Judge Jed Rakoff uses a piece in the New York Review of Books to consider why government officials, who have talked a lot about fraud being at the root of the financial crisis, have not prosecuted the individuals that allegedly perpetrated the fraud. In doing so, he raises some bigger concerns about how government bureaucracies make decisions about whom to pursue and how.
The seeming absence of prosecutions may not be as troubling as Judge Rakoff believes. Some of the talk by government officials of fraud has been rather casual and abstract. He points, for example, to the 157 times that the Financial Crisis Inquiry Commission's report on the financial crisis used the word "fraud," but that number includes fraud by mortgage borrowers. Three of the report's dissenting commissioners "classif[ied] mortgage fraud not as an essential cause of the crisis but as a contributing factor and a deplorable effect of the bubble."
Nevertheless, Judge Rakoff raises concerns that extend beyond whether prosecutors brought enough financial crisis cases. First, he notes that government agencies moved resources away from financial fraud to other types of cases, such as terrorism, insider trading, and--in the case of the post-Madoff SEC--Ponzi schemes. This tendency towards flavor-of-the-day prosecution is a troubling reality of government bureaucracies. Judge Rakoff cites budget constraints as one reason for the SEC's struggles, but simply throwing more resources at agencies does not ensure that they will allocate them well. Second, he points to the government's own role in setting the stage for the financial crisis as a reason for government reticence to bring cases. Unfortunately, government policies that push banks into certain types of activities over others regardless of risk continue to discourage prudent decision-making and also could discourage future prosecutors. Finally, Judge Rakoff points to the trend towards pursuing companies rather than individuals. As he explains, in order for the company to have done something wrong, someone at the company needs to have done something wrong. Rakoff points out that pursuing individuals is harder because they don't settle as readily as companies that use shareholder money to fund an investigation of the wrongdoing and the subsequent large settlement. The government routinely announces large settlements with corporations without fully explaining the nature of the violations and their connection with the penalties paid. For all the harm it caused, the financial crisis could do some good if it helps government agencies to rethink the way they are setting and settling their enforcement agendas.