Wall Street: Not Guilty

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While it may be harder to prove criminal guilt, it's easier for people to believe that some bad actor is the cause of bad things. This is a persistent trait in the national character. Historian Richard Hofstadter identified it in 1964 as The Paranoid Style in American Politics. He was writing mostly about McCarthyism, though he recognized that paranoia isn't limited to the political Right. Nor is it always harnessed to an unworthy cause; convicting criminals, especially in high places, isn't just worthy, it's crucial to democracy.

The paranoid style, as Hofstadter defined it, has as much to do with "style" as paranoia—it's about "the way in which ideas are believed [more] than with the truth or falsity of their content." It spawned a rhetoric that tilted every question toward conspiracy, so that random or unfortunate events were seen to compose a "baffling pattern." Thus, the "sharp decline"—Hofstadter was writing about America's perceived international strength, not the price of real estate—did not "just happen." It was inevitably brought about by "will and intention."

We could follow this strain through the dismal historiography of JFK assassination buffs to the beliefs that Washington was implicated in Pearl Harbor and Sept. 11, to the anti-federalist fantasies of the far right. Such inquiries adhere to what Nassim N. Taleb, author of The Black Swan, describes as the "narrative fallacy"—the desire to impose on chaotic events a more deterministic set of causalities. Although a few people forecast the crash, most people (even in financial firms) did not. There was genuine debate over whether a bubble existed. This is not to deny the atrociously unsound, and often unethical, loan practices. It is to assert that Stan O'Neal probably did not recognize that the mortgages his firm owned were a house of cards. The evidence of bad lending was not so widely apparent as it was later. Even when subprime issuers were in a state of collapse, Ben Bernanke and his colleagues were deeply divided over whether the U.S. faced a recession. The Federal Reserve's view was a muddle. In contrast, the story that accusers tell is coherent. As Hofstadter recognized, "the paranoid mind is far more coherent than the real world."

It may seem incredible that foolishness, greed, and negligence could lead to a calamitous, long-enduring recession in which millions of people lost their jobs. But financial history is replete with bubbles and crashes. No person—no criminal, that is—caused the Great Depression. Stock manipulation (most of it, at the time, legal) was surely a factor in the Crash of '29. Exhibit A was Charles E. Mitchell, president of National City Bank. "Sunshine Charley" avidly sold securities of dubious character to hapless clients and whipped up speculation with margin loans. His trial, on charges of tax evasion, resulted in acquittal. However, the country drew the right lessons. It enacted rules for securities disclosure and created a cop on the beat (the SEC). It also established deposit insurance, which would avert future bank runs. Bankers, though not incarcerated, were shamed, thanks to electrifying public hearings.

Mitchell's closest contemporary peer is Angelo Mozilo. A flamboyant salesman, Mozilo did more at his Countrywide Financial than anyone to popularize subprime mortgages, as well as mortgages with no money down. Neither the products nor their popularization is a crime. Under Mozilo, Countrywide Financial issued billions of dollars of mortgages with apparent neglect for whether the borrowers were creditworthy. His company contributed to the heights of the bubble and to the depths of the crash. Such behavior is why financial markets require renewed, tough regulation and supervision. It's also why the compensation system must be overhauled to remove the incentive for creating ephemeral profits that ultimately go up in smoke. Congress has gone to exhaustive labors, enacting the 2,000-page Dodd-Frank reform (which, among other provisos, creates a new consumer protection bureau) to prevent a future Mozilo. To the extent the reforms may be lacking, it is up to Congress, not the Justice Dept., to make amends.

Mozilo settled civil charges with the SEC for a record $67.5 million. Regrettably, most of the fine was paid by Bank of America (BAC). Moreover, the settlement was dwarfed by Mozilo's compensation, which included (but was in no way limited to) stock sales of nearly $140 million prior to Countrywide's collapse. Prosecutors investigated Mozilo but didn't charge him. Their decision was disappointing at an emotional level, but indictments cannot be geared to repairing feelings of frustration. Lanny Breuer, head of the Justice Dept.'s criminal division, told NPR he sought to bring cases only where guilt could be proved beyond a reasonable doubt, and without filtering decisions through the screen of public opinion. This statement was remarkable only in that Breuer felt it had to be said.

Seligman says he sees "a serious enforcement effort," both civil and prosecutorial. It's hard, of course, to second-guess any specific decision not to indict. But it's worth remembering that in the American legal system, people who merely act badly or unwisely do not do time. And people who contribute to a financial collapse aren't guilty of a crime absent specific violations that make them so. We should be thankful for that.

Lowenstein is a columnist for Bloomberg News.