by L. Randall Wray, Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute and author of Understanding Modern Money.
In a surprising turn of events, the NYFed—no less—has gone after the Bank of America for its fraudulent mortgage business. Yes, the former home to Treasury Secretary Geithner–the best friend Wall Street has ever had–is now acting like the lapdog that bites the hand that feeds.
BofA has reacted as expected, trying to slap the little pipsqueak pet back into submission, announcing an end to its moratorium on foreclosure fraud and threatening to unleash its dark army of lawyers who are ready to do battle in the courts to maintain the myth that the junk banks securitized met required underwriting standards.
It is of course all high drama worthy of a mid-afternoon soap opera, with the Fed proclaiming dismay, nay, shock!, that banks sold it toxic waste. The over-acting would be hilarious if this were not such a serious issue.
In truth, it is all fraud, from start to end—from origination of the mortgages through the securitization, on to the duping of investors, and to the foreclosing on (mostly) innocent bystanding homeowners. The FBI warned of an epidemic of mortgage fraud in 2004, investigations demonstrate that 80% of the fraud is at the hands of lenders, and the fraud was no secret within the industry and within government long before the NYFed, USFed, and Treasury started bailing out the control fraud banks by purchasing their assets, guaranteeing their liabilities, lending against toxic waste, and buying their worthless equities—putting Uncle Sam on the hook in an amount estimated to total more than $20 trillion.
Meanwhile, the bank frauds have been kicking Americans out of their homes, manufacturing fake documents, and re-selling property to which they have no legitimate title.
But the past week has not been good for control fraud banks. State Attorneys General have gone after them, thumbing their collective noses at the weak-kneed Obama Administration that had done nothing more than to plead with the frauds to please be a tad bit nicer as they steal homes.
Judges have also gone after banks—noticing how amateurish the doctored and counterfeited documents looked, and they began to throw the bank plaintiffs out of court. We know that in many or most cases the banks do not have the borrowers’ notes—that are required in almost all states to take away someone’s home. Lots of bank officials and employees have committed crimes for which they can be prosecuted and for which they will serve real prison time.
All of this seems to have forced the Fed’s hand. Most bettors had put their money on Fannie and Freddie, not the Fed, to first call the bluff of the bank frauds. They have far more on the line—no doubt they are sitting on well over a trillion dollars worth of junk that does not meet the underwriting standards claimed by the securitizers. To be sure, they had taken some action, but it was the NYFed’s audacity that grabbed the headlines. Hey, there is, finally, the audacity of hope that President Obama used to talk about—funny that it should rest in the hands of the thoroughly compromised NYFed.
The banks, predictably, claim everything is fine. BofA supposedly spent a couple of hours during its self-imposed introspective moratorium to check through hundreds of thousands of foreclosures to ensure that all its procedures were appropriate. Surprise, surprise, it could not find a single mistake! Boy, these guys ARE good, even though they took over the mother of all control frauds, Countrywide Financial—inheriting its toxic waste. Yet, not one error! There is, again, a certain audacity there—perhaps one more in tune with the protect-Wall-Street-at-any-cost sort of song Karaoked so far at the White House.
Right—please sell me a Brooklyn bridge, or two, too. The fraud continues apace. The banks intend to continue to defraud both homeowners and investors in the toxic securities it sold.
How do we know it is all fraud?
Look, when lenders market “low doc”, “Ninja” and “Liar’s loans” (that accounted for half of all mortgages at the peak of the bubble), there is no question that the intent is to defraud investors. The appellations say it all. When lenders market “nuclear” hybrid loans with low teaser rates that blow up in two or three years, forcing borrowers into default, there is no question that the intent is to defraud borrowers. Fraud was the business model. Everyone in the industry knew that—from property appraisers to originators to credit raters to securitizers to insurers. Fraud, fraud, fraud. It is time to break out that F word and to use it liberally.
In an important piece by Felix Salmon, a “smoking gun” is produced. The big investment banks (Goldman, Bear, Citigroup, Merrill, Lehman, Morgan, Deutsche) used Clayton Holdings to do “third-party due diligence” on the mortgages that were pooled into securities. Note that this was most certainly NOT done to protect the investors who would buy the securities—rather it was to SCREW them. Clayton would “taste sample” some of the mortgages (5% to 35%), typically finding that a third or more did not meet underwriting standards. The investment bank would then kick those out and go back to the originator to renegotiate the price on the entire mortgage pool. Since the investment bank had proof that the pool did not meet standards, it would be able to get a better price.
Here’s the kicker. The investment bank did not, and did not want to, examine the whole pool in order to reject all the bad loans. Indeed, it WANTED a bad pool–a package of mortgages that contained many mortgages that did not meet underwriting standards–because this allowed it to reduce the price paid. Then it would tell the investment buyers of the securities “Oh, yes, we did due diligence, using an expert third party”. Of course the investment bank would not pass along the price discount it had obtained from the originator, and would not tell the buyer that the pool still contained an untold amount of junk mortgages. That would defeat the whole purpose of the third party “due diligence”—which was done only for the benefit of the investment bank in order to screw more profits out of the investor. Amazingly, the banks turned “due diligence” into a mechanism for fraud. These guys ARE audacious. They ARE good!
So here we are. The Fed, Fannie and Freddie, Pimco, and other big holders of the securities are now going after the banks. This is going to get really fun.
There is no better time to declare a bank holiday to try to unravel this mess. The banks will not survive the onslaught. The only question is how long do we really want to drag this out? Should we go through years of court battles while the economy suffers and Americans lose their homes? Or do we just get it over this weekend by shutting down the control frauds? Void all the fraudulent paper, let occupants keep their homes and negotiate fair “rents” in lieu of unaffordable mortgages. Swiftly deal with the fall-out. Pursue, prosecute, and incarcerate the guilty. Return the nation to the rule of law.
I’d mention that audacity of hope, but unfortunately it has been strangled and dragged through Main Street to the point that it is no longer recognizable.
Professor Wray also blogs at New Economic Perspectives, and at New Deal 2.0.