Several of the world’s largest banks are known to have committed large-scale fraud. Why have we done so little about it?

July 16, JDN 2457951

In 2014, JPMorgan Chase paid a settlement of $614 million for fraudulent mortgage lending contributing to the crisis; but this was spare change compared to the $16.5 billion Bank of America paid in settlements for their fradulent mortgages.

In 2015, Citibank paid $700 million in restitution and $35 million in penalties for fraudulent advertising of “payment protection” services.

In 2016, Wells Fargo paid $190 in settlements for defrauding their customers with fake accounts.

Even PayPal has paid $25 million in settlements over abuses of their “PayPal Credit” system.
In 2016, Goldman Sachs paid $5.1 billion in settlements over their fraudulent sales of mortgage-backed securities.
But the worst offender of course is HSBC, which has paid $2.5 billion in settlements over fraud, as well as $1.9 billion in settlements for laundering money for terrorists. The US Justice Department has kept their money-laundering protections classified because they’re so bad that simply revealing them to the public could result in vast amounts of criminal abuse.
These are some of the world’s largest banks. JPMorgan Chase alone owns 8.0% of all investment banking worldwide; Goldman Sachs owns 6.6%; Citi owns 4.9%; Wells Fargo 2.5%; and HSBC 1.8%. That means that between them, these five corporations—all proven to have engaged in large-scale fraud—own almost one-fourth of all the world’s investment banking assets.

What shocks me the most about this is that hardly anyone seems to care. It’s seen as “normal”, as “business as usual” that a quarter of the world’s investment banking system is owned by white-collar criminals. When the issue is even brought up, often the complaint seems to be that the government is being somehow overzealous. The Economist even went so far as to characterize the prosecution of Wall Street fraud as a “shakedown”. Apparently the idea that our world’s most profitable companies shouldn’t be able to launder money for terrorists is just ridiculous. These are rich people; you expect them to follow rules? What is this, some kind of democracy?

Is this just always how it has been? Has corruption always been so thoroughly infused with finance that we don’t even know how to separate them? Has the oligarchy of the top 0.01% become so strong that we can’t even bring ourselves to challenge them when they commit literal treason? For, in case you’ve forgotten, that is what money-laundering for terrorists is: HSBC gave aid and comfort to the enemies of the free world. Like “freedom” and “terrorism”, the word “treason” has been so overused that we begin to forget its meaning; but one of the groups that HSBC gladly loaned money to is an organization that has financed Hezbollah and Al-Qaeda. These are people that American and British soldiers have died fighting against, and when a British bank was found colluding with them, the penalty was… a few weeks of profits, no personal responsibility, and not a single day of prison time. The settlement was in fact less than the profits gained from the criminal enterprise, so this wasn’t even a fine; it was a tax. Our response to treason was to impose a tax.

And this of course was not the result of some newfound leniency in American government in general. No, we are still the nation that imprisons 700 out of every 100,000 people, the nation with more prisoners than any other nation on Earth. Our police officers still kill young Black men with impunity, including at least three dozen unarmed Black men every year, many of them for no apparent reason at all. (The precise number is still unknown, as the police refuse to keep an official database of all the citizens they kill.) Decades of “law and order” politicians promising to stop the “rising crime” (that is actually falling) have made the United States very close to a police state, especially in poor neighborhoods that are primarily inhabited by Black and Hispanic people. We don’t even have an especially high crime rate, except for gun homicides (and that because we have so many guns, also more than any other nation on Earth). We are, if anything, an especially vindictive society, cruel, unforgiving, and violent towards those we perceive as transgressors.

Except, that is, when the criminals are rich. Even the racial biases seem to go away in such circumstances; there is no reasonable doubt as to the guilt of O.J. Simpson or Bill Cosby, but Simpson only ended up in prison years later on a completely unrelated offense, and after Cosby’s mistrial it’s unclear if he’ll ever see any prison time. I don’t see how either man could have been less punished for his crimes had he been White; but can anyone seriously doubt that both men would be punished more had they not been rich?

I do not think that capitalism is an irredeemable system. I think that, in themselves, free markets are very useful, and we should not remove or restrict them unnecessarily. But capitalism isn’t supposed to be a system where the rich can do whatever they want and the poor have to accept it. Capitalism is supposed to be a system where everyone is free to do as they choose, unless they are harming others—and the rules are supposed to be the same for everyone. A free market is not one where you can buy the right to take away other people’s freedom.

Is this just some utopian idealism? It would surely be utopian to imagine a world where fraud never happens, that much is true. Someone, somewhere, will always be defrauding someone else. But a world where fraud is punished most of the time? Where our most powerful institutions are still subject to the basic rule of law? Is that a pipe dream as well?

