One of the central questions we have failed to confront in the rush to rescue our economy is the question of culpability for putting us in this position in the first place. Steve Kroft's segment on 60-minutes last October zeroed in on the heart of the matter.
(link:CBS News Story/video)

The same people who paid themselves bonuses in the hundreds of millions for engineering the financial crisis are now claiming they didn't understand what they were doing by risking depositor funds and shareholder investments in their firms. In simple terms, the most highly compensated executives on Wall Street saw an opportunity to sell securities they knew full well were suspect (sub-prime mortgages to under-qualified borrowers), package them as over-the-counter equities using esoteric mathematical techno-babble which supposedly quantified the risks, but backed that up with what was sold as insurance, albeit under a name which allowed it to escape regulation: 'Credit Default Swap' (CDS).

To explain what a CDS is (in laypersons terms): A CDS is a contract between someone who holds one or more loans and another party who promises to pay off the remaining principle of the loan in the event the primary borrower defaults in paying it back. In return, the party offering the CDS receives a percentage of the monthly interest on the loan. For companies like Citigroup, AIG, Lehman-Brothers, etc., the use of the CDS was a way of hedging their bet that the sub-prime mortgages they were offering would pay off. The CDS also provided a key component to the story they were telling to ratings agencies, depositors and shareholders to whom they were marketing the securities they created (the so-called derivatives). In other words, to those who may have questioned the risk associated with those sub-prime mortgages, the answer was: "We can insure the risk by securing the principle with a CDS contract."

Unfortunately, the value of that insurance depended upon the ability of those offering the CDS contracts to make good on the principle amounts they were guaranteeing. Normally, providers of insurance are subject to strict governmental regulations and oversight. One of the primary purposes of that oversight is simply to make sure the people selling the insurance have sufficient assets to make good on their promises.

In the case of CDS contracts, there was no such oversight. Why? Because a bi-partisan group of Senators and Representatives (led by then Republican Senator Phil Gramm) initiated and passed legislation in 2000 which had the effect of splitting the jurisdiction over these transactions between two separate regulatory bodies. In order to do that, they passed the 'Commodity Futures Modernization Act' (aka: the 'CFM') which provided for a jurisdictional sharing plan between the Commodity Futures Trading Commission and the SEC. Technically, the CFM was initially considered as a separate piece of legislation, but later embedded (some would say 'buried') in a much larger bill: HR 4577, a so-called 'Omnibus Spending Bill', signed into law by Bill Clinton on December 21st, 2000.

To this day, Gramm insists that the SEC had the authority to regulate CDS contracts, but chose not to:

"It wasn't that the regulators weren't there. It wasn't that the regulators didn't have the authority," said Gramm. "It was that the regulators didn't have the concern. In no area of the subprime lending related to mortgages did regulators lack authority." (link reference)

The problem with Gramm's defense, is that they took deliberate action to obfuscate which entity had the authority to regulate the swaps, and now fall back on the argument that this subjective discretionary authority existed, but was not used. It begs the question: what was their motive for creating a subjective construct that would all but guarantee that neither agency could be held accountable for excercising oversight? Could it be that an explicit regulatory authority would be far more onerous to their plans than a more general and subjective one?

Gramm's defense sounds even more specious in light of the testimony just this week before Congress in the Madoff Ponzi investigation, where it was revealed that the SEC had been repeatedly warned and provided with objective evidence of fiduciary misconduct on the part of Mr. Madoff, and the SEC refused to investigate in that case either. If one scratches beneath the surface, it appears that the legislation in 2000 enabling the unregulated expansion of derivatives and CDS contracts amounted to a compromise under which massive regulatory problems and potential risks were put on hold subject to "working out the details later". How much later? The legislation which was generally referred to as the "Commodity Exchange Reauthorization Act" (CEA) eventually passed as part of the "Food, Conservation and Energy Act of 2008" (aka: The 2008 Farm Bill), May 22, 2008. Apparently, considerable damage was done in the interim...

All of this goes to the larger and perhaps defining issue, the principle which underlies almost all of the corruption which we, as voters and members of the electorate know (intuitively) exists, but are unable to articulate in sufficiently rigorous terms to overcome: Plausible Deniability. This principle states (sic):

"Any illegal, dishonest or improper action may be rendered harmless, as long as the perpetrator is able to provide a plausible explanation."

Put another way: if you get caught on a video security camera holding up a convenience store and walking out with $87.27 in cash, you'll go to prison for sure. On the other hand, if you initiate a massive expropriation of public funds, or depositor funds, or shareholder assets, invest them in securities which you know to be far more risky than they appear, and then pay yourself tens or even hundreds of millions of dollars in bonus compensation for the initial apparent value of marketing those securities, you can walk away with the cash, even if those securities eventually prove to have been nearly worthless, precisely because of the risks you knew they carried with them.

What is the difference between the two forms of criminal activity? In the former case (a blue-collar criminal who burglarizes a grocery store), the evidence and the intent of the criminal is empirically obvious and unequivocal. In the case of massive fiduciary misconduct which has led the economy of this nation to the brink of disaster: because it is committed in the abstract, and because it can so readily be reduced to a talking point (with differing subjective opinions as to the nature of the crime), we allow it, and do nothing to those responsible.

In reality, at every step along the way, knowledgeable insiders were skimming commissions and paying themselves performance bonuses for apparently increasing assets and share prices. According to one report, in 2007, $29-Billion in compensation was shared by 50 executives, many of them 'hedge fund managers'.

One of the financial experts interviewed by Kroft referred to the conduct of these executives as 'looking the other way' and as 'criminal negligence', with emphasis on the word 'criminal'. Meanwhile, the Bush administration negotiated with many of these same executives over how much the government would pay to their firms in order to offset losses they incurred. As we now know, $350-Billion in public funds was handed over to these people, who in spite of the economic carnage, managed to pay themselves $18-Billion in bonus compensation for their performance this tax year (2008).

I can only hope that the incoming administration is sufficiently committed to the idea of 'real change' to include ordering the DOJ to investigate these people for criminal conduct. I expect they were careful to avoid the most obvious violations of law with respect to their own industry. And the 8-year long struggle between the SEC and the CFTC over regulatory jurisdiction provides them, no doubt, with a plethora of plausible excuses for not knowing exactly what their fiduciary obligations were.

However, we have a more general statute, called 'RICO', which stands for: Racketeer Influenced and Corrupt Organizations, and it's traditionally been used as a means of busting the leaders of organized crime activities who are able to insulate themselves from the actual perpetrators of the crimes. Here's what the Department of Justice handbook on RICO prosecutions says:

The purpose of the RICO statute is "the elimination of the infiltration of organized crime and racketeering into legitimate organizations operating in interstate commerce." S.Rep. No. 617, 91st Cong., 1st Sess. 76 (1969). However, the statute is sufficiently broad to encompass illegal activities relating to any enterprise affecting interstate or foreign commerce.

In the view of many experts, we're talking about widespread 'criminal negligence' on the part of individuals who were highly compensated precisely because they were expected to understand the complexities of risk associated with their fiduciary responsibilities to investors and bank depositors, and ultimately to this country. One could make the case that the CDS contracts constitute a 'smoking gun' of sorts, which proves these financial racketeers were fully aware of the inherently risky nature of the securities they were creating and selling. Should we not ask our Justice Department to at least investigate and attempt to discover the hard evidence of who knew what, and when?

Their actions, collectively will likely end up costing this country Trillions of dollars. Is the electorate willing to demand of the new administration that these people be prosecuted, and their ill-gotten gains recovered? Does President Obama have the poitical will to go after these people? We'll simply have to wait and see.