Inside Job (29 page)

One could provide many further examples of this kind.

The congressional hearings produced not only widespread revulsion but a clear, widely shared sense that there was an awful lot of lying going on. There have been no prosecutions for perjury.

The Sarbanes-Oxley Act establishes a variety of requirements for CEO and senior management conduct and also establishes criminal penalties for certain violations. CEOs and CFOs
of public companies are required to certify their companies’ financial statements and tax returns, and also to certify the adequacy of the firms’ internal controls for accurate
financial reporting. The SEC is responsible for establishing regulations in these areas and can pursue civil cases for violating them. But the law also provides for criminal penalties, including up
to ten years in prison, for knowingly certifying inaccurate financial statements, destroying records, or retaliating against a whistle-blower for contacting law enforcement authorities.

We have already seen the level of misrepresentation in loan portfolios, prospectuses, investor presentations, and so forth. We have seen the inadequacy of internal due diligence and frequently
the deliberate suppression of such due diligence, with regard to loan quality, and also with regard to how nonconforming loans were handled—many were securitized in conscious violation of
internal guidelines. Does this bespeak adequate internal financial controls? We also know, of course, that both lenders and securitizers were wildly inaccurate in their valuations of loans, of
CDOs, and of their own financial positions. How much of this was known to their CEOs? The answer cannot be none. Indeed, we already have considerable public evidence that suggests the contrary.

Consider Citigroup. One day after Richard Bowen sent his e-mail to four senior Citigroup executives including its CFO and vice-chairman Robert Rubin, Citigroup’s then-CEO Chuck Prince
signed the firm’s Sarbanes-Oxley certification. Three months later, after Prince was replaced by Vikram Pandit, the Office of the Comptroller of the Currency sent a letter, addressed to
Pandit personally, explicitly warning him of major deficiencies in Citigroup’s financial reporting and controls. Eight days later, Pandit signed
his
first Sarbanes-Oxley certification
for
Citigroup. Over the subsequent two years, Citigroup lost billions of dollars more as its earlier securities valuations proved inaccurate.

Or consider AIG. What do we think of AIG’s financial controls in late 2007 and 2008, particularly after AIGFP’s internal auditor resigned in protest after warning AIG’s chief
auditor that he was being blocked from doing his job? And what do we think of Richard Fuld and his CFO, Erin Callan, signing off on Lehman Brothers’ accounting statements in 2008?

Indeed, Lehman provides particularly direct evidence, not  only through disclosure of the Repo 105 accounting trick, but also through the actions of an internal whistle-blower. Matthew Lee
was Lehman’s senior vice president with responsibility for overseeing the firm’s global balance sheet. On 16 May 2008, Mr Lee delivered a letter by hand to four Lehman executives:
Martin Kelley, Lehman’s controller; Gerald Reilly, head of capital markets product control; Christopher O’Meara, chief risk officer; and Erin Callan, the CFO.
³⁸
Lee begins his letter by noting that he had worked for Lehman since 1994, and had been a “loyal and dedicated employee”. He then continues:

For the most part, Lee turned out to be right. About a month later, Lee also warned Lehman’s auditors, Ernst & Young, about the Repo 105 trick. (But that wasn’t necessary; they
had already known about it, and done nothing to stop it, for over a year.
³⁹
They haven’t been prosecuted either.) So, what do we think of Erin
Callan and Richard Fuld certifying Lehman’s financial statements for that quarter?

Or how about Angelo Mozilo’s certifications of Countrywide’s statements and the adequacy of its internal financial controls? Or Stan O’Neal’s
signing off on Merrill Lynch’s statements, while his employees were bribing each other, and the firm’s profits turned to $80 billion in
losses in the two years
after he departed? Et cetera. Yet there have been no civil or criminal cases filed based on Sarbanes-Oxley violations.

Both RICO and US antitrust laws provide tools for prosecuting criminal conspiracies. The Racketeer Influenced and Corrupt Organizations Act (RICO) provides for severe criminal
(and civil) penalties for operating a criminal organization. It specifically enables prosecution of the leaders of a criminal organization for having ordered or assisted others to commit crimes. It
also provides that racketeers must forfeit all illgotten gains obtained through a pattern of criminal activity, and allows government prosecutors to obtain pre-trial restraining orders to seize
defendants’ assets. And finally, it provides for criminal prosecution of corporations that employ RICO offenders.

RICO was explicitly intended to cover organized financial crime as well as violent criminal organizations such as the Mafia and drug cartels. Indeed, the law professor who drafted much of the
legislation, G. Robert Blakey, once told
Time
magazine that “we don’t want one set of rules for people whose collars are blue or whose names end in vowels, and another set for
those whose collars are white and have Ivy League diplomas.” The RICO statute has been used in cases ranging from the sex-abuse scandals of the Catholic Church to Michael Milken. Indeed the
criminal cases brought against both Milken and his firm, Drexel Burnham Lambert, were based on the RICO statute. A great deal of the behaviour that occurred during the bubble, covered in this and
previous chapters, would appear to fall under RICO statutes. Moreover, pre-trial asset seizure is a widely and successfully used technique in combating organized crime, and asset seizures now
generate over $1 billion per year for the US government. However, there has not been a single RICO prosecution related to the financial crisis, nor has a single RICO restraining order been issued
to seize the assets of either any individual banker or any firm.

