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Justice Denied

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A recent article written by former New York Mayor Ed Koch began with the grim observation that no criminal charges have been brought against any of the malefactors responsible for causing the financial crisis:

Looking back on 2010 and the Great Recession, I continue to be enraged by the lack of accountability for those who wrecked our economy and brought the U.S. to its knees.  The shocking truth is that those who did the damage are still in charge.  Many who ran Wall Street before and during the debacle are either still there making millions, if not billions, of dollars, or are in charge of our country’s economic policies which led to the debacle.

Most of us assumed that the Enron scandal had set a precedent for the prosecution of corporate financial crime.  A few Enron executives received prison sentences and the CEO, Ken Lay, died while serving time.  Enron’s auditor, Arthur Andersen & Company, was forced out of business.  In the wake of the Savings and Loan Crisis of the late 1980s, Charles Keating and a few of his associates were indicted by the State of California.  Keating eventually received a ten-year prison sentence for fraud, racketeering and conspiracy.  Keating’s prosecution resulted from pressure brought by William Black, former litigation director for the Federal Home Loan Bank Board.  At one point during Black’s investigation, Keating issued a written memo to one of his minions, with this directive:  “If you can’t get Wright and Congress to get Black . . .  Kill him dead.”

These days, William Black has been doing quite a bit of speaking and writing about the need to initiate criminal proceedings against the culprits responsible for causing the financial crisis.  On December 28, Black characterized the failure to prosecute those crimes as “de facto decriminalization of elite financial fraud”:

The FBI and the DOJ remain unlikely to prosecute the elite bank officers that ran the enormous “accounting control frauds” that drove the financial crisis.  While over 1000 elites were convicted of felonies arising from the savings and loan (S&L) debacle, there are no convictions of controlling officers of the large nonprime lenders.  The only indictment of controlling officers of a far smaller nonprime lender arose not from an investigation of the nonprime loans but rather from the lender’s alleged efforts to defraud the federal government’s TARP bailout program.

What has gone so catastrophically wrong with DOJ, and why has it continued so long?  The fundamental flaw is that DOJ’s senior leadership cannot conceive of elite bankers as criminals.

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Our best bet is to continue to win the scholarly disputes and to continue to push media representatives to take fraud seriously. If the media demands for prosecution of the elite banking frauds expand there is a chance to create a bipartisan coalition in Congress and the administration supporting prosecutions.  In the S&L debacle, Representative Annunzio was one of the leading opponents of reregulation and leading supporters of Charles Keating.  After we brought several hundred successful prosecutions he began wearing a huge button:  “Jail the S&L Crooks!”  Bringing many hundreds of enforcement actions, civil suits, and prosecutions causes huge changes in the way a crisis is perceived.  It makes tens of thousands of documents detailing the frauds public.  It generates thousands of national and local news stories discussing the nature of the frauds and how wealthy the senior officers became through the frauds.  All of this increases the saliency of fraud and increases demands for serious reforms, adequate resources for the regulators and criminal justice bodies, and makes clear that elite fraud poses a severe danger.  Collectively, this creates the political space for real reform, vigorous regulators, and real prosecutors.

Hedge fund manager, David Einhorn (author of  Fooling Some of the People All of the Time) was recently interviewed by Charlie Rose.  At one point during the interview, Charlie Rose asked Einhorn to address the argument that regulators lacked the tools necessary for preventing the financial crisis.  Mr. Einhorn gave this response:

I would actually disagree with that.  I think that the problem was that the laws were not enforced.  After Enron you had Sarbanes Oxley.  And there have been hardly any prosecutions under Sarbanes Oxley.  You put in a tough anti-fraud law.  The CEO has to sign there is no fraud.

The CFO has to sign that the financial statements are correct.  If it’s not, there are going to be criminal consequences to all of this.  And the result was that effectively you passed a law but then they didn’t enforce the law.

And once the bad guys figured out that the law wasn’t being enforced, it effectively provided cover because everybody said, look we have the tough antifraud law.  The fraud must have gone away.

We often hear the expression “crime of the century” to describe some sensational act of blood lust.  Nevertheless, keep in mind that the financial crisis resulted from a massive fraud scheme, involving the packaging and “securitization” of mortgages known to be “liars’ loans”, which were then sold to unsuspecting investors by the creators of those products — who happened to be betting against the value of those items.  In consideration of the fact that the credit crisis resulting from this scam caused fifteen million people to lose their jobs as well as an expected 8 – 12 million foreclosures by 2012, one may easily conclude that this fraud scheme should be considered the crime of both the last century as well as the current century.

While many people have been getting excited about the “insider trading” investigation currently underway, I have been sitting here, wearing my tinfoil hat, viewing the entire episode as a diversionary tactic to direct public attention away from the crimes that caused the financial crisis.  Fortunately, I am not the only cynic with such an outlook.  Jesse Eisenger recently wrote a piece for the DealBook blog at The New York Times entitled, “The Feds Stage a Sideshow While the Big Tent Sits Empty”.  Here is some of what Eisenger had to say about the “insider trading” investigation:

In fact, plenty of people on Wall Street are happy about the investigation.  The ones with clean consciences like the idea that the world of special access to favorable tips is being cleaned up.

