I finally got around to listening to This American Life’s radio piece about Carmen Segarra and her secret recordings while working for the Federal Reserve Bank of New York. Even if the subject of financial regulation doesn’t typically blow your socks off, I’d highly recommend listening to the podcast, which features TAL’s typically tremendous mix of information and entertainment. At the very least, read the transcript.

The episode is about something called “regulatory capture”, which is a phenomenon we see in a lot of industries, particularly finance and banking. As the piece puts it, regulatory capture is a lot like when there’s “a watchdog who licks the face of an intruder and plays catch with the intruder instead of barking at him”.

Why does this happen? We often point to the “revolving door” separating industry and regulation, where people bounce back and forth between the private sector and the regulatory agencies, dulling their incentive to be tough on the companies they’re regulating now but might work for in the future. But the piece seems to suggest there’s something more purely psychological than that at play.

In this case we zoom in on the career of Carmen Segarra, who joined the New York Fed after the 2008 financial crisis as part a push to hire talented, tough-minded people who’d be less likely to be captured. Segarra fit the profile, as a lawyer with a decade of experience in the legal minutiae of complicated banking deals, as well as degrees from three different Ivy League universities and proficiency in four languages. And perhaps most importantly, she was idealistic about her job as a bank supervisor after witnessing the destruction of the crisis first-hand.

But something went wrong early on in Segarra’s time at the New York Fed. Her bosses and colleagues routinely pushed back against her when she started to get tough on the bank she was assigned to supervise, Goldman Sachs. She found this so troubling they she began secretly recording her various daily conversations on the job, with those recordings eventually constituting the basis of the piece.

What’s unique about this story is that, because of the recordings, you can actually listen to the interactions between the bank staff and the NY Fed employees charged with supervising them, and get a feel for what regulatory capture looks like (or at least sounds like) in real life.

The most remarkable part of the story, from my perspective, is when Segarra and her colleagues raise the issue of a shady, though not explicitly illegal deal between Goldman and another bank, one that appears intended to inflate artificially the amount of capital on the books of the second bank in an effort to escape regulatory scrutiny.

The NY Fed’s team assigned to Goldman calls a number of the bank’s executives in for a meeting to explain the deal. Prior to that meeting, as the NY Fed team prepares, there’s an excitement in the air as the team members talk about putting a scare into the bank in the meeting, such that it will think twice about ever engaging in this type of deal in the future. In particular, they plan to drill Goldman’s staff as to why a particular requirement of the deal — an acknowledgement of “no objection” by the NY Fed itself — wasn’t met. And yet, when the meeting finally takes place, we hear clearly from the audio that there is no drilling, there is no pressure, only a whimper and an almost apologetic, passing inquiry into this missing requirement. That’s it.

Really, there’s no way this description can capture what this moment actually feels like. Once again, you need to hear this for yourself to really get it.

So back to the question, Is there something else besides the “revolving door” phenomenon that causes regulatory capture? The answer is clearly Yes. But what?

My best conjecture is that, for a person in a regulatory capacity, standing up and blowing the whistle on a big, powerful investment bank is the equivalent of standing up to your high school bully. That high school bully is big and broad shouldered. He’s a star athlete. He gets the girls. He doesn’t even really need to exert physical force to push you around, and or even be mean. After all, though you fear him, you also long for his approval. Maybe if he puts his arm around you and tousles your hair, you figure some of that magic might just rub off on you. It’s easy to stand up to such a bully in the mirror before bed in the privacy of your own bathroom. But when it’s time to look him in the eye, somehow a lot of the courage and strength you thought you’d muster just doesn’t seem to be there.

I’ve never been a regulator, and I’ve never been a banker. But I have worked in both the Federal Reserve system and in the investment banking industry at different stages of my career, and I can certainly attest to the enormous chasm between the two in terms of culture.

When I got my start out of college working in the research department of one of the Federal Reserve Banks (not New York), the official work week was 37.5 hours. Long lunches and coffee breaks were the norm. The people there were brilliant and we were all doing good work, but the stress level was practically nil. And I am hard pressed to think of more than one or two people I worked with that I would characterize as having “A-type personalities”.

Working on an investment bank trading floor is almost the polar opposite. I now wake up at 5:30am, and when I arrive at my desk most of my colleagues are already there. The F-word is used liberally by almost every one, including middle-aged moms with pictures of their kids on their desks. When a trader screams and slams his fist against the desk after a trade falls through or the market moves against him, it barely attracts attention. Spending hundreds or even thousands on a client dinner is ordinary.

No wonder, then, that when these two cultures collide, the dynamic produced so closely resembles high school. Once again, the actual act of bullying isn’t necessary for that dynamic to arise. What else should we expect when we put a bunch of well-paid, sharply-dressed, aggressive-minded go-getters in a room with, for lack of a better term, nerds?

If you quintupled the salaries of all those working for regulatory agencies while slashing pay for bankers, of course, a lot of these “capture” issues would vanish. The personnel would essentially flip as the A-type people chased the money. Fairly quickly, the entire regulatory system would be stocked with strong-minded, no-nonsense overachievers like Carmen Segarra. In that scenario the regulators, not the bankers, would be the broad-shouldered varsity athletes with the pretty girlfriends.

But that’s not going to happen, not in a world when public budgets are already strapped (ironically as a result of a banking crisis), and every extra dollar spent by government* risks virulent criticism in the news media. And anyway, I’d suspect that overloading the regulatory agencies with well-paid, hyper-aggressive individuals would create a new kind of bullying problem.

So, what are we left with? I’d say what may be missing from the regulatory capture discussion is the strategy so frequently used in schools: education. Anti-bullying efforts in schools are about more than just stopping the jocks from stealing the scrawny kids’ lunch money. They’re also about creating a culture of inclusion and mutual respect in which bullying, hazing, and other destructive social behaviors can’t get traction.

I’m not saying that people in banking need more compliance training modules. If you work in the industry, chances are you’re already drowning in these already. But this type of education is technical in nature, intended mostly for the banks to cover their own rear ends; employees are simply drilled on the rules, and warned about the consequences we bring upon the banks we work for if we violate them. I think what’s missing is some discussion about the systemic need for regulation in the first place, or about the civic responsibilities of the banks and their employees. In other words, both sides — not just the regulators — need to recognize the importance of the other’s work. Banks’ focus should remain squarely on making money, but there should also be some acknowledgement of the indispensable role of regulation, namely to make sure that the golden goose is healthy enough to keep pumping out eggs.

This may sound too airy-fairy for some. Let me make clear that I’m all in favor of technical solutions. For one, simply shrinking too-big-to-fail banks would seem logical to me. But this powerful technical solution may never become a reality. And in the meantime, we’ve now experienced firsthand the difficulty that regulators have in forcing banks to obey the rules, especially when those rules are ambiguous. As long as the fundamental relationship between industry and regulation remains adversarial in nature, one in which companies push the envelope as far as they can within the hazy boundaries of the law, that relationship will stay broken. After all, a high school principal can only do so much to police the bullies. At some point, we’ve got to think about making sure kids don’t become bullies in the first place.

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*The Federal Reserve Banks aren’t government agencies, but private organizations created and given a mandate by Congress.