Your humble blogger must confess to being partly wrong about the Fed’s recent realization that banksters had learned the right lesson from the crisis: crime pays. We were incredulous that the central bank had missed the fact that financial firm employees were unrepentant and their executives saw no reason to make real changes (hence all the howling about reform measures that are pretty minor relative to the damage done). From a recent post:
This story would be funny if it weren’t so pathetic. Yesterday, the Financial Times reported that the New York Fed woke up out of its usual slumber and realized that the crisis has changed nothing and that banks still
are in the business of lootinghave unaddressed ethics issues.
The Federal Reserve Bank of New York is stepping up pressure on the biggest banks to improve their ethics and culture, after investigations into the alleged rigging of benchmark rates led officials to conclude bankers had not learnt lessons from the financial crisis…
Fed officials were surprised that some of that reported behaviour occurred after the 2008 crisis, leading them to believe bankers had not curbed their poor conduct.
To make sure the biggest banks are paying enough attention to ethics and culture, NY Fed bank evaluations have begun incorporating new questions emphasising such issues. Topics include whether the right performance structure is in place to punish bad behaviour, especially when it comes to compensation.
Back to the current post. In fact, the Fed is not wrong to focus on compensation, as well as promotions (which were not mentioned). Anyone who has lived in an organization will tell you that who moves ahead (and money and rank are the key indicators) tells you what the company really values, not what it professes to value. For instance, most corporations exhibit what I like to call “big producer syndrome,” where people who deliver enough in revenues (most often, top salesmen) are allowed to break rules, often flagrantly (the most common misconduct seems to be expense abuses and sexual harassment). But having polite conversations with the banks about these topics was hardly going to have an impact, particularly when some of the most flagrant rule-breakers run the firms (think Jamie Dimon’s Sarbanes Oxley violations and misrepresentations to investors and Congress during the London Whale fiasco).
The Fed is a bit more serious about trying to get the banks to shape up than we had assumed. The pink paper, halfway through an article on how the Fed is dealing with non-bank systemically important financial institutions (SIFIs) like AIG and GE, had this surprising tidbit:
Fed officials are also involving themselves in the kinds of decisions that company management or board directors usually make, including whether employees should be fired or disciplined, which has been surprising, according to some people familiar with the process.
“The Fed is being very intrusive,” said one of these people. “It’s been much more intense than people expected.”
On the one hand, it’s great to see the Fed stepping up and starting to act like a real regulator. On the other hand, banks have become so wedded to their predatory ways that this sort of pressure will only at most make a minor dent in the problem.
For instance, in the late 1980s, when a number of leveraged buyout deals crashed and some raiders like Paul Bilzerian were convicted, Harvard Business School faculty went through some soul-searching over their role in producing some of the financial buccaneers responsible for the wreckage. After a good bit of study, they concluded that teaching ethics was not terribly effective. By the time students were old enough to apply to Harvard Business School, their value systems were formed and not terribly susceptible to influence.
If you accept that view, which seems sound, that means that getting banks to throw out or demote miscreants is a start, but way short of sufficient to achieve culture change. These firms need leaders that will embody and enforce new norms. In most organizations, that means making significant personnel changes at the top of these firms. That’s why, as most readers recognize, the failure to deal harshly with the management of of the banks that drove themselves and the global economy off the cliff was a huge missed opportunity. The boards and most of management needed to be turfed out. The idea that they could not be replaced is a canard. My God, Citi put Vikrim Pandit in charge, a man with no experience in running an operation of that scale and who had no knowledge of retail banking or operations. Sheila Bair, in her book Bull by the Horns, makes it clear she thought Pandit was not up to the job and should have been replaced, but was unable to get him ousted. There were plenty of senior bank executives who’d retired earlier than they liked or otherwise might have been up for a few year stint to see the bank through the post-crisis period and groom a new leadership team.
And as the American public knows well, another way to influence bank behavior would have been prosecutions, or at least heavy fines of executives. Again using Citi as an example, the CFO Gary Crittenden was fined a mere $125,000 for keeping $40 billion of CDOs off the balance sheet. Huh? And that’s before the fact that just about no one save one former Countrywide exec was roughed up at all for all of the subprime lending fraud. And the officialdom has been so desperate to cover up chain of title issues that it has had even less interest in pursuing widespread foreclosure-related misconduct.
So even if the Fed thinks it is now being serious, its blinkered view of what rises to the level of being an abuse, plus its timidity about roughing up top bankers means its interventions fall short. But it is surprise to outsiders that Fed remains so badly captured that it is unable to recognize how much change is really needed.