By William K. Black and L. Randall Wray
William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City. He is a white-collar criminologist and was a senior financial regulator. He is the author of The Best Way to Rob a Bank is to Own One.
L. Randall Wray is a Professor of Economics at the University of Missouri-Kansas City and Research Director with the Center for Full Employment and Price Stability as well as a Senior Research Scholar at The Levy Economics Institute and author of Understanding Modern Money.
After a quick review of its procedures, Bank of America this week announced that it will resume its foreclosures in 23 lucky states next Monday. While the evidence is overwhelming that the entire foreclosure process is riddled with fraud, President Obama refuses to support a national moratorium. Indeed, his spokesmen on the issue told reporters three key things. As the Los Angeles Times reported:
A government review of botched foreclosure paperwork so far has found that the problems do not pose a "systemic" threat to the financial system, a top Obama administration official said Wednesday.
Yes, that’s right. HUD reviewed the "paperwork" problem to see whether it threatened the banks — not the homeowners who were the victims of foreclosure fraud. But it got worse, for the second point was how the government would respond to the epidemic of foreclosure fraud.
The Justice Department is leading an investigation of possible crimes involving mortgage fraud.
That language was carefully chosen to sound reassuring. But the fact is that despite our pleas the FBI has continued its "partnership" with the Mortgage Bankers Association (MBA). The MBA is the trade association of the "perps." It created a ridiculous on its face definition of "mortgage fraud." Under that definition the lenders — who led the mortgage frauds — are the victims. The FBI still parrots this long discredited "definition." That is one of the primary reasons why — in complete contrast to prior financial crises — the Justice Department has not convicted a single senior officer of the large nonprime lenders who directed, committed, and profited enormously from the frauds.
Note that the Justice Department is not investigating foreclosure fraud. HUD Secretary Donovan’s statement shows why:
"We will not tolerate business as usual in the mortgage market," he said. "Where there have been mistakes made or errors, we will hold those entities, those institutions, accountable to stop those processes, review them and fix them as quickly as possible."
Note the language: "mistakes", "errors", "processes" (following the initial use of "paperwork"). No mention of "fraud", "felony", "criminal investigations", or "prosecutions" for the tens of thousands of felonies that representatives of the entities foreclosing on homes have admitted that they committed. Note that Donovan does not even demand that the felons remedy the harm caused by their past fraudulent foreclosures. Donovan wants them to "fix" "processes" — not repair the harm their frauds caused to their victims.
The fraudulent CEOs looted with impunity, were left in power, and were granted their fondest wish when Congress, at the behest of the Chamber of Commerce, Chairman Bernanke, and the bankers’ trade associations, successfully extorted the professional Financial Accounting Standards Board (FASB) to turn the accounting rules into a farce. The FASB’s new rules allowed the banks (and the Fed, which has taken over a trillion dollars in toxic mortgages as wholly inadequate collateral) to refuse to recognize hundreds of billions of dollars of losses. This accounting scam produces enormous fictional "income" and "capital" at the banks. The fictional income produces real bonuses to the CEOs that make them even wealthier. The fictional bank capital allows the regulators to evade their statutory duties under the Prompt Corrective Action (PCA) law to close the insolvent and failing banks.
The inflated asset values allow the Fed and the administration to ignore the Fed’s massive loss exposure and allow Treasury to spread propaganda claiming that TARP resolved all the problems — at virtually no cost. Donovan claims that we have held the elite frauds accountable — but we have done the opposite. We have made the CEOs of the largest financial firms — typically already among the 500 wealthiest Americans — even wealthier. We have rewarded fraud, incompetence, and venality by our most powerful elites.
If the government does not hold the fraudulent CEOs responsible, who is supposed to stop the epidemic of elite financial fraud? The Obama administration’s answer is the fraudulent CEOs themselves, at a time of their choosing. You can’t make this stuff up.
