Let the Punishment Fit the Harm
posted by Frank Pasquale
As a recent BBC documentary has suggested, the banking crisis involved incompetence, fraud, or some toxic mix of both. The criminal law is often concerned with the distinction between evil, mental illness, and stupidity, and perhaps those mens rea issues should inform investigations into entities like ratings agencies or investment banks. Yet given the degeneration of corporate ethics, scrutiny of these managers’ states of mind might prove as fruitless as it would be endless. The main threat these people now pose is their ongoing undue influence on our political system–for their nonstop cultivation of Congress and the White House has turned out to be the wisest investment they ever made. And the lobbying continues, as intensively as ever.
Nobelist Joseph Stiglitz recognizes the extraordinary injustice of recent events:
Too many bankers and other lenders have been focused on trying to beat the system by getting around accounting and banking regulations (through what is called accounting and regulatory arbitrage). Indeed, with bonuses based on short-term profits, they had every incentive to gamble and connive. And now that there’s a bust, no one is being asked to pay back the hefty bonuses earned during the boom.* On the contrary, even as they are dismissed, those who helped send their firms and the American economy into a tailspin are rewarded with generous severance packages. They are enriched regardless of what happens to investors, homeowners, and others who lost so much. Unless we reform incentives, the financial sector will only try to circumvent whatever new regulations are put in place.
Having made so many others financially insecure, those who grabbed while the getting was good are relatively even better positioned to fund campaigns and the 527s now scurrying to stop a Democratic supermajority. One wonders, for instance, why the British plan to prop up their banking sector demanded a 12% rate of return for taxpayers and influence over the use of funds while the US plan only generally demands 5% and offers government little more than moral suasion over how the funds are allocated.
(And that moral suasion isn’t working too well–Morgan Stanley appears to be set to give out even more bonuses, and it’s by no means clear that a big proportion of the US bailout won’t be squandered on massive executive compensation, dividends, and mergers.)
One hope here is that as fraud cases accumulate, some sort of settlement will be reached to help stop the pattern of socialized risk and privatized gain. Just as Fannie and Freddie were forbidden to lobby, Wall Streeters’ ongoing efforts to skew the bailout in their favor should lead to scrutiny of their political spending. Given the crisis, outright bans on their political spending might be considered, First Amendment considerations notwithstanding–as Judge Posner never fails to remind us, the constitution is not a suicide pact. Corrective justice also suggests we spend less time waving the threat of prison at those investigated, and more on crafting settlements that recover for the public purse some portion of the billions of dollars of bonuses this fraudulent paper generated. If we fail to do that, Madeleine Bunting’s indictment of the system will only ring more true:
Those who will pay the heaviest price for the foolhardiness of deregulated financial capitalism are among those who are least responsible, as Brazil’s President Lula angrily pointed out last week. The shockwaves of the west’s banking crisis will shipwreck more vulnerable countries. In developing countries, people don’t have the resources – welfare provision, savings, insurance – to tide them over a crisis. Instead, they go hungry, homeless – and they die.
Those who made fortunes creating this mess deserve to pay for cleaning it up. And before such an idea is dismissed as hopelessly complex to implement, perhaps we should consider re-assigning the IRS agents now charged with scrutinizing, Inspector Javert style, some EITC recipients’ hundreds of dollars of fraud, to the investigation of the real basis of Wall Street’s hundreds of millions of dollars of wealth.
*After Stiglitz’s piece went to press, NYAG Andrew Cuomo started investigating AIG, in an action that could be a model here.
October 25, 2008 at 9:58 pm
Posted in: Corporate Law, Criminal Law, Economic Analysis of Law
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Responses (8)
Brett Bellmore - October 26, 2008 at 10:26 am
“Those who made fortunes creating this mess deserve to pay for cleaning it up.”
Cool. We can start by forcing every member of Congress who got money from Freddie Mac to refund it into a fund to help people having trouble with their mortgages.
The idea that this crisis was created unaided by the financial sector is lunacy. They’re not innocent, to be sure, but they were responding to some pretty heavy duty perverse incentives the federal government set up.
Frank - October 26, 2008 at 11:09 am
I made repeated references in the post to government action bought and paid for by the interests I’m criticizing.
The old dichotomies between private and public are more useless than ever now. As James Galbraith has explained in great detail in The Predator State, we’ve had extraordinary state intervention on behalf of the wealthiest. It’s time to get some relief to ordinary working people. Let’s bail out health care and infrastructure–and stop pretending that some pure and precious market will always allocate resources to their highest and best use.
Brett Bellmore - October 26, 2008 at 12:11 pm
I’d never pretend that, it would require pretending that I thought there WAS an objective “highest and best use”. I just prefer the market to the state because I prefer people who try to buy my cooperation to people who obtain it at the point of a gun.
bill - October 26, 2008 at 11:08 pm
Stiglitz not Stigler. Stigler died in 1991.
Frank - October 27, 2008 at 8:52 am
Thanks, bill, corrected now.
Maryland Conservatarian - October 27, 2008 at 11:31 am
“…we’ve had extraordinary state intervention on behalf of the wealthiest. It’s time to get some relief to ordinary working people. Let’s bail out health care and infrastructure–and stop pretending that some pure and precious market will always allocate resources to their highest and best use.”
What? no references to the sparkling success of the War on Poverty, HUD, Fannie and Freddy or the DC School system? Just out of curiosity – who runs your preferred programs and why do you think they know more than a “pure and precious” market (as if we’ve ever even approached that since the New Deal).
piller - October 28, 2008 at 1:45 am
“they were responding to some pretty heavy duty perverse incentives.” yes now I see. and those who respond to incentives, no matter how creatively interpreted by the responder, ought not to be held at all responsible for those responses. they were just doing the rational thing and no one should ever be asked to hesitate before doing what is profit-maximizing for them so long as it is colorably permissible at the time. I don’t say that no legislator has any responsibility here – they should disorge too – but it is absurd to say that “I was just responding to an incentive, and that’s a complete defense to any demand for restitution, so that all responsibility lies with the person who created the incentive.” There is such a thing as unjust enrichment.
parz - October 28, 2008 at 9:38 pm
Terrific post, Frank. the task now is to craft appropriate measures that would ensure that these remarkably greedy and cynical loybbists (and their minions and masters) cannot continue to profit from their wrongdoing. That will not be an easy task.
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