Heist of the Century
Heist of the century: Wall Street's role in the financial crisis
Wall Street bankers could have averted the global financial crisis, so why didn't they? In this exclusive extract from his book Inside Job, Charles Ferguson argues that they should be prosecuted
Bernard L Madoff ran the biggest Ponzi scheme in history, operating it for 30 years and causing cash losses of $19.5bn. Shortly after the scheme collapsed and Madoff confessed in 2008, evidence began to surface that for years, major banks had suspected he was a fraud. None of them reported their suspicions to the authorities, and several banks decided to make money from him without, of course, risking any of their own funds. Theories about his fraud varied. Some thought he might have access to insider information. But quite a few thought he was running a Ponzi scheme. Goldman Sachs executives paid a visit to Madoff to see ifthey should recommend him to clients. A partner later recalled: "Madoff refused to let them do any due diligence on the funds and when asked about the firm's investment strategy they couldn't understand it. Goldman not only blacklisted Madoff in the asset management division but banned its brokerage from trading with the firm too."
UBS headquarters forbade investing any bank or client money in Madoff accounts, but created or worked with several Madoff feeder funds. A memo to one of these in 2005 contained the following, in large boldface type: "Not to do: ever enter into a direct contact with Bernard Madoff!!!"
JPMorgan Chase had more evidence, because it served as Madoff's primary banker for more than 20 years. The lawsuit filed by the Madoff bankruptcy trustee against JPMorgan Chase makes astonishing reading. More than a dozen senior JPMorgan Chase bankers discussed a long list of suspicions.
The Securities and Exchanges Commission has been deservedly criticised for not following up on years of complaints about Madoff, many of which came from a Boston investigator, Harry Markopolos, whom they treated as a crank. But suppose a senior executive at Goldman Sachs, UBS or JPMorgan Chase had called the SEC and said: "You really need to take a close look at Bernard Madoff. He must be working a scam."
But not a single bank that had suspicions about Madoff made such a call. Instead, they assumed he was probably a crook, but either just left him alone or were happy to make money from him.
It is no exaggeration to say that since the 1980s, much of the global financial sector has become criminalised, creating an industry culture that tolerates or even encourages systematic fraud. The behaviour that caused the mortgage bubble and financial crisis of 2008 was a natural outcome and continuation of this pattern, rather than some kind of economic accident.
This behaviour is criminal. We are talking about deliberate concealment of financial transactions that aided terrorism, nuclear weapons proliferation and large-scale tax evasion; assisting in major financial frauds and in concealment of criminal assets; and committing frauds that substantially worsened the worst financial bubbles and crises since the Depression.
And yet none of this conduct has been punished in any significant way.
Total fines on the banks for their role in the Enron fraud, the internet bubble, violation of sanctions against countries including Iran and money-laundering activities appear to be far less than 1% of financial sector profits and bonuses during the same period.
There have been very few prosecutions and no criminal convictions of large US financial institutions or their senior executives. Where individuals not linked to major banks have committed similar offences, they have been treated far more harshly
The Obama government has rationalised its failure to prosecute anyone (literally, anyone at all) for bubble-related crimes by saying that while much of Wall Street's behaviour was unwise or unethical, it wasn't illegal. With apologies for my vulgarity, this is complete horseshit.
When the government is really serious about something – preventing another 9/11, or pursuing major organised crime figures – it has many tools at its disposal and often uses them. There are wiretaps and electronic eavesdropping. There are undercover agents who pretend to be criminals in order to entrap their targets. There are National Security Letters, an aggressive form of administrative subpoena that allows US authorities to secretly obtain almost any electronic record – complete with a gag order making it illegal for the target of the subpoena to tell anyone about it. There are special prosecutors, task forces and grand juries. When Patty Hearst was kidnapped in 1974, the FBI assigned hundreds of agents to the case.
