THE BLOG
02/26/2013 05:16 pm ET Updated Apr 28, 2013

Inequality, Capitalism and a Nation of Men

John Adams famously sought to create "a government of laws and not of men." Sadly, I suspect John Adams would be disappointed in the nation today. Increasingly, the application of the law reflects what Adams feared: It depends on who the men or women are rather than what they have, or have not, done.

A central principle that is necessary for the rule of law, as well as a successful capitalist economy, is embodied in the statues that stand outside many courthouses. They portray Lady Justice with a blindfold. Justice is blind, and every person--rich or poor, mighty or not-- stands before the court on an equal basis.

Within this framework, the court applies the law without regard to the status of the defendant. The ideal of blind justice is a prerequisite for both a fair society and a vibrant capitalist economy. With all treated equally, buyers and sellers can rely on the courts to enforce their agreements: small businesses know that their agreements with large corporations and institutions of any size will ultimately be protected by the legal system. Contracts, declared immutable in the early days of the Republic under the Dartmouth College case, will be enforced. As a consequence, trade and production occur, while markets and commerce have the opportunity to flourish.

In contrast, when Lady Justice's blindfold is in tatters our economy loses its efficiency and ability to create real wealth. Consumers and businesses grow afraid to borrow from financial institutions knowing they will be at a disadvantage in any contract dispute. The mighty gain an unfair advantage in commerce (since crime starts to pay), knowing they can engage in profitable, but potentially illegal activities with impunity. When this two-tiered system of justice arises, trade and productivity diminish drastically as potential wealth creators know the contracts that protect them for the risks they take will not be fairly enforced.

A central aspect of a system grounded in the rule of law is the fair and equal use of prosecutorial discretion. When prosecutors treat different classes of people in vastly different ways, a system of unequal justice similarly arises. The courts never have the opportunity to enforce the law with equal vigor, as prosecutors create a two-tiered system of justice through the choices they make. For the society and a capitalist economy, there is little difference where the inequality starts: The outcome is the same. Potential wealth creators take far fewer risks, and produce less, since they know the legal system, starting with prosecutors, will allow the rich and powerful to act in potentially criminal ways.

Let's not kid ourselves: the portrait painted above is, in many ways, a charitable portrait of the nation today. We now live in a society where the rule of law, confidence in the judicial system, a fair capitalist economy, and an essential public respect for the law is rapidly disappearing. Indeed, our largest financial institutions seem to break the criminal laws with impunity, and a two tiered system of justice has evolved. I believe John Adams would say he fought a revolution to prevent the type of society that is now evolving.

Here are two examples. Unfortunately, my files contain dozens more:

In the HSBC case, as Matt Taibbi recently wrote,

"the U.S. Justice Department granted a total walk to executives of the British-based bank HSBC for the largest drug-and-terrorism money-laundering case ever. Yes, they issued a fine - $1.9 billion, or about five weeks' profit."

Taibbi further notes:

"For at least half a decade, the storied British colonial banking power helped to wash hundreds of millions of dollars for drug mobs, including Mexico's Sinaloa drug cartel, suspected in tens of thousands of murders just in the past 10 years ...The bank also moved money for organizations linked to Al Qaeda and Hezbollah, and for Russian gangsters; helped countries like Iran, the Sudan and North Korea evade sanctions; and, in between helping murderers and terrorists and rogue states, aided countless common tax cheats in hiding their cash.

"They violated every goddamn law in the book," says Jack Blum, an attorney and former Senate investigator who headed a major bribery investigation against Lockheed in the 1970s that led to the passage of the Foreign Corrupt Practices Act. "They took every imaginable form of illegal and illicit business."

That nobody from the bank went to jail or paid a dollar in individual fines is nothing new in this era of financial crisis. What is different about this settlement is that the Justice Department, for the first time, admitted why it decided to go soft on this particular kind of criminal. It was worried that anything more than a wrist slap for HSBC might undermine the world economy. "Had the U.S. authorities decided to press criminal charges," said Assistant Attorney General Lanny Breuer at a press conference to announce the settlement, "HSBC would almost certainly have lost its banking license in the U.S., the future of the institution would have been under threat and the entire banking system would have been destabilized."

There seems to be little question that the executives involved knew they were breaking the law. These executives assisted in the system that distributes massive quantities of prohibited drugs, which is also inevitably accompanied by violence and murders. The harm to our society was inestimable.
Yet, no criminal prosecutions arose. No accountability (which is fundamental to a fair society and a capitalist system) was demanded. Instead, prosecutors used their discretion to settle for a fine.
For our largest financial institutions, a new tier of justice has arisen: They break the law and pay a fine--which is typically a small cost of doing business as compared to the profits their otherwise prohibited activities generate.

In contrast, how many people are now languishing in jail for drug related crimes that caused far less harm to our society? How much money could you or I launder without facing criminal prosecution?

