A Fortune piece this week shows how editorial tastes can differ, to say the least.

When it chooses to explore the extent to which the credit crisis will produce criminal prosecutions, the business magazine looks for reasons why it shouldn’t, rather reasons than why it should.

That’s why there’s strawberry and vanilla, I suppose.

One can see, of course, obstacles to criminal prosecutions of bankers, bond salespeople, mortgage brokers, and senior financial executives.

But given what Fortune itself describes as a $9 trillion wipeout of investor capital, including a $1 trillion raid on the U.S. Treasury, my first thought would be to imagine that a wealth destruction and transfer of such magnitude might indeed have been amplified by criminal conduct along the way. If I had 4,800 words to explore the question, that’s what I’d look for.

But, again, that’s just me.

In fact The Audit’s Ryan Chittum, in a post yesterday, commended the piece for exploring the subject at all.

I say the piece went out of its way not to see potential criminality in a situation that most non-business reporters would find rich with it. In this sense, the Fortune cover story may be unintentionally revealing about a business-press culture that identifies too closely with the people and institutions it covers.

The piece, headlined “Wall Street: It’s payback time,” explores the prospects for executives’ “heads” winding up “on pikes,” as the result of the crisis.

The subhead and other parts of the story resort to hyperbole, implying that anyone who suspects criminal activity, especially fraud, might have amplified the crash might not be entirely rational.

An angry mob of investors and taxpayers is assembling, and they want to see some executives’ heads on pikes. The question for the courts will be, Who was just foolish with our money - and who was lying, cheating, and stealing?

And from the story:

So there’s an angry mob with pitchforks assembling, and they want to see some heads on pikes.

Actually, is there? Even allowing for colorful language, no evidence is presented to support this point. If you ask me, the public has been fairly stoic, even resigned to this calamity.

And here’s some more:

While former Enron CEO Jeff Skilling could at least try to have his case transferred out of Enron-devastated Houston, the credit-crisis targets will have no such card to play. This time the corporate shenanigans have wrecked the globe. “This is the ugliest enforcement environment I’ve ever seen in my professional career,” says one criminal- defense lawyer, who also asks for anonymity.

Again, is it?

And while we’re at it, since when do we give people, even lawyers, anonymity for making general, banal statements like this? Here’s an even worse example, with my emphasis:

It’s no defense for an executive who bends the truth to say that he did so only to prevent a run-on-the-bank-type situation, says one criminal-defense lawyer. (The lawyer requests anonymity because in this climate, he notes, such an on-the-record statement might lose him some business opportunities.)

Are there so few defense lawyers around?

In any case, Fortune cautions us to tamp down expectations, and, as a respected voice on business matters, helps to lower public pressure on prosecutors.

People have a right to be angry, but anger is not the best frame of mind in which to mete out due process. Here, the process that is due requires distinguishing foolish mistakes from lies and fraud - a line that can get surprisingly fine. To the chagrin of John Q. Public, there will be serious defenses in most of these cases.

The main flaw of this piece, in my view, is that it frames the question so narrowly—did top executives lie to investors about the financial condition of their companies?—so as to exclude, or dismiss arbitrarily, entire categories of potential crimes, rich veins of wrongdoing, lying, cheating, forging, etc., which we’ll get to, that could easily result in criminal prosecution—and probably should.

The narrow frame is set here (with my emphasis):

To be clear, we’re not talking here about sensational, not conceivably legal, out-and-out Ponzi schemes, like the $50 billion one that former Nasdaq chairman Bernard L. Madoff has been arrested for, or brazen forgery and criminal impersonation, like the $100 million spree that glitzy New York litigator Marc S . Dreier has been accused of. Crimes like those typically have only one of two defenses: (a) “It wasn’t me,” or (b) “Okay, it was me, but I was sleepwalking on Ambien at the time.” The probes being discussed here concern statements that ultimately proved incorrect, but which reasonable, straight-faced people can, and vigorously do, contend were honest when made.

I’d note here that this passage sets up a straw man. Outright embezzlement vs. highly fraught discussions with investors during times of great stress and peril. Again, this last is a narrow band of activity in what was a sprawling crisis that encompassed mortgage brokers in strip malls, lenders from Orange County to New York, bond salesmen and their bosses on Wall Street, advisors, due diligence firms, accountants, consultants, raters, intermediaries, you name it.

