One of the rallying cries coming out of the financial crisis was that bankers should go to jail. Yet they didn't.
To some extent that's changed over the past couple of years. Looking over the press releases from the Office of the Special Inspector General for TARP (aka SIGTARP) from just the past couple of months, we see multiple bankers who have been put behind bars.
How are regulators finding a way to incarcerate crisis-era banking criminals? At the risk of oversimplifying, it's because they've found cases that would've been hard to not prosecute. In an early April press release, Christy Romero -- the SIGTARP herself -- described a scheme of the former CEO and president of the First Community Bank of Hammond, La.:
First Community Bank President Harper and bank customer Fouquet turned to bank fraud to hide past due loans from the bank, its regulators, and the Treasury Department in the bank's TARP application. The $3 million dollar fraud scheme, which involved making sham loans to Fouquet through straw borrowers and a cover-up that lasted for years, caused significant losses to First Community Bank and jeopardized the bank's financial stability and ability to serve its community.
I'm no legal expert, but that sounds like clear-cut fraud. In a press release from last week, a former Wilmington Trust banker pleaded guilty to bank fraud. His scheme involved:
... [conspiring] to conceal the true financial condition of the bank, in part by extending new loans to clients to enable those clients to keep existing loans current and by causing the bank to misrepresent its reporting of past due and non-performing loans.
Finally, my favorite, from a prosecution wrapped up in early April:
Driven by greed and risky behavior, Teague engaged in an "extend and pretend" scheme using the proceeds of new bank loans to hide past-due loans. He also hid the bank's growing inventory of foreclosed property by directing the bank to finance sales of the properties to buyers including two Teague-controlled shell companies, GPH ("God Please Help") Investments and PHL ("Please Help Lord") Investments.
Now if that's not a banker who knew things had gotten bad ...
This, however, is unlikely to sate the appetite of most people calling for the jailing of bankers. Their rage was not aimed at small community bankers, but the big boys running financial institutions like Lehman Brothers, Bank of America (NYSE:BAC), and Citigroup. How is it, they wonder, that these giant banks brought the U.S. financial system to its knees and nobody did anything jail-able?
Perhaps there were actual crimes that just haven't been prosecuted. The lack of prosecution may be a result of conduct that toes the line of legality. When a banker makes sham loans to shell companies with names like "God Please Help Investments," it's relatively easy to bring, and win, a case. But in many cases the conduct wasn't that clear -- that is, maybe it was illegal, but maybe it was "just" unethical.
Or maybe it wasn't even really unethical. Maybe it was just stupid. As fellow Fool Morgan Housel wrote back in 2011: "Stupid isn't illegal. ... Crime deserves jail time. Idiocy is another issue."
There are many names for what went on in the halls of Wall Street institutions before the culmination of the financial crisis. Egomania, hubris, chutzpah -- label it what you will, but at the end of the day it was just plain stupidity. They assumed housing prices couldn't go down, they thought that if there was any risk it was confined to the subprime backwater, and they figured if they just "spread risk" far and wide enough that everything would be OK. It wasn't.
Bank of America is a perfect example. The bank was buried by the financial crisis, in very large part thanks to the acquisition of the awful mortgage lender Countrywide Financial. Should B of A CEO Ken Lewis face jail time for making such a terribly diligenced, ill-advised acquisition? Well, no. It was epically stupid, but not illegal.
Of course, the Fool is a site for investors, not legal wonks or amateur detectives. And here's the rub for investors: To a great extent, stupid versus illegal doesn't matter.
Sure, stupid in small ways may not wound a company mortally. But, then again, illegal in small ways won't, either. Just last month, Google (NASDAQ:GOOGL) was fined for, as The New York Times put it, "illegal collection of personal data" in Germany. That's obviously suboptimal for Google, but the $188,000 fine is hardly going to put the company under.
Big illegal (think Enron) or big stupid (B of A or Lehman Brothers) on the other hand, can indeed lead to the destruction or near-destruction of a company. For the record, although there's plenty of talk about how well Bank of America's stock has done since early 2012 (up 130%), on an adjusted basis, the bank's stock still only fetches about 25% of what it did in late 2006. Put that one in the loss column for stupidity.
Evaluating management isn't easy or particularly straightforward. And there aren't simple screens that you can run for a company's management team the way you can for its price-to-earnings ratio or return on equity. But when it comes to the safety of your investment, understanding who's running the company -- and the likelihood that they'll avoid both illegal and stupid -- is not a nicety; it's essential.