The Race to the Bottom Produces Regulators who are Invertebrates and Epidemics of Fraud

By William K. Black
(Cross posted at

I examine how highly conservative newspapers are covering the interplay of widespread “control frauds” by the world’s most elite banks, the carefully structured de-evolution of financial regulators through descent from the subphylum Vertebrata into the phyla of the invertebrates, and the global failure to prosecute the elite frauds that drove the ongoing financial crisis.  The three factors are interrelated.  Vigilant financial regulators serving as the vital “regulatory cops on the beat” are essential to the successful prosecution of large numbers of elite financial frauds.  By ensuring that the top regulators are anti-regulators who believe that it is essential to “win” the regulatory race to the bottom, the finance industry creates a dynamic that acts internationally and nationally to maximize the three “de’s” (deregulation, desupervision, and de facto decriminalization).

The Republican members of the Financial Crisis Inquiry Commission (FCIC) failed to understand that the dynamic of the race to the bottom can simultaneously push a large group of nations to undertake contemporaneously an extreme embrace of the three “de’s.”

“The majority says the crisis was avoidable if only the United States had adopted across-the-board more restrictive regulations, in conjunction with more aggressive regulators and supervisors. This conclusion by the majority largely ignores the global nature of the crisis. For example:

• A credit bubble appeared in both the United States and Europe. This tells us that our primary explanation for the credit bubble should focus on factors common to both regions (FCIC Report 2010: 414).”

The FCIC minority failed to understand that Europe and the U.S. were the leaders in the competition in regulatory laxity.  The three de’s created a criminogenic environment favoring hyper-inflated bubbles in many nations during the same general time period.

The race to the bottom creates an environment that places de-evolutionary pressure to select as financial regulatory leaders those individuals who have most completely discarded their spines.  Similarly, the three de’s created an intensely criminogenic environment in finance in many nations.  Those environments produce fraud epidemics and multiple “Gresham’s dynamics” that turn market forces perverse.  When cheaters gain a competitive advantage, bad ethics drives good ethics out of the markets.  Only vigorous regulators can prevent the Gresham’s dynamic, so honest banks are placed at a crushing economic disadvantage when there is a regulatory race to the bottom.

The last several months have brought to the surface a plethora of frauds that the elite banks have committed over long time periods.  The revelations are so ghastly – senior officers at the biggest banks really will routinely help nations who support terrorists and drug gangs evade U.S. laws against money laundering in order to make a buck and get promoted.  The criminal acts are so common that Standard Chartered created a manual (which stated that its procedures were mandatory) to guide bank officials to uniformly follow practices that would not only violate the law, but also strip real information from the files and supply false information for the sole purpose of deceiving the United States as to the bank’s compliance with the law.

What is even more disturbing is that virtually no one senior goes to prison for committing tens of thousands of felonies (think of the perjured affidavits used to unlawfully foreclose and Standard Chartered and HSBC’s money laundering).  Indeed, it is rare to even have an enforcement action or prosecution that ends with the elite perpetrators admitting their crimes.  Instead, we get settlements in which the banks admit nothing and pay amounts of money that sound large but are farcically small in comparison with the banks’ crimes and (reported) profits.  “Too big to prosecute” has become a common phrase, which only makes market forces in finance ever more perverse.

The ultimate demonstration of how criminogenic such environments are (and the power of what we criminologists refer to as “neutralization” techniques) is the response of many UK officials to the repeated discovery (by the U.S.) that the largest banks based in the City of London committed widespread crimes.  When one U.S. official of Standard Chartered warned that the bank would suffer greatly if its tens of thousands of illegal transactions with Iran were discovered his non-U.S. colleagues allegedly responded:

“As quoted by an SCB New York branch officer, the Group Director caustically replied: ‘You f—ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?’ (New York State Department of Financial Services.  Order in the Matter of Standard Chartered Bank (paragraph 8, quoting from an investigative interview) (August 6, 2012)).”

United States law does not forbid banks “deal[ing] with Iranians.”  It does require banks to engage in special review and notification procedures.  The reasons the U.S. has given for these rules have to with U.S. concerns that Iran finances terrorist organizations and is likely seeking to develop a nuclear weapon.  Standard Chartered engages in massive dollar transactions through its U.S. affiliate.

The neutralization technique used by Standard Chartered’s Group Director (an extremely senior official) was promptly embraced – and embellished – by prominent UK officials.  Boris Johnson, the Mayor of London, led the chorus.

