Why the Banks Are Too Big to Jail

Washington, DC – Among the fundamental principles of any functioning justice system is the following: Don’t lie to a judge or falsify documents submitted to a court, or you will go to jail. Breaking an oath to tell the truth is perjury, and lying in official documents is both perjury and fraud. These are serious criminal offenses, but apparently not if you are at the heart of America’s financial system. On the contrary, key individuals there appear to be well compensated for their crimes.

As Dennis Kelleher of Better Markets has argued, the recent so-called “robo-signing” settlement – in which five large banks “settled” their legal liability for carrying out fraudulent foreclosures on mortgages – is a complete sell-out to the financial industry.

First, there was no serious criminal prosecution – meaning that no one will be charged with a felony, and no one will go to jail. In terms of affecting executives’ incentives, this is the only thing that matters.

Even the terminology used to frame the discussion is wrong. Kelleher, an attorney with extensive experience in private practice and the public sector, tells it like it is: “‘robo-signing’ is massive, systematic, fraudulent, criminal conduct.” Alternatively, as he points out, we could just call it “lying, cheating, and stealing.”

Second, the civil penalties in this settlement – a form of fine – are minuscule relative to the size of the companies involved. As Shahien Nasiripour, one of the best reporters on this issue, dryly put it: “None of the five lenders have said they expect to incur a material charge due to the settlement.” In other words, from a corporate perspective, the penalty is a trifling affair.

Third, such fines are, in any case, paid by the companies’ shareholders, not by their executives or board members (all of whom carry insurance). In the rare cases in which fines have been levied on individuals, either their insurance policies picked up most of the bill, or the penalties were trivial relative to the cash compensation that they received while committing their crimes – or both.

As if all of this weren’t bad enough, the banks reportedly will be able to use government money to write down the value of mortgages, which amounts to subsidizing them to pay their own meaningless fines.

The Obama administration and its allies have worked hard to sell its roughly $20 billion settlement with the banks as one that will have a meaningful impact on the housing market. But nothing could be further from the truth. As Kelleher points out, the United States has “more than 10 million homes under water” (the outstanding mortgage exceeds the house’s value). “Twenty billion dollars doesn’t make a dent in that: one million homes at $20,000 loan forgiveness is it.”

In fact, the Obama administration’s settlement with the mortgage lenders is consistent with its track record on all of its policies related to the financial sector, which has been abysmal. But it is also puzzling. Why would the administration continue to bend over backwards to be lenient towards top bankers under these circumstances?

I honestly do not believe that the administration’s stance reflects any form of corruption – payments made to individuals or even to political campaigns. And, in this case, it does not even appear to reflect the lobbying power of big financial players. That power certainly explains why the Dodd-Frank financial reforms enacted in 2010 were not stronger, and why there is now so much opposition to effective implementation of that legislation (for example, there is currently a huge fight around the “Volcker rule,” which would limit proprietary trading by megabanks). But mortgage lenders’ criminal activities are another matter.

Indeed, at stake in the mortgage settlement are fundamental and systemic breaches of the rule of law – perjury and fraud on an economy-wide scale. The Justice Department has, without question, all of the power that it needs to prosecute these alleged crimes fully. And yet America’s top law-enforcement officials have consistently – and now completely – backed off.

The main motivation behind the administration’s indulgence of serious criminality evidently is fear of the consequences of taking tough action on individual bankers. And maybe officials are right to be afraid, given the massive size of the banks in question relative to the economy. In fact, those banks are bigger now than they were before the crisis, and, as James Kwak and I documented at length in our book 13 Bankers, they are much larger than they were 20 years ago.

Top bankers want to make a lot of money. They also want to stay out of prison. Political leaders can huff and puff as much as they want, but, without a credible threat of poverty and time behind bars, bankers have no reason to comply with the law. For them, it’s all about the trade – and you can be the sucker in public policy as easily as you can be the sucker in an individual loan agreement.

The message to bank executives today is simple: build your bank to be as big as possible – and then keep growing. If you manage to become big enough, you and your employees are not just too big to fail, but also too big to jail.

The Obama administration has just made everyone else the sucker.