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Friday, September 11, 2015

Time for a Change at Justice


by Roy C. Smith
This week the Deputy Attorney General of the US, Sally Q. Yates, “stung by years of criticism that it has coddled Wall Street criminals” (quote from New York Times), announced new policies to place higher priority on the prosecution of individual executives of corporations suspected of wrongdoing. “Corporations can only commit crimes through flesh-and-blood people, Ms. Yates, said, “and those responsible should be held accountable.”
Surely the shareholders of the world’s largest banks that have been forced to pay many billions to settle charges against them rather face criminal trials before uncertain juries would agree. Executives of banks, who are selected and monitored by their board of directors, are not supposed to commit crimes (fraud, larceny, whatever) nor do the banks’ owners (shareholders) want them to be tempted to do so by management urging, compensation or other incentives.
The Justice Department, however, appears unwilling to cede the banks the benefit of the doubt that the intention of their boards is to behave properly. Ever since 2008, the Justice Department has been the Obama Administration’s agent for blaming the banks for the financial crisis and the Great Recession that followed.
The public has accepted this effort to shift responsibility for the whole mess onto the banks, and to infer that their actions could only have been the result of criminal activity that should be punished by jailing responsible executives.
The only trouble is that, despite serious and thorough efforts, the government has not been able to build a case against any of numerous responsible executives of several major banks investigated since the crisis.
Some say that the lack of indictments after 2008 is because financial fraud is hard to prove and top executives insulate themselves purposefully from those who actually do things. This may be true, but after the collapse of several high tech companies in the early 2000’s, the CEOs of Enron, WorldCom and some other companies did go to jail and for considerable periods.
The fact that the Justice Department did not find evidence of crimes would ordinarily satisfy the public that there were no crimes, but not in this case.
You may think that the banks acted unethically during the mortgage-backed bubble, or that they made stupid mistakes, but neither of those allegations are criminal. Disputes between parties in business transactions over ethical missteps or mistakes usually are settled by negotiation or civil litigation with compensation paid for damages. The Justice Department should have nothing to do with such matters.
But, this time around the Justice Department elected to act of behalf of the public by taking a highly political moral stand against the “greedy and reckless banks.” It did so by threatening to sue the banks for unnamed fraudulent actions knowing that the banks would settle, even for enormous amounts. It forced the banks into a position in which they had to choose between a large, perhaps unfair settlement and facing a possible criminal trial, which if lost could be their end as happened to Arthur Anderson, Enron’s accountants, in 2002.
The Justice Department’s practice of bringing such lawsuits changed when Eric Holder, in 1999 when Deputy Attorney General in the Clinton Administration, published the first in a series of memos by Deputy Attorneys General offering guidelines on prosecuting corporations. For a corporation to be indicted it had previously been necessary to demonstrate that it engaged in, or tolerated, or failed to prevent criminal activities.  Holder added the idea that the extent to which a corporation “cooperated” with the Justice Department in its investigations was also a factor. These criteria included turning over information on executives, waving their rights to lawyer-client privilege, and denying payment of executives’ legal expenses. Later some of these were deemed too intrusive of defendants’ rights and were withdrawn.
Ms. Yates’ memo is the latest in the series, but it doesn’t reinstate any of the withdrawn criteria, only notes that to get “credit” for cooperating, companies have to report or identify suspected employees and turn over evidence against them “regardless of their position, status or seniority.”  
Most banks had already assumed they would have to do this if circumstances required, so in that sense Yates’ memo emphasizing individual wrongdoing is nothing new.
What might be new, and certainly would be welcome by the banks, would be Justices’ subtlety deciding it was shifting ground and was finished with its campaign of suing the banks. If so, it’s very subtle, and indeed may only be reassurance to the left that the Obama Administration has not given up on going after the bad guys.
Almost all of the senior-most executives serving in the major banks in 2007-2008 have been replaced and suffered considerable financial losses in the bank shares they held. Some have also been disgraced and left unemployable. They attract little sympathy, however, because, looking back, the banks clearly did turbo-charge their activities in a giant mortgage market bubble that ultimately burst.
But they didn't cause the bubble (low interest rates and enormous institutional demand for mortgage-backed securities did), or the liquidity collapse that forced the mortgage-backed securities to absurdly low levels that caused mark-to-market write offs, that in turn imperiled some of them sufficiently that they had to be bailed out. The government’s actions to rescue Bear Stearns and AIG but not Lehman Brothers further confused the markets and drove prices even lower.
It is now clear that the blame-the-banks posture taken by the government has hurt the banks and the financial system. Not only have the banks faced the huge legal settlements, their regulatory constraints have been tightened to the point that they are struggling to earn enough to cover their cost of capital, not a viable position for the country’s most important banks to be in.
We need strong and healthy banks to help us recover from the too-low economic growth rates we have experienced in the seven years since the crisis. It is time for the government to contribute to the effort to improve the banks rather than to continue to prosecute them.
Let’s hope that that is what Ms.Yates was really trying to say.