The big indictment against SAC Capital Advisors on Thursday offers up another jarring reminder that while the Justice Department continues its old habit of pursuing insider-trading cases, it has let the biggest financial scam in history pass it by without a single conviction of a Wall Street executive. Indeed, the government's entire hope for nailing any Wall Street culprits related to the subprime securitization scandal now depends on one tiny, wriggling fish in another New York courtroom: Fabrice Tourre.
Tourre, of course, is the mid-level Goldman Sachs trader on civil trial over charges that he misled an investment company in a complex securitization deal. But even there the best hope in the civil case is that little Fab will be banned from the securities business and fined. No jail time. And it's a weak case at best: All Goldman and Fab did was out-trade a dumber firm. That's what one does on Wall Street: Dishonor among thieves is the name of the game.
Senior U.S. officials, starting with Lanny Breuer, the former head of the Justice Department's criminal division, have never offered up a good explanation for why they have failed to prosecute individuals who were responsible for scams worth hundreds of billions of dollars, other than it's hard to make a case. But experts contrast the scant number of criminal or civil referrals compared with the savings-and-loan scandal, or even the Enron blowup. "The Office of Thrift Supervision made 30,000 referrals in the S&L debacle," says William Black, a former litigation director of the Federal Home Loan Bank Board and senior deputy chief counsel at the OTS. "It's made zero here." The Financial Fraud Task Force set up by Attorney General Eric Holder has also yielded next to nothing. "It's outrageous. There is evidence out there," says Kathleen Engel of Suffolk University Law School, an expert in mortgage fraud and securitization.
More than four years have passed since we learned that Wall Street was playing a giant confidence game with the world, disguising bad and often fraudulent mortgages as highly rated securities, selling scam derivatives by the hundreds of billions of dollars. No executive has gone to jail. The only ones who've even resigned are those who had no choice because their companies imploded (James Cayne of Bear Stearns, Dick Fuld of Lehman, John Thain of Merrill Lynch) or who were shown to be so incompetent that their boards had no choice but to can them (Stanley O'Neal of Merrill, Chuck Prince of Citigroup). The failed prosecution of former Bear Stearns hedge-fund managers Ralph Cioffi and Matthew Tannin in 2009—in which lawyers managed to show the duo was simply clueless about the risks, not criminal—put a chill in the Justice Department that has endured, turning Holder into a hold-your-fire attorney general. The SEC and Justice Department also declined to file charges against Joseph Cassano, the reckless former AIG financial-products chief whom the writer Michael Lewis once called "the man who crashed the world." Cassano, who sold $500 billion worth of credit-default swaps without hedging them, was able to argue effectively the same thing in his defense as the Bear traders: "I didn't know how bad the crash would be. I was just a moron." (A rich moron, by the way.)
But the evidence is plain that many senior executives on Wall Street knew that fraudulently inflated home values, wholly invented incomes, and other illegal schemes figured in a huge percentage of the subprime loans that they were turning into securities and selling around the world—possibly at least 50 percent nationwide, according to county and state officials as well as real-estate experts interviewed around the country. One piece of evidence: during the height of the bubble it became standard practice to solicit borrowers by giving them "no document" loans, known in the industry as "liars' loans," in which all the borrower must put down to qualify is "stated income" (write anything you want; no one will be checking). The FBI itself warned back in 2004 that "mortgage fraud was pervasive and growing."
All this was done at the urging of Wall Street. The investment banks were so desperate for more mortgage-backed securities to sell that some of them cut deals with the big nonbank lenders to deliver billions of dollars worth of loans a month, no questions asked. Wall Street, in other words, drove the mortgage mania and the collapse in lending standards. "It's like drugs," Jim Rokakis, the former treasurer of Ohio's Cuyahoga County, which was particularly hard hit, told me in 2008. "The police don't really want the small-time drug dealer or user. The guy they really want is the drug lord in Colombia. In this case, the drug lord was Wall Street. This was money looking for people to exploit."
And yet the only culprits that have been prosecuted and jailed were the small-time mortgagers who played along, rather than their drug lords on the Street.
"Fab" Tourre himself was just a bit player, a Goldman trader who allegedly misled executives at another investment firm about the nature of a complex security that those clueless executives thought would increase in value but in reality was designed to fail at the behest of John Paulson, the hedge fund manager who was "shorting" bad mortgages on the bet they would collapse in value. Was there some amount of fraud involved? Perhaps. But who cares? This was not fraud on the public, but a minor falling-out among drug lords.
The bigger question is why haven't prosecutors used leverage against the Fabrice Tourres to go after the higher-level executives who were really involved in creating the scam?
Wall Street's main defense is that no one, even top CEOs, knew the crash would be so bad—largely true—and that no one had a really close eye on what others were doing along the securitization pipeline. That latter point is much less persuasive. Engel has argued that when the big Wall Street firms began buying up mortgage originators further down the pipeline at the height of the bubble, it opened them up to new liabilities. "When they were completely separate entities, and the investment banks were just buying loans that had already been made, it was easy for them to maintain they had no involvement" in fraud, she said. "But over time what happened was that the investment banks, as market makers, would go to the investors and ask them what kind of products they were looking for. They even made loans to the [loan] originators so that the originators would be able to make more loans. And then the originators would pay off those loans [to Wall Street] with their loans." Finally the Wall Streeters began to buy up the originators altogether.
Yet even then they carefully kept the entities separate with holding companies. "The whole process was atomized. At Enron everything kind of happened inside the firm. Same thing with the Savings and Loans," says Engel. "Here they compartmentalized the process."
The government simply hasn't mustered the legal firepower or aggressiveness to break through those compartments. The sad irony is that by letting Wall Street plead collective guilt—everyone's guilty, so no one in particular is—the Justice Department and SEC have ignored a scandal that makes SAC's alleged insider trading look like pickpocketing pennies.
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