Why No Wall Street CEOs Were Prosecuted For Causing The Financial Crisis

Why No Wall Street CEOs Were Prosecuted For Causing The Financial Crisis

by Dartagnan

"If you prosecute a CEO or other senior executive and send him or her to jail for committing a crime, the deterrent effect in my view vastly outweighs even the best compliance program you can put in place."

It's unusual for a Federal Judge to weigh in on specific matters that could conceivably come before his Bench.  It's even more unusual when those matters involve politically sensitive issues of national policy. A hard-hitting essay published recently in The New York Review Of Books by a 70-year old active United States District Judge has raised eyebrows for doing just that. Judge Jed S. Rakoff sits for the United States District Court for the Southern District of New York--the nerve center of the financial world.  A Clinton appointee and former Federal prosecutor, he stunned the SEC in 2011 by rejecting a proposed 285 million dollar settlement between the U.S. and Citigroup in a case where Citigroup had been accused of misleading investors through the sale and packaging of collateralized debt obligations.  Rakoff's rationale for rejecting that settlement--which he characterized as "pocket change"--was that Citigroup was not required to admit culpability.  The SEC changed its position on this practice after this ruling.
Today Rakoff is once again getting under the government's skin. He wonders aloud why no high-level corporate CEO's or other managing officers in private Finance and Banking firms have been prosecuted for causing the financial meltdown that led to what we now know as the Great Recession. His essay, linked above, suggests several reasons and leads to at least one unsettling conclusion: that the Justice Department believes governmental officials' actions tacitly if not directly abetted and enabled the crisis to the point where prosecuting corporate CEO's would simply end up implicating the U.S. government.
His essay opens with some basic questions:

Who was to blame? Was it simply a result of negligence, of the kind of inordinate risk-taking commonly called a “bubble,” of an imprudent but innocent failure to maintain adequate reserves for a rainy day? Or was it the result, at least in part, of fraudulent practices, of dubious mortgages portrayed as sound risks and packaged into ever more esoteric financial instruments, the fundamental weaknesses of which were intentionally obscured?

Rakoff acknowledges that if the Financial crisis were the product of mere negligence, then prosecution of corporate executives would simply be scapegoating "of the worst kind."  But if the evidence points to intentional fraud, that is exactly the type of conduct the Justice Department is designed to confront and its failure to do so a travesty of Justice in its own right:

But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years. Indeed, it would stand in striking contrast to the increased success that federal prosecutors have had over the past fifty years or so in bringing to justice even the highest-level figures who orchestrated mammoth frauds.

(Emphasis supplied) Constrained by his ethical obligation to maintain judicial propriety, Rakoff takes great pains to emphasize he has no knowledge that fraud was in fact committed. What he does is distill the crisis to its basic elements--that subprime mortgages of questionable creditworthiness were being packaged and sold as collateral for highly leveraged securities nonetheless rated as AAA, "low-risk." How this circumstance could arise at all without someone--well, lying along the way would appear to be a rhetorical question which Rakoff raises but lets the reader follow through to its conclusion.  Instead of expressing an opinion, Rakoff allows the record speak for itself:

[T]he stated opinion of those government entities asked to examine the financial crisis overall is not that no fraud was committed. Quite the contrary. For example, the Financial Crisis Inquiry Commission, in its final report, uses variants of the word “fraud” no fewer than 157 times in describing what led to the crisis, concluding that there was a “systemic breakdown,” not just in accountability, but also in ethical behavior.

As the commission found, the signs of fraud were everywhere to be seen...

Rakoff then systematically dissects the Justice Department's three predominant excuses for their failure to prosecute individuals who undoubtedly fostered the conditions that led to the financial meltdown of 2008. The first--the difficulty of proving intent (an essential element to prove fraud), he finds weak.  Judge Rakoff believes that given the scale of the abuse the Justice Department would be capable of eliciting enough evidence to prove conscious disregard, or "willful blindness" on the part of corporate CEO's and officers whose companies engaged in these transactions.  In a Federal criminal trial for fraud, conscious disregard can and does qualify as "intent." The second excuse, that proof of "reliance" would be difficult since the parties to these transactions were sophisticated investors--he dismisses fairly out of hand. The criminal standard for fraud requires no such proof, and he explains why.
Finally, the Justice Department--specifically Attorney General Eric Holder--has raised the possibility that such prosecutions might result in economic harm to the country.  Rakoff believes that for a Federal official charged with enforcing the law this position--the "too big to jail" position-- is disturbing, to say the least.  He notes that Holder recalibrated his remarks and said they had been misconstrued, but in any event this leads Rakoff to his central point--that this concern evaporates if individuals are targeted, rather than institutions.
Rakoff believes that the high-profile prosecution of individual CEO's would have a far greater deterrent effect than do the prosecutions of the companies they work for. So if Justice's excuses are hollow, what is the real reason these prosecutions haven't occurred?  Rakoff tacks off the familiar justifications: First, because agents who could have worked the cases were transferred to anti-terrorism duty after 9/11; second, that the SEC operates under a very limited budget, limited even more by Congressional Republicans; and finally that the potential cases were parceled out to assistant US Attorneys with a greater personal interest in prosecuting "run-of-the-mill" financial fraud such as insider trading because of their immediate payoff.
None of these explanations is particularly satisfactory to him given the scope of the harm done. This brings him to to his second, more alarming point--that the government's own role in fostering the events that led to the crisis has had a chilling effect on prosecutors:

