When I started reading Charles Ferguson’s Predator Nation, a thorough indictment against the financial industry, his repeated use of “criminal” to describe financial industry executives seemed to be just blowing smoke, in view of the government’s lack of successful prosecutions.
That was, until I read the federal rule that Ferguson finally cites on page 190 of his book (after “criminal” has already been used 68 times).
The rule, from the 1934 Securities Exchange Act, reads:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
© To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
Who really believes there has not been “any act, practice, or course of business” that operated “as a fraud or deceit upon any person, in connection with the purchase or sale of any security”?
For example, Goldman Sachs aggressively sold its clients bundled bad debt while successfully betting against that debt themselves, without openly disclosing the company’s role or its opinion about the quality of the product it was selling. Was this not a conflict of interest, covered by the law?
Do we really believe Goldman CEO Lloyd Blankfein when he says that these actions did not pose a conflict of interest “In the context of market making”? Do we really believe that the conflicted party did not omit “to state a material fact” by failing to disclose the conflict, and that a “fraud or deceit” was not committed?
I do not believe it, and I think most people don’t believe it.
Why, then, have we become resigned to assuming that the cynical derring-dos of the financial industry were not, strictly speaking, crimes?
Charles Ferguson has convinced me that a reading of the law says they are crimes. It’s about time someone said so, loudly and plainly.
That, exactly, is Ferguson’s intention.
The remarkable Dr. Ferguson
Charles Ferguson has reached peaks of achievement in several seemingly unrelated fields. He earned a Ph.D. in political science from MIT, following which he was a high-level consultant to the government and technology corporations. Then he formed a company in 1994, Vermeer Technologies, to create a website development tool called FrontPage for the emerging Internet. The company sold to Microsoft in 1996, and Ferguson went back to writing and lecturing at MIT, Berkeley and the Brookings Institution in Washington, D.C.
With no background in filmmaking, Ferguson decided to make the movie No End in Sight about the botched U.S. occupation of Iraq after 2003. The movie was nominated for the Academy Award for best documentary in 2008. Then he made his documentary about the financial crisis, Inside Job, which won the Academy Award in 2010 (I previously reviewed the movie for Advisor Perspectives).
An anti-crony among cronies
Ferguson is very much a member of the intellectual policy elite. In general, such people don’t speak ill of their fellows, or at least they soften or intellectualize their critiques. Ferguson does not do so. Early in the book, he announces his intentions:
I will be saying some rather strong things— things like, these people should be in jail, they should have their wealth taken from them and given to people whose lives they destroyed, they should live in disgrace for the rest of their lives, it is shocking that they have not been prosecuted, and it is obscene and dangerous that they still occupy prominent positions in government, universities, companies, and civic institutions.
He says of Lawrence Summers, who was Director of the National Economic Council under President Obama, President of Harvard University, and Secretary of the Treasury under President Bill Clinton: “Summers is a deeply compromised man who owes most of his fortune and much of his political success to the financial services industry, and who was instrumental in some of the most disastrous economic policy decisions of the last half century.”
Ferguson also criticizes John Thain, who was CEO of the New York Stock Exchange, president of Goldman Sachs, and CEO of Merrill Lynch in 2007 as the financial crisis began to hit. Thain remained at Merrill until it was caught holding too many of the collateralized debt obligations it had created. The company had to be sold to Bank of America. Ferguson says: “While making my film, I spoke frequently and in detail with Thain, who agreed to talk to me on the condition that our conversations remained off the record. Without going into details, I can say that John was not big on accepting personal responsibility.”
Ferguson happens to be on the board of the French-American Foundation. The board has about 40 other members , one of which is John Thain.
I was curious how Ferguson manages his relationships with these other members of the corporate and policy elite, so I requested an interview. Ferguson cheerfully agreed, and we spoke for about 25 minutes over Skype. When I asked how he managed to do all these different things, he was rather casual about it, as if it just sort of happened. About his successful software product, FrontPage, for example, he merely said, “I got an idea.”
Ferguson is a relatively unassuming policy analyst, with a strong geekish streak that keeps him focused on honest analysis devoid of political calculation. Unsurprisingly, I learned that some people with whom he formerly had relationships now cross the street, figuratively speaking, when they see him coming. Ferguson had had a number of interactions with Larry Summers over the years, for example, but he said that Summers now avoids him.
When cronyism becomes criminal
We know from long and sad historical experience that when a crony elite takes over a country, they become corrupt – sometimes even unconsciously – and bad things happen. That is what George Orwell’s enduring parable Animal Farm is about, though it is an allegory for the onset of communism in Russia.
But some level of cronyism is unavoidable. It is embedded in homilies such as, “It’s not what you know — it’s who you know.” When does it become dangerous – or to use Ferguson’s favored term, criminal?
One example is the financial industry’s treatment of Bernard Madoff, of which too little has been said. It is well known now from a number of books that though several of the large banking firms were given the opportunity to channel Madoff funds to investors, they either declined to do so or kept their distance while partaking to some degree. Why was this so? Because they smelled a rat. Ferguson cites the comment of one executive at JPMorgan Chase’s Private Bank unit (which came out in the investigations by Irving Picard, the Madoff bankruptcy trustee) that he “never had been able to reverse engineer how [Madoff] made money.”
Some firms, nevertheless, did cynically partake – including UBS and JPMorgan Chase itself (look here for an interesting account of how they did that). Some, like Goldman Sachs, merely declined. But the belief was clearly in the wind that Madoff was running a Ponzi scheme. Why, then, didn’t these firms report their suspicions to the Securities and Exchange Commission? Why was it left to someone without the clout of a big bank, Harry Markopolos, who was then ignored by the SEC?
