Conservative economists love “creative destruction.” They can’t wait to “get their Schumpeter on” when a business fails and thousands of workers lose their jobs. There is no more “creative destruction” conceivable than when we put a bank that has become a fraudulent enterprise into receivership, remove the controlling officers leading the fraud, and sell the bank through an FDIC-assisted acquisition. Indeed, the pinnacle of creative destruction would be doing this with a systemically dangerous institution (SDI) through a process that split the supposedly “too big to fail” bank into smaller components that (1) were no longer large enough to pose a systemic risk, (2) were more efficient than the bloated SDI, (3) no longer extorted a large (implicit) government subsidy that made real competition impossible, and (4) no longer had dominant political power via crony capitalism. Unlike the situation in which an SDI collapses suddenly in the midst of causing a global crisis when its frauds cause a liquidity crisis, it is vastly easier to put fraudulent SDIs in receivership in today’s circumstances. Unlike Arthur Anderson, the receivership power allows us to keep the enterprise alive and create more competitors rather than fewer.
As I often remarked, it is a testament to the financial and moral sophistication of our successors as financial regulators relative to our primitive era that they have realized that keeping fraudulent CEOs in charge of our largest banks – and virtually never putting such banks into receivership however massive and damaging their serial felonies – is the key to achieving financial stability. Their system, it must be admitted, has proven far superior. GDP losses are merely far more than 100X greater in the current crisis than in the savings and loan debacle. The jihad against effective regulation and prosecution of elite control frauds has been an enormous success. The primary question is whether to classify the resultant epidemics of accounting control fraud as “unintended consequences” of the three “de’s” (deregulation, desupervision, and de facto decriminalization) or as a very “intended consequences.”
I am deliberately violating the fundamental guild rules of theoclassical economists by using the “f” word, by noting that negative “unintended consequences” are the norm when we employ the three “de’s,” and that elite CEOs who use corporate power to produce the three “de’s” frequently intend to use the resultant criminogenic environment to defraud with impunity. It is verboten under guild rules to use the “f” word, to point out that the key to understanding our financial crises is that it is the CEO’s perverse incentives rather than “the bank’s incentives” that matter, to discuss the role of power, to point out that elite class status is important, and to point out that fraudulent CEOs often intend the negative consequences of the three “de’s.” In sum, theoclassical economics is a faith-based creed devoted to the worship of (and service to) the wealthy, particularly elite frauds. They are, of course, well compensated for championing the causes, and puffing the fragile egos, of the fraudulent plutocrats. I mean this literally. George Benston, Daniel Fischel, and Alan Greenspan were three of Charles Keating’s most valuable fraud allies. Lanny Breuer’s infamous “lamentations” speech (while head of DOJ’s Criminal Division) underscored how he fell hook, line, and sinker for the absurd claims of economists hired by today’s most elite fraudulent banksters that banks (and bankers!) should be “too big to prosecute.” By Breuer’s own bumbling admission, he lay awake at night for fear that his (always hypothetical) prosecutions of the major banks might “cause” a fraudulent bank to “fail.” This is, of course, heresy under the Schumpeterian creed of “creative destruction,” but theoclassical economists are very forgiving of their co-religionists who get rich by spreading heresy in the service of fraudulent elites.
Breuer was so bad that he obscured what we primitive regulators and white-collar criminologists had emphasized for decades. First, no banker is “too big to jail.” They are easily replaceable and removing a fraudulent bank CEO from power is the single most productive act that regulators and prosecutors can accomplish. Breuer and Attorney General Eric Holder were involved in a con when they claimed that their failure to prosecute the senior bank officers leading the frauds was in any way related to “too big to fail.” Hilariously, they even applied the “rationale” for non-prosecution to former bank officers – as if a bank would fail “because” its former officers were prosecuted. It is a testament to the weakness of the reportage that this claim was not treated with ridicule.
Second, valid fraud prosecutions do not “cause” a business to fail. The fraud causes them to fail. They should fail when their “profits” arise from fraud. In particular, they should fail in the case of accounting control fraud because their “profits” are the fictional product of accounting fraud. The markets and the economy are greatly improved when fraudulent enterprises are destroyed. There is no more creative form of destruction than removing the frauds that drive the Gresham’s dynamics that cause markets to become so perverse that “bad ethics drive good ethics out of the markets” (and professions).
