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

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.”

The consequences of being able to tap the public treasury when private firms near the brink of collapse are predictable. Indeed, in 1993 another Nobel Prize-winning economist, George Akerlof, teamed with Paul Romer, a renowned expert on economic growth, to study the root causes of the 1980s savings and loan crisis. The New York Times summarized their findings last year, writing that the crisis resulted from investors having “borrowed huge amounts of money, made big profits when times were good and then [leaving] the government holding the bag for their eventual (and predictable) losses.”

In a word, the investors looted. Someone trying to make an honest profit, Professors Akerlof and Romer said, would have operated in a completely different manner. The investors displayed a “total disregard for even the most basic principles of lending,” failing to verify standard information about their borrowers or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,” the economists wrote. “They were right.”

At the time, Akerlof predicted that the next opportunity for the bankers to loot hundreds of billions from the treasury would come in “an obscure little market called credit derivatives.”

When it comes to criminal activity, there is a more fundamental hazard: that potential loss of faith in our justice system. Stiglitz called it “collateral damage” from Wall Street’s crash, noting that “people aren't sure that we have justice for all. Somebody is caught for a minor drug offense, they are sent to prison for a very long time. And yet, these so-called white-collar crimes, which are not victimless, almost none of these guys, almost none of them, go to prison.”

Even in the S and L crisis that Akerlof and Romer studied, those who perpetrated fraud didn’t get off with a mere fine. As financial reporter Zach Carter noted, “During the savings and loan crisis, more than 1,100 bankers went to jail for fraud.” But, he added, “for some reason, the top brass at today’s SEC seems to think that it’s very important to bring these cases against companies, so long as the perpetrators get to walk away.”

James Galbraith echoed that point, telling Bill Moyers that “the overwhelming emphasis, in the [Obama] administration's program, I think, has been to return things to a condition of normalcy, to use a 1920s word, that prevailed five and 10 years ago.”

It’s a matter of enormous social consequence to see justice done in the wake of Big Finance’s serious crimes. But the takeaway from some of our leading economic experts is that doing so also serves a vitally important economic end; if we don't punish the guilty, we’ll never fully recover from the collapse of Wall Street’s house of cards.


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