Who should the SEC punish next for the Madoff scandal? Itself.


J.P. Morgan Chase is nearing a settlement with federal regulators over the bank’s ties to convicted fraudster Bernie Madoff, reports The New York Times. The deal would involve penalties of up to $2 billion dollars and a rare criminal action. The government intends to use the money to compensate Madoff’s victims.

For two decades before his arrest, Madoff had banked with J.P. Morgan — and apparently laundered up to $76 billion through the bank. Employees at the bank had raised concerns about Madoff’s business. In 2006, a J.P. Morgan employee wrote after studying some of Mr. Madoff’s trading records that “I do have a few concerns and questions,” and expressed worry that Madoff would not disclose exactly which trades he had made. Madoff’s company turned out to be an elaborate ponzi scheme that stole an estimated $18 billion from clients; it collapsed in 2008.

Is it fair to blame J.P. Morgan for the activities of Madoff? Do banks have a responsibility to know if their clients are involved in criminal activities? I think so — banks should have strong checks and balances to prevent fraud and money laundering, because if they don’t then criminals like Madoff can get away with it for years and years. According to Robert Lenzner of Forbes, “J.P. Morgan never reported to the Treasury or the Federal Reserve a huge cache of checks going back and forth for seven years between Madoff’s Investment Account 703 and Bank Customer Number One, belonging to real estate developer Norman Levy, who died in 2005.”

By agreeing to pay the fine and the government’s rebuke, J.P. Morgan is admitting a failure of oversight. But it’s not as if J.P. Morgan is the only one to blame. Others on Wall Street had expressed concern about Madoff’s business much earlier.

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Should Corrupt Bankers Face the Death Penalty?

Doing God's Work?

Let’s be clear: financial misdeeds ruin lives. If a Madoff takes your money and uses it to pay off other investors in a ponzi scheme, you won’t be able to get it back. If a Blankfein underling issues you with misleading advice, and then bets against you (creaming himself a nice profit), you won’t be able to get it back. If a Corzine steals your money and uses it to bet on the European sovereign debt market, you might not be able to get it back. You might end up in poverty or worse. You might lose your children’s college money, your retirement money, or capital you needed for your business. You might lose your home.

So shouldn’t we take a tough line against financial misdeeds? Shouldn’t tricking and stealing from investors, tricking and stealing from the public, tricking and stealing from clients carry a heavy disincentive, like death? Would a corrupt banker not think twice about their misdeeds if they knew that apprehension would mean a noose around their neck and a kicked bucket?

Certainly there is a popular impression that big-time criminals with titles, status and MBAs get it easy, while protestors (sometimes protesting the misdeeds of big-time criminals) get shafted by the hyper-vigilant modern security state:

A lot of commentators — like for example, Max Keiser — seem to think so.

And in China financial crimes are treated with a gravity far beyond a cushy minimum security cell, and home visits on the weekends.

Financial criminals in China are often executed.

From Wiki:

China has executed bankers for fraudulent activity:

  • Wang Liming, former accounting officer, China Construction Bank, Henan, with others stole 20 million yuan ($2.4 million in U.S. Currency) from the bank using fraudulent papers, executed.
  • Miao Ping, an accomplice in the same case, executed.
  • Wang Xiang, same bank in an unrelated case, also executed for taking 20 million yuan from the bank.
  • Liang Shihan, Bank of China, Zhuhai, executed for helping cheat his bank out of $10.3 million US.

In a recent case, Wu Ying, a 28-year-old woman, will soon be put to death for taking out multi-million dollar loans from investors she was unable to pay back.

We in the West appear to have a problem; financial crimes ruin lives, but financial criminals either get away with a comparatively small fine (like Goldman did after they misled clients), a cushy prison cell, or sometimes even a taxpayer funded bailout.

Simply, they keep the upside of their behaviour, and pass the downside off to someone else (either a sucker investor, or a junior partner, or the taxpayer).

Hammurabi, the Babylonian King, had a simple principle for dealing with such bullshit:

If a builder builds a house and the house collapses and causes the death of the owner – the builder shall be put to death. If it causes the death of the son of the owner, a son of that builder shall be put to death.

Exact equivalence; you destroy someone’s livelihood, and your livelihood shall be destroyed. Such justice would leave a lot of people, and not just bankers — Dick Cheney, John Yoo, Larry Summers, Tim Geithner — with a lot to fear.

But would it work? Well, China executes bankers — as well as corrupt party leaders, (watch out, Bo Xilai) — and bankers in China keep screwing investors and the nation.

I think the biggest problem with capital punishment is that it is administered by the state (or the mob) and that means that very often it is administered to the wrong people, for corrupt or flawed reasons. Putting the power of life and death in the hands of the state is quite dangerous. More likely than not, the person executed will end up being the innocent junior intern (“take one for the team, buddy!”) while the corrupt CEO enjoys a retirement of golf courses, hookers, viagra, and oxycontin.

A much better goal to aspire to is the end of bailouts, and the end of firing off wads of QE-dollars to preserve badly-run (but well-connected) companies and systems (zombification).

Still, in matters of financial fraud I think it is important to seek out equivalent justice; you destroy a livelihood, we take your trust fund, and your Swiss bank account to compensate the victim. The status quo — where regulators shoot off tiny fines for huge financial crimes — is a joke.

But the best way to punish Goldman Sachs (etc) for their misdeeds is to not bail them out the next time their hyper-fragile leverage-driven business model fails them and they end up over a barrel. It is quick, dirty and emotionally satisfying to talk of executions, but giving the state the power over life and death has far bigger, and far more dangerous consequences, not to mention huge potential for abuse.