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Thursday, May 23, 2013

U.S. Department of Justice: Big Banks May Be Above the Law

The Financial Times reports that lawmakers in the U.S. Congress have claimed the Department of Justice has been “too soft on big banks and their executives by failing to bring criminal cases related to the financial crisis.” In the five years following the financial crisis of 2008, no Wall Street executive was criminally charged with fraud. The U.S. Justice Department chose not to go after the bankers for their lack of due diligence regarding their purchases of sub-prime mortgages from mortgage originators. At Citibank, for example, a manager in the bank’s due diligence department estimated that 50% to 80% of the approved mortgages did not meet the bank’s credit policy, yet Robert Rubin, the CEO at the time, did not act on the manager’s email of warning. This suggests that a criminal complaint could have been lodged against the bank itself, but then what would be the implications for the financial system should Citibank go under after being found criminally guilty?
Simply stated, a company can be so large that its failure due to a guilty verdict could harm innocent third parties, including stockholders, employees, suppliers, and even the general public if the bankruptcy triggers a systemic collapse of the financial system. Such concerns are called collateral consequences. After the collapse of Lehman Brothers in September 2008, systemic risk because a particularly salient concern for criminal prosecutors at the U.S. Department of Justice. Swayed by a desire to minimize the potential disproportionate harm to innocent parties from a verdict-triggered major bankruptcy, the prosecutors believe they are obligated to consider collateral consequences even if that means that big banks are immune de facto from criminal prosecution. Unfortunately, the rule of law takes a major hit in this judgment. Therefore, it is worthwhile to ask whether the Department of Justice should be looking at collateral consequences at all. In my view, it should not.
                                                                                               Mythili Raman testifying before Congress. mainjustice.com

Mythili Raman, Acting Assistant Attorney General in the Criminal Division, has argued that collateral factors as a group should be considered. Testifying before Congress on May 22, 2013, she cited “the disproportionate impact on innocent third parties, including the public at large,” as being entirely appropriate for prosecutors to consider. Her reference to the general public means that systemic risk is among the legitimate factors in her view, and yet she also said, “the size of a corporation will never be a factor in and of itself and that no institution is too big to prosecute.” Crucially, her position is that one particular consequence should never be the only factor. “A single collateral consequence cannot be the reason.” However, she added that “collateral consequences are issues that we must and do consider.” Because banks too big to fail tend to have more than one significant collateral consequence (e.g., many stockholders and employees, as well as systemic risk), such banks may be too big to jail.
In testimony before Congress in March 2013, U.S. Attorney General Eric Holder admitted that the lawyers in his department were wary of the “negative impact” on the economy from prosecuting a large financial institution. “(I)t is a function of the fact that some of these institutions have become too large.” Differing from Raman, he thought the size of large banks “has an inhibiting influence – impact on our ability to bring resolutions that I think would be more appropriate. . . . (a)nd I think that is something that we – you all – need to consider.” I want to unpack this rather robust admission.
Firstly, the Attorney General was hinting at what Sen. Kaufman had observed while in office. Namely, it should not be the F.B.I.’s concern whether the Wall Street banks continue as viable concerns. In other words, systemic risk or even collateral consequences more generally have no business being considered by prosecutors whose job it is to enforce the law. Including systemic risk among the collateral consequences has further compromised the rule of law. As Sen. Charles Grassley put it, “It was stunning to hear the nation’s top prosecutor acknowledge that, from the justice department’s perspective, the big banks are too big to jail. This is worrisome for the fair application of justice in our country.”
Secondly, the Attorney General was suggesting that Congress should reduce the size of the biggest banks—those with over $1 trillion in assets. He had doubtless concluded that the Dodd-Frank Act had not been sufficient to solve the problem of banks being too big to fail. If no systemic risk exists, then third-party collateral damage is not disproportionate on a societal basis and the trade-off does not exist. Accordingly, the Huffington Post observes that lawmakers “may be encouraged to apply even more public pressure on efforts to crack down on big banks.” While Raman was testifying, Rep. Sherman, the chair of the full committee, noted that the fact that the Department of Justice considers collateral consequences rather than simply enforces the law is enough justification to break up the big banks. The tension between him and Raman on whether collateral consequences should be considered even altogether can be transcended with regard to the big banks only if they are broken up. The question is thus whether imposing disproportionate capital reserve requirements on the biggest banks would be enough.
In other words, the technical prosecutorial question leads us to the more fundamental questions of whether we as a society are to tolerate companies that are too big to fail, and  if not, how the whales can be shrunk. Considering that the rule of law itself is being compromised, at least perceptually, there is good reason to conclude that we as a democratic society can ill-afford the continued existence of banks too big to fail. Unfortunately, being too big to fail carries with it tremendous political power—muscle that can be used all too easily to resist legislative proposals oriented to downsizing the mammoth banks. This is the real problem that dwarf whether the Department of Justice has really been reaching out to financial regulators for information on probable collateral consequences or even whether criminal intent beyond a reasonable doubt can be ascertained. Namely, can a republic resist the power of its most powerful for the good of the republic? It may even be that the big banks are the force behind assertions such as Raman’s that collateral consequences “must and should” be considered in deciding whether to prosecute. Whether Raman realized it or not, the implication that the rule of law applied impartially should be compromised by the magnitude of the predicted collateral consequences from a corporate conviction is, euphemistically speaking, troubling.

Shahien Nasiripour and Kara Schannell, “Holder Says Some Banks Are ‘Too Large’,” The Financial Times, March 7, 2013.
Congressional Hearing, “Who Is Too Big to Fail: Are Large Financial Institutions Immune from Federal Prosecution?” Financial Services Committee, Oversight and Investigations Sub-Committee, U.S. House of Representatives, May 22, 2013. See also letter to sub-committee members: http://financialservices.house.gov/uploadedfiles/052213_oi_memo2.pdf
Shahien Nasiripour, “Too-Big-To-Jail Dogs Obama’s Justice Department As Government Documents Raise Questions,” The Huffington Post, May 22, 2013.
The Untouchables,” Frontline, January 22, 2013.