Why Would Prosecutors Want to End Too Big to Jail?

The whole point of nuclear weapons is not to use them. Own your nuclear metaphor, Justice Department!
Doesn't look that big. Photographer: Balint Porneczi/Bloomberg

Would an indictment of Credit Suisse or BNP Paribas bring down those banks and cause a new financial crisis? I don't know and neither do you and neither does the Justice Department, but it sounds like the Justice Department at least is trying to find out:

Mindful that the specter of criminal charges helped put financial institutions such as Bank of Credit and Commerce International and Drexel Burnham Lambert Inc. out of business, prosecutors in Washington and New York have met with representatives of the Federal Reserve and the Office of the Comptroller of the Currency to discuss the regulatory risks of indictments, according to two people briefed on the matter. ...

"You can't do a guilty plea of a systemically important financial institution without first getting the regulators on board a commitment that the conviction won't put the bank out of business," [former Enron prosecutor Samuel Buell] said in an e-mail. "That seems to be going on here, not surprisingly."

This is a little weird? Sure, they should meet with the Fed and the OCC to figure out the regulatory effect of an indictment, but there's something to be said for broadening your horizons beyond regulatory consequences. Banks spend a lot of their time dealing with regulators, yes, but they get most of their revenue from clients. 1 And:

Bank clients -- including trustees, fiduciaries and pension funds -- could be forced to cut ties with a financial institution labeled a criminal enterprise, the lawyers and bankers said, asking not to be named because they weren't authorized to talk publicly. Counterparties also might think twice before entering into billion-dollar transactions with such firms.

True! Do you think that the Justice Department is wandering around asking pension funds if they could still trade with banks with criminal convictions? I worry that the answer is no, but I also feel like that would be a really fun job? 2

We talked yesterday about how silly it is that the Justice Department wants to get criminal convictions but doesn't want the banks to suffer the actual consequences of those convictions: The goal is to get the swagger, not the substance, of criminal charges. Prosecutors are genuinely worried that they won't be able to control the consequences, but they are unafraid to talk a big game. Preet Bharara certainly is:

"Companies, especially financial institutions, will do almost anything to avoid a tough enforcement action and therefore have a natural and powerful incentive to make prosecutors believe that death or dire consequences await," he said. "I have heard assertions made with great force and passion that if we take any criminal action, the skies will darken; the oceans will rise; nuclear winter will be upon us; and the world as we know it will end."

But the Justice Department is worried enough that it's starting small:

Credit Suisse and BNP Paribas may be serving as guinea pigs to see how criminal charges affect banks, potentially paving the way for such claims against larger U.S. firms when they break laws, said Phillip Phan, a professor at the Johns Hopkins Carey Business School in Baltimore.

"These are test cases," said Phan. "There's a pragmatism behind this. You look for a target that's small enough and that will send a message."

This has to be a little worrying for BNP Paribas? The logic seems to be that prosecutors have no real idea if criminal charges would bring down a bank, so they'll just play around for a bit and see what happens. Start with BNP Paribas. Get a criminal guilty plea. If that puts it out of business, sparks a financial panic, and puts its 190,000 employees out of work then, you know, oops! Don't do that again.

But what if it works? What if BNP pleads guilty, pays billions of dollars in fines, is embarrassed, has some paperwork problems, gets dirty looks from few conservative clients, but basically carries on doing business as usual (but, you know, with more contrition and less sanction-violating)? That seems to be the intention of prosecutors: to find a small test case to prove that a criminal indictment doesn't have to be a disaster for a big bank.

Why on earth would they want to do that? JPMorgan paid about $20 billion in penalties to U.S. regulators last year. Zero dollars of that came in the form of jury awards after regulators brought cases and JPMorgan fought fiercely and went down swinging. All of it came in the form of massive settlements. Why did JPMorgan keep shoveling money at any regulator who asked? Possibly because it had a collective guilty conscience. More realistically, though, because regulators had the gigantic stick of criminal chargeswith which to threaten it. Preet isn't kidding; the widely accepted view of a criminal indictment is the nuclear-winter one. So, over and over again, JPMorgan's negotiations could go like this:

Justice Department: Give us $10 billion for mortgages and stuff.
JPMorgan: No.
Justice Department: Okay we'll indict you.
JPMorgan: Nononononono fine here's $10 billion.

Easy peasy! I bet Brian Moynihan has that conversation in his dreams.

But let's say BNP Paribas pleads guilty, not in a dinky find-a-Japanese-subsidiary sort of way, but in a full-blooded, at-the-holding-company sort of way. And then ... it's fine! BNP Paribas keeps its charters and licenses and stuff. Everyone keeps trading with it. Life goes on.

What happens next time JPMorgan does a naughty thing?

Justice Department: Give us $10 billion for electricity or whatever.
JPMorgan: No.
Justice Department: Okay we'll indict you.
JPMorgan: Go for it.
Justice Department: Even the filing of charges can be enough to bring down a bank.
JPMorgan: Naaaah.
Justice Department: You'll lose your charter.
JPMorgan: Not automatically. And we have a pretty good case to make to the OCC and the Fed that we should be okay.
Justice Department: Clients won't want to trade with an indicted bank.
JPMorgan: Oh sure, they'll pack up and take all their business to BNP Paribas.
Justice Department: ...
JPMorgan: See you in court!

I mean. Obviously regulators have lots of other sticks with which to threaten big banks. Good regulatory relations are important, and you can be put out of business without an indictment. But criminal charges are -- were? -- the quickest and simplest and most terrifying way. 3 If you take the terror out of that threat, then you lose a lot of your leverage.

At one level, bank regulation is a system of rules that banks try to game, with plenty of success. But at a very high level, regulation is oddly unconstrained by rules. If you are a regulator with the power to indict, you can force banks to stop doing anything you don't like, whether or not it is explicitly against the rules. 4 And you can charge them whatever fines you like, because they can't say no. The banks may have good technical arguments that their conduct, despite looking horrible, is actually legal, but you can shut down every argument with the threat of indictment. It is, in so many words, your nuclear option.

The whole point of having nuclear weapons is not to use them! Once you lob an indictment at BNP Paribas, and BNP Paribas goes about its business without much damage, that threat is gone. You're left regulating under the rules, with banks who have the ability to fight back. That's not such an attractive place for a regulator to be.

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  1. What percentage of their revenue comes from regulation? I feel like plausible answers range from negative 20 percent to, like, positive 50 percent.

  2. Seriously, I am a weird person and I would love to be in charge of like figuring out all of the potential consequences of an indictment, going to all the counterparties and state regulators and whatever to see what they'd do, and then if necessary trying to get them to change their rules to allow them to trade with a bank with a criminal conviction. I wonder if Credit Suisse employs anyone whose job is to do that. I bet the Justice Department doesn't!

  3. In particular, they're entirely in the discretion of the Justice Department: You don't need any hearing (other than a grand jury for an indictment, but come on) or process. The charges are just the start of a criminal process. But they can bring down the bank before the process starts! Or they could.

  4. That's Eric Schneiderman's approach.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net

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