Goldman Sachs' Revolving Door: Regulatory Capture

In July 2012, Andrew Williams, a former spokesman for U.S. Treasury Secretary Timothy Geithner, announced plans to head over to Goldman Sachs at the end of that month.[1] Williams was the second of the Secretary’s spokesmen to head to theWall Street bank. Such moves may reflect a standing policy at the bank to have a revolving door. The previous U.S. Treasury Secretary, Henry Paulson, had been the CEO at Goldman. This suggests that the revolving door was to include populating high offices in government, presumably not out of a sense of civic duty, but, rather, to see that Goldman's interests would be protected and even promoted through public policy. Hence President Obama was said to have had a Wall Street government with respect to positions bearing on Wall Street. I submit that deconstructing such a revolving door would be very difficult. 

From the standpoint of a government official being hired by Goldman, the prospect of becoming wealthy is a large incentive to make the jump. Such an official would typically have scruples about using his contacts in government to pull strings for the bank. Mired in scandal following the financial crisis of 2008, Goldman’s leadership no doubt understood the value in hiring good PR men. Such hires could even put a good face on the cozy relationship between the bank and people still in government.

The “revolving door” dynamic is also difficult to break up because it contributes toward the capture of regulators by the regulated. This is known as regulatory capture. The regulated companies supply information that regulators need in order to devise regulations; the companies can use this reliance to their advantage even just in providing tainted, self-serving data. Moreover, the revolving door can make it easier for the managements of the regulated companies to get even high government officials to put political pressure on the regulatory agencies to go soft on regulating. In the case of Goldman Sachs, it is reasonable to expect that Henry Paulson would have bent to the bank's request for lax regulatory oversight from the SEC, which of course had no idea how many subprime-mortgage-derivative bonds Wall Street had been producing and selling up to the financial crisis of 2008. 

 

The SEC can be soft on Wall Street and point to insufficient staffing as the reason, while the reality is far more sordid in terms of the relationship between the regulators and the powerful regulated. 

Legislated restrictions on former government financial officials going to Wall Street banks could of course be circumvented, given the incentives described above, though prohibiting employment (or financial enrichment, such as by consulting) in the industries related to an official's area for many years seems possible. Even if Goldman Sachs could not hire away Treasury or SEC offiicals, the bank could still count on ex-Goldman folks who occupy key offices in the U.S. Government. 

Generally speaking, the financial and related political power of such huge aggregations of wealth such as a Wall Street bank has (and is) naturally overpower weak governments, by which I mean governments that depend on or do not have the will to resist the allure of money (or threats) from entities subject to the government. A government whose elected officials must rely on large sums of donated money just to get reelected is ripe for succumbing to corporate offers with strings attached. A strong government is insulated, whether by law, will, or power generally from such strings. A government that has many points of access (of influence) is likely to be weak in not only rebuffing pressure to reduce taxes and spend more, but also standing up to large corporations. A government in a pro-business society is likely to be weak with respect to the power of business, other things equal. Even more significant than these variables, however, is the tenuous basis of representative democracy amid Wall Street bewindowed towers. 

1. Bonnie Kavoussi, “Andrew Williams, Ex-Treasury Spokesman,Headed to Goldman Sachs,” The Huffington Post, July 12, 2012. 

Undermining the Dodd-Frank Act: An Incessant Desire for Profit

In the Dodd-Frank financial reform Act of 2010, financial firms in the U.S. are required to set aside higher reserves to cover losses on trades of securities, including those that “swap” the risk of default of a given security, such as bonds based on subprime mortgages. Almost immediately, the Wall Street bankers set about minimizing the new hindrance.  
Traders in the banks set about getting around the “margin requirements” by treating the “swaps” as futures, which do not require the higher reserves in Dodd-Frank. Whereas a futures contract for corn to sell at a certain price limits residual risk, swapping the risk of the default of an investment puts a party on the line for the entire investment. Moreover, unlike futures contracts, swaps have significant systemic risk because claims can all be made at once, overwhelming the parties assuming the liability in the swaps (e.g. AIG in September 2008). 
Managers at Wall Street firms have tended to not only minimize safeguards even though they protect the banks (from themselves), but also discount or even dismiss such high-risk, low-probability outcomes as come with risk to a bank as well as the entire financial system (i.e., systemic risk). Meanwhile, less money held in reserve means more money available to be lent or put into high-risk investments such subprime mortgages or bonds based bundles of such high-risk mortgages. 
Accordingly, the gradual trajectory already as of the beginning of 2013 was toward yet another systemic collapse of the financial system should enough housing markets take a down turn. “As the market gravitates to the cheaper platform—and it’s cheaper because it’s unsafe—that creates risk for everyone,” said James Cawley, CEO of trade execution firm Javelin Capital Markets.[1]  Put another way, market participants were operating according to the greatest profit, the greater risk notwithstanding. “In a distress scenario, you basically have what you had from AIG in 2008,” Cawley said; “Then someone has to step in, and we all know who that someone is: the U.S. taxpayer.”[2] So the question at the time was perhaps whether the SEC had the taxpayer’s back or was reflective of, or enabling a cozy revolving door between the federal government and Wall Street firms.
To be sure, the Volcker Rule, part of the Dodd-Frank Act, would, unless weakened, bar banks from short-term proprietary trading (i.e., on their own accounts, except for market-making), and from taking ownership states in private equity funds and hedge funds. U.S. Senator John Hatch speaking at Jack Lew’s confirmation hearing in early 2013 raised the question of whether Lew would act as U.S. Secretary of State to constrain banks’ risky proprietary trading, given that he had headed units at Citigroup that were involved in just such practices that would violate the Volcker Rule. 

Jack Lew at his confirmation hearing for U.S. Treasury Secretary. Lew had been the chief operating officer at units at Citibank.     NPR

Lew had been the COO of Alternative Investments at Citi. MAT and Falcon investment funds were sold as low-risk even though those funds were actually hedge funds with high risk.  As COO, Lew refused to offer the misled customers full refunds.  At least fourteen arbitration panels subsequently gave the customers the full refunds they had sought. Although he had not been involved in selling the funds, he did manage units that engaged in risky proprietary trading. The public would be justified in wondering if they too would be left on the hook as taxpayers rather than protected should Lew favor Wall Street's incessant desire for profit over the government's role to place that desire in check for the good of the system/whole.
After Lew, during President Trump's first term, the Federal Reserve Bank voted unanimously in late May, 2018 to weaken the Volcker Rule. The move was consistent with the president's desire to deregulate Wall Street. The flip side of the move that would enhance Wall Street profits was that the government would be doing less to protect the financial system as a whole even though the systemic risk of the largest five banks had increased with their growth. As Senator Dick Durbin had said after the financial crisis when people were looking to Congress to protect even the banks from themselves, “Congress is owned by the banking lobby.” So looking to the legislative branch should the executive be in sync with Wall Street's financial interests may not play well. Even after semi-stringent regulatory constraints have been passed, Wall Street can still have the edge in circumventing or mollifying the speed-bumps even though they are in the bank's own long-term interest, which can come to roust even in the short term as in 2008.

See Essays on the Financial Crisis, available at Amazon.

1. Eleazar Melendez, “Wall Street Setting Itself Up For Next Derivatives Crisis, Market Participants Warn,” The Huffington Post, February 14, 2013.
2. Ibid.