10 questions for departing N.Y. Fed chief William Dudley
WASHINGTON — Federal Reserve Bank of New York President William Dudley announced his retirement last November, but he still has plenty to say about supervising the biggest U.S. banks — and how they supervise themselves.
Having led the New York Fed since January 2009, at the height of the financial crisis, Dudley has seen the industry evolve and expand its capacity for self-supervision, but he told American Banker that the industry still has a lot to learn about the importance of a healthy, ethical industry culture.
“What's happened over the last decade or so is the penalties have gone up, in terms of severity and magnitude,” Dudley said in a recent interview with American Banker. “I think it's gotten senior management's attention, that there really is a consequence of bad behavior. You can't just look at it now as, ‘I'm just writing a check, and this is the cost of doing business,’ and moving on.”
Dudley’s comments were echoed in a speech he delivered on Monday calling for the banking industry to re-examine how it incentivizes its managers and employees. He suggested that management stock grants be replaced with long-term debt that would be used to recapitalize an institution if it were to go into receivership.
In the interview, he also offered some advice to his as-yet-unnamed successor, saying that advancing the interests of the New York Fed as an the institution — rather than one’s own profile — is a critical part of the job.
“You represent the institution, and it's the institution that you want to maximize the influence and impact of,” Dudley said. “You don't want to maximize your personal exposure or fame. It's your job to basically make the Federal Reserve Bank of New York contribute as strongly as it can in payments, internationally, supervision, monetary policy, financial stability.”
What follows is an edited transcript of the interview.
You still have another year left on your term — why leave now?
WILLIAM DUDLEY: It's not quite a year. I had to retire in January 2019. The rule is 10 years or [age] 65, whichever comes latest. And I thought about retiring in January, and that's not the greatest climate to retire [in]. And, if I retired in January I would have no flexibility to make sure that we have a smooth transition when a new person comes in — because you don't know exactly how long the search is going to take. So putting all of those together, I thought summer would be good for me, it would also be good for the incoming person, because the summer is actually a little slower. So [they] could sort of get up to speed in the summer months and be ready go by the time we get to the fall. So there's no big story there.
The process for choosing regional bank presidents is sometimes criticized as opaque. Do you think the process is appropriate as it is? Do you think it will be changed? Could it be changed for the better?
I think what's important is that people reach out broadly to a broad set of constituencies in seeking candidates for these jobs, and I think that's what the New York Fed Board of Directors search committee did. I mean I think they interacted with a very broad set of people to get their views on who would be the appropriate president of the Federal Reserve Bank of New York. Also, you know, when we when we focus on selection, you know you could argue that there is a benefit of having this selection process being a little bit more decentralized nationally. If it was all done through Washington, that wouldn't be a very likely way of developing a diverse slate of candidates.
The fact that we have these 12 reserve banks, the board directors in each of those Reserve Banks has a role, I think probably helps you get a broader set of types of people in those in those roles. Remember it's not just the board directors — this is a two-key approach, the board directors make the recommendation. The bankers are now excluded from the selection process. They make a recommendation down to the Board of Governors, and the Board of Governors has to say yes or no. So there is some checks and balances in the system that I think leads to a good set of candidates.
I don't know that the board has formally rejected candidates, but I'm sure that the board has weighed in when they're unhappy with where the board of directors is going. Ideally, what should happen is there should be a conversation, a back and forth, so at the end of the day, the two sides merge without a lot of discord. But I think there's definitely been cases where the board of governors has been unhappy with where the board directors is going and there's been some midcourse corrections.
Do you think the New York Fed should continue to have a permanent seat on the Federal Open Market Committee? Why or why not?
I think there's really ... some very strong legitimate reasons why the New York Fed president should have a permanent seat. Because, think about the Fed in terms of how it's set up. Policy is done in Washington, but the operations, the execution of monetary policy is in New York. Also New York is one of the two major global financial centers in the world. And so, I think the fact that we execute monetary policy, we oversee the market developments for the Federal Reserve system, makes it important that the Fed president have a little bit more elevated role. Internationally, we also have probably by far the greatest sort of international responsibilities of any of the Federal Reserve bank presidents. We run Central Bank International Account Services, which we have over $3 trillion of custody assets of central banks around the world. So we interact with central banks all over the world. The fact that New York City is what New York City is is a really important element of this I think.
