An investigation into why federal regulators failed to detect the dangerous trading practices at JPMorgan Chase reveals a dilemma that has not gotten enough attention. The examiners have to get close to the banks they regulate or else they won’t understand what they are doing or why. On the other hand, if they get too close, they will inevitably get sucked into identifying with them. If that happens, they can either fail to see the danger or they will discount it.
According to The New York Times, the New York Federal Reserve Bank “in mid-2011 replaced virtually all of its roughly 40 examiners at JPMorgan Chase to bolster the team’s expertise and prevent regulators from forming cozy ties with executives."
“But”, the Times went on, “those changes left the New York Fed’s front-line examiners without deep knowledge of JPMorgan’s operations for a brief yet critical time.” Enough time, apparently, for traders at the bank to lose at least five billion dollars. (See, "Regulators’ Shake-Up Seen as Missed Bid to Police JPMorgan.”)
The dilemma is familiar to virtually all professionals. As “participant-observers” we become part of what we need to understand, while trying to maintain the detachment essential to seeing clearly. Certainly as a psychologist I feel it all the time. I have to get close to my clients to understand them and to empathize with the meaning and motives behind their actions. At the same time I have to maintain sufficient objectivity to see the dangers in what they do and feel free to speak up about them.
“Cozy ties” with clients are not only inescapable in a professional relationship, they can be a vital source of information. As a psychologist, what a patient wants me to see about him tells me a great deal about who he feels he needs to be, how he needs me to think about him in order for him to feel safe. Moreover, how he maneuvers and manipulates our relationship offers clues to what he want to obscure about himself not only from me but from his own consciousness.
It has to be the same with bankers and fund managers, and not just because they want to evade oversight. They have their own unconscious desires to believe in their success and to fear their failures, and they want those who scrutinize their actions to share those convictions. Those are not malevolent desires, but normal human impulses.
The secret to seeing what no one wants you to see is being willing to make mistakes and to learn from them. It’s a skill, and it requires continual effort and self-knowledge. Replacing examiners who make mistakes rather than training them to learn how they made them is just the wrong way to go about it. They need to better detect the signals they missed and reflect on their vulnerability to collusion,
We are not machines whose “defective” parts can be simply replaced. We have to learn from experience, and enlarge our consciousness in order to be more effective. Indeed, bringing in new examiners who haven’t made those mistakes is almost certainly a way to increase the likelihood that the same mistakes will be repeated.