Friday, April 22, 2011

The Pakistani Strategic Concept of 1971 War

The 1971 War

An examination of the strategic concept of the 1971 war


September 2000

The strategic concept of Pakistan’s defence i.e. ‘Defence of East Pakistan lies in the West’ was formulated by Ayub Khan in late fifties and became the foundation of Pakistan’s defence policy. The concept envisaged having bulk of the army in the northern half of the West Wing and was based on the assumption that this arrangement would force India to keep bulk of its army/strategic reserves on its western front. We will analyse the various aspects of this concept as following:-


The interconnection between the internal and external fronts.

The basis of defence and stability of a country is absolute harmony and in consonance with the internal and external fronts.

The internal front means ‘morale of the civilian population’ ‘their belief in the legitimacy and moral credibility of the political government’ ‘belief in national aims and ideology of the country’ ‘identification with the Armed Forces of the country as defenders of the country’s integrity’ etc etc.

External front includes the country’s Armed Forces, and its foreign policy. A country’s defence is based on both and any weakness in one will weaken the other. This inter-relationship was ignored by Pakistan’s civilian and military leadership during the period 1947-71.

The Muslim League was initially dominated by a partnership of refugees from Muslim minority provinces and later by a combination of Punjabi Muslims and civil-military bureaucrats.

The Bengalis were alienated first because of the National language issue and later because of the constitutional representation issue.

The Bengalis were initially patriotic and only demanded linguistic equality and had even agreed to political parity in 1956.

This arrangement was seriously disturbed once Ayub usurped political power in 1958. Immediately after independence the founder of the nation Mr Jinnah made an attempt to broaden the army’s recruitment base by ordering the raising of the East Bengal Regiment in 1948.

This was a purely political decision taken by Mr Jinnah and implemented by a British C in C. By December 1948 two battalions of this unit composed of Bengali Muslims had been raised.

This process was, however, discontinued once Ayub Khan an intellectually naive and tactically timid man became the Pakistan Army’s C in C in 1951. Ayub was biased against having Bengalis in the army.

During his tenure an unwritten policy of not raising any more Bengali infantry battalions was followed. Ayub also retired the most promising Bengali officer Major General Majeed soon after taking over.

The East Bengal Regiment was limited to two units and the expanded Pakistan Army remained a largely Punjabi dominated army. The irony of the whole affair was the fact that during this entire period all the army chiefs were non-Punjabi!

In any case this was the first serious negation of the concept of having a national army. The Army was on the other hand firstly viewed as a Punjabi Army in the East Wing. Secondly and far more worse; it was viewed as an organisation designed primarily for the defence of the West Wing.

The 1965 war further convinced the Bengalis that the army was not a national army but one designed to defend the West Wing. Thus from 1965 the rift between the internal and external fronts became much wider and the army was increasingly viewed as a foreign entity in the East Wing.

The seeds of the events of 1971 were laid during the Ayub era. The Bengali populace viewed the federal government as a neo colonial government with its political base in the West Wing. The Army was increasingly viewed as a coercive instrument which was aimed at perpetuating the West Wing’s political and economic exploitation of the East Wing.

By 1971 Pakistan’s ‘Internal Front’ was seriously eroded and this in turn greatly weakened its external front.


The Military Capability to implement the strategic concept. Till 1962 the military balance between Pakistan and India was equal. The Sino-Indian conflict led to a major change in Indian defence policy and the Indians initiated a major programme of military expansion.

In 1965 when the second Indo-Pak War took place; the relative Indo-Pak military capabilities were not as significant; and Pakistan was better placed at least in terms of strategic reserves.

Stoppage of US military aid in 1965 brought a major change in the military sphere. Pakistan concluded an alternate defence arrangement with China but this was not sufficient to redress the imbalance. India on the other hand more rapidly expanded her Armed Forces and the gap between India and Pakistan in terms of infantry formations became far more wider than in 1965.

Thus India’s overall military superiority over Pakistan increased from 1965 when it was about 20 to 35 in Infantry1 to 15 to 32 in 1971. The situation became far more worse in terms of strategic reserves since Pakistan’s armour potential was severely reduced because of stoppage of US aid.

The Indians on the other hand almost completely replaced their ancient tank fleet of 1965 with brand new Vijayanta-Vickers or Russian supplied T-54/55 Tanks. In brief Pakistan did not possess the military capability to implement the strategic concept.


Pakistan’s Internal Situation. The military regime of Yahya made an honest attempt to bring democracy in Pakistan and successfully held Pakistan’s first ever general elections based on Universal Suffrage since 1946. The country was already polarised because of the political legacy of the Ayub era and the East Wing was on the verge of secession.

This situation was not of Yahya’s making but inherited by him.

The situation demanded extraordinary political vision which was sadly missing in the country’s political as well as military leadership. Yahya although sincere at heart believed in the power of bayonet and thought that the East Wing could be kept within the federation through military action. The consequences of the surgical and brief military action were not fully grasped by Yahya and most of the West Wing’s politicians.

In 1971 the country was divided and in no position to simultaneously deal with a civil war as well as an external war. This adverse internal situation nullified the whole concept.


Lack of clarity in the Pakistani Military Higher Command about the ‘Modus Operandi’ of executing the Strategic Concept.

It may be noted that at least till 1968-69 the Pakistani GHQ was not clear about ‘what action should be taken in West Pakistan if an Indian attack was mounted against East Pakistan’2.

In brief the Pakistani military leadership was confused and vague about the method of execution of the strategic concept; i.e. ‘Defence of East Pakistan lies in West Pakistan’ as late as 1968-69 at the time when defence plans were revised under General Yaqub Khan’s tenure as CGS.

The concept was based on the assumption that Indian pressure/threat against East Pakistan could be dealt with by launching a major counter offensive taking the war inside Indian territory on the Western Front.

This was a very generalized assumption and was interpreted by different officers in a different manner. General Gul Hasan who took over as CGS had more clear ideas about the implementation of this concept; but Gul’s views were not shared by the higher military leadership.

One school of thought led by the CGS General Gul Hassan felt that this could be best done by ‘simultaneous launching of preliminary operations and the counter offensive’ or ‘that the reaction to any Indian invasion of East Pakistan should be an all out offensive by Pakistan’s Strike Corps i.e. the I Corps’3.

Yahya and his Chief of Staff General Hameed felt otherwise. They were of the view that ‘preliminary (local level tactical attacks) operations by the holding formations should be launched first and when the preliminary objectives had been secured and the enemy’s attention had been diverted, the main counter offensive should be set in motion.4

Yahya and Hameed failed to realise that the only chance of salvation in 1971 when Pakistan was facing serious odds was in resorting to the boldest measures. Gul’s views were not accepted and Yahya and Hameed decided on a vague plan of ‘first launch preliminary operations followed by counter offensive’.

Lieutenanat General Gul Hassan Khan

The final strategic plan was vague and confusing on two counts; i.e. firstly it did not take into account the fact that the Indians enjoyed overwhelming superiority in the Eastern Theatre and possessed the potential of overrunning East Pakistan; secondly no time frame was fixed for launching the counter offensive of 1 Corps. It may be noted that Pakistan possessed relatively superior strategic reserves on in the Western Theatre and its 1 Corps two strike divisions i.e. 6 Armoured Division and 17 Division had no offensive role.

In brief once Pakistan embarked on war its strategic plans were confused and vague and its strike formation was not clear about when it was to be launched. This conceptual confusion doomed Pakistan’s strategic plans from the onset.

The Validity of the Chinese Card

The Chinese card on which so much hope was based had limited and seasonal validity!

The Himalayan snow fall blocked the passes through which China could militarily influence the war! This seasonal factor was never incorporated as an important factor in the Pakistani strategic plan.

If China was to be involved or Chinese friendship tested the ideal time to launch a pre-emptive attack on India was mid-June or mid-July or even September.

Manekshaw the Indian Chief realised this and forced Indira to wait till December when the Himalayan snowfall had completely nullified chances of Chinese overland intervention and had freed India’s Mountain Divisions facing China for the attack on East Pakistan.

The Fate of Pakistan Army’s Strategic Plan in Actual Execution

Foch defined two broad essentials of strategy i.e. ‘Economy of Force’ and ‘Preservation of Freedom of Manoeuvre’.

The Pakistani GHQ did well in case of the first and created a strong strategic reserve by new raisings and by economising sectors which were relatively less vulnerable. Its response to the East Pakistan insurgency in the first phase in March 1971 was praised even by Indian military writers as ‘a remarkable performance on Pakistan’s part’5. China aided Pakistan immensely and two new infantry divisions were raised to replace the 9 and 16 Divisions which were Pakistan’s strategic reserve till March 1971.

