Manhattan district court judge Jed S. Rakoff, speaking at an unknown location
Possibly as an aftereffect of his symbiosis with the Beard of Reason, federal district court judge Jed Rakoff has blocked a settlement between the SEC and Citibank on the grounds that he has no way of determining whether the agreement was “fair, reasonable, adequate and in the public interest.” The answers to his questions are define “fair,” not really and nope. At issue in the case is whether the banking giant committed fraud when it assembled a $1 billion mortgage fund from high-risk loans that it then sold to clients, even as it shorted* the fund in its own investments. The SEC alleges that Citibank failed to inform investors that the mortgages in the fund had been deliberately selected to fail. As it often does, the federal enforcement agency agreed to let Citibank settle the case without admitting or denying any fault. Judge Rakoff, however, does not play that.
Citibank made $160 million in the 2007 deal, while its investors lost $700 million. It was similar to the Abacus Fund fiasco at Goldman Sachs, in 
which the “Fabulous” Fabrice Tourre publicly touted and privately shorted a bundle of subprime mortgages that, to use a term from technical finance, ate shit. The difference is that Tourre had to go before a Congressional subcommittee and admit that he was a misrepresentation artist with bitch hair, whereas Citibank got to settle without acknowledging any actual wrongdoing.
That’s good for the banking giant, since an acknowledgement of fraud or other such practices could be used against it in lawsuits from investors. As it is, the SEC settlement leaves Citibank immune from future prosecutions and lawsuits. For $285 million, that’s not a bad deal. As you might imagine, 2007 was kind of a tricky year for the bank, but it still made profits north of $10 billion. In that context, a 2.8% fraud surcharge starts to look like the cost of doing business, which is not the kind of attitude the SEC was designed to foster.
Of course, Citibank also has to promise not to do anything like that ever again. It’s actually done so several times as part of previous SEC settlements, but they have yet to be charged with contempt of court. Rakoff referred to Citibank as a “recidivist” offender on this count, arguing that the company agreed to those terms because it knew they would not be enforced. Basically, Citibank doesn’t have to admit that it did anything wrong and promises not to do wrong in the future, although if it gets caught by the SEC it won’t have to admit it did anything wrong. If you’re wondering how well this approach to law enforcement works, consider this quote from the Times:
A recent analysis by The New York Times of the agency’s fraud settlements with Wall Street firms found 51 instances, involving 19 companies, in which the agency claimed that a company had broken fraud laws that they previously had agreed never to breach.
It’s almost as if a promise from the accused were not a reliable basis on which to settle fraud allegations. Aside from the fine, Citibank suffers no real consequences from its successful defrauding of its own investors. Those investors, meanwhile, are free to look for their $700 million on the job market. Rakoff’s decision to reject this settlement is news not because of the obvious injustice of the system but rather its consistency. The SEC has been settling cases this way forever, in a way that actively makes regulatory enforcement more difficult by preventing the establishment of case law.
This problem—that SEC settlements make cases go away without establishing what actually happened—is what galled Rakoff, who said that the practice “asks the court to employ its power and assert its authority when it does not know the facts.” Seen in this light, the SEC approach to settlement amounts to little more than a public bribe. Citibank gives the SEC $285 million. It does not have to be pronounced guilty or innocent; it does not see any of its activities entered into the judicial record, and it will not suffer any additional consequences if it does the same thing again later. Basically, it pays the SEC to make fraud charges go away.
That is why it is awesome that Judge Rakoff refused to sign off on the Citibank SEC settlement. It’s also why people are pissed. “[This is] a case for which there is no direct precedent,” said Harvey Pitt. “Courts have been approving settlements by government agencies without any admissions of wrongdoing for years.” Pitt should know, since he is the former chairman of the SEC. Now he is chief executive at Kalorama Partners, a Washington lobbying firm that advocates on behalf of the financial industry. Imagine, for a moment, that this story is about the Gambino crime family settling a case with the Department of Justice. Imagine that one of the Gambinos’ lawyers is the former head of the FBI. How do you feel about your federal government?
Great post throughout. Even though I know to expect it, you always* get me with the caption and with the final sentence.
*most of the time
The SEC is a joke. I recommend Matt Taibbi’s piece on their general suckiness. They would allow companies accused of fraud to investigate themselves and decide their punishment. Taibbi compares it to the LAPD allowing the Crips to investigate a drive-by shooting.
Oh, and if they decided there wasn’t enough evidence to launch a full, in-depth investigation, they would destroy all the documents of the initial report.
After this came out on Monday, Mary Schapiro (SEC “Chairman”) wrote to Jack Reed asking for statutory changes so that the SEC could fine offending institutions more than they’re allowed to currently.
Instead of just forcing banks to disgorge ill-gotten earnings in cases like Citi’s, the SEC could fine them triple that. She also asked that the SEC be allowed to take investor losses into account when assessing penalties. This would have made Citi’s liability over this fraudulent CDO way heftier, but it TOTALLY MISSES RAKOFF’S POINT.
