Wednesday, December 12, 2012

DOJ Declares HSBC Too Big To Prosecute

2012 may well be remembered in times to come as the year of the financial scandals. Not that scandals in the finance industry are anything new, but this year seems to have seen a greater number of scandals, and of larger scope, than anything that has come before. It is now clear that fraud and manipulation are widespread in the finance industry, even more so than many cynics, myself included, had previously believed.

In what may be the biggest financial scandal of the year, the United States Department of Justice (DOJ) announced that it would not be indicting HSBC (one of the world's largest banks) on money laundering charges, despite having amassed mountains of evidence showing that HSBC has assisted Mexican drug cartels and others to launder over $60 trillion. Instead, HSBC announced last Tuesday that they had agreed to pay $1.92 billion to settle the allegations. The reason that the DOJ gave for not bringing criminal charges is that a successful prosecution might bring down the bank entirely and destabalize the global financial system.

You're already familiar with Too Big To meet Too Big To Prosecute.

The fine is being portrayed by the mainstream press as a win for prosecutors, since $2 billion sounds like a lot of money to most people. But when one recalls that HSBC likely laundered something in excess of $60 trillion, and that 1 trillion is equal to 1,000 billion, the fine actually seems ridiculously small.

Let's knock off a few zeros and put this in terms we can all understand: 60 trillion is 60,000 billion, so HSBC laundered $60,000 and got fined $2. All of a sudden those 2 billion dollars don't seem like such a big deal. The question one is led to ask is, did HSBC make more than 2 billion dollars for laundering 60,000 billion? The obvious answer would be “yes,” since 2 billion is only .003% of 60 trillion. Even if HSBC was only charging the Mexican drug lords 1% to launder their loot, they still would have made $600 billion.

What this means is that the biggest banks no longer need fear prosecution, even for laundering gargantuan piles of cash on behalf of drug lords, terrorist-funders and embargoed states (HSBC was doing illegal business with both Iran and Cuba). The fines they are likely to pay if they get caught can be written off as merely a “cost of doing business,” and a vanishingly small cost at that. The “Too Big To Fail” banks and financial institutions are now, officially, above the law.

What is even more disturbing than the money laundering itself, is the DOJ's reasoning for its refusal to bring criminal charges. Their concern, in part, is that a guilty verdict or plea in such a case would disallow pension funds from investing in HSBC. You read that correctly, the Department of Justice is refusing to bring indictments for criminal acts committed because doing so would hinder the criminals from having access to your retirement savings. DOJ is now in the somewhat awkward position of fining HSBC for criminal money laundering, while at the same time trying to maintain that HSBC was not engaged in criminal money laundering, since if they were, your pension fund would have to take its business elsewhere, which the DOJ apparently thinks we need to avoid. Welcome to Wonderland, folks; we are definitely through the looking glass, here.

But what if the Department of Justice has a point? What if being too harsh on HSBC and its executives really would destabilize the global economy and lead to another 2008-type crisis? Shouldn't we avoid that at all costs?

There are a number of problems with this line of thinking. The first is the assumption that criminal prosecution of individuals within HSBC will necessarily lead to the total collapse of the bank. HSBC is a massive, highly profitable bank, with a value of $174.38 billion and a profit margin of 27%, according to the New York Times Dealbook. Even without pension fund investors HSBC might still be able to make money, if on a considerably smaller scale.

But even if the withdrawal of pension funds led to the bank's collapse, there is no reason to think that HSBC couldn't be wound down in a relatively orderly manner. Iceland did just this, when it let its biggest banks fail during the financial crisis of 2008, paid off depositors using the banks' assets and made investors take a haircut. As a result, Iceland has been quicker than other European countries to recover from the Global Financial Crisis and, unlike the U.S., now has a banking system cleansed of frauds and criminals. Iceland's example puts the lie to the “Too Big To Fail” meme, proving that letting big banks collapse when they engage in unsound, fraudulent behavior, is a real possibility.

The actual reason that banks in the U.S. and elsewhere get bailed out, and that they only pay a .003% fine when they get caught breaking the law, has more to do with their large contributions to political campaigns and parties, than it does with their importance to our economic system. In fact, and not at all surprisingly, allowing criminality at our largest financial institutions to go virtually unpunished is an extremely bad thing for our economy.

The economy as a whole, and the financial industry in particular, runs on trust. When frauds and criminals are given a free hand to do whatever they like with little-to-no chance of meaningful prosecution, trust becomes a non-existant commodity in the market place and the system grinds to a halt. This is what happened in 2008 during the credit-crisis. Banks refused to lend to each other, none trusting that the others were reporting their financial positions correctly, no one being sure who was actually solvent and who was one step away from bankruptcy. Everyone knew that fraud was widespread, since everyone was engaging in it on a systematic basis, and therefore no one trusted anyone else. As it turns out, individual greed is not enough to make a market function: trust is also required.

And where does that trust come from? It comes from knowing that those who would cheat and defraud are being hunted by authorities, that they are being punished and eliminated from the marketplace. But now the authorities in charge of prosecuting the bad guys have come out and stated openly that they do not intend to prosecute the crimes of the largest players, that they will be given free reign to do whatever they like, whether it's knowingly selling pension funds lemon MBS (mortgage-backed securities) or laundering money for the Sinaloa cartel. Even a cynic like me has to shake his head in disbelief.