But others are pleased for a different reason:  They realize the investigation is a sideshow.

All the hype carries an air of defensiveness.  Everyone is wondering:  Where are the investigations related to the financial crisis?

John Hueston, a former lead Enron prosecutor, wonders, “Have they committed the resources in the right place?  Do these scandals warrant apparent national priority status?”

Nobody from Lehman, Merrill Lynch or Citigroup has been charged criminally with anything.  No top executives at Bear Stearns have been indicted.  All former American International Group executives are running free.  No big mortgage company executive has had to face the law.

There’s an old saying:  “Justice delayed is justice denied.”  The government has demonstrated that it is in no hurry to bring any significant criminal charges against the perpetrators of the crimes that caused the financial crisis.  With the passing of time, it becomes increasingly obvious that those crimes will go unpunished.  The cause of justice is simply no match for the ability of certain individuals to operate “above the law”.  In fact, it never has been.


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More Damned Lies Than You Can Count

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March 15, 2010

Thanks to the great work of Anton Valukas, as court-appointed bankruptcy examiner investigating the collapse of Lehman Brothers, people are finally beginning to realize how significant a role fraud plays on Wall Street.  It turned out that the Enron scandal wasn’t the once-in-a-lifetime event people thought it was.  Accounting fraud occurs on a regular basis, as does fraudulent stock price manipulation.  The 2200-page report prepared by Valukas and his team at Jenner & Block has everyone talking.  It’s about time.

Other lies are getting more exposure as well.  President Obama justified the bank bailouts with the rationale that giving the money to the banks creates a “money multiplier” effect because banks can loan out 8-10 dollars for every bailout dollar they get, giving the economy more bang for the bailout buck.  As I pointed out on September 21, Australian economist Steve Keen published a fantastic report from his website, explaining how the “money multiplier” myth, fed to Obama by the very people who helped cause the crisis, was the wrong paradigm to be starting from in attempting to save the economy.  Here’s some of what Professor Keen had to say:

He justified giving the money to the lenders, rather than to the debtors, on the basis of “the multiplier effect” from bank lending:

the truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses, a multiplier effect that can ultimately lead to a faster pace of economic growth.  (page 3 of the speech)

This argument comes straight out of the neoclassical economics textbook.  Fortunately, due to the clear manner in which Obama enunciates it, the flaw in this textbook argument is vividly apparent in his speech.

This “multiplier effect” will only work if American families and businesses are willing to take on yet more debt:  “a dollar of capital in a bank can actually result in eight or ten dollars of loans”.

So the only way the roughly US$1 trillion of money that the Federal Reserve has injected into the banks will result in additional spending is if American families and businesses take out another US$8-10 trillion in loans.

*  *  *

If the money multiplier was going to “ride to the rescue”, private debt would need to rise from its current level of US$41.5 trillion to about US$50 trillion, and this ratio would rise to about 375% — more than twice the level that ushered in the Great Depression.

This is a rescue?  It’s a “hair of the dog” cure:  having booze for breakfast to overcome the feelings of a hangover from last night’s binge.  It is the road to debt alcoholism, not the road to teetotalism and recovery.

Fortunately, it’s a “cure” that is also highly unlikely to work, because the model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

Now that Australia’s economy is beginning to recover, they have already found it necessary to begin raising interest rates.  As I pointed out last September:

If only Mr. Obama had stuck with his campaign promise of “no more trickle-down economics”, we wouldn’t have so many people wishing they lived in Australia.

Michael Shedlock (“Mish”) recently referred to Professor Keen’s debunking of the money multiplier myth in a fantastic essay:

However, conventional wisdom regarding the money multiplier is wrong.  Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

Indeed, this is easy to conceptualize:  Banks lent more than they should have, and those loans are going bad at a phenomenal rate.  In response, the Fed has engaged in a huge swap-o-rama party with various banks (swapping treasuries for collateral of dubious value) in addition to turning on the printing presses.

This was done so that banks would remain “well capitalized”. The reality is those excess reserves are a mirage.  Banks need those reserves for credit losses coming down the pike, as unemployment rises, foreclosures mount, and credit card defaults soar.

Banks are not well capitalized, they are insolvent, unwilling and unable to lend.

Blogger George Washington recently wrote an extensive, thought-provoking piece about public banking and other potential alternatives to resolve the economic crisis, which appeared at the Naked Capitalism website.  The essay began with a discussion of Steve Keen’s work in exposing the “money multiplier” as a sham.

Speaking of shams, former Labor Secretary Robert Reich recently wrote a great essay entitled, “The Sham Recovery”.  Reich has exposed the propagandists touting the imaginary economic recovery in his unique, clear style:

Business cheerleaders naturally want to emphasize the positive.  They assume the economy runs on optimism and that if average consumers think the economy is getting better, they’ll empty their wallets more readily and — presto! — the economy will get better.  The cheerleaders fail to understand that regardless of how people feel, they won’t spend if they don’t have the money.

It’s always nice when a big lie gets exposed.   It’s even better that we are now learning that the true cause of the financial crisis was plain, old sleaze.



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