The Tea Party regards Barack Obama as a kind of devil figure, but when it comes to hunting down the fraudsters responsible for the economic disaster of the last six years, his administration has stuck pretty close to the Tea Party script. The initial conservative reaction to the disaster, you will recall, was to blame the crisis on the people at the bottom, on minorities and proletarianslost in an orgy of financial misbehavior. Sure enough, when taking on ordinary people who got loans during the real-estate bubble, the president’s Department of Justice has shown admirable devotion to duty, filing hundreds of mortgage-fraud cases against small-timers.
But high-ranking financiers? Obama’s Department of Justice has thus far shown virtually no interest in holding leading bankers criminally accountable for what went on in the last decade. That is ruled out not only by the Too Big to Jail doctrine that top-ranking Obama officials have hinted at, but also by the same logic that inspires certain conservative thinkers—that financiers simply could not have committed fraud, since you would expect fraud to result in riches and instead so many banks went out of business.
“Benjamin Wagner, a U.S. Attorney who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points out that banks lose money when a loan turns out to be fraudulent,” reported a now-famous 2010 story in the Huffington Post. “But convincing a jury that executives intended to make fraudulent loans, and thus should be held criminally responsible, may be too difficult of a hurdle for prosecutors. ‘It doesn’t make any sense to me that they would be deliberately defrauding themselves,’ Wagner said.”
So forget those thousands of hours of Congressional investigation and those thousands of pages of journalism on the crisis. It doesn’t make any sense to the man in charge. No jury would be convinced. Case closed.
As it happens, a trial just ended in Sacramento in which a jury was convinced that “executives intended to make fraudulent loans.” Here’s the thing, though: It wasn’t the government that made the case against the financiers; it was the defendants.
*
The case started as a routine mortgage-fraud prosecution, brought by none other than the aforementioned U.S. Attorney Benjamin Wagner. A group of eastern European immigrants had bought houses in California in 2006, in a real-estate market that was in the early stages of collapse. According to the indictment, filed in 2012, these people’s mortgage applications contained blank spots and wrong information; they were accused of getting the mortgages in order to sell the houses to one another at pumped-up prices in what is called a “straw buyer” scheme. Also, they defaulted on the loans.
However, members of the immigrants’ legal defense team—several of them appointed by the state—had read the newspapers over the years and were aware of the kinds of things that had gone on in real estate during the bubble. They knew, for example, that in the go-go days of the last decade, the mortgage origination industry routinely cranked out “stated income” loans—also known as “liar’s loans”—to people who were obviously unable to make the payments. The bankers back then almost never checked on whether the borrower was telling the truth about their income; they just wanted to make the loan. So the defense team in Sacramento came up with a novel strategy: How can the borrower have committed fraud on a mortgage application if the lender didn’t care whether their answers were truthful?
And lenders so didn’t care back in the bubble days. They invented liar’s loans and blanketed the country with them during the Oughts not because the poors talked them into doing it, or because the liberals in the Bush Administration forced them to do it—on the contrary, the government warned them against issuing these things, just as the government warns us against swallowing arsenic. The reason bankers did it was because liar’s loans were making bankers rich.
This is a difficult thing to understand—indeed, not understanding it is the stated reason Obama Administration officials have made no effort to send financiers to jail—so let us take this slowly. Executives at the mortgage origination companies got huge bonuses in those days for writing lots of loans. OK? They wanted to write more of them, and the only way to really crank out mortgages on a vast scale was by giving one to anyone who wanted one, regardless of their ability to pay, a feat that is only possible by means of the “liar’s loan.” So: Liar’s loans = rich bankers.
Now, it just so happens that liar’s loans are a lousy product, something that is virtually guaranteed to fail when prices stop rising, something that everyone knew at the time would fail when the bubble burst. That’s why you don’t see liar’s loans when banks are honest and regulators are on the job. Because the bank that makes liar’s loans—and the investor who buys a security based on liar’s loans—will eventually lose their money. That’s why they are banned today. So: Liar’s loans = dead banks. Liar’s loans = slow-acting arsenic. But on the other hand, the immediate bonuses that mortgage execs were collecting for making these poisonous loans were so sweet that they didn’t really care about the long-term effects. So while those awful loans they wrote eventually sank all the big subprime houses—and wrecked the global economy to boot, with Europe still in ruins, etc.—the bankers themselves lived to sail away into the sunset, their yachts laden with bullion.
Do you see what I’m saying? Executives do not always share the interests of the corporation that employs them. They weren’t “defrauding themselves,” as our federal protector laughs, they were defrauding the suckers that paid their bonuses, the shareholders that invested in them, the European pension funds that believed their excreta was Grade A Prime.
