Academic journal article Atlantic Economic Journal

A Theory of How and Why Central-Bank Culture Supports Predatory Risk-Taking at Megabanks

Academic journal article Atlantic Economic Journal

A Theory of How and Why Central-Bank Culture Supports Predatory Risk-Taking at Megabanks

Article excerpt

We know that the "executive culture" values returns for stockholders, which creates problems of social responsibility ... (Schein 2010, pg. x)

Recent months have surfaced an intense exchange of top-level finger pointing, both between Congress and the leadership of the Federal Reserve System, between Fed officials and executives in the private sector (McGrane 2015; Dudley 2014) and within the Fed between the Board of Governors and the New York Reserve Bank (Hilsenrath 2015). This intrasectoral in-fighting responds to a growing concern that post-crisis strategies of re-regulation may be increasing regulatory costs in industry and government, without doing much to increase either financial stability or the flow of real investment.

The analysis presented here interprets the finger-pointing not just as exercises in blame avoidance, but also as evidence of the dysfunctional way in which three intertwined segments of the financial sector "help" one another to carry out their respective tasks. The networks I have in mind consist of: (1) giant financial institutions, (2) federal financial regulators, and (3) advocacy and avoidance intermediaries such as Sullivan and Cromwell and the Promontory Group. Blending ideas presented in Kane (2006) with those of Schein (2010) and Gladwell (2008), the first half of this paper uses the methods of cultural anthropology (1) to develop hypotheses about deep-seated assumptions that these networks share, assumptions that in some respects incentivize supervisory behavior (such as too-big-to-fail capital forbearance) that conflicts with the espoused missions and goals of federal regulators. The second half offers a plan for mitigating this conflict by codifying and servicing taxpayers' implicit equity stake in difficult-to-fail organizations.

Applying Schein's Model of Organizational Culture to Executive Cultures in Finance

Organizational cultures are conditioned by the larger national and professional cultures to which their members belong (Aggarwal and Goodell 2014). According to Schein (2010), any culture should be studied at three levels: the level of its observable artifacts, the level of its professed beliefs and values, and the level of the unspoken beliefs and underlying assumptions that its members share. Although reforms can change the character of the first two levels relatively quickly, shared beliefs are difficult to change because they are drilled into participants until they imbed themselves in the very ways that members conceive of their work.

Capital standards, liquidity requirements, and stress tests are observable artifacts, strategic policy instruments, of financial regulatory cultures around the world. Their emergence as important instruments is supported by an irrational belief that advocacy and avoidance specialists will set aside their loyalty to private clients and their culture of value maximization to help them to design policies tough enough to minimize opportunities for regulatee avoidance. For example, having established an effective oligopoly, it would be against the financial interest of the Big Three accounting firms to set standards that could measure mega-institution leverage and other risk exposures accurately enough to allow various balance-sheet ratios to function consistently as reliable proxies for a firm's risk of ruin.

This paper argues instead that the extent of accounting trickery embraced by any mega-institution must be expected to surge as its risk of ruin increases. The likelihood that regulatory standards will be enforced closely in times of distress is undermined by time-tested assumptions (particularly metanorms of regulator helpfulness and information suppression) that distort the measurement and enforcement of leverage requirements throughout the cycle, making regulators slow to discipline industry efforts to innovate around requirements during booms and quick to help firms when they experience problems in rolling over their liabilities during downturns (Kane 2015). …

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