Did Criminal Behavior Cause the Financial Crisis?

James K. Galbraith, professor at the University of Texas, blames criminal behavior for the economic crisis and offers the best way to handle Wall Street perpetrators.


Criminal behavior was behind much of Wall Street’s reckless excess that caused the recent financial crisis, according to James K. Galbraith, professor of government and business relations at the university of Texas, Austin. The question he’s been asking all along is: Why the perpetrators have not been prosecuted yet?

The 1990’s savings and loans crisis is a good example of justice being served to punish financial misconduct. In this case, insiders were actually convicted and imprisoned as a consequence of what they did. Charles Keating, the head of Lincoln Savings and Loan Association, was convicted of fraud, racketeering and conspiracy, and served four and a half years in prison. Five senators, including the Republican John McCain, known as the Keating Five, were accused of corruption after they received political contributions from Keating and intervened on his behalf. “Normally when the evidence of fraud is as clear as it appears to be in the larger environment of this scandal, you have to pursue the perpetrators,” Galbraith says.

Galbraith blames big banks, which control all financial and political activity on Wall Street, as the biggest perpetrators responsible for today’s economic crisis. He believes the current economic crisis will not end as long as those banks remain “opaque and hard to manage as they appear to be.”

In a recent interview with Institutional Investor writer Franziska Scheven, Galbraith discussed the best solutions for reining in Wall Street’s criminal behavior, what policies are needed to protect investors and whether the U.S. is poised for another economic boom.

Institutional Investor: Will the new restrictions on proprietary trading and the reforms enacted by Dodd-Frank Act curb the criminal behavior you believe is influencing Wall Street?

Galbraith: Normally when the evidence of fraud is as clear as it appears to be in the larger environment of this scandal, you have to pursue the perpetrators. And that is what we did in the early 1990’s with the saving and loans scandals. A thousand industry insiders in the saving and loan industry were actually convicted and imprisoned as a consequence of what they did to ruin that industry.


In this case, we have seen practically nothing by way of legal recourse against people who were clearly committing swindles of a high order. Many victims were Germans investors bought the corrupt residential mortgage backed securities.

The question in my mind is: How can we recover trust in the financial sector if we do not have a thorough legal response to the swindles that were already committed? The way to do it is for the Justice department to appoint a strike force to conduct discovery operations.

How should the banking system be restructured and reformed to avoid another crisis?

We will have an ongoing crisis of economic structure and economic activity so long as we have a half a dozen major banks controlling most of banking activity in this country, and in particular, aslong as they are as opaque and hard to manage as they appear to be.

I don’t doubt that there has been considerable restructuring of those banking institutions in the last two years. But the reality is, with five large banks, there is going to be less underwriting of loans to small- and medium-sized businesses that otherise would be available if the banking sector was dominated by more de-concentrated and smaller institutions.

What are your views on the currency debate?

The world currency system will always be somewhat instable. That is true now, and has been at various times in the past. At the moment, I do not think the dollar is the weak link in the world currency system. Every time there is a rumor of crisis, people rush to buy Treasury securities and the dollar gets stronger, rather than weaker. The weak link at the moment is the Eurozone. The European Central Bank needs to assure investors that the weaker countries of the Eurozone will not default.

Of course, it is always possible that investors could decide they wanted to dump dollars and hold Indian rupees instead, but I think the chances of that are very small. As long as the U.S. does not do something extraordinarily stupid, the dollar will probably continue in its present role.

The stock market is on an upward trend and many corporations are reporting record profits. Do you think we are heading into the next economic boom?

Another boomis extremely unlikely any time soon.

The stock exchange is responding to a number of things. The initial run up in 2009, particularly in the financial sector, was a response to the recovery from the extreme panic of the late 2008 period, and secondly because the banks were being permitted to not recognize their losses. There was an element in accounting associated with this.

The current stock market run up is partly a response to the tax measures associated with it. Does it foreshadow a strong economic recovery? I think it means that there is growing confidence that we are not going into another slowdown.

But there is a big difference between having an economy that looks very good from the standpoint of corporate profits, and one that looks good from the standpoint of job creation. We are in reasonably good shape on the first criteria, but in a very poor shape of the second.

The way to make rapid progress on the labor market front is to give people who would be wiling and eager to leave the labor market the reasonable financial incentive to do so by improving the early retirement provisions, social security and Medicare. If you are looking for something that would have a major impact in a short period of time, that would be it.

James K. Galbraith teaches at the LBJ School at the University of Texas. He holds degrees from Harvard and Yale (Ph.D. in economics, 1981) and studied as a Marshall Scholar at King’s College in Cambridge. Galbraith served in several positions on the staff of the U.S. Congress and is the author of several books and other publications, such as “The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too” in 2008 .