There are a lot of vacancies open on the FOMC, both at the board level and among regional bank presidents. Is the FOMC’s future path in flux?
Well, I mean you're right. If you change the composition of the FOMC voting members dramatically you could obviously get a different monetary policy outcome from that. But I think that the risk of that is I think quite a bit exaggerated, because the mandate that Congress sets for the Federal Reserve is very well-established: price stability and maximum sustainable employment. And so everyone's parsing the same set of information in terms of how they can achieve that goal. And so even if you change out the people, the people are probably going to reach very broadly similar conclusions about what monetary policy is appropriate. They all have the same set of information in terms of how they're making that decision.
The New York Fed supervises the country’s largest banks, and you’ve headed the New York Fed since the depth of the financial crisis. How has banking culture changed over your tenure?
I think that, No. 1, some of the banks did have a near-death experience in the crisis and I think that created a more sober view of what sort of risks they should actually take. Number two, I think that the banks realized they maybe weren't quite as good as they thought they were in terms of things like governance, risk management, technology, data. And so I think they understand that they need to raise their game. Because during the financial crisis there were some things that they had trouble actually doing and in a real-time basis, like saying what their consolidated positions were, being able to move collateral around freely from one location to another. So I think that the banks have had a little bit more humility now, and I think that means that they're a little bit more open to different ways of doing things.
That would be number one. Number two, a number of banks have been looking at the cultures in their institutions. In other words asking themselves, "Are we really getting the conduct we need to get from our employees on a consistent basis?" Because you look at the number of fines that banks have had to pay for bad conduct, it's been absolutely enormous. And it's ranged through a wide array of different causes and venues. You have Libor, you have the FX rate-fixing scandal, you have the mortgage underwriting scandal, you have selling customers products that they didn't want or desire. And so I think a number of banks have taken this pretty seriously.
Something that we've been really advocating is that culture really matters. You know there's a role for regulation — you set the rules. There's a role for supervision, to enforce those rules and make sure those rules are followed. But there's also a role for the banks themselves to make sure they have the appropriate set of incentives in place to drive the conduct that they actually want. If you have good incentives, you're probably going to have a good conduct if you have good conduct ... that's going to set the social norms that define culture. So banks are taking this on in a much more serious way, [both] Boards of Directors [and] bank senior leadership. You know it varies from bank to bank, but I think it's we've made a lot of progress over the last decade.
How has supervision changed over the time you’ve been at the New York Fed?
Supervision is changed in a couple of ways. Number one, for the largest institutions is much more focused on taking a horizontal view of how banks are doing. So you can actually compare best practices across banks. It gives us a lot more credibility when we go to a bank and say, "Well, you may think you're doing this well, but we've looked at your peers, and your peers are doing it much better than you in these respects, and so that means that you need to improve your performance." So I think the horizontal approach to supervision of large systemically important banks has been an important innovation.
That's come from the Board of Governors in Washington. I mean Board of Governors always owns the responsibility for supervision. I mean that's a little bit misunderstood. For many, many years they delegated much of that responsibility to the banks and gave the banks quite a bit of autonomy in terms of how to execute on that. And I think the financial crisis caused the Board of Governors to sort of ask themselves the question, "Is that the best way to approach supervision, especially for large systemically important institutions?" And they reached the conclusion that developing a horizontal view across these institutions would be actually very helpful. And I agree with that.
We've made changes in New York, too. We used to have the supervisors mostly on-site in these large institutions, and now we're putting them back to the New York Fed ... for most of most of their activities. And again, that helps foster this horizontal view because now you have people talking about what they're seeing across different firms. And so I think that's actually been effective as well. So that's one of the big changes that I think we in New York decided to implement. That was our decision to do, and I think that's actually been consistent with this new approach to supervision for the large systemically important firms.
