Where Are the Criminals?
Prosecutors keep losing their financial crisis cases in court.
A persistent media-liberal lament—make that a cliché—is that too few
financiers have been prosecuted for the financial crisis. But maybe that's
because when the Obama Administration tries to prosecute a specific individual
for a specific crime, it turns out there was no crime.
The government's latest embarrassments came this month, as one high-profile case collapsed and another was downsized by a federal judge. On November 16, the Securities and Exchange Commission dropped a civil lawsuit against Edward Steffelin. As an employee at GSC Capital, he helped create a synthetic collateralized debt obligation called Squared CDO 2007-1 that was offered by J.P. Morgan Chase JPM +2.63%. It was synthetic because although it allowed investors to bet on the subprime housing market, it involved very little ownership of actual mortgages. Anyone investing in this deal knew he was simply gambling on a continued housing boom.
The government accused Mr. Steffelin of not informing Squared purchasers that another investor in the deal, a hedge fund called Magnetar, had helped select the mortgage pools to be wagered upon while it was simultaneously shorting some of them. Mr. Steffelin argued that Magnetar did not control which assets were in the deal. He also said he had done his job by accurately describing these assets to J.P. Morgan, which as far as he knew had accurately described them to investors. These would be sophisticated institutional investors who were eager to profit from the housing mania but are now cast as victims by prosecutors.
Since the Steffelin prosecution wasn't a criminal case but a civil suit, it presented a much lower bar for prosecutors to clear. But apparently not low enough. Last year U.S. District Judge Miriam Goldman Cedarbaum threw out the SEC's fraud charges, saying that it was a "big stretch" to say that Mr. Steffelin had a fiduciary duty to investors. That left only the accusation of negligence, and Judge Cedarbaum has now allowed the SEC to dismiss its case entirely.
It's true that J.P. Morgan Chase paid $153.6 million of its shareholders' money to settle a related SEC suit for its role in this transaction. But the bank admitted no wrongdoing and sees great value in avoiding adverse publicity. The problem for the government occurs whenever it has to prove that an actual human being has done something wrong.
Memories are still fresh from the SEC's July courtroom loss to Brian Stoker, a former Citigroup C +1.67%employee. The SEC argued that Mr. Stoker had been negligent in assembling a similar mortgage CDO deal, but a jury of his peers decided that he'd broken no securities laws.
Next year will bring the civil trial of former Goldman Sachs GS -0.54%banker Fabrice Tourre, but last Monday U.S. District Judge Katherine Forrest slapped down the SEC's effort to revive a part of the case that was dismissed last year on jurisdictional grounds. So far Mr. Tourre is claiming his innocence, and our guess is that the SEC staff is terrified that "Fabulous Fab" might decide not to settle.
This political prosecution was brought at the height of the Senate debate over Dodd-Frank. Goldman settled by paying $550 million without admitting guilt in a case that also should never have been brought. (See "The SEC vs. Goldman," April 19, 2010.)
The Journal recently reported that another enforcement action against J.P. Morgan will include no charges against individuals. And on Tuesday New York Attorney General Eric Schneiderman sued Credit Suisse CSGN.VX -0.35%over still more mortgage deals, and again with no human defendants. What a concept: wrongdoing by banks that includes no wrongdoing by any bankers.
Speaking of mystery bankers, pundits on the left are now claiming that prosecutors should really be charging people who served at the top of financial firms. So prosecutors are supposed to gather more evidence against the CEO than they can against the employees who crafted the particular deals at issue?
Critics are also blaming incompetence at the SEC or the Department of Justice, as if the quality of prosecutors has suddenly deteriorated. They are no better or worse than ever. The prosecutors have simply been given a difficult assignment trying to find criminality among bankers who were doing what everyone else was doing in a financial mania fueled by government policy.
The Federal Reserve created negative real interest rates and a net subsidy for credit expansion. Washington programs to encourage every American to own a home ensured that the bubble would be concentrated in residential real estate. Government-approved credit-raters, convinced that the U.S. housing market would never suffer a sharp decline, slapped triple-A ratings on bundles of risky mortgages. Federal rules encouraged banks, money-market funds, stock brokerages and other institutions to buy this junk.