 In addition Pakistan raised 18 and 23 Division in June July 1971 and the 33 and 37 Division on the eve of the war. It may be noted that apart from this Pakistan had also raised two independent armoured brigades in 1970 by withdrawing the integral armoured regiments of some of its existing infantry divisions.6

All these measures gave the Pakistani commanders a significant strategic reserve to implement the official strategy of launching a counter offensive on the Western Front aimed at ensuring that the Indians could not concentrate their entire strength and over run East Pakistan.

However, the Pakistani GHQ failed in the actual execution of this strategic plan.

It was in preservation of ‘Freedom of action’ that the Pakistani GHQ failed.

This freedom of action could be preserved and denied on the other hand to the Indians only if Pakistan launched its counter offensive immediately after the war started. If this had been done it was possible that the Indians could have been forced to pull out some of their formations from the Eastern Theatre; thereby reducing the pressure on Pakistan’s Eastern Command.

Since no such counter offensive was launched; India was allowed to invade and conquer East Pakistan at leisure.

In the meantime two Pakistani armoured divisions; one independent armoured brigade (3 Armoured Brigade-Lahore) and three infantry divisions (17, 7 and 37) remained uncommitted during the entire war. Once the war started the Indians were extremely cautious.

Once they realised that Pakistan was irresolute; they became more audacious and stepped up their offensive operation. In Shakargarh for example the Indian 1 Corps Commander had initially earmarked five of his nine infantry brigades for a holding role.

Once he realised by 7th September that Pakistan was not launching any major attack in his area of operations he switched three of his holding infantry brigades into an offensive role.

This increased pressure, forced the Pakistani GHQ to pull out one armoured regiment from its 23 Division attack in Chamb and to commit half of its 33 Division (a part of the strategic reserve) to defence of Shakargarh.

In addition the other half of 33 Division was committed to the defence of the Southern Sector once the 18 Division attack towards Loganewala failed.

As a result of this increased pressure the Indians were unable to impose their will on the Pakistani GHQ in strategic terms.

This was despite the fact that Pakistan had a relatively better offensive potential in the Western Theatre. Yahya Khan based the entire Pakistani plan on the wishful thought that the Indians would never invade East Pakistan.

Once the Indians did so he became indecisive and kept on delaying the decision of launching Pakistan’s strategic reserve in order to reduce Indian pressure on the Eastern Command.

He only decided to launch the counter offensive on 16 December when the Eastern Command had surrendered. Thus the strategic concept i.e. defence of East Pakistan lies in West Pakistan; whatever it was worth in words of General K.M Arif was never tried or implemented.

Chances of Success of Pakistani I Corps Offensive

We will examine in brief the chances of success of the Pakistani 2 Corps offensive; in case it had been launched in brief. The Strike Force consisted of one armoured division (T-59/T-54/55 Tanks) and two infantry divisions (7 and 37 Division) which were based in area Arifwala-Pirowal-Burewala-Bahawalnagar.

This strike corps was to launch the main attack inside Indian territory from general area Sadiq Ganj-Amruka-Minchinabad and thrust towards Bhatinda; thereafter, swinging north towards Ludhiana.

The Indians were relatively well placed in this area and had their 1st Armoured Division in Muktsar area consisting of four armoured regiments (Vijayantas) and three mechanised infantry battalions. Apart from this they had two covering troop forces i.e. the ‘Mike Force’ (T-54 and T-55) comprising one tank regiment and one tank regiment minus, one squadron in area in Ganganagar area.

This force was tasked to threaten the flanks of Pakistani 1st Armoured Division in case it attacked India while the 1st Indian Armoured Division manouvred into action. In addition the ‘Foxtrot Force’ (T-54/55) consisting of one tank regiment and another tank regiment less one squadron was already under command 67 Independent Brigade tasked with defence of Fazilka.

The above mentioned dispositions meant that force wise the Indians were well poised to defend the area where Pakistan’s main counteroffensive was to be launched.

The result would surely have been a fierce clash of armour which may have led to a draw or one side inflicting relatively greater losses on the other without making much headway in the final reckoning. This means that the 1 Corps attack even if launched held no guarantee of success in terms of relieving the pressure on East Pakistan or in terms of capturing a strategic objective.

There was, however, one guarantee of success for Pakistan’s 2 Corps too!

This was in case Pakistan launched a pre-emptive attack on India in early October. This would have been a good option. Pakistan in any case had been condemned for human right violations and genocide and this allegation is levelled even today. Unfortunately its leadership remained obsessed with diplomatic niceties and hairsplitting and tried to play an all correct conduct game.

Thus this golden chance was lost. Other Offensive Options Pakistan had other offensive options to relieve pressure on East Pakistan. These included employment of its northern strike corps i.e. the 1 Corps (6 Armoured Division and 17 Division) to launch a thrust in the far more vulnerable Indian belly between Pathankot and Chamb; thereby threatening the lifeline of four Indian divisions in Kashmir; forcing the Indians to switch their 1st Armoured Division north of Beas River.

This was a far better option since an advance of 15 to 20 miles would have enabled Pakistan to sever the Indian line of communication. In the case of 2 Corps counter offensive the operation involved an advance of more than 60 miles in face of an Indian armoured division.

In 1 Corps area the Indians had two armoured brigades as against one Pakistani Armoured Division and one independent armoured brigades. The Pakistani GHQ, however, made no plans for any offensive employment of 1 Corps, offensive employment and this formation was left unutilised throughout the war.

Initially two of its armoured regiments were employed in the 23 Division attack in Chamb and after 10 December once, one of its armoured regiments reverted back to it; it was given no other task except to be prepared to launch a counterattack in Zafarwal.

Pakistani Military Leadership’s Dilemma

It became fashionable after the war to heap all the blame on Yahya and his cronies. Yahya, as a matter of fact was a far more capable chief than Musa. He inherited a situation which was of Ayub’s making.

Yahya did his best to remedy the serious military imbalances; raised new formations; improved plans where none as a matter of fact had existed. He was faced with a hostile neighbour having full support of USSR; while at the same time facing a civil war created because of ambition of two crafty politicians.

The odds with which Yahya was faced were high and demanded the strategic vision of Moltke and the operational talent of a Rommel or Manstein.

There were some Rommels like General Eftikhar but no Moltke’s to give higher strategic direction. Yahya was initially dynamic but successively became more timid and cautious at a time when the only salvation was in resorting to the boldest measures. Even the Indians praised Yahya’s initial conduct.

One author , and that too an Indian military writer , thus wrote:--

 ‘Nevertheless Yahya showed a good sense in taking decisions and his command decisions were generally well deliberated upon and sound. He had been thrown into a rotten situation, which had come into being the day Pakistan came into being with its two wings. His only hope lay in somehow getting round Mujeeb and getting him to see reason, he tried that… he had perhaps achieved a measure of success too… but the cyclone of 12/13 November destroyed everything… the elections gave the Bengalis an overwhelming majority. The Six Points would have meant a virtual dismemberment of Pakistan. This could not be permitted. So the only course open was to hold military rule and restore the law and order if necessary by force’7.

Kissinger in his White House Years has asserted that it was USA’s intervention which saved West Pakistan from being overrun by India.

This is a vague statement. It is doubtful whether India was willing to invade West Pakistan in force after the fall of East Pakistan. The answer to Pakistan’s dilemma was a bold attack and only a bold all out attack could have forced India to drop the idea of invading East Pakistan.

Long ago Clausewitz well summed up the solution for states like Pakistan in 1971 when he said:--

 ‘Offensive war, that is the taking advantage of the present moment, is always commanded when the future holds out a better prospect not to ourselves but to our adversary’. In this case the future had better prospects for India and Pakistan’s only hope was an all out offensive posture. Clausewitz defined the solution in yet more detail in the following words ‘Let us suppose a small state is involved in a contest with a very superior power, and foresees that with each year its position will become worse: should it not; if war is inevitable, make use of the time when its situation is furthest from worst? Then it must attack, not because the attack in itself ensures any advantages Ñ it will rather increase the disparity of forces-but because this state is under the necessity of either bringing the matter completely to an issue before the worst time arrives or of gaining at least in the meantime some advantages which it may hereafter turn to account’8.

Indian General Candeth who commanded the Indian Western Command made a very thought-provoking remark in his memoir of 1971 war which proves that Pakistan’s only chance lay in offensive action. Candeth thus wrote:-

‘The most critical period was between 8 and 26 October when 1 Corps and 1 Armoured Division were still outside Western Command. Had Pakistan put in a pre-emptive attack, during that period, the consequences would have been too dreadful to contemplate and all our efforts during the war would have been spent in trying to correct the adverse situation forced on us’.9


Only a Napoleon or a Frederick could have saved Pakistan in 1971 from being divided and humiliated and cut to size!

There were potential Napoleons and Fredericks in the Pakistan Army in 1947-48 but these were systematically sidelined or weeded out from 1950 to 1958.

A conspiracy against originality and boldness! Ironically the political situation that the Pakistan Army inherited was created once the West Pakistan Civil servants and the then army C in C had ganged up in the period 1951-58 to keep the much despised Bengali in his place!

