The Consequences of Tight Money Go Far Beyond Unemployment

There’s an old saying that if you kill one man they put you in prison, if you kill 100,000 men they build a statue in your honor. A new article in The Economist suggests a corollary; if an individual extorts money he’s put into prison, if a government extorts money it’s praised for getting tough on banks:

To a public angry at banks for their role in the financial crisis, this may all seem like reasonable retribution. Yet in many cases the rush to punish is overturning basic principles of justice. Take the settlement agreed to by JPMorgan. The accompanying statements from both the bank and the regulator involved, the Federal Housing Finance Agency, provided no indication of what the firm did wrong and no admission of guilt. JPMorgan is the fourth institution to settle over its dealings with Fannie and Freddie without going to trial, following settlements by General Electric, Citigroup and UBS.

Bank executives contend that they have little choice but to accept punitive settlements because the alternative, facing a criminal indictment and going to court, could destroy their businesses, even if they are subsequently found not guilty. This is because they risk losing their banking licences or being shunned by clients while charges are pending. In some cases regulators make these threats explicitly. Last year New York’s financial regulator threatened to revoke the state banking licence of Standard Chartered, which would in effect have excluded the British bank from America. “If you’re a financial institution and you’re threatened with criminal prosecution, you have no ability to negotiate,” Warren Buffett, an investor, said recently. “Basically, you’ve got to be like a wolf that bares its throat…You cannot win.”

Most people react to this type of story that an emotional level; either the banks deserve what they’re getting (liberals) or they’re being treated unfairly (conservatives.) Let’s try to rise above emotions and look at this from a public policy perspective. I see two other issues here:

1. This allows President Obama to raise taxes on banks without congressional approval:

JPMorgan Chase agreed to the biggest of these settlements, of $5.1 billion (with perhaps billions more to come) related to mortgages that it, and banks it later acquired, had sold to two government-backed firms, Fannie Mae and Freddie Mac. In Europe Rabobank, a Dutch co-operative, agreed to pay almost $1.1 billion after admitting that some of its employees had joined in the manipulation of LIBOR, a benchmark interest rate. Piet Moerland, its boss, resigned. In Germany Deutsche Bank set aside €1.2 billion ($1.7 billion) in provisions for litigation. Swiss regulators told UBS to set aside 586m francs ($652m) against possible legal costs and fines.

A billion here and a billion there soon add up. SNL Financial, a data firm, reckons that over the past three-and-a-half years America’s six biggest banks have agreed to pay more than $65 billion in settlements related to the financial crisis and mortgages. Further claims and expected settlements will soon push this figure to $85 billion, it says.

Add in settlements agreed to or being negotiated by European banks and the bill easily tops $100 billion. These include the $1.9 billion fine imposed on HSBC over weak money-laundering controls, the $1.5 billion settlement agreed to by UBS for manipulating LIBOR and the £16 billion ($26 billion) British banks have set aside to compensate customers who bought useless loan-insurance policies. It is not just banks in the firing line. SAC Capital, a hedge fund, was expected to reach a $1.2 billion settlement of criminal charges relating to securities fraud as The Economist was going to press. This follows an earlier $616m settlement of civil claims against the fund.

Whenever the Obama administration needs more tax revenue they can simply “ask” banks for more money. Just like someone in the Mafia might “ask” a small shopkeeper for some money. In the old days the GOP-controlled House of Representatives would’ve been able to stop the Obama people from raising more revenue. That is no longer true.

2.  And the problems don’t stop there. The Fed’s tight money policy, which created the Great Recession and greatly worsened the financial crisis, has many other costs as well:

The bill presented to banks does not stop at fines and redress. The industry is spending billions more trying to comply with new rules of dubious worth. In the first half of this year HSBC added 1,600 people to ensure compliance with proliferating regulation. JPMorgan has added 4,000 people to “control efforts” since the beginning of last year, and increased spending to that end by $1 billion this year alone. Standard Chartered has added 2,000 compliance staff over three years, even as its total headcount has fallen.

Besides raising costs for banks and their clients the current climate of fear poses a number of longer-term risks to the financial system. The first is that big banks will be less ready to buy units of failed rivals, as JPMorgan and others did during the financial crisis. That will make future crises more difficult to manage. As worrying is that banks are being discouraged from confessing to wrongdoing or sharing concerns with regulators. That may make it more difficult for supervisors to assess future risks. And without any proper accounting of banks’ sins, no one will ever know whether justice has been done.

I know what you’re thinking; no regulatory bill is perfect. “Yes, there are flaws, but at least Dodd-Frank put an end to subprime mortgages and reined in the GSE’s.” Oh wait…

3. Or perhaps you are thinking; “Those rich bastards deserve it, at least they won’t come at little people like me.” In that case you may not want to read this article from the same issue of The Economist:

THE names of court cases usually make sense. Think of “US v Bernard Madoff” or“US v Timothy McVeigh”. What, then, is“US v $35,651.11”? Why is Uncle Sam prosecuting a heap of money?

The answer, alas, makes even less sense than the name on the docket. Terry Dehko and his daughter Sandy Thomas (pictured) run a grocery store in Fraser, Michigan. It sells everything from bread to hand-made sausages. Fairly often, someone takes cash from the till and puts it in the bank across the street. Deposits are nearly always less than $10,000, because the insurance covers the theft of cash only up to that sum.

In January, without warning, the government seized all the money in the shop account: more than $35,000. The charge was that the Dehkos had violated federal money-laundering rules, which forbid people to “structure” their bank deposits so as to avoid the $10,000 threshold that triggers banks to report a transaction to the Internal Revenue Service (IRS).

Prosecutors offered no evidence that the Dehkos were laundering money or dodging tax. Indeed, the IRS gave their business a clean bill of health last year. But still, the Dehkos cannot get their cash back. “They offered us 20%,” says Ms Thomas, “But if we settle, it looks like we’re guilty of something, which we’re not.”

In criminal cases, the government can confiscate assets only after a conviction. Under “civil forfeiture”, however, it can grab first and ask questions later. Property can be seized merely on the suspicion that it has been involved in a crime. Citizens have no right to a swift hearing.

Don’t you love the term “structure”?

The rule of law? What a quaint notion!

PS.  Just imagine the complexity of the ObamaCare regulations, and the possibilities it will open up for prosecutors. Remember that in America prosecutors are not interested in justice, they are interested in accumulating scalps to burnish the reputation when they run for higher office.

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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