Earlier this month the United States government finally brought legal action against some of the financial institutions that helped bring us the 2008 financial crisis. Yet, even as a handful of the biggest offenders face at least a modicum of justice, the Federal Reserve’s ongoing blank-check support for mortgage-backed securities enables the very behavior that nearly took down the global economy and undercuts any real efforts at reform.
On August 6, the U.S. Securities and Exchange Commission (SEC) and Department of Justice filed suit against Bank of America, alleging that the bank sold $855 million of fraudulent mortgage-backed securities. (For more on mortgage-backed securities and the role they played in the 2008 crash, see our WealthCycles article, Blaming Credit Default Swaps, or our video commentary, Michael Burry’s Sad Success Story.) According to the government, Bank of America misrepresented the securities to investors as “prime” despite the fact they consisted of “bundles” of sub-prime and already delinquent residential mortgages. Bank of America, of course, admits no wrongdoing, resorting to the age-old defense of caveat emptor—let the buyer beware.
Just one day later, on August 7, JP Morgan Chase admitted that it, too, was under investigation by the criminal and civil divisions of the Department of Justice. According to the bank’s quarterly report, the DOJ’s civil division had preliminarily concluded that JP Morgan Chase violated securities law with mortgage-backed securities issued between 2005 and 2007. In response, the bank raised its estimate of legal losses in excess of reserves to $6.8 billion.
Despite these limited enforcement actions, the U.S. government, through the Federal Reserve, continues to support and acquire mortgage-backed securities, thus sustaining an artificial market for the instruments. Worse, Bernanke has ruled out the sale of any mortgage-backed securities, stating that the Fed will let them wind down on their own over the years. With the government standing ready to snap up these toxic waste dumps at full price, what possible incentive do banks have to stop issuing them?
It appears, then, that the government’s use of legal sanctions against financial institutions is nothing more than a public relations gambit. In fact the federal enforcement actions bear many hallmarks of a mob-operated protection racket: Pay our measly fine, and we’ll go away and let you continue business as usual. As Justice meekly squeaks “foul,” the Federal Reserve roars full steam ahead with subsidizing the same practices Justice is smacking hands for. Meanwhile, the too-big-to-fail banks continue to reap record profits underwritten by the struggling American taxpayer, who, sadly, is so stressed by creeping prices hikes, scarcity of decent jobs and falling real income he or she is unlikely to even notice the institutional double-dealing.