Third, very little is actually “destroyed,” when we place a fraudulent bank in receivership, fire the crooked CEO, and sell the bank to an acquirer of integrity and competence. The new bank will, net, be greatly improved because it has been freed from control by the fraudulent leadership that was “looting” the bank (George Akerlof and Paul Romer, 1993, “Looting: The Economic Underworld of Bankruptcy for Profit”).
Fourth, there is rarely a need to prosecute a bank. In virtually every case in which the bank’s frauds cause serious harm senior officers of the bank will have led the fraud and profited from it. Everyone in law enforcement realizes that any effective deterrence will come from prosecuting those officers and not only removing their fraud proceeds but also imposing fines that will leave the officers bankrupt.
Fifth, the bank’s controlling officers are in an immense conflict of interest when their frauds are detected. They control the bank and its resources. Their first priority is to prevent their own prosecution. Their second priority is to prevent any substantial “claw back” of their compensation. Their third and fourth priorities are to do the same for less senior officers. This isn’t altruism (though it certainly has an aspect of class-based affinity). Fraudulent CEOs realize that it is risky to allow the prosecutors to gain any leverage over more junior officers who may “flip” and testify against the CEO. The fraudulent officers controlling the bank, therefore, will gladly trade seemingly huge fines in exchange for obtaining their top four priorities.
Sixth, Holder and Breuer were delighted by that trade. They got to report record fines without having to try a single major criminal case against the fraudulent bankers who led the fraud epidemics that caused the financial crisis. Breuer “declared victory and went home” (to Covington & Burling).
Seventh, under the Geithner-Breuer-Holder (GBH) doctrine the fines sought against the SDIs were guaranteed to be large in absolute dollar terms – and non-threatening in real terms. The GBH doctrine compels that result because the rationale is that we must take no regulatory or prosecutorial action that poses any conceivable risk of imperiling an SDI lest we trigger the next global financial crisis. This means that DOJ (non) prosecutors had very little negotiating leverage because they could not credibly threaten to enforce the rule of law against SDIs (particularly with a boss like Lanny Breuer lying awake at night in fear that he would be blamed for the next global crisis). Fortunately for DOJ, the SDIs are so enormous (as are the bailouts they received) that their officers can agree to fines that sound large but represent merely a (none-too-high) price of doing fraudulent business. The GBH doctrine is intensely criminogenic. It produces what Akerlof and Romer warned was the “sure thing” of CEO “looting” through accounting control fraud plus the assurance that the CEO will not be prosecuted, forced to surrender his fraud proceeds, or forced to pay fines that bankrupt him. Unsurprisingly, the result has been unprecedented accounting control fraud by elite banksters.
DOJ’s New Strategy of Aggressive Press Leaks
To review the bidding, the appraisers warned three administrations (Clinton, Bush, and Obama) that there was an epidemic of appraisal/mortgage fraud led by the lenders. That warning began, in writing, in 2000 – before Enron failed! The Financial Crisis Inquiry Commission (FCIC) Report emphasizes the point.
“From 2000 to 2007, a coalition of appraisal organizations … delivered to Washington officials a public petition; signed by 11,000 appraisers…. [I]t charged that lenders were pressuring appraisers to place artificially high prices on properties [and] ‘blacklisting honest appraisers’ and instead assigning business only to appraisers who would hit the desired price targets” (FCIC 2011:18).
It took two years to form this “coalition of appraisal organization,” agree on a common strategy, agree on a common text of the petition, and create the web site for the petition. That means that one of the three great epidemics of accounting control fraud that drove the crisis was already sufficiently severe by 1998 that it had been identified as a severe threat 16 years ago. During the 14 years since the appraisers began issuing their public warnings to the (non) regulators and the mortgage industry there have been zero prosecutions of any of the elite bankers for leading the three epidemics of accounting control fraud that drove the financial crisis and the Great Recession. During the decade 1998-2008, the banking regulatory agencies have not publicly identified a single criminal referral they made in response to the three most destructive financial fraud epidemics in history. The anti-regulators literally destroyed the criminal referral process that had once been so effective in prosecuting frauds by senior bank officers. A Pulitzer Prize awaits the investigative journalist who researches who ordered that destruction and when, why, and how it was accomplished. A second prize awaits the reporter who investigates why the Obama administration failed to make its resurrection a major policy initiative that it would tout.
