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U.S. Department of Justice gives up on banks

Eric Holder waves flag, surrenders.

(Photo: i-works/Amana Images/Getty)

(Photo: i-works/Amana Images/Getty)

The head of the U.S. Department of Justice, Eric Holder, on March 6 made a remarkable admission about the banks. In remarks (for the webcast see here at about the 02:17 mark) before the Senate Judiciary Committee, he admitted that the big banks can’t be prosecuted for wrongdoing because doing so might hurt the economy.

If you think you’ve heard this before in “Too Big To Fail,” you’re only half right. Why this instance stands out is because it’s the first time so high a U.S. official has gone beyond acknowledging the dynamic to also admitting that prosecution is unlikely and won’t even be pursued. That it comes from the man ultimately in charge of prosecution is stunning. Bear in mind that TBTF has customarily referred to not letting banks, well, fail—which is a separate, though intimately related issue, from whether or not bank officials and executives should be prosecuted. (TBTF has been addressed by no less than the Federal Reserve itself in “Choosing the Road to Prosperity: Why We Must End Too Big To Fail—Now.”)

Then again, I’m only half right, too. Holder was beaten to the punch in December 2012 by Andrew Bailey, then head of the Financial Services Authority. The FSA is the regulator for the world’s second largest banking centre—London. Bailey was reported as saying, “[prosecution] would be a very destabilising issue. It’s another version of too important to fail.”

What’s the impact of all this? Well, at a minimum it would appear to be a green light to the big banks to engage in as much wrongdoing as they like since, according to the boss himself, they apparently won’t be prosecuted for it.

Business should be just as livid as any anonymous civilian witnessing this double standard because it hurts them too.

For one thing, it costs money that everyone else, taxpayers and businesses alike, effectively have to pay. Citing an IMF study, Bloomberg recently pointed out that the subsidy inherent to TBTF could be worth as much as 0.8%, a discount that applies to all liabilities, including bonds and customer deposits. For the 10 largest U.S. banks, that’s a total of US$83 billion.

It promotes information asymmetry, which actually hurts market efficiency and imposes potentially higher costs on all other market participants. The LIBOR scandal is perhaps the most visible, recent example of this.

More subtly—but perhaps most importantly—it diminishes trust in the rule of law. And the rule of law is critical to the operation of markets.  Some studies and economic analyses have even correlated the degree to which trust and the rule of law is present and operational to the overall level of economic growth a country can expect.

Finally, there is also the problem of another crash. If the big banks are simply able to continue business as usual there’s little reason to think we won’t eventually have a repeat (and possibly worse) of the crash of 2008. And how did we all enjoy that last time?

Some market observers are not impressed.  “Speechless” is how William K. Black, professor of law and economics at the University of Missouri-Kansas City and a former regulator during the S&L crisis, describes himself. He says Holder’s Justice Department is violating the rule of law by declining to launch prosecutions and enabling a regulatory race to the bottom. He predicts the consequences will be severe.

“Once you get past the sticker shock of having so many financial institutions on death’s door and they get back to their old ways, this will further encourage them to engage in even more blatant and destructive fraud. And so we’re looking at future financial crises and also exceptional inequality and a Gresham’s dynamic—bad ethics drives out good ethics in the marketplace.”

Economist Horace Brock, head of Strategic Economic Decisions, is even less charitable. Brock, who has written about the relationship between the rule of law and economic growth, dismisses Holder as an “idiot.”

He adds, “Mr. Holder has it completely backward. It has been his failure to prosecute that has been partly responsible for the ability of the banks to have damaged the world economy. … For a head of the Department of Justice to make such a nihilistic comment makes one wonder why Holder hasn’t been fired—particularly when the Democrats are supposed to represent ‘the people’ and not the banks.”