In the aftermath of the Savings & Loan (S&L) crisis of the 1980s, there were over 1800 criminal prosecutions and more than a thousand financial executives went to prison. So far the financiers who have met a similar fate in the wake of the Financial Crisis—the likes of Bernie Madoff, Nevin Shapiro, Raj Rajaratnam and Rajat Gupta—have been convicted of garden-variety offenses. None have been prosecuted, let alone convicted, for involvement in the kinds of activities that led to the massive damage to the economy, individuals and companies, that accompanied the financial collapse. This despite much documented evidence of irresponsible and outright fraudulent financial products and schemes and promises of rigorous enforcement.
Prominent figures and firms have avoided prosecution and, at most, settled cases with relatively light penalties and without acknowledgement of guilt. It seems as though the Justice Department has given up on further investigations, notwithstanding even a direct, in depth criminal referral from the Senate’s Permanent Subcommittee on Investigations—a referral developed after extensive investigations, hearings and analysis and detailed in a massive, joint majority and minority report published in April 2011 (Wall Street and the Financial Crisis: Anatomy of a Financial Collapse).
Executives were imprisoned two decades ago. Few, if any, have been now, even though the laws are in fact stricter. It therefore seems strange that so few prosecutions have been launched. One explanation could be that we are really only dealing with the sometimes distasteful ethical standards in modern “financial capitalism,” concerns about which are widely shared. Another might be that we are indeed avoiding the prosecution of real criminality.
Many do believe that we are dealing with actual criminality. Some commentators are concerned, even enraged by the fact that no one has gone to jail for “causing” the Financial Crisis. The Attorney General is accused of having no spine. It is asserted that executives are protected simply because they either happen to be supposedly privileged white collar criminals or they give so much money to political campaigns that they are actually protected. Serious and hard working committees have concluded that criminality seems to have occurred.
On the other hand, others believe that the activities in question are not really crimes at all, that there is a public rush to criminalize perfectly legitimate albeit irresponsible activity, and that it is silly to blame the Crisis itself on the specific activities that have been singled out as “crimes.”
One thing seems clear: the situation is very different from that of twenty years ago. In my view, three big factors have been at work.
- Political “normalization” of financial abuse
First, financial abuses have become “normalized” through the political process. Activities that would not have been tolerated two decades ago have attained a degree of “respectability” because their advocates have mastered the ways of Washington, developed theories to justify their actions, and promoted a reverence for economic growth at all costs. Activism on the part of the various components of the financial sector, among others, has succeeded in changing profoundly the terms of the debate: regulation of any kind has become suspect and advocates of measures to restrain financial activities in any way have been placed on the defensive.
When I first joined a (fairly large) bank in 1995, its lobbying activities were crude, to put it mildly. We had a couple of people schmoozing in Washington and the three state capitals where our main subsidiaries were based. Industry associations were active but nowhere near as aggressive as they are now. Some of the “sophisticated” banks (JP Morgan, Citi, Banker Trust, Nationsbank) operated a little more aggressively, using large DC law firms to handle technical matters in Washington. Yet the overall picture was rather bucolic and rather loosely organized as compared to the lobbying of today, and the big finance industry was much more fragmented. Banks enjoyed their “special” status and, in turn, accepted that they had to operate within certain safety constraints.
How this has all changed. Banks, insurance companies and securities firms learned the importance of lobbying and became vastly more sophisticated at it. Now the financial industry spends well over a million dollars per day trying to shape the outcome of legislation and what it looks like when the rubber hits the road as regulatory agencies translate that legislation into real action. The ideology of unbridled competition, even as they continue to enjoy massive subsidies and government protection, has become the mantra for most financial companies.
But the change goes much deeper. In his new book entitled The Payoff: Why Wall Street Always Wins, Jeff Connaughton describes the near-futility of trying to get the White House, Treasury Department and Justice Department to take financial criminality seriously. Connaughton was chief of staff for Senator Ted Kaufman, a tireless campaigner for holding the financial industry accountable in the aftermath of the Crisis. With surprising personal honesty, and having himself been one of the “Permanent Class” in Washington, he describes his growing awareness of the level of cronyism that has evolved in Washington between politicians, politically appointed agency executives, and the financial industry. As Connaughton pungently puts it, “Money is the basis of almost all relationships in DC.”
In this sordid tale, Connaughton’s views run entirely consistent with those of another disillusioned former campaigner for financial integrity, former special inspector general for the Troubled Asset Relief Program (TARP) Neil Barofsky, author of the recent book Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street. Such sense of disillusionment seems equally to seep from the reflections of Anton Valukas, the investigator into the Lehman failure who, among other things, exposed Lehman’s fraudulent use of Repo 105s to conceal its financial condition.
The result of this financialization of public policy is that the relentless defense of industry practice, coupled with the far reaching financial influence of the industry on the overall political process, has produced a situation in which formerly unacceptable activities can be defended with a straight face and expressions of public outrage can be dismissed as a reflection of the general naiveté of the public about the ways of finance. Timid journalists compound this situation by failing to ask simple questions about complicated financial devices out of a fear that they will appear unsophisticated themselves. And, as Katya Grishakova has aptly put it, there seems to be an “enchantment” on the part of even our highest officials as they have become seduced by the siren song of Wall Street.