What really happened in Greece

JDN 2457506

I said I’d get back to this issue, so here goes.

Let’s start with what is uncontroversial: Greece is in trouble.

Their per-capita GDP PPP has fallen from a peak of over $32,000 in 2007 to a trough of just over $24,000 in 2013, and only just began to recover over the last 2 years. That’s a fall of 29 log points. Put another way, the average person in Greece has about the same real income now that they had in the year 2000—a decade and a half of economic growth disappeared.

Their unemployment rate surged from about 7% in 2007 to almost 28% in 2013. It remains over 24%. That is, almost one quarter of all adults in Greece are seeking jobs and not finding them. The US has not seen an unemployment rate that high since the Great Depression.

Most shocking of all, over 40% of the population in Greece is now below the national poverty line. They define poverty as 60% of the inflation-adjusted average income in 2009, which works out to 665 Euros per person ($756 at current exchange rates) per month, or about $9000 per year. They also have an absolute poverty line, which 14% of Greeks now fall below, but only 2% did before the crash.

So now, let’s talk about why.

There’s a standard narrative you’ve probably heard many times, which goes something like this:

The Greek government spent too profligately, heaping social services on the population without the tax base to support them. Unemployment insurance was too generous; pensions were too large; it was too hard to fire workers or cut wages. Thus, work incentives were too weak, and there was no way to sustain a high GDP. But they refused to cut back on these social services, and as a result went further and further into debt until it finally became unsustainable. Now they are cutting spending and raising taxes like they needed to, and it will eventually allow them to repay their debt.

Here’s a fellow of the Cato Institute spreading this narrative on the BBC. Here’s ABC with a five bullet-point list: Pension system, benefits, early retirement, “high unemployment and work culture issues” (yes, seriously), and tax evasion. Here the Telegraph says that Greece “went on a spending spree” and “stopped paying taxes”.

That story is almost completely wrong. Almost nothing about it is true. Cato and the Telegraph got basically everything wrong. The only one ABC got right was tax evasion.

Here’s someone else arguing that Greece has a problem with corruption and failed governance; there is something to be said for this, as Greece is fairly corrupt by European standards—though hardly by world standards. For being only a generation removed from an authoritarian military junta, they’re doing quite well actually. They’re about as corrupt as a typical upper-middle income country like Libya or Botswana; and Botswana is widely regarded as the shining city on a hill of transparency as far as Sub-Saharan Africa is concerned. So corruption may have made things worse, but it can’t be the whole story.

First of all, social services in Greece were not particularly extensive compared to the rest of Europe.

Before the crisis, Greece’s government spending was about 44% of GDP.

That was about the same as Germany. It was slightly more than the UK. It was less than Denmark and France, both of which have government spending of about 50% of GDP.

Greece even tried to cut spending to pay down their debt—it didn’t work, because they simply ended up worsening the economic collapse and undermining the tax base they needed to do that.

Europe has fairly extensive social services by world standards—but that’s a major part of why it’s the First World. Even the US, despite spending far less than Europe on social services, still spends a great deal more than most countries—about 36% of GDP.

Second, if work incentives were a problem, you would not have high unemployment. People don’t seem to grasp what the word unemployment actually means, which is part of why I can’t stand it when news outlets just arbitrarily substitute “jobless” to save a couple of syllables. Unemployment does not mean simply that you don’t have a job. It means that you don’t have a job and are trying to get one.

The word you’re looking for to describe simply not having a job is nonemployment, and that’s such a rarely used term my spell-checker complains about it. Yet economists rarely use this term precisely because it doesn’t matter; a high nonemployment rate is not a symptom of a failing economy but a result of high productivity moving us toward the post-scarcity future (kicking and screaming, evidently). If the problem with Greece were that they were too lazy and they retire too early (which is basically what ABC was saying in slightly more polite language), there would be high nonemployment, but there would not be high unemployment. “High unemployment and work culture issues” is actually a contradiction.

Before the crisis, Greece had an employment-to-population ratio of 49%, meaning a nonemployment rate of 51%. If that sounds ludicrously high, you’re not accustomed to nonemployment figures. During the same time, the United States had an employment-to-population ratio of 52% and thus a nonemployment rate of 48%. So the number of people in Greece who were voluntarily choosing to drop out of work before the crisis was just slightly larger than the number in the US—and actually when you adjust for the fact that the US is full of young immigrants and Greece is full of old people (their median age is 10 years older than ours), it begins to look like it’s we Americans who are lazy. (Actually, it’s that we are studious—the US has an extremely high rate of college enrollment and the best colleges in the world. Full-time students are nonemployed, but they are certainly not unemployed.)

