If you look hard enough, you can find a lot of silliness in the Occupy Wall Street movement. This is unfortunate because, somewhere behind the tents and weird finger communications and alleged drug use, there’s a real story to be told. And the story seems to be bigger than the media can get its arms around.
For example? Financial insiders and those of us in the financial planning profession have watched the brokerage industry fight furiously – and successfully – against having to register their brokers with the Securities and Exchange Commission as registered investment advisors. Why? Because that would require the registered brokers to give advice that puts the interests of their customers ahead of their own and also (quel horreur!) ahead of the companies that employ them.
Perhaps more to the point, those of us in the financial profession have to live with the fact that the major Wall Street firms are rarely held accountable for crimes and other actions that would be severely punished if you or I committed them.
Such as? Consider the recent settlement of an enforcement case that goes back to the 2008 market meltdown. The Wall Street Journal reported that U.S. District Court Judge Jed S. Rakoff is questioning how diligently the U.S. Securities and Exchange Commission enforced securities law when it investigated Citigroup (parent company of brokerage giant Smith Barney) regarding its sale of some of those infamous toxic mortgage-based debt instruments. Smith Barney brokers were selling the subprime mortgage instruments to their customers as highly-rated, safe bond instruments at the same time that the company’s traders were betting heavily that the same packaged bonds would spiral down the toilet. In internal e-mails, one chortling trader described betting against the investments the company was selling, at a commission, to its customers as “The best short ever!!”
This once-in-a-lifetime short bet, combined with selling the dog investments in the first place, resulted in what the SEC estimated to be $160 million in fees and trading profits to Citigroup’s bottom line.
The SEC’s proposed fine, questioned by the judge: $95 million.
It gets worse. In the SEC’s boilerplate language when it settled with major Wall Street firms, Citigroup and Smith Barney were allowed to neither admit nor deny the charges that they would be paying fines to settle. Judge Rakoff questioned whether there wasn’t “an overriding public interest in determining whether the SEC’s charges are true.” Indeed. Somehow, the SEC did not think there was.
Even more egregious, Federal prosecutors have ended a criminal investigation of Countrywide Financial Corp co-founder Angelo Mozilo without bringing any charges. Countrywide Financial Corp sold at least $97 billion worth of subprime loans from 2005 to 2007 (a 2 year period) per the Center for Public Integrity. During this same time, according to the Federal Reserve, approximately 40% of the subprime loans sold were fraudulent and many of the 60% of the borrowers of non-fraudulent loans were steered to subprime when their credit would have allowed them to have a standard, lower interest loan per SEC charges against Countrywide. The loss to the taxpayers on these loans was close to $50 billion as part of the larger bailout, and the income to Countrywide was $1.8 billion per filings with the Treasury. In 2007 Mozilo’s income from Countrywide was $121.5 million while Countrywide lost $704 million. Upon selling Countrywide to Bank of America he received $1.9 million in salary, $20 million in stock awards, $176,513 in other compensation, $44,454 for personal use of the corporate jet, $8,581 for country club fees and $23,755 for personal use of an automobile. The SEC fined Mozilo a record amount of $73 million for fraud in a settlement. Of that amount, Mozilo was required to personally pay $22.5 million. Not a bad deal. He is allowed to keep the $121 million earned in 2007 and the $22 million earned in 2008 in compensation and pay back $22.5 million in penalties. To me, that is the lightest slap on the wrist the government could give. The Enron, Worldcom and Drexel scandals all required jail time and forced the executives into bankruptcy. How things have changed!
Our regulators’ very careful, very gentle admonishment of Wall Street’s nastiest crimes has become such a routine part of our professional landscape that most of us in the financial services business have lost sight of how outrageous it really is. We here at Colman Knight have not, and desire to make you aware of the outrage that is occurring! To put this in perspective, suppose you decided to go out and steal a neighbor’s 60″ flat-screen TV set. If you were caught, would the justice system require you to pay back enough to cover a 10″ flat screen TV and allow you to keep the 60″ one, never have to admit guilt, and promise to watch yourself more carefully in the future?
Might people in all walks of life behave differently if they knew that the routine consequences of their crimes would be so lenient? So the problem in Wall Street and with the government is not that we do not have enough regulation – we do. The problem is that the enforcing agencies – the SEC and Federal Reserve in this case – are not enforcing the law against Wall Street Firms. The effect of preying upon people with good credit but poor financial acumen results in continued poverty and illegal enrichment of executives such as Angelo Mozilo, who did more harm than the infamous Bernie Madoff but is not as widely recognized. Bernie Madoff stole an estimated $16 billion in his Ponzi scheme while Mozilo caused a $400 governmental bailout for Countrywide (per Senator Dodd) in addition to the almost $50 billion loss to individuals who qualified for non-subprime loans.