The Mayor also referred to an email from a senior London-based Standard Chartered executive – thought to be finance director Richard Meddings – to a top official in the New York branch who raised concerns about breaching US sanctions on Iran.

“The email, the content of which was hotly disputed by the bank yesterday, allegedly said: ‘You ****ing Americans. Who are you to tell us, the rest of the world, that we can’t deal with the Iranians?’

Mr Johnson said: ‘I disapprove of the language, of course.

‘But I have to say – and I speak as the proud possessor of an American passport – that there seems to be something fine and sound about the underlying sentiment.’”

Johnson the “proud” then doubled-down on his criticisms of the U.S., with the active support of Bank of England governor Sir Mervyn King.

“Boris Johnson accused US regulators of ‘beating up British banks’, warning them against a ‘self-interested attack on London’s status as the pre-eminent financial centre’.

Writing in The Spectator magazine today, he said: ‘You can’t help wondering whether all this beating up of British banks and bankers is starting to shade into protectionism; and you can’t help thinking it might actually be at least partly motivated by jealousy of London’s financial sector – a simple desire to knock a rival centre.’

New York is still seen as playing second fiddle to London as an international hub for the financial sector.

Bank of England governor Sir Mervyn King said the affair was different from other banking scandals and hit out at the New York regulator which published the critical report.”

The title of the article says it all:  “Stop beating up our banks, US is warned: New York regulators ‘are jealous of City’s success.’”

If the U.S. enforces its laws and discovers that the UK regulators have, in the case of Barclay’s unlawful manipulations of Libor, ignored the violations of UK law what is the U.S. supposed to do to make Johnson and King happy?  The City of London is a disaster, not a success.  It threw the UK into a Great Recession and then supported policies that gratuitously tossed the nation back into recession.  The City of London is a weapon of mass financial destruction.  It has caused millions to lose their jobs and maximized economic, social, and political inequality.  Its most elite banks were bailed out by the UK government.

Note the intimacy of the embrace of the competition in laxity by senior UK officials.  A bizarre paradox emerges when one considers the “second fiddle” metaphor.  The first violinist, the concert master, is supposed to earn his or her position through superior effort and performance.  The “winner” of a competition for regulatory laxity “succeeds” because it fails to put forth effort, skill, and courage.  The winner of a regulatory race to the bottom is the most abject failure in performing its statutory mission.  The results of its failure to put forth the effort, skill, and courage required to achieve its vital mission proved catastrophic for the industry, the economy, the nation, and Europe and the United States.  The elite UK banks’ senior officers and the prominent politicians they support, however, are made wealthy and powerful.  The City of London remains glitzy, even as it actually represents the gravest threat to the UK’s economy and people because the CEOs that control our elite banks overwhelmingly prefer criminogenic environments.  Honest CEOs would avoid such environments.  The UK establishment knows its bank CEOs all too well.  The UK establishment has built a system that selects for the worst of the elite banks by providing only the pretext of regulation.  The paradox is that while the City of London’s regulators and senior bankers represent the worst disgraces to their professions and have caused unprecedented fraud epidemics and crises their pandering political patrons continue to praise them as paragons.  The City of London is a global financial cesspool that like lawless towns of the Wild West attracts the most rapacious thieves who run riot when there are no effective cops on the beat.

Or, to extend the UK’s “second fiddle” metaphor, the UK financial regulators are not the concert masters.  In musical terms, the UK regulators who “won” the race to the bottom represent the worst fiddle players available – the stoned kids who cannot read music and would embarrass the most atonal grunge band wannabes in a Seattle garage.

The Telegraph understands that the CEOs of the City of London’s most elite banks and their anti-regulators are broken, but their analytics are hopelessly confused.

“You can take it as read that it provides parliamentary condemnation, quite rightly, of Barclays behaviour both on the trading floor of Barclays Capital and in the boardroom of Barclays’ head office.

That behaviour, which thrived within the culture of risk taking that Barclays tolerated, has “done great damage to the UK’s reputation” in the words of Tyrie.

Once again we find ourselves digesting a damning report into a British bank and the financial services industry more broadly. Once again we are left asking how could this happen?

Obviously Barclays is one reason why it could happen and the Treasury Select Committee has laid bare the bank’s failings. Barclays tolerated a regime that let traders manipulate Libor. It had a governance culture that institutionalised the practice during the financial crisis, arguably with at least tacit approval of the Bank of England. The evidence on this latter point, submitted on the one hand by Paul Tucker, a deputy governor at the Bank, and Bob Diamond and Jerry del Missier of Barclays on the other, is sufficiently confused and contradictory as to place a plague on both their houses.”