The civilians did well in creating the 1956 Constitution which solved all major political problems of Pakistan.

The politicians were, however, never allowed to implement this constitution since its implementation through holding of a general elections in 1959 may have led to a East Bengali victory, thus seriously reducing the civil-military dominance of Pakistani politics.

Thus martial law was imposed in 1958 to avoid a general election! Ironically the army finally saw the light of the day a bit too late once a martial law was imposed in 1969 to hold a general election ! The tide of history in these 11 years had become irreversible!

Strategic insight could at best have averted total humiliation! But there was no strategic insight since Ayub Khan had ensured from 1950 to 1969 that no strategic insight should be groomed and cultivated!

Sunday, April 17, 2011

How the USA treats its war heroes and how it treats crooks of Wall Street


Purple Heart hero commits suicide

BJ Murphy | April 17, 2011 at 12:41 am | Categories: Health Care, U.S. Imperialism | URL:
April 15, 2011
The suicide rate among troops is alarming.
Corporal Clay Hunt earned a Purple Heart in Afghanistan. Among his colleagues, the 28-year-old Marine-turned-construction worker was known for putting others before himself time and again.
Once Hunt flew to a German hospital to accompany a peer that had been shot in both legs, while Hunt himself had taken a bullet to the wrist a day earlier. He lobbied for veterans on The Hill, performed humanitarian work in Haiti and helped build bikes for wounded veterans after receiving an honorable discharge in 2009.
Hunt's benevolent behavior has come to a head, though. Corporal Hunt, a hero to many, is dead.
It wasn't the gunfire and cataclysmic combat that he faced in Iraq and Afghanistan that killed him, though.
Well, in a way, it was.
Hunt is, according to Army Times, one of around 18 American veterans that commit suicide each day. Data released last year says that there is an average of 950 suicide attempts each month by veterans, and those are just the ones that are receiving treatment from the VA Department. Their suicide hotline has been receiving about 10,000 calls a month from service members—both former and current—and data released from the department in 2010 says that of the more than 30,000 suicides each year in America, veterans constitute around one fifth of them.
Matthew Pelak served in Iraq and worked alongside Hunt doing humanitarian work following the Haitian earthquake. To the Associate Press, Pelak acknowledges the trend. "We know we have a problem with vets' suicide, but this was really a slap in the face," says Pelak. Hunt's death has come as a shock to many even though statistics have shown that this plague is far from outside the periphery. Since retiring from the military, Hunt had devoted much of his time towards efforts that better the lives of his fellow soldiers that have faced hardships as a result of their service to America.
Despite his regular rallying and rooting for his fellow servicemen, Hunt was never able to escape the horrors he faced on duty. "I think everybody saw him as the guy that was battling it, but winning the battle every day," says Jacob Wood, 27, a friend that worked alongside Hunt in Haiti and in the Marines. "He really was looking for someone to tell him what it was he went over to do and why those sacrifices were made," Wood says to AP.
Many men and women who served or are currently enlisted in the military are still searching for a way to make sense of their service. All too many have given up that search, however, and given up on life.
309 active servicemen committed suicide in 2009, a number that has grown in recent years. The number of those that attempted to take their own lives in '09—over 1,000—is more than three times that of those killed on the battlefield. The tally of those that did take their own life between 2005 and 2009—1,100—comes close to exceeding the number of military personnel killed in Afghanistan in nearly a decade.
"Why do we know so much about suicides but still know so little about how to prevent them?" asks Eric Shinseki, a secretary at the VA. "Simple question, but we continue to be challenged."
As simple of a question, it doesn't solve the problem. And it doesn't bring Corporal Hunt back to life, either. Nor does it the hundreds who can't make do with the dilemma themselves every year.

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Thursday, February 24, 2011

Why Isn't Wall Street in Jail-The Crooks of Wall Street Obama and US Department of Injustice-Taibi

Why Isn't Wall Street in Jail?

Financial crooks brought down the world's economy — but
the feds are doing more to protect them than to prosecute

Illustration by Victor Juhasz

Over drinks at a bar on a dreary, snowy night in Washington this past month, a former Senate
investigator laughed as he polished off his beer.
"Everything's fucked up, and nobody goes to jail," he said. "That's your whole story right there.
Hell, you don't even have to write the rest of it. Just write that."
I put down my notebook. "Just that?"
"That's right," he said, signaling to the waitress for the check. "Everything's fucked up, and
nobody goes to jail. You can end the piece right there."
Nobody goes to jail. This is the mantra of the financial-crisis era, one that saw virtually every
major bank and financial company on Wall Street embroiled in obscene criminal scandals that
impoverished millions and collectively destroyed hundreds of billions, in fact, trillions of dollars
of the world's wealth — and nobody went to jail. Nobody, that is, except Bernie Madoff, a
flamboyant and pathological celebrity con artist, whose victims happened to be other rich and
famous people.

This article appears in the March 3, 2011 issue of Rolling Stone. The issue is available now on
newsstands and will appear in the online archive February 18.
The rest of them, all of them, got off. Not a single executive who ran the companies that cooked
up and cashed in on the phony financial boom — an industrywide scam that involved the mass
sale of mismarked, fraudulent mortgage-backed securities — has ever been convicted. 

names by now are familiar to even the most casual Middle American news consumer: companies
like AIG, Goldman Sachs, Lehman Brothers, JP Morgan Chase, Bank of America and Morgan
Stanley. Most of these firms were directly involved in elaborate fraud and theft. Lehman
Brothers hid billions in loans from its investors. Bank of America lied about billions in bonuses.
Goldman Sachs failed to tell clients how it put together the born-to-lose toxic mortgage deals it
was selling. What's more, many of these companies had corporate chieftains whose actions cost
investors billions — from AIG derivatives chief Joe Cassano, who assured investors they would
not lose even "one dollar" just months before his unit imploded, to the $263 million in
compensation that former Lehman chief Dick "The Gorilla" Fuld conveniently failed to disclose.
Yet not one of them has faced time behind bars.
Invasion of the Home Snatchers
Instead, federal regulators and prosecutors have let the banks and finance companies that tried to
burn the world economy to the ground get off with carefully orchestrated settlements —
whitewash jobs that involve the firms paying pathetically small fines without even being
required to admit wrongdoing. To add insult to injury, the people who actually committed the
crimes almost never pay the fines themselves; banks caught defrauding their shareholders often
use shareholder money to foot the tab of justice. "If the allegations in these settlements are true,"
says Jed Rakoff, a federal judge in the Southern District of New York, "it's management buying
its way off cheap, from the pockets of their victims."

