I think I understand the revolving door problem
I was reading this Bloomberg article about the internal risk models at JP Morgan versus Goldman Sachs, and it hit me: I too had an urge for the SEC to hire the insiders at Goldman Sachs to help them “understand risk” at every level. Why not hire a small team of Goldman Sachs experts to help the SEC combat bullshit like what happened with the London Whale?
After all, Goldman people know risk. They probably knew risk even better before 1999, when they went IPO and the partners stopped being personally liable for losses. But even now, of all the big players on the street, Goldman is known for being a few steps ahead of everyone else when it comes to a losing trade.
So it’s natural to want someone from deeply within that culture to come spread their technical risk wisdom to the other side, the regulators.
Unfortunately that’s never what actually happens. Instead of getting the technical knowledge of how to think about risk, how to model a portfolio to squirrel out black holes of mystery, the revolving door instead keeps outputting crazy freaks like Jon Corzine, who blow up firms through, ironically, taking ridiculous risks at the first opportunity.
So, why does this happen? Some possibilities:
- Goldman Sachs promotes crazy freaks because they make great leaders while constrained inside a disciplined culture of calculated risks, but when they get outside they go nuts. This is kind of the model of Mormon children who are finally allowed out into the world and engage in tons of sex and drugs.
- On the flip side, perhaps Goldman Sachs keeps the people who actually understand the technical part of risk very deep in the machine and these guys never get leave the building at all.
- Or maybe, people who understand risk sometimes do go through the revolving door, but they don’t share their knowledge with the other side, because their incentives have changed once they’re outside.
- In other words, they don’t help the regulators understand how banks lie and cheat to regulators, because they’re too busy watering down regulation so their buddies can continuously lie and cheat to regulators.
Whatever the case, for whatever reason we keep using the revolving door in hopes that someone will eventually tell us the magic that Goldman Sachs knows, but we never quite get anyone like that, and that means the the SEC and other regulators are woefully unprepared for the kind of tricks that banks have up their sleeves.