The trouble is that we don’t enforce the laws that we have. The only high-profile federal prosecution to emerge from the 2008 crisis was directed at the managers of the Bear Stearns mortgage hedge fund whose failure in June 2007 heralded the crisis. Bear was a scrappy, entrepreneurial, and Republican shop that forgot the advice of its long-time CEO Ace Greenberg: “Don’t mistake your own body odor for perfume.” I knew the managers of the fund (I worked at Bear 1993-1996), and I also knew that they and a lot of Bear Stearns top managers had their own money in the fund, and lost it. They were guilty of the belief that the housing bubble wouldn’t pop, and nothing more, and a jury rightly acquitted them. By contrast, Corzine’s MF Global appears to have stolen customer money outright.
In my “Spengler” essay at Asia Times Online last week, I recount some personal encounters with dodgy business on Wall Street. Recently a distinguished jurist asked me, “How is it possible that the financial industry — the smartest guys out there — did so many stupid things?” In fact, the financial industry is full of people who know perfectly well that they are mediocre, but who nonetheless want to make a great deal of money. So they cheat. The 2008 crisis spiraled out of control because every level of the investment banks lied to every other level about the extent of the contingent liabilities they had accumulated in order to raise their current fee income. When Lehman hit the rocks in September 2008, its chairman Dick Fuld had no idea of the true extent of the firm’s liabilities. (That, by the way, is why the so-called European financial crisis is not really a crisis, but a negotiation. Everybody knows where the bodies are buried. The only question is who will suffer: German taxpayers, Italian pensioners, bank bondholders, and so forth).
For that matter, I am still amazed that the ratings agencies were never dinged for their role in the crisis. (Actually, I’m not amazed. The powers that be fear that if the ratings agencies are discredited, a shock-wave of risk aversion would roll through the markets.) As I wrote in the cited Asia Times piece:
The ratings agencies became the arbiters of risk not because they had good models (they did not) or because they employed particularly skilled analysts, but because they were eminently corruptible. In October 2008, congressional investigators found e-mails from Moody’s credit analysts warning management that they had “sold our soul to the devil for revenue”.
For every Collateralized Debt Obligations, Moody’s and Standard and Poor’s received a fee in the low six figures, and these fees made up the bulk of their revenues. They acted as a adjunct to the investment banks’ structuring teams, advising them on the best way to game their own models.
Why hasn’t the government prosecuted the rating agencies for fraud? Incredibly, the ratings agencies take the position that their ratings are “opinions” with the same legal status as a newspaper editorial. Newspaper editorialists, though, don’t take money from big advertisers for endorsing their products.
MF Global’s problem — presuming that customer money really was lost in proprietary trading — is much simpler. The technical term is “theft.” Breaking the wall that separates customer money from the firm’s money is like rape: it’s hard to argue that you did it by accident. There is no way that senior management could not have known that customer money was being misappropriated. When the management bet the firm on Italian bonds, it counted every penny of collateral it had to put up for margin. That’s what trading desks do, every day, all day. Hundreds of millions of dollars were stolen, including my residual pittance. What did Corzine know, and when did he know it? Corzine ran a trading desk. He’s a punter; that’s one of the reasons he got the boot from Goldman Sachs. People who run trading desks obsessively watch a spreadsheet that tells them exactly how much cash they have as margin against levered trades, and where the cash comes from. There is simply no way that someone in senior management could NOT have known that hundreds of millions of dollars materializing ex nihilo in the cash column came from customer accounts. Corzine has lawyered up and isn’t talking.
Regulators reportedly are conducting an audit of every futures trading firm to determine whether they are improperly mingling customer money with their own. The impact of MF Global on entrepreneurs in the financial industry is chilling: if a firm run by the former CEO of Goldman Sachs can make off with customer money, whom can you trust? The new set of protections introduced by Dodd-Frank would NOT have protected MF Global’s customers against theft by the firm, as the Financial Times’ Alphaville blog reports today. Passing new laws doesn’t eliminate criminals. The constable and the jailer eliminate criminals.
I have not a modicum of sympathy for the unwashed waste-heads of the Occupy Wall Street movement. But I’m for enforcement of the law, of which we already have many good ones, for example, against stealing. Let the chips fall where they may. Especially on Democrats.