The name for this kind of scheme is a “control fraud”; it happens when the officers who control a firm use their power over the firm to enrich themselves while driving the firm itself to the boneyard. The country has seen control frauds many times before; indeed, the man who invented the term was a regulator of S&Ls during the S&L meltdown of the 1980s, and he saw the pattern so many times back then that he wrote a book about it. I am referring to my friend Bill Black, a professor of economics and law at the University of Missouri-Kansas City and also a Distinguished Scholar in Residence for Financial Regulation at the University of Minnesota’s School of Law. Control fraud, Black says, always follows the same recipe, with banks growing rapidly by making vast numbers of extremely risky loans, executives immediately getting rich with big bonuses, and the bank eventually collapsing under the weight of those malicious loans.
The last decade’s epidemic of crap financial instruments—liar’s loans, NINJA loans, interest-only ARMs and all the rest—fit the pattern perfectly. “It makes no sense for an honest banker to lend in this fashion,” Black told me. “If you lend in this fashion, you will suffer catastrophic losses. So honest banks don’t make loans without effective underwriting. But dishonest banks find, under the fraud recipe, that it optimizes their fraud scheme. To make not just a few bad loans, but to have a regular practice of making, day in and day out, enormous numbers of bad loans. . . . You’re mathematically guaranteed to make the officers rich and then they can walk away while the place collapses.”
*
Bill Black worked for many years as a bank regulator and a lawyer for the Federal government, but these days the Federal government has little interest in litigation against bankers. That’s why the mortgage-fraud case in Sacramento saw him appearing as an expert witness for the defense, on whose behalf he testified at great length about the role of control fraud in pumping the real-estate bubble.
The defense wanted the jury to hear Black’s theory because the essence of our government’s law-enforcement work on mortgage fraud is that banks were the victims. Those poor unfortunate financiers were tricked by little people like the “neighbor” that Rick Santelli once ranted against, trying to get an extra bathroom that he didn’t deserve.
What the defense team sought to prove was that this picture was completely upside-down—that the banks didn’t care if people lied on liar’s loans. According to the legal definition of fraud, the lie in question has to be “material,” meaning it has to influence the decision-makers. When a bank is honest, that is an easy thing to show. But it’s different if the decision-makers are themselves trying to crank out lousy (but profitable) loans. Bill Black again, on the control-fraud formula:
“Not only are they not distressed by crappy loans, they must make crappy loans. That’s the fraud recipe. . . . If the decision-makers are running a fraud in which they want this outcome, then they’re going to approve these loans. And they will create a system designed to approve loans that are 90 percent fraudulent.”
(cont'd)
But high-ranking financiers? Obama’s Department of Justice has thus far shown virtually no interest in holding leading bankers criminally accountable for what went on in the last decade. That is ruled out not only by the Too Big to Jail doctrine that top-ranking Obama officials have hinted at, but also by the same logic that inspires certain conservative thinkers—that financiers simply could not have committed fraud, since you would expect fraud to result in riches and instead so many banks went out of business.
“Benjamin Wagner, a U.S. Attorney who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points out that banks lose money when a loan turns out to be fraudulent,” reported a now-famous 2010 story in the Huffington Post. “But convincing a jury that executives intended to make fraudulent loans, and thus should be held criminally responsible, may be too difficult of a hurdle for prosecutors. ‘It doesn’t make any sense to me that they would be deliberately defrauding themselves,’ Wagner said.”
So forget those thousands of hours of Congressional investigation and those thousands of pages of journalism on the crisis. It doesn’t make any sense to the man in charge. No jury would be convinced. Case closed.
As it happens, a trial just ended in Sacramento in which a jury was convinced that “executives intended to make fraudulent loans.” Here’s the thing, though: It wasn’t the government that made the case against the financiers; it was the defendants.
*
The case started as a routine mortgage-fraud prosecution, brought by none other than the aforementioned U.S. Attorney Benjamin Wagner. A group of eastern European immigrants had bought houses in California in 2006, in a real-estate market that was in the early stages of collapse. According to the indictment, filed in 2012, these people’s mortgage applications contained blank spots and wrong information; they were accused of getting the mortgages in order to sell the houses to one another at pumped-up prices in what is called a “straw buyer” scheme. Also, they defaulted on the loans.
However, members of the immigrants’ legal defense team—several of them appointed by the state—had read the newspapers over the years and were aware of the kinds of things that had gone on in real estate during the bubble. They knew, for example, that in the go-go days of the last decade, the mortgage origination industry routinely cranked out “stated income” loans—also known as “liar’s loans”—to people who were obviously unable to make the payments. The bankers back then almost never checked on whether the borrower was telling the truth about their income; they just wanted to make the loan. So the defense team in Sacramento came up with a novel strategy: How can the borrower have committed fraud on a mortgage application if the lender didn’t care whether their answers were truthful?