But ultimately resolving the problems is not the government’s responsibility, said Michael Barr, assistant Treasury secretary for financial institutions.
"Fundamentally, this is up to the banks and the servicers to fix," he said. "They can fix it as fast as they feel like."
So who is Michael Barr and why is saying things on behalf of the Obama administration that make it appear to be a wholly-owned subsidiary of the fraudulent lenders and servicers? He’s a Robert Rubin protégé and he’s the senior Treasury official for banking policy.
We have a different policy view. We believe that only the government can stop fraud from growing to catastrophic levels and that among the government’s highest responsibilities is to provide the regulatory "cops on the beat" with the competence, resources, courage, and integrity to take on our most elite frauds. We believe that anything less is a travesty that causes tens of millions of Americans to be defrauded and poses a grave threat to our economy and democracy.
Prompt Corrective Action
First, it is time to stop the foreclosures until the banks and servicers adopt corrective steps, certified as adequate by FDIC, that will prevent all future foreclosure fraud. They must also adopt plans to remedy the injuries their foreclosure frauds have already caused, and assist the FBI, Department of Justice, and legal ethics officials investigations of their officers’ and attorneys’ frauds and ethical violations.
Second, it is time to place the financial institutions that committed widespread fraud in receivership. We should remove the senior leadership of the banks and replace them with experienced bankers with a reputation for integrity and competence, i.e., the honest officers that quit or were fired because they refused to engage in fraud. We should prioritize the receiverships to deal with the worst known "control frauds" among the "systemically dangerous institutions" (SDIs). The SDIs’ frauds and fraudulent leaders endanger the global economy.
We propose Bank of America for the first receivership. In the last few weeks, the SEC has obtained a large (albeit grossly inadequate) settlement of its civil fraud charges against the former senior leaders of Countrywide. (Bank of America acquired Countrywide and is responsible for its frauds.) Fannie and Freddie’s investigations — with their findings reviewed by their regulator, the Federal Housing Finance Agency (FHFA) — have identified many billions of dollars of fraudulent loans originated by Countrywide that were sold fraudulently to Fannie and Freddie through false representations and warranties. The Fed, BlackRock, and Pimco’s investigations have identified many billions of dollars of fraudulent loans provided by Countrywide under false reps and warranties. Ambac’s investigation found that 97% of the Countrywide loans reviewed by Ambac were had false reps and warranties. Countrywide also engaged in widespread foreclosure fraud. This is not surprising, for every aspect of Countrywide’s nonprime mortgage operations that has been examined by a truly independent body has found widespread fraud — in loan origination, loan sales, appraisals, and foreclosures. Fraud begets fraud. Lenders that are control frauds create criminogenic environments that produce "echo" epidemics of control fraud in other professions and industries.
We have been amazed that, as one financially sophisticated entity after another found widespread fraud by Countrywide in the entire gamut of its operations, the administration, the industry, and the financial media act as if this is acceptable. Countrywide made hundreds of thousands of fraudulent loans. It fraudulently sold hundreds of thousands of loans through false reps and warranties. It fraudulently foreclosed on large numbers of loans. It victimized hundreds of thousands of people and hundreds of financial institutions, causing hundreds of billions of dollars of losses. It has defrauded more people, at a greater cost, than any entity in history.
Bank of America chose to purchase Countrywide at a point when it — and its senior leaders — were infamous. Bank of America made some of these Countrywide leaders its senior leaders. Yet, Bank of America is not treated as a criminal entity. President Obama, Attorney General Eric Holder, Donovan, and Barr cannot even bring themselves to use the "f" word — fraud. They substitute euphemisms designed to trivialize elite criminality. The administration officials do not call for Bank of America to be the subject of a criminal investigation. They do not demand that Fannie, Freddie, Ambac, the FHFA, and Pimco file criminal referrals about Countrywide’s frauds. They do not demand that Fannie, Freddie, and the Fed refuse to purchase or take as collateral any mortgage instrument from Bank of America. No one at the Harvard Club in New York moves to kick Bank of America’s officers out of their club! The financial media treats Bank of America as if it were a legitimate bank rather than a "vector" spreading the mortgage fraud epidemic throughout much of the Western world.
