Prosecuting Wall Street

As anyone can understand using mere common sense,something is seriously wrong in the US financial system.  Massive printing of fresh currency has beenongoing to patch up the losses, and these are all losses in which the money haslong been spent.

In the meantime we are struggling to finance newcapital investments in the face of a contracting credit bubble.

When a credit bubble blossoms, it is far too easyto paper over past mistakes by simply rolling them forward as hashappened.  When the reversal comes, allthe weak crap comes home to roost.

My point in all this is that everyone who eversigned off on this garbage did so knowingly and was by any definition guilty oftreason.  Restoration of trust will needto see all these folks incarcerated and sent through the criminal justicesystem for the capital crime of treason.

It will obviously need a new president to call theboys to account.

Prosecuting Wall Street Fraud: The US Economy is A GiantPonzi Scheme

By Washington'sBlog

URL of this article:

Bill Gross, Nouriel Roubini, Laurence Kotlikoff, Steve Keen, MichelChossudovsky and the Wall Street Journal all say that the U.S.economy is a giant Ponzi scheme.

Virtually all independent economists and financial experts say that rampantfraud was largely responsible for the financial crisis. See this and this.

But many on Wall Street and in D.C. - and many investors - believe thatwe should just "go with the flow". They hope that we can restart oureconomy and make some more money if we just let things continue the way theyare.

But the assumption that a system built on fraud can continue withoutcrashing is false.

In fact, top economists and financial experts agree that - unless fraudis prosecuted - the economy cannot recover.

Fraud Leads to a Break Down in Trust and Instability in the Markets

As Alan Greenspan said recently:

Fraud creates very considerable instability in competitive markets. Ifyou cannot trust your counterparties, it would not work

Similarly, leading economist Anna Schwartz - co-author of the leading book onthe Great Depression with Milton Friedman - told the WallStreet journal in 2008:

"The Fed ... has gone about as if the problem is a shortage ofliquidity. That is not the basic problem. The basic problem for the markets is that [uncertainty] that thebalance sheets of financial firms are credible."

So even though the Fed has flooded the creditmarkets with cash, spreads haven't budged because banks don't know who is stillsolvent and who is not. This uncertainty,says Ms. Schwartz, is "the basic problem in the credit market. Lendingfreezes up when lenders are uncertain that would-be borrowers have theresources to repay them. So to assume that the whole problem is inadequateliquidity bypasses the real issue."

Today, the banks have a problem on the asset side of their ledgers --"all these exotic securities that the market does not know how tovalue."

"Why are they 'toxic'?" Ms. Schwartz asks. "They'retoxic because you cannot sell them, you don't know what they'reworth, your balance sheet is not credible and the whole market freezes up. We don't know whom to lend to because wedon't know who is sound. So if you could get rid of them, that would be animprovement."

And economics professor and former Secretary of Labor RobertReich wrote in 2008:
The underlying problem isn't a liquidity problem. As I've notedelsewhere, the problem is that lenders and investors don't trust they'll gettheir money back because no one trusts that the numbers that purport to valuesecurities are anything but wishful thinking. The trouble, in a nutshell, is that thefinancial entrepreneurship of recent years -- the derivatives, credit defaultswaps, collateralized debt instruments, and so on -- has undermined all notionof true value.

Robert Shiller - one of the top housing experts in the United States- said recently thatfailing to address the legal issues will cause Americans to lose faith inbusiness and the government:

Shiller said the danger of foreclosuregate -- the scandal in which ithas come to light that the biggest banks have routinely mishandledhomeownership documents, putting the legality of foreclosures and related salesin doubt -- is a replay of the 1930s, when Americanslost faith that institutions such as business andgovernment were dealing fairly.
Nobel prize-winning economist Joseph Stiglitz says about thefailure to prosecute Wall Street fraud:

The legal system is supposed to be the codification of our norms andbeliefs, things that we need to make our system work. If the legal system isseen as exploitative, then confidence in our whole system starts eroding. And that's really the problem that's goingon.


I think we ought to go do what we didin the S&L [crisis] and actually put many of these guys in prison.Absolutely. These are not just white-collar crimes or little accidents. Therewere victims. That's the point. There were victims all over theworld.


Economists focus on the whole notion of incentives. People have an incentive sometimes to behave badly, because theycan make more money if they can cheat. If our economic system is going to workthen we have to make sure that what they gain when they cheat is offset by asystem of penalties.

Wall Street insider and New York Times columnist Andrew RossSorkin writes:

“They will pick on minor misdemeanors by individual marketparticipants,” said David Einhorn, the hedge fund manager who was among theCassandras before the financial crisis. To Mr. Einhorn, the government is “notwilling to take on significant misbehavior by sizable” firms. “But since there have been almost nobig prosecutions, there’s very little evidence that it has stopped bad actorsfrom behaving badly.”

