Criminal Sanctions: How to Save Banks Without Rewarding Bankers

Yves here. This article falls in the “mirabile dictu” category: an economist arguing that putting bankers in jail is necessary to combat the deterioration in behavior.

By Giancarlo Spagnolo, Professor of Economics at University of Rome “Tor Vergata” and CEPR Research Affiliate. Cross posted from VoxEU

How to save the banks but not the bankers? This column argues that fines for criminal behaviour in banks are not enough – it may be time to start locking people up.

Recent revelations on traders’ behaviour in the Libor rigging case is worrisome not only as a sign of the rotten culture of financial operators, but also for the sense of total impunity prevailing among them.1 They suggest that bank CEOs and complacent supervisors have tolerated and encouraged rate rigging – or negligently lost control of banks’ operations, for years. But they also indicate that law enforcement has been extremely weak in the realm of banking and finance.

In the light of these revelations, on 25 July the European Commission amended its proposal for a regulation and a directive on insider dealing and market manipulation to include criminal sanctions against that type of price fixing.2 Meanwhile, following a report by the FSA on the failure of the Royal Bank of Scotland, the UK Treasury started a consultation on how to introduce criminal sanctions against failed banks’ directors, ranging from automatic debarment to full fledged prison for extreme reckless behaviour (like RSB’s last acquisitions).3 The Libor and HSBC money-laundering scandals make this move even more likely.

The need for tougher sanctions is self-evident, as is the need to hold accountable negligent regulators. But are criminal sanctions a good remedy for financial misbehaviour? Wouldn’t it be better to substantially increase monetary fines? The question is warranted given that, with few exceptions, modern economists from Becker (1968) onwards regard monetary fines as a more efficient law enforcement instrument than non-monetary criminal sanctions.4

The problem with monetary fines is that not always wrongdoers can be fined at a sufficient level to achieve deterrence, given the evidently low probability of detection. Wrongdoers may:

• Not have sufficient wealth (not the least because they can conceal it);
• Transfer gains to other parties (uninformed shareholders, directors’ insurance funds, etc.); or
• Be protected by limited liability (for corporate fines).5

If there is a high risk that the individuals that took or covered the illegal acts cannot be reached by sufficiently high fines paid out of their personal wealth, complementing fines with non-monetary criminal sanctions becomes the only way left to enforce the law.

In the remainder of this piece, I will try to clarify why this argument applies in particular to bankers, intended as those individuals with inside information and control on the banks’ business (traders, directors, CEOs…). As we will see, the same reasons that for a long time have made banks ‘special’ for competition policy also ensure that to deter bankers’ wrongdoing, non-monetary criminal sanctions are necessary.6

First allow me to note that I cannot be suspected of favouring criminal sanctions in general. Some years ago, when the European Commission considered the introduction of criminal sanctions in antitrust,7 I argued against that. The main reason was that the potential of high corporate fines combined with leniency programmes (that give amnesty to the first conspirator that collaborates, introduced in the last decades in Antitrust) was far from being fully exploited in the EU. Antitrust fines were – and many think still are8 – too low to achieve cartel deterrence. We therefore suggested trying first to substantially increase antitrust fines, even at levels that could lead wrongdoing firms into financial distress. Selling a failing wrongdoing firm to new independent owners may be the best way to ensure it will change its course of action.9

For banks, however, this would not work. Banks are considered special, in particular from the antitrust perspective, because governments associate large, profitable banks to financial stability. For this reason, corporate fines on banks cannot be increased enough to discipline bankers.

Corporate fines of a sufficient size would weaken banks’ balance sheet, which is something nobody wants. The threat of destabilising banks through a fine will either induce governments to keep fines low (something courts already do with non-financial firms in weak financial situations10); or, it will increase the likelihood that part of the fine will be paid by taxpayers (through a higher risk of bailout, or subsidised liquidity and deposit insurance).

