White-collar crime or just risky business? the role of fraud in major financial debacles

Crime, Law and Social Change

Volumn 42, Issue 4-5, 2005, Pages 309-324

  Pontell, Henry N ^a  

^a UNIVERSITY OF CALIFORNIA   (United States)

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EID: 21344460242     PISSN: 09254994     EISSN: 15730751     Source Type: Journal    
DOI: 10.1007/s10611-005-1934-1     Document Type: Article

References (61)

1. Sutherland, Edwin H. "Is 'White-Collar Crime' Crime?" American Sociological. Review 10, 1945:132-39.
2. Tappan, Paul W., "Who is the Criminal?" American Sociological Review 12, 1947:99.
3. Geis, Gilbert, "White-Collar Crime: What Is It?" In White-Collar Crime Reconsidered, edited by Kip Schlegel and David Weisburd. Boston: Northeastern University Press, 1992:36.
4. Berle, Adolf, and Gardiner Means. The Modern Corporation and Private Property. New York: Macmillan, 1932.
5. Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations (7th Edition). London: A. Strahan and T. Cadell, 1793.
6. Easterbrook, Frank H., and Daniel R. Fischel. The Economic Structure of Corporate Law. Cambridge: Harvard University Press, 1991: 4;
7. Black, William, "Reexamining the Law-and-Economics Theory of Corporate Governance," Challenge 46:2, March/April, 2003:23.
8. Easterbrook and Fischel, op. cit., p. 283.
9. I b i d.
10. For a recent review of such research, see Simpson, Sally S., and Nicole Leeper Piquero, "Low Self-Control, Organizational Theory, and Corporate Crime." Law and Society Review 36(3), 2002: 509.
11. Wheeler, Stanton and Mitchell Lewis Rothman. "The Organization as Weapon in White Collar Crime." Michigan Law Review, 80, 1982: 1405.
12. Black, op. cit., p. 24.
13. Pontell, Henry N., Calavita, Kitty and Robert Tillman. "Fraud in the Savings and Loan Industry: White-Collar Crime and Government Response. " Grant #90-IJ-CX-0059, National Institute of Justice, Office of Justice Programs, U.S. Department of Justice, October, 1994;
14. Calavita, Kitty, Pontell, Henry N. and Robert Tillman, Big Money Crime: Fraud and Politics in the Savings and Loan Crisis. Berkeley: University of California Press, 1997. One high-ranking official put the enforcement response to the S&L crisis in particularly graphic terms when he compared the financial damage to a major environmental disaster, too enormous to be cleaned up effectively: "I feel like it's the Alaskan oil spill. I feel like I'm out here with a roll of paper towels. The task is so huge, and what I'm worrying about is where can I get some more paper towels? I stand out there with my roll and I look at a sea of oil coming at me, and it's so colossal!"
15. Quoted in Pontell, Henry N. Calavita, Kitty and Robert Tillman, "Corporate Crime and Criminal Justice System Capacity: Government Response to Financial Institution Fraud." Justice Quarterly 11, September, 1994:400.
16. Rosoff, Stephen M., Pontell, Henry N., and Robert Tillman, Profit Without Honor: White-Collar Crime and the Looting of America (2nd edn.). Upper Saddle River, NJ: Prentice Hall, 2002:279.
17. U.S. General Accounting Office. Thrift Failures: Costly Failures Resulted from Regulatory Violations and Unsafe Practices: Report to Congress. GAO/AFMD-89-62. Washington, D.C.: Government Printing Office, June, 1989.
18. Akerlof, George A., and Paul M. Romer, "Looting: The Economic Underworld of Bankruptcy for Profit." Brookings Papers on Economic Activity 2, 1993:1-73.
19. Personal interview.
20. See Ely, Bert, "Crime Accounts for Only 3% of the Cost of the S&L Mess." Unpublished report, 1990;
21. White, Lawrence J., The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. NY: Oxford University Press, 1991.
22. White, op. cit., p. 117.
23. Calavita, Kitty and Henry N. Pontell, "Other People's Money Revisited: Collective Embezzlement in the Savings and Loan and Insurance Industries." Social Problems 38 (1) February, 1991: 94-112. In discussing various forms of white-collar crime, Sutherland noted, "the ordinary case of embezzlement is a crime by a single individual in a subordinate position against a strong corporation."
24. (Sutherland, Edwin H. White-Collar Crime. NY: Dryden, 1949.) In contrast, collective embezzlement represents the siphoning off of funds from an institution by that institution's top management. Different from the traditional embezzlers described by both Sutherland and Cressey, those who perpetrate collective embezzlement are not lone lower-level employees but institutions' owners and operators, acting within networks of co-conspirators inside and outside the institution.
25. See Cressey, Donald R. Other People's Money: A Study of the Social Psychology of Embezzlement. Glencoe, IL: Free Press, 1953.
