Settling Prosecutions For Pennies on the Dollar Is a Type of Bailout → Washingtons Blog
Settling Prosecutions For Pennies on the Dollar Is a Type of Bailout - Washingtons Blog

Friday, January 14, 2011

Settling Prosecutions For Pennies on the Dollar Is a Type of Bailout

The following is an excerpt of my much longer roundup of the many covert ways the government is bailing out the giant banks.

Fraud As a Business Model

If you stop and think for a moment, it is obvious that failing to prosecute fraud is a bailout.

Nobel prize-winning economist George Akerlof demonstrated that if big companies aren't held responsible for their actions, the government ends up bailing them out. So failure to prosecute directly leads to a bailout.

Moreover, as I noted last month:

Fraud benefits the wealthy more than the poor, because the big banks and big companies have the inside knowledge and the resources to leverage fraud into profits. Joseph Stiglitz noted in September that giants like Goldman are using their size to manipulate the market. The giants (especially Goldman Sachs) have also used high-frequency program trading (representing up to 70% of all stock trades) and high proportions of other trades as well). This not only distorts the markets, but which also lets the program trading giants take a sneak peak at what the real traders are buying and selling, and then trade on the insider information. See this, this, this, this and this.

Similarly, JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley together hold 80% of the country's derivatives risk, and 96% of the exposure to credit derivatives. They use their dominance to manipulate the market.

Fraud disproportionally benefits the big players (and helps them to become big in the first place), increasing inequality and warping the market.

[And] Professor Black says that fraud is a large part of the mechanism through which bubbles are blown.


Finally, failure to prosecute mortgage fraud is arguably worsening the housing crisis. See this and this.

The government has not only turned the other cheek, but aided and abetted the fraud. In the words of financial crime expert William K. Black, the government "created an intensely criminogenic environment".

And this environment is ongoing today. See this, for example.

Settling Prosecutions For Pennies on the Dollar

Even when the government has prosecuted financial crime (because public outrage became too big to ignore), the government has settled for pennies on the dollar.

Nobel prize winning economist Joe Stiglitz says about the way that the government is currently prosecuting financial crime:

The system is designed to actually encourage that kind of thing, even with the fines [referring to former Countrywide CEO Angelo Mozillo, who recently paid tens of millions of dollars in fines, a small fraction of what he actually earned, because he earned hundreds of millions.].


So the system is set so that even if you're caught, the penalty is just a small number relative to what you walk home with.

The fine is just a cost of doing business. It's like a parking fine. Sometimes you make a decision to park knowing that you might get a fine because going around the corner to the parking lot takes you too much time.

Bloomberg noted on Monday:

The U.S. Securities and Exchange Commission’s internal watchdog is reviewing an allegation that Robert Khuzami, the agency’s top enforcement official, gave preferential treatment to Citigroup Inc. executives in the agency’s $75 million settlement with the firm in July.

Inspector General H. David Kotz opened the probe after a request from U.S. Senator Charles Grassley, an Iowa Republican, who forwarded an unsigned letter making the allegation. Khuzami told his staff to soften claims against two executives after conferring with a lawyer representing the bank, according to the letter….

According to the letter, the SEC’s staff was prepared to file fraud claims against both individuals. Khuzami ordered his staff to drop the claims after holding a “secret conversation, without telling the staff, with a prominent defense lawyer who is a good friend” of his and “who was counsel for the company, not the individuals affected,” according to a copy of the letter reviewed by Bloomberg News.

And Freddie and Fannie's recent settlement with Bank of America - a couple of billions - has been criticized by many as being a bailout.

In "BofA Freddie Mac Putbacks Resolved for 1¢ on $", Barry Ritholtz notes:

Bank of America settled numerous claims with Fannie Mae for an astonishingly cheap rate, according to a Bloomberg report.

A premium of $1.28 billion was paid to Freddie Mac to resolve $1 billion in claims currently outstanding. But the kicker is that the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008. That amounts to 1 cent on the dollar to Freddie Mac.

In "Is Fannie bailing out the banks?", Forbes' Colin Barr writes:

Someone must be getting bailed out, right?

Why yes, say critics of the giant banks. They charge that Monday's rally-stoking mortgage-putback deal between Bank of America (BAC) and Fannie Mae and Freddie Mac is nothing more than a backdoor bailout of the nation's largest lender. It comes courtesy, they say, of an administration struggling to find a fix for the housing market while quaking at the prospect of another housing-fueled banking meltdown.

