[Vision2020] Economist William Black: Why Nobody Went to Jail During the Credit Crisis

[Ted Moffett]

http://www.financialsense.com/financial-sense-newshour/guest-expert/2011/09/14/william-k-black-phd/why-nobody-went-to-jail-during-the-credit-crisis

William Black: Why Nobody Went to Jail During the Credit Crisis

The FBI is no longer chasing white collar criminals

James J Puplava CFP with William K Black PhD

Jim welcomes Professor of Economics and Law William Black to Financial
Sense Newshour. He explains to Jim why no one has gone to jail four
years after the beginning of the historic Credit Crisis. Professor
Black believes that the level of corruption and fraud is so pervasive
that very few of the guilty will ever be brought to justice.

Bill Black is an Associate Professor of Economics and Law at the
University of Missouri – Kansas City (UMKC). He was the Executive
Director of the Institute for Fraud Prevention from 2005-2007. He has
taught previously at the LBJ School of Public Affairs at the
University of Texas at Austin and at Santa Clara University, where he
was also the distinguished scholar in residence for insurance law and
a visiting scholar at the Markkula Center for Applied Ethics.


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Transcript

Jim Puplava:    Joining me on the program is Professor William Black.
He is a Lawyer and an Associate Professor of Economics and Law at the
University of Missouri, Kansas City. He was a Director of the
Institute for Fraud Prevention from 2005 to 2007. He taught at the LBJ
School of Public Affairs at the University of Texas. He was also a
Litigation Director for the Federal Home Loan Bank Board. He is also
author of the book “The Best Way to Rob a Bank Is to Own One.”

And Professor, you played a critical role during the S&L crisis in
exposing congressional corruption. During that period of time, a lot
of corruption was exposed; a lot of people in the financial sector
went to jail, including Charles Keating. I wonder if you would
contrast that to the last credit crisis, let us say from 2007 to 2009
where a lot of money was lost, a lot of things went wrong, but nobody
went to jail. Instead of going to jail, they walked out instead with
multi-million dollar bonuses. What was the difference, what was behind
this in your opinion?

William Black: Well, I say the both of them were driven by fraud. The
Savings & Loan crisis was a tragedy in two parts. First part was not
fraud, it was interest rate risk. But the second phase, which was
vastly more expensive, was to defraud and the National Commission that
looked into the causes of the crisis said that the typical large
failure fraud was invariably present. And there were real regulators
then. Our agency filed well over 10,000 criminal referrals that
resulted in over 1,000 felony convictions and cases designated as
nature. And even that understates the grade in which we went after the
elite. Because we worked very closely with the FBI and the Justice
Department, to prioritize cases—creating the top 100 list of the 100
worst institutions which translated into about 600 or 700
executives—and so the bulk of those thousand felony convictions were
the worst fraud, the most elite frauds.

In the current crisis, of course they appointed anti-regulators. And
this crisis goes back well before 2007 and of course it is continuing,
it does not end at 2009. So the FBI warned in open testimony in the
House of Representatives, in September 2004—we are now talking seven
years ago—that there was an epidemic of mortgage fraud, their words,
and they predicted that it would cause a financial crisis, crisis
being their word, if it were not contained. Well no one thinks that it
was contained.

All right so you have massive fraud driving this crisis,
hyperinflating the bubble, an FBI warning and how many criminal
referrals did the same agency do, in this crisis. Remember it did well
over 10,000 in the prior crisis. Well the answer is zero. They
completely shut down making criminal referrals and whichever
administration you hate the most, you can hate because while most of
this certainly occurred in the Bush Administration, the Obama
Administration has obviously not changed it. Obviously did not see it
as a priority to prosecute these elite criminals who caused this
devastating injury.

Another way to look at it is, how much fraud is there and we know the
following: There are no official statistics on sub prime and similar
categories because there are no official definitions. So there is a
little wishy-wishy in this but the best numbers we have are that by
2006, half of all the loans called sub-prime, were also liars loans.
Liars loans means that there was no prudent underwriting of the loan.
And total, about one-third of all the loans made in 2006, were liars
loans.