Fraud at big corporationssurely dwarfs by orders of magnitude the shareholders’ losses of $8 billionthat Mr. Holder highlightedIf the government spent half thetime trying to ferret out fraud at major companies that it does trackingpump-and-dump schemes, we might have been able to stop the financial crisis, orat least we’d have a fighting chance at stopping the next one.

Economics professor James Galbraith says:

There will have to be full-scale investigation and cleaning up of theresidue of that, before you can have, I think, a return of confidence in the financialsector. And that's a process which needs to get underway.

No wonder Galbraith says thateconomists should move into the background, and "criminologists to theforefront"

Failure to Stop Fraud and Prosecute Criminals Causes a Loss of Trust inGovernment, Which Makes Government Less Effective

As Shiller stated in the quote above, the failure of governmentofficials to stop fraud and prosecute the financial fraudsters has caused alack of trust in government itself.

Indeed, polls show that people no longer trust our economic"leaders". See this and this.

A psychologist wrote an essay published by the Wharton Schoolof Business arguing thatrestoring trust is the key to recovery, and that trust cannot be restored untilwrongdoers are held accountable:

According to David M. Sachs, a training and supervision analyst at the Psychoanalytic Centerof Philadelphiathe crisis today is not one of confidence, but one of trust. "Abusivefinancial practices were unchecked by personal moral controls that prohibit individualcriminal behavior, as in the case of [Bernard] Madoff, and by complex financialmanipulations, as in the case of AIG." The public, expecting to beprotected from such abuse, has suffered a trauma of loss similar to that after 9/11."Normal expectations of what is safe and dependable were abruptlyshattered," Sachs noted. "As is typical of post-traumatic states,planning for the future could not be based on old assumptions about what issafe and what is dangerous. A radical reversal of how to be gratifiedoccurred."

People now feelmore gratified saving money than spending it, Sachs suggested. They havetrouble trusting promises from the government because they feel the governmenthas let them down.

He framed his argument with a fictional patient named Betty Q. Public,a librarian with two teenage children and a husband, John, who had recentlylost his job. "She felt betrayed because she and her husband had investedconservatively and were double-crossed by dishonest, greedy businessmen, and nowshe distrusted the government that had failed to protect them from corporatedishonesty. Not only that, but she had little trust in things turning aroundsoon enough to enable her and her husband to accomplish their previous goals.

"By no means a sophisticated economist, she knew ... that somepeople had become fantastically wealthy by misusing other people's money --hers included," Sachs said. "In short, John and Betty had doneeverything right and were being punished, while the dishonest people were goingunpunished."

Helping an individual recover from a traumatic experience provides auseful analogy for understanding how to help the economy recover from its owntraumatic experience, Sachs pointed out. The public will need to "hold the perpetrators of the economicdisaster responsible andtake what actions they can to prevent them from harming the economyagain." In addition, the public willhave to see proof that governmentand business leaders can behave responsibly before they will trustthem again, heargued.

Government regulators know this - or at least pay lip service to it -as well. For example, as the Director of the Securities and ExchangeCommission's enforcement division told Congress:
Recovery from the fallout of the financial crisis requires importantefforts on various fronts, and vigorous enforcement is an essential component,as aggressive and even-handed enforcement will meet the public's fairexpectation that those whose violations of the law caused severe loss andhardship will be held accountable. And vigorous law enforcement efforts willhelp vindicate the principles that are fundamental to the fair and properfunctioning of our markets: that no one should have an unjust advantage in ourmarkets; that investors have a right to disclosure that complies with thefederal securities laws; and that there is a level playing field for allinvestors.

If people don't trust their government to enforce the law, governmentwill become more and more impotent in addressing our economic problems. Ifgovernment leaders take action, the market will not necessarily respond asexpected. When government leaders make optimistic statements about the economy,people will no longer believe them.

Trying to Cover Up the Truth Extends Financial Crises

Elizabeth Warren, William Black and others say that attemptingto cover up the truth extended Japan'sfinancial problems into an entire "Lost Decade".
As Joseph Stiglitz said about WallStreet fraud:

So the whole strategy of the banks has been to hide the losses, muddlethrough and get the government to keep interest rates really low.

As long as we keep up this strategy, it's going to be a long time before theeconomy recovers ....

Pam Martens - who worked on Wall Street for 21 years - writes:

The massive losses by big Wall Street firms, now topping those of theGreat Depression in relative terms, have yet to be adequately explained. WallStreet power players are obfuscating and Congress is too embarrassed orfrightened to ask, preferring to just throw money at the problem and hope itgoes away. But as job losses and foreclosures mount and pensions and 401(k)sshrink, public policy measures to address the economic stresses require a fullset of unembellished facts...

It was four years after the crash of 1929 before the major titans of WallStreet were forced to give testimony under oath to Congress and the fullmagnitude of the fraud emerged. That delay may well have contributed to thedepth and duration of the Great Depression. The modern-day Wall Streetcorruption hearings in Congress ... must now resume in earnest and with sworntestimony if we are to escape a similar fate.