And lenders so didn’t care back in the bubble days. They invented liar’s loans and blanketed the country with them during the Oughts not because the poors talked them into doing it, or because the liberals in the Bush Administration forced them to do it—on the contrary, the government warned them against issuing these things, just as the government warns us against swallowing arsenic. The reason bankers did it was because liar’s loans were making bankers rich.
This is a difficult thing to understand—indeed, not understanding it is the stated reason Obama Administration officials have made no effort to send financiers to jail—so let us take this slowly. Executives at the mortgage origination companies got huge bonuses in those days for writing lots of loans. OK? They wanted to write more of them, and the only way to really crank out mortgages on a vast scale was by giving one to anyone who wanted one, regardless of their ability to pay, a feat that is only possible by means of the “liar’s loan.” So: Liar’s loans = rich bankers.
Now, it just so happens that liar’s loans are a lousy product, something that is virtually guaranteed to fail when prices stop rising, something that everyone knew at the time would fail when the bubble burst. That’s why you don’t see liar’s loans when banks are honest and regulators are on the job. Because the bank that makes liar’s loans—and the investor who buys a security based on liar’s loans—will eventually lose their money. That’s why they are banned today. So: Liar’s loans = dead banks. Liar’s loans = slow-acting arsenic. But on the other hand, the immediate bonuses that mortgage execs were collecting for making these poisonous loans were so sweet that they didn’t really care about the long-term effects. So while those awful loans they wrote eventually sank all the big subprime houses—and wrecked the global economy to boot, with Europe still in ruins, etc.—the bankers themselves lived to sail away into the sunset, their yachts laden with bullion.
Do you see what I’m saying? Executives do not always share the interests of the corporation that employs them. They weren’t “defrauding themselves,” as our federal protector laughs, they were defrauding the suckers that paid their bonuses, the shareholders that invested in them, the European pension funds that believed their excreta was Grade A Prime.
The name for this kind of scheme is a “control fraud”; it happens when the officers who control a firm use their power over the firm to enrich themselves while driving the firm itself to the boneyard. The country has seen control frauds many times before; indeed, the man who invented the term was a regulator of S&Ls during the S&L meltdown of the 1980s, and he saw the pattern so many times back then that he wrote a book about it. I am referring to my friend Bill Black, a professor of economics and law at the University of Missouri-Kansas City and also a Distinguished Scholar in Residence for Financial Regulation at the University of Minnesota’s School of Law. Control fraud, Black says, always follows the same recipe, with banks growing rapidly by making vast numbers of extremely risky loans, executives immediately getting rich with big bonuses, and the bank eventually collapsing under the weight of those malicious loans.
The last decade’s epidemic of crap financial instruments—liar’s loans, NINJA loans, interest-only ARMs and all the rest—fit the pattern perfectly. “It makes no sense for an honest banker to lend in this fashion,” Black told me. “If you lend in this fashion, you will suffer catastrophic losses. So honest banks don’t make loans without effective underwriting. But dishonest banks find, under the fraud recipe, that it optimizes their fraud scheme. To make not just a few bad loans, but to have a regular practice of making, day in and day out, enormous numbers of bad loans. . . . You’re mathematically guaranteed to make the officers rich and then they can walk away while the place collapses.”
*
Bill Black worked for many years as a bank regulator and a lawyer for the Federal government, but these days the Federal government has little interest in litigation against bankers. That’s why the mortgage-fraud case in Sacramento saw him appearing as an expert witness for the defense, on whose behalf he testified at great length about the role of control fraud in pumping the real-estate bubble.
The defense wanted the jury to hear Black’s theory because the essence of our government’s law-enforcement work on mortgage fraud is that banks were the victims. Those poor unfortunate financiers were tricked by little people like the “neighbor” that Rick Santelli once ranted against, trying to get an extra bathroom that he didn’t deserve.
What the defense team sought to prove was that this picture was completely upside-down—that the banks didn’t care if people lied on liar’s loans. According to the legal definition of fraud, the lie in question has to be “material,” meaning it has to influence the decision-makers. When a bank is honest, that is an easy thing to show. But it’s different if the decision-makers are themselves trying to crank out lousy (but profitable) loans. Bill Black again, on the control-fraud formula:
“Not only are they not distressed by crappy loans, they must make crappy loans. That’s the fraud recipe. . . . If the decision-makers are running a fraud in which they want this outcome, then they’re going to approve these loans. And they will create a system designed to approve loans that are 90 percent fraudulent.”
(cont'd)