Merryn's Blog

Why the US is right to sue its own big banks

Punishing the banks for the US sub-prime debacle might just tip them over the edge - so why not just move on? Because the banks need to learn some accountability.

I've been on BBC World talking about the business of the US suing its own big banks for misrepresenting the quality of the mortgages they both issued and then securitised to sell on at the height of the US housing bubble.

They'll argue, says the New York Times, which reported the story, that the banks failed to performwith due diligence required under securities law while assembling and selling the mortgage securities, and missed signs that borrowers' incomes were inflated or falsified.

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And they want $30bn or so in compensation. That's serious money. Which, of course, is why bank shares immediately slumped in the US.

But should the US on behalf of Freddie and Fannie Mac in this case really be going ahead with this kind of case? After all, the number of people responsible for the sub-prime debacle and consequent global financial crisis goes far beyond the banks.

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There were the central bankers and their insistence on failing to recognise the shifting dynamic of global inflation, and of keeping monetary policy far too loose. There were the politicians who were determined to work things so that as many people as possible ended up owning their own homes, regardless of the risks inherent in doing so. There were the mortgage brokers who actually falsified the documents to keep things going. And of course, the general population the ones who took out the mortgages they must have known they couldn't actually repay. Everyone played their part in the 'house prices never fall' game.

It is also the case that the banks remain very, very fragile. £30bn might push them back over the edge again, meaning that the government's lawsuit leads to another government bail-out. Make the banks pay and everyone pays. Not only might the taxpayer end up on the hook again, but any fines will inevitably be passed on to the customers in higher charges. Then there are the pension funds and so on holding shares in the banks. Anything that pushes their share prices down (as even the news of a lawsuit has) hurts them.

Add it all up and you can make a reasonable case for letting the whole thing go. Everyone behaved badly, said another of the guests on BBC World this morning. "Let's just move on."

But I'm not so sure we should. There is plenty of evidence that there was fraud involved in the whole debacle and the idea that justice shouldn't be done because justice can have nasty consequences is not a good one. As is the fact that you shouldn't aim to punish one guilty party because you can't punish them all the US is never going to sue the Federal Reserve or its own politicians, much as perhaps it should.

And when you hear the banks protesting that the world will end if they are ever penalised for anything, note that they say this every time anyone suggests any reasonable step towards improving the ethics of the financial industry. In an ideal world we would bring cases against all the individuals involved, or at least find a way to retrospectively cut the gains they made from sub prime. But that hasn't proved to be possible so far.

So it seems to me that this case is a necessary one. Sure, it will end with the banks getting a much lesser fine than mooted at the moment, and as such won't in any real sense punish anyone. But it could at least work to remind Wall Street that they have some fiduciary responsibility to act within a moral framework. Even more than that, seeing fraud proved and names named might make the rest of us feel better.

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