Dec. 6 (Bloomberg) — Here’s a not-so-comforting lesson for investors, courtesy of the Securities and Exchange Commission. Just because the SEC says a company’s earnings were fraudulent doesn’t mean the company will ever be required to correct them.

The SEC this week accused Fifth Third Bancorp of committing accounting fraud during the height of the 2008 financial crisis. The company agreed to pay a $6.5 million penalty to settle the agency’s claims.

The funny part: Fifth Third, which is Ohio’s largest bank, has never acknowledged to this day that its numbers were in error. The SEC isn’t requiring it to do so now. A Fifth Third spokesman, Larry Magnesen, said the company considered whether it needed to do a financial restatement and decided it didn’t.

Reasonable people might disagree about whether Fifth Third committed fraud. Per the usual protocol, Fifth Third neither admitted nor denied the SEC’s allegations. Yet it’s beyond belief that the company never had to set the record straight about its financial statements. Fifth Third first disclosed the SEC’s investigation in its 2010 annual report. So the bank has had a few years to revise its figures.

Surely an accounting error that is fraudulent also should be deemed material by SEC. Yet the agency isn’t treating it that way. An SEC spokesman, John Nester, declined to comment.

According to the SEC’s Dec. 4 administrative order, Fifth Third’s loss for the third quarter of 2008 would have been more than twice what it reported, had it complied with generally accepted accounting principles. The bank had been trying to sell some troubled commercial real-estate loans that had plunged in value. However, it continued to classify the loans as “held for investment” instead of “held for sale.” This let the bank avoid a $169 million writedown that quarter. Fifth Third reclassified the loans the following quarter. It sold most of the loans at issue in December 2008 and in 2009.

The SEC in its order said Fifth Third and its chief financial officer at the time, Daniel Poston, violated federal antifraud laws. (Poston, who will pay $100,000, also got a neither-admit-nor-deny deal.) Comment letters to the company from the SEC’s staff show the agency was asking Fifth Third about its loan accounting as far back as May 2010.

“It appears that the company should have restated in 2010,” says Don Whalen, general counsel and research director at Sutton, Massachusetts-based Audit Analytics, which tracks restatement data.

If nothing else, the Fifth Third case may help explain why restatements by U.S. banks declined after the financial crisis got started. Back in March 2011, I wrote a column that noted there were 133 banks that issued corrections from 2008 through 2010, according to Audit Analytics. That was down from 169 banks during the previous three-year period, before the crisis took off in earnest. That made no sense, considering the country had just experienced the greatest banking-industry meltdown since the Great Depression. The obvious conclusion was that the government had given lots of banks a free pass.

In at least this one instance, the SEC identified GAAP violations so egregious that they amounted to fraud — and never required a correction. Perhaps the moral of this story is that if a company drags out an accounting investigation long enough, it won’t have to admit any mistakes, because by then the matter will be ancient history.

(Jonathan Weil is a Bloomberg View columnist. Follow him on Twitter @JonathanWeil)

Photo via Wikimedia Commons

Nov. 22 (Bloomberg) — For years the public has vented about half-baked government settlements in which corporations and white-collar defendants “neither admit nor deny” the allegations against them. The Justice Department wasn’t about to go down that path when it unveiled its big, not-really-$13 billion deal this week with JPMorgan Chase & Co.

So the government made a few sly tweaks. The result is a mutant offspring of the no-admit genre that may be even less satisfying than the parent. JPMorgan didn’t have to admit to any violations of the law. And here’s the rub: The Justice Department didn’t allege any, either.

According to the settlement agreement, the bank will pay a civil penalty “pursuant to” a statute called the Financial Institutions Reform, Recovery and Enforcement Act. However, the Justice Department didn’t lodge any claims against JPMorgan for breaking that law or any other. This was an out-of-court settlement. The Justice Department didn’t file a complaint. No judge’s approval was needed.

The agreement did incorporate an 11-page statement of facts that explained in vague terms what JPMorgan did. Yet none of the acknowledgments by JPMorgan in that document hurt the bank. JPMorgan didn’t admit liability or even any mistakes. That’s no better than the old “neither admit nor deny” boilerplate.

