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Follow the Money: How Finance Keeps the Whip Hand

While the NSA argues that the biggest risk of terrorism is the possibility of a hack attack on our banking system by unspecified assailants, the mortal danger facing the financial services industry is the conduct of the industry itself.

Stock market. (Photo via Shutterstock)

Part of the Series

Truthout is serializing Beatrice Edwards’ book, The Rise of the American Corporate Security State. To read more excerpts from this book, click here.

Daniel Ellsberg writes of The American Corporate Security State: “Edwards is an extraordinary writer who brilliantly captures the essence of what whistleblowers such as [Edward] Snowden have sacrificed their careers and jeopardized their personal liberties to convey.” Get the book by contributing to Truthout here.

Reason to be afraid #5:

Financial reforms enacted after the crisis are inoperable and ineffective because of inadequate investigations and intensive corporate lobbying.

Let’s consider national security for a moment. This isn’t as simple as it sounds because we’re not sure what – exactly – anyone means by national security. Assuming we’re talking about the planning and actions needed to ensure a stable future for the United States, the phrase should include the need to address threats to both our economic and our political systems.

If you’re attending Senate briefings held by the Economic Warfare Institute, you will assume that the most serious threat to national security is the possibility of a hack attack on our banking system by unspecified enemies. In contrast, if you happened to miss the EWI events, and instead you’re looking at the value of your 401k while wondering why your savings accrue 0 percent interest year after year, you’ll know that the management and finance pros inside the banking system itself are the more likely danger. They are the people we ought to be scared of.

Speaking of terror, the weekend that began on Friday, September 12, 2008, was filled with heart-pounding panic at the Treasury Department, the Federal Reserve, and the Federal Reserve Bank of New York (FRBNY). Hank Paulson, secretary of the Treasury; Ben Bernanke, chairman of the Federal Reserve Bank; and Timothy Geithner, chairman of the FRBNY spent their time trying to devise a stop-gap financial plan that could avert the collapse of US financial institutions.

Nonetheless, once the US government took the extraordinary measures necessary to forestall the cataclysm, pressure began building to provide legal immunities to financial institutions (among others) for whatever coordinated cyber-defense actions they might take with military intelligence and law enforcement. The institutions lining up for immunity, however, are the sites of the financial crimes that nearly finished us. The benign response to what the top echelon of bankers did stands in stark contrast to the reaction to the men who attacked us in 2001. Al-Qaeda leaders and anyone associated with them became the subjects of intense manhunts, detention, or execution. Americans who suggested that the War on Terror may have gone too far are still indicted and prosecuted. But those who threatened the national banking system and brought on the Great Recession avoided any direct accountability.

And now, in an impressive sleight of hand, terror – which was once our primary national security concern – has transmogrified into cyber-attack and then cyber-warfare, directed quite possibly at the banking system. This is the national security threat that Michael Hayden, James Woolsey, and Michael Mukasey tell us to fear now. And we should believe them; after all, they represented the NSA, the CIA, and the Justice Department. To combat this threat, we must extend legal immunities to the corporations that own American infrastructure. These companies want to be shielded from any lawsuit that could result from cooperation with US intelligence agencies about cyber threats. They include the same financial institutions that assumed so much risk they became insolvent and brought us to the eve of destruction only a few years ago.

Apparently, the prospect of lawsuits and/or criminal prosecution preoccupies the C-suites at the banks and the corporate owners of America. This seems odd, given that the Department of Justice uses its prosecutorial discretion systematically to spare them. In the wake of the financial crisis of 2008, not a single senior manager of a financial institution was charged criminally. At the same time, by 2014, the Obama Justice Department had indicted three whistleblowers from the intelligence agencies under the Espionage Act, subjecting them variously to investigation, imprisonment, and exile. Their alleged crimes? Informing the US public about CIA torture, NSA fraud, and unconstitutional NSA surveillance.

These two distinct reactions to crises – the suppression of dissent and the impunity accorded the managers of the country’s largest banks and AIG – are the real threats to national life as we know it. Because the bizarre prosecutions and the silent tolerance of systemic fraud are incremental, though, we are not noticing that it’s a dark new day. Today, there are no desperate people jumping from skyscrapers, no collapsing towers, no smoking ruins. There is very little panic, except for the poor souls at the Treasury Department over that terrible weekend in 2008. This threat is much more decorous and discreet.

