Fraud By The Big Banks – More Than Anything Done By The Little Guy – Caused The Financial Crisis
The U.S. Treasury’s Office of Thrift Supervision noted last year (page 7):
The FBI estimates that 80 percent of all mortgage fraud involves collaboration
or collusion by industry insiders.
This confirms what one of the country’s top fraud experts has said for years: that it was fraud by the big banks – more than anything done by the little guy – which caused the financial crisis:
William K. Black – professor of economics and law, and the senior regulator during the S & L crisis – explained last month before to the Financial Crisis Inquiry Commission why banks gave home loans to people who they knew couldn’t repay. The whole piece is a must-read, but here are excerpts from the introduction:
The data demonstrate conclusively that most liar’s loans were fraudulent, which means that there were millions of fraudulent mortgage loans because liar’s loans became common (Credit Suisse estimates that they represented 49% of new originations by 2006). The data also demonstrate that even minimal underwriting of the loan files was sufficient to detect the overwhelming majority of such fraudulent liar’s loans. No honest, rational lender would make large numbers of liar’s loans. The epidemic of mortgage fraud was so large that it hyper-inflated the housing bubble, which allowed refinancing to further extend the life of the bubble (and the depth of the ultimate Great Recession.
In the cases where there have been even minimal investigations (New Century, Aurora/Lehman, Citi, WaMu, Countrywide, and IndyMac) senior lender officials were aware that liar’s loans were typically fraudulent. The lenders could not make an honest business out of selling overwhelmingly fraudulent mortgages.
Liar’s loans were done for the usual reason – they optimized (fictional) short-term accounting income by creating a “sure thing” (Akerlof & Romer 1993). A fraudulent lender optimizes short-term fictional accounting income and longer term (real) losses by following a four-part recipe:
A. Extreme Growth
B. Making bad loans at a premium yield
C. Extreme leverage
D. Grossly inadequate loss reserves
Note that this same recipe maximizes fictional profits and real losses. This destroys the lender, but it makes senior officers that control the lender wealthy. This explains Akerlof & Romer’s title – Looting: The Economic Underworld of Bankruptcy for Profit. The failure of the firm is not a failure of the fraud scheme. (Modern bailouts may even recapitalize the looted bank and leave the looters in charge of it.)
The first two “ingredients” are related. Home lending is a mature, reasonably competitive industry. A lender cannot grow extremely rapidly by making good loans. If he tried, he’d have to cut his yield and his competitors would respond. His income would decline. But he can guarantee the ability to grow extremely rapidly by being indifferent to loan quality and charging weaker credit risks, or more naïve borrowers, a premium yield.
In order to become indifferent to loan quality the officers controlling the lender must eviscerate its underwriting.
There is no honest reason for a secured lender to seek or permit inflated appraisal values. This is a sure marker of accounting control fraud – a marker that juries easily understand.
In other words, banks made loans to borrowers who they knew couldn’t really repay because the heads of the banks could make huge bonuses based on high volumes and fraudulent appraisals, and they didn’t care if their own companies later failed.
In short, they looted their companies and the economy as a whole.
Professor Black brings us current to where we are today:
History demonstrates that if the control frauds get away with their frauds they will strike again.
By allowing the banks to use their political power to gimmick the accounting rules to permit them to hide their massive losses on liar’s loans we have made it far harder to take effective administrative, civil, and criminal sanctions against the elite frauds that caused the Great Recession. Hiding the losses also adopts the dishonest Japanese approach that cripples economic recovery and public integrity.
Prosecuting the elites control frauds can be done successfully. Create a new “Top 100” priority list and appoint regulators that will make supporting the Justice Department a top agency priority. That’s how we obtained over 1000 priority felony convictions of elite S&L criminals. No controlling officer of a large, non-prime specialty lender has been convicted of running a control fraud. Only one has even been indicted.
The FBI has written that any discussion of the crisis that ignores the role of mortgage fraud is “irresponsible.”
But instead of prosecuting fraud, the government just continues to cover it up.