their unethical behavior. Goldman, instead, gave the officers bonuses. Dudley claimed that the NY Fed "supervisors" would require consistently ethical "results." Instead, Dudley's supervisors allowed Goldman's "compliance breaches [to] factor into compensation" by increasing the unethical officers' compensation. Dudley did not simply fail to even try to achieve ethical results and allow Goldman to pay bonuses to the officers who led the unethical scam - he fired Segarra for trying to improve Goldman's corrupt culture, while claiming that curing banking's corrupt culture was "paramount to us as supervisors and central bankers." Dudley claimed that the NY Fed insisted on banks "self-policing" against any unethical manifestation.

"Supervisors will need to see how these frameworks evolve, and more importantly, see evidence of how these efforts yield results in the form of more open and routine escalation of issues, consistent application of "should we" versus "could we" in business decisions, rigor in identifying and controlling of conduct risk, and how compliance breaches factor into compensation.

Measurement and accountability for progress in developing a healthier culture across the industry is paramount to us as supervisors and central bankers.

A core element of any firm's mission and culture must be a respect for law. Federal Reserve guidance advises that banks should strive to '[m]aintain a corporate culture that emphasizes the importance of compliance with laws and regulations and consumer protection.' To maintain such a culture, senior leaders must promote effective self-policing."

Dudley then developed in more detail the duty of bank CEOs, to create a culture of integrity, but his logic applies with even greater force to the NY Fed.

"How will a firm know if it is making real progress? Not having to plead guilty to felony charges or being assessed large fines is a good start.

Individuals should feel that they can raise a concern, and have confidence that the issues will be escalated and fully considered. This is a critical element to prevention. A firm's employees are its best monitors, but this only works well if they feel a shared responsibility to speak up, expect to be heard and their efforts supported by senior management.

What should have happened instead goes like this: A trader asks the LIBOR submitter to adjust the submitted rate. The submitter says 'no way,' tells the trader that this request is inappropriate and that the trader will be reported to compliance. The submitter reports the trader's attempt at manipulation to legal and compliance. Compliance investigates to confirm the facts. The trader is fired and is fully prosecuted for any criminal actions. For this all to happen, a firm doesn't just have to have the right rules and procedures in place, but it also needs the right culture to ensure that those rules and procedures are followed, that the bad behavior sees the light of day immediately and that the transgressors are punished in a way that is known broadly throughout the firm-that is, a clear example of the consequences is demonstrated to others."

Dudley then returned to emphasizing that it was critical for the NY Fed and bank CEOs to clean up bank culture so that even actions that would "bend the rules" would be driven out of banking and that the only way to do so was to ensure that cheating no longer paid.

How Can Better Incentives Help?
In my example, for matters to work properly, I think it is important that all the players-traders, compliance, risk and legal, have the right incentives to behave in the way that is appropriate and that aligns their interests with the broader interests of the firm in rooting out bad behaviors. One way in which incentives can be shaped is through the structure of compensation. I believe that a proper compensation system can be an important tool for enhancing culture, promoting financial stability and rebuilding the public trust in the financial industry.

Similarly, compensation policies can complement an improved culture, and play a role in reducing unethical and fraudulent behavior. Individuals who decide to bend the rules or to step over the line usually do this in the context of an assessment of the expected risks and rewards of their actions.

This implies that one objective should be to rebalance the scales so that the expected risks from unwanted behaviors are more likely to outweigh the expected rewards. The expected risks are a function of the likelihood that an individual (or set of individuals) is caught and the attendant consequences.

Dudley's conclusion stressed that there could be no assurance that banking culture would cease to be corrupt unless the regulators transformed and became effective and that regulatory effectiveness could only be achieved through the transformation of the regulatory culture.

Conclusion
To ensure the behavior that is required for a safe, sound and trusted financial system, we must also be effective in our role as regulators and supervisors. As part of this, we as supervisors must continually work to improve our own cultures to ensure that we can successively carry out our responsibilities. But it also requires good culture at the institutions that we supervise
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Putting Dudley's points together with this conclusion, he was proclaiming that as the NY Fed's leader it was essential that Segarra could count on his support on ethical issues.

"Individuals should feel that they can raise a concern, and have confidence that the issues will be escalated and fully considered. This is a critical element to prevention. A firm's employees are its best monitors, but this only works well if they feel a shared responsibility to speak up, expect to be heard and their efforts supported by senior management" (emphasis supplied).

Dudley failed Segarra and the Nation. Rather than having her "efforts supported by senior management" she was thrown to the wolves for the highest crime society imposes - being correct when the powerful are wrong.