In organised crime investigations, the FBI and government prosecutors often start at the bottom in order to get to the top. They use the well-established technique of nailing lower-level people and then offering them a deal if they inform on and/or testify about their superiors – whereupon the FBI nails their superiors, and does the same thing to them, until climbing to the top of the tree. There is also the technique of nailing people for what can be proven against them, even if it's not the main offence. Al Capone was never convicted of bootlegging, large-scale corruption or murder; he was convicted of tax evasion.
A reasonable list of prosecutable crimes committed during the bubble, the crisis, and the aftermath period by financial services firms includes: securities fraud, accounting fraud, honest services violations, bribery, perjury and making false statements to US government investigators, Sarbanes-Oxley violations (false accounting), Rico (Racketeer Influenced and Criminal Organisations Act) offences, federal aid disclosure regulations offences and personal conduct offences (drug use, tax evasion etc).
Let's take the example of securities fraud. Where to begin?
When did Wall Street insiders know there was a really serious sub-prime mortgage bubble, and that they could game it? Many of the clever ones knew by about 2004, when Howie Hubler at Morgan Stanley first started to bet against the worst securities with the approval of his management. But you can only make money betting against a bubble as it unravels. As long as there was room for the bubble to grow, Wall Street's overwhelming incentive was to keep it going. But when they saw that the bubble was ending, their incentives changed. And we therefore know that many on Wall Street realised there was a huge bubble by late 2006, because that's when they started massively betting on its collapse.
Here, I must briefly mention a problem with Michael Lewis's generally superb financial journalism. In his book The Big Short, Lewis leaves the impression that Wall Street was blindly running itself off a cliff, whereas a few wild and crazy, off-the-beaten-track, adorably weird loners figured out how to short the mortgage market and beat the system. With all due respect to Mr Lewis, it didn't happen like that. The Big Short was seriously big business, and much of Wall Street was ruthlessly good at it.
To begin with, a number of big hedge funds figured it out. Unlike investment banks, however, they couldn't make serious money by securitising loans and selling CDOs (collateralised debt obligations), so they had to wait until the bubble was about to burst and make their money from the collapse. And this they did. Major hedge funds including Magnetar, Tricadia, Harbinger Capital, George Soros, and John Paulson made billions of dollars each by betting against mortgage securities as the bubble ended, and all of them worked closely with Wall Street in order to do so.
In fairness to Mr Lewis, it is true that in several major cases – most notably Citigroup, Merrill Lynch, Lehman and Bear Stearns – senior management was indeed disconnected and thus clueless, allowed their employees to take advantage too long and therefore destroyed their own firms.
But cluelessness was most definitely not an issue with the senior management of Goldman Sachs, JPMorgan Chase and Morgan Stanley. As we saw, Morgan Stanley started betting against the bubble as early as 2004. Conversely, JPMorgan Chase mostly just remained prudently above the junk mortgage fray. Goldman Sachs, though, was in a class by itself. It made billions of dollars by betting against the very same stuff that it had been making billions selling only a year or two before.
Almost all the prospectuses and sales material on mortgage-backed bonds sold from 2005 until 2007 were a compound of falsehoods. And as the bubble peaked and started to collapse, executives repeatedly lied about their companies' financial condition. In some cases, they also concealed other material information, such as the extent to which executives were selling or hedging their own stock holdings because they knew their firms were about to collapse.
In some cases, we have evidence of senior executive knowledge of and involvement in misrepresentations. For example, quarterly presentations to investors are nearly always made by the CEO or chief financial officer of the firm; if lies were told in these presentations, or if material facts were omitted, the responsibility lies with senior management. In other cases, such as Bear Stearns, we have evidence from civil lawsuits that senior executives were directly involved in selling securities whose prospectuses allegedly contained lies and omissions.
The Rico Act provides for severe criminal (and civil) penalties for operating a criminal organisation. It specifically enables prosecution of the leaders of a criminal organisation for having ordered or assisted others to commit crimes. It also provides that racketeers must forfeit all ill-gotten gains obtained through a pattern of criminal activity, and allows government prosecutors to obtain pre-trial restraining orders to seize defendants' assets. Finally, it provides for criminal prosecution of corporations that employ Rico offenders.
