Financial Res Ipsa Loquiter

If the stock market surged 15% in the week since Bernie Madoff finally went to prison, just imagine what it would do once the senior management at companies like AIG, Citigroup, Goldman Sachs, and Fannie Mae are held accountable for their behavior.

And why shouldn’t they be?

Thanks to the legal principle of res ipsa loquiter (Latin for “the thing speaks for itself”), when a patient finds a scalpel in his back after surgery, he doesn’t have to prove negligence to prevail in a malpractice suit against his surgeon(s). Rather, the surgeons have to prove that they didn’t commit malpractice.

So, too, when a company requires $5 billion — or 10X or 50x(!) that — from the U.S. Treasury to prevent a melt-down in the U.S. (no, global) financial system . . . the burden of proof to show gross negligence should be deemed to shift — to the company receiving the bailout. (Don’t need the $5 billion? Then pay it back.)

The best way policymakers can restore confidence in the ailing financial system isn’t by devising some miracle cure that will suddenly make sick banks healthy. Rather, it’s by demonstrating that there are consequences — not rewards — for reckless, outrageous behavior.

“One Down, 999 to Go”

So here’s my proposal.

For every $5 billion in taxpayer money that a company has received, hold one executive at that company personally responsible. If the number trips $100 billion, send the whole board of directors to prison. After all, under state law, which governs most corporate conduct, it is the board that is ultimately responsible for the company’s actions.

Assuming that the U.S. Treasury has now spent or guaranteed about $5 trillion in bad debts, the number of executives subject to such an enforcement action would be around 1,000.

Here’s what a partial breakdown (pun intended) by company would look like:

AIG: Cost to taxpayers — $200 billion; Responsible executives — 40
Citigroup: Cost to taxpayers — $150 billion; Responsible executives — 30
Bank of America: Cost to Taxpayers — $100 billion; Responsible executives — 20
Fannie Mae, Freddie Mac, Goldman Sachs: Cost to Taxpayers — $75 billion; Responsible executives — 15 apiece
Merrill Lynch: Cost to Taxpayers — $50 billion; Responsible executives — 10
Washington Mutual, Wachovia, Bear Stearns, Countrywide: Cost to taxpayers — $25 to $50 billion; Responsible executives — 5 to 10 apiece

But, you object, wouldn’t such a tactic be nothing more than an extra-legal, torch-and-pitchfork mob action?

It needn’t be, conducted properly. In fact, such a response might offer the country its best chance of averting such a mob action.

Today’s financial melt-down has already destroyed more wealth — about $15 trillion; erased more jobs; and caused the foreclosure of more homes, than any other financial calamity in history, including The Great Depression. And that’s just in the U.S.

Far from being an economic Katrina, the melt-down was very much a man-made affair.

Follow the Money

Which men?

As they say, “follow the money.”

Senior executives at the above-named firms collected billions for designing and running a “financial sausage factory” that churned out trillions in securitized debt (principally tied to mortgages). Thanks to the credit ratings agencies, the vast majority of this debt was highly rated, and therefore palatable to investors around the globe.

Incredibly, at least some of these companies figured out how to profit a second and third time from these toxic securities — by “shorting”, or betting against them, after they sold them to customers (Goldman Sachs); by buying insurance policies that paid off when the toxic debt inevitably exploded (Goldman Sachs, Merrill Lynch and a host of others); and by collecting premiums for insuring said toxic debt (AIG).

Incredibly, the Treasury apparently is now honoring these bets through “backdoor bailouts” via AIG.

If executives at these companies knew the egregious risks they were running, they’re guilty of fraud. If they didn’t know the risks . . . they’re guilty of gross negligence. This is exactly the same Hobson’s choice (minus three zeroes) that confronted Enron’s putatively out-of-the-loop executives.

That’s just for starters.

Depending on the company and individual executives, you’d guess that a complete list of misdeeds would include: filing false financial statements (all that off-balance sheet debt); breach of fiduciary duty to their shareholders (isn’t that what a “heads I win, tails you lose” policy amounts to?); insider trading; and corporate waste.

Financial Res Ipsa Loquiter – Part 2

About the author

Ross Kaplan has 19+ years experience selling real estate all over the Twin Cities. He is also a 12-time consecutive "Super Real Estate Agent," as determined by Mpls. - St. Paul Magazine and Twin Cities Business Magazine. Prior to becoming a Realtor, Ross was an attorney (corporate law), CPA, and entrepreneur. He holds an economics degree from Stanford.

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