Page 4 of 4 Either way, it could be an
unkind cut By Henry C K Liu
contagion problems actually are in
subprime mortgage loans, Paulson, having
repeatedly declared that the problem had been
contained in previous weeks, now said: "It's
certainly going to be into the weeks, maybe a
matter of months. I have a difficult time making
projections, but it will be a while."
It
is not clear if Paulson, the nation's highest
finance official, was making a political statement
or deliberately false market analysis
by
someone in the position to know about the true
state of finance in the economy. The US Treasury
for over a decade under both Democrat and
Republican administrations has been the branch of
the government most responsible for pushing
financial globalization to produce a strong
US-dominated global economy at the expense of a
weak US domestic economy held up by debt.
The situation makes it very difficult for
the Fed to use monetary ease, ie, lowing dollar
interest rates, to stimulate the US economy
without pushing the exchange rate of the dollar
down, which will further weaken the US domestic
economy. A collapse of the dollar will make a
recession seem like a tea dance by comparison.
Enron executive not guilty? It
should be recalled that top Enron executives who
made similar, knowingly false statements about
their company to calm markets were convicted of
fraud and sent to prison. The conviction was based
on the so-called "honest services" theory of which
the defendants had conspired to deprive the
company.
On September 11, Paulson finally
came clean on the seriousness of the crisis of
confidence in credit markets and admitted that it
would take longer to work out than previous
financial shocks of the past two decades, such as
the 1982 Latin American debt crisis, the 1997
Asian financial crisis and the 1998 Russian bond
default that sank Long Term Capital Management, a
big, highly-leveraged hedge fund. The uncertainty
over the distribution of holdings and the
complexity of valuing structured finance
instruments based on subprime mortgages could last
for up to two years, as many such loans reset to
higher rates over time. Still, he assures the
market that the US economy is fundamentally
strong, a position that instead of calming markets
only makes him seem disconnected to reality.
Paulson spoke in Washington as Jean-Claude
Trichet, the European Central Bank president,
warned that it was time for global financial
authorities to tackle unregulated entities whose
activities had contributed to the latest
upheavals. Ratings agencies were called to a
special meeting for questioning by regulators on
the way they rated structured financial products
based on mortgage collaterals.
As Treasury
secretary, Paulson of course enjoys legal immunity
on misleading political statements that
technically stay clear of perjury or other
impeachable offenses. And no suggestion is made
here that Paulson is not an honorable man. Yet
moral immunity from robbing society of "honest
services" by the Treasury secretary of the world's
most powerful economy is a different matter in the
court of public opinion and in the judgment of
history.
Interestingly, the day after the
Paulson interview on PBS, former Enron chief
executive officer Jeff Skilling filed an appeal
before the Fifth Circuit Appeals Court in New
Orleans more than 15 months after he was convicted
and nearly nine months after he began serving a
24-year, four-month prison term in southern
Minnesota.
Skilling's top-rated legal
team, led by Daniel M Petrocelli, who also
famously won a wrongful death civil suit against O
J Simpson on behalf of Fred Goldman, surviving
father of murdered victim Ron Goldman, argues that
errors by prosecutors and US District Judge Sim
Lake, who presided over Skilling's first trial in
Houston, require the appeals court to overturn all
19 of his convictions of conspiracy, securities
fraud, insider-trading and lying to auditors.
"They were in search of crimes knowing this wasn't
a clear-cut case, and in particular, that Jeff
Skilling hadn't done anything wrong," said
Petrocelli in an interview, whose firm, O'Melveny
& Meyer, reportedly was owed $30 million in
legal fees by Skilling from the first trial.
The appeal said the government sought to
criminalize normal business activities in its zeal
to ensure someone paid for Enron's failure. "That
someone was Jeff Skilling - the last man standing
when the court meted out its punishment," the
appeal said. Former Enron chairman Ken Lay,
Skilling's co-defendant in their fraud and
conspiracy trial last year, died six weeks after
the pair was convicted, vacating his criminal
liability.
The major arguments presented
by the appeal include: 1. Prosecutors used a
flawed theory that Skilling robbed Enron of his
"honest services" to prove the overarching count
of conspiracy to commit securities and wire fraud.
A Fifth Circuit panel rejected that prosecution
theory in a shareholder class action suit against
Enron two months after Skilling's conviction.