Taibblog: Commentary on politics and the economy by Matt Taibbi
To understand the significance of this, one has to think carefully about the efficacy of fines as a
punishment for a defendant pool that includes the richest people on earth — people who simply
get their companies to pay their fines for them. Conversely, one has to consider the powerful
deterrent to further wrongdoing that the state is missing by not introducing this particular class of
people to the experience of incarceration. "You put Lloyd Blankfein in pound-me-in-the-ass
prison for one six-month term, and all this bullshit would stop, all over Wall Street," says a
former congressional aide. "That's all it would take. Just once."
But that hasn't happened. Because the entire system set up to monitor and regulate Wall Street is
fucked up.
Just ask the people who tried to do the right thing.
Wall Street's Naked Swindle
Here's how regulation of Wall Street is supposed to work. To begin with, there's a semigigantic
list of public and quasi-public agencies ostensibly keeping their eyes on the economy, a dense
alphabet soup of banking, insurance, S&L, securities and commodities regulators like the Federal
Reserve, the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the
Currency (OCC) and the Commodity Futures Trading Commission (CFTC), as well as
supposedly "self-regulating organizations" like the New York Stock Exchange. All of these
outfits, by law, can at least begin the process of catching and investigating financial criminals,
though none of them has prosecutorial power.
The major federal agency on the Wall Street beat is the Securities and Exchange Commission.
The SEC watches for violations like insider trading, and also deals with so-called "disclosure
violations" — i.e., making sure that all the financial information that publicly traded companies
are required to make public actually jibes with reality. But the SEC doesn't have prosecutorial
power either, so in practice, when it looks like someone needs to go to jail, they refer the case to
the Justice Department. And since the vast majority of crimes in the financial services industry
take place in Lower Manhattan, cases referred by the SEC often end up in the U.S. Attorney's
Office for the Southern District of New York. Thus, the two top cops on Wall Street are
generally considered to be that U.S. attorney — a job that has been held by thunderous
prosecutorial personae like Robert Morgenthau and Rudy Giuliani — and the SEC's director of
The relationship between the SEC and the DOJ is necessarily close, even symbiotic. Since
financial crime-fighting requires a high degree of financial expertise — and since the typical
drug-and-terrorism-obsessed FBI agent can't balance his own checkbook, let alone tell a
synthetic CDO from a credit default swap — the Justice Department ends up leaning heavily on
the SEC's army of 1,100 number-crunching investigators to make their cases. In theory, it's a
well-oiled, tag-team affair: Billionaire Wall Street Asshole commits fraud, the NYSE catches on
and tips off the SEC, the SEC works the case and delivers it to Justice, and Justice perp-walks
the Asshole out of Nobu, into a Crown Victoria and off to 36 months of push-ups, license-plate
making and Salisbury steak.
That's the way it's supposed to work. But a veritable mountain of evidence indicates that when it
comes to Wall Street, the justice system not only sucks at punishing financial criminals, it has
actually evolved into a highly effective mechanism for protecting financial criminals. This
institutional reality has absolutely nothing to do with politics or ideology — it takes place no
matter who's in office or which party's in power. To understand how the machinery functions,
you have to start back at least a decade ago, as case after case of financial malfeasance was
pursued too slowly or not at all, fumbled by a government bureaucracy that too often is on a
first-name basis with its targets. Indeed, the shocking pattern of nonenforcement with regard to
Wall Street is so deeply ingrained in Washington that it raises a profound and difficult question
about the very nature of our society: whether we have created a class of people whose misdeeds
are no longer perceived as crimes, almost no matter what those misdeeds are. The SEC and the
Justice Department have evolved into a bizarre species of social surgeon serving this nonjailable
class, expert not at administering punishment and justice, but at finding and removing criminal
responsibility from the bodies of the accused.
The systematic lack of regulation has left even the country's top regulators frustrated. Lynn
Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice
system is broken when it comes to Wall Street. "I think you've got a wrong assumption — that
we even have a law-enforcement agency when it comes to Wall Street," he says.
In the hierarchy of the SEC, the chief accountant plays a major role in working to pursue
misleading and phony financial disclosures. Turner held the post a decade ago, when one of the
most significant cases was swallowed up by the SEC bureaucracy. In the late 1990s, the agency
had an open-and-shut case against the Rite Aid drugstore chain, which was using diabolical
accounting tricks to cook their books. But instead of moving swiftly to crack down on such
scams, the SEC shoved the case into the "deal with it later" file. "The Philadelphia office literally
did nothing with the case for a year," Turner recalls. "Very much like the New York office with
Madoff." The Rite Aid case dragged on for years — and by the time it was finished, similar
accounting fiascoes at Enron and WorldCom had exploded into a full-blown financial crisis. The
same was true for another SEC case that presaged the Enron disaster. The agency knew that
appliance-maker Sunbeam was using the same kind of accounting scams to systematically hide
losses from its investors. But in the end, the SEC's punishment for Sunbeam's CEO, Al
"Chainsaw" Dunlap — widely regarded as one of the biggest assholes in the history of American
finance — was a fine of $500,000. Dunlap's net worth at the time was an estimated $100 million.
The SEC also barred Dunlap from ever running a public company again — forcing him to retire
with a mere $99.5 million. Dunlap passed the time collecting royalties from his selfcongratulatory
memoir. Its title: Mean Business.
The pattern of inaction toward shady deals on Wall Street grew worse and worse after Turner
left, with one slam-dunk case after another either languishing for years or disappearing
altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who
was literally fired after he questioned the agency's failure to pursue an insider-trading case
against John Mack, now the chairman of Morgan Stanley and one of America's most powerful
Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator,
he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art
Samberg. One day, with no advance research or discussion, Samberg had suddenly started
buying up huge quantities of shares in a firm called Heller Financial. "It was as if Art Samberg
woke up one morning and a voice from the heavens told him to start buying Heller," Aguirre
recalls. "And he wasn't just buying shares — there were some days when he was trying to buy
three times as many shares as were being traded that day." A few weeks later, Heller was bought
by General Electric — and Samberg pocketed $18 million.
After some digging, Aguirre found himself focusing on one suspect as the likely source who had
tipped Samberg off: John Mack, a close friend of Samberg's who had just stepped down as
president of Morgan Stanley. At the time, Mack had been on Samberg's case to cut him into a
deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a
lot of money. "Mack is busting my chops" to give him a piece of the action, Samberg told an
employee in an e-mail.
A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston.
Among the investment bank's clients, as it happened, was a firm called Heller Financial. We
don't know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he
had thrown away his notes about the meetings. But we do know that as soon as Mack returned
from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was
cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the
market reopened after the weekend, Samberg started buying every Heller share in sight, right
before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of
Derek Jeter's annual salary for just a few minutes of work.
The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre
told his boss he planned to interview Mack, things started getting weird. His boss told him the
case wasn't likely to fly, explaining that Mack had "powerful political connections." (The
investment banker had been a fundraising "Ranger" for George Bush in 2004, and would go on
to be a key backer of Hillary Clinton in 2008.)
Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to
rehire Mack as CEO. At first, Aguirre was contacted by the bank's regulatory liaison, Eric
Dinallo, a former top aide to Eliot Spitzer. But it didn't take long for Morgan Stanley to work its
way up the SEC chain of command. Within three days, another of the firm's lawyers, Mary Jo
White, was on the phone with the SEC's director of enforcement. In a shocking move that was
later singled out by Senate investigators, the director actually appeared to reassure White,
dismissing the case against Mack as "smoke" rather than "fire." White, incidentally, was herself
the former U.S. attorney of the Southern District of New York — one of the top cops on Wall
Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major
Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him.
In the course of doing so, he finds out that his target's firm is being represented not only by Eliot
Spitzer's former top aide, but by the former U.S. attorney overseeing Wall Street, who is going
four levels over his head to speak directly to the chief of the SEC's enforcement division — not
Aguirre's boss, but his boss's boss's boss's boss. Mack himself, meanwhile, was being
represented by Gary Lynch, a former SEC director of enforcement.
Aguirre didn't stand a chance. A month after he complained to his supervisors that he was being
blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack
was immediately dropped: all depositions canceled, no further subpoenas issued. "It all happened
so fast, I needed a seat belt," recalls Aguirre, who had just received a stellar performance review
from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful
Rather than going after Mack, the SEC started looking for someone else to blame for tipping off
Samberg. (It was, Aguirre quips, "O.J.'s search for the real killers.") It wasn't until a year later
that the agency finally got around to interviewing Mack, who denied any wrongdoing. The fourhour
deposition took place on August 1st, 2006 — just days after the five-year statute of
limitations on insider trading had expired in the case.
"At best, the picture shows extraordinarily lax enforcement by the SEC," Senate investigators
would later conclude. "At worse, the picture is colored with overtones of a possible cover-up."
Episodes like this help explain why so many Wall Street executives felt emboldened to push
the regulatory envelope during the mid-2000s. Over and over, even the most obvious cases of
fraud and insider dealing got gummed up in the works, and high-ranking executives were almost
never prosecuted for their crimes. In 2003, Freddie Mac coughed up $125 million after it was
caught misreporting its earnings by $5 billion; nobody went to jail. In 2006, Fannie Mae was
fined $400 million, but executives who had overseen phony accounting techniques to jack up
their bonuses faced no criminal charges. That same year, AIG paid $1.6 billion after it was
