Alternative priorities and government ties to the conditions that caused the financial crisis could explain the lack of prosecutions.
Without multiplying examples further, my point is that the Department of Justice has never taken the position that all the top executives involved in the events leading up to the financial crisis were innocent, but rather has offered one or another excuse for not criminally prosecuting them – excuses that, on inspection, appear unconvincing. So, you might ask, what’s really going on here? I don’t claim to have any inside information about the real reasons why no such prosecutions have been brought, but I take the liberty of offering some speculations, for your consideration or amusement as the case may be.
At the outset, however, let me say that I totally discount the argument sometimes made that no such prosecutions have been brought because the top prosecutors were often people who previously represented the financial institutions in question and/or were people who expected to be representing such institutions in the future: the so-called “revolving door.” In my experience, every federal prosecutor, at every level, is seeking to make a name for him-or-herself, and the best way to do that is by prosecuting some high-level person. While companies that are indicted almost always settle, individual defendants whose careers are at stake will often go to trial. And if the government wins such a trial, as it usually does, the prosecutor’s reputation is made. My point is that whatever small influence the “revolving door” may have in discouraging certain white-collar prosecutions is more than offset, at least in the case of prosecuting high-level individuals, by the career-making benefits such prosecutions confer on the successful prosecutor.
So, one asks again, why haven’t we seen such prosecutions growing out of the financial crisis? I offer, by way of speculation, three influences that I think, along with others, have had the effect of limiting such prosecutions.
First, the prosecutors had other priorities. Some of these were completely understandable. For example, prior to 2001, the FBI had more than 1,000 agents assigned to investigating financial frauds, but after 9/11 many of these agents were shifted to anti-terrorism work. Who can argue with that? Yet, the result was that, by 2007 or so, there were only 120 agents reviewing the more than 50,000 reports of mortgage fraud filed by the banks. It is true that after the collapse of Lehman Brothers in 2008, new agents were hired for some of the vacated spots in fraud detection, but this is not a form of detection easily learned and recent budget limitations have only exacerbated the problem.
Of course, while the FBI has substantial responsibility for investigating mortgage fraud, the FBI is not the primary investigator of fraud in the sale of mortgage-backed securities; that responsibility lies mostly with the Securities and Exchange Commission (SEC). But at the very time the financial crisis was breaking, the SEC was trying to deflect criticism from its failure to detect the Madoff fraud, and this led it to concentrate on other Ponzi-like schemes that emerged in the wake of the financial crisis, along with cases involving misallocation of assets (such as stealing funds from a customer), which are among the easiest cases to prove. Indeed, as Professor John C. Coffee Jr. of Columbia Law School has repeatedly documented, Ponzi schemes and misallocation-of-asset cases have been the primary focus of the SEC since 2009, while cases involving fraud in the sale of mortgage-backed securities have been much less frequent. More recently, moreover, the SEC has been hard hit by budget limitations, and this has not only made it more difficult to assign the kind of manpower the kinds of frauds we are talking about require, but also has led SEC enforcement to focus on the smaller, easily resolved cases that will beef up their statistics when they go to Congress begging for money.
As for the Department of Justice proper, a decision was made in 2009 to spread the investigation of these financial fraud cases among numerous U.S. Attorney’s Offices, many of which had little or no prior experience in investigating and prosecuting sophisticated financial frauds. This was in connection with the President’s creation of a special task force from which remarkably little has been heard in the intervening four-plus years. At the same time, the U.S. Attorney’s Office with the greatest expertise in these kinds of cases, the Southern District of New York, was just embarking on its prosecution of insider trading cases arising from the Rajaratnam tapes, which soon proved a gold mine of good cases that absorbed a huge amount of the attention of the securities fraud unit of that office.
While I want to stress again that I have no inside information, as a former chief of that unit I would venture to guess that the cases involving the financial crisis were parceled out to Assistant United States Attorneys who also had insider trading cases. Which do you think an Assistant would devote most of her attention to: an insider trading case that was already nearly ready to go to indictment and that might lead to a high-visibility trial, or a financial crisis case that was just getting started, would take years to complete, and had no guarantee of even leading to an indictment? Of course, she would put her energy into the insider trading case, and if she was lucky, it would go to trial, she would win, and she would then take a job with a large law firm. And in the process, the financial fraud case would get lost in the shuffle.
In short, a focus on alternative priorities is, I submit, one of the reasons the financial fraud cases have not been brought, especially cases against high-level individuals that would take many years, many investigators, and a great deal of expertise to investigate. But a second, and less salutary, reason for not bringing such cases is the government’s own involvement in the underlying circumstances that led to the financial crisis. On the one hand, the government, writ large, had a hand in creating the conditions that encouraged the approval of dubious mortgages. Even before the start of the housing boom, it was the government, in the form of Congress, that repealed Glass-Steagall, thus allowing certain banks that had previously viewed mortgages as a source of interest income to become instead deeply involved in securitizing pools of mortgages in order to obtain the much greater profits available from trading. It was the government, in the form of both the executive and the legislature, that encouraged deregulation, thus weakening the power and oversight not only of the SEC but also of such diverse banking overseers as the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC) It was the government, in the form of the Fed, that kept interest rates low, in part to encourage mortgages. It was the government, in the form of the executive, that strongly encouraged banks to make loans to low-income persons who might have previously been regarded as too risky to warrant a mortgage. Thus, in the year 2000, HUD Secretary Andrew Cuomo increased to 50% the percentage of low-income mortgages that the government-sponsored entities known as Fannie Mae and Freddie Mac were required to purchase, helping to create the conditions that resulted in over half of all mortgages being subprime at the time the housing market began to collapse in 2007. And it was the government, pretty much across the board, that acquiesced in the ever greater tendency not to require meaningful documentation as a condition of obtaining a mortgage, often preempting in this regard state regulations designed to assure greater mortgage quality and a borrower’s ability to repay. Indeed, in the year 2000, the OTS, having just finished a successful campaign to preempt state regulation of thrift underwriting, terminated its own underwriting regulations entirely.
The result of all this were the mortgages that later became known as “liars’ loans.” They were increasingly risky; but what did the banks care, since they were making their money from the securitizations; and what did the government care, since they were helping to boom the economy and helping voters to realize their dream of owning a home.
Moreover, the government was also deeply enmeshed in the aftermath of the financial crisis. It was the government that proposed the shotgun marriages of Bank of America with Merrill Lynch, of JPMorgan with Bear Stearns, etc. If, in the process, mistakes were made and liabilities not disclosed, was it not partly the government’s fault? One does not necessarily have to adopt the view of Neil Barofsky, former Special Inspector General in Charge of Oversight of TARP, that regulators made almost no effort to hold accountable the financial institutions they were bailing out, to wonder whether the government, having helped create the conditions that led to the seeming widespread fraud in the mortgage-backed securities market, was all too ready to forgive its alleged perpetrators.
Please do not misunderstand me. I am not alleging that the government knowingly participated in any of the fraudulent practices alleged by the Financial Inquiry Crisis Commission and others. But what I am suggesting is that the government was deeply involved, from beginning to end, in helping create the conditions that could lead to such fraud, and that this would give a prudent prosecutor pause in deciding whether to indict a CEO who might, with some justice, claim that he was only doing what he fairly believed the Government wanted him to do.