Now that's an extraordinary number, especially when you look at the
studies. And here I am going to quote from the Mortgage Bankers
Association. That is the trade association of the perps and this is
their Anti-Fraud Specialist Unit, and they reported this to every
member of the Mortgage Bankers Association in 2006. So nobody can
claim they did not know. They found three critical things, first they
said this kind of loan where you do not do underwriting is, and I am
quoting again, “an open invitation to fraudsters.” Second, they said
“the best study of this found a 90% fraud incident.” In other words,
if you look at 100 liars loans, 90 of them are fraudulent. And third
they said, therefore these loans where the euphemism is stated income
are Alt-A loans, actually deserve the title that the industry calls
the Behind Closed Doors, and that is liars loans. The other thing we
know from other studies and investigations, is that it was
overwhelmingly lenders and their agents that put the ‘lie’ in liars
loans. Now that is obvious when you look at the lies about appraisals,
because homeowners cannot inflate appraisals. But lenders can and how
they did it was shown in an investigation by then New York Attorney
General Cuomo, now Governor, who found that Washington Mutual, which
is called WAMU, and is the largest bank failure in the history of the
United States, and indeed the history of the world, had a black list
of appraisers. But you got on the black list if you were an honest
appraiser, and refused to inflate the appraisal.

Similarly, we know that you could get, for example, a California jumbo
mortgage, that’s one say the size of $800,000. As a loan broker, just
one of these, you could get a fee of $20,000. If it hit certain
parameters. And those parameters would have to do with what is the
interest rate, but also what is the loan to value ratio, and what is
the debt to income ratio. So the loan to value ratio is how big is the
loan compared to the value of your house. Well that is an easy ratio
to gimmick, and we have just explained why, by inflating the
appraisal. If you inflate the appraisal then the loan to value ratio
falls and the loan looks like it is a lot safer, and you can sell it
to Wall Street for significantly more. The debt to income ratio, well
that is even easier to gain. The debt is simply how much are you going
to borrow to buy the house. And the income is, what is the income
stated on the loan application for the borrower. Except that this is a
liars loan, so the lender has agreed that it is not going to check. It
is not going to verify whether the income is real. And so the loan
broker can write down any income number he or she wants. And that will
gimmick that ratio and again it will put it into the sweet spot, for
all of these things, so that you could get your $20,000 fee. Now step
back and ask yourself, many of these guys who are loan brokers, their
previous job was literally flipping burgers, right. So are you going
to leave it up to the borrower to come up magically with the right
income and the right appraisal when they don’t even know what the
magic numbers are and cannot inflate the appraisal? Of course not. You
are going to do it as the loan broker. You are going to tell the
borrower to write in a greatly inflated income number, or maybe you
are afraid that they are too honest, so you may simply write it in
yourself, which happened in many cases.

So again, we got thirty, roughly one-third of all the loans by 2006,
after these warnings. They rapidly increased the number of liars loans
they made. One-third of them are liars loans and 90% of them are
fraudulent, which is to say, that the amount of fraud annually was
well over a million fraud a year. We are talking about hundreds of
billions of dollars in fraudulent instruments.

Jim Puplava:    Professor, I guess one question I would have is, did
the guys at the top of the bank not know that this was going on? I
mean I would find it hard to believe that if I am the CEO of a
financial organization, that I don’t know that our loan standards,
that we went to liar loans and that we were not documenting or
verifying. I mean what happened to 20% down, two years worth of tax
returns, I mean how would somebody at the top, not know this.

William Black: You mean you think liars loan might be a hint?

Jim Puplava:    Yeah, maybe just a little (sarcasm).