Individual fines on wrongdoing bankers may help, but they are also unlikely to suffice.

• First, they can (at least partly) be hedged in the market and through directors’ insurance.
• Second, the less honest bankers, the individuals we want to deter more, are also often specialists in transferring and hiding money; they will likely react to large individual fines by transferring or hiding their wealth.
• Third, companies typically indemnify executives (reimburse their fines, explicitly or indirectly) as long as they can argue that they did what they did for the company. Banks are no exception, and individual monetary fines are likely to be at least partly transferred on uninformed shareholders and taxpayers.

For all this reason fines must be accompanied by individual non-monetary criminal sanctions on wrongdoing bankers. But also by well-run leniency programmes and whistle blower reward/protection schemes.

Indeed, most evidence on financial and corporate misbehaviour comes from whistle blowers, or from settlements in which lenient treatment is traded against important information.11 Recent research shows that leniency in exchange for cooperation works well (has collusion-deterrence effects) if it is limited to the first cooperating wrongdoer and either: a) large rewards are paid out to whistleblowers12, or b) sanctions are sufficiently tough to make people afraid to be betrayed by fellow wrongdoers.13

To wrap up, our discussion suggests that:

a) Non-monetary criminal sanctions for individual misbehaving bankers are necessary as well as well structured leniency and whistle blowers programmes;

b) Settlements such as the recent ones, involving only monetary payments from the banks, but no fines nor other criminal sanctions from the wrongdoing bankers, should be avoided;

c) Such settlements should only be admitted if the information obtained in exchange are crucial to charge criminal sanctions against other wrongdoers, as in antitrust leniency programmes.

In the US criminal sanctions are already present, also in antitrust, and will likely be used to send to jail some of the Libor rigging traders, and hopefully their negligent (or accomplice?) bosses. The US also introduced in 2011 an amendment of the Dodd-Frank Act that allows regulators to reward whistle blowers that denounce financial misbehaviour at the cost of their career. This is promising – let’s see how it will be administered.

In the EU there seems to be no intention to introduce effective whistle blower reward schemes. There is therefore only one option open: steeply increasing sanctions. But as argued above, monetary sanctions will not suffice given that governments don’t want to damage banks with sufficiently high fines and that individual fines can be hedged or transferred on minority shareholders and taxpayers. Non-monetary criminal sanctions (debarment from the industry, and jail in worse cases) are harder to hedge or transfer. They are therefore more likely be born by the wrongdoing bankers.

Criminal sanctions might even help with the Eurozone crisis. Suppose CEOs and directors of the Spanish banks in need of rescue could be fined individually and debarred from working again in the financial sector as a condition to access to the EU rescue plan. Isn’t it likely that the open complaint by 180 German economists against Ms Merkel’s willingness to save the Spanish reckless bankers would be withdrawn? After all, it is not Spanish banks that need to be held accountable, but the Spanish bankers that continued to cash bonuses betting other people’s money on an obvious housing bubble that only bank-sponsored ‘experts’ had the ‘courage’ to deny.


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  1. psychohistorian

    Isn’t it that we seemingly don’t have the balls to enforce the existing laws, instead of needing arranged lipstick on a pig sanctions for the junior puppets.

    Banking should be a utility for the masses, not a blood sucking entitlement for the global inherited rich.

    1. skippy

      Its like a lime tick that has burrowed down so far, that to remove it might kill the host, yet, the blood infection will also, just further down the road.

      Skippy…. fates commingled… how much appendage much we cut off to rid the commons of this parasite… and still have a good chance of survival. Because that’s how they view us in reverse… eh.

    2. F. Beard

      Credit creation, since it creates new purchasing power that dilutes existing purchasing power, is a form of taxation. Thus only governments should create credit and that credit should ONLY be used for the general welfare just like taxes should only be used for the general welfare.

      As for the lending of existing money, that should be a purely private matter to avoid government lending to cronies.

