Neil Irwin had a discussion of the failure to prosecute any of the Wall Street honchos for the conduct that led up to the financial crisis. He concludes that:

"America doesn’t criminalize bad business decisions, even when they lead to business failure."

That is obviously true, but this is not the issue. The Financial Crisis Inquiry Commission (FCIC) found:

"Lenders made loans that they knew borrowers could not afford and that could cause massive losses to investors in mortgage securities. As early as September 2004, Countrywide executives recognized that many of the loans they were originating could result in “catastrophic consequences.” Less than a year later, they noted that certain high-risk loans they were making could result not only in foreclosures but also in “financial and reputational catastrophe” for the firm. But they did not stop.

"And the report documents that major financial institutions ineffectively sampled loans they were purchasing to package and sell to investors. They knew a significant percentage of the sampled loans did not meet their own underwriting standards or those of the originators. Nonetheless, they sold those securities to investors. The Commission’s review of many prospectuses provided to investors found that this critical information was not disclosed."

The question was not whether the top executives of mortgage issuers like Countrywide and investment banks like Goldman Sachs bought into the housing bubble, the question is whether they followed proper business practices in their lust to cash in. The assessment of the FCIC is that they did not. Issuing a mortgage that is known to be based on false information and then selling it in the secondary market is fraud and punishable by time in jail. Similarly, packaging loans into mortgage backed securities that an investment bank has good reason to believe are based on false information is also fraud and punishable by time in jail. (It's actually common for true believers in a bubble to also commit fraud. It is likely top executives at Enron believed that they were actually running a profitable company.)

The way prosecutors would construct a case to prosecute top executives would be by starting at the bottom. They would have gone to branch offices at major subprime issuers like Countrywide and Ameriquest and find out why mortgage agents were issuing so many mortgages with improper documentation. Since this was done by many agents, they presumably could have gotten one or more to report that this was a policy of the branch manager. Presumably branch managers told agents that they needed to issue certain numbers of mortgages and they did not care if the mortgages did not meet proper standards.

Prosecutors would then ask branch managers why they thought it was clever to tell their agents to issue mortgages without proper documentation. Since many branches engaged in these practices, presumably this was the policy of the company. This should have led to prosecutions at the main offices of these subprime issuers, if not the very top executives.

Serious efforts at prosecuting the investment banks would follow the same process. The people who put together some of the worst mortgage backed securities would be asked if they were really dumber than rocks and had no idea that many of the mortgages being put into the packages were fraudulent. If the prosecutors could demonstrate evidence of intelligent life at Goldman Sachs and Morgan Stanley they would then ask the lower level people whether they wanted to spend years in jail or would rather explain why they thought it was a good idea to put tens of millions of dollars of fraudulent mortgages into mortgage backed securities. This would presumably lead to testimony against higher ups at these investment banks.

There would be a similar process at the bond rating agencies. In the case of Standard & Poors, there was actually a famous e-mail in which one auditor complained that they would rate an issue as investment grade if it was structured by cows. A serious effort at prosecution would ask these auditors how they came to believe that it was their job to rate issues structured by cows as investment grade.

There is no guarantee that these sorts of efforts would have landed top executives of financial firms behind bars. However there is no evidence that the Justice Department even began this sort of investigation. At the least, such an investigation would have resulted in prosecutions of lower level actors who clearly violated the law in issuing and passing on fraudulent mortgages. 

As Irwin said, bad business judgment is not a crime. However, it is a crime to allow bad business judgment to lead to fraud. Clearly fraudulent mortgages were a major factor in propping up the housing bubble. No one went to jail for this crime.

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