WHY have so few gone to jail for the financial crisis? The boom and bust in S&L lending in the 1980s ended with nearly one thousand people sent to jail for financial fraud—and that experience was quite mild compared to the recent cycle. A few days ago, America’s public television channel ran a special documentary programme about this curious phenomenon called “The Untouchables.” (You can watch the whole thing here*) The government’s prosecutors argued that it is very difficult to prove fraudulent intent beyond a reasonable doubt. They said that it is more rewarding from the perspective of the public interest to reach negotiated settlements rather than go to trial and lose. After all, America’s Justice Department failed to convict two Bear Stearns hedge fund managers of lying to investors about their exposure to subprime losses, despite initial expectations that the case would be easy. The Securities and Exchange Commission, which had opened a civil lawsuit against the duo, decided to avoid a trial and settled with the accused on terms dismissed by the presiding judge as “chump change.” Most subsequent civil suits launched by the SEC have been targeted at firms rather than individuals, which means that shareholders were the ones who had to pay, rather than anyone who may have been directly responsible. This track record has led others, including several featured in the programme, to wonder whether prosecutors have been sufficiently vigorous and whether they have the right priorities.
Part of the problem may have been the failure of prosecutors to target the right people for the right things. Remember what Thucydides, the ancient Greek historian, said about the Athenian empire:
The Athenians were very severe and exacting, and made themselves offensive by applying the screw of necessity to men who were not used to and in fact not disposed for any continuous labour...For this the allies had themselves to blame; the wish to get off service making most of them arrange to pay their share of the expense in money instead of in ships, and so to avoid having to leave their homes. Thus while Athens was increasing her navy with the funds which they contributed, a revolt always found them without resources or experience for war.
From this perspective, the real wrongdoers were not those who sold risky products at inflated prices but the dupes who bought them on behalf of so many savers and pensioners. (This is not a legal judgment. I am not a lawyer. But I did study ancient history.) One explanation for the confusion is that many things that are considered normal in finance look like fraud to almost everyone else. This does not mean that nothing illegal occurred, but it does help explain why many actions that appear so distasteful have not been prosecuted in the courts. If more people become familiar with this foreign mentality, they might be much less likely to fall for some of the schemes that have caused so much pain over the past few years. At the very least, they will be less likely to tolerate investment managers who lose them money because they are so easily hoodwinked.