If there are no penalties for actions that harm society, you will have more such damage than if such damaging acts are punished. We have come to a pass in our nation where we punish small-scale acts of obvious fraud, but somehow never sanction larger-scale misdeeds. This is going to lead us to have more such damaging activities in the future.
Consider that Minnesota scam artist Patrick Kiley, part of the Trevor Cook Ponzi scheme, has been sentenced to 20 years in jail. That is a good thing. Unfortunately, it seems that MF Global CEO and Democratic senator Jon Corzine probably will walk. So will the Goldman Sachs managers who put together packages of mortgages for investors in direct consultation with a hedge fund manager who would gain directly if the mortgage-backed securities went bad.
These may well be the legally correct outcomes of current law, but they are evidence of perverse incentives built into that system that motivate misdeeds and hurt the efficiency of our economy.
For those unfamiliar with the case, Kiley was one actor in a Ponzi scheme that took hundreds of people for a total of $178 million. It is a telling indicator of our society (or culture) that this amount is now deemed so small that it is of only local interest. Kiley’s role was to sell a fraudulent investment over his financial show on a evangelical Christian radio network. Five others already have been given sentences running from five to 30 years for their actions in the fraud.
As a society we can take some satisfaction that justice was done, although the defrauded investors still are out considerable sums. But we are not likely to get similar satisfaction from Corzine being sent up the river for a similar period, even though the amount lost by MF Global customers was several times as great. And since the former Goldman Sachs managers are the subject of a civil suit by the Justice Department, rather than criminal prosecution, jail time is out of the question.
An important difference, of course, is that the local Ponzi scheme was intentional fraud. The group was conducting no legitimate business, although some peripheral players, including Kiley, claim to have been unaware of that fact.
MF Global, a multiservice commodities firm that Corzine was trying to transform into a major investment bank, did conduct a lot of legitimate business. So does Goldman Sachs, even though its ethical standards grew increasingly lax after it changed its partnership structure into that of a publicly traded corporation in 1999. It also has a history of criminal misrepresentations to clients back in the 1960s.
That does not obscure the fact that MF Global broke the law. It held funds in supposed escrow from commodities firms that used MF Global’s trade-clearing services. These funds actually came from myriad individual private businesses, many of which were small rural feed and grain companies, that were, in turn, clients of these commodities brokers. The law is clear that such client funds are not to be co-mingled with the cash of the firm itself nor used in any aspect of its other businesses.
MF Global did both and lost much of the money.
However, convictions for financial crimes depend on proof of intent. Corzine claims he did not order any tapping of client funds, did not know about it and did not intend for it to happen. Ditto for everyone else at the firm. Just as Topsy, the character in Uncle Tom’s Cabin who was not raised by anyone, but rather “just grew,” the misuse of several hundred million dollars at MF Global apparently “just happened.”
In any case, it appears there will be no criminal prosecution of Corzine or other high-ranking company officials.
No criminal charges, except for incidental insider trading cases, have been brought against any official of any investment bank or other financial firm as a result of the financial debacle that began to unfold in mid-2007. This is in contrast to some 1,800 savings and loan officials prosecuted and 1,072 sent to jail on felony charges for their roles in the S&L meltdown 30 years ago. This episode caused harm to the Treasury and economy that was a couple of orders of magnitude less than the ongoing one.
Why did we prosecute 25 years ago but not now? Again, specificity of crime matters. Banking law is quite well defined, and it was fairly easy for regulators to identify where S&L managers crossed the line.
Securities law is less cut-and-dried. Proving deliberate deception in the prospectus for a “collateralized mortgage obligation” or “structured investment vehicle” isn’t easy. Nor is it easy to prove that high-level executives directed the illegal use of escrowed client funds rather than it being an unwise decision by some midlevel manager feeling the pressure of circumstances.
But it also is clear that money and power matter. High-level investment bankers have personal and company legal and financial resources that are orders of magnitude larger than those of some regional S&L executive. The protections for accused rightly built into our legal system mean that very wealthy defendants can overwhelm the limited resources of the Justice Department.
Political power plays a role, too. Many Wall Street CEOs have political clout based on years of donations on both sides of the congressional aisle.
I am not charging direct political corruption because I have no detailed knowledge of the circumstances of any specific case. But political connections and status give regulators pause. That was true even with the S&Ls. Prominent defendant Charles Keating’s close relationship with five U.S. senators from both parties certainly slowed the federal investigation of fraud in his S&Ls.
Perhaps it is impossible to write laws making extreme risk-taking with other people’s money illegal. Perhaps proving intent by CEOs always will be a fruitless quest. And money will always confer power.
But if we don’t make any advances in this area, we are going to face ongoing economic damage caused by those who have financial incentives to earn money by taking on risk, even in illegal ways, knowing they will get rich if their bets turn out right and they won’t face a criminal penalty even if they don’t.