The U.S. Attorney Who Prosecutes JPMorgan Will Be Its First Witness

By William K. Black
(Cross Posted at Benzinga.com)

The U.S. Attorney for the Eastern District of California is Benjamin Wagner.

“Once the U.S. government built a case against J.P. Morgan and settlement talks began, the Justice Department made several threats that it would file its civil lawsuit, and each time J.P. Morgan responded by offering to talk more or increase the amount of money it might pay, the people familiar with the discussions said.

One critical moment came as the department set an internal deadline, Sept. 24, to file a suit against the bank.

The day before the deadline, the bank offered to pay $3 billion to settle a case tied to mortgage-backed securities—an offer the attorney general rejected. That same day, Ben Wagner, the U.S. attorney from Sacramento, Calif., flew to Washington with two large charts he meant to display at a news conference describing the bank’s alleged misconduct. A criminal and civil investigation into J.P. Morgan’s past sale of mortgages bonds had been handled by Mr. Wagner’s office.”

Note both aspects of the last paragraph.  To ramp up the pressure on JPMorgan to settle, Wagner was prepared to file a civil suit against JPMorgan.  Press leaks suggest that the suit focuses on Washington Mutual’s (WaMu) control frauds in sale of fraudulent originated mortgages to the secondary market through fraudulent “reps and warranties.”  JPMorgan acquired WaMu.  The same leaks claim that Wagner is pursuing that rarest of investigations under the Bush and Obama administration – a criminal investigation of the elite bankers who led the three most financially destructive epidemics of accounting “control fraud” in history – the twin loan origination fraud epidemics (appraisal and liar’s loans) and the epidemic of fraudulent sales to the secondary market.

Wagner’s, reported, unique pursuit of a criminal case against elite bankers led to “local boy makes good” praise in an October 25, 2013 article entitled “Sacramento’s chief federal prosecutor is the top investigator in JPMorgan Chase case.”

“When U.S. Attorney Benjamin Wagner was a line prosecutor in Sacramento, the Internal Revenue Service loved him.

The agency goes after financial crimes, but they are often complex, hard to prove and time-consuming. Thus, many prosecutors shy away from them as not cost effective, given that white-collar crooks routinely get comparatively light sentences.

But Wagner always welcomed IRS agents and their loads of Byzantine evidence with open arms.

“If we don’t do them, nobody will,” he said in an interview Friday. “We have the resources, sophisticated equipment, specially trained investigators, and national jurisdiction.

‘You can’t look just at the prison time. I personally believe these kinds of cases offer more opportunity for deterrence than other areas, such as street crime,’ he added. ‘Just on a personal level, big, white-collar crime is the most challenging, the most interesting, and the psychology of the defendants is fascinating. It’s very rewarding.’

This viewpoint was recognized after President Barack Obama appointed Wagner in 2009 as U.S. attorney in the Sacramento-based Eastern District of California and he began to have more and more contact with the top brass at the Department of Justice in Washington, D.C.

His high standing there led to Wagner and his office taking on JPMorgan Chase & Co., the nation’s largest bank, over questionable mortgage securities it bundled and sold in the run-up to the financial crisis.

Word of a tentative $13 billion settlement between JPMorgan and various stakeholders leaked out a week ago, and the national press has waxed amazed that a prosecutor from Sacramento is spearheading the Obama administration’s move on the leviathan financial institution. Wagner was even called an ‘upstart’ in one article.

But, when U.S. Attorney General Eric Holder set up a working group ‘to bring more resources to bear on the role of the big banks in the mortgage crisis,’ Wagner was chosen as a member. The group is headed by Tony West, a Holder confidant and the third-ranking official in the department.

It became obvious last year, Wagner said, that “there weren’t enough attorneys in Washington and New York” qualified to investigate the labyrinthian business of the banks, and some U.S. attorneys who head larger offices were recruited for the task.

‘I kinda put my hand up to take the JPMorgan case,” Wagner said. “They (Justice Department officials) have a lot of confidence in this office, so it was natural we would be asked to step up.’

On Sept. 23, Wagner flew to Washington prepared to announce the next day a multibillion-dollar civil suit against the bank. He and his two assistants had amassed what they saw as nationwide evidence of fraudulent activity in the packaging of home loans as securities by JPMorgan in the pre-crisis era.”

I will note three puzzling aspects to this story as preliminaries.  Why did JPMorgan (or WaMu) engage in “nationwide … fraudulent activity” in its sales to the secondary market?  An honest bank does not have to make fraudulent reps and warranties to sell its loans.  The officers controlling a bank engaged in accounting control fraud, however, fraudulently originate hundreds of thousands of bad, often fraudulent, mortgage loans because doing so optimizes the fraud “recipe” for a lender.  Given that I am writing about JPMorgan, I will quote a JPMorgan official making the point.  As Jamie Dimon explained in his March 30, 2012 letter to JPMorgan’s shareholders:

“Low-quality revenue is easy to produce, particularly in financial services.  Poorly underwritten loans represent income today and losses tomorrow.”

