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Seriously, Jail the Bankers or This Economy Will Never Fully Recover

By refusing to hold the corporate criminals at the heart of the housing crisis accountable for their crimes, we’re creating powerful incentives for future malfeasance.

The Great Recession showed the world that the crimes that create the most victims are not committed by terrorists, gangbangers or drug traffickers, but by well-heeled crooks in Wall Street’s executive suites. Tens of millions of people have seen their jobs disappear and their pension funds fleeced, and had their homes taken out from under their feet as a result of the crash of Wall Street’s Great Casino. Yet so far, the culprits have been given little more than a slap on the wrist.

Failing to prosecute Wall Street’s high-flying crooks doesn’t only represent a great miscarriage of justice. Powerful voices within the economic establishment are now making the case that holding the bankers criminally culpable is necessary if we ever hope to stop our national economy from moving from one speculation-driven bubble to the next.

Nobel-prize winner Joe Stiglitz recently told AOL’s Daily Finance that major damage resulting from the financial disaster “has not really been taken on board, and that is confidence in our legal system, in our rule of law, in our system of justice.” His prescription? “I think we ought to go do what we did” in the wake of similar financial crises in the past, and “actually put many of these guys in prison.”

His argument is based not on the visceral satisfaction of seeing the high and mighty brought down a peg, but on cold economic grounds. At heart, economics is the study of incentives, and by refusing to hold the corporate criminals at the heart of the housing crisis accountable in any meaningful way, we’re creating powerful incentives for more malfeasance in the future.

As Stiglitz explained, “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.” With those penalties amounting to a small 5 percent or 10 percent tax on illegal profits, what’s to stop the crooks? “You're still sitting home pretty with your several hundred million dollars that you have left over after paying fines,” Stiglitz said.

Economist James Galbraith of the University of Texas agrees. He told Bill Moyers that at the heart of the crisis was “a huge amount of” criminal fraud, which the Bush administration and the FBI knew was occurring but didn’t prosecute. “There will have to be full-scale investigation and cleaning up of the residue of” those crimes, said Galbraith, “before you can have… a return of confidence in the financial sector. And that's a process which needs to get underway.”

According to University of Missouri scholar (and veteran regulator) William Black, there was widespread fraud “at every step in the home finance food chain.” As Black and economist L. Randall Wray recently wrote:

The appraisers were paid to overvalue real estate; mortgage brokers were paid to induce borrowers to accept loan terms they could not possibly afford; loan applications overstated the borrowers' incomes; speculators lied when they claimed that six different homes were their principal dwelling; mortgage securitizers made false [representations] and warranties about the quality of the packaged loans; credit ratings agencies were overpaid to overrate the securities sold on to investors; and investment banks stuffed collateralized debt obligations with toxic securities that were handpicked by hedge fund managers to ensure they would self destruct.

Economists talk about “moral hazard,” which basically means that people -- and institutions -- behave differently when they’re insulated from the potentially negative consequences of their actions. That moral hazard has been a fixture of our under-policed financial sector for years. A shining example of that is Citigroup, which received $45 billion in TARP funds in addition to having another $300 billion in bad paper taken off its books by the Federal Deposit Insurance Corporation. But that was only the latest round; last year, the New York Times noted that over the past 80 years, “the United States government has engineered not one, not two, not three, but at least four rescues of the institution now known as Citigroup.”