Too Big to Jail: Our Banking System’s Latest Disgrace

Three articles below on the impact and meaning of the nonprosecution of HSBC for laundering drug money — $800 million in bulk cash from Mexico.

Too Big to Jail: Our Banking System’s Latest Disgrace

By Neil Barofsky
The New Republic, December 12, 2012

You can be forgiven if you watched the Department of Justice’s announcement yesterday of a $1.92 billion settlement with HSBC with a sense of disappointment–and déjà vu. The event checked all the boxes in a theatrical routine that has become all too familiar.

Descriptions of breathtaking misconduct involving the facilitation of massive drug trafficking and transactions with rogue terror-sponsoring nations? Check.

Broad boasts about the “historic” nature of the settlement that will certainly end the type of criminal misconduct alleged? Check.

Mea culpas from the offending institution with promises that it has really learned its lesson this time and will never ever engage in dastardly conduct again? Yep, that too.

Nothing, however, was quite as it appeared. Sure, HSBC paid a record fine, but there was something vitally important missing from yesterday’s press conference: actual criminal charges for obvious criminal conduct.

Some perspective: HSBC sent more than $800 million in bulk cash from Mexico to the United States, a good chunk of which apparently represented proceeds from some of the most notorious Colombian drug cartels. As someone who tried the first narcotics money laundering case involving extradition from Colombia, let me assure you that this is a lot of money, the discovery of which usually generates vigorous prosecutions and lengthy prison sentences. And it wasn’t HSBC’s only dirty business: There were also hundreds of millions of more dollars of illegally disguised transactions with rogue nations such as Iran and Sudan.

Why no criminal charges? Why instead only some remedial measures and a “historical” fine that can be measured in weeks — not years — of earnings? It certainly wasn’t for lack of evidence. No, instead the government determined that HSBC is not only too big to fail, but also too big to jail. As the New York Times first reported, even though there were strong voices within DOJ pushing for criminal charges, the big banks’ best friends within the government (the Treasury Department, of course, and other unnamed regulators) were too fearful that an indictment could destabilize the global financial system. Yes, it’s 2008 all over again. In the name of systemic stability, a megabank again escapes accountability for its actions, rescued by compliant officials.

In some aspects, DOJ’s surrender is understandable. Notwithstanding regulatory reform efforts in the U.S. and the UK, the largest banks are in many ways even more systemically dangerous today than when we bailed them out in 2008. This indirect acknowledgment that we have failed to fix the too-big-to-fail problem has potentially dire consequences.

One of the reasons why we have a criminal justice system, of course, is to deter criminal behavior. If you know that you will be punished for putting your hand in the cash register at your local supermarket (or illegally stripping out information from a monetary transaction that identifies the source nation as Iran), you are less likely to do so. But if the government offered a blanket waiver from criminal accountability for a certain group — let’s say all left-handed people over six feet tall or a handful of banks deemed so large and so significant that their indictment could destroy the global financial system — we would expect that those exempted would no longer be deterred from committing criminal acts. And although lefty giants may otherwise lack a predisposition for boosting cash, in recent years the largest banks have demonstrated an unbridled zeal for pushing the boundaries of the law as part of their relentless pursuit of profits. DOJ’s actions with regards to HSBC are beyond unfair: They are downright terrifying for weakening the general deterrence for megabanks, both foreign and domestic, which could rationally interpret yesterday’s actions as a license to steal.

The enduring presumption of bailouts in our banking system already drives the largest banks to take on too much risk with too little disclosure and too much leverage, a toxic cocktail that will inevitably lead to another financial crisis. Yesterday’s action now spikes the punch with a new toxin, confirmation that criminal penalties are off the table, leaving a worst-case scenario of a fine totaling far less than even a single quarter’s earnings. Given the potential profits of criminal behavior and the unlikelihood of personal consequences for the executives directing it, the message is clear: Crime pays. This will inevitably lead to more reckless risk-taking that will further undermine systemic stability and lead to an even greater financial meltdown down the road.

There is, of course, a solution for our emerging two-tier system of justice. The largest banks need to be broken up, the only realistic way to truly end both too big to fail and too big to jail. But since our government has demonstrated a reluctance to do so, perhaps the next time a megabank presents HSBC’s argument that it should not be criminally charged because it would destabilize the financial system, instead of capitulating to this threat, DOJ should require at a bare minimum that in return for allowing the bank to survive, it must break itself up, ensuring that it could never hold the justice system hostage again. Otherwise, we can look forward to many more press conferences that are long on drama but short on impact.

