Do Labor Markets Discipline? Evidence from RMBS Bankers

Abstract

In the aftermath of the financial crisis, banks paid record fines for their role in fraudulent RMBS underwriting prior to the financial crisis. These civil actions at the corporate level are predicated on economic theory predicting that firms and labor markets create proper incentives through diminished internal and external job prospects. We find no evidence that senior RMBS bankers at top banks suffered from lower job retention, fewer promotions, or worse job opportunities at other firms compared to their counterparts in other areas of structured finance that experienced no fraud. This result holds for every major RMBS underwriter. Outside of the top underwriters there is some evidence that RMBS employees did relatively worse, potentially due to poor firm performance. We then ask why firms and labor markets did not discipline RMBS bankers. We examine whether banks: (a) disciplined the most culpable employees who directly signed deal documents associated with large amounts of fraud or listed in government settlements, (b) kept RMBS employees only to avoid litigation, (c) disciplined RMBS employees after the fraud was publicly disclosed, or (d) disciplined RMBS employees to a greater extent at banks with larger civil penalties. We find evidence against these hypotheses as complete explanations, and evidence consistent with implicit upper-management approval of RMBS activities. Overall, our findings imply that the record-breaking civil penalties are unlikely to transform bank corporate culture or significantly change perceived individual incentives.

Keywords: RMBS fraud, labor market discipline, financial crisis

JEL Classification: G24, G28, G30