Posts Tagged ‘banks’


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Special mention

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It’s been more than seven years and yet we’re still haunted by the spectacular crash that took place on Wall Street.

The big banks have been fined but no one, at least at or near the top, has been prosecuted let alone gone to jail.

The question is, why?

We know why the Eric Holder and the Justice Department didn’t go after the top executives: they were afraid of undermining the fragile recovery.

What about the Securities and Exchange Commission (which, remember, was set up during the first Great Depression to stem the fraud and abuses on Wall Street)?

We now know, thanks to Jesse Eisinger (based on a treasure-trove of internal documents and emails released by James A. Kidney, a now-retired SEC lawyer) that in the summer of 2009 lawyers at the SEC were preparing to bring charges against senior executives at Goldman Sachs (over a deal known as Abacus) but they never took the case to trial.

He thought that the staff had assembled enough evidence to support charging individuals. At the very least, he felt, the agency should continue to investigate more senior executives at Goldman and John Paulson & Co., the hedge fund run by John Paulson that made about a billion dollars from the Abacus deal. In his view, the SEC staff was more worried about the effect the case would have on Wall Street executives, a fear that deepened when he read an email from Reid Muoio, the head of the SEC’s team looking into complex mortgage securities. Muoio, who had worked at the agency for years, told colleagues that he had seen the “devasting [sic] impact our little ol’ civil actions reap on real people more often than I care to remember. It is the least favorite part of the job. Most of our civil defendants are good people who have done one bad thing.” This attitude agitated Kidney, and he felt that it held his agency back from pursuing the people who made the decisions that led to the financial collapse.

While the SEC, as well as federal prosecutors, eventually wrenched billions of dollars from the big banks, a vexing question remains: Why did no top bankers go to prison? Some have pointed out that statutes weren’t strong enough in some areas and resources were scarce, and while there is truth in those arguments, subtler reasons were also at play. During a year spent researching for a book on this subject, I’ve come across case after case in which regulators were reluctant to use the laws and resources available to them. Members of the public don’t have a full sense of the issue because they rarely get to see how such decisions are made inside government agencies.

Goldman ended up paying a fine of $550 million in 2010, and agree to another $5-billion fine in a separate case with the Justice Department earlier this month. But no Goldman executive has ever been brought up on charges.

Kidney’s own view is that

the SEC, its chairman at the time, Mary Schapiro, and the leadership of the Division of Enforcement were more interested in a quick public relations hit than in pursuing a thorough investigation of Goldman, Bank of America, Citibank, JP Morgan and other large Wall Street firms.

Although the emails and documents I produced to Pro Publica stemming from my role as the designated (later replaced) trial attorney for the Division of Enforcement are excruciatingly boring to all but the most dedicated securities lawyer, even a lay person can observe that the Division of Enforcement was more anxious to publicize a quick lawsuit than to follow the trail of clues as far up the chain-of-command at Goldman as the evidence warranted.  Serious consideration also never was given to fraud theories in any of the Big Bank cases stemming from the Great Recession that would better tell the story of how investors were defrauded and who was responsible, due either to dereliction or design.

All of which gives lie to the idea that the Obama administration has been tough on Wall Street. According to Kidney,

The large fines obtained by the Department of Justice, while a short-term pinch, are simply a cost of doing business.  Relying on fines to penalize rich Wall Street banks, which, after all, specialize in making money and do it well, if not always honestly, is like fining Campbell Soup in chicken broth.  It costs something, but doesn’t change anything in the way of operations or personnel.

Despite billions in fines representing many more billions in fraud, the enforcement agencies of the United States have been unable to find anyone responsible criminally or civilly for this huge business misconduct other than a janitor or two at the lowest rung of the companies.  Nor have they sought to impose systemic changes to these banks to prevent similar frauds from happening again.

Yessir, according to the Obama administration, Goldman Sachs, JP Morgan, Bank of America, Citibank and other institutions made their contributions to tearing down the economy, but no one was responsible.  They are ghost companies.

And that’s why we’re still haunted, more than seven years later, by the crash of 2008.


