Since the financial crisis, shareholders have borne the lion’s share of the cost of banks’ past misconduct. It has been a weighty burden on top of the requirement to put new money into often woefully undercapitalised institutions. Around the world, they have been stuck with penalties amounting to nearly $350bn.
They have certainly taken more pain than those who ran the largest banks. By and large, top executives have got off lightly. True, some have lost their jobs, or seen their wealth eroded because of the tumbling value of their stakes in their own institutions. But most have avoided sanction, hanging on to their professional credentials and much of their winnings. In a recent study of 156 criminal and civil actions brought against large banks by the US Department of Justice (DoJ), individual employees were identified and charged in just 19 per cent of those cases, according to analysis by the Wall Street Journal. In only one was a board level executive actually held to account.
No one questions that shareholders should have responsibility for the conduct of an enterprise — especially one with the economic significance of a big financial institution. Those who both have rights of control and a share in the fruits should bear the costs when things go awry. But it is striking how through the post-crisis period almost all penalties have fallen on the investors, and indeed continue to do so. Just look at the furore about the proposed settlement between the DoJ and Deutsche Bank. Most bank fines have ranged from the annoying to the painful. In this case, the DoJ went further: the $14bn it was apparently demanding — a startling four-fifths of Deutsche’s market capitalisation — actually raised questions about the bank’s ability to pay.
Even so, the real eye-opener was not so much the number (which is anyway likely to be negotiated and much smaller) as the absence of any bank executives from the charge sheet. One might have thought that malfeasance requiring such a level of restitution would at least have resulted in staff being pursued because of what they had done.
Not so. In fact not a single Deutsche employee was fingered for misconduct. And what is more, it has been virtually the same story with a host of settlements involving mortgage-backed securities. Several large US institutions, including JPMorgan, Bank of America and Goldman Sachs, have coughed up a cool $55bn. Yet with just a handful of exceptions, regulators haven’t found individual bank employees who committed prosecutable offences in the whole mortgage mess.
So why single out the principals while not punishing their agents? It seems disproportionate to lean only on investors in listed ventures where the manager enjoys both informational advantage and considerable freedom of action. Shareholders’ control rights are actually more circumscribed in banks than in other corporations. Not only does commercial confidentiality cast an impenetrable veil over their operations; regulatory consent is generally required before executives can be dismissed.
Indeed, this agent advantage may explain not only why shareholders are paying, but why they are being mulcted so massively. The reason springs from the bulge in the number of so-called deferred prosecution agreements (DPAs) and regulatory settlements that has followed the financial crisis. These deals allow the banks to admit wrongdoing, but critically without disclosing significant details about their past misconduct, such as the identities of those responsible or the magnitude of their violations.
That makes it impossible for outsiders to know whether the penalty is appropriate. Prosecutors and regulators presumably square this leniency with their consciences by saying they do not want to bring down a systemic institution. But, in reality, what they have done is to hand bank bosses a way of buying their own firm’s way out of any trouble — using other people’s (ie: shareholders’) cash.
Allowing banks to settle without admitting fully to past misconduct is a form of moral hazard. Sanctions should be imposed not only on shareholders, but also on those individuals who did wrong, or allowed it to go on through connivance or inattention.
The authorities claim that no bank is “too big to jail”. Their continuing reliance solely on escalating fines and settlements says otherwise. The gap between words and deeds is not only proving very costly for shareholders, as Deutsche’s investors are just the latest to discover. It gives the impression that bank capital can be seized as a form of tax, and that executives can buy their way out of their responsibilities to the law or to investors and customers. Nothing is more damaging to a recovery of public trust in banks.