...Even before the start of the housing boom, it was the government, in the form of Congress, that repealed the Glass-Steagall Act, 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 and the Office of the Comptroller of the Currency, both in the Treasury Department. It was the government, in the form of the Federal Reserve, that kept interest rates low, in part to encourage mortgages...[.].

If you read that paragraph carefully you'll notice that--fair or not--no one escapes blame. From the start to the finish, the U.S. government has had its hands in the financial mess, and it was again the U.S. government--recall, for example, the near unanimity between the outgoing Bush and incoming Obama Administrations on TARP-- who readily forgave and immediately bailed out most of the very entities directly responsible for the disaster in the first place.

[W]hat 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.

And that, my friends, is as good a reason as any why you have seen no prosecutions of high level private financial firm CEOs in connection with their actions leading up to the meltdown. While Rakoff won't come out and say it, the implication is clear--if the elements are there to establish fraud, then the prosecutor's job is to prosecute. But who to prosecute when the CEO starts attributing his actions to the government?  And implicating "the government" always means naming names--from Rubin to Gramm to Clinton to Reagan, and everyone in between. Finally, Rakoff criticizes the trend by the Justice Department towards punishing companies as opposed to the folks who run them, a trend he describes as unfortunate, leading to a familiar dance that looks like this:

Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former assistant US attorney, now a partner at a respected law firm, to do an internal investigation...[.] Six months later the company’s counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement [requiring fines and future compliance requirements]... You are happy because you believe that you have helped prevent future crimes; the company is happy because it has avoided a devastating indictment; and perhaps the happiest of all are the executives, or former executives, who actually committed the underlying misconduct, for they are left untouched.

The fact that this is coming from a Judge who has a history of creating heartburn for the Justice Department simply bolsters its credibility.   In the meantime, the consequences of the financial crisis continue to reverberate across the globe in ways that not even the most prescient could have imagined.  On top of the ruined lives and misery inflicted upon tens of millions of Americans, many of whom will never recover economically to pre-Recession levels, the heedless actions of these financial institutions and their principals have unleashed a storm of violent nationalism and xenophobia in Europe, the product of the EU's failed attempt to address the crisis through fiscal austerity. Far right parties are widely expected to increase their power and influence across the continent as stubborn double-digit unemployment threatens to consign an entire generation of young Europeans to stagnation and poverty. The sociological effects of the Great Recession are incalculable, as is the cascading effect of such an economic calamity on generations to follow:

The rightist parties will campaign primarily on the basis of opposition to the European Union, in most instances posing as opponents of austerity measures imposed by the EU throughout Europe. By shifting somewhat from their usual preoccupation with immigration and Islam, they hope to capitalise on popular hostility to the EU and its austerity agenda. *  *  *
The “mainstream” political parties—of the official “left” as well as the right—are politically responsible for a situation in which the far right can strike such a pose, since the entire political establishment is implicated in the savage attacks that have been inflicted on Europe’s workers since the financial crash of 2008.

and:

There are increasing concerns across Europe that what was once considered far-right and racist is moving toward mainstream political thought. Anti-immigration agendas have led to increased worry from immigrant communities across the European Union. In recent weeks, a new study has shown that at the same time, concerns among Jews of a resurgence of anti-Semitism are strong and growing.

The effects of this artificial, completely avoidable economic cataclysm on the entire world were so profound, and the consequences so radical, the true ends will likely not manifest themselves for decades.  Whatever rough beast is likely to arise from the ashes of a transformed Europe is probably not going to be to our liking. The reputations and comfort of a few persons in the U.S. government simply pales in comparison to the amount of harm done here. If Rakoff is right, and the reluctance by the Justice Department to prosecute is out of fear of "putting our government" on trial, then the only rejoinder is that the government--and the people responsible for creating this disaster--deserves to share the blame along with the corporate officers and CEO's who actually turned a blind eye to fraud.  If we fail to hold those responsible to account there will be no expectation of any accounting in the future, and the process will certainly repeat itself as more and more opportunities arise to "package" and transfer vast sums of wealth for the benefit of a tiny, detached and untouchable group of people.  The failure of our society to credibly assign responsibility to those whose unbridled greed caused the Financial crisis will be remembered not just as a human failing but one of the greatest failures of Democracy itself.
       
Note: Nextstep in the comments points out that the SEC in 2011 charged executives of the government-sponsored entities Freddie Mac and Fannie Mae with securities fraud.