While the financial press is reporting on Wall Street crimes gone unpunished, the consumer press is groping to figure out how the rise of enormous, greedy financial gatekeepers is impacting the American economy as a whole. No doubt you’ve read accounts of how the large investment banks took hundreds of billions of dollars in taxpayer bailout money and then refused to lend money back into the American economy as it was teetering on the brink. But Time magazine recently took a deeper look, in a cover article that concludes that America is no longer the world’s leader in upward mobility – the land of opportunity – that it once was.
The magazine rightly calls America the “original meritocracy,” where people were never supposed to be prisoners of the circumstances of their birth. Hard work defined the destiny of Americans. Those who were diligent were able to move out of poverty. With a lender preying upon them such as Countrywide, no wonder the reduction in US upward mobility has occurred.
Time magazine cites research by the Pew Charitable Trust’s Economic Mobility Project, the Brookings Institute and the Organization for Economic Co-operation and Development, all of whom found that today it is harder for a person in America to move up out of his/her current economic status than it is in (I hope you’re sitting down) Europe. Today, 42% of American men with fathers in the bottom fifth of the earning curve remain there – and you know that at least SOME of them were hard-workers. Only a quarter of comparable men in Denmark and Sweden, and only 30% of men in Great Britain do. France and Germany ranked higher on the opportunity scale than today’s America. Sweden and Finland ranked much higher.
How did this happen? The magazine found that the financial sector in America now takes up about 8% of the American economy – a historic high – and this has been correlated with a stall in American entrepreneurship. We wonder how much of the growth in the financial sector came at the cost of preying upon vulnerable people, and how much of the stall in entrepreneurship comes from unnecessarily high lending rates. With the insufficient sanctions raised against CEOs such as Mozelo, is there any wonder that the ability of the US to grow its way out of this economic mess is stalled? Our regulatory agencies are protecting large organizations and their leaders at the expense of the very people they are supposed to protect.
To round out the Occupy Wall Street picture, some researchers are actually starting to question whether the economy needs the banking sector, and what for. In what may be the most accessible report on this wonkish debate, London School of Economics professor Wouter den Haan notes that when the U.S. economy was emerging as the world’s leader, in the decades after World War II, the large investment banks generated about 1.5% of the total profits in the economy. Today, that figure is around 15% – ten times as much. During those periods, the regulators seemed to be able to protect borrowers and keep a tighter rein on rogue bankers. No wonder some economists are wondering whether the financial sector is too influential in our current society.
When the profits were at 1.5%, bankers circulated money efficiently around the business landscape in the form of loans that were carefully researched. That, clearly, provided an enormous net value to society. But the professor wonders whether it was equally valuable when those firms began to extract “huge fees from the rest of the economy to construct opaque securities that were so complex that only a few understood how risky they were.” If the prices had accurately reflected the true value of the products, he says, those fees would have been negative, “since many such products were not beneficial to the buyer or to society as a whole.”
The article doesn’t consider the economic costs to society when a brokerage firm makes its profits betting against the toxic securities it created and sold to its customers.
Very few of these various issues are understood specifically by the people who are squabbling with police over whether they can pitch their tents in parks near the largest financial offices. The Occupy Wall Street crowd is acting on nothing more than a strong instinct that something is terribly wrong in America, and that the large banks are somehow at the center of the problem. The press can only seem to get its arms around small individual pieces of a very big picture. Nowhere, except maybe here, are we discussing the complicity of the SEC, Congress and the banking regulators as well as the financial self-regulating boards such as FINRA. All of these entities should have had a hand in reining in the excesses of Countrywide, yet somehow, even when the abuse came to light, the agencies could do no more than let a man walk away with more than $100 million in compensation in excess of what he paid in fines. At least Bernie Madoff is doing jail time.
That picture, if we can see it clearly, is troubling. The American Dream is at stake. So, too, is the fairness of our legal system. Currently, our system relies upon the financial firms being allowed to hire representatives who give advice that primarily benefits their employers and often exploits their customers which goes against the purpose of the 1940 Securities and Exchange Act. By requiring all financial advisors to act in the best interest of the customer (as required by the Frank Dodd Act), there would be an end to both the lucrative sales of creative new toxic securities and the revenue streams that would come from betting against them. Brokerage firms, insurance companies and banks are vigorously trying to eliminate that portion of the act.
If we can start the debate in earnest about accountability, and regulatory institutions being required to protect the public rather than financial institutions, maybe the tents can come down. Or, at least, the people living in them could tell the reporters who cover them exactly what it is they’re protesting.
If your interest and concern are peaked upon reading this article – or any others for that matter – please forward it to your friends and family and anyone you believe would benefit from gaining a broader view of the financial system.
Rakoff and the SEC: http://blogs.wsj.com/law/2011/10/28/sec-may-have-to-get-admissions/
Time magazine article: http://www.time.com/time/magazine/article/0,9171,2098586,00.html
Wouter den Haan blog: http://pragcap.com/why-do-we-need-a-financial-sector