This isn’t justice. It’s more like the greenmail that companies sometimes pay to corporate raiders who demand premium prices for their shares in exchange for going away. No individuals got pinched. We don’t know much about the details of what the Justice Department’s investigation found. It’s unclear why prosecutors didn’t accuse JPMorgan of fraud, although one possible explanation is that the government lacks proof.

The wording of the settlement agreement was awkward at times, too. It said the Justice Department had investigated the mortgage-bond operations of JPMorgan and two failing companies that it bought: Bear Stearns Cos. and Washington Mutual Inc. “Based on those investigations, the United States believes that there is an evidentiary basis to compromise potential legal claims by the United States against JPMorgan, Bear Stearns and Washington Mutual, for violation of federal laws,” the agreement said.

That line makes it seem like the U.S. doubted its own case, although perhaps it was just poorly drafted. The sentence would have made more sense if it said there was enough evidence to “bring” claims against JPMorgan, not “compromise” them. Maybe the prosecutors were trying to say they believed there was sufficient evidence to merit a settlement. But that doesn’t make much sense, either: The act of settling speaks for itself.

As an aside, it’s fitting that Massachusetts attorney general Martha Coakley took part in the same accord. Of the $13 billion headline figure — which combined the Justice Department’s $2 billion penalty with the amounts secured by several state and federal agencies — the settlement agreement earmarked about $34 million for Massachusetts.

In 2009, Coakley took a similar claim-free approach to squeeze money from Goldman Sachs Group Inc. Her office didn’t file a lawsuit or allege that Goldman Sachs violated any statutes or rules. Goldman Sachs didn’t admit anything, either. But it did pay $60 million to make the Massachusetts investigation go away. Coakley’s office had been looking into Goldman Sachs’ packaging of subprime mortgage bonds.

Surely some of the money that JPMorgan shells out will go to good use. Yet something important is lost when law-enforcement officials strike bargains with powerful corporations behind closed doors and fail to be transparent about what their investigations uncovered.

The Justice Department said this week that the settlement “does not absolve JPMorgan or its employees from facing any possible criminal charges.” By this point, though, it’s hard to take the Justice Department seriously when it says to stay tuned.

The department also said that “JPMorgan acknowledged it made serious misrepresentations to the public” as part of the agreed-upon statement of facts. Actually, it did no such thing. The document didn’t use the word “misrepresentation” or similar language to describe any of JPMorgan’s actions.

Usually when corporations settle with the Justice Department, they agree not to contradict the government’s assertions publicly. Yet on this occasion JPMorgan felt compelled to set the record straight. “We didn’t say that we acknowledge serious misrepresentation of the facts,” JPMorgan Chief Financial Officer Marianne Lake said during a Nov. 19 conference call.

She was right: The Justice Department overreached in its characterization. It isn’t a good sign when the company paying billions of dollars to resolve a government probe comes across as more believable than the government lawyers who cut the deal.

(Jonathan Weil is a Bloomberg View columnist.)

Photo via Wikimedia Commons

Oct. 25 (Bloomberg) — See if you can make sense of this. Somehow, in the space of seven months, U.S. Attorney General Eric Holder has gone from being:

1) The defeatist law-enforcement chief who told the Senate Judiciary Committee that some banks are too big to prosecute because of the economic damage that might ensue, to

2) The crackdown artist who presided over a meeting in which his team told JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon that the bank would need to enter a guilty plea in order to end a criminal investigation by prosecutors in California.

What gives? Maybe Holder will let JPMorgan skate once the probe is completed. Yet clearly a new approach is afoot. After that meeting, the Justice Department proposed that JPMorgan plead guilty to making false statements related to sales of defective mortgage bonds. The bank proposed a non-prosecution agreement, which Holder rejected, according to an Oct. 22 article by Bloomberg News.

Not long ago, large banks could be fairly confident they wouldn’t face criminal charges in the U.S. no matter what they got caught doing. Now the Justice Department is keeping the threat of such charges hanging over JPMorgan while the bank wraps up $13 billion in civil settlements with various government agencies.

Holder said in an interview that the department’s new aggressiveness on bank investigations was a top priority for both President Barack Obama and himself. (Holder didn’t talk about JPMorgan specifically.) Obama promised in his 2012 State of the Union address to hold banks accountable for their role in helping cause the worst recession since the Great Depression. A task force was set up, and it played a significant role in the pending JPMorgan deal.

Other important questions remain unanswered. For instance, what about before 2012? Why did the Justice Department do so little to go after banks during Obama’s first term?