Monday's arrangement, according to this view, will keep the banks standing -- but leave taxpayers on the hook for an even bigger tab should a weak economic recovery falter. Sound familiar?


[Edward] Pinto says truly holding BofA responsible for all the mortgage mayhem tied to its 2008 purchase of subprime lender Countrywide would likely drive it into the arms of the Federal Deposit Insurance Corp., which has enough problems to deal with. Though BofA would surely dispute that analysis, it's easy enough to see where the feds don't want that outcome.


But how sharp is Freddie if all it can do is squeeze a $1.28 billion payment out of a giant customer in exchange for relinquishing fraud claims on $117 billion worth of outstanding loans? The very best its million-dollar executives can do is claw back a penny on each bubbly subprime dollar?

That seems pretty weak even given that this is Congress' favorite subsidy dispenser we're talking about.

"How Freddie can justify this decision to settle 'all outstanding and potential' claims before any of the private-label putback lawsuits have been resolved is beyond comprehension," says Rebel Cole, a real estate and finance professor at DePaul University in Chicago. "This smells to high heaven and they should be called out."

In "Bank Of America Just Admitted That Its Fannie And Freddie Settlement Was A Bailout", Business Insider's Joe Weisenthal writes:

Bank of America has basically confirmed that the critics are correct: It was the beneficiary of a bailout.

According to Bloomberg, BofA's Jerry Dubrowski said: “Our agreements with Fannie Mae and Freddie Mac are a necessary step toward the ultimate recovery of the housing market.”

Get it? This was not about settling mortgage putback exposure at the legal level. It was about helping the greater good. It's the same too-big-to-fail logic all over again: What's good for Bank of America is good for America.

As the Washington post notes:

“This is a gift” from the government to the bank, said Christopher Whalen of Institutional Risk Analytics. “We’re all paying for this because it will show up in the losses from Fannie and Freddie,” he said.
Congresswoman Waters said:

I’m concerned that the settlement between Fannie Mae, Freddie Mac and Bank of America over misrepresentations in the mortgages BofA originated may amount to a backdoor bailout that props up the bank at the expense of taxpayers. Given the strong repurchase rights built into Fannie Mae and Freddie Mac’s contracts with banks, and the recent court setback for Bank of America in similar litigation with a private insurer, I’m fearful that this settlement may have been both premature and a giveaway. The fact that Bank of America’s stock surged after this deal was announced only serves to fuel my suspicion that this settlement was merely a slap on the wrist that sets a bad example for other negotiations in the future.

And see this, this and this.


  1. Like I tell my friends, ladies and gentlemen,an infiltration of our constitutional government has occurred over the years. They allowed in the Federal Reserve which instantly started the economic bleeding and avenues for fraud.

    On 9-11-2001 they pulled a "Tet offensive only invasive" attack and followed up with the Deepwater Horizon bull-shit well blow-out with the supervisor of the deed escorted away to safety 4 days before they set it off and telling him to "take the 5th" and go free, even though Congress determined INTENT as the cause of the blow-out. This INTENT included Robert Kaluza's advisors.
    Pres. Dover's group found "no fault". Pres.Dover sure can take it.

    America is under attack and the method by which this is being done requires the reaction of a force much more strong than I (ie.,Constitutionally mandated). We can later assess and advise the American public that 'does not want get involved'.
    A certain nation has had numerous un-documented citizens found with traces of explosives on their persons and in their moving vans around the U.S. over the past 9 years. WARNING!!! Congress sucks on that nation which gets a huge amount of money from U.S. taxpayers, which is given back to these Congressional sucking things as bribes.
    No one is at war with America beyond the banksters and their soldiers. Our troops are being abused overseas no matter their personal background. We need them to clean house here at home in D.C., by backing U.S. Marshalls who by now certainly know what is up.
    To the author. Nobody "earns" $100 million in the stock market. They merely extract $100 million from the river of blood, ruin and life that flows past like setting up a net at a dam's fish-ladder. It is very insulting to actual producers. With paid-off armed game wardens in control. To hell with them.
    So lets dump the obviously rigged computer voting machines and victory in November. No more mewling and sucking in congress.

  2. People should be going to jail and are not. That is a form of "breakout".

  3. The only way to overthrow TBTF banks at this point is to overthrow the US government.


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