Too big to jail

The Global Financial Crisis, in my view, was caused by a combination of a few factors.

First, complacency – a long period of relatively stable macroeconomic conditions in advanced economies led investors, regulators and others to underestimate low probability but high impact events – what is known as disaster myopia.

Second, poor supervision by regulators (who were also caught up in complacency and who did not use the tools they had on hand) and a lack of understanding of complex financial instruments (to be fair, it seems that the management of some of the banks didn’t understand the risks associated with such instruments either).

Third, and perhaps most importantly, extreme moral hazard and the  socialising of losses from financial institutions that were bailed out. Unfortunately, the reaction of authorities to the GFC has actually increased moral hazard, and this is demonstrated starkly by the most recent settlements involving HSBC and Standard Charter. Instead of allowing the crisis to resolve itself, a huge scare campaign was mounted by vested interests who argued and persuaded governments that they could not be allowed to fail – they were ‘too big to fail’. There is not a shred of evidence to support this contention. In their efforts to prevent a crisis, the authorities have unwittingly spread the seeds for the next mega crisis. (As an aside, I think it is better to allow the odd crisis to hit an economy – a few small crises can prevent a megacrisis. The goal of authorities of ensuring stability – at any cost – has actually led to the creation of a system where it is more likely to be hit by far larger magnitude crises, even if less frequently).

Now we find that HSBC and Standard Charter have reached settlements with the US Department of Justice over money laundering involving substantial transactions with drug cartels and other criminal organisations (including terrorist organisations). HSBC has agreed to pay $US 1.921 billion and Standard Charter $US 667 million. In return, there will be no criminal prosecutions. In other words, the shareholders will pay for the misdeeds of the executives and staff involved who bear no consequence for their actions.

I think Matt Taibbi is spot on in condemning the DOJ’s settlement. Apparently the argument the DOJ is spreading is that the bank (HSBC) would lose its license and people would lose their jobs had they pursued criminal charges. This is from a country that is quite happy to throw numerous people into jail for drug trafficking, yet the HSBC executives get off without consequence, even though the bank has admitted to laundering billions of dollars for Colombian and Mexican drug cartels. Assistant Attorney-General Lanny Breuer said that drug dealers would go into HSBC’s Mexican branches to

deposit hundreds of thousands of dollars in cash, in a single day, into a single account, using boxes designed to fit the precise dimensions of the teller windows

As Taibbi states

This bears repeating: in order to more efficiently move as much illegal money as possible into the “legitimate” banking institution HSBC, drug dealers specifically designed boxes to fit through the bank’s teller windows. Tony Montana’s henchmen marching dufflebags of cash into the fictional “American City Bank” in Miami was actually more subtle than what the cartels were doing when they washed their cash through one of Britain’s most storied financial institutions.

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It doesn’t take a genius to see that the reasoning here is beyond flawed. When you decide not to prosecute bankers for billion-dollar crimes connected to drug-dealing and terrorism (some of HSBC’s Saudi and Bangladeshi clients had terrorist ties, according to a Senate investigation), it doesn’t protect the banking system, it does exactly the opposite. It terrifies investors and depositors everywhere, leaving them with the clear impression that even the most “reputable” banks may in fact be captured institutions whose senior executives are in the employ of (this can’t be repeated often enough) murderers and terrorists. Even more shocking, the Justice Department’s response to learning about all of this was to do exactly the same thing that the HSBC executives did in the first place to get themselves in trouble – they took money to look the other way.

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So you might ask, what’s the appropriate financial penalty for a bank in HSBC’s position? Exactly how much money should one extract from a firm that has been shamelessly profiting from business with criminals for years and years? Remember, we’re talking about a company that has admitted to a smorgasbord of serious banking crimes. If you’re the prosecutor, you’ve got this bank by the balls. So how much money should you take?

How about all of it? How about every last dollar the bank has made since it started its illegal activity? How about you dive into every bank account of every single executive involved in this mess and take every last bonus dollar they’ve ever earned? Then take their houses, their cars, the paintings they bought at Sotheby’s auctions, the clothes in their closets, the loose change in the jars on their kitchen counters, every last freaking thing. Take it all and don’t think twice. And then throw them in jail.

Sound harsh? It does, doesn’t it? The only problem is, that’s exactly what the government does just about every day to ordinary people involved in ordinary drug cases.

The settlement is an outrage, and shows that, in the US at least, there is a two-tiered justice system. One of the most important precepts of the legal system is that all should be equal under the law. The US Department of Justice has failed to honour its obligations under the US Constitution.