  2. Joe

    “Corporate fines of a sufficient size would weaken banks’ balance sheet, which is something nobody wants.”

    Baroque way of making the above point. Indeed, we will have to wait and see how anti-trust laws are “administered” in the US.

    The problem is that the financial and the regulatory system have become so superficial and hence fragile, that changes in peoples expectations(!) have got people scared. You know, if we start investigating how banking really works, well it’s just too terrible to even contemplate. It’s preferable for the administration not to know, because the result of any investigation cannot be determined.

    I mean, on the one hand, the market seems incredibly shallow, because, charging someone like Dimon, would probably send it into a tailspin (depending on how serious the charges and the probability of success were). It’s not because he can’t be replaced, but rather because, when push really comes to shove, an investigation may actually reveal the true state of the financial markets. It would destroy confidence, because confidence is based on myth.

    But how do you change that?

    Ok, at the moment, sane people apparently have no time to think, because they’re all pail in hand, trying to save the sinking ship, but to continue with the analogy of a bail out, you also need to repair the ship. And the ship, being our financial system, (and also perhaps the economic culture) isn’t going to repair itself, only people can do that.

    So, send some of these people to jail. Justice requires that individuals who have caused serious damage to many peoples lives for personal gain be punished, but we need to return to a system based on the real economy and we need to do this quickly. A Ten or twenty year time scale is not going to work…

  3. Nikki Turner

    The mere fact there is so much debate about the possibility of criminal sanctions against bankers makes one thing very clear – they have, until now, had some form of immunity to prosecution. And that makes a mockery of the law.

    Having spent 5 years investigating criminal actions by bankers, I have been absolutely amazed at how difficult it is to persuade any authority to take appropriate action. The law is very clear on the penalty for such crimes as fraud, corruption and money laundering. The FSA Principles for Business are very clear how authorised people must conduct business. The evidence of repeated breaches of the law and the FSA Principles by bankers is abundant and in the public domain but still, the public is being asked to accept bankers are immune for their actions.

    There is no question bankers who commit crimes should be prosecuted. But there is a very big question to be answered now – who has chosen to override the Criminal Justice Act so this does not happen? And is such action not a crime in itself?

    1. Rcoutme

      One of the sites that carries Yves stuff (occasionally) is Roubini’s site (RGE). I read an article there that basically said that when the Fed and Treasury tried to ask for the information that the NY finance officer had on a rogue bank (it was engaged in money laundering for Iran), that official told then to shove it!

      Meanwhile, the Justice Department (and the Fed, iirc) had done their own investigations and, get this, found no reason to indict (even though the US bank president of the company had specifically written about his concern that they could go to jail).

      The Fed and the US Justice Department are not prosecuting wrong-doing. Is it criminal? Probably. Who has the authority to prosecute the Justice Department?

  4. skippy

    National Security trumps even the law.

    Skippy… Banks and Corporations are the stalwarts carrying the flag globaly, it must not fall!

    1. Yata

      That’s exactly the reason. We’re over here with our hopes and dreams of some financial accountability and smacking our collective heads against the glass ceiling of the economic realities that prevent any change in the status quo.

      You just have to look at the screams and howls when the media exposed the size and depth of the LIBOR scandal when we had quite clearly been aware of this, and therefore complicit, for years.
      The U.K. was quick to demonstrate the double standard when we haven’t brought one significant criminal prosecution while being awash in financial scandal.

      Banks worldwide balked at the requirements of the new Basel accords with pecious little pushback from respective financial authorities.

      Dodd-Frank is one huge lobbied work in progress.
      The Volcker Rule is a laugh.
      Tim Geithner himself lobbied to remove fx trade from under the rule of derivitives oversight.

      So yeah, you know and I know the financial powers are the driver behind all foreign policy, military and diplomatic, while we hapless readers of Yves’ blog get a chuckle from TPTB as we smack our little heads against that glass ceiling actually expecting some rule of law to prevail.