The Bush and Obama administration have already allowed the statute of limitations to run on vast numbers of frauds led by the CEOs of mortgage bankers and the 10 year statute of limitations applicable to federally insured banks (which we obtained in response to the S&L debacle) is rapidly running. The recent DOJ IG report documented the hollow nature of the FBI investigations related to the crisis. Even when the statute of limitations has not run it becomes very difficult to try “old” cases because of the loss of documents and memory and the feeling of judges and juries that the matter cannot have been terribly grave if the FBI ignored it for eight years. Even if Holder had a “Road to Damascus” conversion today and tried to prosecute the elite bank frauds that drove the crisis he would be far too late. The DOJ will commit its greatest strategic failure to uphold the rule of law. That does not mean that it could not bring a dozen prosecutions against the most destructive and fraudulent bank CEOs during the waning years of the Obama administration, but there is no evidence that the FBI is even investigating those frauds.
Instead, Holder has given up on prosecuting the CEOs that led the frauds that caused our crisis. The new DOJ press leak indicates that DOJ may charge two foreign banks with committing frauds unrelated to the financial crisis. This is hardly a major accomplishment, but it is all that Holder can bring himself to do so it was ballyhooed in “Deal Book” under this sad title “2 Giant Banks, Seen as Immune, Become Targets.”
One might think that DOJ would be mortified that the Nation’s paper of record would put in print that DOJ has operated for over a decade in a manner in which the SDIs are “seen as immune,” but no, DOJ is immune to embarrassment over its policy of granting de facto immunity to elite bankers and banks from the rule of law. The article offers these damning passages about the GBH Doctrine.
“In doing so, prosecutors are confronting the popular belief that Wall Street institutions have grown so important to the economy that they cannot be charged. A lack of criminal prosecutions of banks and their leaders fueled a public outcry over the perception that Wall Street giants are ‘too big to jail.’
Addressing those concerns, prosecutors in Washington and New York have met with regulators about how to criminally punish banks without putting them out of business and damaging the economy, interviews with lawyers and records reviewed by The New York Times show.
The new strategy underpins the decision to seek guilty pleas in two of the most advanced investigations: one into Credit Suisse for offering tax shelters to Americans, and the other against France’s largest bank, BNP Paribas, over doing business with countries like Sudan that the United States has blacklisted. The approach applies to American banks, though those investigations are at an earlier stage.”
“Earlier stage” is a euphemism for “we cannot admit that we only go after foreign banks.” The article eventually refers to one investigation involving a U.S. bank (Citi) – the operations of its Mexican subsidiary. So, if it happens abroad the new DOJ doctrine is that it might ask for a guilty plea from a bank that commits thousands of felonies. To which one must begin by saying: “good.” We would be happy to learn that there is some level of endemic crime by elite foreign bankers, motivated by the worst motives, rising to the level of an important part of the CEO’s strategic plan, and producing staggering harm that even Holder will no longer allow to occur with total impunity. That would be progress. It is pathetic that DOJ admits to reporters that doing so will require them to adopt a “new strategy.” When I worked for DOJ if I had asked for a meeting with my boss to urge him to announce that we were adopting a “new strategy” of enforcing the law against fraudulent bankers and banks he would have referred me to a psychiatrist. No one at DOJ had ever heard of the concept that the rule of law did not apply to everyone.
Deal Book tries to turn this pathetic tale into a new legend of bold prosecutors and regulators. In this telling the OCC head, a leading apologist for Wall Street, is recast as “Thomas J. Curry, a frequent critic of Wall Street.” Hold on to your seats, Deal Book is veering into an alternative universe. I know it has been a very, very long time since the Nation has appointed a real banking regulator to lead an agency, but consider the implications (for regulation and journalism) of this passage in which Deal Book is trying to force Curry into the mold of a tough regulator. Here is the context of Deal Book’s remarks about Curry.
“At a meeting last September, a top federal regulator vowed not to interfere if Mr. Bharara obtained a guilty plea from JPMorgan Chase over its ties to Bernard L. Madoff, according to the lawyers and records of the meeting. But the regulator, Thomas J. Curry, a frequent critic of Wall Street, warned that federal law might require him to reconsider JPMorgan’s charter if the bank was convicted of a crime.
The discussions with regulators, recounted in interviews with the lawyers and in records obtained through a Freedom of Information Act request, offer a lens into the political and legal minefields that prosecutors navigate when investigating big banks. The interviews also demonstrate that defense lawyers continue to push prosecutors not to act without assurances that regulators will keep a bank in business.
In a recent speech to Wall Street lawyers, Mr. Bharara said this dynamic created a ‘gaping liability loophole that blameworthy companies are only too willing to exploit.’
