Surowiecki discusses failures of self-regulation

The financial sector has a fundamental problem: It can’t self-regulate.

That was the thesis posed by The New Yorker’s financial columnist James Surowiecki during a talk at UNC-Chapel Hill Tuesday. Surowiecki, a UNC alumnus, traveled to Chapel Hill from his home in Brooklyn to take part in a lecture series presented by UNC’s Parr Center for Ethics.

Surowiecki’s first column for The New Yorker came on the heels of the dot-com bust of 2000, and since then, he has meditated on what has made the financial sector a source of repeated ethical lapses. In his mind, the underlying cause for the failures of 2000 and the Great Recession of 2007 to 2009 was an ideology of self-regulation that simply didn’t work.

“What has happened in the finance industry over say the last 15 years has come as somewhat of a surprise to the people who thought the market would in some ways be able to regulate itself,” he said. “The idea that the finance industry could not supervise itself really runs counter to the ideology that has dominated regulatory thinking over the last 15 to 25 years. The basic idea was that reputational incentives would be enough to keep people in line.”

Repeatedly citing the Libor, London Interbank Offered Rate, scandal, in which bankers easily manipulated unregulated interest rates to make millions of dollars, Surowiecki spoke on wide-ranging factors, such as the ramifications of Alan Greenspan-era deregulation and the behavioral psychology of bankers, that promote cheating rather than reputational caution.

“In the right circumstances, most of us will cheat,” Surowiecki said before citing numerous experiments by psychologist Dan Ariely. “… But bankers, it turns out, cheat more.”

Using Ariely’s work extensively as an example, Surowiecki repeatedly harped on how it is evident that being surrounded by wealth and using abstract representations for money, such as CDOs and moving interest rates, heighten a person’s threshold for cheating.

That urge to cheat was exacerbated by a culture within the banks that focused on short-term rewards, notably incentivized by enormous bonuses that were tied to yearly results rather than long-term ones, he said. With long-term incentives being deemphasized, so were long-term reputational forces that self-regulation relied on.

“The problem was that there was very little counterweight to what [bankers] were doing,” Surowiecki said. The markets themselves did not punish the banks enough to keep them from making bad choices, and regulations weren’t enforced enough to punish those choices either.

Conditions in the banking industry have gotten better, Surowiecki said, noting that recent regulations that require banks to carry more capital makes them more responsible. But he also stressed that bonuses still need to have their importance curtailed and the status of regulators and regulations needs to be elevated to counteract the behavioral norms of Wall Street.

“Finance has really become a huge player in this economy, and despite what happened in 2008 and 2009, there is very little sign that that is actually going to shrink,” he said. “And I think what that means going forward is that solving this problem is one of the more fundamental things that Washington will have to solve.”

Eanes is a senior business journalism student at UNC-Chapel Hill