But Greece does have an enormously high debt, right? Yes—but it was actually not as bad before the crisis. Their government debt surged from 105% of GDP to almost 180% today. 105% of GDP is about what we have right now in the US; it’s less than what we had right after WW2. This is a little high, but really nothing to worry about, especially if you’ve incurred the debt for the right reasons. (The famous paper by Rogart and Reinhoff arguing that 90% of GDP is a horrible point of no return was literally based on math errors.)

Moreover, Ireland and Spain suffered much the same fate as Greece, despite running primary budget surpluses.

So… what did happen? If it wasn’t their profligate spending that put them in this mess, what was it?

Well, first of all, there was the Second Depression, a worldwide phenomenon triggered by the collapse of derivatives markets in the United States. (You want unsustainable debt? Try 20 to 1 leveraged CDO-squareds and one quadrillion dollars in notional value. Notional value isn’t everything, but it’s a lot.) So it’s mainly our fault, or rather the fault of our largest banks. As far as us voters, it’s “our fault” in the way that if your car gets stolen it’s “your fault” for not locking the doors and installing a LoJack. We could have regulated against this and enforced those regulations, but we didn’t. (Fortunately, Dodd-Frank looks like it might be working.)

Greece was hit particularly hard because they are highly dependent on trade, particularly in services like tourism that are highly sensitive to the business cycle. Before the crash they imported 36% of GDP and exported 23% of GDP. Now they import 35% of GDP and export 33% of GDP—but it’s a much smaller GDP. Their exports have only slightly increased while their imports have plummeted. (This has reduced their “trade deficit”, but that has always been a silly concept. I guess it’s less silly if you don’t control your own currency, but it’s still silly.)

Once the crash happened, the US had sovereign monetary policy and the wherewithal to actually use that monetary policy effectively, so we weathered the crash fairly well, all things considered. Our unemployment rate barely went over 10%. But Greece did not have sovereign monetary policy—they are tied to the Euro—and that severely limited their options for expanding the money supply as a result of the crisis. Raising spending and cutting taxes was the best thing they could do.

But the bank(st?)ers and their derivatives schemes caused the Greek debt crisis a good deal more directly than just that. Part of the condition of joining the Euro was that countries must limit their fiscal deficit to no more than 3% of GDP (which is a totally arbitrary figure with no economic basis in case you were wondering). Greece was unwilling or unable to do so, but wanted to look like they were following the rules—so they called up Goldman Sachs and got them to make some special derivatives that Greece could use to continue borrowing without looking like they were borrowing. The bank could have refused; they could have even reported it to the European Central Bank. But of course they didn’t; they got their brokerage fee, and they knew they’d sell it off to some other bank long before they had to worry about whether Greece could ever actually repay it. And then (as I said I’d get back to in a previous post) they paid off the credit rating agencies to get them to rate these newfangled securities as low-risk.

In other words, Greece is not broke; they are being robbed.

Like homeowners in the US, Greece was offered loans they couldn’t afford to pay, but the banks told them they could, because the banks had lost all incentive to actually bother with the question of whether loans can be repaid. They had “moved on”; their “financial innovation” of securitization and collateralized debt obligations meant that they could collect origination fees and brokerage fees on loans that could never possibly be repaid, then sell them off to some Greater Fool down the line who would end up actually bearing the default. As long as the system was complex enough and opaque enough, the buyers would never realize the garbage they were getting until it was too late. The entire concept of loans was thereby broken: The basic assumption that you only loan money you expect to be repaid no longer held.

And it worked, for awhile, until finally the unpayable loans tried to create more money than there was in the world, and people started demanding repayment that simply wasn’t possible. Then the whole scheme fell apart, and banks began to go under—but of course we saved them, because you’ve got to save the banks, how can you not save the banks?

Honestly I don’t even disagree with saving the banks, actually. It was probably necessary. What bothers me is that we did nothing to save everyone else. We did nothing to keep people in their homes, nothing to stop businesses from collapsing and workers losing their jobs. Precisely because of the absurd over-leveraging of the financial system, the cost to simply refinance every mortgage in America would have been less than the amount we loaned out in bank bailouts. The banks probably would have done fine anyway, but if they didn’t, so what? The banks exist to serve the people—not the other way around.

We can stop this from happening again—here in the US, in Greece, in the rest of Europe, everywhere. But in order to do that we must first understand what actually happened; we must stop blaming the victims and start blaming the perpetrators.