For the sake of our (and the global) economy, our democracy, and our souls this willingness to allow elite control frauds to loot with impunity must end immediately. The control frauds must be taken down and their officers removed promptly. Receivership is the way to begin to reclaim our souls, our economy, and our democracy and Bank of America has the track record that makes it a good place to start. It is sufficiently large and powerful that its receivership will send the credible signal that America is restoring the rule of law and that even the most elite frauds will be held accountable.
Next we need to remove the rest of the "too big to fail" institutions — we call them systemically dangerous institutions, or SDIs — to reduce the global systemic risks that they pose. We are rolling the dice with disaster every day. The SDIs are inefficient, so shrinking them will reduce risk and increase efficiency. We need to follow three types of policies with respect to SDIs.
- They cannot grow larger and compound the systemic risk they pose.
- They must create an enforceable plan to shrink to a level and functions such that they no longer pose a systemic risk within five years.
- Until they shrink to the point that they no longer pose systemic risks they must be regulated with far greater intensity than other banks. In particular, control fraud poses so severe a risk of triggering another global financial crisis that there must be no regulatory tolerance for control frauds at the SDIs. One of the best ways to reduce their risks is to mandate that high levels of executive compensation be paid only after sustained and superior performance (at least five years), and with "claw back" provisions if compensation was obtained by fraudulent reported income or seriously inadequate loss reserves.
Appointing a receiver for an SDI will be a major undertaking for the FDIC, but it is also well within its capabilities. Contrary to the scare mongering about "nationalizing" banks, receivers are used to returning failed banks to private ownership. Receiverships are managed by experienced bankers with records of competence and integrity rather than the dread "bureaucrats." We appointed roughly a thousand receivers during the S&L and banking crises of the 1980s and early 1990s under Presidents Reagan and Bush.
Here is how it works. A receiver is appointed on Friday. The bank opens for business as normal (from the bank’s customers’ perspective) on Monday. The checks clear, the ATMs work, and the branches all open. The receiver’s managers direct the business operations, find the true facts about the bank’s operations, senior managers, and financial condition, recognize the real losses, and make the appropriate referrals to the FBI and the SEC so that the frauds can be investigated and prosecuted.
The receiver is also a well-proven device for splitting up banks that are too large and incoherent by selling units of the business to different bidders who most value the operations.
Dealing with the "Dirty Dozen" Control Frauds
Simultaneously, we should put in place a system to replace the existing cover up of the condition of other banks with vigorous investigations and honest accounting. The priority for these investigations should be the "Dirty Dozen" — the twelve largest banks. The Fed cannot conduct a credible investigation. It has taken so many fraudulent nonprime loans and securities as collateral that it is the leading proponent of covering up these losses.
The FDIC should lead the investigations (it has "backup" regulatory authority over all banks), but it should hire investigative experts to add expertise to its Dirty Dozen examination teams. The priorities of the teams will be identifying existing losses and requiring their immediate recognition (the regulatory authorities have the authority to "classify" assets that can trump the accounting scams that Congress extorted from FASB). The FDIC should prioritize the order of its examinations of the largest SDIs on the basis of known indicia of fraud. For example, Citi’s senior credit manager for mortgages testified under oath that 80% of the loans it sold to Fannie and Freddie were made under false reps and warranties. The Senate investigation has documented endemic fraud at WaMu (acquired by Wells Fargo). The FDIC should sample nonprime loans and securities held by Fannie, Freddie, the Federal Home Loan Banks, and the Fed to determine which nonprime mortgage players originated and sold the most fraudulent loans. This will allow the FDIC to prioritize which SDIs it examines first.