Any observer from outside the nation, perhaps a time traveler from the past, who observed this pattern would undoubtedly conclude America is not a nation where equal justice prevails. The S&L scandal in the late 1980's led to over 1,100 criminal prosecutions. Each of these individual executives broke the law and paid the price; but, it's worth recognizing that these individuals probably had a far less destructive impact on our society than the central executives at HSBC who knowingly participated in the money laundering activities.

In many states, if an individual is caught smuggling a small quantity of prohibited drugs he or she could well spend over a decade in jail. This smuggler has, under the law, harmed our society. Specific HSBC executives knowingly participated in creating far greater harm to our society than most of the drug dealers now sitting in state and federal prisons, yet prosecutors chose not to seek criminal indictments.

Similarly, in the so-called robo-mortgage scandal bank officials stood up in open court and admitted that they had filed false affidavits with the court over 10,000 times per month. In many states, a false affidavit is the equivalent of felony perjury. So, individual employees of the largest banks have stood up in open court and acknowledged that they knowingly committed all of the elements of the crime of felony perjury over 10,000 times.

Prosecutors inevitably say that the reason they have not pursued criminal indictments in cases of the type described above is "that they are hard cases to make." This explanation is simply not credible. Prosecutors have an open and shut case based simply on the testimony discussed above. As I have written before, I sincerely believe it would take less than a week to put together indictments of the most egregious violators.

The harm done to our society by the failure of prosecutors at both the state and federal levels to enforce the criminal law, despite egregious violations, cannot be underestimated.

Indeed, It leads to the ongoing destruction of our capitalist system. Each day it seems that some new, socially destructive, egregious and potentially illegal activity by our largest banks is reported. One of the purposes of criminal prosecution is to change behavior: By punishing wrong-doers a message is sent to others in a position to violate the law. They now know they will be prosecuted.

By failing to fulfill this important function, prosecutors have sent the opposite message. They facilitate ongoing malfeasance by financial institutions as executives conclude they can act with impunity. Some of the consequences include:

  • The largest financial institutions gain an unfair marketplace advantage. They can compete by behaving in questionable (and possibly illegal) activities that are not open to smaller institutions which justly fear prosecution.
  • Efficient markets are destroyed. It's not simply that large financial institutions have an unwarranted competitive advantage. As the impunity from enforcement of these institutions becomes widely recognized, businesses shy away from transactions with them. What's the point of a contract which may be illegally manipulated? In effect, far less potentially valuable economic activity--which could be creating real wealth for the nation--takes place.
  • It ensures that inequality becomes self-reinforcing--thereby further destroying our capitalist system. As the largest institutions gain power, they use it to ensure their hegemony. The massive lobbying and polarization in American politics today are clear examples of this behavior. In a nutshell, those at the top of the system make the economy less and less of a fair marketplace in order to ensure that they continue to win.

We are experiencing these effects right now. Inequality is continuing to widen. In a March 2012 paper, Professor Emmanuel Saez, the nation's leading expert on measuring income inequality, calculated that in 2010 the top 1% of U.S. families captured as much as 93% of the nation's total income growth.

In addition, as this cycle progresses, all types of activity which are the antithesis of a fair, capitalist economy are championed by those at the top of the system to further ensure their continued aggregation of wealth. Indeed, the essence of capitalism is accountability. Yet, I would suggest that the concept of "accountability" has not been applied to a major financial institution for the past five years.

Finally, as the sense of entitlement and impunity grows, those at the top of the society lose their sense of empathy or concern about their impact on society.

In Democracy and America, de Tocqueville wrote that one of the reasons America would be a great nation is what he called "self-interest well understood." In his view, people did not act purely out of altruism. At the same time, they knew that when they cleared new land, established a trading business, or started a farm, what they were doing was good for themselves as well as the country at large.

This insight has meaning for us today. Many financial institutions have defended their activities by simply telling us "these activities were legal." Yet, as de Tocqueville foresaw, when an individual knowingly does something that is good for him or her, but bad for the society, then a downward spiral can occur. The real (not paper) wealth of the society will diminish. Adam Smith's invisible hand--which has been repeatedly misinterpreted--certainly did not posit that if I do something that is good for me and obviously bad for everyone else--I have somehow made us all better off simply because the activity was legal.

There is a clear, but often unrecognized link between inequality and the destruction of fair capitalism. Those who argue that capitalism is the cause of inequality have it wrong. It is crony capitalism, socialism for the wealthy, or whatever else we want to call our current economic system which exacerbates inequality. The current system is not, however, actual capitalism. Real and fair capitalism forces those at the top to continue to compete fairly and to continue to build real wealth for our society.

In On Political Equality, Yale's eminent political scientist, Robert Dahl, postulated that there may be a point of no return. At some point, the influence of the wealthy so overwhelms our political system that what we now call the 99% become effectively without influence. Hopefully, we have not yet hit this point.

There is one simple step which could make a real difference immediately. It is a step our nation can and must take. Prosecutors simply need to do their jobs.