‘Regulatory Capture’ Emasculated The Regulators Of Megabanks

Senator Elizabeth Warren set him up brutally. HSBC had admitted “to laundering $881 billion that we know of from Mexican and Colombian drug cartels,” she said, leaving us to imagine what we don’t know of. They “also admitted to violating our sanctions”—against Iran—“and they didn’t do it just one time… they were caught… and kept doing it,” she said.

HSBC, which is based in London but earns about half of its profits in Asia, settled these allegations for $1.92 billion before taxes (so perhaps $1.2 billion after taxes), the steepest penalty ever assessed by banking regulators in the US. Yet, after charging that fine to its income for the year 2012, it still had a net profit of $13.5 billion: the fine for years of wrongdoing had dented its bottom line by half a quarter’s worth of net profit—a “difficult” year, said Chairman Douglas Flint, as he lamented the “legacy issues and regulatory challenges.”

So Senator Warren turned up the heat. “HSBC paid a fine but no individual was banned from the bank and there was no hearing to consider shutting down HSBC’s activities in the United States,” she said (webcast). “How many billions of dollars of drug money do you have to launder before someone will consider shutting down a bank?”

David Cohen, the Treasury’s Under Secretary for Terrorism and Financial Intelligence, twitched on her skewer. He did the best he could under the circumstances, offering that they took money laundering “very seriously,” and so on. She became testier and wanted him to draw a line in the sand, a crime that would be big enough for the bank to be shut down. Turns out, there was no crime that would be big enough.

Everybody already knew it. These banks were too-big-to-jail. Attorney General Eric Holder, the top guy at the Department of Justice, had made it official the day before when he told the Senate Judiciary Committee, “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them.” They didn’t prosecute banks, or apparently high-level individuals associated with them, if that would have “a negative impact on the national economy, perhaps even the world economy,” he said.

But who decides which bank qualifies for too-big-to-jail? The DOJ defers to bank regulators on that issue, particularly the Treasury. Under the Geithner doctrine of supporting the megabanks instead of regulating them, it bamboozled the DOJ into thinking that HSBC’s US operations, not its much larger operations elsewhere, would be too large and systemic to prosecute.

But there is another principle at work. Cohen joined the Treasury in 2009, after having spent seven years at the Washington law firm Wilmer Hale, where he focused on “the defense of regulatory investigations into accounting and financial fraud, and anti-money laundering and sanctions,” according to the Treasury’s website. His clients were “a broad range of financial institutions including banks.”

He’d been at the Treasury before, starting in 1999, for about three years, in the Office of the General Counsel, where he worked on the Bank Secrecy Act that gave the Treasury “new tools to combat money laundering and the financing of terrorism.” He also advised senior officials on issues such as “the Department’s anti-money laundering and counter-terrorist financing policies.” Before then, he’d worked for another law firm.

There are thousands of people like Cohen who rotate in and out of government through the revolving door. Smart, hard-working, competent people with a lot of experience. They form deep connections not only in government, but also in the industry they’re supposed to regulate one day and work in, or get their clients from, the next. Once critical mass builds up, the lines begin to blur between the regulatory agencies and the companies they’re supposed to regulate until the agencies are essentially controlled by the culture and insiders of the industry. A condition called, “regulatory capture.”

Hence, the Treasury’s efforts to do whatever it can to protect and support the megabanks. Other regulators have suffered the same fate. Regulatory capture has emasculated them as regulators. Now there is a bi-partisan display of frustration with these megabanks that have caused so much havoc while their major players have become immensely rich without having to answer for practically anything. But if history is any guide, this too shall pass, like so many other Congressional outbursts, while megabanks pay some fines and go on about their business.

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