Here is one way to look at it: For about five years, there were entire categories of wrongdoing by large financial-services companies that were all but deemed exempt from criminal prosecution. We’ve never gotten a satisfactory explanation from anyone in the government as to why.

But it wouldn’t be a surprise if someday we learned that a conscious policy decision was made during the Obama administration’s early days that aggressive investigations of too-big-to-fail banks and their senior executives would be contrary to the national interest because of the threat that prosecutions posed to financial stability and the economic recovery.

Even if this isn’t what happened, the White House and Justice Department must know this is the outward impression they created by their unexplained inaction. What’s more, the facade of trying to look tough while doing almost nothing was coming undone. In August, for example, the Justice Department admitted to grossly inflating how many mortgage-fraud prosecutions it had brought in years past.

A crucial difference between now and when Obama took office is that the stock market has rebounded and the financial-services industry has stabilized after much help from the government, especially the Federal Reserve. Even so, public anger over the lack of accountability has failed to subside, and cynicism about Wall Street’s pull in Washington has skyrocketed. The government didn’t want to be seen as giving the banking industry a pass.

So the administration had to come up with new, creative ways of holding the country’s banks to account. The largest ones seem healthy enough again to withstand government attacks. Yet the five-year statute of limitations for many fraud cases has elapsed. This, of course, presented a problem for the Justice Department, which had to be a bit more inventive than normal.

One of the department’s favorite new tools has been a once-obscure statute called the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which was passed in response to the 1980s savings-and-loan crisis. Federal prosecutors in New York used the act, known as FIRREA, to win their jury verdict this week in a civil trial against Bank of America Corp.

The law, which has a 10-year statute of limitations, lets prosecutors file civil claims for violations of criminal mail-fraud and wire-fraud statutes that affect “a federally insured financial institution.” It is a strange creature that has led to some odd outcomes.

In the case against Bank of America, prosecutors accused the company of defrauding Fannie Mae and Freddie Mac. Those two entities don’t take federally insured deposits. Nonetheless, in an August ruling, U.S. District Judge Jed Rakoff said the case could proceed on the grounds that Bank of America is a federally insured financial institution and that any fraud it may have committed would have affected itself.

That reasoning may follow the letter of the statute, but it isn’t an intuitive basis for a lawsuit. Plus, if the government believes criminal laws were broken, why pursue only civil claims? Maybe it’s because even on their best days, prosecutors seem interested mainly in easy wins for which the burden of proof is low.

We have yet to see what violations the Justice Department will cite in its civil settlement with JPMorgan. Another FIRREA case may be possible. The Justice Department filed a second FIRREA lawsuit against Bank of America in August and, as Bloomberg News reported this week, Bank of America faces three other FIRREA probes across the country. Several other large banks, including Citigroup Inc. and Credit Suisse, are contending with FIRREA investigations, too.

Prosecutors also used FIRREA in their February lawsuit against Standard & Poor’s. In that case, the government alleged that Citigroup was duped by S&P credit ratings on subprime mortgage bonds that Citigroup itself created and sold. Bank of America, too, allegedly was “affected” by S&P’s ratings in the same way. The theory is bizarre at first glance. But for now, the law seems to be on the Justice Department’s side.

There is no telling what great things U.S. prosecutors might have accomplished had Holder and his team been this determined and creative all along, before the biggest fraud cases of the financial crisis turned cold.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: ryanjreilly via Flickr

Sept. 20 (Bloomberg) — You don’t often see Washington regulators publicly raising alarms about banks’ accounting practices. That’s why a speech this week by the comptroller of the currency, Thomas Curry, deserves more attention.

The way Curry described the situation, you get the sense that some banks’ numbers may be too good to be true. He made clear he wasn’t warning about an imminent crisis. Yet he cautioned that some banks seemed to have been “scrimping on their allowances against their loan losses,” which is a fancy way of saying they may be fudging their numbers.

To understand better what he was referring to, here’s a brief accounting primer. Loan-loss allowances are the reserves that lenders set up on their balance sheets for perceived bad loans. Provisions are the expenses they record to boost those allowances. As losses are confirmed, lenders charge off the uncollectible amounts, reducing the allowances.