caught in a major accounting scandal that would indirectly lead to its collapse two years later,
but no executives at the insurance giant were prosecuted.
All of this behavior set the stage for the crash of 2008, when Wall Street exploded in a raging
Dresden of fraud and criminality. Yet the SEC and the Justice Department have shown almost no
inclination to prosecute those most responsible for the catastrophe — even though they had
insiders from the two firms whose implosions triggered the crisis, Lehman Brothers and AIG,
who were more than willing to supply evidence against top executives.
In the case of Lehman Brothers, the SEC had a chance six months before the crash to move
against Dick Fuld, a man recently named the worst CEO of all time by Portfolio magazine. A
decade before the crash, a Lehman lawyer named Oliver Budde was going through the bank's
proxy statements and noticed that it was using a loophole involving Restricted Stock Units to
hide tens of millions of dollars of Fuld's compensation. Budde told his bosses that Lehman's use
of RSUs was dicey at best, but they blew him off. "We're sorry about your concerns," they told
him, "but we're doing it." Disturbed by such shady practices, the lawyer quit the firm in 2006.
Then, only a few months after Budde left Lehman, the SEC changed its rules to force companies
to disclose exactly how much compensation in RSUs executives had coming to them. "The SEC
was basically like, 'We're sick and tired of you people fucking around — we want a picture of
what you're holding,'" Budde says. But instead of coming clean about eight separate RSUs that
Fuld had hidden from investors, Lehman filed a proxy statement that was a masterpiece of
cynical lawyering. On one page, a chart indicated that Fuld had been awarded $146 million in
RSUs. But two pages later, a note in the fine print essentially stated that the chart did not contain
the real number — which, it failed to mention, was actually $263 million more than the chart
indicated. "They fucked around even more than they did before," Budde says. (The law firm that
helped craft the fine print, Simpson Thacher & Bartlett, would later receive a lucrative federal
contract to serve as legal adviser to the TARP bailout.)
Budde decided to come forward. In April 2008, he wrote a detailed memo to the SEC about
Lehman's history of hidden stocks. Shortly thereafter, he got a letter back that began, "Dear Sir
or Madam." It was an automated e-response.
"They blew me off," Budde says.
Over the course of that summer, Budde tried to contact the SEC several more times, and was
ignored each time. Finally, in the fateful week of September 15th, 2008, when Lehman Brothers
cracked under the weight of its reckless bets on the subprime market and went into its final death
spiral, Budde became seriously concerned. If the government tried to arrange for Lehman to be
pawned off on another Wall Street firm, as it had done with Bear Stearns, the U.S. taxpayer
might wind up footing the bill for a company with hundreds of millions of dollars in concealed
compensation. So Budde again called the SEC, right in the middle of the crisis. "Look," he told
regulators. "I gave you huge stuff. You really want to take a look at this."
But the feds once again blew him off. A young staff attorney contacted Budde, who once more
provided the SEC with copies of all his memos. He never heard from the agency again.
"This was like a mini-Madoff," Budde says. "They had six solid months of warnings. They could
have done something."
Three weeks later, Budde was shocked to see Fuld testifying before the House Government
Oversight Committee and whining about how poor he was. "I got no severance, no golden
parachute," Fuld moaned. When Rep. Henry Waxman, the committee's chairman, mentioned that
he thought Fuld had earned more than $480 million, Fuld corrected him and said he believed it
was only $310 million.
The true number, Budde calculated, was $529 million. He contacted a Senate investigator to talk
about how Fuld had misled Congress, but he never got any response. Meanwhile, in a
demonstration of the government's priorities, the Justice Department is proceeding full force with
a prosecution of retired baseball player Roger Clemens for lying to Congress about getting a shot
of steroids in his ass. "At least Roger didn't screw over the world," Budde says, shaking his head.
Fuld has denied any wrongdoing, but his hidden compensation was only a ripple in Lehman's
raging tsunami of misdeeds. The investment bank used an absurd accounting trick called "Repo
105" transactions to conceal $50 billion in loans on the firm's balance sheet. (That's $50 billion,
not million.) But more than a year after the use of the Repo 105s came to light, there have still
been no indictments in the affair. While it's possible that charges may yet be filed, there are now
rumors that the SEC and the Justice Department may take no action against Lehman. If that's
true, and there's no prosecution in a case where there's such overwhelming evidence — and
where the company is already dead, meaning it can't dump further losses on investors or
taxpayers — then it might be time to assume the game is up. Failing to prosecute Fuld and
Lehman would be tantamount to the state marching into Wall Street and waving the green flag
on a new stealing season.
The most amazing noncase in the entire crash — the one that truly defies the most basic notion
of justice when it comes to Wall Street supervillains — is the one involving AIG and Joe
Cassano, the nebbishy Patient Zero of the financial crisis. As chief of AIGFP, the firm's financial
products subsidiary, Cassano repeatedly made public statements in 2007 claiming that his
portfolio of mortgage derivatives would suffer "no dollar of loss" — an almost comically
obvious misrepresentation. "God couldn't manage a $60 billion real estate portfolio without a
single dollar of loss," says Turner, the agency's former chief accountant. "If the SEC can't make a
disclosure case against AIG, then they might as well close up shop."
As in the Lehman case, federal prosecutors not only had plenty of evidence against AIG — they
also had an eyewitness to Cassano's actions who was prepared to tell all. As an accountant at
AIGFP, Joseph St. Denis had a number of run-ins with Cassano during the summer of 2007. At
the time, Cassano had already made nearly $500 billion worth of derivative bets that would
ultimately blow up, destroy the world's largest insurance company, and trigger the largest
government bailout of a single company in U.S. history. He made many fatal mistakes, but chief
among them was engaging in contracts that required AIG to post billions of dollars in collateral
if there was any downgrade to its credit rating.
St. Denis didn't know about those clauses in Cassano's contracts, since they had been written
before he joined the firm. What he did know was that Cassano freaked out when St. Denis spoke
with an accountant at the parent company, which was only just finding out about the time bomb
Cassano had set. After St. Denis finished a conference call with the executive, Cassano suddenly
burst into the room and began screaming at him for talking to the New York office. He then
announced that St. Denis had been "deliberately excluded" from any valuations of the most toxic
elements of the derivatives portfolio — thus preventing the accountant from doing his job. What
St. Denis represented was transparency — and the last thing Cassano needed was transparency.
Another clue that something was amiss with AIGFP's portfolio came when Goldman Sachs
demanded that the firm pay billions in collateral, per the terms of Cassano's deadly contracts.
Such "collateral calls" happen all the time on Wall Street, but seldom against a seemingly solvent
and friendly business partner like AIG. And when they do happen, they are rarely paid without a
fight. So St. Denis was shocked when AIGFP agreed to fork over gobs of money to Goldman
Sachs, even while it was still contesting the payments — an indication that something was
seriously wrong at AIG. "When I found out about the collateral call, I literally had to sit down,"
St. Denis recalls. "I had to go home for the day."
After Cassano barred him from valuating the derivative deals, St. Denis had no choice but to
resign. He got another job, and thought he was done with AIG. But a few months later, he
learned that Cassano had held a conference call with investors in December 2007. During the
call, AIGFP failed to disclose that it had posted $2 billion to Goldman Sachs following the
collateral calls.
"Investors therefore did not know," the Financial Crisis Inquiry Commission would later
conclude, "that AIG's earnings were overstated by $3.6 billion."
"I remember thinking, 'Wow, they're just not telling people,'" St. Denis says. "I knew. I had been
there. I knew they'd posted collateral."
A year later, after the crash, St. Denis wrote a letter about his experiences to the House
Government Oversight Committee, which was looking into the AIG collapse. He also met with
investigators for the government, which was preparing a criminal case against Cassano. But the
case never went to court. Last May, the Justice Department confirmed that it would not file
charges against executives at AIGFP. Cassano, who has denied any wrongdoing, was reportedly
told he was no longer a target.
Shortly after that, Cassano strolled into Washington to testify before the Financial Crisis Inquiry
Commission. It was his first public appearance since the crash. He has not had to pay back a
single cent out of the hundreds of millions of dollars he earned selling his insane pseudoinsurance
policies on subprime mortgage deals. Now, out from under prosecution, he appeared
before the FCIC and had the enormous balls to compliment his own business acumen, saying his
atom-bomb swaps portfolio was, in retrospect, not that badly constructed. "I think the portfolios
are withstanding the test of time," he said.
"They offered him an excellent opportunity to redeem himself," St. Denis jokes.
In the end, of course, it wasn't just the executives of Lehman and AIGFP who got passes.
Virtually every one of the major players on Wall Street was similarly embroiled in scandal, yet
their executives skated off into the sunset, uncharged and unfined. Goldman Sachs paid $550
million last year when it was caught defrauding investors with crappy mortgages, but no
executive has been fined or jailed — not even Fabrice "Fabulous Fab" Tourre, Goldman's
outrageous Euro-douche who gleefully e-mailed a pal about the "surreal" transactions in the
middle of a meeting with the firm's victims. In a similar case, a sales executive at the German
powerhouse Deutsche Bank got off on charges of insider trading; its general counsel at the time
of the questionable deals, Robert Khuzami, now serves as director of enforcement for the SEC.
Another major firm, Bank of America, was caught hiding $5.8 billion in bonuses from
shareholders as part of its takeover of Merrill Lynch. The SEC tried to let the bank off with a
settlement of only $33 million, but Judge Jed Rakoff rejected the action as a "facade of
enforcement." So the SEC quintupled the settlement — but it didn't require either Merrill or
Bank of America to admit to wrongdoing. Unlike criminal trials, in which the facts of the crime
are put on record for all to see, these Wall Street settlements almost never require the banks to
make any factual disclosures, effectively burying the stories forever. "All this is done at the
expense not only of the shareholders, but also of the truth," says Rakoff. Goldman, Deutsche,
Merrill, Lehman, Bank of America ... who did we leave out? Oh, there's Citigroup, nailed for
hiding some $40 billion in liabilities from investors. Last July, the SEC settled with Citi for $75

