How to Prosecute the Elite Bank CEO that Led the Frauds that Drove the Crisis

By William K. Black

Step one: Understand the three “control fraud” epidemics that drove the crisis.

Control fraud occurs when the person that controls a seemingly legitimate entity uses it as a “weapon to defraud.”  In finance, accounting is the “weapon of choice.”  Lenders engaged in accounting control fraud display the four “ingredients” of the fraud “recipe.”

  1. Grow massively by
  2. Making loans at a premium yield that are so bad that they will produce losses
  3. Employing extreme leverage and
  4. Providing only trivial allowances for loan and lease losses (ALLL)

The recipe produces three “sure things.”  The lender will report record profits in the near term, the controlling officers will promptly be made wealthy through modern executive compensation, and the firm will suffer catastrophic losses.  The recipe is also an ideal means to hyper-inflate a financial bubble in real estate, which can delay loss recognition for many years.  Minor variants on this recipe drove the savings and loan debacle and the Enron-era frauds.

An honest home lender would never engage in two fraudulent loan origination practices that became epidemic – appraisal fraud and making endemically fraudulent “liar’s” loans.  The Financial Crisis Inquiry Commission (FCIC) found:

“From 2000 to 2007, a coalition of appraisal organizations … delivered to Washington officials a public petition; signed by 11,000 appraisers…. [I]t charged that lenders were pressuring appraisers to place artificially high prices on properties [and] “blacklisting honest appraisers” and instead assigning business only to appraisers who would hit the desired price targets.

One 2003 survey found that 55% of the appraisers had felt pressed to inflate the value of homes; by 2006, this had climbed to 90%” (FCIC 2011: 18, 91).

The appraisal is the lender’s great protection against loss so no honest lender would extort appraisers to inflate appraisals, but extortion was the norm at lenders making endemically fraudulent liar’s loans (FCIC 2011: 110-111).  Fraudulent lenders inflated the appraised value in order to make the loans appear safer by purportedly “compensate[ing]” for the borrower’s fraudulently inflated income (FCIC 2011: 166).  It was overwhelmingly the lenders and their agents who put the lies in liar’s loans.  (Yes, you read that correctly – the fraudulent lenders had the chutzpah to use fraudulently inflated home values to “compensate” when reviews discovered that the lenders had had fraudulent inflated the borrower’s income, and vice versa.)  This aided the third control fraud epidemic – the sale of fraudulently originated mortgages to the secondary market through endemically (45%) fraudulent “representations and warranties” (FCIC 2011: 166).  There is no fraud exorcist, so fraudulently originated loans stay fraudulent and can only be sold to the secondary market through fraud.

Step 2:  Restore the destroyed criminal referral process, restore the partnership with the banking regulatory agencies, and end the partnership with the “perps”

To produce over 1,000 felony convictions in cases the Department of Justice (DOJ) designated as “major” during the S&L debacle, the Office of Thrift Supervision (OTS) made over 30,000 criminal referrals.  In this crisis, which is over 70 times larger than the debacle in terms of losses and fraud, OTS made zero criminal referrals, as did the Office of the Comptroller of the Currency and the Federal Reserve.  (The FDIC is smart enough to refuse to answer how many referrals it made.)  The OTS “Criminal Referral Coordinators” that once provided the finest criminal referrals were eliminated during the run up to the crisis.  It was open season on America for fraudulent bank CEOs.

Criminal referrals by the banking regulators are not “important” – they are essential to prosecute an epidemic of control financial control fraud.  There are only 2,300 FBI white-collar investigators and there are over 1,000 industries.  There are two FBI agents per industry so they rarely have industry expertise (particularly after the section’s best financial investigators were transferred to fight terrorism) and they cannot “walk a beat.”  They investigate when there is a criminal referral and banks don’t make criminal referrals against their own CEOs.  Whistleblowers are helpful, but only come forward episodically.  The recent civil case that DOJ won against Bank of America was made possible by a whistleblower.  It was a travesty that at the press conference announcing the filing of the civil case (which should have been a criminal prosecution) the DOJ did not praise the whistleblower and urge other whistleblowers to come forward.  Only the banking regulators have the expertise, resources, and (if properly led) the incentives to make the successful prosecution of the CEOs that lead the fraud epidemics possible and a top priority.

The criminal referral process is only one vital aspect of what the regulators must add to the DOJ and the FBI’s efforts.  The regulators must provide the expertise to the FBI and DOJ to allow them to understand the arcane, complex financial world we inhabit.  During the S&L debacle we were critical contributors to the training of FBI agents and DOJ attorneys, we served as internal experts to the FBI on the highest priority investigations (we “detailed” examiners to report to the FBI so that our personnel could have access to grand jury materials and help the FBI and DOJ analyze those statements and documents), we worked with the FBI and DOJ to prioritize the 100 worst fraud schemes (involving 300 S&Ls and over 600 individuals) so that the highest priority, most elite defendants were prosecuted.  We serve as the “Sherpas” – we do the heavy investigative lifting that allows DOJ to climb mountains and we serve as the trial guides that show how to get to the summit by explaining to the FBI, DOJ, judges, and juries why these frauds are led by the CEO.

None of the steps I have just described are happening now.  The FBI and the DOJ did not have to reinvent the wheel.  Sadly, they are acting as if they have forgotten that wheels exist.  The FBI, desperate for industry expertise because the regulators deserted the field by ending criminal referrals, formed a “partnership” with the Mortgage Bankers Association (MBA) in 2007.  The MBA is the trade association of the “perps” – the mortgage lenders who committed the three mortgage fraud epidemics.  The MBA’s “contribution” to the “partnership” was a faux definition of “mortgage fraud” under which the lender is always the victim and the purported villains are cunning hairdressers defrauding the poor Wall Street bankers who make $500,000 annual salaries when they are hired (and whose bonuses far exceed those salaries).  As astonishing as it may seem, the FBI and DOJ swallowed this facially ridiculous myth of the Virgin Crisis conceived without sin in the C-suite whole.  The DOJ prosecutor who is conducting the criminal investigation of JPMorgan exemplifies the crippling effects of the myth.

“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. ‘It doesn’t make any sense to me that they would be deliberately defrauding themselves,’ Wagner said.”

Wagner has forgotten the leading fraud scheme that drove the S&L debacle and the Enron-era frauds – accounting control fraud by which the CEO (“they”) loots the firm (“themselves”).  Wagner thinks the CEO and the bank are the same entities.  JPMorgan will probably call him as their first defense witness if he does ever prosecute them.

Collectively, our efforts produced a 90% conviction rate in these elite cases despite going up against the best criminal defense lawyers in the world.  We know how to successfully prosecute the most elite financial frauds.  It is desperately late in terms of the statute of limitations, but if President Obama instructed the banking regulators to make the steps I’ve outlined a top priority we can snatch victory from DOJ’s most embarrassing strategic defeat.  As of today, there are still zero prosecutions of the elite bankers who led the three mortgage fraud epidemics that drove the crisis.  Not a single elite banker who grew wealthy by leading the fraud epidemics has had that wealth removed, or even dramatically reduced by DOJ.

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