One could provide many further examples of this kind.
The congressional hearings produced not only widespread revulsion but a clear, widely shared sense that there was an awful lot of lying going on. There have been no prosecutions for perjury.
Sarbanes-Oxley Violations (Civil and Criminal)
The Sarbanes-Oxley Act establishes a variety of requirements for CEO and senior management conduct and also establishes criminal penalties for certain violations. CEOs and CFOs of public companies are required to certify their companies’ financial statements and tax returns, and also to certify the adequacy of the firms’ internal controls for accurate financial reporting. The SEC is responsible for establishing regulations in these areas and can pursue civil cases for violating them. But the law also provides for criminal penalties, including up to ten years in prison, for knowingly certifying inaccurate financial statements, destroying records, or retaliating against a whistle-blower for contacting law enforcement authorities.
We have already seen the level of misrepresentation in loan portfolios, prospectuses, investor presentations, and so forth. We have seen the inadequacy of internal due diligence and frequently the deliberate suppression of such due diligence, with regard to loan quality, and also with regard to how nonconforming loans were handled—many were securitized in conscious violation of internal guidelines. Does this bespeak adequate internal financial controls? We also know, of course, that both lenders and securitizers were wildly inaccurate in their valuations of loans, of CDOs, and of their own financial positions. How much of this was known to their CEOs? The answer cannot be none. Indeed, we already have considerable public evidence that suggests the contrary.
Consider Citigroup. One day after Richard Bowen sent his e-mail to four senior Citigroup executives including its CFO and vice-chairman Robert Rubin, Citigroup’s then-CEO Chuck Prince signed the firm’s Sarbanes-Oxley certification. Three months later, after Prince was replaced by Vikram Pandit, the Office of the Comptroller of the Currency sent a letter, addressed to Pandit personally, explicitly warning him of major deficiencies in Citigroup’s financial reporting and controls. Eight days later, Pandit signed his first Sarbanes-Oxley certification for Citigroup. Over the subsequent two years, Citigroup lost billions of dollars more as its earlier securities valuations proved inaccurate.
Or consider AIG. What do we think of AIG’s financial controls in late 2007 and 2008, particularly after AIGFP’s internal auditor resigned in protest after warning AIG’s chief auditor that he was being blocked from doing his job? And what do we think of Richard Fuld and his CFO, Erin Callan, signing off on Lehman Brothers’ accounting statements in 2008?
Indeed, Lehman provides particularly direct evidence, not only through disclosure of the Repo 105 accounting trick, but also through the actions of an internal whistle-blower. Matthew Lee was Lehman’s senior vice president with responsibility for overseeing the firm’s global balance sheet. On 16 May 2008, Mr Lee delivered a letter by hand to four Lehman executives: Martin Kelley, Lehman’s controller; Gerald Reilly, head of capital markets product control; Christopher O’Meara, chief risk officer; and Erin Callan, the CFO.38 Lee begins his letter by noting that he had worked for Lehman since 1994, and had been a “loyal and dedicated employee”. He then continues:
I have become aware of certain conduct and practices, however, that I feel compelled to bring to your attention . . .
I have reason to believe that certain conduct on the part of senior management of the firm may be in violation of the [Lehman] Code [of Ethics]. The following is a summary . . .
1. On the last day of each month, the books and records of the firm contain approximately five (5) billion dollars in assets in excess of what is managed . . . I believe this pattern indicates that the Firm’s senior management is not in sufficient control of its assets to be able to establish that its financial statements are presented to the public and governmental agencies in a “fair, accurate, and timely manner.” . . . I believe . . there could be approximately five (5) billion dollars of assets subject to a potential write-off . . . at the minimum, I believe the manner in which the firm is reporting these assets is potentially misleading to the public and various governmental agencies. . . .
2. The Firm has an established practice of substantiating each balance sheet account . . . The Firm has tens of billions of dollars of unsubstantiated balances, which may or may not be “bad” or nonperforming assets or real liabilities. In any event, the Firm’s senior management may not be in a position to know whether all of these accounts are, in fact, described in a “fair, accurate, and timely” manner, as required by the Code . . .
3. The Firm has tens of billions of dollar [sic] of inventory that it probably cannot buy or sell in any recognized market, at the currently recorded market values . . .
4. I do not believe the Firm has invested sufficiently in the required and reasonably necessary financial systems and personnel to cope with this increased balance sheet . . .
5. I do not believe there is sufficient knowledgeable management in place in the Mumbai, India finance functions and department. There is a very real possibility of a potential misstatement of material facts . . .
6. Finally, . . . certain senior level internal audit personnel do not have the professional expertise to properly exercise the audit functions they are entrusted to manage . . .
I would be happy to discuss regarding the foregoing with senior management but I felt compelled, both morally and legally, to bring these issues to your attention . . .
For the most part, Lee turned out to be right. About a month later, Lee also warned Lehman’s auditors, Ernst & Young, about the Repo 105 trick. (But that wasn’t necessary; they had already known about it, and done nothing to stop it, for over a year.39 They haven’t been prosecuted either.) So, what do we think of Erin Callan and Richard Fuld certifying Lehman’s financial statements for that quarter?
