The Government Has It Bass-Ackwards: Failing To Prosecute Criminal Fraud by the Big Banks Is Killing – NOT Saving – the Economy
Failure to Prosecute Fraud Causes Economic Downturns
U.S. Attorney General Eric Holder
said today:
I am concerned that the size of some of these
institutions [banks] becomes so large that it does become difficult for
us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy
As we’ve repeatedly noted, this is
wholly untrue.
If the big banks were important to the economy, would so many
prominent economists, financial experts and bankers be calling for them to be broken up?
If the big banks generated prosperity for the economy, would they have to be virtually
100% subsidized to keep them afloat?
If the big banks were helpful for an economic recovery, would they be
prolonging our economic instability?
In fact, failing to prosecute criminal fraud has been
destabilizing the economy since at least 2007 … and will cause
huge crashes in the future.
After all, the
main driver of economic growth is a strong rule of law.
Nobel prize winning economist Joseph Stiglitz says that
we have to prosecute fraud or else the economy won’t recover:
The legal system is supposed to be the codification of
our norms and beliefs, things that we need to make our system work. If
the legal system is seen as exploitative, then confidence in our whole
system starts eroding. And that’s really the problem that’s going on.
***
I think we ought to go do what we did in the S&L [crisis]
and actually put many of these guys in prison. Absolutely. These are not
just white-collar crimes or little accidents. There were victims.
That’s the point. There were victims all over the world.
***
Economists focus on the whole notion of incentives. People have an
incentive sometimes to behave badly, because they can make more money if
they can cheat. If our economic system is going to work then we have to
make sure that what they gain when they cheat is offset by a system of
penalties.
Nobel prize winning economist George Akerlof has
demonstrated
that failure to punish white collar criminals – and instead bailing
them out- creates incentives for more economic crimes and further
destruction of the economy in the future.
Indeed, professor of law and economics (and chief S&L prosecutor) William Black
notes that we’ve known of this dynamic for “hundreds of years”. And see
this,
this,
this and
this.
(Review of the data on accounting fraud confirms that
fraud goes up as criminal prosecutions go down.)
The Director of the Securities and Exchange Commission’s enforcement division
told Congress:
Recovery from the fallout of the financial crisis
requires important efforts on various fronts, and vigorous enforcement
is an essential component, as aggressive and even-handed enforcement
will meet the public’s fair expectation that those whose violations of
the law caused severe loss and hardship will be held accountable. And
vigorous law enforcement efforts will help vindicate the principles that
are fundamental to the fair and proper functioning of our markets: that
no one should have an unjust advantage in our markets; that investors
have a right to disclosure that complies with the federal securities
laws; and that there is a level playing field for all investors.
Paul Zak (Professor of Economics and Department Chair, as well as the
founding Director of the Center for Neuroeconomics Studies at Claremont
Graduate
University,
Professor of Neurology at Loma Linda University Medical Center, and a
senior researcher at UCLA) and Stephen Knack (a Lead Economist in the
World Bank’s Research Department and Public Sector Governance
Department)
wrote a paper called Trust and Growth,
showing that enforcing the rule of law – i.e. prosecuting white collar fraud – is necessary for a healthy economy.
One of the leading business schools in America – the Wharton School of Business –
published
an essay by a psychologist on the causes and solutions to the economic
crisis. Wharton points out that restoring trust is the key to recovery,
and that trust cannot be restored until wrongdoers are held accountable:
According to David M. Sachs, a training and supervision
analyst at the Psychoanalytic Center of Philadelphia, the crisis today
is not one of confidence, but one of trust. “Abusive financial practices
were unchecked by personal moral controls that prohibit individual
criminal behavior, as in the case of [Bernard] Madoff, and by complex
financial manipulations, as in the case of AIG.” The public, expecting
to be protected from such abuse, has suffered a trauma of loss similar
to that after 9/11. “Normal expectations of what is safe and dependable
were abruptly shattered,” Sachs noted. “As is typical of post-traumatic
states, planning for the future could not be based on old assumptions
about what is safe and what is dangerous. A radical reversal of how to
be gratified occurred.”