He noted that regulators often possessed many of the same facts, including emails and documents, that underpin a criminal case. The prosecutors and regulators, he said, need to ‘work in concert.’”
Deal Book does not understand the true, revealing implications of these passages.
- DOJ is now admitting that from 2009-2014 it operated under the old GBH “strategy” (aka its unilateral disarmament doctrine) of not prosecuting elite banks or bankers even when they committed massive frauds that endangered public safety (HSBC), national security (Standard Chartered), and the global economy (all the SDIs) – and failed even to recover the bankers’ fraud proceeds. Consider how damning DOJ’s assessment is of the costs of DOJ’s unilateral disarmament. “Mr. Bharara said this dynamic created a ‘gaping liability loophole that blameworthy companies are only too willing to exploit.’” I have only one friendly amendment to Bharara’s assessment – it should read “bankers exploit.” The bankers’ frauds will frequently involve looting the bank. Bharara’s prosecutions of insider trading largely involve frauds that made hedge funds more profitable, but I’m sure he would agree with my friendly amendment were he to consider the matter.
- DOJ is blaming the GBH Doctrine on the (anti) regulators, with the unstated implication that it came from Geithner. Note that in prior articles Geithner and his fellow anti-regulators have pushed back on this conclusion by saying that DOJ makes the sole decision whether to prosecute. Both statements are almost certainly true – the anti-regulators warn of doom and say that they cannot promise that prosecuting would not cause a global catastrophe. DOJ, inevitably when run by the likes of Mukasey, Holder, and Breuer, decides not to prosecute given the anti-regulators’ (absurd) claims that prosecuting bankers would cause the world’s economy to collapse.
- None of this explains why they don’t prosecute bankers (much less ex bankers)
- Curry “vowed not to interfere” if DOJ prosecuted JPMorgan – “interfering” with a prosecution is normally a felony (“obstruction of justice”). This is what passes for toughness in a regulator today? To rephrase it in English: Curry: “I won’t try to prevent a successful prosecution of a bank that I know has engaged in over a dozen massive felonies.”
- I guess it would sound odd to Curry, but as regulators we did everything possible to encourage, indeed demand, that DOJ prosecute fraudulent banks and bankers. We did so even when it might impair recovery under our civil suits.
- And speaking of JPMorgan, Madoff, and obstruction of justice. Banks have a duty under the rules to make criminal referrals when they find “suspicious activities” indicative of likely fraud. JPMorgan found copious evidence that Madoff was running a Ponzi scheme – and reportedly refused to file a criminal referral. When the OCC examiners tried to access JPMorgan’s evidence about Madoff’s frauds JPMorgan reportedly refused to give the examiners access. The bank examiners have a right to access such information, and JPMorgan has a duty to provide that access. The OCC’s IG sought DOJ support to enforce a subpoena – and DOJ reportedly refused to enforce the subpoena to get the information. JPMorgan, DOJ, and the OCC (before and during Curry’s reign) have been interacting in a manner that has allowed Jamie Dimon and Madoff to become apex predators. Madoff’s frauds had nothing to do with causing the crisis. JPMorgan’s frauds were vastly larger and at the core of causing the crisis. Guess which one gets prosecuted.
- The entire “I might be forced to pull JPMorgan’s charter if you prosecute” meme was a deliberately disingenuous threat of self-mutilation by Curry designed to prevent the prosecution of JPMorgan. There was zero chance that Curry would have pulled JPMorgan’s charter.
- Let’s, solely for purpose of analysis in this bullet point, go with Deal Book’s tale of Curry the fierce critic of Wall Street eager to bring its controlling officers to justice. Put yourself in the place of Deal Book’s Curry the Conqueror. You are critical of Wall Street because its CEOs have led the three most destructive epidemics of financial fraud in world history and those fraud epidemics hyper-inflated the bubble, caused the financial crisis, and caused the Great Recession. You are determined to clean up Wall Street and you do not care about career repercussions. You detest the “too big to fail” concept and you know that JPMorgan poses a grave systemic danger, is vastly too large to be managed efficiently, and receives a massive (implicit) federal subsidy that makes “free market competition” impossible in banking. DOJ is willing to bring a criminal case against JPMorgan and many of its senior officers. You are overjoyed and fully supportive of the prosecution. Indeed, one of the grounds for placing JPMorgan in receivership is “violations of law.” You encourage the prosecution. You “detail” your best examiners to assist the FBI so that they can serve as their internal banking experts and have access to Grand Jury materials under Rule 6 (e). You prepare the receivership recommendation for JPMorgan and the civil suits and enforcement actions against its culpable leaders. Then you and DOJ have a “come to Jesus” meeting with JPMorgan’s board (which is controlled by Dimon rather than the other way around). And you become the man that restored the rule of law, the possibility of real competition, and demonstrated that the largest bank in the world and its leaders could no longer commit frauds with impunity. You end JPMorgan’s record of well over a decision massive frauds under Dimon’s rule.