William Black: Yeah, we have known for centuries, that if you don’t
underwrite loans, or if you don’t underwrite insurance, you’ll get
something called "adverse selection". And that means you get the worse
possible borrowers or people being insured and the expected value of
lending to somebody, in conditions of serious adverse selection, is
negative. Or to put that in English, that means if you lend this way,
you lose money. And we have known this for centuries. This is like
betting against the house in Las Vegas. You could win some individual
bets, but you stay at the table for three years, and you are going to
lose everything. And as we say, you will lose the house, to the house.
And, that is exactly what is going to happen here. So yeah, the CEO’s
knew all about this. Why did they do it? And the answer is, here is
the recipe, it’s got four ingredients for creating what the Nobel
Prize Winner in Economics, George Akerlof and his colleague Paul Romer
said in 1993 was "a sure thing". And that sure thing is what in
criminology we call accounting control fraud.

So control fraud is when the person who controls a seemingly
legitimate entity, uses it as a weapon to fraud. In the financial
sphere, the weapon of choice is accounting. So here are the four
ingredients of the recipe that produce a sure thing of record
accounting income.

Grow like crazy
Make preposterously bad loans but at a premium yield.
Have extreme leverage. That means you have a ton on debt.
Put aside only ridiculously low allowances for future loan losses.

You do those four things, you are mathematically guaranteed to report
record, albeit fictional, profits in the short term. You are also
guaranteed with modern executive compensation, to make the Senior
Executives wealthy, and you are guaranteed, because after all, if you
think about those four ingredients, they are the perfect recipe as
well for maximizing real losses. And that’s why the title of Akerlof
and Romer’s article says it all, “Looting: The Economic Underworld of
Bankruptcy for Profit.” The firm fails but the executives walk away
rich. This is the same concept with my book “The Best Way to Rob a
Bank Is to Own One.” It is these internal people who control the
seemingly legitimate entity that can get away with financial murder.
And here is the really bad news. I mean that is bad news right there,
but the really bad news, is that this tends to happen as the FBI
warned, and again in 2004, seven years ago. So the next time you hear
some moron tell you that no one could have predicted this, it was
predicted by the Premiere Law Enforcement entity in the world dealing
with white-collar crime.

Jim Puplava:    You know, we just talked about, with these liar loans
being made, the executives at the top knew that this was going on. But
it was driving record profits that they were reporting, their stock
prices were going up. They were getting paid bonuses and you know
their option values were worth just, you know, some of these
compensation packages were just unreal. But here’s the thing that I
guess some of these people did know as we mentioned the executives at
the top, but some knew how to make profit from them. For example, we
found out in congressional testimony that Goldman Sachs at the same
time that they were selling these mortgage polls to let’s say many of
it’s customers, at the same time, internal memos and e-mails said the
stuff was garbage and they were shorting it, making money. Is it
because they control so many of Congress that this time there was no
law enforcement by the regulators coming in and looking at these guys
that walked away with these bonus packages. Or the fact that you had
conflicts of interest of selling bogus mortgage polls that you knew
that were garbage. And at the same time you were selling them to a
customer, you were taking the opposite side of the trade and shorting
it.

