Counterpoint: Invitation to a Witch-hunt

Summer 2009 -- I am not surprised that Bob Barr, who has been a consultant for the ACLU, should take a litigious approach to the current financial crisis. But my own researches into post–World War II prosecutions of businessmen persuade me that such an approach to the crisis would sidetrack the needed investigation into what went wrong and substitute a witch-hunt against innocent people.

It’s the Law

To justify his approach, Barr adopts the standard prosecutorial line, which says: The government’s regulation of business may not be proper under the standard of economic liberty, but those regulations are nevertheless the law of the land and therefore they must be enforced.

I see two flaws in that argument.

First, there are now so many regulations governing the economy that every businessman in America is surely in violation of at least one. Martha Stewart, remember, faced a ten-year prison term for protesting her innocence of a crime that she had not been charged with committing. Thus, we cannot simply take an approach that says, “It’s the law. We must enforce it.” Enforcement of economic regulations has always been and will always be highly selective. The only realistic question is: what standard will the government use to select its targets?

Professor Larry Ribstein, who specializes in corporate law at the University of Illinois College of Law, has surveyed the recent history of business prosecutions and has abstracted the two rules that apparently govern them:

The Apple Rule provides for an exception from corporate criminal liability when a popular business executive is accused of, or presides over a company that is accused of, misconduct. ‘Popular’ is defined as ‘liked by journalists.’ . . . By contrast, when an ‘unpopular’ business executive (i.e., unliked by business journalists) is associated with criminal misconduct, the ‘Enron rule’ applies. This means that the executive becomes the target of the criminal investigation.

Ribstein’s two rules would, as a matter of fact, govern the selection of victims if America were to follow Barr’s prosecutorial approach to the financial crisis. The result would be to make anti-capitalist journalists the judges who determined whether or not a businessman went to jail. One can easily imagine what sort of businessmen would suffer most under that regime.

But I have another objection to Barr’s dictum that “we must enforce the law,” and it stems from the wide variability of outcomes that can eventuate when businessmen are prosecuted. Not all prosecutions are created equal, and the most important difference arises long before a case goes to trial. Transgressions of business regulations can generally be pursued either as civil violations or as criminal violations. When anti-business sentiment is quiescent, the route of civil prosecutions is generally taken. But when an anti-business Reign of Terror is underway, as it is today, the same violations are treated as crimes. Moreover, since virtually every violation of a regulation has by now been raised to felony status, and since the facts underlying a single count can be made to support multiple counts, our culture’s sans-culottes have the power to convert an unlimited number of big businessmen into “convicted felons,” guilty on scores of charges.

Michael Milken, one recalls, faced ninety-eight charges and was bludgeoned into pleading guilty to six felonies, although his “crimes” were merely violations of minor securities regulations. Indeed, each of Milken’s six “felonies” had, before his trial, invariably been treated as a civil matter resulting in a fine. Yet the anti-business mob, led by Rudy Giuliani, prosecuted Milken criminally and managed to get him sentenced to ten years in prison.

The Question of Fraud

To be fair, it must be noted that Barr waffles between calling for the prosecution of anyone who has violated an economic regulation and calling for the prosecution of those who have committed “fraud,” which of course is an act forbidden even by the standards of laissez-faire capitalism. Unfortunately, in these days of “evolving standards” and “living constitutions,” limiting prosecution to fraud would not by itself be sufficient to guarantee the rule of law. Consider the law of frauds under which Eliot Spitzer terrorized the New York financial district. It was known as the Martin Act, and, as a senior editor of Legal Affairs wrote: “To win a case, the [New York Attorney General] doesn’t have to prove that the defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded.” Such legal vagueness inclines me increasingly to think that fraud should never be treated as a criminal offense, if all genuine victims are fully and promptly recompensed for their provable losses.

When Barr comes to specify examples of fraud, he gives us only two. First is “the creation of these ridiculous so-called monetary instruments that had virtually no known value at all or arbitrary values were assigned to them.” I suppose Barr is speaking of those complex mortgage-backed securities whose risks were evidently underestimated. But, as with “junk bonds” in the 1980s, we must distinguish among three things: (a) the development of complex financial instruments, which is a glory of the free-market system; (b) the inexpert use of such instruments by some people, which is the way of the world and just one more reason that governments should not bail out financial firms; and (c) the fraudulent use of such instruments by some people, which will always be a marginal phenomenon in a free economy.

Barr’s only other specific charge is that Franklin Raines, the CEO of the Federal National Mortgage Association from 1999 to 2004, was involved in “cooking the books.” And apparently that is true. According to The Washington Post (May 24, 2006), a report by the Office of Federal Housing Enterprise Oversight (OFHEO) declared that “Fannie Mae engaged in ‘extensive financial fraud’ over six years by doctoring earnings so executives could collect hundreds of millions of dollars in bonuses.” In 2006, civil charges were filed against Raines by OFHEO, and in 2008 he reached a settlement, paid a $2 million fine, and returned some $20 million in compensation. So, Barr is not quite correct in saying that “nothing happened to him,” but certainly this friend of Democratic presidents was treated more leniently than those book-cooking, dot-com businessmen whose twenty-year sentences ensure they will die in prison.

Still, if Franklin Raines is Barr’s example of a person deserving prosecution, how shall we generalize from that example? Fannie Mae was a semi-public enterprise and Franklin Raines was a major figure in the Democratic Party, appointed CEO of Fannie Mae by President Clinton. If Raines exemplifies the sort of person we should put on trial, then we should be focusing on political figures, not businessmen. And if Raines’s firm exemplifies the sort of corporation we should be investigating, then we should be scrutinizing political-economic institutions, not private financial companies.

In the end, though, I simply do not believe that fraud is the cause of our current financial plight. Having read the work of Stanford University’s John B. Taylor, I suspect that the immediate causes were blunders by government officials meddling in the economy. (For a summary of Taylor’s analysis, see his op-ed, “How Government Created the Financial Crisis,” Wall Street Journal, February 9, 2009.) And behind that governmental blundering, I feel sure, stood the ideology of anti-discriminatory egalitarianism, which permeated both the administration of Bill Clinton and the administration of George W. Bush, and which is the essence of modern liberalism.

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