It is Wednesday, April 7, 2010, and the Financial Crisis Inquiry Commission (FCIC) convenes in room 2123 of the Rayburn Building of congressional offices just across Independence Avenue from the US Capitol. The commission, appointed to identify the causes of the crisis of 2008, is expecting a high-profile day. At 9:00 a.m., the former chairman of the Federal Reserve Board will testify, and the place is packed. The press wants a good look at the expected exchange between the commission and Alan “the Maestro” Greenspan. The assembled reporters will not be disappointed. This morning Greenspan will make his 70-percent-right/ 30-percent-wrong remark that then headlines the websites of news outlets all day long:

I mean, I think, I mean, my experience has been in the business I was in, I was right 70 percent of the time, but I was wrong 30 percent of the time. And there are an awful lot of mistakes in 21 years.

When the FCIC chairman, Phillip Angelides, asks Greenspan if his refusal to regulate the financial derivatives market is part of the 30-percent-wrong quotient, Greenspan famously replies that he doesn’t know.

This is passing strange because, without being nearly so clever as the Maestro, the rest of us know. Virtually everyone in America with a mortgage or a 401k is pretty sure that Greenspan’s decision to leave derivatives unregulated back in the 1990s and early 2000s was the wrong call. As an indirect result of that decision, the housing market blew up, and the stock market crashed. Nevertheless, Greenspan rambles on in his self-exculpatory way for a good long while. By the time Citigroup whistleblower Richard Bowen testifies early that afternoon, the tone of confusion is already well-established.

Around 12:30 p.m., when the commission reassembles, Bowen and three others are seated at the witness table, and each gives an opening statement about the panel’s topic: subprime mortgage origination and securitization. Bowen’s statement is a bit different from those of his fellow witnesses, who imply that their employers’ intentions were good but their risk assessment systems were flawed. Richard Bowen was the business chief underwriter for Citi in early 2006 with responsibility for vetting more than $90 billion of mortgage loans annually. During 2006 and 2007, he calculated that 60 to 80 percent of the mortgage-backed securities (MBSs) Citi was selling to investors were defective. When he testifies, he reveals that Citi was well aware of its time bomb of liabilities:

During 2006 and 2007, I witnessed business risk practices which made a mockery of Citi credit policy. I believe that these practices exposed Citi to substantial risk of loss. And I warned my business unit management, repeatedly, during 2006 and 2007 about the risk – risk issues I identified.

I then felt like I had to warn Citi executive management. I had to warn the board of directors about these risks that I knew existed.

On November the 3rd, 2007, I sent an email to Mr. Robert Rubin, Mr. Dave Bushnell, the chief financial officer and the chief auditor of Citigroup. I outlined the business practices that I had witnessed and had attempted to address. I specifically warned Mr. Rubin about the extreme risks and unrecognized financial losses that existed within my business unit.

I also requested an investigation. And I asked that this investigation be conducted by officers of the company outside of my business unit.

At this moment, Richard Bowen is not telling the commission anything its members don’t already know. In his written testimony, delivered a week before, he relayed the same message in detail. With that document, he provided evidence showing he warned senior management and the board about the poor quality of substantial percentages of the MBSs Citi sold to investors, among them Fannie Mae and Freddie Mac. These securities, Bowen asserted, did not meet the credit worthiness standards set by the bank. Because Citi guaranteed investors that they did, the bank could be obliged to buy them back if they went bad. If that occurred, Citi faced a staggering liability, for which it was unprepared.

Richard Bowen testified to the commission that he notified Robert Rubin, then chairman of the executive committee of the board of Citigroup, of the impending disintegration of Citi’s MBS portfolio. Bowen sent his email on Saturday, November 3, 2007, because Charles Prince, then Citi’s CEO, planned to resign the next day. The board was expected to name Rubin as chairman of the board. Bowen felt that he had to get the facts about Citi’s hidden liabilities to the board that day because, as the end of the year approached, the chair and the chief financial officer would have to certify that the bank’s internal controls were effective to meet regulatory requirements set out under Sarbanes-Oxley legislation (SOX), which passed in the wake of the 2001 implosion at Enron. Bowen was therefore warning Rubin that he could not sign such a certification because the internal controls at Citi were, in effect, broken.

Rubin did not respond to him. In fact, Richard Bowen says today that no one with responsibility for the SOX certification would speak to him before January; they did not want to know too much before they certified that the internal controls were effective at the end of the year. In January 2008, when senior management did begin to communicate with Bowen, it was to tell him not to return to the office and, subsequently, to terminate him.

Bowen’s November 3, 2007, email, setting out the problem for Rubin, was attached to his written testimony and submitted to the commission. Remarkably, the testimony received a polite audience from the FCIC, and then he was dismissed.

