Restoring Capitalism: Unequal Justice — Banker Arrests O; Protester Arrests 2,511

by Bruce Judson on October 28th, 2011

Since the start of the financial crisis, Americans have wondered why, if laws were broken, none of the occupants of Wall Street or other financial centers have been arrested. Now arrests are starting to happen with growing frequency. To date, an estimated 2,511 people have been arrested on Wall Street and elsewhere for activities related to the crisis. Unfortunately, it’s the protesters who account for these arrests. The current tally: 2,511 people arrested for disturbing the peace and related activities; no arrests for any of the financiers who broke the law and plunged millions into untold misery.

“Equal justice under the law” is a cornerstone of the American Republic. In statues, Lady Justice is blindfolded to symbolize that justice is blind to the differences between the powerful and the weak, the rich and the poor. Today, I fear that Justice’s blindfold is in tatters, and equal justice under the law has become a myth in the American economic system.

Capitalism is not an abstract ideal. It is a set of rules and principles that, over the past two centuries, has combined with democracy to create a great America. Yet without blind, impartial, and equal justice, capitalism simply does not work.

The life-blood of any capitalist economy is the idea that a fair bargain is binding. Indeed, this principal was enunciated in the early days of the Republic in the famous Dartmouth College case, when the Supreme Court ruled on the sanctity of contracts. A natural corollary of this principle is the notion that it will be enforced by our justice system with equal vigor for all of the parties to the contract.

There are four broad principles associated with criminal law that apply to a capitalist system:

First, stupidity — no matter how great or how extreme the consequences — is not a crime. Poor, high-risk decisions that led to the financial crisis are not, in themselves, criminal. Indeed, no economy can thrive if bad decisions carry criminal penalties. Crimes are violations of specific laws.

Second, there are at least two purposes in prosecuting an individual for criminal misconduct: punishment for misbehavior and changing behavior within the larger society. When a crime is prosecuted, it has a deterrent effect. The prosecutor is sending a message to the general public and anyone else contemplating such crimes in the future that this behavior will not be tolerated.

Third, prosecutors have discretion in pursuing a specific individual for an alleged criminal act. I have spoken with a host of prosecutors with regard to the financial crisis, and the most common answer is “these are hard cases to make” and “the budget to prosecute a complex financial crime is extraordinary.” As a result, civil settlements, where the banks pay large financial penalties, have come to rule the day. (However, as discussed below, in many instances egregious violations of the laws make these easy cases to make.)

Fourth, as should be obvious, no individual in our society has the right to decide whether a law is irrelevant. Laws are the rules that everyone is expected to follow. This applies to everyone citizen, no matter how high or how low they stand in our society.

Now, let’s return to the financial crisis. In simple terms, three types of behavior have been documented: (1) “bad actors” who knew they were probably acting immorally but were not breaking the law, (2) activities that were most likely criminal, but without a trial no one has admitted to criminal behavior, (3) and admissions as testimony in open court of massive violations of the law (the robo-mortgage scandal is one example) with no prosecutions.

The consequences of the second and third type of behavior are inevitably calamitous for a capitalist economy. Business activity relies on the belief that, after the buyer and seller (or borrower and lender) have done all of their due diligence, our society will ensure that those who perpetrate false contracts will be punished. Fraudulent bargains will not be allowed. The alternative is massive uncertainty and a dysfunctional economy. For example, if a business person can’t rely on the law to protect his or her rights in a transaction, the individual is not going to enter into new contracts. The net result: Less investment, less economic activity, and far less innovation.

The SEC recently announced a $285 million dollar civil settlement with Citigroup. The firm had sold securities to investors and then turned around and shorted these same securities. The bank not only believed the securities would decline in value, but it actually spent its own money to make money off the terrible product it had sold to customers. Suppose I am in the jewelry business and I pretend that I am selling you a diamond that I know is really glass. I strongly suspect I would be guilty of some type of criminal fraud and would probably go to jail. At a fundamental level, I fail to see the difference between the jeweler and Citibank. Both have swindled the customer.