Or how about Angelo Mozilo’s certifications of Countrywide’s statements and the adequacy of its internal financial controls? Or Stan O’Neal’s signing off on Merrill Lynch’s statements, while his employees were bribing each other, and the firm’s profits turned to $80 billion in losses in the two years after he departed? Et cetera. Yet there have been no civil or criminal cases filed based on Sarbanes-Oxley violations.
RICO Offences and Criminal Antitrust Violations
Both RICO and US antitrust laws provide tools for prosecuting criminal conspiracies. The Racketeer Influenced and Corrupt Organizations Act (RICO) provides for severe criminal (and civil) penalties for operating a criminal organization. It specifically enables prosecution of the leaders of a criminal organization for having ordered or assisted others to commit crimes. It also provides that racketeers must forfeit all illgotten gains obtained through a pattern of criminal activity, and allows government prosecutors to obtain pre-trial restraining orders to seize defendants’ assets. And finally, it provides for criminal prosecution of corporations that employ RICO offenders.
RICO was explicitly intended to cover organized financial crime as well as violent criminal organizations such as the Mafia and drug cartels. Indeed, the law professor who drafted much of the legislation, G. Robert Blakey, once told Time magazine that “we don’t want one set of rules for people whose collars are blue or whose names end in vowels, and another set for those whose collars are white and have Ivy League diplomas.” The RICO statute has been used in cases ranging from the sex-abuse scandals of the Catholic Church to Michael Milken. Indeed the criminal cases brought against both Milken and his firm, Drexel Burnham Lambert, were based on the RICO statute. A great deal of the behaviour that occurred during the bubble, covered in this and previous chapters, would appear to fall under RICO statutes. Moreover, pre-trial asset seizure is a widely and successfully used technique in combating organized crime, and asset seizures now generate over $1 billion per year for the US government. However, there has not been a single RICO prosecution related to the financial cris
is, nor has a single RICO restraining order been issued to seize the assets of either any individual banker or any firm.
It is important to note here that asset seizures would not merely represent justice for offenders, but for victims as well. US law allows seized assets to be used to compensate victims. In this case, the potential economic impact of seizures could be enormous. Seizing the personal assets of just seven people who bear significant responsibility for the bubble and crisis (Angelo Mozilo, Richard Fuld, Jimmy Cayne, Joseph Cassano, Stan O’Neal, Henry Paulson, and Lloyd Blankfein) could provide over $2 billion to compensate victims. If the US government were to seize assets from, say, five thousand people representing a substantial fraction of total investment banking bonuses (and potential criminal behaviour) related to the bubble, this would potentially generate tens of billions of dollars in victim compensation. Such actions would probably provide more victim compensation than the entire $26 billion settlement of the foreclosure fraud lawsuits brought by 49 state attorneys general.
Antitrust law provides another tool for both criminal prosecution and extraction of financial restitution. Since 1975, US antitrust law has provided for severe criminal penalties for antitrust violations. Antitrust law also provides for treble damages in civil judgements, which can be based upon evidence from criminal convictions.
There is ample reason to suspect that collusion and antitrust violations are common within the financial industry. Several prominent observers of the industry—including Simon Johnson, Eliot Spitzer, and financial journalist William Cohan—have suggested that American banking deserves serious examination for antitrust problems. One major antitrust investigation, under way as of this writing and being conducted by American, European, and Japanese regulators and prosecutors, is focused on price-fixing of interest rates, particularly the London Interbank Offered Rate (LIBOR), the interbank lending rate used to set many short-term interest rates. There have also been a series of civil settlements, described above, related to price-fixing and bidrigging in the US municipal bond market.
More generally the industry has become extremely concentrated, and all the major firms do business with each other, even in markets in which they supposedly compete. The overwhelming majority of all US securities underwriting, private equity financing, merger and acquisition transactions, and derivatives trading is now controlled by Goldman Sachs, JPMorgan Chase, Morgan Stanley, Citigroup, Bank of America, and Wells Fargo. The largest private equity firms (such as KKR, Blackstone, and the Texas Pacific Group) often cooperatively bid for companies, and work not only with each other but with major banks in constructing financing packages for leveraged buyouts.
All the major banks charge the same fees for major services such as underwriting initial public offerings (7 percent), junk bonds (3 percent), or loan syndications (1 percent).40 Moreover, both stock and bond offerings are often “syndicated”. In this case, whichever bank wins the business of underwriting a given offering subcontracts portions of the offering to its supposed competitors. The banks also have created and operate a number of joint ventures, including two, MERS and Markit, that were heavily involved in the financial bubble and crisis.
By sheerest coincidence, the client agreements used for brokerage accounts by the major banks all contain identical provisions, by which all clients give up the right to use the courts to sue their brokerage for fraud. Rather, clients must use arbitration proceedings controlled by FINRA, the industry’s generally spineless self-regulatory body. This arbitration provision is not intended to improve efficiency; on the contrary, FINRA arbitrations are protracted and extremely expensive, requiring high legal fees and payments to arbitrators. Rather, the industry’s motivation is that FINRA arbitrations tend to favour the industry, and, importantly, they are secret, as opposed to court cases in which embarrassing information could be made public. How all the banks spontaneously decided to use the same brokerage contract terms has not been explained.
