Why Do Dangerous Financial Criminals Roam Free?
American Public Media's "Marketplace" had a recent segment focused on why it has taken so long to bring criminal prosecutions related to the financial crisis. Reporters observed that at the beginning of the crisis, the Obama administration wanted to calm the financial industry rather than impose accountability. They speculated, along with Tea Party and Occupy Wall Street participants, many of whom have been calling for prosecutions, that Obama’s creation of a new group to prosecute mortgage fraud led by New York Attorney General Eric T. Schneiderman was likely to be politically motivated. And they indicated that financial crimes are complex and prosecutors need time to develop their cases.
But here's what they didn't say: A major reason the prosecutions don’t exist is that President George W. Bush took the cops off the beat.
Think about street crime. Imagine, for example, a protection racket in which gangs extort payment from fearful shopkeepers. Prosecutors rarely initiate criminal prosecutions; indeed, they may not even know that the crime is occurring. The police pound the beats that keep them aware of the increase in crime, respond to complaints, investigate, determine that a crime may have occurred that warrants attention, create a file and send it to the prosecutor’s office. In routine cases, the prosecution proceeds on the basis of the police report alone. In more complex cases, the prosecutor may supplement the police investigation. But prosecutors rarely initiate cases. Even when a task force is appointed to target crime in a particular sector, it typically involves prosecutors working with the police. The prosecutors simply don’t have the skills or the manpower to detect crime, conduct investigations and make the record necessary to prosecute.
So where were the police in the current financial crisis? The FBI did investigate and warned in 2004 that an epidemic of mortgage fraud was underway. The Bush administration took the FBI’s white-collar experts, however, and reassigned them to terrorism cases. The inquiries under way in 2004 – and the public cries of alarms that accompanied them – largely disappeared. The cops were literally yanked off the beat.
In the early part of the increase in subprime lending, state attorneys general were bringing cases, and calling attention to predatory lending practices. Financial conglomerates complained to the Bush administration. In 2003, the Office of the Controller of the Currency (OCC) relied on a clause from the 1863 National Bank Act to preempt all state predatory lending laws. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government's actions were so egregious that all 50 state attorneys general, and all 50 state banking superintendents, challenged the new rules and in 2009, the Supreme Court invalidated the OCC action.
By then, however, the damage had been done. Not only could the states not prosecute the mortgage brokers involved in the predatory practices that underlay the financial crisis, they stopped investigating them – in effect, taking the state cops off the beat.
Worst of all, however, was the wholesale elimination of effective supervision by the banking regulatory agencies. During the savings and loan crisis, those regulatory agencies made 10,000 criminal referrals. During the current crisis, the Office of the Comptroller of the Currency and the Office of Thrift Supervision made none, though they had authority over some of the worst actors in the mortgage crisis.
The Bush administration stacked the agencies with anti-regulatory officials who did not believe they should ever make criminal referrals, no matter how egregious the conduct. The officials thought that they should be “cheerleaders” for the industry and they turned a blind eye to practices that would have generated regulatory action in other administrations. Their practices are the equivalent of your neighborhood patrolman saying it’s not his job to tell the prosecutors the local mob has created a protection racket or to do anything to stop it.
Complementing the front line banking agencies’ refusal to see crime unfolding before their eyes was the decision of the Federal Reserve Board not to look. Tim Geithner testified before Congress that he “had never been a regulator.” But at the New York Fed, Geithner had regulatory authority over bankholding companies such as Citicorp, the parent company of Citibank, and other parts of the mortgage market. The Fed chose not to exercise that authority because Chairman Alan Greenspan didn’t believe in regulation. (See Joseph Stiglitz, Freefall, p. 270.) Greenspan’s views are the equivalent of saying that there is no need to put cops on the beat because the market will guarantee that crime doesn’t happen.
When the cops are taken off the beat, criminals multiply. And without the investigations documenting the practices, it is easy not to recognize the criminal practices underlying the mortgage crisis. The prosecutorial group that President Obama recently appointed has to play catch-up – it has to go out and create cases from scratch. While the Financial Crisis Inquiry Commission has documented some of the abuses, there were remarkably few regulators on the ground over the course of the last decade creating the records and making the referrals that ordinarily lay the foundation for effective prosecutions. That foundation doesn’t exist because the regulatory officials who are supposed to oversee the financial sector – the cops who police financial crime – were and to a large extent still are missing in action.
If we want crooks behind bars -- and if want to stop future financial crimes -- we need to rebuild this foundation by appointing regulators who believe in the mission and have a proven record of success.