(Some readers may be thinking about the sophistication of the investors and the many agreements they probably signed disavowing representations by Citigroup. However, the fact of the settlement suggests that improper behavior absolutely occurred — if not, Citigroup would have fought the settlement. In addition, there is a strong argument that agreements that insulate any economic player from blatant misrepresentations should be void as against public policy.)

In a larger sense, the many financial institutions that have entered into settlements of hundreds of millions of dollars with the government are aware of all of the issues discussed above. My analysis is they have settled for two reasons: they don’t want to risk criminal prosecution and they don’t want the full details of their behavior to be discussed publicly in open court. And as noted in my earlier article, these settlements have become simply a “cost of doing business” for our increasingly monopolized financial sector and are unlikely to impact its behavior. In discussing the recent Citigroup settlement, The New York Times noted:

The settlement will refund investors with interest and include a $95 million fine — a relative pittance for a giant like Citigroup. On Monday, the company reported that in the third quarter alone it earned profits of $3.8 billion on revenue of $20.8 billion.

The message to people and entities, large and small, is that they cannot rely on a blind justice system to protect them from unscrupulous transactions. The idea of fair dealing — which is at the heart of our economy — is breaking down. This implicit message also erodes the underpinnings of a vibrant capitalist economy. The rich and powerful can violate the law and will receive a slap on the wrist. As a result, the rights of the less powerful entities, which were violated by these elites, will not be protected by our justice system.

Sadly, it gets worse.

It can be argued that it is not absolutely clear that the many civil settlements do in fact reflect violations of criminal law. With limited public records and no prosecution, financial institutions can assert that I lack all of the relevant facts in my discussion above and that the decision by the government to limit enforcement to civil action is proof that no laws were broken. I disagree, but it is arguable. In contrast, there are areas where there is no question the law was massively violated. Financiers have admitted it. The cases are open and shut. Yet no prosecutions have occurred.

Both cases reflect the ultimate destruction of a capitalist economy. They prove that some participants are above the law. The concept of fair dealing collapses.

Moreover, small businesses, which are repeatedly recognized as a key source of new jobs, are the hardest hit in an economy where a bargain is not a bargain and laws are not equally applied. These businesses have the fewest resources to ensure their rights are protected. A new calculus is added to all of their activities: Will they be treated in accordance with the rules that govern our society? If not, how can they possibly risk new activities where their rights and potential profits can evaporate because Justice no longer wears a blindfold?

The consequences of the prosecutorial failure to indict even the most egregious violators of laws associated with the financial crisis are high:

First, it encourages the belief among our financial elite that they are above the law. The dangerous sense of entitlement I referenced in my earlier article is reinforced. A vibrant capitalist economy depends on what an individual accomplishes, not who they are. Financiers can, perhaps rightly, assume that no matter how badly they corrupt our capitalist system they will be spared any meaningful penalties.

Second, I would suggest that if prosecutors sent one banker to jail, they would cause a change in behavior throughout our financial institutions. If prosecutors looked for the person who most obviously violated the law, has already admitted it (so this is an easy case), and sent this perpetrator to jail — the deterrent effect would be high. Instead, the absence of prosecutions effectively validates ongoing criminal misbehavior throughout the financial sector.

Third, as these cases are publicized, the public loses faith in our judicial system. Vibrant capitalism depends on the belief that everyone is treated fairly — and bargains will be fairly enforced.

Finally, capitalism is, in part, based on the Horatio Alger ideal. If I play by the rules, the benefits of my work and innovations will accrue to me. When people lose faith in this ideal, they stop taking the type of risks that create great innovations. Now potential innovators must wonder whether law-breaking financiers will ultimately co-opt the societal wealth they may create. As their confidence in the fairness of the system erodes, so does their willingness to risk creating the new companies, and attendant jobs, the nation so badly needs.

Now let’s return to the protestors on Wall Street. Almost 3,000 people have been arrested for activities that caused minimal, if any, injury to our society. At the same time, no financiers have been arrested for blatant legal violations, probably including extensive fraud, which have led millions of people to suffer and have practically brought our great nation to its knees.

There is constant discussion in Washington of economic healing and economic recovery. These can only happen when we return to the primary principles that made us a great nation. One of these paramount principles is that our capitalist economy requires a new blindfold for Lady Justice.

Next article in this series: Creating profits does not necessarily create societal wealth.

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