Another Nobel Economist Says We Have t o Prosecute Fraud Or Else the Economy Won’t Recover

THURSDAY, NOVEMBER 4, 2010
Guest Post: Another Nobel Economist Says We Have to Prosecute Fraud Or  
Else the Economy Won’t Recover

As economists such as William Black and James Galbraith have  
repeatedly said, we cannot solve the economic crisis unless we throw  
the criminals who committed fraud in jail.
And Nobel prize winning economist George Akerlof has demonstrated that  
failure to punish white collar criminals – and instead bailing them  
out- creates incentives for more economic crimes and further  
destruction of the economy in the future. See this, this and this.

Nobel prize winning economist Joseph Stiglitz just agreed. As Stiglitz  
told Yahoo’s Daily Finance on October 20th:
This is a really important point to understand from the point of view  
of our society. The legal system is supposed to be the codification of  
our norms and beliefs, things that we need to make our system work. If  
the legal system is seen as exploitative, then confidence in our whole  
system starts eroding. And that’s really the problem that’s going on.
***
A lot of the predatory practices in automobile loans are going to be  
able to be continued. Why is it OK to engage in bad lending in  
automobiles and not in the mortgage market? Is there any principle? We  
all know the answer to that. No, there’s no principle. It’s money.  
It’s campaign contributions, lobbying, revolving door, all of those  
kinds of things
***
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.].
***
I know so many people who say it’s an outrage that we had more  
accountability in the ’80’s with the S&L crisis than we are having  
today. Yeah, we fine them, and what is the big lesson? Behave badly,  
and the government might take 5% or 10% of what you got in your ill- 
gotten gains, but you’re still sitting home pretty with your several  
hundred million dollars that you have left over after paying fines  
that look very large by ordinary standards but look small compared to  
the amount that you’ve been able to cash in.
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.
***
I think we ought to go do what we did in the S&L [crisis] and actually  
put many of these guys in prison. Absolutely. These are not just white- 
collar crimes or little accidents. There were victims. That’s the  
point. There were victims all over the world.
***
So do we have any confidence that these guys who got us into the mess  
have really changed their minds? Actually we have pretty [good]  
confidence that they have not. I’ve seen some speeches where they  
said, “Nothing was really wrong. We didn’t get things quite right. But  
our understanding of the issues is pretty sound.” If they think that,  
then we really are in a sorry mess.
***
There are many aspects of [deterring people from committing crime].  
Economists focus on the whole notion of incentives. People have an  
incentive sometimes to behave badly, because they can make more money  
if they can cheat. If our economic system is going to work then we  
have to make sure that what they gain when they cheat is offset by a  
system of penalties.
And that’s why, for instance, in our antitrust law, we often don’t  
catch people when they behave badly, but when we do we say there are  
treble damages. You pay three times the amount of the damage that you  
do. That’s a strong deterrent. Unfortunately, what we’ve been doing  
now, and more recently in these financial crimes, is settling for  
fractions – fractions! – of the direct damage, and even a smaller  
fraction of the total societal damage.That is to say, the financial  
sector really brought down the global economy and if you include all  
of that collateral damage, it’s really already in the trillions of  
dollars.
But there’s a broader sense of collateral damage that I think that has  
not really been taken on board. And that is confidence in our legal  
system, in our rule of law, in our system of justice. When you say the  
Pledge of Allegiance you say, with “justice for all.” People aren’t  
sure that we have justice for all. Somebody is caught for a minor drug  
offense, they are sent to prison for a very long time. And yet, these  
so-called white-collar crimes, which are not victimless, almost none  
of these guys, almost none of them, go to prison.

***
Let me give you another example of where the legal system has gotten  
very much out of whack, and which contributed to the financial crisis.
In 2005, we passed a bankruptcy reform. It was a reform pushed by the  
banks. It was designed to allow them to make bad loans to people to  
who didn’t understand what was going on, and then basically choke  
them. Squeeze them dry. And we should have called it, “the new  
indentured servitude law.” Because that’s what it did.
Let me just tell you how bad it is. I don’t think Americans understand  
how bad it is. It becomes really very difficult for individuals to  
discharge their debt. The basic principle in the past in America was  
people should have the right for a fresh start. People make mistakes.  
Especially when they’re preyed upon. And so you should be able to  
start afresh again. Get a clean slate. Pay what you can and start  
again. Now if you do it over and over again that’s a different thing.  
But at least when there are these lenders preying on you should be  
able to get a fresh start.
But they [the banks] said, “No, no, you can’t discharge your debt,” or  
you can’t discharge it very easily.
***
This is indentured servitude. And we criticize other countries for  
having indentured servitude of this kind, bonded labor. But in America  
we instituted this in 2005 with almost no discussion of the  
consequences. But what it did was encourage the banks to engage in  
even worse lending practices.
***

The banks want to pretend that they did not make bad loans. They don’t  
want to come into reality. The fact that they were very instrumental  
in changing the accounting standards, so that loans that are impaired  
where people are not paying back what they owe, are treated as if they  
are just as good as a well-performing mortgage.
So the whole strategy of the banks has been to hide the losses, muddle  
through and get the government to keep interest rates really low.
***
The result of this is, as long as we keep up this strategy, it’s going  
to be a long time before the economy recovers ….
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