      This is fine though, let them run the economy into the ground. I’ll be fine eating tree bark and gravel the rest of my life if i could just know that den of thieves actually have to get a productive job.

    2. Yata

      “All I hear from you, you spineless cowards, is how poor you are; how you can’t afford my taxes. Yet somehow, you managed to find the money to hire a gunfighter to kill me. If ya got so much money, I’m just gonna have to take some more. Because clearly some of you haven’t got the message! This is my town! I run everything! If you live to see the dawn, it’s because I allow it! I decide who lives and who dies!”

  5. Justicia

    The wonder of economics is that it takes economists longer than everyone else to understand the obvious.

    Of course fines against corporate law breakers (banks et al) don’t work because the law breakers don’t pay the fines. Their shareholders do. And, as the article notes, personal penalties are avoided by hiding the malefactor’s wealth. Jail is the only sanction that punishes the individuals responsible for breaking the law.

  6. F. Beard

    How to save the banks but not the bankers? Giancarlo Spagnolo

    No, the question should be how to destroy banking without damaging the economy.

    That’s simple enough if one starts from the indisputable fact (“loans create deposits”) that the bank are counterfeiters that cheat everyone but especially the non-rich since they are less credit-worthy.

    So …

    1) Ban further counterfeiting (so-called credit creation). This would cause massive deflation by itself because:
    a) Over 90% (95%?) of the money supply is credit and
    b) Credit ceases to exist as it is repaid.

    2) Bailout the entire population, including non-debtors, equally with new fiat at a rate metered to just replace the credit destroyed in 1). Continue till all private credit debt is replace with new reserves (100% reserves). US Notes (or equivalent for other countries) should be used so as to not increase the National Debt.

    Since the total money supply (reserves* + credit) would not change then neither price inflation or price deflation should be expected.

    Note that honest lending (100% reserve) would still be allowed so business and consumer needs to borrow could still be accommodated. It interest rates were too high then the amount of the bailout could be increased to lower them.

    *Reserves do not circulate except between banks so they are not normally considered part of the money supply. However, with 100% reserve lending everyone would deal with reserves as money.

    1. rob

      The transition to full reserve banking,sounds right to me. This again is an idea ,enumerated in the HR 2990 “NEED ACT” sponsored by kucinich in the last two congress’s.The real deal is on the table… collecting dust. WHile paul ryans pretense of a budget has the talking heads all in a chatter.
      The time to start throwing all these bigwigs in jail, is AS the REAL banking reform(HR 2990)Is being shown to the masses, and debated everywhere…. because at that moment, these banking celebrity/cult of personalities will have no percieved power in the light of real movement towards the creation of a more perfect union.Give the people something real to digest, and let the parasites go by the wayside,probably unnoticed..but for the long haul none the less.

  7. killben

    The wrap up is spot on….

    But will it happen .. with regulators, banksters, government and politicians in cohorts….

  8. Nelson Alexander

    Pickpockets Worked the Hangings of Pickpockets

    I am gratified to finally see someone mention the fact that taxpayers are not only the victims of many banking crimes, we also have to pay the fines. This may be done indirectly, but in the case of certain “settlements” I believe a large part of the payments can be written off right up front as “normal business expenses.”

    This is all the more galling considering that bankers themselves write two thirds of the laws, then can’t even obey those. “Predator Nation” by Charles Ferguson lays out an excellent case for criminal prosecutions, complete with a blueprint of names and crimes any prosecutor might follow. If only.

    The real tragedy is that it may be too late. I am not sure that regulatory agencies or even nation states have the political power to tackle the most entrenched plutocrats and their political hacks. We will see how the aptly named Mr. Lawsky fares. I for one have a hard time believing that the bank records used to bring down Spitzer just sort of “came to the attention” of law enforcement. When power is affronted, things do go bump in the night.

