The JPMorgan Chase settlement this week—the bank is tentatively set to pay the U.S. government $13 billion for faulty mortgage practices in the run-up to the 2007 financial crisis—is the biggest settlement ever reached between a single company and the government, making up nearly half last year’s income for the bank. It may be a blueprint for punishing other Wall Street giants, and holding an institution accountable for bad loans that caused the recession has a certain cathartic feel. Problem is, little hard evidence shows that such settlements deter bad behavior—and anecdotal evidence says they don’t.
Using settlements as a deterrent has two big shortcomings: First, they usually affect shareholders, not the culpable employees. This can be effective if the shareholders are galvanized to demand changes at the bank, but that’s hard to accomplish in firms like JPMorgan and its peers, which have large and diverse shareholder groups that don’t always coalesce around a single goal.
Second, there’s the question of size. Thirteen billion dollars is a record, but no one’s talking about the end of JPMorgan. In 2008, German engineering firm Siemens paid fines totaling $1.6 billion for bribing foreign government officials to the tune of $1.4 billion (presumably not at a 1:1 ratio for the rewards they got). So, as Gregory Gilchrist, a law professor at the University of Toledo who has studied banks and crime, explains: A future rational actor might say, OK, if there’s a 10 percent chance we get caught, that $1.6 billion is really more like $160 million. The equation spits out over $1.2 billion profit for the company.
On the other hand, if penalties cripple or bankrupt a firm, there’s a fairness problem. Tens of thousands of employees lost their jobs when accounting firm Arthur Andersen went out of business in the wake of the Enron scandal. Not all of them helped Enron executives commit fraud, but reports at the time said the newly jobless employees of both companies struggled to find work due to their firms’ tarnished reputations. It’s a problem of collective justice. More than one person who works on corporate governance and white-collar criminal cases made the connection in interviews with National Journal to the old gun joke: Banks don’t commit crimes—certain bankers do.
Legal and financial-industry experts agree that pursuing individual employees is a more effective deterrent. William Black, a white-collar criminologist who investigated the savings-and-loan crisis of the 1980s and 1990s, testified to the Senate Judiciary Committee on Wall Street fraud in 2010: “Only prison sentences can deter the violations that caused the debacle.” That and regulation are the best ways to impede white-collar criminals who use perverse incentives to “twist … private market discipline into an immoral force that harmed markets.” Yet the Justice Department and the Securities and Exchange Commission have rarely pursued top officials in the wake of the recent financial crisis.
An example from the past suggests that government officials can scare Wall Street straight with the threat of hard time. Investment firm Drexel Burnham Lambert collapsed in 1990 under investigations into its work in the junk-bond market. The $650 million SEC settlement removed Michael Milken, the head of the firm’s high-yield and convertible-bonds department, from power. He was later sentenced to 10 years in prison. “The SEC was more feared [after that],” says John Coffee, a Columbia University law professor who studies white-collar crime. “For a period of time, we saw insider trading as being seen as very dangerous behavior—career-ending.”
The problem is that financial transactions can be tough to comb through, and proving an intent to do wrong in a sea of emails and transactions is still harder. The number of pages of evidence in the digital age can run to the millions—difficult for even an entire law firm to look over, page by page. For agencies looking to hold someone accountable, and quickly, it’s easy to see why they go for lower-hanging fruit (one prominent example is Fabrice “Fabulous Fab” Tourre, a bond trader at Goldman Sachs who was found liable this summer for fraud) or skip this step altogether.
Crucially, the tentative settlement with JPMorgan leaves the door open to criminal convictions. But for now, perhaps the happiest possibility is that the settlement changes the culture at JPMorgan and beyond. Spokesmen for Citigroup and Goldman Sachs declined to comment on whether government pacts like JPMorgan’s affect the way their firms look at risk or compliance. But when HSBC was under investigation for money laundering last year, it implemented changes in its compliance department, which were itemized in the deferred prosecution agreement filed in December. It’s a defensive move for the banks, but it makes a difference.
This article appears in the October 26, 2013 edition of National Journal Magazine as Bad Medicine.