Even more remarkably, the FCIC seemed uninterested in Rubin’s reaction to Bowen’s email when he, Rubin, appeared the following day before the commission. In fact, he left the hearing room unscathed except for subsequent critical observations that he didn’t seem sufficiently remorseful about what had happened in September 2008.

Clearly, a prosecutor was called for when Rubin sat down to testify, but instead, the diplomatic commissioners went to considerable lengths to keep their collective eyes off the ball that day. Pointedly, Angelides did not ask, and Rubin did not volunteer, what happened to Richard Bowen himself after he sent Rubin the email. Thus, a senior manager’s warning to the board chair of Citigroup that the bank had a $60 billion hole about to yawn open on its balance sheet eleven months before the US financial sector blew up disappeared with hardly a trace. After the FCIC interviewed Richard Bowen, the Justice Department never called him, and the SEC, in possession of his whistleblower disclosure since 2008, did not follow up, either.

Then, on September 21, 2013, exactly five years after the US financial world froze, William Cohan published a coda to the Bowen story in the New York Times. The story asserted that the FCIC forced Richard Bowen to alter his written testimony, directing him to excise specific parts of it. Under threat that he would not be allowed to testify at all if he did not comply, Bowen removed the materials the FCIC identified from his written testimony. These included substantive references to his SEC disclosure, as well as his account of the Sarbanes-Oxley problems Citi faced in 2007. Representations to investors about the credit worthiness of the MBSs Citi sold, as well as all names and specific incidents and any reference to his own status at Citi, had to be deleted. The instructions to delete came from the FCIC deputy general counsel, who eight months later joined a law firm that counts Citigroup as a major client.

Further, the transcript of Bowen’s closed-door interview with FCIC investigators was placed under seal in the National Archives and cannot be released until 2016. By that time, the federal statute of limitations for fraud will have run out.

Bowen’s warnings internal to Citigroup, his whistleblower disclosure to the SEC and written testimony for the FCIC were a problem for the US government as well as for Robert Rubin.

Undeniably, Bowen’s warnings internal to Citigroup, his whistleblower disclosure to the SEC and written testimony for the FCIC were a problem for the US government as well as for Robert Rubin. Given the timing of the FCIC hearing, Bowen’s statements were especially worrisome. At the end of March 2010, as he prepared to testify, the Treasury Department, a major post-bailout shareholder in Citigroup, announced the upcoming sale of 7.7 billion shares of the corporation’s stock. The estimated value was more than $32 billion. As stated by William Cohan:

The projected profit at the time, $7.2 billion, would be among the largest from the government bailouts.

The bank bailout of 2008 had been unpopular in many quarters, especially as millions of homeowners faced foreclosure and lost their homes. Politically, it was important that the liberal president from the Democratic Party show that the operation was not, in the end, a taxpayer subsidy to the same financial interests responsible for the recession. In other words, when Treasury sold its bank stock after these institutions stabilized, it was imperative that the sale price be respectable.

If Richard Bowen openly testified in April 2010 that Citigroup operations were contaminated by systemic fraud, there was a real possibility that shares in Citi would not be attractive to investors shortly thereafter. In that event, Treasury would never have collected a $12 billion return on the sale of its bailout holdings. And if Treasury lost money, then the president and the government could be accused of using taxpayer funds to subsidize the already rich. On the other hand, if Treasury made money, then the bailout was a wash. A cost-free happy ending.

Making money. That’s the key. In Washington, there are two vulgar sayings that guide the thinking of many who work here: 1) Follow the money and 2) It’s the economy, stupid. Which brings us to Dodd-Frank and the financial reforms that never came.

To ensure that we do not have to witness the hearings of an FCIC II, the Congress and the Obama White House drafted the outlines of a reform that ultimately became the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. The physical law called Dodd-Frank is officially 848 pages long. Matt Taibbi in Rolling Stone aptly describes the way in which the reforms have been neutralized by intense, never-ending lobbying from the financial world, first of the Congress and now of executive agencies responsible for writing the implementing regulations. Taibbi compares Dodd-Frank to the fish reeled in by Hemingway’s Old Man: “[N]o sooner caught than set upon by sharks that strip it to nothing long before it ever reaches the shore.”