To the extent that the government tries to cover up - instead of openlydiscuss - financial fraud, it will only extend America's economic malaise.

Failing to Prosecute Fraud Encourages Financial Players to Take Biggerand More Blatantly Illegal Actions

Nobel prize winning economist George Akerlof has demonstrated thatfailure to punish white collar criminals - and instead bailing them out-creates incentives for more economic crimes and further destruction of theeconomy in the future. Joseph Stiglitz, Professor Black, and many others agree.See thisthis and this.

It was largely fraud which brought down the financial system in 2008.Unless we prosecute the fraudsters, they will do even bigger, stupider and moreblatantly illegal things in the future which will lead to even bigger crises.

Failure to Prosecute Fraud Exacerbates the Sovereign Debt Crisis

The governments of the world have spent trillions trying to paper overthe fraud and prop up the big, insolvent banks, instead of forcing them torestructure and forcing bondholders and shareholders to take a haircut.

A study of 124 banking crises by the International Monetary Fund found that proppingbanks which are only pretending to be solvent drives up the costs to thecountry:

Existing empirical research has shown that providing assistance tobanks and their borrowers can be counterproductive, resulting in increasedlosses to banks, which often abuseforbearance to take unproductive risks at government expense. Thetypical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, andeven more severe credit supply contraction and economic decline than would haveoccurred in the absence of forbearance.

Cross-country analysis to date also shows thataccommodative policy measures (such as substantial liquidity support, explicitgovernment guarantee on financial institutions’ liabilities and forbearancefrom prudential regulations) tend to be fiscallycostly andthat these particular policies do not necessarily accelerate the speed ofeconomic recovery.

All too often, central banks privilege stability over cost in the heatof the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain toprove insolvent anyway.Also, closure of a nonviable bank is often delayed for too long, even whenthere are clear signs of insolvency (Lindgren, 2003). Since bank closures facemany obstacles, there is a tendency to rely instead on blanket governmentguarantees which, if the government’s fiscal and political position makes themcredible, can work albeit at the cost of placing theburden on the budget,typically squeezing future provision of needed public services.

The American banks and government have certainly pretended that all ofthe big banks are solvent. As ABC wrote in October2009:

The Treasury Department and the Federal Reserve lied tothe American public last fall when they said that the first nine banks toreceive government bailout funds were healthy,
[the special inspector general for the Troubled Asset Relief Program]states in a new report released today.

Similarly, the stress tests were a complete and utter sham.

The government has given the giant banks huge amounts in loans andguarantees based upon their false representations about their financial health.The Fed has larded up its balance sheet with toxic assets from the banks.

Debt levels are also getting dangerously close to the level that theybecome a drag on the economy. See this and this. When Keynesianeconomists argue that debt does not harm the economy, they are talking aboutdebt incurred to pay for stimulus andproductive things for the economy. Butthrowing trillions at the giantbanks - who are mainly using the money to gamble - is not stimulus. It helps the executives of the bigbanks and their shareholders and bondholders, but not the broader economy.

Indeed, attempting to prop up big, insolvent banks is preventing stimulusfrom getting out into the economy.
Fraud Causes Growing Inequality, Which Undermines the Economy

Growing inequality is very harmful to our economy. Indeed, if wealth isconcentrated in too few hands, the "poker game" ends, as only too fewfat cats are left with all of the chips. See thisthisthis and this.

Fraud benefits the wealthy more than the poor, because the big banksand big companies have the inside knowledge and the resources to leverage fraudinto profits. Joseph Stiglitz noted in Septemberthat giants like Goldman are using their size to manipulate the market. Thegiants (especially Goldman Sachs) have also used high-frequency program trading(making up between 40- 70% of all stock trades) which not only distorts the markets,but which also lets the program trading giants take a sneak peak at what thereal traders are buying and selling, and then trade on the insider information.See thisthisthisthis and this.

Similarly, JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup,and Morgan Stanley together hold 80% of the country's derivativesrisk, and 96% of theexposure to credit derivatives. They use their dominance in themarket to manipulate the market

Fraud disproportionally benefits the big players (and helps them to become bigin the first place), increasing inequality and warping the market.

Fraud Increases the Severity of Boom-Bust Cycles

More and more people - such as the Bank of International Settlements and Barons - are sayingthat bubbles inevitably lead to busts, thus destabilizing the economy.

Professor Black says that fraud isa large part of themechanism through which bubbles are blown.

Without strong laws against fraud, bubble after bubble will be blown,guaranteeing that the financial system cannot be stabilized in a fundamentalsense.

Failure to Prosecute Fraud Is Worsening the Housing Crisis

Finally, failure to prosecute mortgage fraud is arguably worsening thehousing crisis. See this and this.

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