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In my first year of law school I learned why enforce­ment of crim­i­nal and civil law is essen­tial for the United State’s social and eco­nomic func­tion­ing. Appar­ently, the elite lawyers of the Bush Admin­is­tra­tion didn’t learn the same les­son since they have a non-existent enforce­ment pol­icy which has made the US finan­cial mar­kets a Petri dish of ille­gal and immoral behav­ior. The SEC, Jus­tice Depart­ment and bank­ing reg­u­la­tors’ tol­er­ance for uneth­i­cal busi­ness behav­ior and bla­tant dis­re­gard for the law is the root cause of the cur­rent credit cri­sis. With­out a rad­i­cal change in enforce­ment pol­icy by the next Pres­i­dent, the last 7 years of mis­takes will be repeated.

Bla­tant dis­re­gard for law and reg­u­la­tion is SOP for banks and bro­ker­ages. As the finan­cial cri­sis unfolds and tril­lions of dol­lars are lost, it is clear that bankers can engage in com­mer­cial, secu­ri­ties or bank­ing fraud with­out fear of pros­e­cu­tion or civil ret­ri­bu­tion. For exam­ple, in the last few weeks we have learned that Indy­Mac man­age­ment orga­nized Sat­ur­day work ses­sions for employ­ees to inflate appraisals on loans that didn’t meet mar­ket stan­dards. In mid-July, the Fed­eral Reserve felt they had to tell sub-prime mort­gage orig­i­na­tors that coer­cion of apprais­ers is no longer accept­able (coer­cion appears to remain OK for prime mort­gage orig­i­na­tors). There hasn’t been a major Sarbanes-Oxley or 10b-5 enforce­ment action in years even though many banks and bro­kers reg­u­larly lie to share­hold­ers and lack inter­nal con­trols. And, despite these and other issues there has been no announce­ment of mean­ing­ful pros­e­cu­tion at any level and the Bush Admin­is­tra­tion hasn’t assumed a posi­tion of lead­er­ship on these issues.

In law school I learned that there are three prin­ci­pal rea­sons for crim­i­nal laws and enforce­ment. Set forth below is a brief dis­cus­sion each of these objec­tives so we can start to remem­ber why being a nation that respects laws is important.

  • Deter­rence. Every­one who went to ele­men­tary school and saw some kid made an “exam­ple of” by the teacher under­stands why deter­rence works and how it should be applied. When deter­rence is lack­ing, soci­ety engages in a “race to the bot­tom” as bul­lies and uneth­i­cal peo­ple assert author­ity. Indy­Mac wouldn’t have forged doc­u­ments if their employ­ees thought there was a real­is­tic chance that they would be pros­e­cuted and spend time in prison. SEC fil­ings would have full and fair dis­clo­sure if direc­tors and offi­cers believed that their free­dom was at stake for “for­get­ting” to dis­close busi­ness or finan­cial risks. And, we wouldn’t have the Fed­eral Reserve telling mort­gage orig­i­na­tors the obvi­ous, that coer­cion isn’t accept­able, if pros­e­cu­tors were doing their job and indict­ing any­one who tam­pers with, or cre­ates fraud­u­lent, appraisals, appli­ca­tions or loan doc­u­ments. No deter­rence has resulted in use­less SEC report­ing and abuse of investor and bor­rower trust.
  • Ret­ri­bu­tion. Soci­ety wants and needs “bad guys” to be pun­ished. If the crim­i­nal law sys­tem doesn’t work, pop­ulist politi­cians will leg­is­late ret­ri­bu­tion and “mob jus­tice” will be dis­pensed. The cathar­tic effect of active and fair crim­i­nal pros­e­cu­tion is needed to make all classes of soci­ety feel that every­one is treated equally and that “rich peo­ple” can­not com­mit finan­cial crimes with­out con­se­quence. At var­i­ous times in United States his­tory, mob jus­tice has caused leg­isla­tive over­re­ac­tion that hand­i­capped legit­i­mate busi­ness inter­ests and opportunities.
  • Seg­re­ga­tion. Vio­lent crim­i­nals need to be seg­re­gated from soci­ety so they don’t hurt oth­ers. White col­lar crim­i­nals need to be sep­a­rated from the orga­ni­za­tions and tools that they used to com­mit their crimes so that they can’t per­pe­trate future finan­cial frauds. Pro­fes­sional and busi­nesses licenses are priv­i­leges and not rights. Such licenses are granted by the SEC, bank­ing reg­u­la­tors, insur­ance reg­u­la­tors and pro­fes­sional orga­ni­za­tions and can be lost in civil enforce­ment actions. Dur­ing the 1980’s and 1990’s, in the fall­out from the last bank and thrift cri­sis, many peo­ple lost their abil­ity to work for banks, thrifts and bro­kers. So far, in the cur­rent cri­sis, there has been no effec­tive civil enforce­ment or license sus­pen­sion and per­pe­tra­tors of bad acts and reck­less judg­ment can re-invent them­selves and come back to destroy new orga­ni­za­tions and finan­cial interests.

Free mar­kets don’t mean cor­rupt mar­kets. Hon­est com­pa­nies have a tough time com­pet­ing in a rigged mar­ket envi­ron­ment and we are all suf­fer­ing from the Bush Administration’s almost com­plete lack of inter­est to enforce exist­ing laws and reg­u­la­tions. Let’s hope the next Pres­i­dent has some pas­sion for the tough and detailed work of law enforce­ment and reg­u­la­tory oversight.

Posted in: BANKS, Bernanke, Brokerage, Bush Administration, Credit Crisis, Criminal Law, Federal Reserve, Finance, McCain, Obama, REGULATION, SEC

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