The problem, of course, with such narrow attributions of blame is that the overall financial system and its regulatory architecture get absolved. We need not worry about the system; we just need to root out the evil-doers. And since there are not very many of them, we might as well wait until something goes wrong. So ultimately, the “bad apples” theory becomes an argument for both lax regulation and lax enforcement.
But such thinking is quite damaging for financial security. First, it is important to remember the entire aphorism about apples: a few bad apples will rot the whole barrel. Without scrupulous enforcement of laws and regulations, the bad apples earn competitive advantages over the other apples – which invariably lead to a greater bad apple market share or the corruption of good apples. Second, changes in the structure of the financial system have made it easier to survive as a bad apple. As financial firms grow in size and complexity, it becomes much harder for large financial firms to monitor activities of their employees. But more importantly, the firms have little incentive to do so. This neglect of supervision allows executives the opportunity to deny any complicity and (you guessed it) blame problems on a few bad apples.
So why do our political leaders promote the bad apple approach? Much of it has to do with social acceptance of white-collar crime. Prosecuting Wall Street doesn’t generate the electoral rewards that come from going after street criminals. In particular the financial sector’s wealth and political connections inhibit pursuing Wall Street. But there are limits to such explanations. The government has aggressively prosecuted certain financial crimes such as insider trading. The SEC charged Steven Cohen of SAC Capital with the “failure to supervise” employees who were engaged in insider trading. That is about as close as the government gets to blaming the barrels.
When it comes to large financial institutions, the government’s approach has been less aggressive. Investigations, civil and criminal, have tended to focus on specific bad low-hanging apples such as Goldman’s Fabrice Tourre or the specific traders involved in the manipulation of the Libor index. In these cases, no higher up was charged with “failure to supervise.” Nor does it appear that prosecutors tried to leverage their investigations of the lower level employees for evidence of organizational complicity (as they would have if it were a drug gang rather than a bank). In civil cases, the Department of Justice and regulators have tended to settle for modest fines and no admissions of wrongdoing (a federal judge threw out one of these “no fault” settlements only to have his decision overturned on appeal).
In our view, large financial firms have received such favorable treatment because they are TBTJ (too big to jail). Despite the attempts at financial reform that were designed so as to minimize the damage of the failure of a single financial firm, politicians and regulators still act as if their first priority is to protect large banks. Criminal investigations of firms and high-level executives are too risky as they might result in the loss of a banking license which would force liquidation. Civil fines large enough to deter financial shenanigans are eschewed because of the damage they could do to balance sheets. With reference to UBS in the Libor scandal, Assistant Attorney General Lanny Breuer aptly commented, “Our goal here is not to destroy a major financial institution.” The resulting forbearance undermines the accountability of large firms to the law.
This brings us to this week’s announced settlement between the government and JP Morgan. Is this the end of the bad apples taboo? Perhaps not. In absolute terms, the size of the settlement is staggering. But even at $13 billion, it represents just slightly more than half of the bank’s annual profits and only 50 percent more than what it has so far paid out in compensation so far in 2013. And a large part of the government’s settlement will go to compensate potential private litigants that JP Morgan probably would have wound up paying anyway. And after tax deductions, the $13 billion may well be only $9 billion. Investors seem nonplussed as JP Morgan’s stock price has barely budged from where it was before word of the settlement leaked. But if there is one silver lining for those who would like to see accountability restored, it is that Attorney General Eric Holder refused to end criminal investigations as part of the settlement. But it is still too early to know if this will be the start of turning over the whole barrel. It’s easier to turn over a small barrel than a big one. So enforcement and monitoring problems are yet another argument for breaking up the big financial institutions.