Why did Obama and Cameron save a Criminal Enterprise like HSBC?

By William K. Black

Why is HSBC still in operation?  On the same day (December 10, 2012) that the Obama administration leaked the story of the HSBC settlement a story ran in the New York Times that was full of self-praise by the Obama and Cameron (U.K.) governments for their “cooperative approach” to cracking down on systemically dangerous institutions (SDIs).  SDIs are treated as “too big to fail” because they pose a global systemic risk when they fail.  The HSBC settlement puts the lie to the Obama/Cameron crack-down on the SDIs for it revealed a disgrace – Obama and Cameron treat the SDIs as too big to prosecute.  Indeed, HSBC demonstrates that the SDIs’ senior officers are treated by Obama and Cameron as too elite to prosecute.   The propaganda meme of the NYT story – that the SDIs would never again be given special favors due to reforms being adopted by Obama and Cameron – lasted four hours before it was destroyed by the disgraceful reality of the Obama and Cameron governments’ refusal to prosecute HSBC and its officers for their tens of thousands of felonies.

The NYT article begins by accepting the Obama/Cameron framing of the SDI issue, without any critical analysis.  “It is one of the thorniest problems hanging over the financial system: how should authorities deal with the collapse of a sprawling global bank to protect the financial system at large?”  The reporter’s implicit assumption is that we must have banks that are systemically dangerous when they fail.

This example exemplifies why implicit assumptions are so dangerous.  They exclude far better alternatives or terrible risks from even being considered – and they do so unknowingly.  If the reporter had made the assumption explicitly he would have been forced to defend it with analytics.  The article acknowledges that SDIs drove the financial crisis that caused the Great Recession.  In the U.S. alone this caused over a $15 trillion loss in wealth and led to the loss, or prevented the creation, of over 10 million jobs.  According to the Bush and Obama administrations we were lucky in preventing the crisis from growing vastly larger.  SDIs are economic weapons of mass destruction – but they cause their primary destruction inside the nation in which they reside.

Why allow a weapon of mass destruction that primarily destroys your own nation?  That is an act of insanity.  The City of London cannot credibly threaten the United States by creating SDIs and threatening to destroy the UK’s economy.  The proponents of SDIs bear an enormous burden of persuasion to prove why we shouldn’t end the catastrophic danger they pose by shrinking them to the point where they are no longer potential weapons of mass economic destruction.  Their burden is even greater when one considers the dominant view of economists that the smaller banks would be more efficient than the SDIs, which are massively too large to manage.  The NYT reporter does not even attempt to meet that burden.  The reporter also presents no indication that the U.S. and U.K. regulators even considered ending our exposure to these weapons of mass economic destruction.

The article acknowledges that trying to prevent an SDI from causing a systemic, global financial crisis once it fails is likely to fail.  First, the regulators are not at all sure that they can prevent a systemic crisis with their “cooperative” proposals.  Second, few regulators would risk a global systemic crisis when the alternative of bailing out the failing SDI inherently exists.  Regulators have seen the disastrous results of failing to bail out Lehman.

The obvious alternative (to everyone except the reporter, the U.S. and U.K. regulators, and the Obama and Cameron governments who have implicitly assumed it out of existence) is to shrink the SDIs to the point that they no longer pose a systemic risk and to conduct the shrinkage now before they fail.  That alternative would vastly reduce the economic WMD and make the banks more efficient – a win-win solution.

The further good news is that those two “wins” are not the limits of the advantages of shrinking the SDIs before they fail.  The NYT article, implicitly, assumes the Obama/Cameron framing of another issue critical to determining the SDI policies we should adopt.  “‘Too big to fail’ is the label for the problem that confronts governments when a large bank is on its last legs.”  The implicit assumption is that SDIs pose a “problem” only when they are on their “last legs.”  Had the reporter made this assumption explicitly he would have recognized it is unsupportable. Beyond their inefficiency, SDIs pose grave risks to a nation when they are profitable and growing.  SDIs make “free markets”, integrity, and justice impossible to maintain, they create the perverse political power that produces crony capitalism, and they drive the “competition to laxity” that drives regulatory failure.  I have explained most of these points in prior writings, so I will summarize.

Guaranteed to Loot: The Perverse Incentives of Systemically Dangerous Institutions’ CEOs   

SDIs’ uninsured, general creditors get bailed out even though the contractual deal they agree to would normally cause them to suffer severe losses.  The result is that they can borrow significantly more cheaply from general creditors than can their smaller rivals.  SDIs that are insured banks receive an explicit governmental subsidy (deposit insurance), but the implicit federal subsidy to general creditors is far larger and is unique to SDIs.  The very conservative economists who authored the book Guaranteed to Fail (2011) describe the implicit subsidy as being so large that it is the metaphorical equivalent of “bringing a gun to a knife fight.”  They conclude that the subsidies are so large that they inherently create “a highly distorted market.”  Indeed, they argue that the SDIs that created the mortgage crisis so distorted the market that there was “nothing free” about the mortgage markets.  The authors also explain the SDIs’ immense political power and their ability to corrupt regulators and regulation.

The HSBC case illustrates why SDIs destroy integrity and justice.  Public reports of the results of the government investigations of HSBC describe a bank that has been a criminal enterprise for at least 15 years.  The current settlement addresses only three of the many scandals HSBC has committed over that time period.  HSBC is a recidivist of epic proportions, but the Obama and Cameron governments have failed to prosecute HSBC or any of its officers.  When powerful corporations and their controlling officers grow wealthy through massive frauds and do so with impunity from criminal sanction integrity and justice are eaten away.  Effective financial regulation, supervision, and prosecutions are essential to “free” financial markets.  When cheaters prosper honest firms are driven from the markets, a point that the Nobel Laureate George Akerlof explained in his famous 1970 article on markets for “lemons.”  He described a “Gresham’s” dynamic in which bad ethics drove good ethics from the marketplace.

