Too-Big-To-Fail Banks Not Guilty As Not Charged

The following post comes to us from Nizan Geslevich Packin of the University of Pennsylvania Law School; Zicklin School of Business, Baruch College, City University of New York.

In the paper, Breaking Bad? Too-Big-To-Fail Banks Not Guilty As Not Charged, forthcoming in the Washington University Law Review, Vol. 91, No. 4, 2014, I focus on the benefits that the largest financial institutions receive because they are too-big-to-fail. Since the 2008 financial crisis, rating agencies, regulators, global organizations, and academics have argued that large banks receive significant competitive advantages because the market still perceives them as likely to be saved in a future financial crisis. The most significant advantage is a government implicit subsidy, which stems from this market perception and enables the largest banks to borrow at lower interest rates. And while government subsidies were the subject of a November 2013 Government Accounting Office report, in the paper I focus on a specific aspect of the benefits the largest banks receive: the economic advantages resulting from exempting the largest financial institutions from criminal statutes. I argue that this exemption—which has been widely discussed in the media over the last few years, following several scandals involving large financial institutions—not only contributes to the subsidies’ economic value, but also creates incentives for unethical and even criminal activity.

The paper commences by providing some background on the framework in which the too-big-to-fail subsidies and benefits exist. According to the 2013 Government Accounting Office report, which was the result of a highly controversial debate on the existence, nature and scope of too-big-to-fail banks’ subsidies, such financial benefits do exists and are quite substantial. And while this might be surprising given that the purpose of the 2010 Dodd Frank Act was to solve the too-big-to-fail problem, it appears that the largest financial institutions have continued to enjoy a variety of unique benefits and advantages in the years following the financial crisis. Focusing on one of those unique benefits, the paper continues with a description of the too-big-to-jail Department of Justice policy, which allows for “deferred prosecution” and advancing settlements instead of criminal charges for large financial institutions that violate criminal laws.

In discussing this deferred prosecution policy, the paper gives specific examples of instances in which the largest financial institutions violated laws such as money laundering and drug trafficking in recent years, but were not prosecuted for their actions. Such cases include, for example, HSBC paying a fine of approximately $1.9 billion to settle money laundering charges in 2012, and JP Morgan paying a record fine of approximately $13 billion in a settlement over illegal mortgage practices in 2013. The background for this too-big-to-jail policy, according to Attorney General Eric Holder, is the assumption that prosecuting the largest financial institutions might harm the economy, which is an undesired scenario. Moreover, some of the largest global financial institutions have become so massive that it is extremely difficult for the Department of Justice to prosecute them, even if it desired to do so.

The paper then exposes the flaws in the too-big-to-jail policy by examining the negative effects of enabling the largest financial institutions to dodge criminal liability. First, the too-big-to-jail policy effectively vitiates the law as written by Congress. Second, the policy enables the largest financial institutions to, de facto, receive more favorable treatment than their smaller competitors do, which conflicts with the basic constitutional principle of equality under the law. More specifically, confirming that it employs such a purposeful policy of flexible law enforcement when dealing with the largest financial institutions effectively means that the government is intentionally discriminating in favor of the largest financial institutions. Doing that contradicts one of the most fundamental American legal principles, reinforced by the Supreme Court’s equal protection jurisprudence. Third, the too-big-to-jail policy makes the Department of Justice less interested in prosecuting the individuals who were employed by such large financial institutions and who were responsible for the company’s legal transgressions, even in the cases where those individuals had direct personal involvement, as has been the case in several of the recent scandals. Moreover, in some instances, those executives were the ones who planned the strategy adopted by the relevant financial institutions. Finally, the large fines imposed on too-big-to-fail financial institutions in lieu of prosecution for illegal actions increases already-existing negative behavioral incentives—and even creates new incentives for bad conduct—among large financial institutions’ executives and decision-makers.

The paper concludes by calling for financial regulators to have greater civil powers to hold senior executives and managers at large financial institutions accountable for such corporate misconduct. Additionally, the paper calls for the Department of Justice to use its power and authority to criminally charge too-big-to-fail banks and their executives that have violated laws, as has also been suggested by a United States District Court Judge.

The full paper is available for download here.

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