Sometimes lenders decide, in hindsight, that their allowances are too big. When this happens, they may undo some of the provisions they had previously booked. Bankers refer to this as “releasing reserves,” which boosts earnings and capital. This has been happening at several large U.S. banks lately, such as JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. Investors often refer to these gains as “low-quality earnings.”

Curry, who became comptroller in April 2012, said some reserve releases are to be expected as underwriting standards, loan performance and the economic climate improve. “But for some banks, the ease with which the allowance could be repurposed as earnings has proved habit-forming,” he said, without naming any companies. He noted that “this is happening despite loosening credit underwriting standards, which suggests that risks are increasing that may result in larger charge- offs.”

Loan-loss provisions and charge-offs have both been on the decline industrywide for a few years. Curry pointed out, though, that provisions have been falling at a faster rate — a signal that banks’ optimism about their loan quality might be outpacing reality. During the second quarter of this year, lenders regulated by his office recorded about $6.1 billion of provisions, equivalent to only 56.6 percent of their net charge-offs, according to data compiled by the agency. A year earlier, provisions were $10.4 billion, equivalent to 67.1 percent of net charge-offs.

One result is that recent surges in capital, which banks tout as a sign of resilience, may in part be illusory. An easy way for a bank to overstate its capital is to underestimate its losses. To find a period when banks’ provisions exceeded net charge-offs you would have to go back to the fourth quarter of 2009.

One good sign is that the banking industry’s loan-loss allowances are still more robust than they were during the years leading up to the financial crisis. Allowances at comptroller-regulated banks were equivalent to about 2.1 percent of total loans and leases, as of June 30. That percentage has been declining the past few years, after topping 4 percent in 2010. Back in early 2007, the figure was a mere 1.1 percent, which helped make banks look healthier and more profitable than they really were.

If banks are low-balling their provisions, accounting standards may be partly to blame. The way the rules stand now, lenders typically must meet two conditions before they can recognize loan losses. It must be “probable” that a loss has been incurred as of the balance-sheet date. The loss also must be reasonably estimable. Otherwise, no loss gets recorded.

These sorts of judgments and estimates can get extremely complex, especially for banks with millions of customers. The answers may be difficult for outsiders to challenge. Bankers who want to show lower losses can put on blinders, at least for a while, as many did during the financial crisis. Likewise, it may be tempting for some banks to overestimate losses and create excess reserves that they can dip into later like a cookie jar when they want to show higher earnings and capital.

Curry said he favors a proposal by the U.S. Financial Accounting Standards Board that would change the rules so that banks could recognize credit losses more quickly. Instead of having to decide whether it’s probable that a loss has been incurred, they could record “expected” losses. On paper, this should make it harder for banks to delay losses, because the threshold for recognizing them would be lower. (That is, if the banks do what the rules say.)

This has a possible downside, too. If Curry is worried about excessive reserve releases now, just wait to see what happens when banks get to book loan losses earlier and more often. Banks that were inclined to create cookie-jar reserves before could wind up having an easier time doing so.

Perhaps the best we can hope for is that the solution won’t be worse than the problem. To his credit, Curry is flagging the issue. Banking regulators didn’t emerge from the last crisis looking so good. This counts as progress.

(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)

Photo: Steve Jurvetson via Wikimedia Commons

Aug. 30 (Bloomberg) — Hardly a week goes by without a new report about a government investigation of JPMorgan Chase & Co. and how much money the bank might have to pay because of some alleged violation of the law.

The ritual is familiar by now. Details of the probe emerge, then settlement talks get leaked by one side or the other before the case is resolved, perhaps as a pressure tactic or to alert the market so that the final deal is barely news once it’s unveiled. And the outcome proves unsatisfying because the company doesn’t admit liability for breaking any specific laws.

The cases often present a bounty of ironies for a company that has reported $21.3 billion in legal fees and litigation costs since the start of 2008, which is almost as much as it paid in shareholder dividends. Sometimes the proceedings seem like bona fide attempts at law enforcement, notwithstanding that JPMorgan will always be afforded special treatment as a too-big-to-fail bank. Other times the payments look like a mere cost of doing business, with no moral judgment attached, even if the claim is something as serious as fraud.

A couple of recent examples: This week the Financial Times and other news organizations reported that the Federal Housing Finance Agency, which is the conservator for Fannie Mae and Freddie Mac, recently demanded a $6 billion settlement from JPMorgan in a lawsuit it filed two years ago over faulty mortgage bonds that Fannie and Freddie bought.