By September 2013, five years after the crisis and three years after the law’s passage, just about half of the regulations required to implement Dodd-Frank were finalized. To fully appreciate how significant this is, you have to take a glance at the law itself. Here’s a sampling of section 165:

The Board of Governors shall, on its own or pursuant to recommendations by the Council under section 115, establish prudential standards for nonbank financial companies supervised by the Board of Governors and bank holding companies with total consolidated assets equal to or greater than $50,000,000,000.

This section establishes an authority to prevent or mitigate threats to the financial stability of the United States through prudential standards (for managing risk) to be applied to systemically important financial institutions (SIFIs) with assets over $50 billion (such as AIG). As written, the law does not specify the content of “prudential standards,” which would be established through regulation. Consequently, the work of the regulatory agencies is crucial, and the law is virtually useless in the absence of finalized regulation.

In December 2013, the regulators released the finalized Volcker Rule, one of the primary battlegrounds over the implementation of Dodd-Frank. This is the rule that will govern proprietary trading by bank holding companies. The rule had to strike a balance between which trades would be allowed so that banks could hedge their holdings and which would be prohibited as speculative. Now the regulators say, the effectiveness of Dodd-Frank and the Volcker Rule depends on how the regulation is enforced.

Over the course of 71 pages, the respective agencies exhaustively laid out rigorous guardrails of what could and could not be permissible by large financial institutions like JP Morgan Chase and Goldman Sachs in the years ahead [under the Volcker Rule]. But agency officials were also direct in their concern about the upcoming challenge in ensuring that major banks would be held accountable in complying with the rule.

This means that first there’s the law, then the regulation, then the agency guidelines for implementing the regulation. And then there’s the question about whether banks will be held accountable for any of it.

It is significant that one of the regulations not finalized by the end of December 2013 is the one establishing capital rules for the biggest banks: the proposed leverage ratio. The ratio proposed by regulators is reportedly not popular with the big banks, who are lobbying against it by stalling it, pending agreement to a new framework by overseas regulators. This ratio is fundamental to preserving the stability of the financial system in the face of systemic stresses such as those experienced in 2008. Five years after the crisis, however, there is still no agreement on a higher capital ratio.

At GAP we encountered Dodd-Frank directly through whistleblowers who came to us about the resolution plans required of certain types of institutions governed by Dodd-Frank. These documents, we found, were colloquially called “living wills.” In the world of finance, the $50-billion-plus banks and AIG-like conglomerates are to develop them for implementation should it become necessary to figuratively pull the plug. In part, this requirement was a reaction to the public perception that certain large banks were too big to fail. And in part, the living will requirement tells you something about the level of optimism shared by Senator Dodd and Congressman Frank, the primary congressional authors of the reform, concerning the likelihood of avoiding another financial crisis. With the inevitability of death, the collapse is near, and the best we can do is get ready.

Our first problem is that the big banks and AIG operate the way Ford did when its directors realized that Ford Pintos were prone to explosions in rear-end collisions

Our first problem is that the big banks and AIG operate the way Ford did when its directors realized that Ford Pintos were prone to explosions in rear-end collisions. Or the way the tobacco companies did when they realized that their product was carcinogenic. Because of half-hearted law enforcement on their beat, their risk assessment, to a large extent, consists of determining the cost of getting caught relative to the value of earnings accumulated before that happens. There’s a major difference, though, between a Reynolds Tobacco shutdown and the collapse of JP Morgan Chase. The first closing costs jobs and dislocation in Winston-Salem, North Carolina, to be sure, but it would not affect the country as a whole. In contrast, if JP Morgan Chase goes down, the US economy is going down with it. Consequently, JP Morgan cannot be allowed to conduct business in the same shabby ways that the tobacco companies did.

[O]n Wall Street, regulators would rather collect money than prosecute criminals.

Nonetheless, it does. A whistleblower, for example, reports to the SEC alleged criminal activity at the bank where she works. The SEC validates the whistleblower’s disclosure but collects a fine instead of prosecuting the bank’s managers or directors. The fines are substantial relative to the budget of the SEC, but they’re not especially painful for the bank. The SEC benefits from fines, and the bank benefits from crime – probably some form of fraud. In the legal world this is known as civil compromise for nonviolent felonies. Both parties maintain a nonadversarial relationship as they work toward a resolution that benefits both. To put it crudely, on Wall Street, regulators would rather collect money than prosecute criminals.

The Clinton administration acknowledged this reality by establishing guidelines for deferred prosecution agreements (DPAs) for corporations, from which AIG and the SEC would handsomely benefit in the early 2000s. Under these agreements, a corporation simply pays the relevant government agency a fine and promises to do better. In exchange, the errant enterprise escapes prosecution.