When a Crip gang bangs, he’s directly harming members of society. Punishment for him entails immediate removal from society and ostensibly an immediate gain for society. Financial firms are quite different in their impact. They facilitate the flow of capital around the market, enabling businesses to be invested in and people to retire (while funding those businesses). The complicated stuff like derivatives enable firms to reduce their exposure by collateralizing their debt, creating a sort of financial safety net not unlike social security which has obvious stabilizing value for society. Without those firms performing this role capitalism as an institution basically stops. Efficiency decreases and impoverishes us all. Think Feudalism. Citibanks and other firms are a good thing for society, sometimes just too good. The investment and derivatives always carry risk, and occasionally that blows up in our faces. Too much medicine is usually lethal as well, but the pharmaceutical industry doesn’t catch the same kind of populist ire that the financial industry has.
Though not quite perfect, the Gambinos are a little more apt of an analogy to the financial system. Organized crime is a parasite on the economy, but not a clear and present danger the way the average Crip is. I just watched The Godfather and am now aware of how many jobs gambling, prostitution, and racketeering actually create (that movie had almost a million characters). And the way those characters speak reveals a sort of limited toleration by authorities. They’re too scared to wage open war on other families because that would present a clear and present danger, thus necessitate a response by authority. Similarly, if you blow up our economy you’re gonna get regulated. But unless that’s happening we’ll place nice, because you’re not a Crip.
I understand that letting a firm fine itself violates our sense of justice, but I also understand how little I know about financial securities and details of how capital flows through the economy. For instance, the word capital has no meaning to me. Whenever I see it I just substitute money and keep on going. My lack of expertise gives me pause before calling for blood.
I also don’t apply any sense of justice to an astrophysicist studying planetary formation, even though the grant funding his research costs some taxpayer or investor money. I don’t know what aspects of planetary formation are promising, if the specific astrophysicist is the best guy for the job, or even what the consequences of his success would be. It’s too complicated for my primitive evolutionary psychology sense of justice. This is true for the financial industry as well, right? So I don’t understand how people feel so comfortable prescribing punishments for a system they don’t understand either, and this provides insight as to why some SEC policies may exist. We would hope they’re just as knowledgeable as the people they regulate, but astonishingly, and I mean that sincerely, they appear not to be.
I’m not suggesting there is no room for moral indignation towards the financial industry and it’s failed regulators; there is. I just don’t think that uninformed moral indignation is useful when trying to find the solution. But if something is going to blow up in my face I much prefer it to be too many low-income people getting financed into owning property than a gun. It’s unreasonable to compare the financial industry to a Crip or Gambino. One forms of robbery is much worse than the other. One is medicine, the other is poison.
“Financial firms are quite different in their impact. They facilitate the flow of capital around the market, enabling businesses to be invested in and people to retire (while funding those businesses). The complicated stuff like derivatives enable firms to reduce their exposure by collateralizing their debt, creating a sort of financial safety net not unlike social security which has obvious stabilizing value for society.”
LOLOLOLOLOL
Yo, Attempt #1, Dan’s post today seems to be quite INFORMED indignation. If he’s faking an understanding of financial regulation, he’s faking it extremely well.
I think he makes a good point, though, about the breakdown of the analog between Citibank and the Gambinos. One is engaged in moneymaking activities that are fundamentally illegal, while the other is engaged in moneymaking activities that it sometimes does in illegal ways. It’s worth noting, too, that while the fraud charge brought by the SEC is a criminal offense, the misrepresentation claim that defrauded investors might make in lawsuits is a civil offense.
My problem with the SEC’s settlement policy is that it robs investors of the chance to file that civil suit. By allowing Citibank/Citigroup to settle the fraud charge without admitting guilt or claiming innocence—and thereby without establishing a body of evidence in court—the SEC is essentially selling Citi indemnity again lawsuits from the people it defrauded. Here is where one of the many actual lawyers who read Combat! blog would be able to shed more light than I, but it seems as if the SEC’s method of regulating the financial industry is actually undermining a potential free-market source of regulation.
Moral indignation is an idea I’m pulling from wider discourse about the financial industry (see Inside Job, Occupy Wallstreet) . Dan’s opinion on this judge’s ruling wasn’t outrageous. I do think the customary analogy of industry insiders to thugs is a bit excessive, but Dan’s was a bit better than most.
As per the comparison to astrophysics, I think the standard for “informed” regarding the financial industry is much higher than it is on many other policy issues. That’s what financial regulators say anyway. They might just be proffering a fucked up defense of the incestuous relationships between the industry and it’s themselves, but it also might be true. I’m quick to point out that from where I sit I have no ability to evaluate that statement and I wager the majority of commentators on the internet are sitting in the same arm chairs. This reminder isn’t for Dan specifically to heed, it was just part of sharing my opinion.
But isn’t the problem with CDO and other “exotic” instruments that, by providing banks with ways of trimming their risk, they completely pervert the incentives that should be built into a market.
When a mortgage broker can sell any mortgage no matter the structure to Citi, and Citi can package this up (with the help of an investment bank), and sell it to whomever, the risks inherent to this lending are completely masked, and the incentives are all fucked up. There’s no incentive to examine the risks inherent to mortgage lending, especially when the assumption of the era was that real estate ALWAYS appreciates.
So these mortgage backed CDOs were already fucking up the functioning of our economy, creating places like Phoenix and Las Vegas, both of which are nothing if not a direct affront to God.
It’s hard to make an argument for the economic value of complex instruments that misdirect capital in such vast amounts.