Just Lock Them Up

Giancarlo Spagnolo, a professor at the University of Rome, makes a rather appealing suggestion, that we start criminally charging the banksters:

Recent revelations on traders’ behaviour in the Libor rigging case are worrisome not only as a sign of the rotten culture of financial operators, but also for the sense of legal impunity prevailing among them (Economist 2012). They suggest that bank CEOs and supervisors may have tolerated or encouraged rate rigging, or negligently lost control of banks’ operations, for years. They also indicate that law enforcement has been extremely weak in the realm of banking and finance. The recent allegations that some large UK banks have been involved in extensive money-laundering activities in favour of Mexican drug cartels and Iran reinforce this impression considerably.

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. Meanwhile, following a report by the FSA on the failure of the Royal Bank of Scotland, the UK Treasury had already opened a consultation on how to introduce criminal sanctions against failed banks’ directors, ranging from automatic debarment to full fledged prison for extreme reckless behaviour.

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 (Polinski and Shavell 2000, Werder and Simon 1986).

The problem with monetary fines is that not always can wrongdoers be fined at a sufficient level to achieve deterrence. Wrongdoers may:

• Not have sufficient wealth, or may conceal it;
• Transfer fines to other parties (uninformed shareholders, directors’ insurance funds, etc.); or
• Be protected by limited liability (for corporate fines).

In the remainder of this column, I will try to clarify why these problems are particularly acute for banks and in particular for 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.

As an aside here, the idea of piercing the veil of corporate indemnification, so, for example, income of all forms in excess of (for example) that of the President of the United States, would not be covered by limited liability for a period of a few years.

Prof. Spagnolo does not discuss this, but it should be up there.

If people knew before the fact that if their banks had to bailed out, that all their property could be taken by a court judgement, it would deter them.

As it stands now, the worst case, taking the example of Michael Milken, who did his few years at club Fed, and left still prison fabulously wealthy.

H/t Naked Capitalism.