The story goes on to discuss the potential criminal liability that might attach to statements made by Bear Stearns’s Alan Schwartz, Lehman Brothers’s Dick Fuld, AIG’s Joseph Cassano, Fannie Mae and Freddy Mac executives, and so on.

And quite reasonably, I think, the piece describes the difficulties in making a case that the executives deliberately lied to investors, rather simply put the best face on ambiguous situations in an attempt to protect shareholder interests.

Here’s the bit about Cassano:

In August 2007, a month after those agencies downgraded hundreds of CDOs, Cassano spoke to investors in a conference call. “It is hard for us, without being flippant,” he said, “to even see a scenario … within any kind of realm of reason that would see us losing $1 in any of these transactions.”
In a sense, Cassano’s prognostication was not as far off as one would think. Even today very few CDO tranches insured by AIG FP have actually stopped paying as anticipated. But what Cassano and AIG were not disclosing - and at that stage might not themselves have appreciated - was that if market confidence in the CDOs fell sufficiently, AIG could be forced to post billions of dollars in cash collateral to protect the counterparties to its credit default swaps. It would also face writedowns in the value of its credit default swap portfolio, causing huge quarterly losses, sending the company’s stock price lower, threatening its own credit rating, and making it harder for the company to raise new capital. Thus, even without cash losses, the unit’s portfolio could start the company on a downward spiral to oblivion.

The piece as a whole reads more or less like that.

Again, there isn’t a word in the piece that is wrong, but it is crafted in such a way that it ignores the main victims of the credit crisis: borrowers and bond investors.

One category, for instance, dismissed by Fortune, but which is the subject of multiple federal criminal investigation, is alleged fraud by lenders, on a mass scale, against borrowers. We’re not talking about gray-area behavior, like teaser rates and liar’s loans, but plain vanilla fraud: forgery and other tampering with documents, verbal and written misrepresentation, slipping in changes in basic loan terms at the time of closing, and so on.

Evidence of institutionalized corruption at now defunct lenders is by now overwhelming, as I tried to illustrate in a piece in CJR’s September/October print edition.

Here’s an excerpt:

The mortgage mania appears to have entered its Baroque phase sometime around 2004. That year, Countrywide approved a brokerage known as One Source Mortgage, Inc., owned by five-time felon Charles Mangold, which proceeded to embark on “rampant” fraud, Illinois says, including the wholesale doctoring of loan files.

But systemic corruption—and that is the right word—has been unveiled at lenders across the board. Two of the most revealing stories on the culture that overtook the lending industry were published early—February 4 and March 28, 2005—by the Los Angeles Times. Reporters Mike Hudson and E. Scott Reckard found court records and former employees who described the boiler-room culture that pervaded Ameriquest—hard-sell, scripted sales pitches, complete with the “art department” in Tampa. Ex-employees confirmed, as did Lisa Taylor, the loan agent quoted at the top of this story, that copies of Boiler Room, the movie about ethically challenged stockbrokers, was indeed passed around as an Ameriquest training tape.

Etc., etc.

As of last summer, the Federal Bureau of Investigation had opened criminal probes of lending practices at twenty-one companies, including Countrywide, IndyMac, and other market leaders.

And yet Fortune, again, sees only possible fraud against stock investors. Strange.

The problems will arise where the executives tried to distinguish their companies from the pack by highlighting their allegedly superior underwriting techniques, higher-quality portfolios, early anticipation of the downturn, or other purported advantages that proved to be insufficient at best and fictitious at worst. Some officials, like CEO Angelo Mozilo of Countrywide Financial, portrayed the growing market turmoil as an opportunity: “This will be great for Countrywide at the end of the day,” Mozilo told CNBC’s Bartiromo in March 2007, “because all the irrational competitors will be gone.”

In all these cases, prosecutors and the SEC will likely be scrutinizing the executives’ stock sales as the crisis played out, looking for both insider trading and evidence of the executives’ true state of mind…

The same myopia affects the magazine’s view of Wall Street behavior.