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”

Fraud and the destruction of integrity among SDIs will tend to spread to their market rivals due to this Gresham’s dynamic.  The result is another form of systemic risk.

The Justice Department, HSBC’s regulators, and the Obama and Cameron governments had the perfect opportunity to break this Gresham’s dynamic and restore justice and integrity by prosecuting and taking vigorous regulatory steps that forced HSBC to shrink over the next five years to the point that it was no longer an SDI.  They could have done so at a time when HSBC was reporting very high profits rather than during a crisis.  It was their paramount role and duty as prosecutors and regulators to break the Gresham’s dynamic by restoring the rule of law.  Doing so would have been good for the markets, for increased competition, for bank efficiency, for the independence of the regulators and prosecutors, for safety and soundness, and for our democracy.  Instead, they made the Gresham’s dynamic far worse, shamed their institutions and professions, and betrayed their duty to the nation and citizenry.

But things are likely far worse than this description suggests, for the pathetic truth is that there is no indication that the regulators, prosecutors, or government leaders considered doing the right thing at HSBC.  That is how destructive making implicit assumptions and adopting the pro-crony framing of issues is in the real world.  I hope I am wrong and that an insider will resign in disgust and disclose how she fought to shrink HSBC but was overruled by her superiors.

4 responses to “Why did Obama and Cameron save a Criminal Enterprise like HSBC?

  1. Why? I’m guessing for the same smokescreen-type reason the banksters met some years back at Wolfsberg Chateau (and called themselves the Wolfsberg Group), to hash out those “anti-money laundering” protocols, which ostensibly were implemented by the IMF’s Edgemont Group, setting up FIUs (Financial Intelligence Units) around the world at the various offshore finance centers (excepting for certain WTO members, like the UK and USA, which already had them set up), to officially guard against money laundering, while in actualy seeking to control it for the banksters. Perhaps HSBC was fined for stepping on too many toes, or raiding someone else’s backyard?

    The Breakdown

    Paulson and Goldman Sachs met and devised a CDO, the Abacus CDO, made up of the crappiest loans possible (guaranteed to default), then they purchased a boatload of credit default swaps (CDS, called naked swaps when the purchaser has no immediate connection to the investment, as was the case with Paulson), and then made a fortune — as in $3.4 billion for Paulson and billions for Goldman Sachs.

    You see, for each CDS purchased at $1.4 million Paulson had purchased, the payout was $100 million, and he purchased oodles and oodles of them.

    So AIG’s Financial Products group sold $460 billion of those unregulated insurance policies , or CDSes, with no capital on hand to back up a potential payout of between $20 trillion to over $40 trillion (note, the currency amount was in the trillions — hence the bailouts from the US Treasury along with over $23 trillion pumped out worldwide by the Federal Reserve Bank (we know it was over $23 trillion, but not how much over as there’s never been a forensic audit of the Federal Reserve).

    Magnetar Capital followed the same financial fraud process — 96% of their deals went bad, yet they walked away with billions. Ever wonder how those private equity guys make so much money while destroying companies (and employment) all the time? Well, now you know!

    Now, since the US Treasury is adamant that the naked swap continues to exist and thrive, this situation will occur again and again and again, only far worse, as debt has accumulated — their debt that is, the stuff they keep shoveling onto the rest of us while screaming for austerity for the rest of us! (Not surprising, given that the Treasury is comprised of so many Goldman Sachs and JPMorgan Chase alumni.)
    In the OCC report (Office of the Comptroller of the Currency), ending 2011, it stated that 97% of bank credit derivatives were Credit Default Swaps, and 40% of that number were in the speculative category (i.e., naked swaps or uncovered swaps). While we must take these numbers, as horrendous as they sound, on faith (much the same way we take on faith that talking snake in the Garden of Eden, Santa Claus and the Easter Bunny), it is important to recall that the naked swap was the primary tool of economic destruction (and enrichment for the super-rich) which was wielded by hedge fund dudes, private equity LBO dudes, and various and assorted bankster types, to crash the economy back in 2007-2008 — which will take decades to deleverage, or set aright.

    Just as John Paulson, his hedge fund, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Magnetar Capital, and so many others, used those swaps to enrich themselves while destroying companies and jobs and many people’s equity and savings, so too do those weapons still exist.

    The breakdown: 97% of credit derivatives are controlled by the top five banks, while 100% are controlled by the top 25 banks.

    And that is why financial types keep claiming that the next crash will be worse than the last……


    [p. 10, CDS = 97% of bank credit derivatives at end of 2011]

    [p. 11: The five banks with the most derivatives activity hold 96% of all derivatives, while the largest 25 banks account for nearly 100% of all contracts.]

    Recommended reading (and the best business book in the last fifty years):


  2. It’s counter-productive not to have criminally prosecuted because it’s yet a further step in the breakdown of trust in UK and US societies. Peter Turchin analyzes and illustrates this from an historical and cyclical perspective in his 2006 book “War and Peace and War.”

    • The opposing book to that would be the aforementioned book by Michael Perino: The Hellhound of Wall Street — and the best argument, along with Prof. Black, for the long-overdue criminal prosecution.

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