Willed Ignorance: Refusing To Learn The Lessons of the Financial Crisis

In a blink-or-you'll-miss-it story in the business section, the SEC announced that it had reached a $75 million settlement with Citibank to settle subprime claims. As this follows quickly on the heels of the $500 million Goldman settlement, it's worth noting how the differences between these two cases, and their resolution, shows how our regulatory agencies continue to fail to police the finance industry

Goldman Sachs was loudly accused of committing fraud by brokering a transaction between housing bear John Paulson (one of many such transactions he entered into, btw) and a group of banks and hedge funds that wanted to continue going long on housing. Everyone was looking at the same set of numbers, but Paulson was almost alone in concluding that subprime was about to blow up and take out the financial system with it. That's why he's a billionaire today and the Richard Fulds and Stan O'Neils of the world are in disgrace. Goldman's "fraud" essentially consisted of failing to disclose that Paulson was on the short side of the transaction. Somehow this was worth $500 million, plus the usual front-page headlines and microphone pounding.

Citibank, on the other hand...well, check it out

Citigroup agreed on Thursday to pay $75 million to settle federal claims that it failed to disclose vast holdings of subprime mortgage investments that were deteriorating during the financial crisis and ultimately crippled the bank.

The settlement centers on events in the fall of 2007, when Citigroup’s reported losses started to cascade, eventually prompting the federal government to rescue the bank a year later. The case is the first to focus on whether banks adequately disclosed to their shareholders the increasingly precarious state of their finances during the crisis.

It is also the first time the Securities and Exchange Commission has brought charges against high-ranking bank executives over their involvement with subprime mortgage bonds.

The commission singled out two Citigroup executives — Gary L. Crittenden, the former chief financial officer, and Arthur Tildesley Jr., the former head of investor relations — for omitting material information in disclosures to shareholders, according to the complaint.

Mr. Crittenden agreed to pay a $100,000 fine; Mr. Tildesley will pay $80,000.

While we can debate whether Fannie/Freddie, CRA, Jimmy Carter, Alan Greenspan, or whatever "caused" the Crash of '08, I think we can all agree on this basic narrative: banks and other large financial institutions became dangerously over-exposed to subprime loans and other mortgage backed securities. When those securities began to lose value at an alarming rate, many of these institutions became functionally insolvent, or close to it. But, rather than disclose this, these institutions used all manner of accounting trickery and fund raising to try to hide the true state of affairs of their balance sheets. This directly led to the credit crunch and the Crash of '08 as investors and lenders could no longer trust one another and lending/investment activity ceased.

In other words, Citibank has just settled an enforcement action where they were accused of doing the exact thing that caused the credit crunch and wrecked the economy. And, while Goldman may have failed to make a disclosure to a group of sophisticated investors, Citibank was lying to everybody: its regulators, its shareholders, its counter-parties, and the public. Doesn't that seem, I don't know, worse? As the Times notes, the $75 million fine is nothing compared to the $40 billion Citi failed to disclose. (and God knows what might still be lurking in its balance sheet!) The miniscule fines levied against the two Citi executives are likewise a joke. How are they not getting the full Ken Lay treatment?

I'm not going to sit around and read minds, but it sure is odd that the "tough" new SEC seems to have so little stomach to punish activity that was at the heart of the financial crisis while coming down hard on a complex transaction between equals. But, Goldman is politically unpopular, while Citi is a ward of the government. Just a coincidence, I'm sure.