The answer is obvious. It’s joked that sharks won’t eat each other out of professional courtesy. Madoff was not some unknown jerk. He had been the Chairman of NASDAQ. You don’t rat on one of your own, or it will place you all in danger.
The prosecution solution
Ferguson believes that this, among many errors of commission and omission on the part of large institutions and individuals, was a prosecutable offense. Those who deliberately declined to report Madoff to the authorities were accessories to his crime.
And if this is not prosecutable, what about prosecuting for lots of other offenses? Ferguson notes that the notorious prohibition-era criminal Al Capone, who was believed responsible for a number of murders, was finally indicted and imprisoned for tax evasion.
Ferguson notes that “every year, about fifty thousand people are arrested in New York City for possession of marijuana— most of them ordinary people, not criminals… Not a single one of them is ever named Jimmy Cayne [the former CEO of Bear Stearns], despite the fact that his marijuana habit has been discussed multiple times in the national media.”
He notes furthermore that “everyone in New York knows that investment banking is probably the largest cocaine market on the planet, not to mention a pillar of the strip club and escort industries. Who did the Feds bag for hiring escorts? Eliot Spitzer [the New York State Attorney General and financial industry nemesis].”
Ferguson believes that every prosecutorial tool at our disposal should be used to indict, fine severely, and imprison these people – not just their companies, but the executives as individuals.
The Goldman defense
I’ll consider briefly what I’ll call the “Goldman defense,” which was advanced by hedge fund manager Seth Klarman, founder and president of the Baupost Group. According to an Advisor Perspectives article, Klarman “recognizes that Wall Street does not exist for his or anyone else’s benefit.”
“I know Wall Street will always try to rip our eyeballs out,” Klarman said. Consequently, he “does not expect them to act as a fiduciary in a trading relationship.” In short, when Lloyd Blankfein says “in the context of market making,” he means, “in the context of trying to rip your eyeballs out.”
This is a rather extreme version of caveat emptor – let the buyer beware. The response, I think, is simple. It’s not fair to the fireman or teacher whose life savings have been entrusted to, say, the Missouri State Employees’ Retirement System, which lost big on CDOs. It’s not only not fair but deceptive, to the point of fraud. Such a fireman was made to believe, by all the sales pitches and assurances of consultants, fund managers and fund administrators, that the funds would be managed in his best interests. He would not have been told that the managers would “try to rip his eyeballs out.” It would be as if the firefighter assured a homeowner that he would protect his home, then actually looted it. It is, at best, an omission of a material fact not to so inform the investor, or the homeowner. It is, as Ferguson argues, illegal.
Prosecution vs. reregulation
After the financial crisis, much of the criticism focused on the deregulation of the financial industry and how to prevent the next crisis through reregulation. But this line of pursuit has two problems. First, it condones the misdeeds as the product of an out-of-control industry unconstrained by proper regulation. This may be the source of the assumption that the misdeeds are not prosecutable. The second problem is that it is difficult to design the perfect regulatory framework, especially when the industry is inured to regulation and adept at finding ways around it.
How about, instead of trying to design new and better regulation, we go with the regulation we’ve got and enforce it to the hilt? Ferguson says that if we did that, we would get the culprits one way or another.
Except, of course, that they’ve got the whole regulatory system in their pockets. One thing Ferguson points out is the total corruption of the academic community from which expert witnesses can be drawn. Many academics – including people whom he criticizes explicitly and individually by name, such as Summers – slide comfortably from academia to government and financial-industry corporations. These academics participate quite profitably and rewardingly in the entire crony culture. Universities, Ferguson points out, do not require professors to disclose conflicts of interest when they write articles on industries that pay them consulting fees. By contrast, “reporters at the New York Times, Fortune, and other major news publications are strictly prohibited from accepting money from any industry or organization they write about.”
Ferguson recalls one time when he spoke with senior officials in the U.S. Justice Department about companies he believed were violating federal law.
“They told me that one significant barrier to any such action was that few if any prominent … economists would be willing to testify for the government, because nearly all of them worked for the incumbents, at pay rates typically 10- to 50-times higher than government consulting rates,” Ferguson writes.
Ferguson notes that some countries, such as Singapore, pay civil servants and regulators competitive salaries, sometimes more than $1 million annually. But would the financial lobby allow the U.S. government to pay senior civil servants enough to even begin to compete with the lure of corruption? Fat chance.
By taking no stand on deregulation and focusing only on prosecution for crimes committed under existing regulation, Ferguson can be a non-partisan critic. He complains that “Obama has brushed the mud off the same dishonest and discredited people, kept the financial sector’s privileges and incomes intact, avoided prosecution of financial crime, and done almost nothing about the foreclosure crisis… In the new Democratic Party, when President Obama hosts a White House State Dinner in January 2011 for Hu Jintao, the president of China, he invites Lloyd Blankfein and Jamie Dimon… In fact, Mr. Blankfein had visited the White House 10 times as of early 2011.”
What to do about it?
Ferguson’s book poses a convincing argument that “the United States is increasingly controlled by an amoral oligarchy that has progressively corrupted the federal government and the political system.”
I agree with Ferguson that the focus of activity – and activism – should now be on prosecution for crimes already committed. Tinkering with regulation would not be as effective as bringing down the people we think have been responsible for grave misdeeds. Imprisonment, fines and even public disgrace would be more effective in preventing further abuses than trying to come up with better or reinstated regulation.
What we really need most is more Charles Fergusons.
Michael Edesess is an accomplished mathematician and economist with experience in the investment, energy, environment and sustainable development fields. He is a senior research fellow with the Centre for Systems Informatics Engineering at City University of Hong Kong and a project consultant at the Fung Global Institute, as well as a partner and chief investment officer of Denver-based Fair Advisors. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler.
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