In a rare move, it also fined two Citi executives, former CFO Gary Crittenden and
investor-relations chief Arthur Tildesley Jr. Their penalties, combined, came to a whopping
Throughout the entire crisis, in fact, the government has taken exactly one serious swing of the
bat against executives from a major bank, charging two guys from Bear Stearns with criminal
fraud over a pair of toxic subprime hedge funds that blew up in 2007, destroying the company
and robbing investors of $1.6 billion. Jurors had an e-mail between the defendants admitting that
"there is simply no way for us to make money — ever" just three days before assuring investors
that "there's no basis for thinking this is one big disaster." Yet the case still somehow ended in
acquittal — and the Justice Department hasn't taken any of the big banks to court since.
All of which raises an obvious question: Why the hell not?
Gary Aguirre, the SEC investigator who lost his job when he drew the ire of Morgan Stanley,
thinks he knows the answer.
Last year, Aguirre noticed that a conference on financial law enforcement was scheduled to be
held at the Hilton in New York on November 12th. The list of attendees included 1,500 or so of
the country's leading lawyers who represent Wall Street, as well as some of the government's top
cops from both the SEC and the Justice Department.
Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not
adversarial combat, with cops and crooks duking it out in interrogation rooms and courthouses.
Instead, it's a cocktail party between friends and colleagues who from month to month and year
to year are constantly switching sides and trading hats. At the Hilton conference, regulators and
banker-lawyers rubbed elbows during a series of speeches and panel discussions, away from the
rabble. "They were chummier in that environment," says Aguirre, who plunked down $2,200 to
attend the conference.
Aguirre saw a lot of familiar faces at the conference, for a simple reason: Many of the SEC
regulators he had worked with during his failed attempt to investigate John Mack had made a
million-dollar pass through the Revolving Door, going to work for the very same firms they used
to police. Aguirre didn't see Paul Berger, an associate director of enforcement who had rebuffed
his attempts to interview Mack — maybe because Berger was tied up at his lucrative new job at
Debevoise & Plimpton, the same law firm that Morgan Stanley employed to intervene in the
Mack case. But he did see Mary Jo White, the former U.S. attorney, who was still at Debevoise
& Plimpton. He also saw Linda Thomsen, the former SEC director of enforcement who had been
so helpful to White. Thomsen had gone on to represent Wall Street as a partner at the prestigious
firm of Davis Polk & Wardwell.
Two of the government's top cops were there as well: Preet Bharara, the U.S. attorney for the
Southern District of New York, and Robert Khuzami, the SEC's current director of enforcement.
Bharara had been recommended for his post by Chuck Schumer, Wall Street's favorite senator.
And both he and Khuzami had served with Mary Jo White at the U.S. attorney's office, before
Mary Jo went on to become a partner at Debevoise. What's more, when Khuzami had served as
general counsel for Deutsche Bank, he had been hired by none other than Dick Walker, who had
been enforcement director at the SEC when it slow-rolled the pivotal fraud case against Rite Aid.
"It wasn't just one rotation of the revolving door," says Aguirre. "It just kept spinning. Every
single person had rotated in and out of government and private service."
The Revolving Door isn't just a footnote in financial law enforcement; over the past decade,
more than a dozen high-ranking SEC officials have gone on to lucrative jobs at Wall Street banks
or white-shoe law firms, where partnerships are worth millions. That makes SEC officials like
Paul Berger and Linda Thomsen the equivalent of college basketball stars waiting for their first
NBA contract. Are you really going to give up a shot at the Knicks or the Lakers just to find out
whether a Wall Street big shot like John Mack was guilty of insider trading? "You take one of
these jobs," says Turner, the former chief accountant for the SEC, "and you're fit for life."
Fit — and happy. The banter between the speakers at the New York conference says everything
you need to know about the level of chumminess and mutual admiration that exists between
these supposed adversaries of the justice system. At one point in the conference, Mary Jo White
introduced Bharara, her old pal from the U.S. attorney's office.
"I want to first say how pleased I am to be here," Bharara responded. Then, addressing White, he
added, "You've spawned all of us. It's almost 11 years ago to the day that Mary Jo White called
me and asked me if I would become an assistant U.S. attorney. So thank you, Dr. Frankenstein."
Next, addressing the crowd of high-priced lawyers from Wall Street, Bharara made an interesting
joke. "I also want to take a moment to applaud the entire staff of the SEC for the really amazing
things they have done over the past year," he said. "They've done a real service to the country, to
the financial community, and not to mention a lot of your law practices."
Haw! The line drew snickers from the conference of millionaire lawyers. But the real fireworks
came when Khuzami, the SEC's director of enforcement, talked about a new "cooperation
initiative" the agency had recently unveiled, in which executives are being offered incentives to
report fraud they have witnessed or committed. From now on, Khuzami said, when corporate
lawyers like the ones he was addressing want to know if their Wall Street clients are going to be
charged by the Justice Department before deciding whether to come forward, all they have to do
is ask the SEC.
"We are going to try to get those individuals answers," Khuzami announced, as to "whether or
not there is criminal interest in the case — so that defense counsel can have as much information
as possible in deciding whether or not to choose to sign up their client."
Aguirre, listening in the crowd, couldn't believe Khuzami's brazenness. The SEC's enforcement
director was saying, in essence, that firms like Goldman Sachs and AIG and Lehman Brothers
will henceforth be able to get the SEC to act as a middleman between them and the Justice
Department, negotiating fines as a way out of jail time. Khuzami was basically outlining a fourstep
system for banks and their executives to buy their way out of prison. "First, the SEC and
Wall Street player make an agreement on a fine that the player will pay to the SEC," Aguirre
says. "Then the Justice Department commits itself to pass, so that the player knows he's 'safe.'
Third, the player pays the SEC — and fourth, the player gets a pass from the Justice
When I ask a former federal prosecutor about the propriety of a sitting SEC director of
enforcement talking out loud about helping corporate defendants "get answers" regarding the
status of their criminal cases, he initially doesn't believe it. Then I send him a transcript of the
comment. "I am very, very surprised by Khuzami's statement, which does seem to me to be
contrary to past practice — and not a good thing," the former prosecutor says.
Earlier this month, when Sen. Chuck Grassley found out about Khuzami's comments, he sent the
SEC a letter noting that the agency's own enforcement manual not only prohibits such "answer
getting," it even bars the SEC from giving defendants the Justice Department's phone number.
"Should counsel or the individual ask which criminal authorities they should contact," the
manual reads, "staff should decline to answer, unless authorized by the relevant criminal
authorities." Both the SEC and the Justice Department deny there is anything improper in their
new policy of cooperation. "We collaborate with the SEC, but they do not consult with us when
they resolve their cases," Assistant Attorney General Lanny Breuer assured Congress in January.
"They do that independently."
Around the same time that Breuer was testifying, however, a story broke that prior to the
pathetically small settlement of $75 million that the SEC had arranged with Citigroup, Khuzami
had ordered his staff to pursue lighter charges against the megabank's executives. According to a
letter that was sent to Sen. Grassley's office, Khuzami had a "secret conversation, without telling
the staff, with a prominent defense lawyer who is a good friend" of his and "who was counsel for
the company." The unsigned letter, which appears to have come from an SEC investigator on the
case, prompted the inspector general to launch an investigation into the charge.
All of this paints a disturbing picture of a closed and corrupt system, a timeless circle of friends
that virtually guarantees a collegial approach to the policing of high finance. Even before the
corruption starts, the state is crippled by economic reality: Since law enforcement on Wall Street
requires serious intellectual firepower, the banks seize a huge advantage from the start by hiring
away the top talent. Budde, the former Lehman lawyer, says it's well known that all the best legal
minds go to the big corporate law firms, while the "bottom 20 percent go to the SEC." Which
makes it tough for the agency to track devious legal machinations, like the scheme to hide $263
million of Dick Fuld's compensation.
"It's such a mismatch, it's not even funny," Budde says.
But even beyond that, the system is skewed by the irrepressible pull of riches and power. If talent
rises in the SEC or the Justice Department, it sooner or later jumps ship for those fat NBA
contracts. Or, conversely, graduates of the big corporate firms take sabbaticals from their rich
lifestyles to slum it in government service for a year or two. Many of those appointments are
inevitably hand-picked by lifelong stooges for Wall Street like Chuck Schumer, who has
accepted $14.6 million in campaign contributions from Goldman Sachs, Morgan Stanley and
other major players in the finance industry, along with their corporate lawyers.
As for President Obama, what is there to be said? Goldman Sachs was his number-one private
campaign contributor. He put a Citigroup executive in charge of his economic transition team,
and he just named an executive of JP Morgan Chase, the proud owner of $7.7 million in Chase
stock, his new chief of staff. "The betrayal that this represents by Obama to everybody is just —
we're not ready to believe it," says Budde, a classmate of the president from their Columbia days.
"He's really fucking us over like that? Really? That's really a JP Morgan guy, really?"
Which is not to say that the Obama era has meant an end to law enforcement. On the contrary: In
the past few years, the administration has allocated massive amounts of federal resources to
catching wrongdoers — of a certain type. Last year, the government deported 393,000 people, at
a cost of $5 billion. Since 2007, felony immigration prosecutions along the Mexican border have
surged 77 percent; nonfelony prosecutions by 259 percent. In Ohio last month, a single mother
was caught lying about where she lived to put her kids into a better school district; the judge in
the case tried to sentence her to 10 days in jail for fraud, declaring that letting her go free would
"demean the seriousness" of the offenses.
So there you have it. Illegal immigrants: 393,000. Lying moms: one. Bankers: zero. The math
makes sense only because the politics are so obvious. You want to win elections, you bang on
the jailable class. You build prisons and fill them with people for selling dime bags and stealing
CD players. But for stealing a billion dollars? For fraud that puts a million people into
foreclosure? Pass. It's not a crime. Prison is too harsh. Get them to say they're sorry, and move
on. Oh, wait — let's not even make them say they're sorry. That's too mean; let's just give them a
piece of paper with a government stamp on it, officially clearing them of the need to apologize,
and make them pay a fine instead. But don't make them pay it out of their own pockets, and don't
ask them to give back the money they stole. In fact, let them profit from their collective crimes,
to the tune of a record $135 billion in pay and benefits last year. What's next? Taxpayer-funded
massages for every Wall Street executive guilty of fraud?
The mental stumbling block, for most Americans, is that financial crimes don't feel real; you
don't see the culprits waving guns in liquor stores or dragging coeds into bushes. But these frauds
are worse than common robberies. They're crimes of intellectual choice, made by people who are
already rich and who have every conceivable social advantage, acting on a simple, cynical
calculation: Let's steal whatever we can, then dare the victims to find the juice to reclaim their
money through a captive bureaucracy. They're attacking the very definition of property —
which, after all, depends in part on a legal system that defends everyone's claims of ownership
equally. When that definition becomes tenuous or conditional — when the state simply gives up
on the notion of justice — this whole American Dream thing recedes even further from reality.

