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United States District Judge Jed S. Rakoff is already kind of a hero to me, given that he’s the guy who rejected a “do not admit wrongdoing” settlement between Citigroup and the SEC over mortgage-backed securities fraud because, according to Rakoff, the proposed settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest.”

More recently Rakoff has written a fine essay in the New York Review of Books entitled The Financial Crisis: Why Have No High-Level Executives Been Prosecuted? which I will summarize below but is well worth your time to read.

Rakoff’s essay

First Rakoff made the point that if there was no intentional fraud we should not scapegoat people and put them to jail. But on the other hand, if there was intentional fraud, then it’s a reflection on a dysfunctional justice system that nobody has gone to jail.

Then he examined that first possibility and found it unlikely, given that “… the Financial Crisis Inquiry Commission, in its final report, uses variants of the word “fraud” no fewer than 157 times in describing what led to the crisis…” In fact, fraud permeated at every level.

The Department of Justice (DOJ) has focused on explaining why nobody has gone to jail in spite of the existence of fraud. They have three reasons.

First, the DOJ claims it’s hard to prove intent for high-level management. But Rakoff demurs on this point, explaining that in cases of accounting fraud, “willful blindness” or “conscious disregard” is a well-established basis on which federal prosecutors have asked juries to infer intent.

Second, since many counterparties were “sophisticated,” it’s difficult to prove “reliance“. Again Rakoff demurs, pointing out that “In actuality, in a criminal fraud case the government is never required to prove—ever—that one party to a transaction relied on the word of another.”

Third, because of the “Too Big To Jail” problem, namely that prosecuting fraud would kill the economy. To this, Rakoff points out what that means in terms of class: that poor people can be prosecuted but the rich are protected.

Next, Rakoff says what he thinks is actually happening. First he discounts the revolving door: he thinks lawyers are thoroughly incentivized to make a name for themselves. Then what? He’s got three reasons.

Well, first, people were distracted. The FBI was distracted by terrorists, and the SEC was focused on Ponzi schemes and insider trading. The DOJ was inexperienced and the Southern District US Attorney’s Office was also focused on insider trading. And given the complexity and incentives, it’s hard for a given lawyer to decide to go with an MBS case instead of insider trading.

Second, the government had direct conflict in the fraud, given that the Fed and the regulators had deregulated everything in sight and then kept interest rates low to keep the mortgage machine going. They also meddled a lot during the crisis, deciding which failing bank should be taken over by whom. It made it hard for them to admit shit went wrong.

Finally, it’s because it’s now in vogue to prosecute corporations instead of people, but that really doesn’t work. Here’s Rakoff on this prosecutorial method:

Although it is supposedly justified because it prevents future crimes, I suggest that the future deterrent value of successfully prosecuting individuals far outweighs the prophylactic benefits of imposing internal compliance measures that are often little more than window-dressing. Just going after the company is also both technically and morally suspect. It is technically suspect because, under the law, you should not indict or threaten to indict a company unless you can prove beyond a reasonable doubt that some managerial agent of the company committed the alleged crime; and if you can prove that, why not indict the manager? And from a moral standpoint, punishing a company and its many innocent employees and shareholders for the crimes committed by some unprosecuted individuals seems contrary to elementary notions of moral responsibility.

And then his final conclusion:

So you don’t go after the companies, at least not criminally, because they are too big to jail; and you don’t go after the individuals, because that would involve the kind of years-long investigations that you no longer have the experience or the resources to pursue.

Comments

First, I am super grateful for Judge Rakoff’s essay, because as an experienced lawyer he has way more ammunition than I do to explain this stuff from the perspective of what is actually done in law. The “willful blindness” issue is particularly ridiculous. I’m glad to hear that courts have a way to deal with that problem, even if they aren’t using their tools against Jamie Dimon.

I am also grateful to hear him make the point that widespread fraud, unprosecuted, is not simply a theoretical issue. It exposes the dysfunctionality of our justice system and it exposes basic unfairness in society, where depending on how rich you are and how complicated your crime is, you can avoid going to jail. Personally, in the past few months I’ve gone from being angry at the bankers to being angry at the prosecutors.

Finally, I disagree with Rakoff on one point. Namely, his argument against the negative effect of the revolving door. His argument, I stipulate, only works for lawyers in a US Attorney’s office. I don’t think the average SEC lawyer or economist, or for that matter an employee at any captured regulator, has that much incentive to take on a big MBS case and be hard-assed. I think we would have seen more cases if that were true.