Some of those bonds were sold by JPMorgan. It’s also true that a large portion were sold by Washington Mutual Inc. and Bear Stearns Cos., which the government practically begged JPMorgan to buy in 2008 to keep the financial system from going kaput. JPMorgan assumed those companies’ liabilities, of course, and now finds itself facing some that perhaps it hadn’t counted on and weren’t of its own doing.

Separately, the Wall Street Journal reported this week that JPMorgan may pay as much as $600 million to resolve various investigations of the London Whale scandal, in which the bank lost control over some of its derivatives traders and wound up losing more than $6 billion. The Securities and Exchange Commission has insisted that JPMorgan admit wrongdoing — whatever that’s supposed to mean — as part of any civil settlement, according to news reports.

That doesn’t mean JPMorgan would have to admit legal liability. It probably won’t, based on precedent. So once again, the SEC would allow admissions of liability to be a sort of third rail that it refuses to require of settling defendants. Heaven forbid that other litigants might use it against the company in separate proceedings.

And who would a $600 million penalty hurt? In this case, the shareholders, of course. It’s debatable whether this is a just outcome. This isn’t like the $410 million that JPMorgan agreed to pay the Federal Energy Regulatory Commission last month for manipulating electricity markets. Shareholders deserved to be penalized in that instance, because they benefited from the company’s alleged misconduct in the form of extra profits. (This week, a Senate investigative panel sought records on that case, adding yet another headline to the company’s clip file.)

In the London Whale matter, investors were harmed by JPMorgan’s poor internal controls and inaccurate financial reports, not to mention the $6.2 billion trading loss. Fining the company arguably would penalize some shareholders twice — but not all of them. Those who bought the stock shortly after the scandal broke last year have done well because the price rebounded fabulously. The trading debacle is what created their buying opportunity. (JPMorgan shares were recently trading for about $50 after bottoming at $31 in June 2012.)

Another way of looking at this same case: Perhaps fines against the corporation are warranted — not because of any harm JPMorgan caused to its investors, but because of the risk the bank poses to the country were it to have a total meltdown in controls and tank the economy.

Meanwhile, two former JPMorgan traders have been criminally charged over their conduct in the London Whale affair. The prosecutors couldn’t find sufficient evidence on anybody higher up than them — such as the executives who created the incentives and the control environment in which they operated.

As for JPMorgan, it’s no secret that the government can’t enforce the law to its fullest extent. An indictment of the company, if one were ever warranted, could jeopardize the financial system and the economy. Both the Justice Department and the SEC in recent years have attached provisions to settlement agreements with JPMorgan in which the company agreed not to violate the law again. Those “obey-the-law” directives almost never get enforced against repeat offenders, and there’s scant reason to believe they would be against JPMorgan.

We simply don’t have a good way to punish big financial institutions for breaking the law. This, of course, encourages law-breaking. It’s hard to see this changing. Too many competing economic and political forces get in the way. If the government won’t let big banks fail, it isn’t about to try to kill them off. Still the prosecutors and regulators feel obligated to show they’re doing something.

JPMorgan’s shareholders are accustomed to the headlines. They can’t be pleased about them. In its latest quarterly report, the company disclosed six investigations by the Justice Department alone. This week we learned the Justice Department had joined another one: a bribery probe of the bank’s hiring practices in China. It could be years before the company gets its name out of the police blotter.

Jamie Dimon, JPMorgan’s chairman and chief executive officer, must be longing for the days when the big news about his bank was all the things it did right.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: Steve Jurvetson via Wikimedia Commons

Aug. 23 (Bloomberg) — Why didn’t the U.S. Justice Department get someone like Leslie Caldwell years ago when it needed her?

Caldwell, a partner at the New York law firm Morgan Lewis & Bockius LLP, is the former prosecutor who led the Justice Department’s Enron Task Force from 2002 to 2004, which resulted in criminal prosecutions of 36 defendants after the Houston energy-trading company collapsed. She is now the lead candidate to become chief of the department’s criminal division, succeeding the rather passive Lanny Breuer, who left in March to return to the white-shoe law firm Covington & Burling LLP. Caldwell, 55, is in the final stages of the vetting process, Bloomberg News reported this week.