You have been a critic of the culture of the banking industry before, and again in your speech today. Does the industry take its culture seriously as a source of risk?
I think you can see the culture as by how the bank itself is performing internally. You know, the worst thing that you can see in a culture is when people say, "Well, he didn't really do this or that correctly, but he's a strong revenue producer so therefore we should give him a pass." You really want to see that not be an acceptable outcome. I think good conduct and bad conduct ... are pretty clear.
Culture is a little bit ... squishier, and I've tried to make it a little bit less squishy in terms of how I talk about it. That's really why I focus on incentives, because that's something that supervisors can examine. Does the bank have good incentives in compensation, promotion? How people are treated when they're there when there are problems? That's something that the banks can affect in terms of how they set up their operations. And so I think that makes it a little bit clearer that culture is not just this amorphous thing, that people actually can do something about it by the choices that they make.
The problem is that the rules are necessary, but they're not sufficient. You know, in some ways, having really very clearly delineated rules, that can actually be counterproductive to have a good culture, because people can then say, "Well, I can do anything within the scope that's been outlined for me by the rules," as opposed to what is actually right. So I think that we have to recognize that writing down all the things that a bank can and cannot do really ... probably makes it harder for banks to have a good culture rather than easier.
Are you optimistic that bank culture will become more accountable in the near future?
I think it's going to be, some people are going to get it, and some people are going to get ... to a lesser degree. I think it's in the interest of all the banks to be on the right side. I mean another aspect of this that doesn't get a lot of attention is also but how do you actually recruit young people into this industry. We've had a number of conversations with deans of business schools, and one theme that came out of those conversations was that there was an increasing proportion of people graduating from business school who didn't want to go into the financial services industry because they thought it wasn't ethical. Now, that's not a great dynamic. If the only people that are willing to go in are people who don't care about the ethics of the industry that's a really negative self-selection process. So there's another reason to do it — to get really good quality people.
What's happened over the last decade or so is the penalties have gone up, in terms of severity and magnitude. And I think it's also important. I think it's gotten senior management's attention, that there really is a consequence of bad behavior. You can't just look at it now as, "I'm just writing a check, and this is the cost of doing business" and moving on. It really has severe reputational effects to the institution that will last over a long period of time.
The N.Y. Fed has been scrutinized as being too cozy with the banks it supervises. Is that criticism valid? What does the bank do to ensure that its relationship with Wall Street remains objective and independent?
The issue of regulatory capture is one that we have to be aware of and guard against, there's absolutely no question about that. So you know a healthy skepticism in terms of what you're told. I think also bringing our people back to the bank to spend more time, and spend less time in the institution itself is also helpful in guarding against regulatory capture. Having a regime where people with disparate views can register those views and have those views fully vetted is also helpful. So we think it's a legitimate issue that we have to be on guard [against], and we've made a lot of changes in terms of supervision. We do supervision at the New York Fed to try to you know lean against that to the greatest degree possible.
What advice would you give to your successor? What is the most important lesson you’ve learned in your time heading the New York Fed?
There's a couple of things. One important thing is just, keep calm. You know people are always looking at you ... in a time of crisis. I remember the financial crisis of course, the worst days. It's really important just to keep calm and ... you know, carry on, to quote the British expression. Because people are going to look to you and they're going to take their cue from the leader, and so keeping that composure is I think really important in terms of the message that you send to the broad organization. So I think it's very, very important.
The second thing I think is important is really to understand that you represent the institution, and it's the institution that you want to maximize the influence and impact of. You don't want to maximize your personal exposure or fame. It's your job to basically make the Federal Reserve Bank of New York contribute as strongly as it can in payments, internationally, supervision, monetary policy, financial stability. You know, think about the very broad mandate of the Federal Reserve Bank of New York, and think about, "How can I help this institution achieve all it can and all those in those various dimensions?" That's how I think about it.