It is important to note here that asset seizures would not merely represent justice for offenders, but for victims as well. US law allows seized assets to be used to
compensate victims. In this case, the potential economic impact of seizures could be enormous. Seizing the personal assets of just seven people who bear significant responsibility for the bubble
and crisis (Angelo Mozilo, Richard Fuld, Jimmy Cayne, Joseph Cassano, Stan O’Neal, Henry Paulson, and Lloyd Blankfein) could provide over $2 billion to compensate victims. If the US
government were to seize assets from, say, five thousand people representing a substantial fraction of total investment banking bonuses (and potential criminal behaviour) related to the bubble,
this would potentially generate tens of billions of dollars in victim compensation. Such actions would probably provide more victim compensation than the entire $26 billion settlement of the
foreclosure fraud lawsuits brought by 49 state attorneys general.

Antitrust law provides another tool for both criminal prosecution and extraction of financial restitution. Since 1975, US antitrust law has provided for severe criminal penalties for
antitrust  violations. Antitrust law also provides for treble damages in civil judgements, which can be based upon evidence from criminal convictions.

There is ample reason to suspect that collusion and antitrust violations are common within the financial industry. Several prominent observers of the industry—including Simon Johnson,
Eliot Spitzer, and financial journalist William Cohan—have suggested that American banking deserves serious examination for antitrust problems. One major antitrust investigation, under way as
of this writing and being conducted by American, European, and Japanese regulators and prosecutors, is focused on price-fixing of interest rates, particularly the London Interbank Offered Rate
(LIBOR), the interbank lending rate used to set many short-term interest rates. There have also been a series of civil settlements, described above, related to price-fixing and bidrigging in the US
municipal bond market.

More generally the industry has become extremely concentrated, and all the major firms do business with each other, even in markets
in which they supposedly compete. The
overwhelming majority of all US securities underwriting, private equity financing, merger and acquisition transactions, and derivatives trading is now controlled by Goldman Sachs, JPMorgan Chase,
Morgan Stanley, Citigroup, Bank of America, and Wells Fargo. The largest private equity firms (such as KKR, Blackstone, and the Texas Pacific Group) often cooperatively bid for companies, and work
not only with each other but with major banks in constructing financing packages for leveraged buyouts.

All the major banks charge the same fees for major services such as underwriting initial public offerings (7 percent), junk bonds (3 percent), or loan syndications (1 percent).
⁴⁰
Moreover, both stock and bond offerings are often “syndicated”. In this case, whichever bank wins the business of underwriting a given offering
subcontracts portions of the offering to its supposed competitors. The banks also have created and operate a number of joint ventures, including two, MERS and Markit, that were heavily involved in
the financial bubble and crisis.

By sheerest coincidence, the client agreements used for brokerage accounts by the major banks all contain identical provisions, by which all clients give up the right to use the courts to sue
their brokerage for fraud. Rather, clients must use arbitration proceedings controlled by FINRA, the industry’s generally spineless self-regulatory body. This arbitration provision is not
intended to improve efficiency; on the contrary, FINRA arbitrations are protracted and extremely expensive, requiring high legal fees and payments to arbitrators. Rather, the
industry’s motivation is that FINRA arbitrations tend to favour the industry, and, importantly, they are secret, as opposed to court cases in which embarrassing information could be made
public. How all the banks spontaneously decided to use the same brokerage contract terms has not been explained.

The banks, together with Visa and Mastercard, also seem to have arrived at identical conclusions in setting “interchange fees” for processing credit card transactions. Interchange
fees in Europe and Australia are generally 0.6 percent of transaction value or less; US interchange fees are uniformly 2 percent. In September 2005, a large coalition of
retail industry associations filed a class-action antitrust lawsuit against Visa, Mastercard, and America’s thirteen largest banks.
⁴¹
 As of early 2012, the case is still pending. Potential damages estimates have ranged from several billion to tens of billions of dollars. However, the government antitrust
authorities have taken no action.

Indeed, despite this pattern of widespread industry collusion, there has not been a significant criminal antitrust conviction of any major bank, or any individual banker, in the United States in
the last thirty years.

On 27 November 2011, Bloomberg News reported that as a result of its Freedom of Information Act filings, it had learned that during the crisis, Federal Reserve Board loan
assistance to the largest banks had been far larger than previously believed. The Fed had kept the information secret; previous estimates based on then-available documents had set the total amount
of assistance at $2 trillion to $3 trillion. Upon obtaining the documents, Bloomberg found that the actual amount, including loans, loan guarantees, securities purchases, and other commitments, was
a rather amazing
$7.8 trillion
, with several hundred billion dollars in loans outstanding at any given time during the height of the crisis.
⁴²
Bloomberg estimated that these low-interest loans generated $13 billion in additional profits for the banks; one of my colleagues believes that the banks’ profits were probably far
larger.