Unchecked greed and financial insanity on Wall Street crashed our economy. Much of that insanity was legal -- bankers lobbied hard for weak regulations, and got what they paid for. But much of that craziness was outright illegal, and in recent months, a number of shocking scams have come to light that could result in huge fines for banks or even put bankers behind bars. Though Wall Street has yet to see serious prosecutions for the current calamity, prosecutions are not at all uncommon after financial crises -- more than 1,000 bankers went to prison after the savings and loan debacle alone.
From laundering drug money to scamming you on overdrafts, here are five recent Wall Street scandals that have "illegal" written all over them. The SEC is attempting to settle civil fraud charges it has filed in many of these cases, but in finance, the only difference between civil fraud and criminal fraud is the burden of proof. If the Justice Department wanted to go after many of these crooked dealers, it could.
1) Wachovia Launders $380 Billion in Drug Money
The financial crisis is full of complex schemes and indecipherable acronyms, but the most astonishing alleged fraud of the entire mess is pretty straightforward: Wachovia allowed Mexican drug cartels to launder $380 billion of drug money through its bank, repeatedly looking the other way and ignoring internal whistleblowers who alerted them to the problem.
This was a clear violation of federal law, but Wachovia appears to be getting away with it. The Justice Department is not seeking an indictment against the company, out of fears that it could destabilize financial markets. Instead, it's reached a "deferred prosecution agreement" -- effectively a settlement -- in which the bank agrees to pay $160 million and promise to never, ever launder drug money again.
Pretty light penalty for, you know, laundering drug money. The fine amounts to about one-half of one-hundredth of a percent of the drug money that DOJ says passed through the bank. Outside the too-big-to-fail world, getting caught laundering billions of dollars in drug money doesn't just earn you hefty fines, it plants you in jail.
And Wachovia wasn't alone. According to the U.N., laundering drug money was common during the darkest days of the financial crisis, as faltering banks sought to get their hands on any money they could find -- regardless of where it came from.
2) Chamber of Commerce Launders AIG's Lobbying Cash
Money laundering has been very profitable for Wall Street, and not just drug money. The U.S. Chamber of Commerce is a lobbying front-group for a lot of powerful corporations, and some of its most aggressive members are Wall Street titans. A watchdog group has filed a complaint with the Internal Revenue Service accusing the Chamber and notorious AIG kingpin Maurice "Hank" Greenberg of tax fraud. Greenberg was ousted from AIG in 2005 amid a massive accounting scandal, but not before helping to establish the insurance giant's ridiculous credit default swap wing, which would destroy the company only a few years later.
Greenberg and the Chamber are accused of abusing a charity in order to hide millions of dollars in lobbying expenditures by AIG. In 2003, a foundation handled by Greenberg gave $5 million to the charitable wing of the Chamber of Commerce. The Chamber operates a charity called the National Chamber Foundation. The next year, Greenberg's foundation gave another $10 million to the Chamber's charity. In 2003 and 2004, 80 percent of the National Chamber Foundation's budget was coming from Greenberg and AIG. The charity's main function was to serve as a front for AIG lobbying.
Guess what? According to U.S. Chamber Watch, that money was turned over to the Chamber's lobbying arm. At the time, the Chamber was raising tons of money to help reelect President George W. Bush, and AIG was trying to weaken accounting fraud laws. It's illegal for a tax-exempt charity to funnel money to political operations. If the allegations are true, the Chamber's charity would be shut down.
3) The $40 Billion Subprime Lie From Citibank and Robert Rubin
As the subprime mortgage market was falling apart in 2007, Citibank was trying to calm investor fears about a total meltdown -- just like every other big Wall Street bank. Its chief tactic was to highlight that it had "only" $13 billion in subprime mortgage holdings, repeatedly touting the figure publicly.
The statement was true, if you ignored another $40 billion in subprime exposure that the firm held. Lying to shareholders is a major no-no in Corporate America -- it's considered securities fraud, and people can go to jail for it. The SEC is attempting to settle with Citi, but isn't recommending criminal prosecutions or even charging individuals with formal wrongdoing. Instead, the SEC wants to fine Citi shareholders $75 million -- a total slap in the face to basic conceptions of fairness, not to mention American taxpayers. See, if Citi execs did what the SEC says they did, then they were hurting their own shareholders. As punishment, the SEC wants to impose a fine on those same shareholders, the very parties who were wronged.