Harper Wash Post Dec 28 2010 Out of Lehman's ashes Wall Street gets most of what it wants
Dec. 13 (Bloomberg) -- Wall Street's biggest banks, rebounding after a government bailout, are set to complete their best two years in investment banking and trading, buoyed by 2010 results likely to be the second-highest ever, according to data compiled by Bloomberg. Bloomberg's Sheila Dharmarajan reports. (Source: Bloomberg)
By Christine Harper
(c) 2010 Bloomberg News
Tuesday, December 28, 2010; 2:54 AM
Wall Street's biggest banks, whose missteps caused a global financial crisis and economic slowdown two years ago, were more agile when it came to countering the political and regulatory response.
The U.S. government, promising to make the system safer, buckled under many of the financial industry's protests. Lawmakers spurned changes that would wall off deposit-taking banks from riskier trading. They declined to limit the size of lenders or ban any form of derivatives. Higher capital and liquidity requirements agreed to by regulators worldwide have been delayed for years to aid economic recovery.
"We continue to listen to the same people whose errors in judgment were central to the problem," said John Reed, 71, a former co-chief executive officer of Citigroup Inc., who estimated only 25 percent of needed changes have been enacted. "I'm astounded because we basically dropped the world's biggest economy because of an error in bank management."
The last two years have been the best ever for combined investment-banking and trading revenue at Bank of America Corp., JPMorgan Chase & Co., Citigroup, Goldman Sachs Group Inc. and Morgan Stanley, according to data compiled by Bloomberg. Goldman Sachs CEO Lloyd Blankfein, 56, and his top deputies are in line to collect more than $100 million in delayed 2007 bonuses -- six months after paying $550 million to settle a fraud lawsuit related to the firm's behavior that year. Citigroup, the bank that needed more taxpayer support than any other, has a balance sheet 14 percent bigger than it was four years ago.
Wall Street's army of lobbyists and its history of contributions to politicians weren't the only keys to success, lawmakers, academics and industry executives said. The financial system's complexity gave bankers an advantage in controlling the narrative and dismissing the ideas of would-be reformers as infeasible or dangerous. A revolving door between government and banking offices contributed to a mind-set that what's good for Wall Street is good for Main Street.
To make their case, bankers and lobbyists characterized proposed regulations as stifling innovation, competitiveness and economic growth. They said the industry had learned its lessons and that firms were adopting changes voluntarily to be more transparent and accountable. Successful companies shouldn't be punished for the sins of those that failed, they said.
"It is important to look beyond the rhetoric and ask the tough questions about underlying structural changes that promote responsible reforms and stability to our financial system, yet support the ability of financial firms to innovate and serve the needs of families and employers," Timothy Ryan, CEO of the Securities Industry and Financial Markets Association, an industry lobbying group, wrote in a Feb. 5 op-ed piece for the Washington Post.
That argument resonated with lawmakers under pressure to boost a fragile economy and bring down an unemployment rate that has hovered near 10 percent since August 2009, its highest level in more than a quarter of a century.
"The big financial industry has convinced a lot of people, particularly in Congress and on the regulatory side, that they bring value to the economy with new instruments and new approaches," said Byron Dorgan, a Democratic senator from North Dakota who is retiring this year. "Anybody who wants to do things that seem aggressive is called a radical populist."
U.S. President Barack Obama was elected in 2008, weeks after Lehman Brothers Holdings Inc. collapsed in the largest bankruptcy and the Federal Reserve and government provided unprecedented support to insurance company American International Group Inc. as well as nine of the largest banks. Obama, who raised $15 million on Wall Street, promised that his administration would "crack down on the culture of greed and scheming" that he said led to the financial crisis.
While Obama vowed to change the system, he filled his economic team with people who helped create it.
Timothy F. Geithner, 49, who had been responsible for overseeing banks including Citigroup while president of the Federal Reserve Bank of New York, became Treasury secretary and named a former Goldman Sachs lobbyist as his chief of staff. Lawrence H. Summers, 56, who is stepping down as Obama's National Economic Council director, opposed derivatives regulation and supported the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial and investment banking, when he served as deputy Treasury secretary and Treasury secretary in President Bill Clinton's administration.