Dudley made a speech on October 13, 2009 before the NY Fed's effort to build an effective supervisory staff began through hiring examiners like Segarra. The speech focused on the need to "improve the capital standards for" SDIs. "Today, I am going to focus mainly on the need to improve the capital standards for large, systemically important financial institutions." The NY Fed had an opportunity to increase the capital standard for an SDI - Santander. Instead, it allowed Santander and Goldman's leaders to conspire together to work a scam whose sole purpose was to degrade Santander's capital standards.

Dudley's warning foretold Santander's scam.

System Dynamics
Over the course of this crisis, it has become evident that our system has some powerful reinforcing mechanisms built into it. This suggests that one important focus of regulation should be on how to change the system in order to eliminate or at least mitigate those destructive dynamics. Let me give you a few examples.

In times of stress, banks may have incentives to continue to pay dividends to show they are strong even when they are not. This behavior depletes the bank's capital and makes the bank weaker. To correct this shortcoming in our system, we should craft policies that either incent or require weak and vulnerable firms to cut dividends quickly in order to conserve capital. This would introduce a dampening mechanism into our system.

Another example of a reinforcing mechanism is a situation in which firms have incentives to structure activities to minimize regulatory capital or other requirements without transferring risk. Creation of off-balance sheet funding vehicles, structured products and complex corporate structures to minimize regulatory requirements and tax obligations reduces transparency, introduces new risks and limits the effectiveness of resolution regimes.

One problem evident during the crisis has been the reluctance of banking organizations to raise sufficient capital to be able to credibly have the resources to withstand particularly adverse economic conditions.

The NY Fed chose to allow Goldman and Santander's controlling officers reprise the disasters that helped cause the crisis.

Silva so Terrorized Santander That It Became a Model Bank (Not)

Silva's strategy of "terrofussing" (terror in the form of "fuss[ing") consisted of inflicting such raw terror that even a moral cripple and torture aficionado like John Yoo would have ran screaming from the room screaming "Oh, the humanity!." I apologize in advance to my readers for presenting the raw truth of the transcript reporting again the exact words Silva used to flay alive the Goldman officials.

Mike Silva 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...?

Silva's Delusional Self-Evaluation of His "Big Shot Across [Goldman's] Bow"

Mike Silva At a minimum, we made them, I guarantee they'll think twice about the next one, because by putting them through their paces and having that large fed crowd come in. You know we fussed at 'em pretty good.

Silva's after-action report is too pathetic to analyze. In his dreams, Silva's view of what it means to be a successful bank supervisor is that the bankers will "think twice" before they take sleazy actions again that helped blow up the global economy. At the end of "thinking twice" they'll realize there were huge fees to Goldman, big bonuses to the Goldman and Santander officers, and no negative consequences to doing the same thing again. Silva is not going to take any act to prohibit future scams of this kind. He must not have teenagers, or he'd know that "fuss[ing]" is the most useless (non) activity imaginable.

Savor Silva's definition of "fussed at 'em pretty good." Goldman's team was scarred for life by Silva's diabolical attack on them, consisting of pummeling Goldman with these 37 words of fury.

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...?

Silva's steely determination and palpable menace has doubtless done its job and transformed Santander's managers into the most compliant bank on earth. Sorry, I was reporting that from an alternative universe. Santander reacted like teenagers do when their parents natter uselessly rather than holding them accountable - they screw up even more frequently and severely.

The U.S. "stress tests" are notoriously weak, but the EU version makes the U.S. regulators look like Seal Team 6. In March 2014, the U.S. rejected the capital plans of three U.S. subsidiaries of foreign SDIs. Santander was in the not-so-proud company of its fellow worst-of-the-worst banks: HSBC and RBS. The Fed singled out Santander for special condemnation based on the fact that they did pretty much everything important wrong.

[A]t Santander, the Fed found 'widespread and significant deficiencies in several areas, including governance, internal controls, risk-identification and risk management.

It's shocking to learn that if you do not enforce the law or insist on integrity in banking you end up with a Gresham's dynamic in which bad ethics drives good ethics out of banking. The "Kumbaya" regulation theorists assured us that if we simply let bankers make all the decisions without regulatory "interference" they would respond with a "big bang" of hyper-inflated integrity and usher in a new cosmos of honest banking. The OECD is still peddling this disastrous line.

When a bank fails a stress test its authority to pay dividends is circumscribed or removed so that it will build capital and clean up its "governance, internal controls, risk-identification and risk management. That was supposed to convince Santander's CEO to clean up the criminal enterprise that is Santander.

On September 18, 2014, however, the Wall Street Journal announced in a headline that "Fed Takes Enforcement Action Against Santander's U.S. Unit: Regulator Says Spanish Bank's Subsidiary Paid Unauthorized Dividend."

The enforcement action, by the Boston Fed, not the NY Fed, forced:

[T]he Spanish bank to repay the subsidiary the lost capital and barring the unit from additional dividend payouts.

