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    Paul McMorrow

    At last, feds are out for bankers’ heads

    AFTER MORE than three years of scouring the country’s economic wreckage for shots at punishing those responsible, Washington still doesn’t know which it prefers - a perp walk, or a nine-figure check stapled to a press release.

    Two months ago, the FBI’s former financial-crisis point man was talking publicly about sloughing most of the government’s post-meltdown legal cleanup off on the Securities and Exchange Commission, since the cases the Justice Department was looking at were either doomed, too complex for a jury, or both. Yet the SEC’s usual approach doesn’t go nearly far enough; in effect, the agency has a standing policy of taking cash to make cases go away.

    The agency has collected $2 billion in fines related to the financial crisis, but it seems more interested in collecting fines than in driving home accountability for past crimes. Goldman Sachs paid $550 million for setting up a mortgage deal that one of its customers wanted to fail, but the bank only had to say it was a “mistake’’ not to disclose this crooked deal to investors.


    Fortunately, election-year politics are pushing Justice to do what it should have been doing all along. On Friday, Attorney General Eric Holder pledged to try really, really hard to throw a few economy-ruining Wall Street types in prison. If this makes for good election-year rhetoric, then so be it.

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    The underlying problem is that, while it was clearly crooked when the financial system inflated the housing bubble, it’s harder to say how much of it was illegal.

    Wall Street grew wealthy by trading loans that were built to blow up on borrowers. Low introductory interest rates were designed to jump significantly after a few years as a way of seeding future mortgage demand. But while it may be morally reprehensible to hand out mortgages that are designed to fail and then pocket fees while selling off risk to investors, it’s not criminal.

    There’s more hope of prosecuting Wall Street for the way it packaged these loans into securities. Investment banks and their wholesalers often cut corners, fudging home values and borrowers’ incomes. When these mortgages were packaged into securities and sold to investors, their SEC offering sheets drastically understated how risky the mortgages really were.

    Even if the Justice Department hasn’t been aggressive in seeking payback, others are: Big banks are currently facing a slew of billion-dollar lawsuits from investors in mortgage securities; the investors say banks deliberately misstated mortgage risk in their SEC filings. Private-sector investors like AIG and MassMutual are suing, but so are public and quasi-public entities like the FDIC, the Federal Home Loan Banks, Fannie Mae, and Freddie Mac. These civil cases carry a lower burden of proof than a criminal case over faulty securities would; in a criminal case, prosecutors have to prove that fraud was intentional.


    It may be possible to do so. According to Christopher Mayer, a professor at Columbia’s business school, there’s strong statistical evidence that banks knew they were selling junk, since the mortgage securities that banks repackaged and sold to their customers performed twice as badly as the stuff they kept for themselves. But because this stuff is complex and tough to prove to a jury, two months ago the Wall Street Journal reported that the Justice Department was handing off financial fraud cases to the SEC - a shift that was reversed last week.

    While calling for bankers’ heads may resonate with voters, what’s more important are the underwhelming results of the SEC’s financial fraud cases. Even Angelo Mozilo, the former CEO of Countrywide, the housing bubble’s worst offender, skated. Mozilo complained in e-mails about Countrywide’s loans being “toxic,’’ but his $67 million settlement didn’t require him to admit any guilt. A standoff in a Manhattan federal court has thrust this dynamic into public view. The judge, Jed Rakoff, scuttled a proposed SEC settlement with Citigroup because the deal wouldn’t require the bank to accept culpability for selling mortgage securities and then betting against them.

    Rakoff accused the SEC of seeking “pocket change’’ from Citi, and grabbing a “quick headline’’ without holding the bank accountable for anything. He’s right.

    If the Justice Department comes up empty in future prosecutions, it’s a sign that the financial sector’s ability to hurt the economy is running ahead of federal rules that are 70 to 80 years old. But that doesn’t mean prosecutors should preemptively throw up their hands.

    Paul McMorrow is an associate editor at CommonWealth magazine. His column appears regularly in the Globe.