"It was very clear by February 2009 that the banks were going to get a free pass," said Simon Johnson, a former chief economist for the International Monetary Fund who is now a professor at the Massachusetts Institute of Technology's Sloan School of Management. "You could see from the hiring of Tim Geithner and from the messages that he and his team were putting out that this was going to go very badly."
Even when changes were advocated by people who couldn't be characterized as radical populists, their ideas were dismissed as unrealistic, misinformed, advancing ulterior motives or damaging to U.S. competitiveness.
Such tactics helped bat back suggestions from billionaire hedge fund manager George Soros and Berkshire Hathaway Inc. Vice Chairman Charles Munger that regulators ban purchases of so- called naked credit-default swaps -- contracts that allow speculators to profit if a debt issuer defaults.
Geithner was an early opponent of any such ban, arguing at a March 2009 House Financial Services Committee hearing that it wasn't necessary and wouldn't help.
"It's too hard to distinguish what's a legitimate hedge that has some economic value from what people might just feel is a speculative bet on some future outcome," he said.
Dorgan, 68, who offered an amendment to the Dodd-Frank bill that would have banned such swaps and who wrote a 1994 article for Washington Monthly warning about the dangers posed by over- the-counter derivatives, said supporters in Congress backed down because they didn't get pressure from their constituents.
"The debate that's necessary on these subjects is a debate that is so unbelievably complicated that the larger financial institutions have always controlled the narrative," Dorgan said. "Even things that were fairly mild were contested as anti-business and going to injure and ruin the economy."
Instead Dodd-Frank gave regulators at the Commodity Futures Trading Commission and the Securities and Exchange Commission the responsibility of writing rules governing the $583 trillion market in over-the-counter derivatives. The law, named after Connecticut Senator Christopher Dodd and Massachusetts Representative Barney Frank, requires that most derivatives be traded on third-party clearinghouses and regulated exchanges.
The CFTC withdrew a proposed rule on Dec. 9 after at least one commissioner, Scott O'Malia, a former aide to Republican Senator Mitch McConnell, objected. The rule would have required dealers of private swaps to quote prices to all market users before trades could be executed on an electronic system. A new version, approved Dec. 16, will save dealers billions of dollars, according to Moody's Investors Service, because they will be able to limit price information to select participants.
An amendment requiring banks to spin out their swaps- dealing operations into separately capitalized units, so they wouldn't have access to government backstops, made it into the Dodd-Frank bill. It was diluted at the end to exempt interest- rate and foreign-exchange contracts that make up more than 90 percent of the derivatives held by U.S. banks.
Banks were also allowed to trade derivatives used to hedge their own risks and given up to two years to trade other types of derivatives, such as credit-default swaps that aren't standard enough to be cleared through a central counterparty.
A suggestion that banks deemed too big to fail should be broken up or made small enough to fail -- an idea backed by former Federal Reserve Chairman Alan Greenspan, Bank of England Governor Mervyn King and hedge-fund manager David Einhorn -- also failed to win support from U.S. policy makers, as bank executives argued that size alone didn't make a company risky and that it could be essential for banks to compete.
Jamie Dimon, JPMorgan's CEO, said in a January 2010 interview that most of the financial firms that collapsed during the crisis were narrowly focused investment banks, insurers, mortgage brokers or thrifts, not big integrated conglomerates.
"A lot of companies are big because they're required to be big because of economies of scale," he said.
The closest the Obama administration came to trying to limit the size of banks was in January, when the president proposed levying a fee on financial firms with assets of more than $50 billion. The idea was never adopted by Congress. Instead, it supported Geithner's plan for a so-called resolution authority that would give regulators the ability to manage an orderly wind-down of a large financial company. Critics say the authority is unlikely to work in practice because regulators won't have power over a bank's international operations.
"The resolution authority as drawn up by Dodd-Frank does not apply to the megabanks and doesn't apply to JPMorgan Chase, nor can it because that authority only applies to U.S. domestic financial entities," said MIT's Johnson. "If anything, it's gotten worse because we have fewer big banks. The ones that remain are undoubtedly too big to fail."
Even before Obama took office in January 2009, former Federal Reserve Chairman Paul A. Volcker, an economic adviser to the president-elect, was calling for clear distinctions between banks that take deposits and make loans and those that engage in riskier capital markets businesses. The recommendation, a modern version of Glass-Steagall, was put forward in a report by the Group of 30, an organization of current and former central bankers, financial ministers, economists and financiers whose board Volcker chairs.
Reed, the former Citigroup co-CEO, and David Komansky, a former CEO of Merrill Lynch & Co., were among those who said publicly that they regretted having played a role in overturning Glass-Steagall. Both of their former companies were crippled by investments in mortgage-linked securities during the crisis, and Merrill was sold to Bank of America in a hastily reached agreement the same weekend Lehman Brothers went bankrupt.
"We have to think of the original reasons why Glass- Steagall was brought down in the first place, and that is the U.S. banks were competing with large, universal banks around the world," Goldman Sachs CEO Blankfein said in a March 2009 interview with Bloomberg Television. "So I don't think we'd turn the clock back."
The idea was left out of Geithner's original financial regulation proposals and didn't gain much support until January, after a Republican upset a Democrat in a Massachusetts senate race. Obama and his economic team, including Volcker, then announced they were supporting a so-called Volcker rule that would ban proprietary trading at regulated banks and prohibit them from owning hedge funds and private equity funds.
E. Gerald Corrigan, a former New York Fed president who worked under Volcker at the Fed and is now a managing director at Goldman Sachs, told a Senate hearing that banks shouldn't be prevented from owning and sponsoring hedge funds or private equity funds because they promote "best industry practice." He urged a distinction between proprietary trading and "market making" for clients or hedging related to such market making.
In the final version of Dodd-Frank, the Volcker rule ended up looking much more like the Corrigan rule. Banks were allowed to own or sponsor hedge funds and private equity funds and even to invest in them as long as their holdings didn't account for more than 3 percent of the bank's capital or 3 percent of the fund's capital.
The ban on proprietary trading exempted dealing in government and agency securities. Regulators were charged with deciding what other types of trading would be considered proprietary and which would be deemed market-making.
Volcker was disappointed with the final version, according to a person with knowledge of his views.
Goldman Sachs Chief Financial Officer David Viniar, who told analysts in January that "pure walled-off proprietary trading" accounted for about 10 percent of the firm's revenue, said in October that the company had closed one such business and was waiting to see if the rules would require other changes.
While the Dodd-Frank Act is the most sweeping financial legislation in decades, creating a consumer-protection office for financial products and a council of regulators charged with monitoring systemic risk, it won't fundamentally change a U.S. banking system dominated by six companies with a combined $9.4 trillion of assets, MIT's Johnson said.
The law won't prevent lenders with federally guaranteed deposits from gambling in the derivatives markets, though it will place restrictions on some types of contracts and require more transparent trading and central clearing. It does little to solve the danger posed by leveraged firms reliant on fickle markets for funding.
"It's not my point to say that the legislation enacted is worthless," said Dorgan. "It requires more transparency and disclosure and a series of things that are useful, even though it falls short of what I think should have been done."
The Treasury Department takes a more positive view. The law "fundamentally changes the landscape of our financial regulatory system for the better," said Steven Adamske, a Treasury spokesman, in an e-mailed statement.
"The Obama administration and Secretary Geithner fought hard to enact a tough set of reforms that reins in excessive risk on Wall Street, protects the economic security of American families on Main Street, and makes certain taxpayers are never again put on the hook for the reckless acts of a few irresponsible firms," Adamske said. "It also creates a safer, more transparent derivatives market through comprehensive reform, bans risky pay practices, and it puts in place the strongest consumer protections in history."
The biggest financial companies increased their spending on lobbying in the first nine months of 2010 as they sought to influence the legislative outcome, according to Senate records. JPMorgan's advocacy spending grew 35 percent, to $5.8 million from $4.3 million, while Goldman Sachs's jumped 71 percent to $3.6 million.
Banks had "2,300 pages worth of reasons" for spending, said Scott Talbott, a lobbyist at the Financial Services Roundtable, which represents the largest lenders and insurance firms, referring to the size of the Dodd-Frank bill. "The issues on Capitol Hill required more attention."
Spending during 2010 probably played only a small role in the ability of financial companies and trade groups to influence legislators, according to Anthony J. Nownes, a political science professor at the University of Tennessee in Knoxville whose books on the role of lobbyists include "Total Lobbying: What Lobbyists Want (and How They Try to Get It)" (Cambridge University Press).
"The idea that they stepped up their activity has some truth, but the larger truth is that they always spend a lot of money and this was no exception," Nownes said. "They're always there, their viewpoints are always heard and it is a cumulative effect -- they've been saying the same things for years and years and years."
Even as they were spending more on lobbying, the largest U.S. banks cut their political giving for the 2010 elections. Of the 10 biggest financial firms, only Goldman Sachs, MetLife Inc. and the U.S. subsidiary of Deutsche Bank AG spent more from their political action committees during the 2009-2010 election cycle than they did in 2007-2008, according to Federal Election Commission filings.
Talbott said the decrease was partly because of the economic slump, and also because some members of Congress refused to take donations from banks that received federal funds during the crisis.
The financial industry is adept at hiring people with experience in Congress and government, which gives it an edge in understanding the best tactics to use, Nownes said. This month Citigroup recruited former Obama administration budget director Peter Orszag as a vice chairman in its global banking business, and Goldman Sachs hired Theo Lubke from the New York Fed, where he oversaw efforts to make the derivatives market safer.
Research shows that lawmakers are more susceptible to lobbying on issues that are complex, technical or economic, which benefits the banks, Nownes said.
"This certainly was a huge advantage for them, especially in designing some of the more intricate details of this piece of legislation," he said. "The more technical and complex, the bigger the informational advantage they have."
Even in areas that weren't technical, such as bonuses, the financial industry was able to resist tough regulation.
With polls showing strong popular support for limits on pay, former British Prime Minister Gordon Brown pressed for a tax on banker bonuses and one on financial transactions to deter speculative trading.
Obama didn't go that far. Instead, the administration appointed Washington lawyer Kenneth Feinberg to review pay for the 100 top executives at firms receiving "exceptional assistance" from the Troubled Asset Relief Program. Feinberg ordered cuts at Bank of America, Citigroup and AIG, as well as at two bankrupt car companies and their finance divisions.
The administration, while opposing any pay caps, urged regulators to require changes that would better align compensation with risk, such as paying bonuses in restricted stock. Several banks responded by raising bankers' salaries. So far this year, five Wall Street banks -- Bank of America, JPMorgan, Citigroup, Goldman Sachs and Morgan Stanley -- have set aside more than $91 billion for salaries and bonuses.
In early 2010, Virginia Senator James Webb and California Senator Barbara Boxer, both Democrats, proposed an amendment to a jobs bill that would have imposed a 50 percent tax on any bonuses above $400,000 collected in 2009 by executives at banks that received at least $5 billion in TARP funds.
The U.S. Chamber of Commerce, which opposed the tax, urged senators to reject the idea because it "would likely hamper efforts to resolve the ongoing financial crisis, restore economic growth, spur job creation and is likely unconstitutional." The bill never made it to a vote.
"Neither party wanted to touch that issue," Webb said at the Washington Ideas Forum on Oct. 1. "Quite frankly, the way that money affects the political process sometimes paralyzes us from doing what we should do."
In a Bloomberg News National Poll conducted Dec. 4 through Dec. 7, 71 percent of Americans said big bonuses should be banned this year at Wall Street firms that took taxpayer bailouts, and 17 percent said bonuses above $400,000 should be subject to a one-time 50 percent tax. Only 7 percent of the respondents said they consider bonuses a reflection of Wall Street's return to health and an appropriate incentive.
Reed, the former Citigroup executive, said he didn't understand why lawmakers gave so much credit to arguments made by financial-industry participants whose job it is to put the interests of their shareholders above any concern for the safety of the financial system.
"I'm surprised that the people in Washington think that the stockholders are the people that they should protect," Reed said. "It would seem to me that the people who should be protected are the overall banking system and the many, many, many companies that depend on it."

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