The “behaviour” that Barclays used to “manipulate Libor” is the newspaper’s euphemism for fraud and the operation of an unlawful cartel.  The paper asserts that “that behaviour” arose because of Barclays’ “culture of risk taking.”  The opposite is true.  Barclays and its fellow cartel members manipulated Libor to avoid taking honest risks and attempt to create a sure thing through crime.  When traders bet wrong they retroactively manipulated Libor to change bad risks into wins.  Later, Barclays and its fellow cartel members manipulated Libor to artificially depress the reported interest rate in order to deceive investors and creditors about its true financial condition and borrow funds more cheaply.  When UK regulators learned about this massive fraud and cartel it is contested whether they encouraged Barclays to manipulate Libor or merely stood by as the banks did so – even after warnings from U.S. anti-regulators.  Note that while the paper says that the “behaviour” by City of London banks has repeatedly done great damage to the UK’s reputation and repeatedly prompted the paper to ask “how could this happen?” the newspaper and the UK establishment have scrupulously avoided any serious examination of “how could this happen.”  To do so would require them to examine the fact that the competition in laxity is inherently criminogenic and that the UK and the 99% lost when the City of London “won” the race to the bottom.  Indeed, the world is the victim of that perverse competition.

The newspaper acknowledges the accuracy of UK reports that have shown that the City of London is cancerous.

“But what we’re also left with, yet again, is a story of regulatory failure. Since 1997 the UK has been plagued by porous rules that have allowed unalloyed avarice to seep into every nook and cranny of City life. It is Tyrie’s conclusions and recommendations in this area which are the most important elements of the report.

The committee has quite rightly used its findings into the Libor scandal as ammunition in its attempts to get urgent changes made to the legislation passing through Parliament that will merge two failing institutions (the Financial Services Authority and the Bank of England) into one, even larger, failing institution. If we don’t get the future of regulation right, we’ll never get the future of banking right.”

These passages at least hint at the key problem.  The newspaper and the UK government share a failure to have a positive theory of financial regulation.  The paper is correct that if we fail to financial regulation right we will not get banking right, but it fails to ask why that is so.  It is correct that “unalloyed avarice” characterizes the City of London and that such avarice leads to endemic fraud, but it fails to analyze either why this is true or the radical implications of these admissions.  Adam Smith famously asserted the paradox that it is the village butcher and baker’s dedication to self-interest that ensures we will be served wholesome meat and bread.  Understanding the limits of Smith’s claims and its general inapplicability to finance leads to the recognition that market forces can become so perverse in the presence of a Gresham’s dynamic that the CEO will loot the shareholders whose interests he is supposed to hold sacred.  The paper implicitly admits that the UK’s proposed “reform” (moving regulation from the FSA to the Bank of England) is facially inane, but because it has no theory of what a financial regulator must do to prevent a Gresham’s dynamic and criminogenic environments it cannot provide a path to essential regulation.

In general, the UK problem was far more anti-regulatory leaders rather than “porous rules.”  The critical fact that the UK establishment and the newspaper fail to understand is that a regulatory system that embraces the race to the bottom will inherently produce regulators who lack a backbone and will fail to enforce the rules.

“Tyrie’s report does highlight how the FSA, led by chairman Lord Turner, has shown glimpses of the so called “judgment-led” regulation that will be the founding principle of the new regime. Judgment-led regulation is the notion of regulators standing toe to toe with bank chiefs and telling them when they don’t like what they see on their balance sheets and informing them what needs to change. It’s about telling a board that changes need making to key personnel. The banks will hate it but that’s exactly the point. The quid pro quo is that at least some of the petty box ticking will be abolished that drives bankers wild and probably encourages, rather than discourages, the culture of pushing regulatory boundaries to the limit.

But Tyrie’s report also reveals how Lord Turner and his counterpart at the Bank of England, Sir Mervyn King, were unable to exercise that judgment-based regulation properly when it came to the removal of Bob Diamond. They wielded the axe in an arbitrary way which was inappropriate and which cannot be tolerated. The fact that Lord Turner tried and failed to secure Diamond’s resignation and subsequently had to get Sir Mervyn involved also exposes him as a weak operator. Put this together with the fact that the FSA, along with the Bank, failed to spot Libor manipulation in the first place and that “doesn’t look good” to quote Tyrie once again. It doesn’t look good for the FSA but neither does it look good for Lord Turner’s candidacy to be the next Governor of the Bank of England, with supreme power over all financial regulation.

