By James Saft
March 8 Now that it is official that the U.S.
Justice Department pulls its punches when it comes to
prosecuting the largest banks, it is time for investors to
understand why they, too, are the losers.
Attorney General Eric Holder came right out this week and
told the Senate Judiciary Committee what many observers have
long suspected - that his department has refrained from more
aggressive criminal prosecutions of the so-called
too-big-to-fail banks, exactly because of their special status.
"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 bring a criminal charge, it will have a negative impact on
the national economy, perhaps even the world economy," Holder
said on Tuesday. "I think that is a function of the fact that
some of these institutions have become too large."
Lawmakers have expressed surprise that no corporate or
personal criminal prosecutions emerged from the HSBC Holdings
Plc case, in which the bank was fined $1.9 billion over
money laundering, including money from Mexican and Colombian
Justice Department officials also cited economic stability
concerns in December when announcing a $1.5 billion fine, but no
criminal charges, against UBS AG, in a multiyear
scheme to manipulate Libor and other benchmark interest rates.
In short, we have the top law enforcement official in the
United States admitting that if a bank is big enough and
systematically important enough, it will not be subject to the
same laws as the rest of us.
First of all, it is Holder's job to enforce all laws - not
just the ones that he thinks are consistent with financial
Secondly, he is almost certainly dead wrong that slamming
a too-big-to-fail bank with a criminal prosecution would hurt
the global economy. Indeed, it is quite the reverse.
The too-big-to-fail (TBTF) and too-big-to-jail status serves
as a tax on the rest of us - everyone who uses a bank, invests
in a bank, or invests in a company that uses banks, suffers.
Many investors commit funds to the too-big-to-fail banks
because they figure their investments will benefit from the
special status they enjoy. What, they reason, is not to like
about a bank with implicit government backing and which, if it
is caught with its hand in the cookie jar, won't pay the full
A look at the funding costs of the biggest banks, estimated
in an IMF paper at 0.8 percent lower annually than the rest of
the market, reveals that investors are indeed putting their
money behind TBTF banks.
For investors, there is no getting on the right side of this
kind of wrongdoing as the very poor share performance of the
TBTF banks over the past decade amply demonstrates.
Lots of people were getting rich off of Citigroup, for
example, but they weren't the widows and orphans with Citi
shares in their mutual funds; they were employees who took big
risks, took home big rewards and didn't have to stand good for
the mess they made.
The strength of the rule of law has to be one of the biggest
protections for shareholders, and whatever weakens it threatens
them. A country with lawless and entitled large banks is a
country which will have lower structural growth and worse
investment returns. Sound familiar?
Money will be badly allocated, both because TBTF banks will
have an incentive to make financial products as complex as
possible, and because bank employees will game the system to
their own advantage. Heard this story before?
Imagine for a moment that a certain class of large hospital
got a big subsidy, like the banks in funding, but couldn't be
sued for malpractice. What do you imagine the impact on
healthcare would be?
Looked at from ground level, this is going to sting
investors even if they try to take advantage of TBTF banks'
TBTF bank employees will have even more incentive than
before the crisis to take on too much risk and to flout the law.
After all, they will continue to pocket huge sums and the most
they can lose is their job rather than their liberty.
Senior managers, whatever they say, have less reason to
control their subordinates, and given the short shelf life of so
many banking careers, that much more incentive to make coin
while times are good. Money will flow into and out of the
largest banks, but very little of it will be captured by those
actually footing the bill.
While Holder was right in calling for better measures to end
too-big-to-fail, he was dead wrong in his calculations of the
costs of the matter. We are all paying, every day.