26. Pizzo, Stephen, Frocker, Mary, and Paul Muolo, Inside Job: The Looting of America's Savings and Loans. NY: McGraw Hill, 1989:36.
27. U.S. General Accounting Office, 1989, op. cit;
28. Mayer, Martin, The Greatest Ever Bank Robbery: The Collapse of the Savings and Loan Industry. NY: Charles Scribner's Sons, 1990;
29. Pizzo et al., 1989, op. cit.
30. U.S. General Accounting Office, 1989, op. cit. p. 21.
31. Another important distinction, and one which leads to the importance of recognizing control fraud as a new and insidious phenomenon brought into play by the perverse economic incentives present during the S&L crisis, is that previous studies have differentiated between corporate crime, in which the corporation perpetrates fraud on its own behalf, and embezzlement, in which crime is committed against the corporation. Wheeler and Rothman (op. cit.) note that "[e]ither the individual gains at the organization's expense, as in embezzlement, or the organization profits regardless of individual advantage, as in price-fixing." Similarly, Coleman argues, "The distinction between organizational crimes committed with the support from an organization that is, at least in part, furthering its own ends, and occupational crimes committed for the benefit of individual criminals without organizational support, provides an especially powerful way of classifying different kinds of white-collar crime" (Coleman, James William, "Toward an Integrated Theory of White-Collar Crime." American Journal of Sociology 93, 1987: 407). These categories neglect, however, the possibility of organizational crime in which the organization is a vehicle for perpetrating crime against itself, as in the case of savings and loan fraud (and the more recent corporate scandals). Collective embezzlement in the thrift industry used organizational support to loot the organization. It thus represents a hybrid: "crime by the corporation against the corporation." The incentives for such crime were greatly heightened during the S&L crisis
32. (Calavita and Pontell, 1991, op. cit.).
33. Tillman, Robert, and Henry N. Pontell, "Organizations and Fraud in the Savings and Loan Industry." Social Forces 73(4) June, 1995: 1439-1463.
34. Barth, James, The Great Savings and Loan Debacle. Washington, D.C.: American Enterprise Institute, 1991;
35. National Commission of Financial Institution Reform, Recovery and Enforcement (NCFIRRE). Origins and Causes of the S&L Debacle: A Blueprint for Reform. A Report to the President and Congress of the United States, Washington, D.C.: Government Printing Office, 1993.
36. Ibid., p. 1458.
37. Lowy, Martin, High Rollers: Inside the Savings and Loan Debacle. NY: Praeger, 1991: 100-11;
38. White, 1991, op. cit., p.117.
39. Congressional Budget Office, The Economic Effects of the Savings and Loan Crisis. Washington, D.C.: U.S. Government Printing Office, 1992;
40. Kane, Edward, "The Savings and Loan Insurance Mess." Society 29, 1992: 4-10;
41. White, 1991, op. cit.
42. Tillman and Pontell, 1995, op. cit., p. 1458. The results of this study showed that those institutions that were the sites and vehicles for the most frequent, the most costly, and the most complex amounts of white-collar crime were those that: (1) were stock owned; (2) were less involved in the home mortgage market; (3) had committed a greater proportion of their assets to direct investments; and (4) undertook strategies that led to dramatic growth in assets.
43. I b i d.
44. Another analysis (Black, William K., and Henry N. Pontell, "Regulatory and Economic Incentives for White Collar Crime: The U.S. Savings and Loan and Insurance Crises of the 1980s." Paper presented at the 22nd Seminar of the European Group of Risk and Insurance Economists, University of Geneva. Switzerland, September 20, 1995) characterizes the conventional economic wisdom on the S&L crisis as constituting the following essential points. S&Ls faced moral hazard as they were exposed to systemic interest rate risk by government limits on their asset powers. The regulators then compounded the problem by failing to close insolvent S&Ls. This, combined with federal deposit insurance and a relaxing of regulatory and accounting oversight provided a significant incentive to "gamble for resurrection" on high risk assets. These gambles often failed, leading to the debacle. Fraud did not play a material role in the crisis. The contrasting view of government regulators, enforcement personnel, crimmologists, and some economists is that these factors also provided an optimal environment for control fraud and other crimes. A criminogenic environment is one that facilitates the commission of criminal activity. In the case of the S&L crisis, the environment allowed for the following conditions that would encourage the proliferation of control fraud: (1) complete insider domination ("The best way to rob a bank is to own one."); (2) plentiful liquid assets relative to liabilities (the larger the amount, the more that can be looted, and/or spent on political intervention to fend off regulators); (3) the ability to grow quickly (growth implies success and garners positive attention as well as increased liquid assets); (4) the ability to convert corporate assets to personal gain (creating phony income that appears to warrant extra bonuses, "perks," and stock dividends; (5) the ability to hide losses and create phony income (investing in assets that have no readily ascertainable market value so they can be overstated and losses hidden); (6) the ability to impede detection and prosecution of fraud (diffuse victimization, and making fraudulent business transactions appear "normal."); and (7) minimal ethical barriers to insider fraud, i.e., an ethos that considers greed a virtue, and government regulation as unnecessary provides a lethal combination of factors that can only weaken if not ultimately destroy fiduciary standards.
45. Black, William K., Calavita, Kitty, and Henry N. Pontell, "The Savings and Loan Debacle of the 1980s: White-Collar Crime or Risky Business?" Law and Policy 17(1) January, 1995: 23-55.
46. Ibid., p. 33. This explanation is related directly to the concept of "moral hazard." There were perverse economic incentives for behavior, and individuals benefited with little to no personal risk by engaging in activities that were inefficient or counter-productive at the organizational level. According to this gambling for resurrection hypothesis, the bulk of the losses associated with the thrift crisis resulted from potentially high yield investments in extremely risky assets that had very high default rates. Thrift owners, acting as rational economic actors trying to resurrect their institutions, engaged in high-risk gambles, which if they paid off, would save their S&Ls from insolvency. For insolvent thrifts, the perverse incentive for such gambling was clear: "Heads I win and tails you (FSLIC) lose. " An insolvent thrift had nothing to lose and everything to gain by engaging in such longshot gambles. If this excessive risk taking explanation is correct, the study argues that one would predict the following historical artifacts in the S&L crisis using both logical deduction and an extension of the underlying economic paradigm: (1) Thrift owners most influenced by such moral hazard would be those whose institutions were the most deeply insolvent, and they should be at stock owned thrifts rather than at mutuals, since according to finance theory, mutual managers tend to be more risk averse, and because shareholders of stock associations would stand to gain the most through stock appreciation and dividends if the gambles succeeded. For insolvent institutions this would be an entirely rational approach, since shareholders had already lost their capital investment unless some long-shot gambles saved them; (2) Losses would be concentrated in thrifts where managers made high-risk investments, because of the higher likelihood of failure of these investments. In addition, one would expect to see faster growth in these thrifts through increased high-risk investments, and according to portfolio diversification theory, greater diversification of portfolios, as rational economic actors would seek to increase potential returns. Only a few "plungers" would concentrate their portfolios in relatively few assets, as this would limit their chances for a successful return on their investment; (3) Exceedingly careful underwriting would be present. Thrift owners who were trying to make their high-risk investments succeed, and bring their institutions back to solvency, would have employed excellent underwriting practices, since the only chance for resurrection would be picking successful high-risk investments, which, by their very nature require increased scrutiny by rational economic actors; and (4) At the aggregate level, thrifts should have had a significant level of success in gambling for resurrection in the 1980s. While they started from a deficit (i.e., they were market value insolvent), interest rates dropped sharply by 1982 and by the mid-1980s most unrealized market losses were eliminated. Many markets such as real estate and junk bonds produced fine returns throughout most of the 1980s. Had rational thrift owners enjoyed even a minimum level of success in a diversified portfolio of investments with adequate underwriting, they should not have failed. On the contrary, one would expect to see a reasonable number of highly successful gambles. Moreover, among those institutions that did fail, one would expect to see a wide range of failures, including relatively minor losses and much greater ones.
