Category Archives: William K. Black

What if the SEC investigated Banks the way it is investigating Mutual Funds?

Posted on December 27, 2011 by | Comments Off on What if the SEC investigated Banks the way it is investigating Mutual Funds?

By William K. Black 

The Wall Street Journal ran a story today (12/27/11) entitled “SEC Ups Its Game to Identify Rogue Firms.”

“Rogue” is an interesting word with a range of definitions. When it is used as an adjective its meaning is: “a playfully mischievous person; scamp.” The trivialization of the most destructive elite frauds is one of the most common forms of what criminologists call “neutralization” of the moral content of wrong doing. Neutralization increases crime.

The actual story makes it clear that the criminals that the SEC was identifying were not “rogues.” They were the CEOs of seemingly legitimate firms. The SEC is identifying “accounting control frauds” – the frauds that cause greater financial losses than all other forms of property crime combined. The SEC is not identifying a few rotten apples, but roughly 100 hedge funds likely to have engaged in accounting fraud. The WSJ describes the SEC’s identification system:

“The list is the low-tech product of a high-tech effort by the SEC to crack down on fraud at hedge funds and other investment firms. After the agency failed to detect the $17.3 billion Ponzi scheme by Bernard L. Madoff, who wowed investors with steady returns over several decades, SEC officials decided they needed a way to trawl through performance data and look for red flags that might signal a possible fraud.

In 2009, the SEC began developing a computer-powered system that now analyzes monthly returns from thousands of hedge funds. Officials won’t say exactly how it works or how much it cost to build, but the agency has announced four civil-fraud lawsuits filed as a result of what it calls the “aberrational performance initiative.””The SEC should be applauded for finally understanding that “if it’s too good to be true; it probably isn’t true.” Our agency put a similar system in place in 1984 to identify the S&L accounting control frauds that were driving that crisis. A quarter-century later, the SEC began to follow our well-trodden trail – but only with regard to felons inhabiting the middle of the fraud food chain (hedge funds). 

The SEC has, inevitably, discovered that accounting fraud is common among hedge funds. It is unlikely that the SEC system is really “high-tech” in information science terms. Low-tech information systems have been capable of identifying “aberrational performance” for at least thirty years. We did not have to create any pioneering software in 1984 in order to identify aberrational performance. The cost and time to create our “red flags” was trivial (a few hours of programming time by an agency staffer). (We were collecting the data and computing the necessary ratios anyway. One simply decides the level of a few key variables worthy of being flagged. There’s nothing magic about a “flag.” All it means is that suspicious levels are highlighted on the computer screen and on physical copies of the periodic reports so that they capture the reader’s attention.)

The SEC took two years to create its “aberrational performance” system and is embarrassed enough about the cost that it wants to keep it secret. The two year development process allowed the SEC to make a major advance relative to our system – they invented a title consisting of two words and eight syllables. Devising a title that recondite doubtless accounts for six months of the time it took the SEC to develop its flags.

The most interesting aspects of the WSJ story, however, are two unexamined topics that should have been central to the story. First, there is not a word in the article about criminal prosecutions for the frauds the SEC has identified. The frauds, as described in the article, are so blatant that they would make relatively simple to prosecute. There is no indication that the SEC wanted the WSJ to know that they had made well over a hundred criminal referrals against hedge fund CEOs and senior officers. There is no indication that the WSJ reporters were interested in whether the SEC had made criminal referrals against these moderately elite felons. As a result, we have no information on whether the SEC has in fact made hundreds of criminal referrals against the senior officers at the hedge funds that they have identified as having engaged in likely fraud. Indeed, we have no evidence that they have made any criminal referrals. Neither the SEC nor the WSJ reporters indicated that any prosecutions, or even Department of Justice investigations, resulted from the SEC hedge fund investigations.

Second, why isn’t the SEC’s top priority the systemically dangerous institutions (SDIs)? The SDIs are the financial institutions that are so large that the administration fears that their failure will cause a new global crisis. The SDIs pose by far the greatest risk to the economy and investors of any entity. Their frauds reached “epidemic” proportions and drove our ongoing crisis and the Great Recession. The SEC, however, applied its “aberrational performance” system to its smallest entities and is now expanding it to mutual funds. There is no indication that the SEC intends to use the system to spot fraudulent SDIs. There is no indication that the SEC has even contemplated using the system to spot fraudulent SDIs. There is no indication that the WSJ reporters asked why the SEC was failing to use its system where it was most needed.

