The Shadow Justice System
It’s the ten year anniversary of the financial crisis, and the headlines are full of questions about the bailout, about the failure to save Lehman Brothers, about the lack of criminal prosecutions. The passage of a decade hasn’t changed the debates. The mood of the nation is still sour.
A big part of the problem is what I call the “shadow justice system”—the system by which big corporations are able to work out settlements with the Justice Department behind closed doors, leaving the public clueless as to what actually transpired. According to a remarkable tally by the Wall Street Journal, the big banks have paid $110 billion in mortgage-related fines, many stemming from the Justice Department’s investigations. These sums, of course, were paid by shareholders, not by executives. Which is bad. But the truly pernicious part is the private nature of the deals that were struck in cases where the public surely had a right to know what happened.
Some of what seemed to be the clearest cases of securities fraud emanating from the crisis were Wall Street’s purchases, and subsequent packaging into securities, of subprime mortgages that didn’t meet their own standards. Back in 2010, investigators for the Financial Crisis Inquiry Comission found that a firm called Clayton Holdings, which was hired by Wall Street firms to examine the mortgages they purchased, had examined almost a million mortgages and found that almost 30% failed to meet the underwriting standards that had been set, like the amount of money the borrower had put down. And yet, Wall Street waived almost 40% of those questionable loans, sticking them into securities anyway.
As the FCIC wrote, “The prospectuses and other offering materials used in connection [sic] the sale of residential mortgage backed securities in a substantial number of offerings between 2006 and 2007 (and maybe before), may have contained false statements and omissions relating to disclosures about the credit risks and origination standards of the underlying mortgage loans.” Hello, securities fraud! Or so it seems.
The settlements offer no clarity. In fact, a close look at the little that is public reveals…well, nothing. Take a look the statement of facts that accompanied Morgan Stanley’s early 2016 $2.6 billion settlement. Morgan Stanley “did not disclose to securitization investors that employees of Morgan Stanley received information that, in certain instances, loans that did not comply with underwriting guidelines and lacked adequate compensating factors and/or had understated loan to value ratios were included in the RMBS sold and marketed to investors,” it reads.
There is not a single name in the entire statement of facts—which, come to think of it, is not so much a “statement of facts” as it is a document that is negotiated to be as anodyne as possible.
Criminal law can be very different from moral wrongdoing. It’s possible that despite the incendiary language in the accompanying press release—including that Morgan Stanley made “false promises” that “helped bring about the most devastating financial crisis in our lifetime”—those unnamed employees’ behavior didn’t violate securities laws. Indeed, the Justice Department also wrote, “The United States believes that there is an evidentiary basis to compromise potential legal claims by the United States against Morgan Stanley for violations of federal laws in connection with the packaging, marketing, sale, structuring, arrangement and issuance of these RMBS.” Translation: Justice wasn’t sure that a case against Morgan Stanley was winnable.
But what was that “evidentiary basis?”
It’s unclear if Morgan Stanley’s employees were able to evade justice by having shareholders pay out money—or if the government extorted money from Morgan Stanley when no crime was actually committed.
That’s true of all of the bank settlements.
And so, the rest of us—the public, whose money paid for the bailout, and whose lives have been changed by the crisis—are left with no real answers. No wonder the mood is still sour. In the end, I don’t think a shadow justice system did anyone, including the banks, any favors.
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