Criminal Prosecution Pattern Recognition:
What Can We Learn From the 2008 Banking Crisis To Help Predict Potential Criminal Enforcement Priorities in the Wake of the 2023 Silicon Valley Bank Collapse?
Pattern recognition can be very important in identifying similarities between current events associated with the recent collapse of Silicon Valley Bank (“SVB”) and past events, such as the 2008 banking crisis. From the perspective of a criminal defense lawyer, there are potential criminal enforcement prediction models that we can draw from looking back at the 2008 financial crisis and what might follow form the SVB collapse.
Desperate financial times can often cause individuals to engage in reckless and even criminal conduct. We saw a significant rise in financial fraud prosecutions in the wake of the 2008 financial crisis. The question is, whether we will see a similar increase in financial fraud criminal prosecutions if Fed’s current historic rate hikes trigger a similar banking crisis.
Several criminal prosecutions resulted from the 2008 financial crisis. Some notable criminal cases that resulted from the financial crisis include:
Bernard Madoff: Madoff was arrested in 2008 for running a massive Ponzi scheme that defrauded investors of billions of dollars. He was sentenced to 150 years in prison in 2009. Madoff Case
Goldman Sachs: In 2010, the SEC charged Goldman Sachs with fraud for allegedly misrepresenting the risks associated with a mortgage-backed security it sold to investors. Goldman Sachs settled the case for $550 million. Goldman Sachs SEC Press Release
JPMorgan Chase: In 2013, JPMorgan Chase agreed to pay $13 billion to settle a lawsuit over the bank's role in the sale of mortgage-backed securities leading up to the financial crisis. JP Morgan DOJ Press Release
Credit Suisse: In 2014, Credit Suisse pleaded guilty to helping wealthy Americans evade taxes and agreed to pay a $2.6 billion fine. Credit Suisse DOJ Press Release
Bank of America: In 2014, Bank of America agreed to pay a $16.7 billion settlement for its role in selling risky mortgage-backed securities leading up to the financial crisis. BOA DOJ Press Release
Wells Fargo: In 2018, Wells Fargo agreed to pay a $2.09 billion fine to settle allegations that the bank had misled investors about the quality of its mortgage-backed securities leading up to the financial crisis. Wells Fargo DOJ Press Release
The question lingers whether we will see a similar pattern of criminal prosecutions come out on the other side of this new potential looming banking crisis.
Lawyers are trained to looked at prior precedent as a predictor of future potential outcomes. Recognizing patterns and correlations between how financial institutions, policymakers, legislators and regulators responded to the 2008 banking crisis—and how those same groups are currently responding to the current SVB collapse—is one possible predictor of the potential contagion effects of SVB’s insolvency. By spotting these patterns associated with incoming potential financial “crisis”, lawyers can try to forecast potential risks and outcomes and take steps to help clients mitigate against potential downsides.
One of the key benefits of pattern recognition in this context is that it allows decision-makers to identify potential warning signs and take action before a crisis occurs. Sadly, in the context of the current Fed response to inflation, banks failed to predict the risk of investing customer deposits in low-interest (and presumably low-risk) treasuries. As banks increased exposure on their lending side, it became clear that they were under-collateralized and over-exposed relative to their ability to return customer deposits in the event of a “bank-run” by customers. As the fed rapidly began to raise rates to “cool” inflation, the rate of return on treasuries skyrocketed. This left banks holding past fixed-rate low interest treasury notes in a market where current treasury notes are fetching higher returns.
At the same time, banks also turned to a more risky investment option to shore-up the imbalance on their books between customer deposits and bank loans. Banks invested in Mortgage Backed Securities (“MBS”). MBS is a type of asset-backed security that is created by pooling together a group of mortgages and selling them to investors as securities. Essentially, an MBS is a bundle of mortgages that are packaged together and sold to investors as a single investment product. The MBS is then sold to investors, who receive a share of the cash flows generated by the underlying mortgages. These cash flows typically consist of the interest and principal payments made by the borrowers on the individual mortgages. MBS’s can be risky investments, especially in the case of subprime mortgages or other types of high-risk loans. In the event of a large number of mortgage defaults, the value of an MBS can decline rapidly, potentially leading to significant losses for investors. Risky MBS’s were a major contributor to 2008 banking crisis.
Because many of these MBS’s were bundled in low-interest mortgage loans, the returns on those bundles of MBS’s is lower compared to the newer bundles of MBS’s that are tied to the higher interest rate mortgages currently offered in the marketplace The rates on mortgages have also gone up sharply as the Fed continues to raise interest rates to cool off inflation. That means that there are higher rates of return for investors on the post-Fed hike MBS bundles as opposed to the pre-Fed hike MBS bundles many banks are currently holding on their balance sheets.
SVB got caught-up in the middle of the above squeeze because as the rates on treasuries soared, the returns on their huge inventory of existing MBS’s plummeted. SVB Collapse When SVB customers got wind of this, they became alarmed and flooded the bank with requests to withdraw funds. SVB could not keep up with this flood of customer requests because they did not have sufficient cash reserves on-hand to cover such a potential “run on the bank”.
The question now lingers as to what the contagion effects of SVB’s collapse will be for other banks and their customers. Lawyer can use pattern recognition techniques to identify these potential contagion effects . By comparing what happened to SVB with the 2008 bank collapse, lawyers can help clients identify future risks and vulnerabilities and advise clients on steps they can take mitigate against them.
The 2008 banking crisis, also known as the global financial crisis, was a major economic event that impacted the world economy. It was triggered by several interrelated factors, including. One of the major factors that led to the 2008 finical crisis was excessive leverage by banks. Banks and financial institutions borrowed heavily to finance their activities, using high levels of leverage to amplify their returns. This made them vulnerable to sudden shifts in market conditions or changes in asset values.
We can see a similar pattern potentially unfolding now in the wake of SVB’s collapse. As banks continue to see diminished returns on MBS investment bundles and long-term fixed treasury notes due to rising interest rates, consumer could begin to question whether they can get their money out of these banks.
Yes, the FDIC (Federal Deposit Insurance Corporation) provides deposit insurance to protect depositors in case their bank fails or goes out of business—$250,000 per depositor, per insured bank, for each account ownership category—but For depositors who have more the $250,000 on deposit with a bank, this raises concerns whether their money is safe in the event of a “bank run”.
We are currently seeing these concerns unfold in realtime as account holders with the now defunct SVB bank anxiously await word from the FDIC on how they will handle the return of customer deposits.
Sadly, we’re also seeing similar concerns being reported by customers in other banks that are allegedly over-leveraged at this moment. For example, asecond California based bank, First Republic, is currently trying to avoid a potential SVB-type bank-run as customer voice concerns over whether they can get their money out. First Republic Bank
As this unfolds, it will no-doubt draw the attention of State and Federal criminal investigators and prosecutors who will closely scrutinize current banking practices looking for 2008-type instances of fraud. They will likely rely on the same pattern recognition patterns discussed above to look for and spot potential areas for criminal prosecution.