The Enron team’s record under Caldwell wasn’t perfect, of course. Yet when the country needed a seasoned prosecutor to bring tough cases and help restore investor confidence after a wave of accounting scandals, she and her squad performed admirably. Enron’s former chief financial officer, Andrew Fastow, pleaded guilty to fraud charges shortly before Caldwell stepped down as the task force’s director in March 2004. His testimony later helped prosecutors win guilty verdicts against former Enron Chief Executive Officers Jeffrey Skilling and Ken Lay.

In July 2002, after the telecommunications giant WorldCom Inc. imploded, President George W. Bush created a new corporate-fraud task force that went far beyond Enron. It resulted in almost 1,300 convictions, which included about 200 CEOs and corporate presidents and more than 50 CFOs.

That’s the type of response the U.S. needed to the 2007-2009 financial crisis. The country never got it. One of the central features of the crisis was how obvious it was that lots of big financial companies’ balance sheets were a farce. This helped cause the collapse in confidence that could only be restored with taxpayer backing. Yet no senior executive of a major financial institution was prosecuted.

Gretchen Morgenson and Louise Story of the New York Times nailed one of the crucial reasons in a landmark April 2011 article. In 1995, bank regulators made 1,837 criminal referrals to the Justice Department, according to data the Times reporters obtained from the Transactional Records Access Clearinghouse at Syracuse University. From 2007 to 2010, the average number of referrals for criminal prosecution was 72.

The plunge makes it seem like this must have been the result of a policy choice, perhaps motivated in part by a desire to promote financial stability. It’s as if the Justice Department simply forgot how to pursue serious financial-fraud cases — with the exception of Manhattan U.S. Attorney Preet Bharara’s campaign against insider trading at hedge funds. U.S. Attorney General Eric Holder told the Wall Street Journal this week that more cases spawned by the crisis may be unveiled in coming months. Yet some of the best opportunities may have been lost to time. The statute of limitations for many crisis-era fraud cases has passed or soon will.

Lehman Brothers Holdings Inc. wasn’t even under investigation when it filed for bankruptcy in September 2008. Recall that the night before it filed for Chapter 11, television reports showed Lehman employees streaming out of the building carrying boxes of documents — walking proof that the company hadn’t received subpoenas or been told by the government to preserve evidence. It’s no wonder nobody from Lehman was ever charged. The scene was cold by the time investigators arrived.

No senior executives were charged at American International Group Inc., Bear Stearns Cos., Citigroup Inc. or Merrill Lynch, to name a few. The Securities and Exchange Commission’s civil-trial win this month against former Goldman Sachs small fry Fabrice Tourre doesn’t count for much. Nor do all those SEC settlements where the defendants neither admitted nor denied anything.

Sure, corporate-fraud cases are complex and often hard to prove. In crises past, the government found a way to bring them and win. Caldwell certainly knows how, notwithstanding that the conviction of Enron’s accounting firm, Arthur Andersen LLP, was overturned on appeal.

That Holder is tapping her is a signal, if nothing else, that he is concerned about the relentless criticism the Justice Department has endured for its lack of criminal charges against Wall Street executives, as well as its habit of letting off corporate defendants with non-prosecution or deferred-prosecution deals. Those were the criminal division’s white-collar hallmark during Breuer’s four-year tenure.

Assuming Caldwell gets the post, we will have to see if she still has the same prosecutorial chops she did in 2002, when she took over the Enron investigation in Houston. (Before that, she served in the U.S. Attorney’s office in San Francisco, where she was chief of the criminal division and the securities-fraud section.) Sometimes white-collar defense work, like the kind she has done at Morgan Lewis, softens veteran prosecutors. For others, representing the other side only makes them better when they go back to government service.

So much time has passed since the financial crisis that the best we can hope for now is that the government regains its footing when it comes to prosecuting financial crimes. It clearly lost its way. If Leslie Caldwell has the same stuff she did when she led the charge against Enron’s bad boys, there is hope for things at the Justice Department to get better.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: The Aspen Institute via Flickr.com

Aug. 2 (Bloomberg) — Richmond, California, sent the securities and real estate industries into a tizzy this week. The city said it is moving ahead with plans to use its power of eminent domain to seize home mortgages and restructure them for residents who owe more money than their homes are worth.

This would be a first in the U.S. Normally when governments do things that upset Wall Street millionaires it’s a sign they’re going down the right path. There are exceptions, of course.

