I congratulate everyone involved with the successful prosecutions. The TBW/Colonial Bank cases are the exceptions that prove the rule – the senior officers of the large nonprime lenders that caused the financial crisis have been able to loot with impunity. How did the TBW/Colonial Bank frauds come to prosecuted? They were very special cases and their frauds and their investigations reveal many of the pathologies that explain the severity of this crisis and the underlying frauds. First, according to the Department of Justice (DOJ), TBW was already failing by early 2002 – nine years ago! TBW was able to continue a fraud for over seven years (it was closed in 2009).
Court documents state that in early 2002, Bowman learned that TBW began running overdrafts in its master bank account at Colonial Bank because of TBW’s inability to meet its operating expenses….
Second, in addition to the fraud against Colonial Bank, TBW defrauded Freddie Mac by selling to Freddie Mac the same assets (bad loans) it was purportedly selling to Colonial Bank.
In his statement of facts, Bowman admitted that he learned from Farkas and other co-conspirators at TBW that within a year of its creation, Ocala Funding had a significant collateral deficit. As Bowman acknowledged, the government could prove that by August 2009, that deficit had grown to approximately $1.5 billion and that TBW had caused Colonial Bank and the Federal Home Loan Mortgage Corporation (Freddie Mac) to falsely believe that they each had an undivided ownership interest in thousands of the same loans worth hundreds of millions of dollars.
Third, note that while a Colonial Bank officer pleaded guilty for assisting these frauds against Colonial Bank, no one has pleaded guilty at Freddie Mac. The critical question is whether TBW actually delivered the key loan documents to Freddie Mac. Did Freddie Mac obtain an enforceable security interest or was it defrauded by TBW? Was Colonial Bank the only victim of the double sale/pledge?
Fourth, a number of states identified severe problems with TBW, and brought actions against it, before the Federal authorities took any action. Similarly, Alabama took the lead in closing Colonial Bank.
In August 2009, the Alabama State Banking Department, Colonial Bank’s regulator, seized the bank and appointed the FDIC as receiver.
Fifth, the criminal case was brought to the FBI’s attention by the Special Inspector General for the TARP program (SIGTARP) and perhaps the HUD/FHA inspectors. The FDIC did not initiate the criminal case or produce the key investigative findings. The record of the banking regulatory agencies’ failure to identify and make criminal referrals against the fraudulent lenders that drove the crisis remains intact.
Sixth, the task force that supported the TBW/Colonial Bank investigation did not include federal banking examiners or supervisors. The only federal banking regulatory personnel listed as supporting the investigation are the FDIC’s OIG staff. That is disturbing. The FDIC OIG is not expert in banking or banking fraud. It is an internal audit unit and its reports on failed banks reveal a repeated inability to identify fraud even when they describe actions that only make sense if the failed bank’s officers were engaged in accounting fraud. The FDIC has hundreds of examiners who have far greater expertise than their internal auditors with respect to banks and bank frauds. Again, even the FDIC (and the FDIC is by far the most vigorous of the federal banking regulatory agencies) did not make support for the first major fraud prosecution of a large nonprime lenders’ officers a priority.
Seventh, TBW was not subject to the Community Reinvestment Act. Its senior officers caused it to make bad loans, and cover up the losses on those bad loans in order to produce fictional short-term accounting income that would cause their compensation to increase. The title to Akerlof & Romer’s 1993 article says it all: “Looting: the Economic Underworld of Bankruptcy for Profit.” The question is why Freddie Mac would purchase loans from a mortgage banker that was notorious for the poor quality of its underwriting. The answer is that Freddie Mac’s senior managers’ rose dramatically when they purchased bad loans at a premium yield.
Eighth, the senior managers of Colonial Bank were either in on the fraud or grossly negligent. They allowed their SVP in charge of their Mortgage Warehouse Lending Division to assist TBW in carrying out an enormous, crude series of frauds for seven years. Colonial Bank’s controlling officers and directors also appear from the DOJ allegations to have entered into transactions designed to fund TBW’s fraudulent capital injection into Colonial Bank.
Ninth, neither the FHA nor the FDIC appear to have spotted any of these frauds even though they were enormous, crude, and growing over a seven year period. Indeed, the FHA and the FDIC appear to have been supportive for some time of TBW’s fraudulent (and fictional) injection of capital into Colonial Bank. The FHA allowed TBW and Colonial to grow so rapidly that they became among the FHA’s largest providers.
Tenth, the DOJ’s March 14, 2011 press release that I have been quoting from makes one point quite forcefully.
This prosecution was brought in coordination with President Barack Obama’s Financial Fraud Enforcement Task Force. President Obama established the interagency Financial Fraud Enforcement Task Force to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes.
Got that, “President Obama” deserves the credit. There’s some truth to this PR. President Bush’s Attorney General Mukasey notoriously refused to create a national task force to investigate the accounting control frauds that caused this crisis. He claimed that the mortgage frauds were so small-time that they were the equivalent of “white-collar street crimes.”
Mukasey was right in a way – because he was so wrong. Under his leadership the FBI investigated only the small time mortgage frauds. There are two great truths to investigating epidemics of accounting fraud:
- If you don’t look; you don’t find
- Wherever you look; you will find
Because he refused to look at the massive frauds he didn’t find any of the massive mortgage frauds. Because he looked at the small frauds he found tens of thousands of small frauds. Because his staff found only minor frauds he assigned only a minimal number of FBI agents to investigate mortgage fraud (120 nationwide in FY 2007 – one-eighth of the number of FBI agents assigned to investigate S&L frauds during the S&L debacle even though the current crisis is dramatically more severe than the S&L debacle). His staff of FBI agents assigned to mortgage fraud cases was divided up among scores of field offices. That meant that no field office could investigate even one of the large nonprime lenders. (The military rightly condemns these tiny units incapable of effective action against a major foe as “penny packets.”) Because his penny packets assigned to investigate the smaller frauds found – smaller frauds – Mukasey reached the “logical” conclusion that their investigations confirmed his assumption that mortgage fraud was equivalent to “white-collar street crime.”
Senator Obama warned of the wave of mortgage fraud and called for increased budgets for the FBI and DOJ to investigate and prosecute the frauds. He could have made the investigation and prosecution of the major accounting control frauds one of the nation’s top priorities. The result would have transformed his administration and the public support for those holding the elite frauds accountable. The DOJ press release says all the right things.
President Obama established the interagency Financial Fraud Enforcement Task Force to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes.
But DOJ has not “walked the walk.” Instead, we have one case brought not because of the underlying accounting fraud involving its lending, but because the leaders of the accounting control fraud sought to rip off TARP and came to the attention of one of our two (the other is Elizabeth Warren) most vigorous and effective public servants – Neil Barofsky (SIGTARP). Unfortunately, Mr. Barofsky has resigned.