So what have we learnt? We’ve learnt that the old guard has had its day. It’s changing at the banks but now it must change at the regulators too.”

There are so many things wrong with this claim as to “what have we learnt” that it would take a book to do the task justice.  For the sake of brevity I make four points.  First, if regulation is determined by the race to the bottom the regulatory leadership will be selected (with a great deal of self-selection plus industry dominance) for their opposition to effective regulation.  The leaders will lack a spine.  The idea that anti-regulatory invertebrates (think slugs) will successfully go “toe to toe” with a fraudulent CEO is fatuous.  Anti-regulators are bred to be lap slugs.

Second, “judgment-led regulation” is a PR phrase – not a positive theory of financial regulation.  Honest bank CEOs would not “hate” effective financial regulation.  Instead, they would see it as essential to their ability to compete.  The true independence of effective regulators (as opposed to the faux independence of inside and outside professionals hired and fired by the CEO) is also invaluable to honest bankers.

Third, the PR phrase appears to be a pretext for further deregulation in the UK designed to achieve greater regulatory laxity in order to “win” the race to the bottom.  It is disastrous to remove the regulations that drive dishonest banks CEOs “wild.”  In the U.S., for example, the savings and loan underwriting requirement for mortgage lending that the Clinton administration removed was the single most destructive act of deregulation.  The rule was a paperwork rule – the category that the anti-regulators love to target.  We used it in 1990-1991 to stop S&Ls in Orange County, California (where all good financial frauds originate) to drive liar’s loans out of the industry.  The rule was extremely useful in preventing criminogenic environments, bad loans, and in helping to prosecute accounting control fraud.

Fourth, the “old guard” at the regulatory agencies was the solution, not the problem.  The S&L “old guard” established systems and professionalism that survived even the appointment of anti-regulatory leaders in 1987.  The folks that failed during the current crisis were typically the anti-regulatory leaders of the regulatory agencies appointed to “win” the race to the bottom.

In the U.S., the Wall Street Journal’s reporters warn against any effort to end the suicidal race to the bottom and instead institute a competition in integrity.  The WSJ’s editorial staff has long been selected for its anti-regulatory passions, but its reporters have increasingly treated Murdoch’s anti-regulatory dogmas as facts.  Consider this purportedly factual statement about New York State’s financial regulatory leader, Benjamin Lawsky in an August 29, 2012 article entitled “Sharp Elbows Among Street Lawmen.”

“For decades, New York has served as home to ambitious prosecutors and regulators eager to make waves that ripple well beyond its boroughs.

But the race to investigate, indict, subpoena and fine has reached a new level of intensity this year, as the creation of a new state financial-services watchdog—led by former federal prosecutor Benjamin M. Lawsky—has added another powerful player to an already crowded field.”

The WSJ normally considers ambition to be a virtue and rarely describes Wall Street bankers as ambitious even though the all-consuming nature of their ambition is one of their defining characteristics.  It is hilarious, however, to characterize the U.S. (or New York) regulation as a “race to investigate, indict, subpoena and fine” Wall Street’s elite bankers or banks.  Let us be clear – the U.S. was an active competitor in the regulatory race to the bottom that made the ongoing crisis possible.  The failure to indict the Wall Street leaders who grew wealthy by looting and accounting control fraud and caused the epidemic of mortgage fraud is a national scandal.  New York is also home to the Federal Reserve Bank of New York and the resident examiners and regional staff of the Office of the Comptroller of the Currency.  Both of those entities competed to weaken federal regulation and aggressively used the preemption doctrine to try to prevent state investigations of and actions against fraudulent mortgage lenders.  Both agencies virtually eliminated making criminal referrals.  Timothy Geithner’s failure to make a criminal referral about Barclay’s Libor fraud was the norm, not an exception.  There is no “race” to indict (or even investigate) the Wall Street elites.  The elites committed the frauds that drove the crisis with impunity from criminal sanction.  The supposedly straight WSJ news story is delusional.

That delusion leads the WSJ article to this sympathetic treatment of the supposed need for the U.S. to “win” the international competition in regulatory laxity.  The article emphasizes the claims of one of the nation’s leading proponents of the regulatory race to the bottom.

“The budding rivalries and partnerships between these lawmen are making corporations, along with New York’s local industry, Wall Street, nervous. Corporate and financial executives and their advocates fear an arms race of prosecution, driven by ambition and the public’s desire to blame the business community for the financial crisis.

