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The Incredible Con the Banksters Pulled on the FBI

By       Message William K. Black, J.D., Ph.D.       (Page 1 of 2 pages)     Permalink    (# of views)   5 comments

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This is the second in my series of articles based on the FBI's most (2010) "Mortgage Fraud Report."

In my first column I began the explanation of how many analytical conclusions one can draw from a close reading of what is left out of the FBI report.

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In particular, I emphasized the death of criminal referrals by the SEC and the banking regulatory agencies.  The FBI report implicitly confirms the investigative reporting of David Heath that first quantified the death of criminal referrals by the banking regulatory agencies.

Because banks will not make criminal referrals against their own CEOs, this means that criminal referrals have virtually vanished against the "accounting control frauds" that drive our recurrent, intensifying financial crises.  As George Akerlof and Paul Romer explained in their famous 1993 article ("Looting: The Economic Underworld of Bankruptcy for Profit") the death of prosecutions of the controlling officers of banks will lead to accounting control fraud becoming a "sure thing."

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[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution? (1993: 4-5).

In criminology jargon, the death of criminal referrals has created an intensely criminogenic environment which creates incentives so perverse that accounting control fraud can become epidemic.

The central puzzle is how the largest epidemics of elite white-collar crime in history, frauds that drove the ongoing financial crisis and made the Wall Street banksters wealthy beyond their most avaricious dreams, resulted in not a single conviction of those elite frauds.  The FBI report allows us to figure out some of the key missing puzzle pieces that explain this tragic mystery.

This article (and the next) focus on the brilliant con that the mortgage lending industry was able to pull on the FBI because the banking regulatory agencies and the SEC failed to provide the FBI with the expertise and investigative findings of fraud essential for the FBI and the Department of Justice (DOJ) prosecutors to succeed in investigating and prosecuting the officers controlling complex frauds.  Three key facts are essential for the public to understand the FBI's total dependence on criminal referrals from the banking regulatory agencies.  First, "control frauds" cause greater financial losses than all other forms of property crime -- combined.  "Accounting control frauds" must gut their underwriting process and internal controls in order to make massive amounts of bad loans.  That is equivalent to hanging a sign on the front door inviting thieves to rob the bank with impunity.

Second, the FBI has roughly 2,300 white-collar specialists and our Nation has over 1,300 industries.  That means that the FBI "specialists" will rarely have expertise in the industry they are investigating.  It also means that FBI agents do not "walk a beat."  They only investigate when they receive a criminal referral alerting them to a possible white-collar crime.  The only sure (and generally safe) means by which they can gain the essential expertise about the industry and its fraud schemes is from the federal regulators.

Third, banks virtually never make criminal referrals against the people who control them.  This means that only the regulators will make criminal referrals against the elite banksters.  If the regulators do not make criminal referrals the FBI agents will never learn of the control frauds.  The (minor) exception is whistleblowers.  Whistleblowers, however, are rare and typically are too low in the food chain to have direct evidence of the controlling officers' frauds.  Whistleblowers cannot stop or even impede materially an epidemic of control fraud.  Only the regulators can bring the necessary expertise, resources, relentless attention, and vigor to make the criminal referrals (and take a vast range of other actions) essential to stem an epidemic of control fraud and prosecute many hundreds of elite white-collar criminals.  In the vastly smaller S&L debacle our agency, the Office of Thrift Supervision (OTS), made over 30,000 criminal referrals and produced over 1,000 felony convictions in cases designated as "major" by DOJ.

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So we return to the question this column addresses -- how could the DOJ make zero criminal prosecutions of the elite banksters that caused this crisis through the twin epidemics of accounting control fraud by lenders (appraisal fraud and fraudulent "liar's" loans)?  The FBI Report shows (indirectly) that the answer is an exceptionally effective con run by the mortgage industry on the FBI.  The con could have never succeeded had the banking regulators not ceased making criminal referrals and providing their expertise to the FBI and DOJ on accounting control fraud schemes.  The OTS was supposed to regulate Countrywide, Washington Mutual (WaMu), and IndyMac -- three of the most notorious fraudulent lenders in the world.  The OTS made zero criminal referrals in this crisis -- which was over 70 times worse than the S&L debacle in terms of losses and fraud.

The FBI's Perverted "Partnership" with the Perps' Lobbyists

In the absence of the banking regulators providing the essential criminal referrals and expertise, the FBI took two seemingly logical, but disastrous steps.  First, they focused on the criminal referrals they did receive -- from the lenders.  My fourth column in this series will explain why that proved so harmful.  Second, in 2007 as the fraudulent mortgage lenders began to collapse on a twice weekly basis the FBI formed what it called a "partnership" with the Mortgage Bankers Association (MBA) -- the trade association of the "perps."

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William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)

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