Here’s Fortune’s treatment of Bear:

Plaintiffs class-action lawyers claim that Bear’s problems should not end there [with already indicted Bear hedge-fund managers.] Two months after the hedge funds collapsed, CEO James E. Cayne assured investors that “the balance sheet, capital base, and liquidity profile have never been stronger. Bear Stearns’ risk exposures to high-profile sectors are moderate and well controlled.” Seven months later the company sought emergency funding from the Federal Reserve and was quickly sold to J.P. Morgan Chase (JPM, Fortune 500).

Of course, as the world has seen, a lot can change in seven months, so it will be hard to prove that Cayne did not believe what he was saying. A tougher case is presented by his successor, Alan Schwartz, who was saying much the same thing as late as the morning of March 12, 2008, just 36 hours before seeking emergency funding. “Our liquidity and balance sheet are strong,” Schwartz told CNBC’s David Faber. “We don’t see any pressure on our liquidity, let alone a liquidity crisis.”

Although federal prosecutors in Brooklyn were asking some questions immediately after the company’s collapse, there does not appear to be any active criminal inquiry. Counsel for Schwartz declined to comment, as did U.S. Attorney Campbell.

What this and other Wall Street examples leave out is the sale, by Bear and others, of billions of dollars of defective securities, and the extent to which sellers knew they were defective. Fortune tosses off this entire category of behavior as “a bad business model.”

To begin with, bad business models - even business models that in retrospect look like prescriptions for disaster - are not crimes as long as they are fully disclosed to investors. And the fact that lenders were hawking outlandishly risky mortgages to people who were terrible credit risks was, in fact, no secret in America: It was bipartisan national policy. The fact that exotic mortgages (like “pick a payment option” AR Ms and “Alt-A” loans with no documentation of the buyer’s assets or income) were then being packaged into complex derivative securities - some rated AAA by Moody’s, S &P, and Fitch - was not just well known but also hailed as ingenious by some of the putatively best financial minds in the country.

Actually, this passage is deeply unfair to the professionals who maintained their integrity and refused to sell exploding products. Everybody wasn’t doing it. And to the extent that journalism such as this discourages public clamor for investigation of who knew what when in the investment banks, it’s a disservice.

The Fortune story was too much for Janet Tavakoli, a financial industry consultant and author who warned of presciently potential problems in financial firms. In an email to CJR that inspired this post, she doesn’t buy the argument even that executives will get off for misstating their firm’s financial position:

The premise of this week’s Fortune cover story… is not only incorrect, it lacks Common Sense. The article seems unable to muster outrage. In the words of Thomas Paine: “a long habit of not thinking a thing WRONG, gives it a superficial appearance of being RIGHT.” Fortune talks about the difficulty of proving criminal intent when the SEC, Fed chairman and others thought (or more to the point, studiously avoided rational thought) things had gotten as bad as they could get. Since when are the popular delusions of those outside one’s firm a defense for willfully failing to mark your positions to market and material accounting weaknesses if not misstatements?

Fortune also gives the benefit of the doubt to senior managers who were way off the mark in their earnings releases and says “we’re not talking here about …Ponzi schemes.” In a few cases, the latter is actually true, but in others, we should be talking about Ponzi schemes and asking why the SEC did not shut down the securitization groups at some of the major investment banks doing business in the United States.


Let me help the folks at Fortune out. As I explain in my new book, Dear Mr. Buffett: What An Investor Learns 1,269 Miles from Wall Street, value-destroying securitizations went well beyond securitizing bad mortgage loans with unexpectedly bad performance combined with a “bipartisan national policy,” and morphed into the accelerated manufacture of CDOs and CDO-squared transactions (especially in 2007) designed to cover up losses. Many of the securitizations were doomed on the day they closed, and any multi-million dollar payday securitization professional worth his or her salt knew it or should have known it.

Fortune’s not alone, it must be said. The bizpress generally still hasn’t really focused on the bread-and-butter of this crisis: the sale of defective loans and defective securities, by the bushel, and the extent to which the sellers knew of those defects.

That’s unfortunate.

Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014).

Follow Dean on Twitter: @deanstarkman.