Commentary: UBS and Too-Big-to-Punish – James Saft

As well as too-big-to-fail it looks as if we must think of our largest banks as too-big-to-punish as well.

After comments from top U.S. Justice Department officials in the wake of the $1.5 billion settlement with UBS over interest-rate manipulation, the bank’s counterparties, employees, clients and competitors certainly will.

UBS was fined and a subsidiary pleaded guilty to one count of felony wire fraud over its part in a wide-ranging effort to doctor key benchmark interest rates such as the London Interbank Offered Rate (Libor).

The combined fines and disgorgement UBS has made to regulators in Britain, Switzerland and the U.S. were big – three times larger than those paid by Barclays in a related scandal.

Comments made by U.S. Attorney General Eric Holder and Lanny Brauer, head of the Justice Department’s criminal division, however, indicate that UBS very likely got off more lightly than you, me or the local credit union might have done had we committed the same offenses.

Asked after the deal was announced why UBS was not criminally charged at the parent company level, Breuer replied:

“Our goal here isn’t to destroy a major financial institution,” according to remarks reported on twitter by Financial Times correspondent Shahien Nasiripour.

“In the world today of large institutions where much of the financial world is based on confidence one of the things we want to ensure as we come forward to a right resolution is to ensure that counterparties don’t flee an institution, that jobs are not lost, that there is not some world economic event that is disproportionate to the resolution we want.”

Asked at the same press conference about financial stability concerns and the criminal prosecution of banks, Holder trod a similar path:

“The impact on the stability of the financial markets around the world is something we take into consideration. We reach out to experts outside of the Justice department to talk about what are the consequences of actions that we might take, what would be the impact of those actions if we want to make particular prosecutive decisions or determinations with regards to a particular institution.”

Now of course it would be silly to expect them to act without consideration of the consequences of their actions, but the fact that they seem so cautious over the knock-on effects of a full-tilt prosecution of a major bank is disturbing.

The worry, presumably, is that prosecution could bring down a bank, thereby setting in train the kind of round-robin of counterparty panics and failures regulators feared after the failure of Lehman Brothers.

That’s possible, but a world in which prosecutors need to be mindful of not upsetting confidence in banks which have behaved criminally is one in need of reform.

We don’t know if bringing down a major bank would cause more damage than benefit. My guess is that we overestimate the damage. We do know that being the politicians or government official who does so is a role with more risk than reward.

Therefore even if the DOJ’s mindfulness over the fate of UBS is prudent; it fully and horribly illustrates why too-big-to-fail is intolerable. These kind of statements cement in the minds of executives, employees and counterparties that, theoretically at least, justice is not blind when it comes to our largest banks.

That must act as an incentive to wrong-doing, and almost more importantly, an incentive for the “TBTF” to never willingly relinquish that status. I haven’t got a strong opinion about whether UBS was dealt with harshly enough, but I do worry that those making the decisions about how to deal out justice are hamstrung by a set of government policies which, in effect, enshrine too-big-to-fail status for our largest banks.

Let’s think about other industries, and consider our reaction if they were treated with kid gloves in the same way.

Remember, what UBS was accused of was subverting one of the central price setting mechanisms which it is its privilege to take part in. What if a regional hospital, dominant in its market, escaped the full penalty of the law for price gouging because of the fear of what its end might mean for hospital service in that region? What would be the long-term effect on healthcare of that, I wonder?

Or what if we went easy of the manufacturer of unsafe airplanes because we were worried about losing a national champion in that industry? I know I’d start taking the train.

The point is not that prosecutors should take no account of collateral damage, but rather that the largest banks should be rendered forcibly smaller so that a financial panic is no longer even a minor consideration in punishing criminality.