To see how weak this approach is, think about the Internal Revenue Service (IRS) as the regulatory agency that oversees you and your taxes. Suppose you’re an accountant with a salary, but you moonlight as an auditor for a couple of small businesses that pay you a total of $5,000 one year. You need the money, so you cheat on your taxes and don’t report that income to the IRS, saving about $1,000. If you’re caught – and you will be because the businesses you audited deduct your charges from their own taxes – you will owe the IRS the tax on the $5,000, plus penalties and interest – let’s say $1,500 – which you had better pay. Suppose instead that, when you cheat, you get a deferred tax-paying agreement: the IRS simply sends you a letter telling you not to do that again and fining you $50.

Are you going to cheat again next year? I might. That’s how self-reporting and deferred prosecution agreements work for the big banks. The penalty – or fine – such as it is, is not a deterrent. And there are no prosecutions to speak of.

The American banking system is rotting at its core, and we have to be ready for failures of large interconnected financial institutions. Thus, the living wills required by Dodd-Frank. At GAP, however, after seeing the way in which living wills are put together, we are guessing that most of them are rotten, too.

The first hole in the new regulatory regime is the Federal Reserve Bank (FRB). At the behest of the Obama White House, the Fed, an institution that presided over the collapse of 2008, gained greater authority as a systemic risk regulator in finance and is now one of the reviewers of the living wills. Not even the Congress thought this was a good idea – at first. Christopher Dodd, quoting a knowledgeable observer on the issue, said:

[G]iving the Fed more responsibility at this point is like a parent giving his son a bigger, faster car right after he crashed the family station wagon.

[G]iving the Fed more responsibility at this point is like a parent giving his son a bigger, faster car right after he crashed the family station wagon.

Second, the law left bank holding companies much discretion in formulating these plans. Deloitte, for example, gave clients the following advice about drawing up living wills.

Even as the regulations are finalized, keep in mind that regulators are prescriptive, not descriptive, in their guidance. They will not tell banks what to do, because each organization is unique. It will be up to the banks themselves to determine how to satisfy this requirement.

Even before the regulations implementing living wills were finalized, the pros in the field knew this would be “regulation lite.”

Third, the data in the living wills are largely self-reported, so the banks and the SIFIs have to be sure only that the numbers add up and the tables square. Little external oversight is involved, and if the plans are inadequate, the Fed isn’t going to realize it until the plan has to be executed, at which point, it’s too late to correct it. Submitting information that is insufficient to serve as an effective roadmap for bank dissolution, under the regulations, is not a crime.

To complicate matters, congressional oversight of the financial regulators is split among the committees on banking (Senate), financial services (House), and the agriculture committees of the Senate and House, just as it was before the 2008 crisis. As Treasury secretary, Timothy Geithner tried to remedy this, but he lost. He thought the banking and financial services committees should oversee all reporting on financial institutions and markets, but the agriculture committees wanted to keep their cut. They exercise oversight of the Commodities Futures Trading Commission (CFTC), which regulates financial derivatives. So long as the agriculture committees hold on to this function, its members are in line for campaign contributions from the finance industry, which can be quite generous. So the best Geithner could get was a joint task force.

This divided oversight is an illustration of how money talks:

[F]inancial interests contributed $8.7 million to members of the House Agriculture Committee, compared to $7 million donated by agribusiness interests. For the Senate Committee the numbers were even more striking: $29.3 million given to members of both parties by financial interests, versus $10.8 million given by agribusiness.

The SEC, for its part, reports to the banking and finance committees. These are among the largest committees in the Congress, and their members, too, are beneficiaries of the largesse of the finance industry. Members of the senate banking committee collected more than $36 million from political action committees and individual donors representing the financial and real estate industries during the 2014 election cycle.

And there we have it. The financial reform that will not fix anything.

[A] cold, clear look at banking (and insurance) shows that the mortal danger facing finance is the conduct of the industry itself.

This is the puzzling thing: Michael Hayden and Keith Alexander, heading up the NSA, are certain that our banks must be protected from terrorism by collecting and storing personal information about all of us and freely exchanging it with US intelligence agencies. But a cold, clear look at banking (and insurance) shows that the mortal danger facing finance is the conduct of the industry itself. The NSA and the regulators, however, pretty much rely on what the industry sees fit to give them, which, by all accounts, isn’t much. At the same time, if a corporation is caught misleading regulators or investors, a deferred prosecution agreement awaits, together with a fine that funds the lax regulator for not really regulating.


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