David Zaring is assistant professor of legal studies at the Wharton School of Business.
Two of the three branches of government have responded to the financial crisis, but we are only beginning to hear from the third one. As the executive branch, the White House and the Treasury Department organized bailouts of auto makers, money market funds and most of the large banks in the country. Congress passed a rescue and stimulus statute in the thick of the crisis, and the Dodd-Frank Act after it.
But the courts have been, until recently, almost totally silent. Part of that silence is structural; we may not hear the Supreme Court opine on any aspect of it for years, given the complexities of its appellate jurisdiction. And part of it â€" the part that the lower courts are beginning to play only now â€" is uneven.
Courts are supposed to put the policies of presidents and Congress to the test of judicial review, to evaluate decisions by the executive to sancti on someone for wrongdoing and to resolve disputes between private parties. But the really sweeping programs that Congress and the president put in place during the financial crisis will not receive much courtroom attention at all, even as the executive's individual enforcement decisions receive scrutiny. It is only in private disputes that the facts of the financial crisis will get a judicial airing â€" and even then, all signs point to the airing being a modest one.
The courts have played such a low-key role for three reasons: the government has rarely been challenged for its own crisis-related conduct; at the same time, the Justice Department and other federal agencies have hesitated to prosecute the financial executives in place during the crisis; finally, private litigation over losses sustained during the crisis has been slow to develop, and quick to settle. In all, it is likely to be a disappointment to those who believe that the blame for the financial cris is can only really be apportioned through verdicts and judgments.
The government's own conduct is beginning to get a bit of glancing scrutiny from the courts, albeit largely through nontraditional means. The government is defending its bailouts of the American International Group, General Motors and Chrysler against shareholders or franchisees who argue that their property was taken in the restructurings, and it faced a smidgen of litigation during those bankruptcy proceedings. It is also facing a long-shot challenge from conservative activists over the constitutionality of Dodd-Frank.
The Dodd-Frank challenge singles out the Consumer Financial Protection Board and the Financial Stability Oversight Council, in both cases arguing that the new entities violate principles of separation of power by being (in the case of the Consumer Financial Protection Board, too insulated from presidential supervision; and in the case of the Financial Stability Oversight Council, too insulated from judicial review). Separation-of-powers cases are easy to understand, but hard to win, especially in light of various procedural hurdles that face litigants worried about agencies that have not taken many concrete actions yet.
The cases that were in response to the bailouts, which are known as takings cases, are interesting because the shareholders of A.I.G., led by the former chief ex ecutive, Maurice R. Greenberg, and the various auto dealers are essentially arguing that their property was taken without process (and the bailouts were, in fact, orchestrated very quickly), leaving them disproportionately on the hook for government action that should have been borne more equally by taxpayers. The trick in these cases will be pinning the taking on the government, rather than on the boards of the bailed-out firms, which agreed, at arm's length, to restructure their corporate arrangements in exchange for the infusion of cash. That looks less like eminent domain and more like vulture investing, but these cases have met with some early favor in the courts.
But generally, this sort of litigation has been minimal. The stimulus package has received no judicial review, the various takeovers engineered by the government were not subject to any of the Delaware Chancery Court suits that we usually see in the wake of a controversial merger, and the bailouts are being contested creatively, rather than through traditional means, like the Administrative Procedure Act, which is the usual way that government action is evaluated by the courts.
Ever since the acquittal of the failed Bear Stearns hedge fund managers, Ralph Cioffi and Matthew Tannin, for criminal fraud, the president's prosecutors have been remarkably reluctant to go after Wall Street denizens for financial crisi s excesses in court. They have passed on prosecutions of subprime mortgage bundlers par excellence like Angelo R. Mozilo of Countrywide Financial, structured product sellers like the Goldman Sachs trader Fabrice Tourre and almost everyone else.
Even civil efforts to single out executives have gone poorly. A Citigroup executive, Brian Stoker, was cleared of his role in selling a complicated $1 billion mortgage fund deal. The Securities and Exchange Commission‘s fraud case against the Bent family, which was be hind the Reserve Primary Fund that broke the buck, ended up in personal victories for the Bents.
There are a variety of explanations for the frankly surprising dearth of individual penalties imposed in the aftermath of this crisis. During the savings-and-loan crisis of the 1980s, hundreds of financial executives were convicted of crimes. And in the wake of the dot-com collapse, more than 1,000 were. But the inability of the government to convince juries that the desperate e fforts of executives to persuade investors that things were under control in the depths of the crisis amounted to wrongdoing has perhaps played the most important part.
Individual responsibility has not yet been apportioned in court, but the government has recently gotten to work after a lengthy period of quiet. The government supervisor overseeing Fannie Mae and Freddie Mac has sued almost 20 banks for making false representations in the products sold to the housing giants. Wells Fargo and other banks have been sued for the mortgages insured by the Federal Housing Authority under the Federal False Claims Act. JPMorgan Chase and Bear Stearns have been sued by the New York attorney general for failing to inspect the quality of the mortgages they put in mortgage-related products, which were then sold to investors.
These suits have relied on a mix of statutes; they notably do not all turn on violations of the securities laws. With various agencies in action, and various bases for litigation, the best way to characterize the government's civil enforcement strategy w ould be as a diversified portfolio.
In many ways, this modest turn to the courts is underwhelming. Practicing finance during a recession should not necessarily be a criminal offense, but holding no executives responsible for the actions that led to the housing market collapse, after hundreds were imprisoned during earlier downturns, suggests arbitrariness. Even worse, it sets a different standard for Wall Street financiers of today and the bankers who went to jail in the wake of the 1980s bailout of the thrifts.
And while the government has been criticized for not holding individuals accountable for the crisis, the really huge decisions it made â€" on whom to bail out, and how to stimulate the economy â€" will be subject to little judicial oversight. Even though those are precisely the kinds of decisions for which a second look might be helpful.
Instead, much of the judicial action will consist of suits between private parties. Many of these disputes are securities class action lawsuits against the financial institutions that originated mortgages that became toxic securities, or the monolines and banks that facilitated their packaging and resale. Kevin LaCroix's D&O Diary blog has already compiled a list of 55 settlements of these class actions, some of which have been settled, including Countrywide Financial's $624 million agreement. Approximately twice as many such suits have been dismissed, but many more are pending.
Some shareholders have also sued companies like A.I.G., Bear Stearns and Merrill Lynch, thus far with little success. And a number of pension plan beneficiaries have sued financial institutions who have such plans for imprudent investments; Merrill Lynch and Countrywide have settled lawsuits on these grounds already. Add to that a few breach of contract suits, and you have a civil docket that will keep many lawyers busy for a long time â€" even if it doesn't amount to the flood of litigation that one sees from, say, a man-made disaster like the Gulf oil spill.
But there is a cost to delegating responsibility in the financial crisis to the private sector. If the courts are focused on the resolution of disputes between private parties, we are likely to see settlements instead of sweeping opinions on the legality of what the banks did during and before the crisis, and what the government did to mitigate it.
We may be waiting for a long time before the courts say anything definitive about the crisis.