- Complex modern finance
Second, the scale and complexity of modern finance has made it extremely difficult to pinpoint criminal liability in ways that make successful prosecutions likely.
Perhaps “banksters” don’t go to prison anymore because this new environment has rendered prosecutors pusillanimous and legislators and regulators corrupt. I am not sure this is the case. Even if financial crimes were prosecuted more vigorously, we might not see many convictions because there is another major obstacle: the nature of the modern financial enterprise. The scale and complexity of modern financial operations is vastly different than it was in 1990.
Many of today’s financial companies have become massive and their services highly complex. This has in turn diluted the responsibility and therefore the accountability of individual executives and dispersed the overall actions across the enterprise as a whole. In the S&L Scandal, the financial institutions involved were tiny: Lincoln Savings and Loan, which was the principal financial company within the infamous Charles Keating’s American Continental Corp., had no more than $6 billion in assets. Every executive in a company of that size, including the CEO, knows–or at least should and easily could know—exactly what the other executives are doing.
Now we are talking about trillion dollar, diversified organizations. When a bank gets larger than about $100 billion and starts to combine all kinds of financial instruments and services, the assumption that executives in the company know what is going on starts becoming a fantasy. Roles become highly specialized and the combination of services becomes increasingly synthetic. In such situations individuals cease to be fully responsible for the final product. Think of workers in an auto production line who never see the final vehicles they make until they reach the showroom.
This makes it extremely hard to put together a case against individual executives that would meet the high standards of criminal liability, even if the overall actions of the corporation itself resulted in a crime. If prosecutions are brought it is likely that well-funded lawyers will defend well-heeled clients. The definitions of the crimes themselves will be tested against demanding constitutional standards, and the actual knowledge of all the elements of criminal activity will be very hard to prove against specific individuals. So, as Jeff Connaughton has described in his book, when the Justice Department itself chooses not to treat financial crimes as a priority it is no surprise that prosecutors tend to shy away from committing massive resources only to hope that they might get lucky with a jury, and then only to face a realistic prospect of being overturned on appeal.
- Perceived social benefit
Third, while even this dispersion of responsibility need not be an absolute bar to criminal liability, we have not as a society clarified what should be the acceptable limits of risk-taking.
Bill Black, perhaps the person most responsible for sending S&L executives to prison in the late 1980s, developed a theory of “control fraud” in which he attempts to show that the standards of criminal liability for high-level executives, particularly CEOs, should take into account the fact that they are able to control the overall actions of various actors within the organization. The control fraud doctrine has not, to my knowledge, gained much traction in the courts as an independent basis for prosecuting financial executives.
Nevertheless, we could more directly address the problem with legislation in ways that are not even very novel. For many decades, even centuries, we have solved the problem of fragmented culpability by making it a crime to be part of an organization that commits crimes, and we measure criminal intention by much broader concepts than the precise intention to commit the underlying crime itself.
The most famous example of such a “crimes of crimes” is perhaps the Racketeer Influenced and Corrupt Organizations Act (RICO), enacted to help prosecutors break up the Mob and other criminal enterprises. We could take a few instances of actual bank criminality committed by a specific bank–and recent scandals have shown that there are enough to go around–and then make it a crime for the executives to be organizing with the knowledge that such underlying or “predicate” crimes will inevitably be committed somewhere within the organization. We could even go further to define culpability in strict liability terms, not requiring a specific intention or expectation that a criminal outcome will be committed.
But we have not taken this action because to do so would force us to confront our cultural and social values. This effort becomes really uncomfortable.
Whereas we believe that it is a rather criminal thing to shoot people or sell them drugs and that no earthly good could ultimately come of this activity, we don’t really think it is criminal to take risk, even great risk, in order to make profit. We might believe that financial risk taking should be restricted if it threatens to cause harm to others. We might believe that we should even stop participants where they repeatedly make high-risk mistakes without concern for the consequences. But we don’t think organizing to take risk in an inherently risky marketplace is criminal. We know that all kinds of motivations lead to risky behavior, particularly during the widespread exuberance or madness of crowds that creates bubbles and leads to crises. We find the excesses of some quite distasteful and we want them to pay back their recklessly gotten gains. Sometimes we remove them from their positions. We usually object to bailing them out even if they convince us that we must do in order to save ourselves from their wreckage.
But as a society that understands the risk-reward correlation and bases our entire prosperity on this correlation, we just don’t really think it is actually criminal for the individual participants to undertake these risks– even when the outcome itself becomes a crime. However dubious our belief might be—and it surely is in part a self-delusion—we just think too much good comes of the overall activity to get serious about curbing it.
Putting a few executives in jail would not only satisfy our lust for vengeance; it would very likely change behavior on Wall Street. Nevertheless we worry that the chilling effect of doing so might be excessive, that we would be turning into criminals the individuals who might be like the rest of us in different circumstances.
This is perhaps another, more basic reason why I don’t think we will see serious effort being devoted to the detailed investigation and forceful prosecution necessary to make examples of some financial executives.