Here is another story about Richmond, a city of about 106,500 on the east side of San Francisco Bay. In May, its No. 2 administrator, Leslie Knight, stepped down. A corruption investigation, which started with a whistleblower complaint, found she had been using municipal offices and employees to run a personal gift-basket and party-favor business. She was also collecting a car allowance and using a city car at the same time. She later paid back $10,000 to the city, according to local news reports.

Knight wasn’t fired. The city manager gave her a warning and let her resign as assistant city manager and head of human resources, which meant she got to keep her pension. Protesters have picketed the district attorney’s office demanding that he prosecute her. (He declined.) The Contra Costa Times in June wrote that Richmond’s city attorney “stonewalled, trying to block public access to documents about the case” — which were released only after the newspaper brought in its own lawyer. The same city officials would oversee the new eminent-domain program in one fashion or another.

This is the nature of local government in much of the U.S. It tends to be corrupt. Or at least it has been that way everywhere I have lived, from Colorado and New Jersey to Texas, Florida and Arkansas. It’s easy to see how a plan to grab loans from their out-of-town owners would inspire graft. Supposedly city governments would have to pay them fair compensation, but you can be assured most would offer less. The losers mainly would be bondholders that own mortgage-backed securities.

Richmond has 4,600 underwater mortgages. It sent purchase offers this week to the owners of several hundred. Just wait till some nosy gadfly or enterprising journalist figures out that some of those borrowers are friends, relatives or patrons of local politicians — or on the city’s payroll themselves. It’s bound to happen, if not in Richmond then in other municipalities that try to follow its example. Then picture the recriminations as folks figure out who scratched whose back in exchange for getting their principal balance reduced by tens or hundreds of thousands of dollars. This could be the biggest wealth creator to hit some small towns since the invention of roadside speed traps.

Imagine what would ensue if a program like this were tried in some ethically challenged city such as New Orleans or Miami. Or Hoboken, New Jersey, the town I call home, where two of the last four mayors have gone to prison for taking bribes. Where I live, it’s amazing what people have managed to accomplish with brown paper bags of cash and by knowing the right people.

Some residents who receive help could be hurt worse. Like game-show contestants who win a new car and suddenly find they owe the Internal Revenue Service more money than they have, the lucky borrowers might face big tax bills if their loan reductions wind up counting as income. I suppose the city can dream up something magical to make those debts vanish, too.

Perhaps using eminent domain in this way is legal. The big lobbying groups for the financial-services industry say it’s unconstitutional. So do civil libertarians. The government conservator for mortgage giants Fannie Mae and Freddie Mac last year said it “has significant concerns about the use of eminent domain to revise existing financial contracts.” Litigation would be inevitable and drag on for years.

Cornell law school professor Robert Hockett, in a Federal Reserve Bank of New York paper published in June, explained how a system like this would work. In typical academic fashion, he made it all seem so smooth and sensible. I can’t fathom how it would be in practice.

For instance, we learned from the banking scandals a few years ago that many of the companies trying to foreclose on people’s homes can’t prove who owns the mortgages. The problem cuts both ways. What will a city do when it can’t verify ownership of a loan, especially when it discovers this only after buying one?

Cities usually use eminent domain to seize land and buildings. If they’re going to start seizing home mortgages, why stop there? In some states cars are subject to local property taxes. Why not seize auto loans, in the name of economic development and promoting the public good? Maybe next they could go for people’s past-due credit card debt. How could anyone stand by idly and not help local voters who are deemed deserving, right? Then watch city officials complain when banks charge all of their constituents more money for credit because of their ZIP code.

Legal or not, well intentioned or otherwise, this is a horrible idea. The mortgage market may be dysfunctional, but the status quo is better than letting city employees choose winners and losers. It isn’t often that I can say this, but this time when the banks win, they will deserve to.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: “BasicGov” via Flickr.com

July 19 (Bloomberg) — Looking at the way that U.S. senators Elizabeth Warren and John McCain are pitching their proposal for a 21st-century version of the Glass-Steagall Act, I can’t help but wonder if they’re making a mistake.

