The Reckoning

Let’s Teach Wall Street—the Land of TARP, MBSs and SIVs—a New Acronym: RICO

What in God’s name is wrong with the SEC? The Securities and Exchange Commission—spoken of as though it has the power to destroy entire economies with a single question—continues to engage in settlement talks with banks caught red-handed defrauding investors and who know that the $285 million or so they’ll have to pay to the federal government as result would barely register on their books.

And yet this persists. Late last month, as we were still recovering from our Thanksgiving turkey, U.S. District Court Judge Jed Rakoff threw out another kind of turkey – one presented by the SEC to his court. Citigroup, which like many other banks regularly created “investment vehicles” for clients that it then bet on to fail, had agreed to pay $285 million to prevent these practices from being dragged through the courts, or admitting guilt, which would not only be embarrassing (though at this point, could shame really matter?) but also potentially expose senior executives to criminal charges.

 “Criminal Charges.” Imagine that. Yes, I know, attorneys regularly cut such deals to save court costs or, perhaps, because they worry the charges might not stick at trial. But let’s face it, the American public—right, left and center—has had it with white-collar criminals being treated as “overzealously creative” while teenage shoplifters are threatened with jail. The SEC’s response—to petition Congress for the right to raise the fines—is not enough. These cases should not be settled; the settlements send a message of impotence that will come back to haunt us.

The reforms of banking regulation and securities law in the United States and Europe have been uncoordinated and, while sometimes useful, often blunted and sidestepped by the financial industry. Amazingly, the market for over-the-counter derivatives— the SIVs (structured investment vehicles) and MBSs mortgage-backed securities and CDSs (credit default swaps) that dragged the world towards the abyss in 2008—remains almost entirely unregulated. Thirteen years after Brooksley Born, then-chairwoman of the Commodities Futures Trading Commission, warned in the 1990s that this market concealed a ticking timebomb, and four years since it detonated, trillions of dollars worth of transactions that tie American banks to their counterparties around the world remain opaque.

Born was shutdown by Wall Street’s Clinton-era guardians of the day—Alan Greenspan, Robert Rubin and Larry Summers. Similarly, efforts to reimpose the Glass-Steagal separations of commercial and investment banking after the 2008 debacle also failed. This, for now, appears to be the state of play—American democracy, entangled in the political complexities of legislative wrangling, has chosen to cross its fingers rather than put up its dukes.

But the Obama administration can still do a great deal of good by simply rediscovering its stomach for prosecution. The Justice Department in the United States should pursue broad charges against those who led America’s leading investment banks and other financial institutions to the brink of collapse in 2008. Focusing on fraudulent claims about the performance of complex securitized financial products—products sold as AAA risks—should be possible, particularly if the Justice Department employs the RICO (Racketeer Influenced and Corrupt Organizations) statutes that helped bring the U.S. mafia down to size two decades ago.

Astoundingly, when Goldman Sachs was found to have sold subprime mortgage products that it specifically designed to fail—in part so that a major client, Paulson & Company, could bet against it—the government accepted a 2010 settlement offer rather than continue with a criminal case. The settlement was a record $550 million. That’s a rounding error on Paulson’s balance sheet (though they had a miserable 2010, it must be said, as karma apparently has finally taken a hand).

But pursuing such cases to their legal end, even if the prosecution somehow failed, would restore credibility to U.S. regulators and ultimately have a much more profound effect on the financial sector. Instead, the government sent a message that, yes, it may pursue charges in egregious cases, but the option to pay it off will remain.

Clearly, RICO was not designed for Wall Street. But then, back in the mid-1980s, the National Organization for Women used RICO to file suit against radical anti-abortion groups that had gone beyond protesting and actually physically blocked women from entering clinics providing abortion services (not to mention those that simply existed in order to blow them up). The case went to the Supreme Court, which ultimately ruled in 1994 that RICO could be applied to a political organization.

It’s worth noting that the entire case rested on whether RICO could be applied to an entity, like the anti-abortion movement, which wasn’t in business to make a profit. I highly doubt that issue presents much of an obstacle with Wall Street.