Let's Talk About: Putting Banksters In Prison

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A bank is basically a collection of thousands of random variables, squirming around. Sometimes they squirm themselves over a boundary beyond which the assets are worth less than the liabilities, or whatever, and then your bank fails. That sucks! But it happens; random variables will do that to you. Sometimes.

Is that description kind of bullshit? Oh, sure, I mean, you get to pick your assets and decide on your leverage and your mix of businesses and your risk limits and so forth, and in most conditions a modestly competent banker should be able to avoid bankruptcy with a high degree of certainty. But it's not entirely bullshit; even the most careful banker really is always sitting on top of a squirming pile of random variables and, while they're probably pretty far away from the insolvency boundary, there's always a chance that they'll squirm their way right over it before he can stop them. That, again, is what they do. Sometimes.

Anyway "British lawmakers are calling for criminal prosecutions of senior bankers who cause the collapse of financial institutions," which is sort of charming? Parliament's Tyrie Reportcalls for "a new criminal offence of reckless misconduct in the management of a bank," and would be "be pursued in cases involving only the most serious of failings, such as where a bank failed with substantial costs to the taxpayer, lasting consequences for the financial system, or serious harm to customers." One question you might ask is, if you blew up a giant British bank with substantial costs to the taxpayer, how sympathetic would people be to a defense of "I did everything right, but you know how random variables are"?1 By "people" I mean "jurors" obviously.

Other questions abound. One is: what kind of person would run a giant British bank, if this becomes law? That's not meant as a rhetorical question to which the answer is "nobody," though, consider this article about how people are terrified of becoming directors of US-listed Chinese companies because they might be sued; consider also that jail is probably worse than being sued. I actually think there's an interesting set of possible answers, including:

  • People who are confident in themselves and the justice system - who are sure that (1) they will not behave recklessly and (2) no jury will find them reckless if they're not.
  • People who do not share my cynical stochastic-squirming view of banking.2
  • People who value a high probability of a lot of money over a low probability of prison and infamy.
  • People who just do not worry about low-probability events (like blowing up their bank and going to prison).
  • Psychopaths.3

I don't think there's a separate group that is just like "people who will manage their bank very conservatively and avoid any risk of blowing it up." People who think they're in that category all fall in category 1 or 2 or both.

If you're a regulator, which of those categories do you want to draw your bankers from?4 And: how do you improve the odds of getting people from the right categories? And, also: what categories do senior bankers come from now?

One thing to like about a crime of "recklessly blowing up a bank" is that then you have a crime of "recklessly blowing up a bank," so you don't have to ad-hoc together an alternative. If you don't have that crime, and Bentley Q. Bankster recklessly blows up a bank, then what do you do? One choice is "not put him in jail," which I'm sure he would appreciate, though others would feel differently. When banks blow up, putting banksters in jail becomes an extremely popular activity to talk about anyway.

Other choices, though, include "find something else to prosecute him for," or "find someone else to prosecute," and both of those seem to be popular in America anyway. Since "stupidly blowing up Enron" wasn't a crime, "lying to investors" was pressed into somewhat dubious service. Prosecutors tried something similar with "blowing up Bear Stearns," sort of. Small-fry mortgage fraud prosecutions substitute for mortgage-crisis-recklessness prosecutions. It's not clear that any of those things are much better than just "you blew up a bank, two years."5 At least that's predictable.

British Commission Calls for New Laws to Prosecute Bankers for Fraud [DealBook]
Banking Commission publishes report on changing banking for good [Parliament]

1.Does the answer change depending on whether your bank is (1) the only bank to blow up or (2) one of a zillion banks all blowing up at once? On the one hand: it seems more likely that you were reckless if you're the only one blowing up, and less likely if your blow-up was due to a feedback loop of everyone blowing up. On the other hand: the consequences of, public ire about, and lack of sympathy for of your blow-up will probably be worse if everyone fails at once. "Bankster" is a post-2007/2008 word.

2.A variant on this is: People who intend to make sure that their bank is not a bunch of squirming random variables, whatever anyone else does. I dunno, what's a random variable? "We will take insured deposits and make only whole loans to creditworthy borrowers that we will hold to maturity and not mark to market on an accounting basis, so there's no randomness." Umm. I think this is just a subcategory of not believing in the stochastic-squirming model? The difference strikes me as epistemological rather than ontological.

3.Here's something from the internet:

Psychopaths do not have the fear response experienced by most of us to the potential negative consequences of criminal or risky behavior and are relatively insensitive to punishment. They tend not to be deterred from their self-serving behaviors by criminal or social penalties.

In recent years it seems that a bunch of already fabulously wealthy people have committed pretty straightforward dumb insider trading for relatively unimpressive amounts of money. I assume any reasonable explanation of that has to include the word "psychopath"?

4.I think "none" is a plausible answer, though "categories 1 and 2" is perhaps more plausible. Some might find category 1 - "I'd never be reckless, and any jury will be able to see that!" - over-confident, and category 2 - "what's a random variable?" - unsophisticated, though these are questions of taste. Categories 3, 4 and 5 seem bad, though I guess you could live with 3.

5.Or whatever. The Tyrie Report ruminates:

In consulting on a possible criminal sanction for a criminal offence last year, the Treasury made no reference to the possible penalties for commission of the offence. ... Sir Donald Cruickshank argued for severe penalties to be available for an offence: "the penalties for individuals would be unlimited fines and up to 10 years in jail". Gregory Mitchell QC argued that prison would not be an appropriate response to many of the failures seen in banking:

The wrongdoing that one has seen in the various reports to what led up to the crisis appears to be largely a failure on the part of people who should have known better to exercise a greater degree of care and skill, so the culpability essentially appears to be that of negligence. In our system, people do not generally get sent to prison for negligence.

By way of contrast, the maximum sentence for a director found guilty of consent, contrivance or neglect where a company has been convicted of health and safety offences is an unlimited fine and to a prison sentence of up to two years, even in cases where that has led to someone's death.

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Let's Talk About: Basel III

The Fed last night unleashed eight zillion pages of Basel III implementation on the universe and I'm tempted to be like "open thread, tell us about your hopes and fears for capital regulation." So do that! Or don't because it is super boring, that is also a valid approach. Still I guess we should discuss. Starting slow though. Banks have to have capital, meaning that they have to fund some of their assets with things that are long-lived and loss-absorbing, like common equity, rather than with things that have to be paid back soon and at face value. The reason for this is that the rest of banks' assets are funded with things that we really do want to be paid back soon and at face value, like deposits, and if the value of those assets declines you don't want those deposits to be wiped out. The rules say that you need capital equal to a percentage of your assets. The game is deciding (1) what that percentage is, (2) what is capital (proceeds from selling common stock, and actual earnings, yes, but, like, deferred tax assets?), and (3) how you count assets (you might want more capital to shield you from losses in, say, social media stocks than you would to shield you from losses in Treasury bonds, so regulators use "risk-weighted assets," so that $1 of corporate bonds counts as $1 of assets, $1 of Treasuries counts as $0 of assets, and $1 of Facebook stock counts as $3 of assets*). Anyway, here are the required capital levels: