The Situationist

Retroactive Liability for our Financial Woes

Posted by The Situationist Staff on September 27, 2008

In the following editorial, “Take the Banker’s Porsche” (published in The Seattle Post Inquirer), Situationist contributor Adam Benforado makes an interesting case for a tort-like response to our financial situation.

* * *

With our eyes focused on the staggering price tag of the impending bailout, it is easy to overlook the fact that a significant number of people profited handsomely as they took actions that led to the latest global financial crisis. Over the past five years, much more than $100 billion of bonuses were paid out to the Wall Street elite (including $39 billion just last year). Multimillion-dollar homes in East Hampton were bought; Bentleys were purchased; Gucci handbags were scooped up by the handful; Warhols were hung.

Most of those luxury items will be kept. And, over the next decades you — the medical resident in Philadelphia, waitress in Reno and musician in Nashville — will be receiving the bill.

The story of the mortgage debacle is a complex and meandering tale, but the endgame math is just that simple. The harm has happened, someone has to pay and, because of our discomfort with retroactive statutes and regulations, the burden is going to land on taxpayers in general.

It does not have to be that way and it ought not to be that way. Those who were directly involved in the decision-making and profited from the deals that ultimately resulted in the economic collapse have been unjustly enriched. To satisfy the $700 billion hole the government will soon find itself in after buying up the private sector’s bad debt, we should first look to the tainted assets of those whose hearty bellows stoked the fire.

Perhaps the most famous piece of retroactive legislation, the Comprehensive Environmental Response, Compensation and Liability Act (popularly known as Superfund), reflects exactly this sense of fairness: Although dumping hazardous waste may not have been illegal at the time it occurred, those who created the waste — and profited from it — ought to be liable for the consequences of their actions.

Under the act, the government — and, thus, the people at large — is to pay response expenses only “where a liable party does not clean up, cannot be found or cannot pay the costs of cleanup.”

Those who reaped great benefits from the subprime mortgage market have left us with a toxic mess and it is upon their shoulders that the responsibility for market decontamination should fall first.

There are at least three reasons why retroactive liability is particularly justified in this context.

First, one of the main grounds for reluctance as to retroactivity is that new laws applied to old conduct tend to catch people unfairly by surprise. However, if we look at the situation here, a lot of the market players knew that what they were doing was risky: The writing had been on the wall for years that the housing and credit bubbles could not be sustained. Those involved were gambling that they could milk a little bit more from the system before things went sour. It was greed not naiveté that kept them at the teat.

Second, the “due notice” concern is only one type of relevant fairness consideration. A competing — and arguably more fundamental — concern is that those individuals who commit harms should have to pay to make things right and those that are comparatively innocent should not. In America, it’s “You break it; you bought it.”

Third, and most important, the complaint of unfair retroactivity is really a red herring because, in truth, the implicated bankers are in no different position than taxpayers as a whole in this regard. Actions were taken in the past that resulted in grave economic damage and now someone has to pay to repair the system. The choice is not between retroactivity and nonretroactivity; the choice is between potentially liable parties.

Are there significant legal, political and practical barriers to making financial insiders responsible for the mortgage crisis before taxpayers? Yes, but those challenges do not dilute the arguments made above.

The strength of this approach is not just that it would be fairer than the alternative, but also that it would act as a powerful deterrent to those who would be tempted to engage in similarly risky strategies in the future.

As any economist will tell you, a moral hazard problem exists when government bailouts occur: The key actors are not forced to internalize the costs of their harmful behavior. Putting investment bankers back where they started — and using their seized assets to treat the problem they engendered — would be a powerful warning to those looking to exploit financial markets in the future.

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2 Responses to “Retroactive Liability for our Financial Woes”

  1. […] Situationist has a provocative post about using the law to make those financiers, whose reckless practices have ruined the economy, pay to cl….  It makes a very good case.  Throw the get rich quick ”house flippers” in with the […]

  2. Lochgelly said

    Good editorial…Even Time Magazine predicted the crisis

    http://www.time.com/time/business/article/0,8599,1723152,00.html

    Mortgage lenders knew that they were selling bad mortgages but they didn’t care because they knew they could separate the liability from the mortgage…and the guys on the street were making a killing on commissions…

    The big banks new their “little’ bundles of bad assets were doomed but they didn’t care because there were plenty of trades going on…they could dump them…hedge fund managers didn’t care…it wasn’t their money…and that AIG insurance would salvage a crisis.

    AIG didn’t care because this was a massive new market…massive.

    And worst of all….the rating companies…Moodys and Standard and Poors didn’t care because business was booming in this new market.

    I think all of these entities could be convicted under existing Consumer Protection statutes….however, a new retroactive liability Financial Fraud statute would be even better…

    Ever hear the expression…pipe dream?

    Sigh…I can’t wait till it gets warm again…I need to go trout fishing.

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