Of course, the “income today” is fictional because the bank has, fraudulent, failed to establish loss reserves for the losses that are inevitable “tomorrow.”  Again, the key is the point made by George Akerlof and Paul Romer in their 1993 article (“Looting: The Economic Underworld of Bankruptcy for Profit”) – the fraud recipe for a lender produces three “sure things.”  The lender – even without sales to the secondary market – is sure to report record (albeit fictional) earnings in the near-term, the controlling officers are sure to be made promptly wealthy, and lender will suffer severe losses.

Note that selling the bad loans to the secondary market does not avoid this last “sure thing” because fraudulent originated bad loans can only be sold through fraudulent reps and warranties.  (There is no fraud exorcist – fraudulent originated fraudulent loans remain fraudulent throughout any chain of sale.)  Indeed, Fannie and Freddie’s suits (which DOJ hijacked to claim some of the credit) have made that very point in the context of JPMorgan and over 15 other massive banks.  WaMu and Bear Stearns (which JPMorgan also acquired) and JPMorgan all originated enormous numbers of endemically fraudulent liar’s loans and WaMu was infamous for inflating appraisals.  It was inevitable that if they sold such fraudulently originated mortgages to the secondary market, and they did in enormous amounts, that the sales would have to be made through fraudulent reps and warranties.  If the leaks are accurate, then the FBI and Wagner’s investigation has confirmed this fact.

But note that the DOJ’s vaunted “task force” only investigates secondary market sales of residential mortgages.  So Wagner, according to these reports, only looked at one of the three fraud epidemics and ignored the twin loan origination fraud epidemics.  This is a bizarre means of (dis)organizing an investigation because the two types of fraud by lenders (origination and sale) are inextricably linked and the witnesses and documents needed to understand the fraud schemes overlap.  Ignoring the loan origination fraud could lead jurors to ask the question I posed above – why would the lenders sell loans the DOJ is treating as honest through fraudulent reps and warranties?

Recall that the DOJ leadership and President Obama routinely downplay “fraud” as a cause of the financial crisis, yet the DOJ’s insipid investigations have confirmed “nationwide” fraud by the world’s largest banks.  The DOJ, however, refuses to prosecute anyone to date and refuses to even bring civil fraud cases against the twin epidemics of loan origination fraud.

How can this be?  Wagner exemplifies the answer to the FBI’s and the DOJ’s most profound failure.  Because criminal referrals by the regulatory agencies virtually ceased against elite bankers in this crisis as the anti-regulatory agency heads destroyed the essential agency criminal referral process, the FBI and the DOJ were systematically shorn of vital industry expertise.  The FBI’s white-collar section suffered grievously in response to the 9/11 attacks because the FBI’s leaders transferred hundreds of agents that the leaders viewed as being the best investigators with the best financial investigative skills.  The FBI was so desperate for industry expertise that it formed a “partnership” with the Mortgage Bankers Association (MBA) in 2007.  The MBA foisted a preposterous “definition” of “mortgage fraud” on the FBI and DOJ under which control fraud is defined out of existence and the senior bank leaders are always honest and faithful in their lending.  Thus began the myth of the “Virgin crisis” – conceived without sin in the “C-suites.”

I have long urged reporters to ask the regulators how many criminal referrals they made during this crisis.  David Heath, an investigative reporter at the Huffington Post was the first to do so, over three years ago.  The answers he received (“no referrals”) were chilling, but they began to explain DOJ’s humiliating failure to prosecute any of the Wall Street elites whose frauds drove the crisis.

Heath did the Nation a great service by reporting the death (not dearth) of criminal referrals by regulators.  Heath added to that service by asking the U.S. Attorney for one of epicenters of the accounting control fraud epidemics that drove the crisis to respond to my criticism of DOJ’s failure to prosecute.  The U.S. Attorney responded that accounting control fraud was fictional because it required irrational actions.

“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.”

I was appalled by Wagner’s comment, but delighted to have the claim made publicly, expressly rather than implicitly, and in such stark, unqualified terms.  I wrote him privately to explain accounting control fraud and its decisive role in driving prior crises and the current crisis and to provide citations so he could review the relevant economics, criminology, and regulatory literature.  I gently explained the obvious logical error embedded in his word usage.  “They” refers to the CEO.  “Themselves” refers to the bank.  “They” are not “defrauding themselves.”  The lender’s CEO makes far more money, and obtains a “sure thing” of being made promptly wealthy by causing the lender to make “fraudulent” loans that cause the bank to “lose money.”  I, of course, received no reply.

Wagner thinks the motivation of elite white-collar criminals is mysterious:  “the psychology of the defendants is fascinating.”  The psychology of elite financial frauds can be “fascinating” in the sense of how twisted sociopaths are, but the more typical financial fraud’s motivations are boringly banal – they know that while it would be exceptionally difficult to obtain vast wealth in Tyler Cowen’s fantasy of a “hyper-meritocracy” it is simple to do so through the “sure thing” of accounting control fraud.

If I were JPMorgan’s criminal defense counsel the first witness I would call to testify would be Wagner.  I would have him explain to a jury why loan origination fraud “doesn’t make any sense” for elite bankers and then explain how “reps and warranties” work and why “banks lose money when a loan [sale] turns out to be fraudulent.”  That should blow up Wagner’s case in record time.