The Wrongologist

What’s Wrong Today:

Last week, Jesse Eisinger at ProPublica had an article co-published with the NYT Magazine questioning our Department of Justice’s (DOJ) efforts to prosecute bankers for wrongdoing in the 2008 financial crisis. He shows that only one banker went to jail for his actions.

This proves we have a two tier legal system that dovetails nicely with our two tier economic system. The top 1% earn more and also abide by different rules than the rest of us. The banks play by different games, but they are still held by certain standards and terms, for example this current expected credit loss model compliance requirements in 2019.

The only Wall Street “executive” to go to jail for the financial crisis was Kareem Serageldin, the head of a trading desk at Credit Suisse. Serageldin pleaded guilty to holding mortgage-backed securities at artificially high marks in order to minimize reported losses on his trading portfolio.

“High marks” refers to the requirement that banks “mark to market” assets in their portfolios every day. Marking crappy mortgages that had lost much of their original value to market would cause the banks to show higher losses on their loans, and would simultaneously lower the bank’s capital ratios. As James Kwak of the Baseline Scenario says:

The Financial Standards Accounting Board (FASB) changed its rules in April 2009 to make it easier for banks to inflate their marks. And the Obama administration’s “homeowner relief program” (HAMP) was really designed to allow banks to delay realizing losses on their mortgage loans by dragging out—but generally not preventing—foreclosures.

This was a deliberate strategy called “foam the runway”.

Dave Dayden quotes Neil Barofsky’s book Bailout about a meeting between Elizabeth Warren (then Head of the Congressional Oversight Panel) who asked (then Treasury Secretary) Timothy Geithner about HAMP. After trying to avoid an answer, Geithner finally said:

The picture you get isn’t pretty. It’s a picture of the immense resources of the American criminal justice system deployed against bit players, with no consequences for the people responsible for the financial crisis. The judge in Serageldin’s case called his conduct:

Why hasn’t the Justice Department tried to convict anyone at a bank with any significant responsibility? What about Standard Chartered, where manually typing over data fields to circumvent money laundering controls was a written procedure? 

Serageldin’s former employer had revised its past financial statements to account for a loss of $2.7 billion that should have been reported. Lehman Brothers, AIG, Citigroup, Countrywide and many others had also admitted that they were in much worse shape than they initially allowed. Merrill Lynch, in particular, announced a loss of nearly $8 billion, three weeks after claiming it was $4.5 billion.

According to Eisinger, there was a change in strategy about pursuing individual prosecutions starting during the Bush administration, when Michael Chertoff initially went hard at companies like Enron’s accounting firm, Arthur Anderson. Anderson closed after its conviction costing nearly 10,000 jobs. Subsequently, the DOJ decided to seek large fines from corporations for wrongdoing rather than put executives in jail. From Eisinger:  

So the record is clear, they reached financial settlements in 9 times as many cases in 8 years than they had in the prior 12 years. This occurred in part because of a persistent effort to reduce prosecutorial power:

No change was momentous on its own. Indeed, some may have legitimately restored the rights of defendants, but taken together they marked a significant, if almost unnoticed, shift toward the defense.

Then there is the revolving door, which prosecutors and regulators walk through on their career climb up the corporate ladder. Moving from government to Wall Street or the big law firms that serve Wall Street keeps the prosecutions from getting too personal. As James Kwak says:

The erosion of the DOJ’s actual trial skills soon became apparent. In November 2009, the US attorney’s office in Brooklyn lost the first criminal case of the crisis against two Bear Stearns executives accused of misleading investors.

The prosecutors rushed into trial, failing to prepare for the exculpatory emails uncovered by the defense team. After two days, the jury acquitted the two money managers. The fear of losing put a chill on future efforts to prosecute.

Are the bank executives inoculated against lawsuit? Maybe. The prosecution and conviction of global financial institutions and their top executives is believed by the Fed and the Treasury Department to pose systemic risk to the world financial system, so we get spun, and the DOJ asks the banks for fines, not scalps.

All of this has made American banks view the rules of the game the same way that they look at rules in football. There is a rule in football against offensive holding. But nobody considers holding to be cheating, because holding comes with a penalty which is assessed as part of the game:

• It is the offensive lineman’s job to open holes for runners and to protect the quarterback
• It is the referee’s job to observe infractions of the rules and to assess the stipulated penalties

So holding in football is a part of the game which carries a certain risk. The lineman rolls the dice and holds if the situation seems to demand it, and attempts not to get caught, but nobody considers this cheating.

When Wall Street bankers are arrested, they do what is known in finance as an expected-value analysis: They weigh the cost of fighting, how long it would take and the chances of the best and worst outcomes. And they consider the fines to be just a cost of doing business.

How apparent does the death of the rule of law have to become before the little people catch on? Meanwhile, the “little” taxpayers fund these regulatory agencies whose primary purpose is to provide cover for executives involved in corporate criminal enterprises.

The Divide by Matt Taibbi details how the high-income investment banker types pay a fine, admit no personal wrong-doing, and walk away to do it again. It is worth your time and money.

Our society has become really good at punishing the little guy (sometimes for nothing at all) and abysmal at taking on the big fish who are perpetrating economic crimes against society.