The thing you would never do if you were the Curry gussied up for Deal Book’s rousing tale of tough regulation is whine “I might have to pull JPMorgan’s charter.” Deal Book’s fictional Curry was a bravely seasoned and spicy meal rich in garam masala. The real Curry is a pale imitation that fears to offend through any bold ingredients.
- It is not our job as regulators to “keep a bank in business.” It is our paramount job as regulators to place banks that commit serious felonies led by the controlling officers in receivership. DOJ does not have to worry about creating some new means “to criminally punish banks without putting them out of business and damaging the economy.” A receivership does not have to “put [a bank] out of business.” What it does do is put the corrupt controlling officers out the business of looting the bank. That helps the economy. Indeed, it is the single most important thing we do as regulators that helps the economy.
- There are no “political and legal minefields that prosecutors navigate when investigating big banks.” DOJ has ample legal authority to investigate banks. They cannot credibly claim that there is any “legal minefield.” The Swiss do sometimes seek to obstruct U.S. criminal investigations, but that is not a “legal minefield” and the U.S. wins these disputes if we are resolute.
What is the “political … minefield” that prosecutors today feel must be “navigate[d]” if they wish to investigate “big banks?” That would be a fascinating subject for Deal Book to explain, though it would have the danger of pushing them to discuss ethics. (Yes, this Deal Book story is again an ethics-free zone.) I know people will consider me naïve when I say this, but I believe there are no “political minefields” that DOJ must “navigate” “when investigating big banks.” I think it is all an excuse. I doubt seriously that during this crisis DOJ or Curry has ever been called in by the Speaker of the House and yelled at and cursed for moving to remove a fraudulent CEO controlling Vernon (aka Vermin) Savings or had five U.S. Senators try to pressure them not to take an action against Lincoln Savings. My colleagues and I are actually not naïve about real political minefields. We took our advice from that popularly (and almost certainly inaccurately) attributed to Rear Admiral Daniel Farragut at the battle of Mobile: “Damn the torpedoes! Full speed ahead! (The torpedoes he was referring to were naval mines.)
The most destructive “political … minefields” restricting the action of regulators, prosecutors, and members of the armed services are often those that exist only in our own imaginations and fears. Bold action against those that imagine they are immune from accountability is essential. The SAS motto captures this quality: “Who Dares Wins.” (Yes, “bold” and “daring” are not sufficient, you also have to plan and do excellent investigations.)
- Bharara’s final comment is the most depressing evidence of the abject failure of the Bush and Obama administrations. They have refused to even do the most basic things, which are not even controversial, that are essential to success in prosecuting epidemics of bank fraud.
“[Bharara] noted that regulators often possessed many of the same facts, including emails and documents, that underpin a criminal case. The prosecutors and regulators, he said, need to ‘work in concert.’”
My readers know at what length I have made the point that criminal referrals by the regulators are the absolute requisite to success against substantial fraud by elite bankers and that the referral only begins the vital transfer of expertise form regulators to prosecutors. Bharara has put in print that the regulators possessed the facts “that underpin a criminal case” but are failing to “work in concert” with the prosecutors. In short, they are not making the criminal referrals and they are not making agency support of criminal investigations and prosecutions a top priority. Instead, they are still discouraging prosecutions (e.g., Curry’s silly claim about having to pull JPMorgan’s charter).
Deal Book has written another article praising a moral and policy travesty. Read beyond the article’s propaganda and you will find that it actually contains admissions by senior DOJ officials confirming that our description of the disgraceful policies that we charged that DOJ and the anti-regulators were following was correct and confirming that our conclusion that such policies were deeply criminogenic had proved correct. Bharara admitted that the GBH Doctrine created a “gaping liability loophole that blameworthy [controlling bank officers] are only too willing to exploit.” Until we appoint regulators with the spines, integrity, brains, and courage to realize that our paramount function is to place banks led by frauds into receivership and end the CEO’s ability to lead a control fraud we will fail to have a sound banking system and we will fail to restore the rule of law.