William Black: So to just close the loop on what I was saying, if a
bunch of folks follow the same strategy at the same time, they
hyper-inflate a financial bubble. And when you have huge financial
bubbles and they collapse, that’s when you get great recession. So
your question is, so why, this is the greatest financial crime in the
history of the world and no one senior, at any of the major places
that drove the crisis, has gone to jail? In fact, no one has been
indicted. There were some at Bear Stearns, for the real specialized
stuff, but for the basic fraud we are talking about, no one has even
been charged with a crime. What has happened? And the answer, the
first answer is it all has to start with the regulators. The
regulators have to serve as the Sherpas on something like this, in
criminal prosecution. The Sherpas of course, are the folks that help
you get to the top of the Himalayan Mountains. And this is a hard
task, it is hard to prosecute sophisticated white-collar crimes, and
they do have the best criminal defense lawyers in the world. So it is
not an easy thing. And getting those thousand plus felony convictions
in the Savings and Loan crisis, was a massive success for which the
Department of Justice, the FBI and the agencies deserve a lot of
credit. What do the Sherpas do? The Sherpas do two functions. One,
they do the heavy lifting and in this context, that means they the
great bulk of the investigative work. And two, they serve as the
guides, they have the expertise, they’ve seen this before, they know
what works and what does not. And in this context, that means they
have expertise in the fraud mechanisms, the fraud schemes, identifying
it and explaining it. And so a criminal referral is not just a sort of
a useful thing, it is the absolutely essential thing. Criminal
referral in our era might be twenty to thirty pages and have two
hundred to three hundred pages of attachments of all the key
documents. It would be the roadmap to continue this metaphor that
says, here’s the fraud, here’s how it works, here are the key people,
here is where the money moved, here are the key documents to be able
to prove the case. Here are the key witnesses, this is how you contact
them, right? And I told you that we went to zero criminal referrals
from well over ten thousand. That has made it impossible for the FBI
and the justice department to have any substantial success. But of
course, this is not the question of them simply not having substantial
success, they ain’t having no success. And there you have to look at
what, after a brilliant start with this September 2004 warning, with
no help from the regulators, well you could not get any significant
number of FBI agents assigned in the Bush Administration, to
investigate these cases.

Now part of what has happened is in some sense understandable, when
the 9/11 attacks ten years ago occurred, we of course found that our
national security FBI agents, could not infiltrate Al Qaeda. So what
we could do is follow the money. And the experts at following the
money are the white-collar FBI agents. So they transferred 500 white
collar FBI Specialists, over to National Security. Okay, we can
understand why they do that. What you cannot understand is why the
Bush Administration refused to allow the FBI to replace this enormous
loss of white-collar specialists. And so as a whole, white collar
prosecutions fell significantly in the Bush Administration. That meant
that as recently as fiscal year 2007, there were nationwide, only 120
FBI agents working all mortgage fraud cases. To give you a comparison,
at the peak of the Savings and Loan Crisis, there were 1,000 FBI
agents working the cases.

Jim Puplava:    Wow

William Black:  Eight times more FBI agents than were working the
cases in fiscal year 2007. And this crisis is forty times bigger and
worse than the Savings and Loan Crisis. So you would have required
massively more people. To give you another idea of scope, to
investigate Enron, and Enron was complex, but it was nowhere near as
big and as complex as Washington Mutual. It took 100 FBI agents. So
you can see that with 120 nationwide, at most you could have done one
major case. But instead, they divided them up in what the military
would call, Penny Packets, which is to say two or three agents per
field office. And that means they cannot investigate anything
substantial. So they were put on relatively smaller cases. And they
being diligent FBI agents, they worked those cases, and that’s where
they wrote the memos, okay we found this, prosecute these people,
don’t prosecute these people. The FBI in late 2007 – 2008, figures out
this cannot work. Remember I told you there were over a million cases
of mortgage fraud a year and that overwhelmingly it’s lenders who foot
the fraud, the lie in the liars loan. But the FBI couldn’t and didn’t
investigate any of the major lenders. So it is looking at these
relatively small folks, and that is what it reports back. The FBI
decides you know, as I said, this cannot work. This is like going to a
beach in San Diego and throwing handfuls of sand in the Pacific Ocean
and wondering when you are going to be able to walk to Hawaii. Every
year, with a million plus cases of fraud a year, if you prosecute a
thousand of them or two thousand of them or three thousand of them,
you are a million cases further behind every year, right. It is just
insane. So the FBI says we got to start going after the big guys at
which point Bush’s Attorney General Mukasey says no, he refuses to
even create a National Task Force against mortgage fraud, saying
famously, this is simply the equivalent of, and I am quoting again,
“White Collar Street Crime,” little tiny stuff. Well of course he has
assigned the FBI to only look at little cases and they report back,
hey we’re finding little cases. And the Mukasey interprets from that,
hey only little cases exist.

