Leeway for Lehman Brothers

Clusterstock's Carney trips all over himself arguing against prosecutions

I suppose we shouldn’t be surprised that John Carney thinks “We Should Not Criminally Prosecute Lehman Executives.” After all, this is someone who is a fan of insider trading, which he says “harms no one” and ought to be legalized, and who thinks the Community Reinvestment Act played a significant role in causing the crisis.

Despite his concern for Lehman executives, however, he’s not above, putting together a slideshow on “The People Who Are Going To Get Nailed In The Lehman Examiner Fallout.” Lots of clicks to be had for Clusterstock wasting people’s time with unnecessarily frequent page jumps, after all!

But his argument on why not to prosecute is an even bigger mess, as you might imagine. Skip the first nine paragraphs of throat-clearing and start with this gem:

It’s far from clear that a criminal prosecution would be the best response to alleged fraud at Lehman Brothers. In the first place, the alleged fraud is not what brought down Lehman Brothers and did not cause the broader financial crisis. The questionable Repo 105 transactions may have actually forestalled a collapse for several months because they may have concealed Lehman’s failure to improve its financial condition in 2007 and 2008.

So that $50 billion worth of lying and cheating? Well, it didn’t hurt the company, mind you. In fact, it helped keep it alive! You thought you, Mr. Lehman shareholder, Ms. Lehman counterparty, wanted to know about $50 billion here or there on its balance sheet, but you really didn’t. What you didn’t know didn’t hurt you or something.

Behold, Poor Reason No. 2:

What’s more, we may actually learn less about the collapse of Lehman if the case goes criminal. The problem is criminal prosecutions are rarely the best way to uncover facts. The threat of long prison sentences creates an all-or-nothing situation in which top executives refuse to testify in order to avoid self-incrimination. The public might well lose valuable information—information that could be useful to the formation of new regulations or at least investor awareness of the risk of management shading the truth—if prosecutors insist on bringing criminal charges.

That’s what you call a conclusion in search of an argument.”Investor awareness of the risk of management shading the truth”? Come on. That makes about as much sense as the rest of the paragraph, which is what’s known in the biz as “concern trolling.” It’s written like Carney is auditioning for a spot on The Wall Street Journal editorial page, perhaps as the Holman Jenkins of the Blog Generation. But even those guys aren’t quite this transparently nonsensical.

See Carney tying himself up in knots here (emphasis mine):

The trade-off for the societal cost of this lost information should be the deterrent effect from criminal prosecutions. But it’s not clear that there is much of a deterrent effect at all. The long sentence handed out to Enron’s Jeff Skilling did not seem to deter Lehman executives. It’s doubtful anyone at a major public company or a Wall Street financial firm feel any deterrence effect from the prosecution of Lehman executives.

That’s quite the change from Carney’s thoughts on deterrence four months ago when he was cheering the acquittal of another couple of white-collar defendants, Ralph Cioffi and Matthew Tannin of Bear Stearns:

The very threat of prosecution may be a deterrent enough for many, even if they think they would be acquitted in the end.

A year before that, Carney came to the defense of—you guessed it—Lehman’s very own Dick Fuld, saying he shouldn’t be prosecuted, in part because “there is probably zero deterrent effect to prosecuting Fuld.”

So for Carney, the threat of prosecutions is a deterrent. Actual prosecutions? Not a deterrent.

After saying something about prosecutions not being a deterrent because “Only executives who happened to work at firms that failed face prosecution,” which is just false, Carney writes:

This is the deepest problem with the criminal prosecution of Lehman executives—it would essentially be punishing business failure with criminal liability. The market does a fine job of punishing business failure by putting the worst failures out of business.

But business failure isn’t a crime. You know what is a crime? Breaking the law. And the second sentence there is an inevitable bit of market puffery. Apparently the market does a fine job of punishing business failure by encouraging businesses to get so big and interconnected that we can’t let them fail lest they send the markets over the cliff like Lehman did.

Unfortunately, there’s yet more tortured logic here:

The bailout of Lehman’s rivals compounds the lottery aspect. Many of the survivors arguably were not spared Lehman’s fate because they better managed the crisis. They survived because they outlasted the government’s patience with the liquidation of financial firms in 2008. So we’re not only punishing Lehman’s executives for failing—we’re punishing them for not being bailed out. What kind of justice is that?

The justice is the kind where we know of specific possible crimes by Lehman executives. Carney’s argument here is sort of like the burglar who tripped the alarm complaining about the cat burglar who didn’t get busted. Where’s the justice? Some people get caught. Most don’t. But if you really want to make it a level playing field, here’s betting most folks would be happy to beef up the Angelides Commission (or make it the Angelides/Valukas Commission) to sniff out specific possible crimes by Merrill, Citi, or Goldman executives. Even then, Carney would like them fined rather than jailed:

In short, one generation of Enrons should have been enough for us. Lehman shouldn’t be Enronized. Instead, it should be normalized, treated as an ordinary case of business failure, perhaps with civil liability for any malfeasance or deception by executives.

To add a little context, and in a programming decision we’d like to think was designed to make The Audit’s head explode, CNBC had Carney on with Larry “Goldilocks” Kudlow to talk about the Lehman failure and how it proves that market discipline beats the pants off regulation any ol’ day.

The Great Unspoken thing here is that the regulators had been hog-tied and gutted because of the likes of Kudlow and Carney over the course of three decades—through both Democratic and Republican administrations. Still, Kudlow calls the SEC “another bunch of regulatory dopes that completely missed this.”

This would be the same bunch of regulatory dopes headed by Christopher Cox, a man Kudlow lauded as a “forward-looking, Internet-minded visionary” in a 2005 column in the National Review, calling the move “a brilliant stroke and an inspired decision” by President Bush, who put forth a regulator “likely to reinterpret some SEC rules in a much more investor- and business-friendly manner.”

Cox, of course, was thereafter almost universally derided—even by the Wall Street executives in Too Big to Fail—as a frozen-grinned empty suit, who didn’t do or know how to do his job. Which was the whole point.

Now, Kudlow and Carney, nodding in agreement, believe that the failure of the SEC to sniff out the Lehman Brothers affair means that any new regulation is automatically suspect.

The message from Carney then is you can’t regulate them to try to prevent them from cheating, and you can’t jail them if you actually happen, somehow, to catch them cheating.

Non-white-collar criminals, presumably are a different story entirely.

UPDATEresponse here.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.