Bill speculated several days ago that prosecutors’ use of criminal law to pursue the executives of firms that go spectacularly bust may often serve no other purpose than to discourage firms from engaging in the kinds of risks that make a market economy go. I for one think that this is a very real danger. Executives who commit crimes should be punished, of course, but often prosecutors seem to identify the targets in high profile cases first, and then start looking for criminal provisions to prosecute them with.
There are two problems with this, in my view.
The first is the one Bill mentioned, that selective prosecutions may do little more than chill entrepreneurial behavior. In many countries, such as England, liability is imposed on managers who continue to run the business after it encounters financial trouble. We have never had such a rule in this country, based on the view that punishing managers who fail will send precisely the wrong message. It will tell them it’s better to play it safe, than to take the kinds of entrepreneurial risks that can lead to great innovation.
The second problem is that criminal show trials are sometimes used as a substitute for (or an excuse to avoid making) reforms that would actually make the regulatory framework better. The most productive response to Spitzer’s downfall would be to think about some of the issues Bill has raised, such as our uneven prosecution of prostitution. With the subprime crisis, we should be trying to identify flaws in the regulatory framework and considering how to improve it, not looking for executives to serve as the focus of a series of show trials.
I worry that this weekend’s bailout of Bear Stearns will give us the worst possible world with the subprime crisis. We’ll find some executives to put in jail, while propping up the banks whose extravagant bets helped to fuel the crisis. It’s hard to imagine a more mixed message. A few executives will be hung out to dry if their business fails, but noone else will be expected to bear the consequences of the failure. The sale of Bear Stearns may be the only silver lining in all of this, since it at least suggests that Bear Stearns' decisions had real consequences, and that there are limits to the Fed's willingness to bail out a troubled bank.