Jim Puplava:    Yeah, but you know, in the S&L Crisis, you had some
high profile cases. For example Charles Keating, and that got a lot of
play. So maybe if they didn’t have the manpower, maybe going after
some very high profile cases, might have made the point. You are
saying they backed off from that. What about the Obama Administration?

William Black: They never did it. They didn’t even back off. They
never, you can tell from the numbers that they have, in how many FBI
personnel it takes to do a really sophisticated, large institutional
investigation. They have never done what would have been considered a
real investigation in the Savings and Loan era of any, any of the
major fraudulent lenders and investment banks that created the
worthless financial derivates—not worthless, but not worth very
much—financial derivatives.

Jim Puplava:    What about the Obama Administration? Had they came in,
they continued with the same policy basically, they ignored it. Where
they could have had let us say, an opportunity. Is it because
Professor, that the process is you know, some have said that Congress
is bought and paid for by the financial industry. I mean, is that part
of the reason?

William Black: Well, it’s not just Congress of course. The President
has said that he wants to raise a billion dollars in the reelection
effort and despite all the press you may have heard about how the
White House is despised by finance—in fact, last I read, a bigger
percentage and a bigger absolute dollar amount of contributions in
this effort, than in the original effort had come from finance. And so
both parties are tremendously beholden to finance. That is part of it
but again, the Obama Administration was better than the Bush
Administration. The Obama Administration was willing to create a task
force and it’s the numbers of FBI Agents have been increased, but they
are still looking at relatively small cases. And they are nowhere near
the numbers required and so unless something dramatic or radical
changes, this is going to be the greatest case of elite fraud with
impunity in the history of the world. And it is only going to change
if we express our outrage as the people and demand that it is changed.
Let me tell you how bad it is. The Federal Housing Finance
Administration, has just last week, or about ten days ago now, filed
fifteen hundred plus pages of complaints against seventeen financial
entities. And about ten of them are among the biggest financial
entities in the world saying, every investigation has found repeated
enormous fraud at these entities. So, and there is a track record, a
paper trail of that fraud. But these entities got reports saying these
assets were trash and that they lied and then sold the assets to
Fannie and Freddie by making acts of deceit, which is of course, the
key element of fraud.

So, now that this has happened, there are really only two
possibilities. Either the Federal Housing Finance Administration has
gotten all those documents wrong, and there is no such record, or
there is such a record in which case, where is the Justice Department,
why is it not bringing criminal prosecution against most of the
largest banks in the world.

Jim Puplava:    You know, there was a documentary film called “Inside
Job,” which won an Oscar this year, and it ended with the Director and
Producer pointing out the fact that you just brought up—not one single
prosecution was brought in this entire situation, what is probably the
largest fraud committed in history. And yet it still goes on
Professor, we still have the financial industry contributing large
amounts of money to politicians in both parties, both at the national
level, the local level, and so basically, what you have is influence
buying here. Because it seems to me that there were so many obviously
cases, even in the hearings, where I think it was, Senator Levin,
basically talking about the conflicts of interest in internal e-mails.
I thought my goodness, there was enough evidence to go after but not
one thing was done. And even when a lot of these firms went under, as
the shareholders lost everything, the taxpayers losing everything, the
guys at the top walked away with some of the biggest bonus packages
I’ve seen in my investment career.

William Black: Again, Akerlof and Romer have been proven correct.
Akerlof and Romer worked with us and strongly support the kind of
efforts that need to be done. The title of their article again is
“Looting: The Economic Underworld of Bankruptcy for Profit.” The firm
failed because you followed the fraud recipe that I gave you, which
causes catastrophic losses but their CEO’s and other Senior Officers
can walk away incredibly rich. There is, by the way, one case and was
done after the movie, the documentary that you are talking about, and
it’s the proverbial exception that proves the rule. The Taylor case,
and it refers to a pretty obscure mortgage-banking firm in the
southeast. Ten people have been convicted who were officers. But the
only reason they were convicted was because these people after
thousands of acts of fraud, over a ten-year period, tried to defraud
the TARP Program and the Special Inspector General to the TARP
Program, which is called SIGTARP, was very good. He has since left the
government service. And they found this and they made the criminal
referral. What we discovered in the course of that, was that Fanny Mae
discovered this fraud in 2000 but refused to make a criminal referral.