47. Ibid., p. 37. This model predicts the following: (1) Stock associations would have a much greater incentive to secure expert management, and thus failures would be concentrated among mutual associations. Failures should also be disproportionate among institutions that had a change in ownership; (2) Poor asset diversification and nontraditional investment strategies; (3) Although inexperienced and incompetent managers might have engaged in inadequate underwriting, one would reasonably expect that even they would be able to understand the most basic aspects of the procedure, and improve internal controls over time. Moreover, one would expect that they would be responsive to regulatory concerns about underwriting, potential violations, and the soundness of their investments. Well-intentioned, rational, yet inexperienced managers should have welcomed such free advice; (4) Regarding patterns of failure, one would expect to see insolvencies following the entrance into the industry of such managers, and that these should have decreased with time as managers gained greater experience.
48. Ibid., p. 38. It predicts that: (1) Greater failures in deregulated states that allowed for nontraditional investments, concentrated in thrifts that were insolvent on a market basis, and that were tightly-held stock associations. Failures and losses would also be disproportionate at thrifts that experienced a change of ownership immediately before increased nontraditional investment activity, especially where the recent entrants had substantial conflicts of interest, e.g. real estate developers; (2) Ideal vehicles for fraud entail nontraditional investments, such as ADC loans, and other direct investments where losses should be concentrated. Such investments would entail little portfolio diversification, and many loans would be at or exceeding the loans-to-one-borrower limit. Thrifts would also be experiencing rapid growth, not only to increase the value of the fraud, but because the large development loans, if they provided the vehicles for such fraud, would require a rapidly growing portfolio of reported assets to camouflage such criminality; (3) Under-writing would be weak to nonexistent, as the frauds would be more readily exposed to regulators. Internal managers engaged in control fraud would have both the ability and incentive to undo any internal controls that would interfere with the commission of their crimes. Such managers would also have an incentive to deceive regulators, and to cover up the financial transactions that would reveal the failing health of their institutions; (4) Material insider fraud would almost inevitably lead to insolvency, frequently with very large losses. Such failures and losses would surpass the intrinsic (non-fraud) risks of the institutions high-risk assets.
49. Ibid., p. 44.
50. I b i d.
51. Will, Susan, Pontell, Henry N., and Richard Cheung, "Risky Business Revisited: White Collar Crime and the Orange County Bankruptcy," Crime & Delinquency 44(3) July, 1998:367-387.
52. Rosoff, Pontell, and Tillman, 2002, op. cit., p. 470.
53. Quoted in ibid., p. 471.
54. I b i d.
55. Ryan, William, Blaming the Victim (Revised Edition). New York: Vintage Books, 1976, p. 3.
56. Quoted in Malloy, T.K. "Greenspan Blasts 'Infectious Greed'." washtimes.com. July 16, 2002.
57. Levi, Michael, "Giving Creditors the Business: The Criminal Law in Inaction." International Journal of the Sociology of Law 12, 1984: 322.
58. This, of course is true of common crime as well, and the phenomenon has been empirically demonstrated in terms of the system capacity model of criminal justice, but is exacerbated in the case of white-collar crimes given the legal complexities and intricacies involved, the legal resources of perpetrators whether they be individuals or organizations, and the hidden nature of the crimes themselves. Thus, the major tenets of deterrence and prevention are essentially denied. The legal system simply cannot respond effectively to such massive economic crime after it occurs. Pontell, Calavita, and Tillman, "Corporate Crime and Criminal Justice System Capacity," 1994, op. cit.;
59. Calavita, Pontell, and Tillman, Big Money Crime, 1997, op. cit.
60. Emshwiller, John, and Rebecca Smith. "Enron Jolt: Investments, Assets Generate Big Losses." Wall Street Journal. October 17, 2001: C1.
61. Rosoff, Stephen, Pontell, Henry N., and Robert Tillman, Looting America: Greed, Corruption, Villains, and Victims. Upper Saddle River, NJ: Prentice Hall, 2003:24.