Rico was explicitly intended to cover organised financial crime as well as violent criminal organisations such as the mafia and drug cartels. A great deal of the behaviour that occurred during the bubble would appear to fall under Rico statutes. Moreover, pre-trial asset seizure is a widely and successfully used technique in combating organised crime, and asset seizures now generate more tha $1bn a year for the US government. However, there has not been a single Rico prosecution related to the financial crisis, nor has a single Rico restraining order been issued to seize the assets of any individual banker or any firm.
It is important to note here that these asset seizures would not merely represent justice for offenders but for victims as well. US law allows seized assets to be used to compensate victims. In this case, the potential economic impact of seizures could be enormous.
Finally, personal conduct subject to criminal prosecution might range from possession and use of drugs, such as marijuana and cocaine, to hiring of prostitutes, employment of prostitutes for business purposes, fraudulent billing of personal or illegal services as business expenses (sexual services, strip club and nightclub patronage), fraudulent use or misappropriation of corporate assets or services for personal use (eg use of corporate jets), personal tax evasion and a variety of other offences.
I should perhaps make clear here that I'm not enthusiastic about prosecuting people for possession or use of marijuana, which I think should be legal. In general, I tend to think that anything done by two healthy consenting adults, including sex for pay, should be legal as well.
But the circumstances here are not ordinary. First, there is once again a vast disparity between the treatment of ordinary people and investment bankers. Every year, about 50,000 people are arrested in New York City for possession of marijuana – most of them ordinary people, not criminals, whose only offence was to accidentally end up within the orbit of a police officer. Not a single one of them is ever named Jimmy Cayne, despite the fact that the marijuana habit of the former CEO of Bear Stearns has been discussed multiple times in the national media (his predecessor in the job, Ace Greenberg, called him a "dope-smoking megalomaniac").
There is also a second, even more serious, point about this. If the supposed reason for failure to prosecute is the difficulty of making cases, then there is an awfully easy way to get a lot of bankers to talk. It is a technique used routinely in organised crime cases. What is this, if not organised?
As time passes, criminal prosecution of bubble-era frauds will become even more difficult, even impossible, because the statute of limitations for many of these crimes is short – three to five years. So an immense opportunity for both justice and public education will soon be lost. In some circumstances, cases can be opened or reopened after the statute of limitations has expired, if new evidence appears; but finding new evidence will grow more difficult with time as well. And there is no sign whatsoever that the Obama administration is interested.
Heist of the century: university corruption and the financial crisis
Why was the response from US academic experts to the global financial crisis so muted? In the second extract from his book Inside Job, Charles Ferguson argues that corruption in universities is deeply entrenched
Many people who saw my documentary Inside Job found that the most disturbing portion of the film was its revelation of widespread conflicts of interest in universities, at thinktanks, and among academic experts. Viewers who watched my interviews with eminent professors were stunned at what came out of their mouths.
Yet we should not be surprised. Over the past couple of decades medical professionals have amply demonstrated the influence money can have in a supposedly objective, scientific field. In general, medical schools and journals have responded well, adopting disclosure requirements. The economics discipline, business schools, law schools and political science schools have reacted very differently.
Over the past 30 years, significant portions of American academia have deteriorated into "pay to play" activities. These days, if you see a famous economics professor testify in Congress, or write an article, there is a good chance he or she is being paid by someone with a big stake in what's being debated. Most of the time, these professors do not disclose these conflicts of interest, and most of the time their universities look the other way.
Half a dozen consulting firms, several speakers' bureaus and various industry lobbying groups maintain large networks of academics for hire for the purpose of advocating industry interests in policy and regulatory debates. The principal industries involved are energy, telecommunications, healthcare, agribusiness – and, most definitely, financial services.