What's more, the U.S. government took a stake in Citi as part of its epic bailout of the poorly managed financial behemoth. Taxpayers are being asked to help foot the bill for wrongs committed by the executives we bailed out. Thanks a lot, SEC.
The SEC has filed documents indicating that both Citi CEO Chuck Prince and board member Robert Rubin knew about the inaccurate statements, but isn't filing charges against them. The stiffest penalty the SEC wants to impose on a Citi executive under the settlement is a $100,000 fine against Citi CFO Gary Crittenden. Crittenden took home $19.4 million in 2007 alone. I'll bet he's really sweating the rounding error on his bonus.
Fortunately, a federal judge has so far refused to sign off on the SEC's settlement, calling it far too weak given the seriousness of the allegations. The SEC shouldn't just be seeking huge fines against executives, it should be working with prosecutors on criminal cases.
4) Merrill Lynch: Inventing Fake Demand For Subprime Junk
This beauty of a scandal was uncovered by two investigative journalists at ProPublica. Like much of what happened on Wall Street over the past decade, it's complicated, clever and totally corrupt.
During the boom years of the housing bubble, Merrill Lynch was top producer of fancy financial products called "Collateralized Debt Obligations," or CDOs. Thousands of mortgages were packaged together and sliced up into securities called mortgage-backed securities, or MBS. Those MBS, in turn, were cobbled together to create a CDO -- creating a byzantine product that former Merrill CEO John Thain now acknowledges was simply too complex to value -- even supercomputers couldn't figure the damn things out.
But creating gimmick securities and selling them to investors wasn't the scam that caught ProPublica's attention: shady as it was, just about everybody on Wall Street did that. When Merrill sold its CDOs to investors, it divided the big mess into different tiers, known as "tranches," reflecting different levels of risk. The riskiest tranche of the CDO fetched the highest price, because it was the most likely to default, while the "safest" tranche fetched the lowest price. But as investors began to worry about the subprime craze in 2006, they stopped ponying up for the risky bits.
But this lack of demand was no problem for Merrill. When it couldn't offload the tranche from one of these garbage CDOs, it just created a new CDO, and used the new security to buy up the unwanted junk from the old one. The result was a catastrophic daisy chain, in which Merrill was able to keep producing new CDOs by inventing fake demand -- all while subjecting itself to dangerous levels of risk. By 2007, a full 42 of the bank's 92 CDOs included pieces of other CDOs it had previously sold -- 46 percent.
Often, two newly created CDOs would simply swap assets with each other. ProPublica says a full $107 billion worth of CDOs were created and traded assets within days.
Merrill wasn't the only bank to engage in this behavior. According to ProPublica, Goldman Sachs, Citigroup and Swiss scandal-magnet UBS all did so as well. But Merrill was the leader, packaging the most CDOs and the most CDOs with gimmicked demand. These practices had a significant effect on the real economy -- they kept mortgage prices inflated and kept the subprime machine moving, allowing the housing bubble to grow larger and more devastating. The SEC is investigating the practice for evidence of fraud.
5) Wells Fargo Overdraft Theft
Ever wonder how you managed to rack up such high overdraft fees? Well, there's a decent chance you didn't. U.S. banks scored an astonishing $38 billion in overdraft revenues in 2009 -- pretty impressive for an industry whose total combined profit was just $12.5 billion that same year. For years, banks have been rearranging the order of their customers' checking transactions, hoping to push account balances down to zero faster so they can charge more fees.
Say you've got $80 in your checking account, and need to pay some bills and run a couple of errands. You spend $30 on gas and another $20 on your water bill. Later, you head to the grocery store and spend $81 -- oops! -- on groceries. Any reasonable person would believe that the last transaction put you over the edge and earned you an overdraft fee, but megabanks aren't reasonable people. Instead, the bank automatically processes your $81 purchase ahead of your previous charges. As a result, you do not get hit with one overdraft fee for your groceries, you get hit with three, because your costliest purchase was processed before the others -- even though you made the cheaper purchases first.
Now, there's no reason why banks can't, say, notify you about your overdrafts before approving them. In the example above, you could have put the tomatoes back on the shelf and saved yourself $39. But reordering transactions is beyond the pale -- if bankers did this with their stock options, it'd be called "backdating" and it could land them in a federal penitentiary.
A judge in California has now said that this practice violated state law, and has ordered Wells Fargo bank to return hundreds of millions of dollars in such ill-gotten gains to its California customers. But Wells Fargo wasn't alone -- every major U.S. bank had overdraft programs that worked the same way Wells Fargo's did.