Jul222014

Some criminal bank executives should go to jail

 Punishing shareholders with corporate fines does little to deter bad behavior among corporate executives. Some of them need to go to jail.

If I had to narrow my list down to the people most responsible for the housing bubble, Anthony Mozilo would be near the top of the list.mozilojail

The Option ARM loan was the primary loan product that inflated the housing bubble. Using negative amortization and teaser interest rates, people were able to borrow more than twice the amount than they could afford with a conventional 30-year fixed-rate amortizing mortgage. Once the Option ARM imploded and lending retreated to conventional mortgages, prices needed to fall significantly to rebalance affordability. The Option ARM was the Ponzi virus that caused the debilitating financial disease that inflated the housing bubble and created the current economic morass still plaguing the country.

The only person perhaps more responsible for the housing bubble is Alan Greenspan. If he hadn’t let the Ponzi virus out of its vial, and if he didn’t allow unregulated insurance “swaps” to encourage dumb money to flow into what they thought were riskless transactions, the air that inflated the housing bubble would not have found its way into Option ARM loans being peddled by Mozilo. Greenspan and Mozilo are my nominees for the fools most responsible for the housing bubble.blinded_by_ignorance_alan_greenspan

Alan Greenspan was clueless, incompetent, and philosophically blinded to the mess he created. What’s arguably worse about Mozilo is that he recognized that he released a monster and did nothing about it. Anthony Mozilo should go to jail, but the road to that end is a difficult one for prosecutors.

Most corporate executives have contracts that require the corporation to pay their legal defense bills for anything they do while running the corporation. While they also have “bad boy” clauses that release the corporation if the executive does anything criminal, getting a conviction is extremely difficult, and the corporation will pay the bills if the executive is not convicted. It’s a farce, and it’s hurting America.

Punish the Executives, Not Just the Banks

Posted by James Surowiecki, July 15, 2014

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When a company finds itself seven billion dollars poorer, it’s normally a big deal.

(See: How many billion must the TBTF banks pay for their malfeasance?)

Yet when the Justice Department announced Monday that Citigroup had agreed to pay seven billion dollars (four billion of which will be in hard cash, and most of the rest in what are called “soft dollars”—mortgage modifications, financing of rental housing) to settle charges relating to its marketing of bad mortgages, the general reaction was muted, to say the least. Citigroup’s stock, buoyed by its announcement of better earnings, actually ended the day higher. And while the Justice Department trumpeted the fact that this was the biggest cash penalty ever levied against a company, it’d be hard to find anyone who felt that the deal was going to have any impact on Wall Street’s behavior in the future.

Why would it change behavior? The people committing these acts are not being punished, and the shareholders are treated as whipping boys.occupy-london-protests

There’s a simple reason for that: punishing institutions, rather than individuals, doesn’t get at the root of the problem. Bank shareholders (who are the ones effectively paying the fine) certainly deserve blame for tolerating—and, in some cases, arguably encouraging—banks’ risky and dubious lending practices during the housing bubble. But Citigroup shareholders were already harshly punished by the market in the wake of the housing crash: at one point, Citigroup’s stock was down ninety-eight per cent from its all-time high, and today it’s still more than eighty per cent below its 2007 peak. If that didn’t teach shareholders to be more cautious about investing in big banks, it’s hard to see how this fine will do it.

More to the point, if you really want to punish and, perhaps more important, deter bad corporate acts, you have to penalize the individuals who committed them.

This concept seems like something we all learn in kindergarten, and it shouldn’t need to be stated, but since these executives are getting away with it, we need to be reminded that these men knowingly did bad things that hurt other people purely for personal gain.

Instead, at least so far, the people who made the decisions to securitize and market loans that they knew were almost certain to go bad have gone untouched. Set aside the question of criminal prosecution. They haven’t even been forced to give up their bonuses or the salaries they got as a reward for putting together these ridiculous, and often corrupt, deals. They’ve been able to keep gains that were, by any measure, ill-gotten.

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Punishing individuals is especially important in the case of Wall Street, because one of the biggest problems in the run-up to the housing bubble was that individual traders and executives were incentivized to engage in behavior that was incredibly lucrative for them (since their bonuses were pegged to short-term performance) but incredibly destructive to their companies. This was the basic logic behind what they called “I’ll be gone, you’ll be gone” loans, where people were willing to do deals that they knew were likely to blow up, because they figured that by the time the deals went bad, they themselves would have moved on (while pocketing hefty bonuses in the meantime). You can certainly fault Citigroup and the other Wall Street banks for setting up these kinds of incentive structures, and for creating a business climate in which shady behavior was encouraged. But while the banks themselves did incredibly badly during the financial crisis, plenty of Wall Street employees (including plenty of bank C.E.O.s) did incredibly well. And the fact that they’ve kept the money they made doesn’t exactly send the right message.

Again, isn’t this common sense? Do we no longer have a moral compass in this country? Is doing business a matter of seeing what you can get away with?

It’s true that over the past few years banks have tried to do a better job of making sure that the interests of companies and employees are aligned, so that contracts are now more likely to have things like clawback provisions (where ill-gotten bonuses have to be paid back). But the reality is that short-term incentives are still incredibly powerful on Wall Street, and there are always going to be people on the Street (which is the ideological center, after all, of eat-what-you-kill capitalism) who put their own interests ahead of those of the company—or, needless to say, of their customers. So it’s naïve to think that a settlement that touches no individual is going to have any deterrent effect going forward. Institutional accountability is important. But holding people accountable is ultimately the only way to bring about real change on Wall Street.

With the current state of our political system, any change is unlikely. Financial interests own our Congress with the huge donations, and the populace is distracted by bread and circuses and keeping up with the Kardashians, so they really don’t care. Perhaps if the excesses get even more out of control, political pressure will build for Congress to do something meaningful, but in the short term, it’s business as usual on Wall Street.

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