‘It highlights a vicious cycle we’ve seen since [former Attorney General Eliot] Spitzer, where financial regulators are competing more for headlines than ensuring that our markets are competitive,’ said Tom Quaadman, vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.”

“Competitiveness” is the buzz word for the proponents of winning the race to the bottom.  Again, we are supposed to believe that the facts are that Wall Street fears “an arms race of prosecution” – when the reality is the total failure to prosecute the Wall Street frauds who drove the crisis and Wall Street’s fervent desire to continue to be able to become wealthy by committing fraud with impunity.

Two days earlier, the WSJ published an even more delusional straight news article.  It contained this statement, which was so obviously factual that it did not require explanation or citation.

“In prior elections, Wall Street has tended to give a majority of its donations to the political party that holds power in Washington. But after Mr. Obama took office, many financial-services executives turned against the president in part because he demonized their industry and helped enact tough regulations after the financial-services collapse.”

President Obama “demonized” “financial-services,” which explains why their executives “turned against the president.”  President Obama continued President Bush’s bailout that saved the financial services industry from collapse.  He appointed an economic team beloved by the industry.  Obama’s economic team met extensively with financial services executives in non-public discussions and hired many of them to fill key slots.  Geithner intervened with AIG to direct it to pay its massive bank creditors in full rather than negotiating a significantly smaller payment.  Geithner intervened with then New York Attorney General Cuomo to discourage even an investigation of the banks’ mortgage frauds.  The Obama administration repeatedly sought to limit the investigation and liability of banks for endemic foreclosure fraud.  The Obama administration structured its foreclosure relief programs to foam the runways to aid banks.  Obama and Attorney General Holder have consistently minimized any criminality by banks and have failed to do a meaningful investigation of any large lender of endemically fraudulent liar’s loans much less bring a criminal prosecution.  Obama and his economic team have repeatedly praised the CEOs of several of the systemically dangerous institutions (the biggest U.S. banks).  Obama has carried the banks’ water, not demonized them and the idea that (1) it is illegitimate not to continue the suicidal regulatory race to the bottom and the claim that Dodd-Frank produced “tough regulations” is unsustainable.  Over four years later, the principal regulatory change in response to the crisis remains the Federal Reserve’s action on July 14, 2008 (during the Bush administration) largely banning liar’s loans on the grounds that they were endemically fraudulent.  (The banks opposed the rule and Chairman Bernanke delayed its effective date for 15 months because one would never wish to inconvenience a fraudulent lender.)

The takeaway is that the elite banks demand that their political patrons be total sycophants like London’s mayor, who will celebrate banks committing felonies that aid terrorists as long as the banks are located in the City of London.  The elites believe in the divine rights of bankers.  Anything less that unconditional devotion from their political lackeys represents “demonization” and requires that the politicians be defeated and replaced.  Modern bank CEOs are not tough.  They are thin-skinned adolescents who demand veneration.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @williamkblack

8 responses to “The Race to the Bottom Produces Regulators who are Invertebrates and Epidemics of Fraud

  1. I think you mean “de facto decriminalization” in the first para.

  2. Prof. Black, you and Prof. Hudson, our last hope.

    “Perversion” is the name of the game in the British Empire, since time out of mind. Nothing will stand in the way of satisfying their lust for ill-gotten gains personal/political/financial. London is perversion incarnate, exported to “the rest” by force, by hook and crook, for centuries now. Standard Chartered’s slap on the wrist in New York is proof of the power of perversion, “British” style, and its corruption of the world entire.

  3. If Barack Obama ordered Eric Holder to go after these bastards, and that he could expect a pink slip if he didn’t get it done, then it would get done. It starts with the political leadership. They are in bed with the money men … I’m not sure I see a way out. I don’t see any sign of an epiphany on the part of Obama. I don’t think he had much of an idea of how the world worked, or how he wanted it to work. Maybe we will see something new in a second term. Considering that Mitt Romney IS actually one of the Wall Street predators (instead of just taking orders from them), I don’t think he is the solution.

  4. JEHR — He did. Thanks!

  5. Pingback: The Race to the Bottom Produces Regulators who are Invertebrates & Epidemics of Fraud - US Message Board - Political Discussion Forum

  6. “They are thin-skinned adolescents who demand veneration.” Exactly. Thank you.

  7. +1 I’m always amazed at Bill’s sophisticated use of the English language.

  8. Obama, as a Marxist, believes the Republic’s financial system is a fraud and illegitimate. Also, check out the work of the conservative economist Martin Hutchinson…he writes a weekly column at prudentbear and has published several books.