    Personally, I don’t believe that jailing bankers will accomplish much structurally. After all, Victorian pickpockets swarmed the hangings of other pickpockets. Yet it will sow distrust among thieves, preventing some collusion. It projects fairness…. and makes for gratifying television.

    1. Rcoutme

      I think I would be more gratified if said miscreants were more publicly humiliated. Putting them in the stocks each day for 12 hours in front of their former workplace comes to mind. Perhaps making them clean up the streets in Harlem or other such communities would suffice, I’m not sure. In either case, C-SPAN should be allowed to run a small camera shot in the corner of one of its broadcasts to show the miscreants being punished.

      Anything else is almost equally unlikely to deter many of the criminals. Consider one Bernard Madoff…

  9. silentdisruptor

    The way you fine the banks is by making them issue new shares to the government. Dilute the shareholders, reduce compensation tied to stock performance, and transfer a sufficient amount of wealth to the government. Seems like a win-win.

    1. F. Beard

      Your solution is in the direction of the ideal one, that banks should use their common stock ITSELF as private money.

  10. brian

    i’ve thought it long past for hanging and burning in effigy
    say on the nice quiet sunday afternoon on the steps of their ofices in nyc

  11. barrisj

    Regrattably, much of the behaviour we all have witnessed within the realm of “finance” since the ’80s has been subsumed under the rubric of “the new normal”, with apparently blatant illegal acts (as defined under applicable statutory law) now being “settled” in a purely civil as opposed to criminal sanction. Among the more pernicious effects of “regulatory capture” has been the willingness to tolerate activities that should have led to referrals for criminal prosecution, but now require only a consent decree and fine (paid by the offending corporation, not by the criminally negligent officers or employees of such companies), and the overall effect of all of this is in fact inducement to commit fraud, or, at the very least, lack of disincentive to play it straight. We now see the consequences of what happens when both players and regulators share the same mindset: rampant criminality and collapse of any sort of ethical (and, do I suggest – moral)
    environment, and where “getting away with it” is the default modality. The famous Americanism “nice guys finish last” has been the ruling precept in the financial community
    for several decades now, and the tack to take is simply playing dirty because…wait for it – everybody does it because the gains far, far outnumber the penalties.

  12. Jim Shannon

    “National Security trumps even the law.”
    … and that is exactly what the CentaMillionaire$ and Billionaire$ who own our government want the ignorant masses to believe.
    For “Liberty and Justice” to ever again exist for “We The People”, it has become clear to anyone who can think and absolutely necessary to TAX all CentaMillionaire$ and Billionaire$ out of existence – World Wide!!!!!!
    Might makes right and money buys might! We The People need to put an end to financial corruption, and that can easily be accomplished by TAXING all Net Worth above $10,000,000 at 100%.
    WTF are We The People afraid of? I know the answer to that question – do you!

    1. Ruff

      So if you worked your ass off, built a business, you lose it all.

      This is anonymous of killing an entire city for the crime of a few. If you agree with this, than don’t complain when the government throws citizens in jail just because.

    2. Ruff

      If my point is not clear, at that stage you wont have to worry about the rich, but you sure should be worried about the government.

      1. Jim Shannon

        … so you are one of those who made more than $10,000,000 and you did it all by yourself and did not need “We The People” to be the market so you could make Million$.

  13. Jim Shannon

    “New Normal” slang for we’ve been lied to and stolen from and all the Mergers and Acquisitions and Wealth Building going on World Wide was ALL FINANCIAL CORRUPTION!!!!!
    “New Normal” CentaMillionaire$ and Billionaire$ now own all the politicians and all the government’s World Wide!!!
    “New Normal” CentaMillionaire$ and Billionaire$ stole your home and eliminated your job. TOO BAD – WTF can you do about? Nothing! They own all the Lawyers and All the Judges.
    “New Normal” Liberty and Justice for the CentaMillionaire$ and Billionaire$!!!
    WTF – but that’s not new – Just History repeating itself!!

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