We should also create a strong incentive for financial entities to voluntarily disclose to the regulators, the SEC, and the FBI their frauds, their unrecognized losses, and the officers that led the frauds — and to fire any officer (VP level and above) who committed (or knew about and did not report) financial fraud. Any SDI that originated or sold more than $2 billion in fraudulent nonprime loans or securities should be placed in receivership unless it has conducted a thorough investigation and made the voluntary disclosures discussed above prior to the commencement of the FDIC examination, and developed a plan that will promptly recompense fully all victims that suffered losses from mortgages that were fraudulently originated, sold, or serviced.
We make three propositions concerning what we believe to be institutions that are run as "control frauds". To date, this situation has been ignored in the policy debates about how to respond to the crisis. The propositions rest on a firm (but ignored) empirical and theoretical foundation developed and confirmed by white-collar criminologists, economists, and effective financial regulators. The key facts are that there was massive fraud by nonprime lenders and packagers of fraudulent nonprime loans at the direction of their controlling officers. By "massive" we mean that lenders made millions of fraudulent loans annually and that packagers turned most of these fraudulent loans into fraudulent securities. These fraudulent loans and securities made the senior officers (and corrupted professionals that blessed their frauds) rich, hyper-inflated the bubble, devastated millions of working class borrowers and middle class home owners, and contributed significantly to the Great Recession — by far the worst economic collapse since the 1930s.
Our first proposition is this: The entities that made and securitized large numbers of fraudulent loans must be sanctioned before they produce the next, larger crisis. Second: The officers and professionals that directed, participated in, and profited from the frauds should be sanctioned before they cause the next crisis. Third: The lenders, officers, and professional that directed, participated in, and profited from the fraudulent loans and securities should be prevented from causing further damage to the victims of their frauds, e.g., through fraudulent foreclosures. Foreclosure fraud is an inevitable consequence of the underlying "epidemic" of mortgage fraud by nonprime lenders, not a new, unrelated epidemic of fraud by mortgage servicers with flawed processes. We propose a policy response designed to achieve these propositions.
S&L regulators, criminologists, and economists recognize that the same recipe that produced guaranteed, record (fictional) accounting income (and executive compensation) until 2007 produced another guarantee: massive (real) losses, particularly if the frauds hyper-inflated a bubble. CEOs who loot "their" banks do so by perverting the bank into a wealth destroying monster — a control fraud. What could be worse than deliberately growing massively by making loans likely to default, converting large amounts of bank assets to the personal benefit of the senior officers looting the bank and to those the CEO suborns to assist his looting (appraisers, auditors, attorneys, economists, rating agencies, and politicians), while simultaneously providing minimal capital (extreme leverage) and only grossly inadequate loss reserves, and causing bubbles to hyper-inflate?
This nation’s most elite bankers originated and packaged fraudulent nonprime loans that destroyed wealth — and working class families’ savings — at a prodigious rate never seen before in the history of white-collar crime. They created the worst bubble in financial history, echo epidemics of fraud among elite professionals, loan brokers, and loan servicers, and would (if left to their own devices) have caused the Second Great Depression.
Nothing short of removing all senior officers who directed, committed, or acquiesced in fraud can be effective against control fraud. We repeat: Foreclosure fraud is the necessary outcome of the epidemic of mortgage fraud that began early this decade. The banks that are foreclosing on fraudulently originated mortgages frequently cannot produce legitimate documents and have committed "fraud in the inducement." Now, only fraud will let them take the homes. Many of the required documents do not exist, and those that do exist would provide proof of the fraud that was involved in loan origination, securitization, and marketing. This in turn would allow investors to force the banks to buy-back the fraudulent securities. In other words, to keep the investors at bay the foreclosing banks must manufacture fake documents. If the original documents do not exist the securities might be ruled no good. If the original docs do exist they will demonstrate that proper underwriting was not done — so the securities might be no good. Foreclosure fraud is the only thing standing between the banks and Armageddon.
We will deal with objections to our proposal in the next piece.