The banks, together with Visa and Mastercard, also seem to have arrived at identical conclusions in setting “interchange fees” for processing credit card transactions. Interchange fees in Europe and Australia are generally 0.6 percent of transaction value or less; US interchange fees are uniformly 2 percent. In September 2005, a large coalition of retail industry associations filed a class-action antitrust lawsuit against Visa, Mastercard, and America’s thirteen largest banks.41 As of early 2012, the case is still pending. Potential damages estimates have ranged from several billion to tens of billions of dollars. However, the government antitrust authorities have taken no action.
Indeed, despite this pattern of widespread industry collusion, there has not been a significant criminal antitrust conviction of any major bank, or any individual banker, in the United States in the last thirty years.
Federal Aid Disclosure Regulations
On 27 November 2011, Bloomberg News reported that as a result of its Freedom of Information Act filings, it had learned that during the crisis, Federal Reserve Board loan assistance to the largest banks had been far larger than previously believed. The Fed had kept the information secret; previous estimates based on then-available documents had set the total amount of assistance at $2 trillion to $3 trillion. Upon obtaining the documents, Bloomberg found that the actual amount, including loans, loan guarantees, securities purchases, and other commitments, was a rather amazing $7.8 trillion, with several hundred billion dollars in loans outstanding at any given time during the height of the crisis.42 Bloomberg estimated that these low-interest loans generated $13 billion in additional profits for the banks; one of my colleagues believes that the banks’ profits were probably far larger.
Since 1989, SEC regulations have required public companies to disclose material government assistance. None of the banks disclosed the size of these loans or their impact on profits.43 This would be a civil, not a criminal, offence. But at the same time that the banks were so heavily dependent upon massive government support, several of them claimed that their financial positions were secure. Potentially, this could be interpreted as a securities fraud violation. There have been no related SEC civil cases filed or criminal prosecutions.
Personal Conduct Offences
Personal conduct subject to criminal prosecution might range from possession and use of drugs, such as marijuana and cocaine, to hiring of prostitutes, employment of prostitutes for business purposes, fraudulent billing of personal or illegal services as business expenses (sexual services, strip club patronage, and nightclub patronage), fraudulent use or misappropriation of corporate assets or services for personal use (e.g., use of corporate jets), personal tax evasion, and a variety of other offences.
I should perhaps make clear here that I’m not enthusiastic about prosecuting people for possession or use of marijuana, which I think should be legal. In general, I tend to think that anything done by two healthy consenting adults, including sex for pay, should be legal too. I’m ambivalent about cocaine, which does seem to be destructive, although its criminalization is hugely destructive too. My general point is simply that, in ordinary circumstances, I would not advocate expending law enforcement resources in this area.
But the circumstances here are not ordinary. First, there is once again a vast disparity between the treatment of ordinary people and investment bankers. Every year, about fifty thousand people are arrested in New York City for possession of marijuana—most of them ordinary people, not criminals, whose only offence was to accidentally end up within the orbit of a police officer. Not a single one of them is ever named Jimmy Cayne, despite the fact that his marijuana habit has been discussed multiple times in the national media. It’s sometimes said in New York that investment banking might rate as the largest cocaine market on the planet, and perhaps also as a pillar of the strip club and escort industries. Who did the Feds bag for hiring escorts? Eliot Spitzer.
There is also a second, even more serious, point about this. If the supposed reason for failure to prosecute is the difficulty of making
cases, then there is an awfully easy way to get a lot of bankers to talk. It is a technique used routinely in organized crime cases. What is this, if not organized?
As time passes, criminal prosecution of bubble-era frauds will become even more difficult, even impossible, because the statute of limitations for many of these crimes is short—three to five years. So an immense opportunity for both justice and public education will soon be lost. In some circumstances, cases can be opened or reopened after the statute of limitations has expired, if new evidence appears; but finding new evidence will grow more difficult with time as well. And there is no sign whatsoever that the Obama administration is interested.
But enough about criminality. Let’s turn to large-scale economic waste and destabilization—because deregulated modern banking is good at that, too.
CHAPTER 7
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AGENTS OF PAIN: UNREGULATED FINANCE AS A SUBTRACTIVE INDUSTRY
WE NOW TURN TO the large-scale implications of financial sector conduct. The first is that a rogue financial sector is not merely unethical, even criminal; it is seriously dangerous to the economic health of a country.
In the US (and sometimes elsewhere), financial deregulation is defended by arguing that it is critical to retain “competitive advantage” in financial services, because the financial sector is a major employer, wealth creator, and engine of economic growth. Actually, however, the reverse is true: unregulated finance imposes huge net costs on the American and global economy. Far from enhancing finance’s proper role of channelling money to productive uses, the transformation and deregulation of finance has been economically destructive—hugely so.
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