Cecchetti & Schoenholtz:
Conflicts of Interest in Finance: ...Financial corruption ... is ... widespread... The corruption exposed in recent years is breathtaking in its scale, scope, and resistance to remedy. We have seen traders collude to manipulate LIBOR ... and the foreign exchange (FX) market... We have seen firms facilitate tax evasion and money laundering. We have seen financial behemoths taking concentrated risks that undermine their capital and their funding, threatening the financial system as a whole until they are bailed out by public support. And we have witnessed what are arguably the largest Ponzi schemes in history (see our earlier post).
The policy response also has been wide-ranging. Congress enacted the most far-reaching financial reform since the 1930s. Regulators leaned on financial firms to diminish risk-taking incentives in their compensation schemes. Prosecutors, regulators and private litigants obtained ever-larger pecuniary settlements – the total since 2009 is now approaching $200 billion.
Previously frustrated by the “too big to jail” taboo (following the 2002 collapse of Arthur Andersen), in 2014 prosecutors again moved beyond simply seeking monetary settlement without admission of guilt and charged a bank with criminal behavior. They are also pursuing individual traders in the LIBOR and FX scandals in the criminal courts. Finally, leading regulators are openly warning the largest U.S. institutions that a failure to improve their ethical culture could lead policymakers to seek a dramatic downsizing of their firms to ensure financial stability.
So far, the most obvious response from the financial sector has been on the employment side: firms have hired or will hire thousands of compliance officers and risk managers to police the behavior of their employees (see here, here, and – if you have Wall Street Journal access – here).
We will be delighted if these reforms work to reduce corruption dramatically, but we remain skeptical. ... What to do? The only major alternatives we see are either to break up large institutions into smaller ones with restricted scope, to hold individuals more accountable, or some mix of both. ... Our preferred approach emphasizes a version of the second remedy: hold managers collectively more accountable for the actions of their firm. ...
One can hope that with their financial solvency really at stake, managers would become more aggressive in policing behavior inside of their organizations. Either that, or they will simply refuse to engage in activities where conflicts are most likely to arise. So much the better.
Unfortunately, there exists no panacea for containing conflicts of interest. ...
[I cut quite a bit from the original.]