PhillyDeals: 'Broken windows': Saving U.S. from financial fraud

Back in the fat years, before so many of its heavy users went broke, the credit card industry down in Wilmington recruited a string of former FBI officials. Bankers wanted their anti-Mafia experience - to fight fraud and to sell more credit cards to law enforcement pros.

Over breakfast at the Hotel du Pont one morning in the late 1990s, former FBI Deputy Director William J. Esposito and former New York boss investigator Jules Bonavolonta, newly hired by the former MBNA Corp., told me one reason their Federal Bureau of Investigation had lately managed to break up long-standing ethnic gangs: The end of the Cold War freed the agency from a lot of domestic political monitoring, so it could systematically pursue gunmen, industrial shakedown artists, and their professional enablers.

What about white-collar criminals? I asked. They're next, they told me.

Then the Sept. 11, 2001, terrorist attacks sent a lot of FBI resources back to watching a new generation of potential radicals.

Meanwhile, financial fraud has thrived, to where some bank-watchers say it's a national security threat.

The political scientist James Q. Wilson, who died March 2, is remembered for his "broken-windows" theory: Suppress graffiti, vandals, streetwalking prostitutes, window-smashing burglars, and you'll find violent drug gangs and stickup men go away. It seemed to work, at least in Rudolph Giuliani's New York.

Financial crime needs a similar approach, argues University of Missouri-Kansas City professor William K. Black, who used to fight mortgage fraud for the Federal Home Loan Bank Board.

Wilson didn't take white-collar crime too seriously. But to Black, in a column published last week by UMKC's New Economic Perspectives, the parallels are clear: "Anticonsumer frauds are a direct assault" on the public. A little leads to a lot: Bosses, financial officers, and salespeople who cheat and get away with it "erode peer restraints on misconduct."

Look what happened to the home-loan business, says Black: "It was overwhelmingly the lenders and their agents" who put the lies in the so-called liar loans that blew up giant banks and stalled the home-building, home-finance, and homeownership machine that used to power the U.S. economy.

At the corporate level, "earnings management" corrupts financial staff, auditors, executive compensation consultants, sales managers. The State of Delaware, legal home to half the companies on the New York Stock Exchange, made things worse when its business-friendly courts agreed to let companies weaken their old "fiduciary duties of loyalty and care." So, everybody does it - and you end up with the recent financial crisis, and the next one.

Business students "have learned no lessons" about avoiding the frauds of the recent past, warns Francine McKenna, the veteran accountant who writes The Auditors blog, in a column last week for American Banker. On college visits, she finds soon-to-be-accountants and junior managers, hungry for corporate jobs to pay their loans, say it's natural to help management "smooth" financial data.

It has gotten so bad that Robert J. Shiller, the Yale economist and home-price tracker who wrote prescient books spotlighting the dot.com and subprime-lending bubbles as they happened, has rushed to the defense of the very system whose failures he plumbed.

Shiller's new book, Finance and the Good Society, reminds us that Wall Street, banks, auditors, regulators, the whole system, evolved to help legitimate enterprises and careers grow faster, sounder, better.

Bad behavior and poor policing feed public skepticism about the honesty of businesspeople, he writes, and the "illusion," inside and outside business, that enterprise profits only from "aggressive and inhuman" methods that "attack and subjugate, economically, the majority of the population."

People need to see liars and thieves stopped, Shiller concludes. Educated consumers, businesses, and banks can prosper in a "democratic" financial system that "redirects the inevitable human conflicts into a manageable arena."