President’s bailout of Wall St. too much and came too late

The Federal Bureau of Investigation has launched an investigation into whether fraud played a role in the failure of Fannie Mae, Freddie Mac, Lehman Brothers and AIG, Inc. The failures contributed to the stock market’s recent single day loss of $1.2 trillion. While it is important to hold those accountable for wrong-doing in the market, an equally important question is whether vigorous oversight, investigations and prosecutions could have had a positive impact on the financial markets?

According to the Los Angles Times, the FBI was aware, as early as 2004, that the subprime mortgage business was rife with “shady operators and billions in losses were possible.” Chris Swecker, the FBI’s director of criminal investigations said at the time, “It has the potential to be an epidemic ... we think we can prevent a problem that could have as much impact as the S&L crisis.”

The problem began when lenders aggressively offered subprime mortgages to risky borrowers. The loans with higher fees and interest rates were contingent on the premise that property values would continue to increase and lenders, as well as homeowners, would be protected. The predatory mortgages were then bundled into investments known as collateralized debt obligations and sold to investors worldwide. Many banks sold unregulated insurance policies on the mortgage debt, often without reserves to cover potential losses. Again, banks gambled on property values continuing to rise.

When the real estate bubble burst the ripples were felt from top to bottom. Homeowners could not sell their houses for enough to pay off their mortgages, banks were on the hook for default premiums they did not have the reserves to pay, and investment banks lost billions.

Why did President Bush’s Justice Department fail to intervene as suggested by the FBI in 2004? In fact the administration did have an influence on the looming crisis but not in the way you might think. Since 9/11 the primary focus of the FBI has been terrorism. More than 2,400 agents assigned to criminal investigations were transferred to domestic terrorism details and few were replaced. An investigation by the Seattle Post-Intelligencer found that the number of criminal cases investigated by the FBI had steadily declined. In 2005, the FBI brought about 20,000 cases to prosecutors, compared with about 31,000 in 2000. More telling, according to the Post-Intelligencer, was the 65-percent drop in white-collar crime investigations between 2000 and 2005.

The FBI had asked two Bush administration attorneys general to increase the budget and personnel involved in criminal investigations. The requests were ignored. Dale Watson, a former FBI executive assistant director, told the Post-Intelligencer that by the time the FBI started preparing its fiscal 2007 budget, “we realized we were going to have to pull out of some areas—bank fraud, investment fraud, ID theft—cases that protect the financial infrastructure of the country.”

The Bush administration’s influence on today’s financial crisis goes beyond merely underfunding or ignoring corporate corruption, but actually signaling to corporate wrong-doers that they will not be prosecuted and that they can actually pay their way out of corporate crime.

Prosecution agreements

Eric Lichtblau of The New York Times recently wrote about the Bush administration’s ever-increasing use of deferred prosecution agreements. In cases where the FBI had investigated and alleged corporate wrong-doing the prosecution could be set aside if the corporation paid a hefty fine and agreed to have outside monitors impose internal reforms. The company never admits guilt and the agreements generally expire in a couple of years with the charges being permanently dismissed. In one case a corporation paid $52 million to former attorney general John Ashcroft’s consulting firm to serve as the outside monitor.

According to Lichtblau, “Deferred prosecutions have become a favorite tool of the Bush administration (35 agreements last year). But some legal experts now wonder if the policy shift has led companies, in particular institutions now under investigation for their roles in the subprime mortgage debacle, to test the limits of corporate anti-fraud laws.”

As President Bush and congressional leaders resort to a $700 billion-plus rescue package, it appears that a tiny fraction of that amount properly directed to the FBI to investigate investment fraud along with a more aggressive posture by the Justice Department with regard to corporate wrong-doing might have averted or at least mitigated the current world-wide financial crisis.

X Matthew T. Mangino is the former district attorney of Lawrence County and a featured columnist for the Pennsylvania Law Weekly.