2. Judge Lake gave flawed jury instructions,
most notably allowing jurors to find Skilling
guilty of deliberately ignoring fraud when his
defense was that no fraud existed. Lake refused to
move the trial from Houston, where the defense
contends anger about those hurt by Enron's
collapse poisoned the jury pool. Skilling never
asserted an "ostrich" defense, a usual
prerequisite to issuing the "deliberate ignorance"
instruction. 3. Skilling's prison term is
excessive and unconstitutional, being four times
longer than any other convicted Enron executive,
two to three times longer than comparable
white-collar defendants and six years longer than
the average federal sentence for murder, albeit
slightly less than the record-breaking 25 years in
prison being served by Bernie Ebbers, the former
boss of bankrupt WorldCom.
Judge Patrick
Higginbotham of the Fifth Circuit signaled last
December that Skilling's legal argument could be
well received regarding 14 of the 19 counts. In a
ruling denying Skilling's request to remain free
on bond during appeal, Higginbotham pointed to
"serious frailties" in those counts, noting
"difficulties brought by a decision of this court
handed down after the jury's verdict".
Higginbotham did not sit on the panel that issued
the honest services decision, but he also wrote
that Skilling had not raised issues likely to lead
to reversal of all his convictions.
Skilling's appeal argues, however, that
the prosecution's "honest services" theory taints
all the other counts and that Skilling should get
a new trial. The theory took a judicial hit in
August 2006 when the appeals panel threw out
convictions of four former Merrill Lynch & Co
executives in the Enron case. The judges said
prosecutors improperly argued that the defendants
robbed Enron of their "honest services" when they
helped push through a loan on Nigerian barges
disguised as an asset sale in late 1999 to help
the energy company meet its missed earnings
targets.
The appeals panel ruled that the
"honest services" theory did not apply because the
Merrill Lynch defendants acted in Enron's
corporate interests and did not take money or
property from the energy company, even though
their firm profited financially from the
arrangement. There was no criminality because the
money came from society, an entity that apparently
has no court-recognized legal rights or advocate
of legal standing in the legal system of market
capitalism.
Prosecutors in the Skilling
case had argued that he "robbed" Enron of his
"honest services" by breaching his duty to make
sure financial statements correctly reflected the
state of the company.
Skilling argues in
his appeal that he did not steal anything. Yet he
was unjustly convicted of one count of conspiracy,
a dozen counts of securities fraud, one count of
insider trading and five counts of making false
statements to auditors, while he was acquitted of
nine counts of insider trading. The "honest
services" theory was presented by the prosecution
only with the conspiracy count, but the appeal
argues an instruction Judge Lake gave the jury
links it to the other counts as well. Oral
arguments in the appeals case are expected to be
scheduled for 2008.
Conflict between
systemic guilt and individual guilt The
issue raised by the Skilling appeal, beyond the
legal technicalities, was a conflict between
systemic failure and individual responsibility.
The court found Skilling guilty personally to
absolve the system from guilt. The Appeals Court
has ruled in related cases that convicted
defendants were acting within the laws and
regulations then governing their behavior. The
court's decision implies that criminality rests
with the system, not the individuals involved.
However, logic would suggest that Skilling, by
participating in a guilty system, cannot escape
personal criminality even though he did not
violate any laws of the system. That logic has
been firmly established by the historic Nuremburg
trials for war criminals.
Over the years
of the liquidity boom, some people have profited
very handsomely securitizing and selling subprime
mortgages. These people were not even required to
pay their fair share of taxes. Now in the
consequential liquidity bust, these same people
are home free because they have passed the risk
onto unsuspecting money market and pension funds
that hold the savings of middle income citizens.
The structured financiers are keeping their
ill-earned profit while the massive loss will be
borne by millions of others who innocently thought
they were investing in risk-averse instruments
created by the same financiers. Even the former
chairman of the Federal Reserve had been on record
for having said publicly that systemic risk is a
good trade-off for unprecedented economic
expansion. There is a high probability that
individuals responsible for the credit melt-down
that will hurt millions will be brought to justice
before the end of the day. The uncertainty is who
they will be.
Henry C K Liu is
chairman of a New York-based private investment
group and visiting professor of global development
in the economics department of the University of
Missouri at Kansas City. His website is at
www.henryckliu.com.
(Copyright 2007
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