People now feel more gratified saving money than spending it, Sachs
suggested. They have trouble trusting promises from the government
because they feel the government has let them down.
He framed his argument with a fictional patient named Betty Q.
Public, a librarian with two teenage children and a husband, John, who
had recently lost his job. “She felt betrayed because she and her
husband had invested conservatively and were double-crossed by
dishonest, greedy businessmen, and now she distrusted the government
that had failed to protect them from corporate dishonesty. Not only
that, but she had little trust in things turning around soon enough to
enable her and her husband to accomplish their previous goals.
“By no means a sophisticated economist, she knew … that some people
had become fantastically wealthy by misusing other people’s money — hers
included,” Sachs said. “In short, John and Betty had done everything
right and were being punished, while the dishonest people were going
unpunished.”
Helping an individual recover from a traumatic experience provides a
useful analogy for understanding how to help the economy recover from
its own traumatic experience, Sachs pointed out. The public will need to
“hold the perpetrators of the economic disaster responsible and take
what actions they can to prevent them from harming the economy again.”
In addition, the public will have to see proof that government and
business leaders can behave responsibly before they will trust them
again, he argued.
Note that Sachs urges “hold[ing] the perpetrators of the economic
disaster responsible.” In other words, just “looking forward” and
promising to do things differently isn’t enough.
Robert Shiller – one of the top housing experts in the United States –
says that the mortgage fraud is a lot like the fraud which occurred
during the Great
Depression. As Fortune
notes:
Shiller said the danger of foreclosuregate — the scandal
in which it has come to light that the biggest banks have routinely
mishandled homeownership documents, putting the legality of foreclosures
and related sales in doubt — is a replay of the 1930s, when Americans
lost faith that institutions such as business and government were
dealing fairly.
Indeed, it is beyond dispute that bank fraud was
one of the main causes of the Great Depression.
Economist James K. Galbraith
wrote in the introduction to his father, John Kenneth Galbraith’s, definitive study of the Great Depression, The Great Crash, 1929:
The main relevance of The Great Crash, 1929 to the great
crisis of 2008 is surely here. In both cases, the government knew what
it should do. Both times, it declined to do it. In the summer of 1929 a
few stern words from on high, a rise in the discount rate, a tough
investigation into the pyramid schemes of the day, and the house of
cards on Wall Street would have tumbled before its fall destroyed the
whole economy.
In 2004, the FBI warned publicly of “an epidemic of mortgage fraud.”
But the government did nothing, and less than nothing, delivering
instead low interest rates, deregulation and clear signals that laws
would not be enforced. The signals were not subtle: on one occasion the
director of the Office of Thrift Supervision came to a conference with
copies of the Federal Register and a chainsaw. There followed every manner of scheme to fleece the unsuspecting ….
This was fraud, perpetrated in the first instance by the government on the population, and by the rich on the poor.
***
The government that permits this to happen is complicit in a vast crime.
Galbraith also
says:
There will have to be full-scale investigation and
cleaning up of the residue of that, before you can have, I think, a
return of confidence in the financial sector. And that’s a process which
needs to get underway.
Galbraith recently
said
that “at the root of the crisis we find the largest financial swindle
in world history”, where “counterfeit” mortgages were “laundered” by the
banks.
As he has repeatedly noted, the economy will not recover until the
perpetrators of the frauds which caused our current economic crisis are
held accountable, so that trust can be restored. See
this,
this and
this.
No wonder Galbraith has
said economists should move into the background, and “criminologists to the forefront.”
The bottom line is that the government has it exactly backwards. By failing to prosecute criminal fraud, the government is
destabilizing the economy … and
ensuring future crashes.
Postscript: Unfortunately, the government made it
official policy not to prosecute fraud, even though
criminal fraud is the
main business model adopted by the
giant banks.
Indeed, the government has done everything it can to
cover up fraud, and has been
actively encouraging criminal fraud and
attacking those
trying to blow the whistle.
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