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Why Did the OCC Ignore HSBC's Criminal Ties?

David Callahan posted a terrific blog yesterday that outlined HSBC’s outrageous behavior as catalogued in a 350-page report by the Senate’s Permanent Committee on Investigations. For more than a decade, HSBC used its network of correspondent banks (subsidiaries in many countries) and relationships with other non-US banks to enter into tens of thousands of transactions that should have been thoroughly vetted for money laundering by rogue states, terrorists and drug cartels, among others. For years, this behavior was condoned by senior management and even encouraged. This poses a very serious set of issues for HSBC and may well result in a criminal inquiry by the Justice Department.

The lessons from Subcommittee’s report are not limited to HSBC’s bad actions. It is abundantly clear that U.S. regulators had more than enough information to pursue HSBC’s actions aggressively for a long, long time. Why on earth is a Senate report in 2012 needed to finally address a problem that has persisted for more than a decade?

For example, the Office of the Comptroller of the Currency finally, in October 2010, issued a cease and desist order requiring HSBC to strengthen its anti-money laundering procedures in which, among other things, it cited a backlog of 17,000 alerts of suspicious activity that had not yet been reviewed. Prior to the time of this order, at least 28,000 transactions that should have been caught in the filters required by Treasury’s Office of Foreign Asset Control went through without question by HSBC. The outside auditors reviewing HSBC transactions have yet to complete their work, so the number should increase over time. Of these 25,000 involved Iran during the period when governments around the world have struggled to block its development of nuclear weapons.

The report, exhibiting remarkable and undeserved restraint, says this about the OCC:

Since many of these criticisms [in the OCC’s cease and desist order] targeted severe, widespread, and longstanding [anti-money laundering] deficiencies, they also raised questions about how the problems had been allowed to accumulate and why the OCC had not compelled corrective action earlier.

The report goes on to detail a number of specific procedural and technical flaws in the OCC’s approach to money laundering issues. While these are significant from a bureaucratic perspective, the bottom line is that OCC tolerated massive numbers of transactions involving many billions of dollars without even reducing their rating of the quality of HSBC management, much less raising alarms throughout the government. The scope of these activities and the involvement of high level bank management that promulgated policies encouraging or enabling money laundering is persuasive evidence, by itself, that actual violations were widespread.

Banks are powerful institutions. For regulators to cross one of the world’s largest banks, they must be willing to take pressure inflicted directly and through politicians whose friendship with the banks is procured by dubious, though most times legal, means. Historically, no regulatory entity has been more dominated by the banks than the OCC. This is so even though the OCC is housed in the Treasury Department and is shielded, at least to some extent, from congressional pressure.

The OCC appears to have decided that HSBC’s behavior did not raise issues of “safety and soundness” of the bank. Really? Thousands of transactions that constitute evidence of criminal involvement with Mexican drug cartels, middle eastern terrorists and the most outcast and dangerous regimes on the planet were seen as not threatening the soundness of the bank?

Thomas Curry was confirmed as the Comptroller of the Currency at the end of March. He cannot be blamed for the shortcomings of the OCC prior to that date. However, he is now responsible for changing the culture of the agency. It is far too dangerous to allow the OCC to continue as a captive of the banks that it is tasked to oversee. Mr. Curry has a tremendous job ahead of him if the OCC is to reverse a decades-old reputation of being a sympathetic, and many times collaborative, regulator of the financial sector.

But this problem is not limited to the OCC. Many regulatory agencies have fallen short of challenging the all-powerful banking interests over the years. The independent and secretive Federal Reserve is among them, with a system that even includes bank executives such as Jamie Dimon on the board of directors of the New York Fed. And even the Treasury Department, itself, is often seen as aligned with the banks.

This consequences of regulatory capture by the banks is broader than the prevention of dangerous and immoral behavior. The public understandably believes that the banks are beyond the reach of the law. After all, not a single Wall Street bigwig has been prosecuted even though Wall Street’s rampant disregard for rules triggered the financial catastrophe that remains a millstone around the neck of the economy four years after the collapse.

Gary Gensler, Chairman of the CFTC, has been castigated by those sympathetic to the financial services industry. He should be proud of that. And he would be a fine role model for Mr. Curry and others who are responsible for keeping the banks in check.