Neil Barofsky was the Special United States Treasury Department Inspector General to oversee the Troubled Assets Relief Program from 2009 until his resignation in February 2011. He is currently a senior fellow at the NYU School of Law and is the author of Bailout (Free Press, 2012).

Why Did Obama and Cameron Save a Criminal Enterprise Like HSBC?

By Willam Black
Huffington Post, December 13, 2012

Why is HSBC still in operation? On the same day (December 10, 2012) that the Barack Obama administration leaked the story of the HSBC settlement, a story ran in the New York Times that was full of self-praise by the Obama and David Cameron (U.K.) governments for their “cooperative approach” to cracking down on systemically dangerous institutions (SDIs). SDIs are treated as “too big to fail” because they pose a global systemic risk when they fail. The HSBC settlement puts the lie to the Obama/Cameron crack-down on the SDIs for it revealed a disgrace — Obama and Cameron treat the SDIs as too big to prosecute. Indeed, HSBC demonstrates that the SDIs’ senior officers are treated by Obama and Cameron as too elite to prosecute. The propaganda meme of the NYT story — that the SDIs would never again be given special favors due to reforms being adopted by Obama and Cameron — lasted four hours before it was destroyed by the disgraceful reality of the Obama and Cameron governments’ refusal to prosecute HSBC and its officers for their tens of thousands of felonies.

The NYT article begins by accepting the Obama/Cameron framing of the SDI issue, without any critical analysis. “It is one of the thorniest problems hanging over the financial system: how should authorities deal with the collapse of a sprawling global bank to protect the financial system at large?” The reporter’s implicit assumption is that we must have banks that are systemically dangerous when they fail.

This example exemplifies why implicit assumptions are so dangerous. They exclude far better alternatives or terrible risks from even being considered — and they do so unknowingly. If the reporter had made the assumption explicitly he would have been forced to defend it with analytics. The article acknowledges that SDIs drove the financial crisis that caused the Great Recession. In the U.S. alone this caused over a $15 trillion loss in wealth and led to the loss, or prevented the creation, of over 10 million jobs. According to the Bush and Obama administrations we were lucky in preventing the crisis from growing vastly larger. SDIs are economic weapons of mass destruction — but they cause their primary destruction inside the nation in which they reside.

Why allow a weapon of mass destruction that primarily destroys your own nation? That is an act of insanity. The City of London cannot credibly threaten the United States by creating SDIs and threatening to destroy the UK’s economy. The proponents of SDIs bear an enormous burden of persuasion to prove why we shouldn’t end the catastrophic danger they pose by shrinking them to the point where they are no longer potential weapons of mass economic destruction. Their burden is even greater when one considers the dominant view of economists that the smaller banks would be more efficient than the SDIs, which are massively too large to manage. The NYT reporter does not even attempt to meet that burden. The reporter also presents no indication that the U.S. and U.K. regulators even considered ending our exposure to these weapons of mass economic destruction.

The article acknowledges that trying to prevent an SDI from causing a systemic, global financial crisis once it fails is likely to fail. First, the regulators are not at all sure that they can prevent a systemic crisis with their “cooperative” proposals. Second, few regulators would risk a global systemic crisis when the alternative of bailing out the failing SDI inherently exists. Regulators have seen the disastrous results of failing to bail out Lehman.

The obvious alternative (to everyone except the reporter, the U.S. and U.K. regulators, and the Obama and Cameron governments who have implicitly assumed it out of existence) is to shrink the SDIs to the point that they no longer pose a systemic risk and to conduct the shrinkage now before they fail. That alternative would vastly reduce the economic WMD and make the banks more efficient — a win-win solution.

The further good news is that those two “wins” are not the limits of the advantages of shrinking the SDIs before they fail. The NYT article, implicitly, assumes the Obama/Cameron framing of another issue critical to determining the SDI policies we should adopt. “‘Too big to fail’ is the label for the problem that confronts governments when a large bank is on its last legs.” The implicit assumption is that SDIs pose a “problem” only when they are on their “last legs.” Had the reporter made this assumption explicitly he would have recognized it is unsupportable. Beyond their inefficiency, SDIs pose grave risks to a nation when they are profitable and growing. SDIs make “free markets,” integrity and justice impossible to maintain, they create the perverse political power that produces crony capitalism, and they drive the “competition to laxity” that drives regulatory failure. I have explained most of these points in prior writings, so I will summarize.

