By James Kwak
Last week Peter Eavis of DealBook highlighted a statement made last year by New York Fed President William Dudley (formerly of Goldman Sachs, then a top lieutenant to Tim Geithner): “There is evidence of deep-seated cultural and ethical failures at many large financial institutions.” There was a point, say in 2008, when many people probably thought that our largest banks were just guilty of shoddy risk management, dubious sales practices, and excessive risk-taking. Since then, we’ve had to add price fixing, money laundering, bribery, and systematic fraud on the judicial system, among other things.
Eavis also tried to make something positive out of a couple of other recent comments. Dudley said, “I think that trust issue is of their own doing—they have done it to themselves,” while OCC head Thomas Curry said, “It is not going to work if we approach it from a lawyerly standpoint. It is more like a priest-penitent relationship.”
I don’t see much reason for optimism. First, framing the problem as a “trust issue”—customers no longer see banks as trustworthy institutions—is beside the point. Wall Street’s main defense is that its clients already realize that investment banks do not have their buy-side clients’ best interests at heart, and clients who don’t realize that are chumps. And in the wake of the financial crisis, I suspect there are few individuals out there who believe that their banks are there to help them. The banking industry has discovered that it can thrive without trust, which is not surprising; retail depositors trust the FDIC, and bond investors know that trust isn’t part of the equation.
Second, when an entire industry shows a deep proclivity to flaunt the law, it’s distressing that one of its top regulators sees himself more as a priest than as a lawyer. With a priest, the presumption is that the congregant actually wants to be saved, and therefore will listen to the priest. Wall Street banks just care about profits, which is only natural. Once they’ve learned that they can be profitable without being ethical, there’s no turning back. The only way to change the equation is to make lawbreaking unprofitable, which means serious penalties, both civil and criminal.
In that vein, the SEC is especially proud of a judge’s decision last week to impose an $825,000 fine on Fabrice Tourre, the Goldman employee implicated in the ABACUS deal. The SEC’s enforcement director claimed that the penalty reflected “the S.E.C.’s intent of pursuing meaningful sanctions to punish individuals responsible for misconduct and deter others from violating the federal securities laws.” If only.
That is a meaningful sanction, particularly because the judge prohibited Goldman from covering Tourre’s penalty of $650,000. I doubt, however, that she could stop Goldman employees from individually gifting cash to Tourre. And, if they have any kind of sense of fairness, they should start passing the hat—because Tourre was the only one out of probably thousands of people engaged in similar behavior who got busted. Which means that, if you want to structure deals so they are likely to collapse and lie about it to your buy-side clients, the odds are spectacularly in your favor. More important, if you are a senior executive and you want to pressure your employees (including by promising them huge bonuses) to structure deals that are likely to collapse and lie about it to your buy-side clients, the odds in your favor approach certainty.
Talk is cheap. But ultimately, it’s hard to see how anyone’s behavior is going to change with the regulators we’ve got.