Mostly they have promoted their new bill in terms of protecting taxpayers and the broader economy from a too-big-to-fail bank that might need another bailout. A lot of voters don’t get the connection between the problem and the solution being proposed, and it’s debatable if there is one. Here’s a better argument: The reason it’s a good idea to separate securities firms from commercial banks is to protect consumers from brokers selling schlock investments.

If the senators are going to persuade Congress to bring back Glass-Steagall, they should show examples of real, sympathetic people. This brings me to the story of Philip L. Ramatlhware, an immigrant from Botswana who went to a Citigroup Inc. branch in downtown Philadelphia one day five years ago to open a regular bank account.

He was 48 years old at the time and disabled, after being hurt in an accident as a passenger on a Greyhound bus. His English wasn’t good, he had no college education and his last job had been at a fast-food kiosk at the Philadelphia airport. In April 2008, he received $225,000 in a settlement for his injuries, part of which went to pay legal fees. He was holding the settlement check when he walked into the branch.

Immediately he was referred to a broker for a “financial consultation,” according to an arbitration claim he filed against Citigroup. The broker assured him the money would be invested in “guaranteed” funds and that he could have access to them whenever the need arose, the complaint said. Ramatlhware gave him $150,000 to invest. The broker put $5,000 into a bank certificate of deposit, bought a $133,000 variable annuity and invested the rest in a series of mutual funds.

Less than six months later, Ramatlhware had lost $40,000, according to the complaint. Citigroup settled the case in 2010 for $22,500, without admitting liability, according to a report on the case by the Financial Industry Regulatory Authority.

There are countless tales like this of banks cross-selling unsuitable investments to unsophisticated customers. For whatever reason, lots of people trust the advice they get from someone working in the lobby of their local retail bank branch, even if they normally would never set foot in a brokerage firm.

Here’s another example from Finra’s files, involving a Michigan couple, Alberto Ferrero and Qingwen Li, who filed a claim in 2010 against CCO Investment Services, a unit of Royal Bank of Scotland Group Plc. They sought $60,000, plus attorneys’ fees and other damages. They were awarded almost $72,000.

Their story began one day in April 2007 when they walked into their local bank, Charter One, also owned by RBS. Here’s how the arbitrator explained the November 2012 ruling in their favor:

“Claimants are recent immigrants to the United States, and they had very limited investment experience,” wrote James Graven, an attorney from Toledo, Ohio, who was the arbitration panel’s chairman. “Claimants went to their bank to roll over their CD. The bank directed them to a registered representative. Claimants’ primary objective was capital preservation.

“The broker recommended a solicited trade placing one third of claimants’ net worth in one speculative fund. The broker made material misrepresentations and omissions concerning risk. Claimants lost approximately 50 percent of their investment in 18 months. The broker invested claimants’ whole account into one high-risk junk municipal bond fund.”

The banking industry has a long history of preying on unsuspecting depositors by selling them garbage securities without regard to suitability. This was a big reason Glass- Steagall was originally enacted during the Great Depression. It has been a recurring problem ever since key portions of the act were repealed during President Bill Clinton’s administration.

There were $61 billion in settlements between large banks and the Securities and Exchange Commission over sales of auction-rate securities, the market for which crashed in 2008. At Wachovia Corp., for example, the SEC said bank employees helped recruit retail depositors for the investments. (Wachovia was bought by Wells Fargo & Co. in 2008.)

Most recently, according to a July 8 article in American Banker, the Office of the Comptroller of the Currency warned JPMorgan Chase & Co. early last year that the bank had wrongfully steered clients into in-house investment products. As a result of its findings, the OCC required the company to refund fees to an unknown number of customers. Unfortunately, we don’t know many more details because the examination findings are confidential (which should make this ripe for a congressional inquiry). American Banker said its source was a person with direct knowledge of the findings.

Now back to Senators Warren, a Democrat from Massachusetts, and McCain, the Arizona Republican. What they should do is canvass the country for the most gut-wrenching stories they can find about ordinary depositors who have been ripped off by their banks’ broker-dealer arms. Then invite them to testify before Congress and tell the country what happened, in their own words. The Senate Permanent Subcommittee on Investigations, where McCain is the ranking Republican, would be an ideal forum.

The best way to keep the sharks from preying on the customers in the bank lobby is to not let them in there in the first place. If this also helps make systemically dangerous banks smaller, that’s all the better.

(Jonathan Weil is a Bloomberg View columnist.)

Photo: bruceg1001 via Flickr