Headlines from the past few months would suggest that justice is finally being served for the 2008 financial crisis. The Justice Department recently reached a record $13 billion settlement with JPMorgan for fraudulent lending practices. A Bank of America manager may even go to jail over similar charges. However, even the record size JPMorgan settlement is tiny compared to the damage done: more people below the poverty line than ever before in the measurement’s history, tens of millions unemployed, and $19.2 trillion in wealth destroyed according to an April 2012 report by the Treasury Department.
In a February 2013 Senate Banking Committee hearing, Senator Elizabeth Warren (D-MA) asked federal financial regulators when they last took a large financial institution, a “Wall Street bank,” to trial. None of them were able to answer precisely because the practice is so uncommon. Rather, government negotiated settlements have been the dominant tool used to address the crimes central to the financial crash and Great Recession.
Sasha Werblin, Economic Equity Director at The Greenlining Institute, a racial and financial justice advocacy group, takes issue with the focus of these settlements. She points out that by not forcing banks to admit wrongdoing, most settlements restrict the ability of consumer litigants to pursue their own cases. Additionally, the money that actually finds its way to the consumer is generally small compared to the harm done. As Werblin puts it, “the implementation to make consumers whole is lacking.”
The settlement model has some potential if its focus shifts. Werblin points to the Independent Foreclosure Review program, created in a federal settlement not only to provide monetary restitution to victims of foreclosure fraud but also credit score readjustment, which would, among other things, help them find a new home. This approach was ultimately abandoned in favor of a larger cash settlement, demonstrating how regulators have prioritized extracting money over addressing the harms done.
Even well-crafted settlements are not enough. In the same February 2013 hearing, Senator Warren noted, “if [banks] can break the law and drag in billions in profits and then turn around and settle, paying out of those profits, they don’t have a lot of incentive to follow the law.” She also points out the effects on regulator credibility: “if a party is too timid to go to trial…then the consequence is they have a lot less leverage in the settlements that do occur.”
As Phil Angelides, former California State Treasurer and Chairman of the Financial Crisis Inquiry Commission (FCIC) points out, “institutions as institutions don’t engage in wrongdoing.” Even if wrongdoing is pervasive, he points out, settlements targeting the organization only end up taking money from shareholders. “There need to be consequences for individuals,” he claims. “Otherwise there’s no deterrence.”
Avoiding prosecution also creates unacceptable inequality under the law. In a 2010 interview, then-Treasury Secretary Timothy Geithner, a key architect of the federal response to the financial crisis, decried calls for prosecution of those responsible as the pursuit of “Old Testament justice” which would have undermined public “[confidence] in the future.” Angelides calls that argument “morally bankrupt” and points out in an ideal system “someone’s importance has nothing to do with how they’re handled by the law.”
Though prosecution is important in terms of equity and accountability, creating a just financial system ultimately requires systemic change. The Consumer Financial Protection Bureau (CFPB), created by 2010 Dodd-Frank financial reform bill, is an important part step. Especially important, Werblin notes, is the CFPB’s monitoring of credit markets, which have long been allowed “to play by their own rules.” She adds that in terms of transparency and accessibility, the CFPB sets a “new precedent for other regulators to model themselves on.”
Much more reform remains necessary. Extremely high leverage ratios, the amount of assets a bank has for every dollar in capital, were a chief cause of the financial crisis. Angelides claims that this problem persists and that banks remain “businesses that banks wouldn’t led to,” calling for capital requirements from Dodd-Frank to be cleansed of loopholes and raised. Even if doing so raised interest rates marginally, he claims it would be “worth it if they protect the country from cataclysm.”
According to CNN, the five largest banks control 37% more assets than they did five years ago, with only 8% more assets in the system as a whole. Since being bailed out for being “too big to fail,” the biggest banks have only gotten bigger. The 21st Century Glass-Steagall Act, sponsored by Senators Warren (D-MA) and McCain (R-AZ) would address this problem by separating traditional banking from riskier financial services, which would force banks to downsize and make any one failure less damaging to the whole system.
Private sector reforms are also important. Werblin points to new financial products that banks promise to back directly, calling that increased accountability central to creating “affordable, sustainable banking systems…moving forward.”
Executive compensation is another area that needs reform. Current practices distort executive incentives away from those of society, Angelides claims, by over-rewarding risk and providing huge bonuses when risky bets pay off without large reductions in pay, so-called clawbacks, when deals turn sour. He also asserts that total compensation should be reduced to a “rational” size, putting the onus for both reforms on shareholders, especially powerful ones like pension funds.
Outsized profits have concentrated power to a dangerous degree. “These banks have more power than God in Washington,” Angelides declares. He describes how a single bank’s lawyer earned more than the entire FCIC budget. This influence, also projected through campaign contributions and lobbying, is a huge impediment to effective reform and helps explain why only about 40% of the rules required under Dodd-Frank have been enacted three years later.
Financial intermediation is an important service, but something is wrong when it stops being an economic lubricant and becomes a casino. As Angelides describes, if you’re a banker, the system is like “a blackjack game you can only win. So why are you going to leave the table?”