Why Wall Street Breeds So Many Bad Apples

Why Wall Street Breeds So Many Bad Apples

If Wall Street bankers and their regulators are once again under fire, the heat got turned up on Friday. 

At a hearing of the Senate Banking Committee, senators grilled William Dudley, president of the Federal Reserve Bank of New York, which has been criticized for being too close to the financial powerhouses under its jurisdiction. 

“Is there a cultural problem at the New York Fed? I think the evidence suggests that there is,” Senator Elizabeth Warren (D-MA) said. “Either you need to fix it, Mr. Dudley, or we need to get someone who will.” 

Related: Something Is Dangerously Wrong at the New York Fed 

Dudley, who has criticized Wall Street culture, denied there were similar institutional issues or a “long list of failures” at the New York Fed: “I don’t think we have serious cultural problems to the same degree. But are we perfect? Absolutely not.” 

Absolutely not is absolutely right. At Goldman Sachs, a junior banker has been shown the door, fired along with another executive, for improperly obtaining and distributing confidential information about the New York Federal Reserve’s supervision of several banking institutions, including at least one mid-sized bank that was a Goldman Sachs client. 

It’s the kind of behavior that seems to support allegations made by Carmen Segarra, a former bank examiner with the New York Fed who was assigned to supervise Goldman Sachs and later fired, that the relationship between banks and their regulators is just too darn cozy. The Federal Reserve on Thursday said it was undertaking two separate reviews of the manner in which it supervises large banks. 

Segarra filed a wrongful termination lawsuit against the Fed and her bosses, alleging that her dismissal came after she raised concerns at the apparent lack of what she felt was an adequate company-wide conflict of interest policy at Goldman Sachs. The judge dismissed her suit on jurisdictional grounds earlier this year. 

Related: FDIC Says 'Too Big to Fail' Bank Bailouts Could Happen Again

The Segarra story seemed to confirm the worst suspicions that everyone cherished about the relationship between Wall Street and its regulators, and especially between Goldman Sachs and the Fed. After all, wasn’t Dudley formerly the chief U.S. economist at Goldman Sachs and a partner at the firm? Wasn’t one of Dudley’s predecessors in the top job at the New York Fed, E. Gerald Corrigan, now comfortably ensconced at Goldman Sachs? 

And now, here we are, with confidential New York Fed data making its way out of the latter’s fortress-like building and across lower Manhattan to the gleaming towers of Goldman Sachs’s new building and onto the desk of a 29-year old banker, who promptly distributed it to his colleagues to study. The banker, it seems, had been hired to work with the very banks he once supervised as part of a regulatory team. 

Meanwhile, in Washington, other Goldman Sachs executives were in the spotlight for quite another reason, as they underwent another grilling by Congressional lawmakers concerned that the bank’s ownership of a physical commodities business created a conflict of interest problem and gave its traders an unfair advantage in the markets. 

Related: Fed Investigating Bank Conduct in Forex Markets 

So far, there have been no smoking guns in the commodities case; no examples of abuse or illicit dealings. But if any arose, it’s clear that the bank would distance itself very rapidly from the individual or individuals responsible for the problem. It’s never the system that is at fault on Wall Street; it’s always the individual. 

Consider the London Whale trading fiasco that cost JP Morgan Chase $6.2 billion in losses. When the news broke, the bank’s top leadership rapidly identified Bruno Iksil, a trader in the London-based Chief Investment Office, as having put the trades in place. But while later reports faulted the bank and its top leadership for their role in the debacle, Ina Drew, the executive heading up the CIO, simply sought to pin the blame on her underlings

Over and over again, we’ve heard the banks tell us, it isn’t about them, but about a few bad apples. 

But is it? 

As Goldman was tossing the latest bad apples onto the compost heap, some other news hit the headlines. 

It turns out that a group of economists at the University of Zurich began to wonder whether it was the apples or the barrel itself that was the problem. So they created a study to try to measure professional dishonesty, and then tested a group of more than 200 bankers working for a large international bank and some smaller banks. 

According to the results of the study, when they were asked questions before the test that reminded them of their professional identity as bankers, or to focus on stuff like financial success, they were more likely to cheat. There were built-in incentives to cheat — to “win” the game that the economists devised, and earn the $200 prize, they had to have a certain number of “correct” coin tosses; only their honesty stood between them and their ability to capture the prize by lying. 

“Our results thus suggest that the prevailing business culture in the banking industry weakens and undermines the honesty norm, implying that measures to re-establish an honest culture are very important,” the authors wrote. 

Related: CFPB Hits a Bad Bank Where It Hurts 

The study, published in the journal Nature, didn’t even name the big bank involved. Never mind. Already, the American Bankers Association was feeling huffy about the findings. America’s 6,000 banks just wouldn’t do that kind of thing; they “set a very high bar,” the group said. 

Until, of course, there is an institutional incentive to lower that bar. 

That’s pretty much what happened during the years leading up to the 2008 financial crisis, when banks saw little risk and lots of upside in loading up their balance sheets with subprime mortgages and engaging in lots of other risky activities. Of course, we all know what happened next. Citigroup alone required $2.5 trillion in Federal Reserve support through a variety of facilities and programs established in the aftermath of the crisis. 

Late last month, the New York Fed’s own watchdog criticized Dudley’s organization for dropping the ball when it came to scrutinizing JPMorgan Chase. If the New York Fed hadn’t mishandled the reviews of the bank’s operations in 2008, 2009, and 2010, the Fed’s Office of Inspector General said, they might have averted the worst of the problems at the CIO. 

Related: Are Regulators About to Let Another Bank Get Too Big to Fail? 

So is it nurture or nature that determines whether some of those apples turn out to be rotten? Intriguingly, those Swiss researchers discovered that it was the newer hires who cheated more often on their coin toss game. 

Former Goldman Sachs trader Fabrice Tourre was one of hundreds who bragged of selling toxic subprime mortgage securities to “widows and orphans I ran into at the airport.” Tourre’s e-mails boasting of his achievements simply made it into the public domain. Odds are that anyone who found — or finds — that kind of culture or attitude distasteful simply doesn’t stick around for very long. 

Perhaps it’s time for those on Wall Street to sign a kind of banking industry variant of the Hippocratic Oath — a pledge to, first and foremost, do no wrong. It’s a lovely idea, isn’t it? An honesty oath, in which bankers promise not to cheat their clients (and we could ask them not to take the financial system back to the brink of disaster, too). 

The problem is that the bankers cling to the “bad apple” theory, and have no reason or interest in disposing of it. Even when they do have a compelling interest to embrace what is known as a fiduciary standard — in which brokers promise to place their clients’ interests legally ahead of their own and those of their firm — they have resisted strenuously. 

Even if they did take the oath, just imagine the incentive that would exist to cheat on it… 

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