The obvious questions are who created these "financial incentives" and why they created incentives so perverse that Wagner labels them "an open invitation" to fraud. The controlling officers of the lenders are decision-makers that shaped these perverse incentives, knew they were creating "an open invitation" to fraud, and continued and often made more perverse those incentives even as they received multiple warnings and data on endemic fraud. Wagner also admits that the group that "took advantage of the opportunities presented" by this "open invitation" to commit fraud includes "mortgage lenders." To state what should be obvious, the only logical reason the lenders' controlling officers would act in this manner is that they were leading accounting control frauds. No honest banker creates and maintains for years perverse "financial incentives" to corrupt the work of everyone critical to prudent lending and sends "an open invitation" to defraud the bank while simultaneously gutting underwriting so as to "create an ideal environment for fraud."
It is important to understand that the lenders' controlling officers deliberately created overwhelmingly powerful and perverse incentives for even the lowest agents and employees in the mortgage "food chain."
"More loan sales meant higher profits for everyone in the chain. Business boomed for Christopher Cruise, a Maryland-based corporate educator who trained loan officers for companies that were expanding mortgage originations. He crisscrossed the nation, coaching about 10,000 loan originators a year in auditoriums and classrooms.
His clients included many of the largest lenders--Countrywide, Ameriquest, and Ditech among them. Most of their new hires were young, with no mortgage experience, fresh out of school and with previous jobs 'flipping burgers,' he told the FCIC. Given the right training, however, the best of them could 'easily' earn millions.
'I was a sales and marketing trainer in terms of helping people to know how to sell these products to, in some cases, frankly unsophisticated and unsuspecting borrowers,' he said. He taught them the new playbook: 'You had no incentive whatsoever to be concerned about the quality of the loan, whether it was suitable for the borrower or whether the loan performed. In fact, you were in a way encouraged not to worry about those macro issues.' He added, 'I knew that the risk was being shunted off. I knew that we could be writing crap. But in the end it was like a game of musical chairs. Volume might go down but we were not going to be hurt.'"
On Wall Street, where many of these loans were packaged into securities and sold to investors around the globe, a new term was coined: IBGYBG, "I'll be gone, you'll be gone." It referred to deals that brought in big fees up front while risking much larger losses in the future. And, for a long time, IBGYBG worked at every level.
The fraudulent lenders often did more than craft powerful, perverse incentives. They also trained employees to make fraudulent loans (while maintaining plausible deniability for the controlling officers). They frequently harmed the employees and officers who tried to stop bad loans rather than praising and promoting them. They refused to remove the perverse incentives.
Cruise explains that by making hundreds of bad loans annually a minor loan employee could "easily" earn millions. (FCIC should have put the words "earn" and "best" in quotations.) Their quintessential prior job (flipping burgers) paid roughly $17,000 annually. Lenders created intense, perverse incentives for loan brokers to seek out and take advantage of unsophisticated borrowers. As the CFPB explained:
"[C]ompensation was frequently structured to give loan originators strong incentives to steer consumers into more expensive loans. Often, consumers paid loan originators an upfront fee without realizing that the creditors in the transactions also were paying the loan originators commissions that increased with the interest rate or other terms."
A loan broker, even lower in the food chain than the loan officials who worked for the lenders, could make $20,000 by brokering a single large "jumbo" loan in which the broker was able to convince the borrowers to pay a materially higher interest rate than the lender was willing to loan to those borrowers at. Most of the compensation was in the form of a kickback from the lender called a "yield spread premium" (YSP). But loan brokers only received these enormous fees if the loan closed, and inflating the borrower's income and the value of the home appraisal was ideal for the fraudulent decision-makers controlling the banks so they created overwhelming incentives to produce millions of frauds yet maintain plausible deniability.
The leaders of accounting control frauds understand how effective compensation is in producing endemic fraud while maintaining a sheen of deniability. The Business Roundtable (lobbyist for the 100 largest U.S. corporations) had to appoint a spokesperson to explain the Enron-era frauds to the media. They, because it is impossible to compete with unintentional self-parody, chose Franklin Raines, Fannie Mae's CEO, and Business Week asked him to explain why there were so many elite securities frauds. Raines responded:
"Don't just say: 'If you hit this revenue number, your bonus is going to be this." It sets up an incentive that's overwhelming. You wave enough money in front of people, and good people will do bad things.'"
Given that the SEC would soon sue Fannie Mae claiming that Raines had created just such perverse incentives this is another case of unintentional irony (and candor).
Financial CEOs knew that the perverse financial incentives they crafted would prove decisive. Consider these two statements by another unintentionally ironic CEO, William Dallas, whose bank made the OCC's "worst of the worst" list. Ask yourself how Dallas expected others to respond to the perverse incentives that he admitted led him to make loans he knew would cause grave losses.
Savor the facts reported in the introductory paragraph in the May 8, 2007 New York Times article entitled "East Coast Money Lent Out West" that sets out how much money one was "routinely" guaranteed to make through accounting control fraud. The context is a report on the 2006 failure of the Dallas mortgage banking firm, Ownit:
"Gone are the lavish parties, the extravagant trips and the executive salaries and sales commissions that routinely topped a million dollars."
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