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The latest bank to admit criminal fraud is Wells-Fargo. The largest U.S. mortgage lender and third-largest U.S. bank by assets, Wells-Fargo deceived the U.S. government into insuring thousands of risky mortgages, and formally reached a record $1.2 billion settlement of a U.S. Department of Justice lawsuit. Several lenders, including Bank of America Corp, Citigroup Inc, Deutsche Bank AG, and JPMorgan Chase & Co, previously settled similar federal lawsuits.

To read Paul Krugman (who’s “been doing a lot of shovel work for the Hillary Clinton campaign lately”), the real problem in the run-up to the spectacular crash of 2007-08 was not Too Big to Fail banks like Wells-Fargo, but the so-called shadow-banking system. But, as Matt Taibi [ht: db] explains, “Krugman is just wrong about this.”

The root problem of the ’08 crisis lay in a broad criminal fraud scheme in the mortgage markets. Real-estate agents fanned out into middle- and low-income neighborhoods in huge numbers and coaxed as many people as possible into loans, whether they could afford them or not.

Those loans in turn were bought up by giant financial companies on Wall Street, who chopped them up into a kind of mortgage hamburger. Out of this hamburger, they made securities. These securities were then sold to institutional investors like pension funds, unions, insurance companies and hedge funds.


source (pdf)

There’s no doubt shadow-banking activities surpassed those of the traditional banking system in the years leading up to the crash. But—and this is crucial—they weren’t two separate systems or sets of institutions; they were just two different sets of activities by a wide variety of firms within the financial system. And so-called traditional banks were heavily involved in the shadow-banking activities.

The two economically most important shadow banking activities are securitization and collateral intermediation. According to Stijn Claessens, Zoltan Pozsar, Lev Ratnovski, and Manmohan Singh,

The first key shadow banking function, securitisation, is a process that repackages cash flows from loans to create assets that are perceived by market participants as almost fully safe and liquid. The repackaging occurs in steps, and takes the form of risk transfer. First, risky long-term loans are ‘tranched’ into safe and complementary (‘equity’ and ‘mezzanine’ respectively) tranches. Then the safe tranche is funded in short-term money markets, with additional protection provided by liquidity lines from banks. The resulting assets, such as Asset-Backed Commercial Papers (ABCPs), were regarded prior to the crisis by market participants as safe, liquid, and short-term, i.e. almost money-like, but with returns exceeding those on short-term government debt. . .

Another key function of shadow banking is supporting collateral-based operations within the financial system. Such operations include secured funding (of bank and, especially, nonbank investors), securities lending, and hedging (including with OTC derivatives). Collateral helps deal with counterpart risks and more generally greases financial intermediation. One of the main challenges in using collateral is its scarcity. The shadow banking system deals with the scarcity through an intensive re-use of collateral, so that it can support as large as possible a volume of financial transactions. The multiplier of the volume of transactions to the volume of collateral (the ‘velocity’ of collateral) was recently about 2.5 to 3.

The key is that traditional banks (such as Goldman Sachs, Morgan Stanley, JP Morgan, Bank of America-Merrill Lynch, and Citibank in the United States, in addition to Barclays, BNP Paribas, Crédit Suisse, Deutsche Bank, HSBC, Royal Bank of Scotland, Société Générale, Nomura, and UBS elsewhere—all of them classified as “strategically important financial institutions”) both financed and directly participated in shadow-banking activities. The traditional banks made record profits from those activities and served both to expand shadow banking and to increase the degree of risk, instability, and contagion.

In other words, traditional banks played a key role in creating the financial house of cards that came crashing down in 2007-08.

So, it’s simply wrong to assert that Too Big to Fail or Jail banks were peripheral in creating the conditions that caused the global financial crisis—or, for that matter, that continue to plague the financial system today.

What this means is that regulating and transforming the financial system—by taxing financial transactions, breaking up the now-Too Bigger to Fail banks, and creating new forms of financial intermediation (such as various forms of public and community banking)—are still on the agenda.

It’s time, then, to bring both the financial system and arguments by mainstream economists that attempt to shield traditional banks and their favorite political candidates out of the shadows.

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