by Jed S. Rakoff
The New York Review of Books
January 9, 2014 Issue
Five years have passed since the onset of what is sometimes called the Great Recession.
But if, by contrast, the Great Recession was in material part the product of intentional fraud, the failure to prosecute those responsible must be judged one of the more egregious failures of the criminal justice system in many years.
Again, in the 1980s, the so-called savings-and-loan crisis, which again had some eerie parallels to more recent events, resulted in the successful criminal prosecution of more than eight hundred individuals, right up to Charles Keating.
In striking contrast with these past prosecutions, not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis, and given the fact that most of the relevant criminal provisions are governed by a five-year statute of limitations, it appears likely that none will be. It may not be too soon, therefore, to ask why.
One possibility, already mentioned, is that no fraud was committed. This possibility should not be discounted. Every case is different, and I, for one, have no opinion about whether criminal fraud was committed in any given instance.
But the stated opinion of those government entities asked to examine the financial crisis overall is not that no fraud was committed. Quite the contrary.
As the commission found, the signs of fraud were everywhere to be seen, with the number of reports of suspected mortgage fraud rising twenty-fold between 1996 and 2005 and then doubling again in the next four years.
While officials of the Department of Justice have been more circumspect in describing the roots of the financial crisis than have the various commissions of inquiry and other government agencies, I have seen nothing to indicate their disagreement with the widespread conclusion that fraud at every level permeated the bubble in mortgage-backed securities.
But what I do find surprising is that the Department of Justice should view the proving of intent as so difficult in this case. Who, for example, was generating the so-called "suspicious activity reports" of mortgage fraud that, as mentioned, increased so hugely in the years leading up to the crisis? Why, the banks themselves.
This, of course, is what is known in the law as "willful blindness" or "conscious disregard."
- Second, and even weaker, the Department of Justice has sometimes argued that, because the institutions to whom mortgage-backed securities were sold were themselves sophisticated investors, it might be difficult to prove reliance.
- The third reason the department has sometimes given for not bringing these prosecutions is that to do so would itself harm the economy.
In fairness, however, Holder (who later claimed his comment was misconstrued) was referring to the prosecution of financial institutions, rather than their CEOs.
Without multiplying examples further, my point is that the Department of Justice has never taken the position that all the top executives involved in the events leading up to the financial crisis were innocent; rather it has offered one or another excuse for not criminally prosecuting them - excuses that, on inspection, appear unconvincing.
At the outset, however, let me say that I completely discount the argument sometimes made that no such prosecutions have been brought because the top prosecutors were often people who previously represented the financial institutions in question and/or were people who expected to be representing such institutions in the future: the so-called "revolving door."
So, one asks again, why haven't we seen such prosecutions growing out of the financial crisis?
Of course, while the FBI has substantial responsibility for investigating mortgage fraud, the FBI is not the primary investigator of fraud in the sale of mortgage-backed securities; that responsibility lies mostly with the SEC.
As for the Department of Justice proper, a decision was made in 2009 to spread the investigation of financial fraud cases among numerous US Attorney's Offices, many of which had little or no previous experience in investigating and prosecuting sophisticated financial frauds. This was in connection with the president's creation of a special task force to investigate the crisis, from which remarkably little has been heard in the intervening four-plus years.
While I want to stress again that I have no inside information, as a former chief of that unit I would venture to guess that the cases involving the financial crisis were parceled out to assistant US attorneys who were also responsible for insider-trading cases.
In short, a focus on quite different priorities is, I submit, one of the reasons the financial fraud cases have not been brought, especially cases against high-level individuals that would take many years, many investigators, and a great deal of expertise to investigate.
On the one hand, the government, writ large, had a part in creating the conditions that encouraged the approval of dubious mortgages.
Thus, in the year 2000, HUD Secretary Andrew Cuomo increased to 50 percent the percentage of low-income mortgages that the government-sponsored entities known as Fannie Mae and Freddie Mac were required to purchase, helping to create the conditions that resulted in over half of all mortgages being subprime at the time the housing market began to collapse in 2007.
It was the government, pretty much across the board, that acquiesced in the ever-greater tendency not to require meaningful documentation as a condition of obtaining a mortgage, often preempting in this regard state regulations designed to assure greater mortgage quality and a borrower's ability to repay.
Moreover, the government was also deeply enmeshed in the aftermath of the financial crisis.
Please do not misunderstand me. I am not suggesting that the government knowingly participated in any of the fraudulent practices alleged by the Financial Inquiry Crisis Commission and others.
- The final (third) factor I would mention is both the most subtle and the most systemic of the three, and arguably the most important.
The reasons were obvious.
In recent decades, however, prosecutors have been increasingly attracted to prosecuting companies, often even without indicting a single person.
If you are a prosecutor attempting to discover the individuals responsible for an apparent financial fraud, you go about your business in much the same way you go after mobsters or drug kingpins:
But if your priority is prosecuting the company, a different scenario takes place. Early in the investigation, you invite in counsel to the company and explain to him or her why you suspect fraud. He or she responds by assuring you that the company wants to cooperate and do the right thing, and to that end the company has hired a former assistant US attorney, now a partner at a respected law firm, to do an internal investigation.
Six months later the company's counsel returns, with a detailed report showing that mistakes were made but that the company is now intent on correcting them. You and the company then agree that the company will enter into a deferred prosecution agreement that couples some immediate fines with the imposition of expensive but internal prophylactic measures.
I suggest that this is not the best way to proceed.
These criticisms take on special relevance, however, in the instance of investigations growing out of the financial crisis, because, as noted, the Department of Justice's position, until at least recently, is that going after the suspect institutions poses too great a risk to the nation's economic recovery.
In conclusion, I want to stress again that I do not claim that the financial crisis that is still causing so many of us so much pain and despondency was the product, in whole or in part, of fraudulent misconduct.