The Fed’s Culture War

CAMBRIDGE – At a closed-door conference attended by senior bankers, regulators, and some academics, Federal Reserve Governor Daniel Tarullo and Federal Reserve Bank of New York President William Dudley used their bully pulpit to do something unexpected. Instead of focusing on how to bolster bank stability – channeling more capital toward the largest institutions, curbing their riskiest activities, and determining how to manage a failing bank without bailing it out – the officials discussed the bankers themselves.

Tarullo focused on managerial misbehavior, arguing that managers who do not comply fully and willingly with regulations should face tougher sanctions than they do now. Instead of blaming “a few bad apples” for wrongdoing, he insisted, institutions should implement controls that prevent “bad apples” from poisoning the organization. To this end, organizations should embed respect for law, regulation, and the public trust in internal compensation systems.

Moreover, Tarullo cited criminal prosecution and imprisonment of individuals as the most effective way to deter illegal conduct, such as breaches of antitrust law. Of course, as he acknowledged, prosecuting an individual for such violations is difficult, because regulators lack criminal enforcement powers, evidentiary hurdles are high, and the circumstances are often uncertain. But regulators have not taken enough advantage of the authority that they do have to punish errant managers: they can ban these individuals from working in finance.

According to Tarullo, a few well-chosen “bans from banking” could change the financial industry for the better. He urged bank boards and senior executives to preempt such bans by firing highly problematic managers publicly, rather than sending them quietly out the back door. Public executions would deter the rest of the organization from bad behavior.