SDIs’ uninsured, general creditors get bailed out even though the contractual deal they agree to would normally cause them to suffer severe losses. The result is that they can borrow significantly more cheaply from general creditors than can their smaller rivals. SDIs that are insured banks receive an explicit governmental subsidy (deposit insurance), but the implicit federal subsidy to general creditors is far larger and is unique to SDIs. The very conservative economists who authored the book Guaranteed to Fail (2011) describe the implicit subsidy as being so large that it is the metaphorical equivalent of “bringing a gun to a knife fight.” They conclude that the subsidies are so large that they inherently create “a highly distorted market.” Indeed, they argue that the SDIs that created the mortgage crisis so distorted the market that there was “nothing free” about the mortgage markets. The authors also explain the SDIs’ immense political power and their ability to corrupt regulators and regulation.

The HSBC case illustrates why SDIs destroy integrity and justice. Public reports of the results of the government investigations of HSBC describe a bank that has been a criminal enterprise for at least 15 years. The current settlement addresses only three of the many scandals HSBC has committed over that time period. HSBC is a recidivist of epic proportions, but the Obama and Cameron governments have failed to prosecute HSBC or any of its officers. When powerful corporations and their controlling officers grow wealthy through massive frauds and do so with impunity from criminal sanction integrity and justice are eaten away. Effective financial regulation, supervision, and prosecutions are essential to “free” financial markets. When cheaters prosper honest firms are driven from the markets, a point that the Nobel Laureate George Akerlof explained in his famous 1970 article on markets for “lemons.” He described a “Gresham’s” dynamic in which bad ethics drove good ethics from the marketplace.

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”

Fraud and the destruction of integrity among SDIs will tend to spread to their market rivals due to this Gresham’s dynamic. The result is another form of systemic risk.

The Justice Department, HSBC’s regulators, and the Obama and Cameron governments had the perfect opportunity to break this Gresham’s dynamic and restore justice and integrity by prosecuting and taking vigorous regulatory steps that forced HSBC to shrink over the next five years to the point that it was no longer an SDI. They could have done so at a time when HSBC was reporting very high profits rather than during a crisis. It was their paramount role and duty as prosecutors and regulators to break the Gresham’s dynamic by restoring the rule of law. Doing so would have been good for the markets, for increased competition, for bank efficiency, for the independence of the regulators and prosecutors, for safety and soundness, and for our democracy. Instead, they made the Gresham’s dynamic far worse, shamed their institutions and professions, and betrayed their duty to the nation and citizenry.

But things are likely far worse than this description suggests, for the pathetic truth is that there is no indication that the regulators, prosecutors, or government leaders considered doing the right thing at HSBC. That is how destructive making implicit assumptions and adopting the pro-crony framing of issues is in the real world. I hope I am wrong and that an insider will resign in disgust and disclose how she fought to shrink HSBC but was overruled by her superiors.

Bill Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics. He was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and General Counsel of the Federal Home Loan Bank of San Francisco, and Senior Deputy Chief Counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.

Outrageous HSBC Settlement Proves the Drug War is a Joke

By Matt Taibbi
Rolling Stone, December 13, 2012

If you’ve ever been arrested on a drug charge, if you’ve ever spent even a day in jail for having a stem of marijuana in your pocket or “drug paraphernalia” in your gym bag, Assistant Attorney General and longtime Bill Clinton pal Lanny Breuer has a message for you: Bite me.

Lanny Breuer

Assistant Attorney General Lanny Breuer

Breuer this week signed off on a settlement deal with the British banking giant HSBC that is the ultimate insult to every ordinary person who’s ever had his life altered by a narcotics charge. Despite the fact that HSBC admitted to laundering billions of dollars for Colombian and Mexican drug cartels (among others) and violating a host of important banking laws (from the Bank Secrecy Act to the Trading With the Enemy Act), Breuer and his Justice Department elected not to pursue criminal prosecutions of the bank, opting instead for a “record” financial settlement of $1.9 billion, which as one analyst noted is about five weeks of income for the bank.