On May 1, a unit of Santander Holdings USA, Inc. declared a roughly $52 million dividend, despite being under dividend constraints since failing the Fed's financial stress test in March.

Pun intended, paying an unlawful dividend because you're undercapitalized is a capital offense, particularly coming from a bank that the Fed found was shockingly badly run. It's not like they forgot about an obscure order issued a decade earlier. They got the capital deficiency letter in March and violated it on May 1 through the illegal dividend. Dividends are a really big deal because they further weaken capital. Dividends are paid upon the vote of the directors with the active participation of the CEO. The illegal dividend proved, in the starkest way possible, that the Fed's criticisms of Santander's governance and controls had radically understated the utter collapse of governance, controls, and ethics among Santander's controlling officers.

The Boston Fed should have cleaned out the senior managers of Santander's derelict U.S. unit. (Actually, of course, Santander (Spain) should have fired the senior Santander (U.S.) officials years earlier and certainly when they paid the illegal dividend.) Instead, the Boston Fed took no action beyond requiring the holding company to repay a portion of dividends. That, pathetically weak response to a multiple-loser bank is the only enforcement action the Fed has ever taken on a failed capital plan arising from this crisis. At its toughest, the Fed's supervision and enforcement remain pathetic. We should not forget, however, that the same facts demonstrate the abject failure of the controlling officers of Santander (Spain) and (U.S.).

I have written more on what the Fed's enforcement action inexplicably did not do below. Please read it, for it begins to tell the back story of corruption and shame.

Surely, the distinction of being the only bank whose capital plan and controls were so bad that the Fed went to the trouble of insisting on an enforcement action must have finally put the fear of G-d (and the Fed) into Santander's managers and caused them to clean up their act. After all, the things Santander was doing so desperately wrong are things that every honest banker would strive desperately to avoid. When your controls and governance stink and you cannot identify or measure risk you take actions with a negative expected value, or a positive expected value due to fraud or other misconduct. If your officers make loans or investments with negative expected values - you will lose money. That is what drove the financial crisis. So, it was unambiguously a good thing for any honestly run bank with grossly inadequate controls, governance, and risk management to have their regulators tell them they had an urgent need to clean up their act. Notice that "private market discipline" did not send that message to Santander's controlling officers, its internal controls did not send that message, and its external private-sector controls did not send that message.

The Wall Street Journal reported on February 20, 2015, however, that the leak (and one must imagine the associated insider trading) is that Santander and another disgraceful bank, Deutsche Bank, have failed the Fed's latest stress test. The leak claims that Santander failed for the same old reason "Shortcomings seen in how banks measure and predict potential losses and risks."

When senior bank officials refuse to fix pathetic controls for years, it is because they want pathetic controls because the senior officers wish to run an unethical or even criminal enterprise.That should lead one to ask who is running Santander (U.S.) and what that unit is doing.

Thomas Dundon is chief executive of Santander Consumer USA, a consumer-finance company that specializes in subprime auto loans. He owns about 23% of the company through his own shares and shares owned by a limited liability company, according to regulatory filings.

In May, Santander Consumer paid a $52 million dividend to shareholders, according to filings. That likely yielded Mr. Dundon around $12 million based on his current ownership.

So let's review the bidding. Santander (U.S.) is engaged in lending that is increasingly infamous among U.S. financial regulators. The lending is inherently risky, but it is being done in a manner that greatly increases that risk.

Dundon knew that the dividend was illegal and must have pushed for it to be paid anyway. Dundon made a huge amount of money personally because of the illegal dividend he pushed to have paid. That illegal dividend payment, according to the Fed, exposed Santander and the financial system to undue risk. The Fed could have ordered Dundon to repay the dividend to Santander, removed and prohibited Dundon (and his entire team that approved the illegal dividend), and ordered Santander (U.S.) to cease making subprime auto loans until it demonstrated that it had fixed it grave, persistent problems with controls, governance, and risk. Dundon had just demonstrated that the Fed's grave concerns were understated and should have expressly included integrity. The Fed did not take any of these actions.

I have been critical of many failures by federal financial supervisors and their bosses, but this one is beyond all reason. I cannot conceive of a regulator in the world who would not have been enraged at Dundon's actions and come down on him with the entire weight of the rule of law. The Dundon debacle should have caused a revolt at the Fed. There have to be some real supervisors and enforcers somewhere in its ranks who will blow the whistle on this travesty. I guarantee that there is a sordid back story that explains the otherwise inconceivable decision by the Fed to allow Dundon to violate the Fed's order, the law, every concept of integrity and good governance, and everything Dudley has been saying about the vital need to end Wall Street's corrupt culture.

Conclusion

When Silva and Dudley refused to back Segarra they started a chain collision that continues to claim new victims. Three years later, Santander remains a nightmare and Goldman continues to profit by aiding and abetting the most unethical bankers and government officials.









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