The zeal to prosecute bankers is part of the politically convenient narrative that the financial crisis was all created on Wall Street. Bankers were greedy as ever and their risk management was faulty. But the fact that Washington can't find a real criminal should focus public attention back on the real crime. That was Beltway policy.
The government's latest embarrassments came this month, as one high-profile case collapsed and another was downsized by a federal judge. On November 16, the Securities and Exchange Commission dropped a civil lawsuit against Edward Steffelin. As an employee at GSC Capital, he helped create a synthetic collateralized debt obligation called Squared CDO 2007-1 that was offered by J.P. Morgan Chase JPM +2.63%. It was synthetic because although it allowed investors to bet on the subprime housing market, it involved very little ownership of actual mortgages. Anyone investing in this deal knew he was simply gambling on a continued housing boom.
The government accused Mr. Steffelin of not informing Squared purchasers that another investor in the deal, a hedge fund called Magnetar, had helped select the mortgage pools to be wagered upon while it was simultaneously shorting some of them. Mr. Steffelin argued that Magnetar did not control which assets were in the deal. He also said he had done his job by accurately describing these assets to J.P. Morgan, which as far as he knew had accurately described them to investors. These would be sophisticated institutional investors who were eager to profit from the housing mania but are now cast as victims by prosecutors.
Since the Steffelin prosecution wasn't a criminal case but a civil suit, it presented a much lower bar for prosecutors to clear. But apparently not low enough. Last year U.S. District Judge Miriam Goldman Cedarbaum threw out the SEC's fraud charges, saying that it was a "big stretch" to say that Mr. Steffelin had a fiduciary duty to investors. That left only the accusation of negligence, and Judge Cedarbaum has now allowed the SEC to dismiss its case entirely.
It's true that J.P. Morgan Chase paid $153.6 million of its shareholders' money to settle a related SEC suit for its role in this transaction. But the bank admitted no wrongdoing and sees great value in avoiding adverse publicity. The problem for the government occurs whenever it has to prove that an actual human being has done something wrong.
Memories are still fresh from the SEC's July courtroom loss to Brian Stoker, a former Citigroup C +1.67%employee. The SEC argued that Mr. Stoker had been negligent in assembling a similar mortgage CDO deal, but a jury of his peers decided that he'd broken no securities laws.
Next year will bring the civil trial of former Goldman Sachs GS -0.54%banker Fabrice Tourre, but last Monday U.S. District Judge Katherine Forrest slapped down the SEC's effort to revive a part of the case that was dismissed last year on jurisdictional grounds. So far Mr. Tourre is claiming his innocence, and our guess is that the SEC staff is terrified that "Fabulous Fab" might decide not to settle.
This political prosecution was brought at the height of the Senate debate over Dodd-Frank. Goldman settled by paying $550 million without admitting guilt in a case that also should never have been brought. (See "The SEC vs. Goldman," April 19, 2010.)
The Journal recently reported that another enforcement action against J.P. Morgan will include no charges against individuals. And on Tuesday New York Attorney General Eric Schneiderman sued Credit Suisse CSGN.VX -0.35%over still more mortgage deals, and again with no human defendants. What a concept: wrongdoing by banks that includes no wrongdoing by any bankers.
Speaking of mystery bankers, pundits on the left are now claiming that prosecutors should really be charging people who served at the top of financial firms. So prosecutors are supposed to gather more evidence against the CEO than they can against the employees who crafted the particular deals at issue?
Critics are also blaming incompetence at the SEC or the Department of Justice, as if the quality of prosecutors has suddenly deteriorated. They are no better or worse than ever. The prosecutors have simply been given a difficult assignment trying to find criminality among bankers who were doing what everyone else was doing in a financial mania fueled by government policy.
The Federal Reserve created negative real interest rates and a net subsidy for credit expansion. Washington programs to encourage every American to own a home ensured that the bubble would be concentrated in residential real estate. Government-approved credit-raters, convinced that the U.S. housing market would never suffer a sharp decline, slapped triple-A ratings on bundles of risky mortgages. Federal rules encouraged banks, money-market funds, stock brokerages and other institutions to buy this junk.
The zeal to prosecute bankers is part of the politically convenient narrative that the financial crisis was all created on Wall Street. Bankers were greedy as ever and their risk management was faulty. But the fact that Washington can't find a real criminal should focus public attention back on the real crime. That was Beltway policy.
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