The banks’ laundering transactions were so brazen that the NSA probably could have spotted them from space. Breuer admitted that drug dealers would sometimes come to HSBC’s Mexican branches and “deposit hundreds of thousands of dollars in cash, in a single day, into a single account, using boxes designed to fit the precise dimensions of the teller windows.”

This bears repeating: in order to more efficiently move as much illegal money as possible into the “legitimate” banking institution HSBC, drug dealers specifically designed boxes to fit through the bank’s teller windows. Tony Montana’s henchmen marching dufflebags of cash into the fictional “American City Bank” in Miami was actually more subtle than what the cartels were doing when they washed their cash through one of Britain’s most storied financial institutions.

Though this was not stated explicitly, the government’s rationale in not pursuing criminal prosecutions against the bank was apparently rooted in concerns that putting executives from a “systemically important institution” in jail for drug laundering would threaten the stability of the financial system. The New York Times put it this way:

“Federal and state authorities have chosen not to indict HSBC, the London-based bank, on charges of vast and prolonged money laundering, for fear that criminal prosecution would topple the bank and, in the process, endanger the financial system.”

It doesn’t take a genius to see that the reasoning here is beyond flawed. When you decide not to prosecute bankers for billion-dollar crimes connected to drug-dealing and terrorism (some of HSBC’s Saudi and Bangladeshi clients had terrorist ties, according to a Senate investigation), it doesn’t protect the banking system, it does exactly the opposite. It terrifies investors and depositors everywhere, leaving them with the clear impression that even the most “reputable” banks may in fact be captured institutions whose senior executives are in the employ of (this can’t be repeated often enough) murderers and terrorists. Even more shocking, the Justice Department’s response to learning about all of this was to do exactly the same thing that the HSBC executives did in the first place to get themselves in trouble – they took money to look the other way.

And not only did they sell out to drug dealers, they sold out cheap. You’ll hear bragging this week by the Obama administration that they wrested a record penalty from HSBC, but it’s a joke. Some of the penalties involved will literally make you laugh out loud. This is from Breuer’s announcement:

“As a result of the government’s investigation, HSBC has . . . “clawed back” deferred compensation bonuses given to some of its most senior U.S. anti-money laundering and compliance officers, and agreed to partially defer bonus compensation for its most senior officials during the five-year period of the deferred prosecution agreement.”

Wow. So the executives who spent a decade laundering billions of dollars will have to partially defer their bonuses during the five-year deferred prosecution agreement? Are you fucking kidding me? That’s the punishment? The government’s negotiators couldn’t hold firm on forcing HSBC officials to completely wait to receive their ill-gotten bonuses? They had to settle on making them “partially” wait? Every honest prosecutor in America has to be puking his guts out at such bargaining tactics. What was the Justice Department’s opening offer – asking executives to restrict their Caribbean vacation time to nine weeks a year?

So you might ask, what’s the appropriate financial penalty for a bank in HSBC’s position? Exactly how much money should one extract from a firm that has been shamelessly profiting from business with criminals for years and years? Remember, we’re talking about a company that has admitted to a smorgasbord of serious banking crimes. If you’re the prosecutor, you’ve got this bank by the balls. So how much money should you take?

How about all of it? How about every last dollar the bank has made since it started its illegal activity? How about you dive into every bank account of every single executive involved in this mess and take every last bonus dollar they’ve ever earned? Then take their houses, their cars, the paintings they bought at Sotheby’s auctions, the clothes in their closets, the loose change in the jars on their kitchen counters, every last freaking thing. Take it all and don’t think twice. And then throw them in jail.

Sound harsh? It does, doesn’t it? The only problem is, that’s exactly what the government does just about every day to ordinary people involved in ordinary drug cases.

It’d be interesting, for instance, to ask the residents of Tenaha, Texas what they think about the HSBC settlement. That’s the town where local police routinely pulled over (mostly black) motorists and, whenever they found cash, offered motorists a choice: They could either allow police to seize the money, or face drug and money laundering charges.

Or we could ask Anthony Smelley, the Indiana resident who won $50,000 in a car accident settlement and was carrying about $17K of that in cash in his car when he got pulled over. Cops searched his car and had drug dogs sniff around: The dogs alerted twice. No drugs were found, but police took the money anyway. Even after Smelley produced documentation proving where he got the money from, Putnam County officials tried to keep the money on the grounds that he could have used the cash to buy drugs in the future.

