It’s only Tuesday but the world will have to try very hard if it wants to come up with a worse idea than the monster hatched from the foam and froth of Paul Collier’s brain in the Guardian today. I’m talking about his idea of creating a new class of criminal conduct called “bankslaughter.”
With bankslaughter, when the bank blows up – even if it is a decade later – a criminal investigation traces back to determine whether crucial decisions were reckless. If a reasonable banker faced with the information available at the time would not have taken those risks, the person responsible is dragged off the golf course and jailed.
Once bankslaughter was on the books, bonuses would be less dangerous. Managers would have to weigh the balance between risk and return and take defensible decisions. I doubt hyper-caution would be a problem: the overly cautious would not get bonuses. Surely we can rely on our bankers to exhibit the necessary degree of greed.
This is a terrible idea that needs to be nipped in the bud before some populist lawmaker tries to make a garden party out of it. Even some usually sensible people are already stopping and sniffing the thorny rose. “Is it reasonable to hold professionals criminally liable if they take reckless risks with other people’s money? I don’t see why not,” Reuters columnist Felix Salmon writes.
Let’s try to cure his blindness. In the first place, Collier doesn’t seem to have given much thought to the costs of over-deterrence. Bank executives faced with the prospect of a criminal investigation and possible conviction would likely be overly cautious. We’d lose a lot of socially beneficially risk taking by criminalizing bank failure.
There’s also a serious fairness issue. Only those executives whose risky bets blow up get investigated, prosecuted and punished. Those whose bets pay off are untouched. This means that being unlucky in the markets becomes a criminal matter. Criminality becomes a kind of lottery.
More importantly, this may not deter the true rogues who take the riskiest bets. While people of normal sensibilities will be deterred from risk taking, the really reckless gamblers tend to be all-too confident that they’ll wind up as winners. At the very least, they’re willing to take the chance that they’ll be rich if they win, and only stand a slight chance of prosecution if they lose. A system that deters the normal but doesn’t touch the reckless until it’s too late is a recipe for disaster.
The criminal process is not well-suited to settling the kind of complex financial investigation that Collier proposes here. There’s good reason that civil liability obtains to most corporate wrong doing—the systems were built for each other. The prosecutors would be pound the square peg of criminality into the round hole of day-to-day corporate governance and investment decisions.
Bankslaughter would also be pro-cyclical. As failures multiply during an economic downturn and prosecutors begin to launch bankslaughter investigations, banks would be reign in their own risk-taking. If you think the credit crunch is bad now, imagine how much worse it would be if Jamie Dimon thought he might go to jail for allowing his bankers to authorise loans to consumers and business already burdened with debt.
Collier also imagines that shareholders and executives are at odds when it comes to risk taking. I’m not convinced this is the case. Shareholders and executives both enjoy potentially unlimited upsides from risk-taking and limited downsides from failure. Sure we like to say that Lehman Brother’s failure “wiped out shareholders” but that’s really only true for undiversified shareholders who have no other assets. What really happened is that shareholders in Lehman lost their investment in Lehman, which is actually a lot like the executives losing their jobs. In fact, the huge holdings of shares of Lehman by its own executives is evidence that the real problem with banks isn’t the lack of shareholder control.
To put this last point slightly differently, the relationship between shareholders and the executives who run banks is mostly a contractual one. Executives can live up to their obligations and the expectations of shareholders, or they can fail to live up to those standards. The typical resolution for this failure would be a civil lawsuit. Bankslaughter introduces some kind of objective test that neither shareholders or executives agreed to.
Because bankslaughter is backward looking but conducting business is forward looking, it would almost certainly result in wrongful convictions. Lots of activity that looks reckless after the fact can seem perfectly sensible ahead of time. Unless the crime required bankers to know they were being reckless—in which case it would deter almost no-one and result in approximately zero convictions—it would wind up punishing bankers for just being wrong.
In short, criminal liability is simply inappropriate in corporate cases that don’t involve outright theft or fraud.
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