Some examples. Glenn Hubbard became dean of Columbia Business School in 2004, shortly after leaving the George W Bush administration. Much of his academic work has been focused on tax policy. A fair summary is that he has never seen a tax he would like. In November 2004 Hubbard co-authored an astonishing article, jointly with William C Dudley, then chief economist at Goldman Sachs. The article, How Capital Markets Enhance Economic Performance and Facilitate Job Creation, warrants quotation. Remember, this is November 2004, with the bubble well under way: "The capital markets have helped make the housing market less volatile ... 'Credit crunches' of the sort that periodically shut off the supply of funds to home buyers … are a thing of the past."
Hubbard refused to say whether he was paid to write the article. He also refused to provide me with his most recent government financial disclosure form, which we could not obtain otherwise because the White House had destroyed it. Hubbard was paid $100,000 (£63,000) to testify for the criminal defence of two Bear Stearns hedge fund managers prosecuted in connection with the bubble, who were acquitted. Last year, Hubbard became a senior economic adviser to Mitt Romney's presidential campaign.
Larry Summers has held almost every important government position in economics. Treasury secretary under President Clinton, in 2009 he became director of the National Economic Council in the Obama administration.
Although sensible about many issues, Summers has made a succession of well-documented mistakes and compromises. And his views on the financial sector would be hard to distinguish from those of, say, [Goldman Sachs chief] Lloyd Blankfein or [JP Morgan boss] Jamie Dimon.
Most of our information about Summers comes from his mandatory government disclosure form. Summers' 2009 disclosure form stated his net worth to be $17m-$39m. His total earnings in the year prior to joining the government were almost $8m. Goldman Sachs paid him $135,000 for one speech.
Summers is a compromised man who owes most of his fortune and much of his political success to the financial services industry, and who was involved in some of the most disastrous economic policy decisions of the past half century. In the Obama administration, Summers opposed strong measures to sanction bankers or curtail their income.
Harvard still does not require Summers to disclose his financial-sector involvements. Both Harvard and Summers declined my requests for information.
The problem of academic corruption is now so deeply entrenched that these disciplines, and leading universities, are severely compromised, and anyone considering bucking the trend would rationally be very scared. Consider this situation: you're a PhD student, or a junior faculty member, considering doing some research on, say, compensation structures on risk-taking in financial services, or the potential impact of public disclosure requirements on the market for credit default swaps. The president of your university is … Larry Summers.
The chairman of your department is …Glenn Hubbard. Or you're at MIT, and you want to examine the decline in corporate tax payments. The president of MIT is Susan Hockfield, on the board of GE, a company that has managed to avoid paying hardly any corporate taxes for several years.
How much do these forces actually affect academic research and policymaking? The available evidence suggests that the effect is large
Academic commentary on the financial crisis by economists has been remarkably muted. There are, to be sure, some notable exceptions. But for the most part, the silence has been deafening. How can an entire industry come to be structured such that employees are encouraged to loot and destroy their own firms? Why did deregulation and economic theory fail so spectacularly?
The release of the film Inside Job clearly touched a nerve with regard to these questions. I was contacted by a large number of students and faculty, and there has been a great deal of debate. Departments including the Columbia Business School have adopted disclosure requirements for the first time. But most universities still have no such requirements, and few if any have any limitations on the existence of conflicts of interest. The same is true of most academic publications. Newspaper reporters are strictly prohibited from accepting money from any industry or organisation they write about.
Not so in academia.
There has been one significant positive development. Earlier this year, the American Economics Association adopted a disclosure requirement for the seven journals it publishes. But most institutions continue to oppose further disclosure and, when I was making my film, refused even to discuss the subject.
Re: Heist of the Century
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Re: Heist of the Century
you bumped this to the first page to say that?
Re: Heist of the Century
"too long" for the "too stupid" .. nice article. thanks
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Re: Heist of the Century
I lifted a pen off a waiter last night, that was a pretty good haul also.
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