Seriously, that happened. It happens all the time, and even Lanny Breuer’s own Justice Deparment gets into the act. In 2010 alone, U.S. Attorneys’ offices deposited nearly $1.8 billion into government accounts as a result of forfeiture cases, most of them drug cases. You can see the Justice Department’s own statistics right here:

 Justice Department’s own statistics

Justice Department

If you get pulled over in America with cash and the government even thinks it’s drug money, that cash is going to be buying your local sheriff or police chief a new Ford Expedition tomorrow afternoon.

And that’s just the icing on the cake. The real prize you get for interacting with a law enforcement officer, if you happen to be connected in any way with drugs, is a preposterous, outsized criminal penalty. Right here in New York, one out of every seven cases that ends up in court is a marijuana case.

Just the other day, while Breuer was announcing his slap on the wrist for the world’s most prolific drug-launderers, I was in arraignment court in Brooklyn watching how they deal with actual people. A public defender explained the absurdity of drug arrests in this city. New York actually has fairly liberal laws about pot – police aren’t supposed to bust you if you possess the drug in private. So how do police work around that to make 50,377 pot-related arrests in a single year, just in this city? That was 2010; the 2009 number was 46,492.)

“What they do is, they stop you on the street and tell you to empty your pockets,” the public defender explained. “Then the instant a pipe or a seed is out of the pocket – boom, it’s ‘public use.’ And you get arrested.”

People spend nights in jail, or worse. In New York, even if they let you off with a misdemeanor and time served, you have to pay $200 and have your DNA extracted – a process that you have to pay for (it costs 50 bucks). But even beyond that, you won’t have search very far for stories of draconian, idiotic sentences for nonviolent drug crimes.

Just ask Cameron Douglas, the son of Michael Douglas, who got five years in jail for simple possession. His jailers kept him in solitary for 23 hours a day for 11 months and denied him visits with family and friends. Although your typical non-violent drug inmate isn’t the white child of a celebrity, he’s usually a minority user who gets far stiffer sentences than rich white kids would for committing the same crimes – we all remember the crack-versus-coke controversy in which federal and state sentencing guidelines left (predominantly minority) crack users serving sentences up to 100 times harsher than those meted out to the predominantly white users of powdered coke.

The institutional bias in the crack sentencing guidelines was a racist outrage, but this HSBC settlement blows even that away. By eschewing criminal prosecutions of major drug launderers on the grounds (the patently absurd grounds, incidentally) that their prosecution might imperil the world financial system, the government has now formalized the double standard.

They’re now saying that if you’re not an important cog in the global financial system, you can’t get away with anything, not even simple possession. You will be jailed and whatever cash they find on you they’ll seize on the spot, and convert into new cruisers or toys for your local SWAT team, which will be deployed to kick in the doors of houses where more such inessential economic cogs as you live. If you don’t have a systemically important job, in other words, the government’s position is that your assets may be used to finance your own political disenfranchisement.

On the other hand, if you are an important person, and you work for a big international bank, you won’t be prosecuted even if you launder nine billion dollars. Even if you actively collude with the people at the very top of the international narcotics trade, your punishment will be far smaller than that of the person at the very bottom of the world drug pyramid. You will be treated with more deference and sympathy than a junkie passing out on a subway car in Manhattan (using two seats of a subway car is a common prosecutable offense in this city). An international drug trafficker is a criminal and usually a murderer; the drug addict walking the street is one of his victims. But thanks to Breuer, we’re now in the business, officially, of jailing the victims and enabling the criminals.

This is the disgrace to end all disgraces. It doesn’t even make any sense. There is no reason why the Justice Department couldn’t have snatched up everybody at HSBC involved with the trafficking, prosecuted them criminally, and worked with banking regulators to make sure that the bank survived the transition to new management. As it is, HSBC has had to replace virtually all of its senior management. The guilty parties were apparently not so important to the stability of the world economy that they all had to be left at their desks.

So there is absolutely no reason they couldn’t all face criminal penalties. That they are not being prosecuted is cowardice and pure corruption, nothing else. And by approving this settlement, Breuer removed the government’s moral authority to prosecute anyone for any other drug offense. Not that most people didn’t already know that the drug war is a joke, but this makes it official.

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