Can—and Should—Bankers Be Prosecuted for Crimes?

The spate of books describing unethical, deceptive, and apparently illegal practices that led us into the housing bubble and the Great Recession have left many wondering why people have not been brought to trial for their actions. This lack of judicial action has generated frustration and the suspicion that bankers and financiers are less answerable to the law than other citizens. We have lived through the bailout, now where is the accountability? Jeff Madrick and Frank Partnoy address this issue in an article in The New York Review of Books: Should Some Bankers Be Prosecuted? Their answer is "yes."

The authors provide this summary of legal actions.

"In September 2011, the Securities and Exchange Commission asserted that overall it had charged seventy-three persons and entities with misconduct that led to or arose from the financial crisis, including misleading investors and concealing risks. But even the SEC’s highest- profile cases have let the defendants off lightly, and did not lead to criminal prosecutions. In 2010, Angelo Mozilo, the head of Countrywide Financial, the nation’s largest subprime mortgage underwriter, settled SEC charges that he misled mortgage buyers by paying a $22.5 million penalty and giving up $45 million of his gains. But Mozilo had made $129 million the year before the crisis began, and nearly another $300 million in the years before that. He did not have to admit to any guilt."

"The biggest SEC settlement thus far, alleging that Goldman Sachs misled investors about a complex mortgage product—telling investors to buy what had been conceived by some as a losing proposition—was for $550 million, a record of which the SEC boasted. But Goldman Sachs earned nearly $8.5 billion in 2010, the year of the settlement. No high-level executives at Goldman were sued or fined, and only one junior banker at Goldman was charged with fraud, in a civil case. A similar suit against JPMorgan resulted in a $153.6 million fine, but no criminal charges."

The Department of Justice has been provided documentation by various committees and agencies, but has yet to bring a case to trial. In fact, it has dropped a major investigation against Washington Mutual because the findings did not appear prosecutable under law.

The authors recognize that there are understandable reasons for such apparent timidity. Bringing down bankers would have economic consequences, and the financial lobby is very effective at influencing members of government. Bankers also try to protect themselves by making participants sign a statement saying that they are "sophisticated enough to understand the risks of the investment," a tactic that has worked in some cases.

However, the major reason for inaction probably lies within the financial laws themselves.

"To convict someone of criminal fraud under any of the [financial] laws we have mentioned, a prosecutor must prove both that the defendant misrepresented important facts to investors and also that he or she knew those facts were false. In other words, failure to disclose pertinent facts to investors out of sheer negligence can’t give rise to prosecutable fraud; there must be full knowledge that such essential information is not being disclosed."

While we can be charged with criminal negligence, bankers cannot. So bankers are held to a lower standard than normal citizens.

Proving criminal knowledge and intent is difficult, time and resource intensive, and it leads to uncertain results since jurors are easily confused about complex financial transactions. The result has been that government agencies usually settle for a fine rather than prosecute.

Madrick and Partnoy are sympathetic with the prosecutors over this dilemma. They assign fault to Congress for not strengthening these laws so that merely criminal negligence need be proven.

However, they argue that it is absolutely necessary for a legal precedent to be set. They compare the situation to the incidences of insider trading. In that case there is clear legal guidance and financial people have a definite indication of what is acceptable and what is prosecutable. Until a similar situation exists in banking, there is no motivation for financial people to resist pushing legal and ethical limits.

The authors indicate that the report by the Senate’s Permanent Subcommittee on Investigations (PSI), Wall Street and the Financial Crisis, contains a number of instances that could be prosecutable. They suggest one in particular where the evidence is particularly strong.

"The deal in question involves a $1.1 billion offering called Gemstone 7, assembled by the large German bank Deutsche Bank."

"The Gemstone 7 pool of mortgage bonds was particularly risky. Numerous e-mails uncovered by the PSI show that Deutsche Bank’s traders knew full well the risks of these securities. Almost a third of Gemstone 7’s securities were subprime mortgages issued by Long Beach, Fremont, and New Century, three notoriously low-quality lenders, according to PSI analyses. According to the Senate report, Deutsche Bank’s own employees used words like ‘crap’ and ‘pigs’ to describe these mortgages, and the bank’s traders even bet against some of these securities themselves."

Madrick and Partnoy believe it is critical that a prosecution be initiated in this or in a similar case.

"And if there were a guilty verdict, it would establish precedents that would make other prosecutions workable. Then—and perhaps only then—would a strong deterrence against such activities be created. If prosecutors are paralyzed by fear of losses and the complexity of these cases, justice may never be done."

And if this doesn’t work, then perhaps the solution is a full-fledged Occupy Congress movement to demand laws that allow financial criminals to be treated like criminals.