Bloomberg's Roger Lowenstein argues in "Wall Street: Not Guilty" that the outcry for Wall Street prosecutions is both misguided and dangerous.
Citing the misgivings of Charles Ferguson, Joe Nocera, The New York Times, NPR, Matt Taibbi and even Bernie Madoff, Lowenstein concludes:
[T]hese sentiments imply that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.
I love a periodic sentence as much as the next guy, but these conclusions are specious. The vast majority of people asking for more action by prosecutors do NOT believe these things. Let's take them one by one.
"[T]he financial crisis was caused by fraud." While some of the people Lowenstein cites might argue that fraud caused the crisis, not all of them would, nor indeed would most serious observers. But the issue of causality is really beside the point. Those of us arguing for more aggressive action from the DOJ and state AG's make that argument, not on the basis that criminal activity was the sole or even primary cause of the crisis, but because specific instances of fraud and criminal activity actually took place. They should be investigated and prosecuted. By and large, they haven't. That's the problem.
To suggest, as Lowenstein does, that the arguments for prosecution hinge on a theory of causality is not merely to move the goal posts, but to play a different game altogether. People are demanding more prosecutions because they believe that particular crimes took place, not because they believe that fraud, in the abstract, caused the entire crisis. It didn't.
"[P]eople who take big risks should be subject to a criminal investigation." This is a straw man. And the quote from Joe Nocera, that "Wall Street bigwigs...took unconscionable risks," is from an article arguing that many executives are probably NOT liable to prosecution. Nowhere does Nocera, or any other serious critic, suggest that risk-taking, as such, should be criminal. Whenever critics have cited the enormous risks taken by Dick Fuld, for example, it is usually in the context of pointing out that certain actions they took were not only illegal, but that those illegal actions were related to risk-taking that was extremely dangerous to both their firms and the financial system. Lowenstein unnecessarily conflates these two points.
"[E]xecutives of large financial firms should be criminal suspects after a crash." Again, this is a misleading straw man. Some notable critics, such as Bill Black, have concluded -- based on extensive research and long experience -- that financial crises, including this one, are almost always accompanied by what he calls "accounting and control fraud." This is a pretty unremarkable and uncontroversial conclusion, but this is not the same thing as saying, as Lowenstein suggests, that financial executives should be investigated or prosecuted, willy nilly, simply because there was a crash. Just about everyone would agree that aggressive action by prosecutors should be based on reasonable suspicion of criminal wrongdoing, and nothing less.
"[P]ublic revulsion indicates likely culpability." Ironically, Lowenstein gets this one precisely backwards. The public revulsion stems from the likely culpability, not the other way round.
"[I]t is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy." I don't even know where this conclusion is coming from, unless it's just an attempt to attach the name of Madoff to the arguments made by serious critics. Moving on.
"Wall Street bears collective guilt for which a large part of it should be incarcerated." Again, who actually makes this argument, or has made arguments that imply this view? A citation would be helpful, but it's worth pointing out that many of the most angry observers and critics work in the financial services industry and either work on Wall St. or worked there in the past. Yves Smith, Larry Doyle, Barry Ritholtz and the founder of The Daily Bail come to mind. Moreover, many of us calling for prosecutions are fierce believers in individual rights, capitalism and free markets, and therefore find the idea of collective punishment both stupid and revolting.
Now, Lowenstein goes on to argue that "the meltdown was multi-causal" and this fact should therefore throw a monkey wrench into the arguments of "armchair prosecutors." Again, to draw this conclusion is to assume that calls for prosecution hinge on the idea that fraud, and fraud alone, caused the crisis. In Bailout Nation, Ritholtz discusses a number of factors leading to the crisis and puts Alan Greenspan, loose monetary policy, Phil Gramm and the ratings agencies at the top of his list. CDO managers are much further down (232). However, he also points out that "the vast majority of Wall Streeters are hardworking souls who are deeply upset about the way their industry has been hijacked and what that has done to our nation" (288).
Ritholtz is not only influential, but I would argue that his view of Wall Street is probably representative of even the most fierce critics of the DOJ. Not everyone who works in finance or the capital markets committed fraud or some other crime. But some certainly did.
And that is the fundamental problem. Largely through stupidity and hubris, the largest financial institutions helped cause the crisis, their executives grew enormously wealthy while doing so, and when they got into trouble they were bailed out by ordinary taxpayers. By 2009, individual Wall Street executives were again raking in millions of dollars in annual bonuses, even though they still relied on goverment subsidies (low interest rates, government guaranteed debt issuance, accounting forbearance). Meanwhile, the real economy suffered the greatest recession in our lifetimes and official unemployment reached 10%. Those facts alone are bad enough, but the reason so many people are so angry is that even where known instances of fraud and criminal wrongdoing have taken place, there have been almost no prosecutions and very few investigations.
Finally, Lowenstein writes:
[I]t's worth remembering that in the American legal system, people who merely act badly or unwisely do not do time. And people who contribute to a financial collapse aren't guilty of a crime absent specific violations that make them so.
We couldn't agree more. But the danger is not that prosecutors are being swept up by popular sentiment and recklessly prosecuting people with little regard for the facts. Just the opposite, the danger is that they have so far failed to pursue cases where there is likely to have been fraud involved, even those, such as Goldman's Abacus CDO, where there is already enough information in the public domain to at least warrant an investigation. The SEC believed the deal was fraudulent, but why is the DOJ so uninterested?
We have heard from industry insiders that a serious effort by the Obama administration to investigate deals like Abacus would likely uncover other, similar cases. A serious effort is the least this administration owes the American people. But folks like Roger Lowenstein can probably rest easy. The Obama administration has so far shown no indication that they are going to do anything other than pay lip service to serious investigations and so this entire argument is, unfortunately, entirely hypothetical.
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