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Today’s Washington will never bring charges against big banks’ major Wall Street criminals – criminal charges, that is.
Five years have passed since the peak of the subprime financial crisis, in which the nation’s largest banks formulated sloppy loans that taxpayers ended up paying for. Wall Street’s greed cost the United States nearly 9 million jobs (6% of the workforce), a 30% fall in housing prices, and a 50% dip in the stock market.
All in all, the estimated total crisis-related loss equals around 40% of 2007 gross domestic product.
Yet, even with this long list of multi-million-dollar costs, not a single too-big-to-fail chief executive officer (CEO) is in jail.
Instead, former Lehman Brothers CEO Dick Fuld walked away from the subprime crisis with half a billion dollars and three homes. And former Bear Stearns CEO Jimmy Cayne left with more than $300 million; he and his wife own two Manhattan residences, a vacation house on the Jersey shore, and a $3 million condo in Boca Raton.
There is a simple reason why these Wall Street thugs weren’t criminally charged.
It all started back in 2007, before the collapse of Bear Stearns that would be the death knell of the economy…
The Case That Ended All (Criminal) Cases
By 2007, banks had made an estimated $3.2 trillion in loans to homebuyers with bad credit and/or undocumented incomes.
Wall Streeters had bundled these loans into mortgage-backed securities (MBS). Then hedge fund managers packaged them into funds with different risk levels.
Among these hustling hedge fund managers: Ralph R. Cioffi and Matthew M. Tannin.
In 2007, Cioffi and Tannin ran two hedge funds at Bear Stearns that together had about $20 billion invested in asset-backed securities. Their funds hadn’t performed badly – yet – but the men weren’t exactly forthcoming to clients about the involved risks.
Turns out, the two men may have known the funds were in risk of collapse, due to their exposure to subprime loans.
Email evidence detailed the two men discussing the downward spiral of their hedge funds. Tannin wrote in one, “The entire subprime market is toast.”
“They said everything was OK. They didn’t say they were taking huge losses, when they knew it,” recalled Money Morning’s Capital Wave Strategist Shah Gilani.
Then they allegedly lied about the performance. According to court records, Cioffi at one point told investors there had been “a couple million of redemptions,” but the total was more like $47 million.
In June 2008, federal prosecutors charged and arrested Cioffi and Tannin with securities fraud violations that amounted to a $1.6 billion loss for investors when the subprime bubble burst.
“As far as I know, this marks the first time the people behind the corporation were individually sued by the government on criminal charges for defrauding investors,” said Gilani.
Prosecutors argued the defendants purposefully misled their clients. But the defense argued that investors knew and understood the risks of hedge funds. And that regardless, it is unreasonable to expect Cioffi and Tannin to know the future of the market with certainty.
They said Cioffi and Tannin did not knowingly defraud investors…
In November 2009, a jury acquitted Cioffi and Tannin, agreeing with the defense.
One juror said afterward, “The entire market crashed. You can’t blame that on two people. How much can two men do?”
Another juror stated even though she felt like the men “committed something,” it wasn’t proven with enough certainty to convict.
A third juror said she was so sure Cioffi and Tannin weren’t guilty, she’d invest her own money with them.
Indeed, the government lost because the jury was convinced that Cioffi and Tannin were simply “traders,” in the sense that they could not have foreseen a global meltdown was coming.
“The jury thought, ‘These guys don’t have a crystal ball, and the market has gone down and bounced back before,'” Gilani said.
The case is precisely the reason the justice department rarely goes after individuals behind the subprime crisis criminally. It knows the public will not be convinced these traders behaved, beyond a reasonable doubt, with malicious intent.
So the justice department has stopped spending taxpayers’ money on a criminal case it will have a hard time winning.
Instead, what we have been seeing is a massing of civil suits.
A Civil Action
“The justice department will not cut off the fountainhead by trying to throw the guys responsible for the subprime crisis in jail. The strategy is, let these guys keep earning more money. Then, the justice department will come take it,” Gilani said.
That might sound like a good alternative to the seemingly impregnable criminal action against these bad actors, but rest assured, it’s not.
Unfortunately, the justice department’s method leaves shareholders to pay for the bad deeds of the management. Shareholders suffer the losses, while the culprits are left at the top to keep earning.
For instance, an investigation released in September 2013 shows that the top executives from the 25 largest pre-crisis subprime lenders are back in the mortgage business. At least 14 were CEOs or founders. To top it off, the mortgage companies they’re with are less regulated than banks.
And taking money away from the company via civil action doesn’t really touch management’s pockets.
“The Fed is pumping out money and liquefying banks with cash. The banks know they are on the hook for legal bills and settlements when the justice department goes after them, so they hold higher reserves,” Gilani explained.
So what does this mean for investors?
Wall Street Criminals and Your Money
The main point shareholders must remember is that civil suits and settlements will be the harshest punishment Wall Street will ever see.
Last month saw JPMorgan Chase & Co. (NYSE: JPM) pay $13 million in settlement, the largest amount ever paid by a single corporation to the federal government. That’s triple the $4.5 billion paid by BP (NYSE: BP) for the 2010 Gulf of Mexico oil spill.
But does it really punish JPMorgan?
Well, the company banked $21.3 billion in profits in 2012. Plus, it certainly saw a settlement of this nature in its future, and had time to plan ahead.
So… not really.
The recurring theme of Washington and Wall Street these days is the public is always the lender of last resort.
The bad actors that caused the subprime crisis and subsequent financial collapse remain in positions of power to make more money, and play more games. There is no increased regulation, and it’s never “game over.”
“We may be in the fifth inning of these settlements. There will be repercussions for a long time, including new rules for making the banks safer, and making them hold higher reserves,” Gilani said. “Unfortunately, that means less money to lend out, which again, screws the consumers.”
And the banks will take more risk to make up for what they’re not making.
Did you hear the one about the Wall Street firm that made $15 million by manipulating a credit default swap? (Yes, the one “The Daily Show” highlighted.) Totally legal, too… Read all about it here: How the Masters of the Financial Universe Use Derivatives for Fun and Profit
- Money Morning:
How the Masters of the Financial Universe Use Derivatives for Fun and Profit
- Money Morning:
Sorry CNBC, but the $13 Billion JPMorgan Fine Was No Shakedown
- Money Morning:
The Greatest Criminal Enterprise in the World