They refused to make a criminal referral because it wanted to secretly
dump the paper that had been provided by this mortgage-banking firm.
And so the mortgage banking firm, the fraudulent mortgage banking
firm, they would have been caught red handed doing the frauds. Simply
went across the street, metaphorically, and defrauded Freddie Mac for
nine years. So again, if people, I do not understand who have never
done this, how absolutely critical the criminal referrals are.

Jim Puplava:    Well, it seems like as we have seen here, as you
pointed out, zero criminal referrals have been brought in this entire
case, and you just cannot help but believe that this goes on and
meanwhile, you and I as taxpayers, are going to have to front the bill
for this. It is unfortunate. Let me ask you a final question, we
supposedly as a result of all of this, we had Dodd Frank, that was
supposed to bring in like Sarbanes-Oxley, all this financial
legislation that would basically prevent this kind of thing from
happening again. Will Dodd Frank help us in this way or is it just
more red tape and which is useless if regulators and let’s say the
FBI, aren’t allowed to do their job.

William Black: Dodd Frank has some individual components that are
useful and the Republican Party unfortunately is trying to kill each
of them. The Administration is not necessarily fighting strong for
any, the Dodd Frank Bill was not created and designed to deal with the
actual causes of the crisis. And so it most likely will not stop the
next crisis. But the focus on legislation is a bit misleading. Under
the existing laws and regulation, this was an easy crisis to prevent.
People think of it as much more difficult and complex. But as I say,
it was overwhelmingly driven by liars loans. Liars loans were easy to
figure out. We, as regional regulators in 1990 and 1991, killed a wave
of liars loans that was starting, especially in Orange Country Savings
and Loans. And as a result, those lenders gave up their Federal
Deposit Insurance precisely to escape our jurisdiction, and created
mortgage banks. But the Fed, the Federal Reserve Board, had authority
from 1994 on, in other words, a long time before the crisis, to
regulate anybody that did home loans. And it was an easy call that
something called a liars loan had to be stopped. Alan Greenspan and
Ben Bernanke refused to do their statutory authority to stop them.
Because they didn’t believe in regulation. Bernanke was reappointed by
President Obama. You know, I tried as little, what one little person
could, to stop that. We need to have a complete new crew. Geithner
needs to go, Attorney General Holder needs to go, and Bernanke needs
to go and we need to put people in who will make a high priority
ending the ability to loot institutions with impunity.

Jim Puplava:    Yeah, that was one of the aspects that was brought out
in the documentary, “Inside Job.” A lot of the people, Larry Summers
who until recently was in the Obama Administration, Geithner, Alan
Greenspan tried to stop Brooksley Born on derivatives. And it seems
like the guys that were behind all of this are the same people that
have been put in charge of fixing it. Well listen Professor, your book
once again is “The Best Way to Rob a Bank Is to Own One.” And you have
written several articles so if our listeners would like to follow the
work that you do, I hope you keep up the good work because we do need
hopefully some day we will get honest people in there that will care
more about doing what is right than about their positions and the pay
that they get.

William Black: We have written hundreds of articles that if folks are
interested, check out “New Economic Perspectives”, the UMKC Economics
blog.

Jim Puplava:    Okay, one more time?

William Black: “New Economic Perspectives”, the blog of the Economics
Department at the University of Missouri at Kansas City.

Jim Puplava:    All right, well we have been speaking with Professor
Black, Professor thank you for coming on the program and helping to
clarify why this big crime really went unpunished, which is a real
tragedy for not only most Americans but all of us as taxpayers who
have paid for the bill.

William Black: Thank you sir, take care.

Jim Puplava:    Thank you.
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Vision2020 Post: Ted Moffett