Big Banks Go Wrong, but Pay a Little Price

Are banks too big to jail

If there was any doubt about the answer to that question, Eric Holder, the nation’s attorney general, last week blurted out what we’ve all known to be true but few inside the Obama administration have said aloud: Yes, they are.

“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute â€" if we do bring a criminal charge â€" it will have a negative impact on the national economy, perhaps even the world economy,” Mr. Holder told the Senate Judiciary Committee. “I think that is a function of the fact that some of these institutions have become too large.”

Mr. Holder continued, acknowledging that the size of banks “has an inhibiting influence” He said that it affects “our ability to bring resolutions that I think would be more appropriate.”

In other words, Mr. Holder said, for the first time, that he has not pursued prosecutions of big banks out of fear that an indictment could jeopardize the financial system.

Mr. Holder’s comment raises all sorts of questions. Does this mean that our banks are still too big to fail Should we prosecute corporations Should the size of an institution or its systemic importance influence the decision of prosecutors What’s the right policy

At a minimum, Mr. Holder’s comments are embarrassingly at odds with the Obama administration’s view that too-big-to-fail was fixed by the Dodd-Frank financial regulation law.
Here’s Timothy Geithner, the former Treasury secretary, with the administration’s official line at a hearing in 2010 right before the Dodd-Frank bill passed: “The reforms will end too-big-to-fail,” he said unequivocally. “The federal government will have the authority to close large failing financial firms in an orderly and fair way, without putting taxpayers and the economy at risk.”

Apparently, Mr. Holder didn’t get the memo.

As you can imagine, both the left and the right made hay of Mr. Holder’s statement, using it as a damning explanation for the lack of prosecutions of Wall Street. Senator Elizabeth Warren led the charge.

“It has been almost five years since the financial crisis, but the big banks are still too big to fail,” Ms. Warren, a Democrat, said in a statement. “Attorney General Holder’s testimony that the biggest banks are too-big-to-jail shows once again that it is past  time to end too-big-to-fail.”

Putting aside the important matter of whether our banks are too big to fail, there is a more pressing and difficult question that needs to be answered here and now: Do we want to indict corporations And is it effective

In the aftermath of the financial crisis, the prevailing view is that nobody on Wall Street was held accountable for the damage caused to the economy and millions of Americans. But the fact that prosecutors have not claimed a big-time scalp in the financial crisis obscures the issue of pros! ecuting c! ompanies themselves and the complications such prosecutions raise.

Forgotten is the lesson of Arthur Andersen, the accounting firm that was charged with obstruction of justice in the bankruptcy of Enron. The charges against the firm put it out of business, and 28,000 employees â€" most of whom had nothing to do with the Enron case or the shredding of documents â€" lost their jobs. Making matters worse, the conviction of Arthur Andersen was overruled on appeal by the Supreme Court. Prosecutors decided not to pursue the case.

Ever since then, the Justice Department has been much more cognizant of the collateral damage of bringing a criminal case against a company â€" as opposed to prosecuting the individual employees responsible for the crime.

According to Justice Department guidelines, before bringing a criminal case, prosecutors must consder “the nature and seriousness of the offense, including the risk of harm to the public, and applicable policies and priorities, if any, governing the prosecution of corporations for particular categories of crime.”

The conventional wisdom is that simply charging a company with a crime raises the possibility of putting the firm out of business because customers, suppliers, counterparties and others will stop doing business with it. That is debatable, but it is a view that has been widely adopted by prosecutors.

In truth, our banks aren’t the only companies that are too big to jail. If any of the largest employers in the country were to be indicted, what would happen The government could clamp down with new controls on operations. But it is also possible that charges could bring down the companies, leaving huge job losses in their wake, and harming shareholders, pensioners and suppliers.

“There is something fundamentally wrong about condemnation of one person for the actio! ns of ano! ther, and if this is true for individuals, it is at least somewhat true when corporations, consisting of many component parts, are blamed for the actions of one component part,” Elizabeth K. Ainslie, a former prosecutor, wrote in a seminal paper called “Indicting Corporations Revisited: Lesson of the Arthur Andersen Prosecution.”

But what about the deterrence effect Doesn’t charging an entire company with a crime make employees less likely to engage in criminal behavior

“On balance, the public benefits generated by prosecuting Andersen criminally were minimal or, if they existed at all, were exceedingly subtle. No one went to jail as a result of its conviction, nor could they have under the law,” Ms. Ainslie wrote.

That’s not to say the government shouldn€™t pursue prosecutions of criminal conduct at corporations. They should do so aggressively.

But there is a powerful argument to be made that prosecutors should focus on the individuals responsible for the misconduct.

If prosecutors had already claimed a prominent scalp from the financial crisis, there wouldn’t be such a loud conversation about too-big-to-jail.