Don't Underestimate the Effects of Conflicts of Interest II - Oversight by Friends and Those You Trust
Last month, <a href="http://www.cityethics.org/node/543" target="”_blank”">I wrote</a>
about the conflict of interest that led credit agencies to ignore the
risk inherent in mortgage-backed securities. <a href="http://www.nytimes.com/2008/11/23/business/23citi.html" target="”_blank”">A
front-page article</a> in today's New York Times shows how a different
sort of conflict of interest at Citigroup allowed the risks involved in
these securities to be ignored. No crimes, no politics, just plain old
conflict of interest. With an extremely big price tag for our society.<br>
<br>
The Citigroup conflict takes two forms. First, for a while risk
managers (the ones who are supposed to monitor investments and put the
brakes on when the risk is determined to be too high) were reporting
not only to the senior risk officer, but also to the head of trading.
You can't be allowed to manage people who are supposed to be
monitoring you. Or, from the other point of view, you can't be asked to
monitor your boss.<br>
<br>
But another conflict appears to have been more damaging. The senior
risk manager came up through the Citigroup ranks with two men, one of
whom became the head of trading, the other of whom became the deputy to
this man, in charge of trading mortgage-related securities. The
risk manager and the deputy were close friends, commuting together,
fishing together, etc.<br>
<br>
According to the article, this friendship between monitor and monitee
"raised eyebrows inside the company among those concerned about its
controls." People knew that if you wanted to push an especially risky
investment, you went to the deputy, who would convince his friend that
it was a risk worth taking. Considering losses of $65 billion, so far,
there appear to have been an awful lots of risks one friend convinced
the other to allow him to take.<br>
<br>
One former executive from this group told the Times that risk
management "has to be independent, and it wasn't independent at
Citigroup."<br>
<br>
The same thing goes for government. Conflicts of interest can be
extremely damaging when they involve people who are supposed to be
providing oversight. This is true in a number of areas, including
procurement, finance, pensions, bonds, and legal advice. Take
procurement. Politicians will often try to play games with procurement
contracts, but they can do so only if there is no independent person
overseeing procurement, that is, saying no to procurement practices
that don't meet ethical or practical standards.<br>
<br>
This also applies to
consultants, for example, insurance specialists brought in to write or
amend the specifications for the rebidding of an insurance contract. If
such a specialist is somebody's friend or business associate, as so
often happens, the specifications may be skewed toward one or another
broker or company. It's easy to do this when the person overseeing the
process is more interested in the interests of the person who hired him
than in the public interest in getting the best price for insurance.<br>
<br>
But, an official will protest, I'm going to hire someone I trust, not
someone I don't know. But there are two kinds of trust: personal trust
and professional trust. Hiring someone with a record of success and
good recommendations will usually give you someone trustworthy, but not
someone who will do your bidding. Who you trust should not be about who
you know, but who will protect the interests of the public. Even if the
person you know does great work and stands up to you, the appearance
will be that the government is rewarding friends, and the friends are
doing what the official asks them to do.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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