"One Down, 999 to Go" (cont.)

Financial Res Ipsa Loquiter - Part 2

[Note: please return to this post after reading Part 1]

Even people who agree that holding Wall Street accountable is a laudable goal are likely to raise four objections. The most serious arguments -- and the rebuttals -- are:

One. "No laws were broken."

Specifically, the SEC allowed Wall Street investment banks to borrow 35:1; the Financial Accounting Standards Board ("FASB") permitted companies to keep toxic debt off their balance sheets; and even the credit rating agencies put their "seal of approval" on the securitized debt.

Rebuttal: This is nothing more than financial chutzpah (the regular kind is defined as killing your parents, then throwing yourself on the mercy of the court because you're an orphan).

When it comes to regulation, Wall Street got exactly the rules it wanted, or, in the case of credit derivatives, forbearance on the ones it didn't.

Investment banks, led by Goldman Sachs head (and future Treasury Secretary) Henry Paulson pressured the SEC to raise permissible leverage. The same crew dismantled Glass-Steagall, the Depression-era bulwark separating investment and commercial banking. FASB has long been intimidated by the companies it purports to regulate. And companies like Standard & Poor's and Moody's were co-opted by gaudy Wall Street fees much the same way Arthur Andersen was seduced by Enron.

Two. Holding Wall Street's senior executives accountable for their actions will be bad for the market and the country's morale.

Rebuttal: Not holding them accountable is bad for the markets and morale.

Three. It's logistically impractical -- and legally cost-prohibitive -- to figure out which executives did what, when, and what their motives were. In a world where Exxon is still appealing liability for the Exxon Valdes spill, Hell will freeze over before Wall Street executives head to prison en masse.

Rebuttal: That's why the burden of proof needs to be shifted to the companies. In fact, don't stop there: require the companies to identify which individuals were most responsible for their corporate conduct -- after all, they're the ones in the best position to know. Such a tack also avoids the inevitable, Eichmann-style "we were just following orders" defense.

If the companies don't finger the responsible persons . . . hold the board of directors responsible instead.

Four. Such an approach smacks of collective -- not to mention "cruel and unusual" -- punishment.

Rebuttal: Collective punishment for collective behavior is eminently appropriate.

Just like Madoff, none of these senior executives acted alone; they were part and parcel of a culture that partook of the rewards and sloughed off the risks and responsibility.

Given the economic harm wrought by their actions, it's hard to argue that any punishment, however severe, would constitute "cruel and unusual." Besides the direct economic cost -- already in the trillions -- the indirect cost to the financial system, measured in broken lives and destroyed trust, is incalculable.

In any case, there is ample precedent for imposing disproportionately harsh punishment when the public policy stakes are so high.

That's exactly what the Supreme Court has opined in numerous cases brought by members of the posse comitatus, famous for filing expletive-filled tax returns (if they file them at all) -- and drawing very long prison sentences as a result.

According to the Supreme Court, the Internal Revenue Service relies on a system of voluntary compliance. It is allowed to make examples of the few to "encourage" the majority to do their duty.

Capitalism is no different. If the worst kinds of greed and self-dealing go unchecked, why should ordinary citizens behave? Or trust such a system with their life savings?

Before taxpayers replenish the hen house that has just been so spectacularly looted -- or set about the long-term task of restoring security -- it would seem wise to apprehend the foxes who made off (sorry, couldn't resist) with the chickens.

Or, to put it in slightly less modern terms, society should take steps to assure that "as you reap, so shall you reap."

"One Down, 999 to Go"

Financial Res Ipsa Loquiter

If the stock market surged 15% in the week since Bernie Madoff finally went to prison, just imagine what it would do once the senior management at companies like AIG, Citigroup, Goldman Sachs, and Fannie Mae are held accountable for their behavior.

And why shouldn't they be?

Thanks to the legal principle of res ipsa loquiter (Latin for "the thing speaks for itself"), when a patient finds a scalpel in his back after surgery, he doesn't have to prove negligence to prevail in a malpractice suit against his surgeon(s). Rather, the surgeons have to prove that they didn't commit malpractice.

So, too, when a company requires $5 billion -- or 10X or 50x(!) that -- from the U.S. Treasury to prevent a melt-down in the U.S. (no, global) financial system . . . the burden of proof to show gross negligence should be deemed to shift -- to the company receiving the bailout. (Don't need the $5 billion? Then pay it back.)

The best way policymakers can restore confidence in the ailing financial system isn't by devising some miracle cure that will suddenly make sick banks healthy. Rather, it's by demonstrating that there are consequences -- not rewards -- for reckless, outrageous behavior.

"One Down, 999 to Go"

So here's my proposal.

For every $5 billion in taxpayer money that a company has received, hold one executive at that company personally responsible. If the number trips $100 billion, send the whole board of directors to prison. After all, under state law, which governs most corporate conduct, it is the board that is ultimately responsible for the company's actions.

Assuming that the U.S. Treasury has now spent or guaranteed about $5 trillion in bad debts, the number of executives subject to such an enforcement action would be around 1,000.

Here's what a partial breakdown (pun intended) by company would look like:

AIG: Cost to taxpayers -- $200 billion; Responsible executives -- 40
Citigroup: Cost to taxpayers -- $150 billion; Responsible executives -- 30
Bank of America: Cost to Taxpayers -- $100 billion; Responsible executives -- 20
Fannie Mae, Freddie Mac, Goldman Sachs: Cost to Taxpayers -- $75 billion; Responsible executives -- 15 apiece
Merrill Lynch: Cost to Taxpayers -- $50 billion; Responsible executives -- 10
Washington Mutual, Wachovia, Bear Stearns, Countrywide: Cost to taxpayers -- $25 to $50 billion; Responsible executives -- 5 to 10 apiece

But, you object, wouldn't such a tactic be nothing more than an extra-legal, torch-and-pitchfork mob action?

It needn't be, conducted properly. In fact, such a response might offer the country its best chance of averting such a mob action.

Today's financial melt-down has already destroyed more wealth -- about $15 trillion; erased more jobs; and caused the foreclosure of more homes, than any other financial calamity in history, including The Great Depression. And that's just in the U.S.

Far from being an economic Katrina, the melt-down was very much a man-made affair.

Follow the Money

Which men?

As they say, "follow the money."

Senior executives at the above-named firms collected billions for designing and running a "financial sausage factory" that churned out trillions in securitized debt (principally tied to mortgages). Thanks to the credit ratings agencies, the vast majority of this debt was highly rated, and therefore palatable to investors around the globe.

Incredibly, at least some of these companies figured out how to profit a second and third time from these toxic securities -- by "shorting", or betting against them, after they sold them to customers (Goldman Sachs); by buying insurance policies that paid off when the toxic debt inevitably exploded (Goldman Sachs, Merrill Lynch and a host of others); and by collecting premiums for insuring said toxic debt (AIG).

Incredibly, the Treasury apparently is now honoring these bets through "backdoor bailouts" via AIG.

If executives at these companies knew the egregious risks they were running, they're guilty of fraud. If they didn't know the risks . . . they're guilty of gross negligence. This is exactly the same Hobson's choice (minus three zeroes) that confronted Enron's putatively out-of-the-loop executives.

That's just for starters.

Depending on the company and individual executives, you'd guess that a complete list of misdeeds would include: filing false financial statements (all that off-balance sheet debt); breach of fiduciary duty to their shareholders (isn't that what a "heads I win, tails you lose" policy amounts to?); insider trading; and corporate waste.

Financial Res Ipsa Loquiter - Part 2