Column: Criminal Acts Didn’t Cause the Recession
Economic historians debate the causes of the Great Depression — from the gold standard to the Smoot-Hawley Tariff Act — but few assign much blame to criminal fraud.
People saw it differently at the time. When bank failures crippled Chicago in 1933, local prosecutors hunted for guilty parties. They indicted hotel and insurance magnate Ernest Stevens for fraud and embezzlement in connection with his company’s defaulted bonds. He was convicted and sentenced to 10 years.
The Illinois Supreme Court unanimously overturned the conviction a year later, finding that the state had criminalized what was really desperate but non-felonious financial juggling. “In this whole record, there is not a scintilla of evidence of any concealment or fraud attempted,” the court wrote.
Alas, the stress had already proved too much for Stevens’ co-defendants, his father and brother: The former suffered a stroke; the latter committed suicide.
The story should be a cautionary tale for those who today demand that more top bankers go to jail for the crimes that purportedly caused the Great Recession.
Obviously, the government should pursue solid cases of wrongdoing. Yet it is also true, as Ernest Stevens’ son, Supreme Court Justice John Paul Stevens, told The New York Times Magazine in 2007, that “the criminal justice system can misfire sometimes.”
Appropriate prosecutorial discretion informed the Obama administration’s approach to allegations of criminal fraud in the trade of mortgage-backed securities, the collapse of which triggered global panic.
As Lanny Breuer, then the chief of the Justice Department’s criminal division, explained in an interview with PBS’ Frontline last year, it’s one thing to say, in hindsight, that bankers knowingly sold their victims shoddy securities and quite another to prove, beyond a reasonable doubt, “that you had the specific intent to defraud” and “that the counterparty, the other side of the transaction, relied on your misrepresentation.”
Having reviewed the facts, Breuer concluded not only that he couldn’t bring many criminal fraud cases but also that illegal conduct did not cause the crash.
The real scandal is the counterproductive behavior that was perfectly legal: Americans’ shared, erroneous belief in ever-rising housing prices and corresponding mania to profit from them. “People in Wall Street, and throughout, thought that there was no going down in the market. Everybody was going to get rich,” Breuer told Frontline.
Some continue to fan the populist flames. In a recent column, the Nation’s Katrina vanden Heuvel called for “perp walks.”
U.S. District Judge Jed S. Rakoff, whose Manhattan courtroom could be the venue for future trials, gave a speech last week in which he imprudently faulted the Justice Department for allegedly offering “excuses” not to prosecute “that, on inspection, appear unconvincing.”
Rakoff disparaged Attorney General Eric Holder for saying that indicting an institution of systemic importance (a Bank of America or a JPMorgan Chase) could pose risks to the global economy. This implied, Rakoff said, a “disturbing” Justice Department “disregard for equality under the law” — as though the poor and middle class would be fine if a bank brought the economy down with it.
Supposedly, this is about accountability and deterrence, not vengeance. But packaging shoddy securities backed by subprime loans has been punished — and deterred — by the market.
As for accountability, even Rakoff conceded that it’s blurred by government encouragement for the securities boom through lax regulation, the Fed’s low interest rates and Fannie Mae’s purchases of the toxic paper.
In President Obama’s second term, his administration has tried to appease the populists by bringing civil fraud charges against big banks. Although they don’t carry jail time, these cases are easier for prosecutors because the standard of proof is lower. Most recently, JPMorgan Chase settled with the Justice Department, agreeing to cough up $13 billion.
This doesn’t satisfy critics such as vanden Heuvel, who rightly noted that the bank’s shareholders will ultimately foot the bill.
What’s really questionable, though, is how Justice conjured up liability. At the time of the bank’s alleged misconduct — roughly 2007 — it was widely understood that there was a five-year statute of limitations on civil securities fraud. U.S. Attorney Preet Bharara argued, hypertechnically, that this could be extended to 10 years under an obscure 1989 law making banks liable for fraud “affecting” any federally insured financial institution, including, Bharara said, the alleged offender bank itself. A couple of judges bought this creative argument, and — presto! — the banks’ settled expectations were no longer operative. They were legally on the hook.
It is human nature, perhaps, to reduce complex historical processes to the machinations of an evil few. The rule of law exists to control that dangerous tendency.
Charles Lane is a member of The Washington Post’s editorial board.