Mystery over US regulators going soft on the fraudsters

It is a question asked repeatedly across America: Why, in the aftermath of a financial mess that generated hundreds of billions in losses, have no high-profile participants in the disaster been prosecuted?

Answering such a question — the equivalent of determining why a dog did not bark — is anything but simple. But a private meeting in mid-October 2008 between Timothy Geithner, then-president of the Federal Reserve Bank of New York, and Andrew Cuomo, New York’s attorney general at the time, illustrates the complexities of pursuing legal cases in a time of panic. At the Fed, which oversees the nation’s largest banks, Geithner worked with the treasury department on a large bailout fund for the banks and led efforts to shore up the American International Group, the giant insurer. His focus: stabilizing world financial markets.

Whether prosecutors and regulators have been aggressive enough in pursuing wrongdoing is likely to long be a subject of debate. All say they have done the best they could under difficult circumstances. But several years after the financial crisis, which was caused in large part by reckless lending and excessive risk taking by major financial institutions, no senior executives have been charged or imprisoned, and a collective government effort has not emerged. This stands in stark contrast to the failure of many savings and loan institutions in the late 1980s. In the wake of that debacle, special government task forces referred 1,100 cases to prosecutors, resulting in more than 800 bank officials going to jail. Among the best-known: Charles H Keating Jr, of Lincoln Savings and Loan in Arizona, and David Paul, of Centrust Bank in Florida.

Former prosecutors, lawyers, bankers and mortgage employees say that investigators and regulators ignored past lessons about how to crack financial fraud.
As the crisis was starting to deepen in the spring of 2008, the Federal Bureau of Investigation scaled back a plan to assign more field agents to investigate mortgage fraud. That summer, the justice department also rejected calls to create a task force devoted to mortgage-related investigations, leaving these complex cases understaffed and poorly funded, and only much later established a more general financial crimes task force.

Leading up to the financial crisis, many officials said in interviews, regulators failed in their crucial duty to compile the information that traditionally has helped build criminal cases. In effect, the same dynamic that helped enable the crisis — weak regulation — also made it harder to pursue fraud in its aftermath.

A more aggressive mindset could have spurred far more prosecutions this time, officials involved in the S&L cleanup said. “This is not some evil conspiracy of two guys sitting in a room saying we should let people create crony capitalism and steal with impunity,” said William K Black, a professor of law at University of Missouri, Kansas City, and the federal government’s director of litigation during the savings and loan crisis. “But their policies have created an exceptional criminogenic environment. There were no criminal referrals from the regulators. No fraud working groups. No national task force. There has been no effective punishment of the elites here.”

Merrill Lynch, for example, understated its risky mortgage holdings by hundreds of billions of dollars. And public comments made by Angelo R. Mozilo, the chief executive of Countrywide Financial, praising his mortgage company’s practices were at odds with derisive statements he made privately in emails as he sold shares; the stock subsequently fell sharply as the company’s losses became known.

False assurances

Executives at Lehman Brothers assured investors in the summer of 2008 that the company’s financial position was sound, even though they appeared to have counted as assets certain holdings pledged by Lehman to other companies, according to a person briefed on that case. At Bear Stearns, the first major Wall Street player to collapse, private litigants say evidence shows that the firm’s executives may have pocketed revenues that should have gone to investors to offset losses when complex mortgage securities soured.

But the justice department has decided not to pursue some of these matters — including possible criminal cases against Mozilo of Countrywide and Joseph J Cassano, head of financial products at AIG, the business at the epicenter of that company’s collapse. Cassano’s lawyers said that documents they had given to prosecutors refuted accusations that he had misled investors or the company’s board. Mozilo’s lawyers have said he denies any wrongdoing.

Among the few exceptions so far in civil action against senior bankers is a lawsuit filed last month against top executives of Washington Mutual, the failed bank now owned by JPMorgan Chase. The Federal Deposit Insurance Corp sued Kerry Killinger, the company’s former chief executive, and two other officials, accusing them of piling on risky loans to grow faster and increase their compensation.

Representatives at the justice department and the SEC say they are still pursuing financial crisis cases, but legal experts warn that they become more difficult as time passes.

“If you look at the last couple of years and say, ‘This is the big-ticket prosecution that came out of the crisis,’ you realise we haven’t gotten very much,” said David Skeel, a law professor at the University of Pennsylvania. “It’s consistent with what many people were worried about during the crisis, that different rules would be applied to different players. It goes to the whole perception that Wall Street was taken care of, and Main Street was not.”

As nonprosecutions go, perhaps none is more puzzling to legal experts than the case of Countrywide, the nation’s largest mortgage lender and among the most aggressive. Last month, the office of the US attorney for Los Angeles dropped its investigation of Mozilo after the SEC extracted a settlement from him in a civil fraud case. Mozilo paid $22.5 million in penalties, without admitting or denying the accusations.

White-collar crime lawyers contend that Countrywide exemplifies the difficulties of mounting a criminal case without assistance and documentation from regulators — the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Fed, in Countrywide’s case.

“When regulators don’t believe in regulation and don’t get what is going on at the companies they oversee, there can be no major white-collar crime prosecutions,” said Henry Pontell, professor of criminology, law and society in the School of Social Ecology at the University of California, Irvine. “If they don’t understand what we call collective embezzlement, where people are literally looting their own firms, then it’s impossible to bring cases.”

Financial crisis cases can be brought by many parties. Since the big banks’ mortgage machinery involved loans on properties across the country, attorneys general in most states have broad criminal authority over most of these institutions. The justice department can bring civil or criminal cases, while the SEC can file only civil lawsuits.

All of these enforcement agencies traditionally depend heavily on referrals from bank regulators, who are savvier on complex financial matters. But data supplied by the justice department and compiled by a group at Syracuse University show that over the last decade, regulators have referred substantially fewer cases to criminal investigators than previously.