Applying the SEC system to the SDIs would have led the SEC to develop a more sophisticated analytical approach to identifying fraud. There is no indication that the SEC has any familiarity with the criminology, economics, and regulatory literature about how to identify accounting fraud. Admittedly, the SEC (finally) has taken seriously the warning that generations of parents have impressed upon their children – “if it’s too good to be true; it probably isn’t true.” The Achilles’ heel of the SEC analytics is that it assumes fraud must be aberrational and its flags are (at least as described in the story) all tied to identifying aberrations premised on the implicit assumption that fraud cannot be endemic. The SEC official told the WSJ reporter that they looked for “outliers.” Accounting control fraud, however, can become endemic, particularly in a product line, because it produces a “Gresham’s dynamic” in which bad ethics drives good ethics out of the market. Accounting control frauds report results that are too good to be true, but they all report extraordinary results because accounting fraud is a “sure thing” (George Akerlof and Paul Romer, “Looting: the Economic Underworld of Bankruptcy for Profit, 1993). Accounting control fraud was far more common among the SDIs than the SEC system has identified among hedge funds.

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President Obama’s view of fraud “from 40,000 feet” (without an oxygen mask)

Posted on December 20, 2011 by | Comments Off on President Obama’s view of fraud “from 40,000 feet” (without an oxygen mask)

By William K. Black
(Cross-posted from Benzinga)


Sixty Minutes’ December 11, 2011interview of President Obama included the following gem:

KROFT: One of the things that surprised me the mostabout this poll is that 42%, when asked who your policies favor the most, 42%said Wall Street. Only 35% said average Americans. My suspicion is some of thatmay have to do with the fact that there’s not been any prosecutions, criminalprosecutions, of people on Wall Street. And that the civil charges that havebeen brought have often resulted in what many people think have been slap onthe wrists, fines. “Cost of doing business,” I think you called it inthe Kansas speech. Are you disappointed by that?

PRESIDENT OBAMA: Well, I think you’re absolutelyright in your interpretation. And, you know, I can’t, as President of theUnited States, comment on the decisions about particular prosecutions. That’sthe job of the Justice Department. And we keep those things separate, so that there’sno political influence on decisions made by professional prosecutors. I cantell you, just from 40,000 feet, that some of the most damaging behavior onWall Street, in some cases, some of the least ethical behavior on Wall Street,wasn’t illegal.

That’s exactly why we had to change the laws. Andthat’s why we put in place the toughest financial reform package since F.D.R.and the Great Depression. And that law is not yet fully implemented, butalready what we’re doing is we’ve said to banks, “You know what? You can’ttake wild risks with other people’s money. You can’t expect a taxpayer bailout.

Hallucinations occur at high altitude when you become oxygen deprived.  Let’s review the bidding on theBush/Obama record in prosecuting the elite control frauds that drove theongoing crisis.  There are noconvictions of the Wall Street elites that made, purchased, packaged, and soldmillions of fraudulent liar’s loans. There are no federal prosecutions of the major banks that committed over100,000 fraudulent foreclosures. There are a few settlements that sound like large dollar amounts, butare merely what even Obama concedes to be the (deeply inadequate) “cost ofdoing (fraudulent) business.” Fraud pays – it pays enormously and our elites now commit it withimpunity as a means of becoming wealthy. We have just witnessed the travesty of Wachovia admitting to criminalconduct in their (grotesquely weak) settlement with the Department of Justice(which has a policy of no longer prosecuting large corporations that commitcrimes) – and having the SEC refuse to require Wachovia to make similaradmissions in its settlement.  Allthis, the President implicitly or even explicitly concedes.



But the President asserts:  “Ican tell you, just from 40,000 feet, that some of the most damaging behavior onWall Street, in some cases, some of the least ethical behavior on Wall Street,wasn’t illegal.”  Kroft, sadly, didnot follow up on this incredible and, if true, extraordinarily importantassertion.  Obama’s statementsabout fraud and ethics are inaccurate on multiple levels. 
Obama’s factual assertions about the failure to prosecute fraud areunresponsive to the question, false, and logically inconsistent.  Note the artful manner in which Obamaevaded answering Kroft’s question. Kroft asks why there are no prosecutions of the Wall Street frauds thatdrove the crisis.  Obama answersthat “some” unethical Wall Street actions were not illegal.  Obama’s answer implicitly admitted thatmost Wall Street actions that causedthe crisis were criminal.  Hesimply argues that some highlyunethical behavior by Wall Street that was not illegal contributed to thatcrisis.  As David Cay Johnstonemphasized in his column about Obama’s response to Kroft’s question, Obama’s answeris a non-answer.  Why has he failedto prosecute any of the criminal conduct by Wall Street that drove thefinancial crisis?  The (alleged)fact that “some” destructive Wall Street conduct was highly unethical, but notillegal, obviously provides no basis for not prosecuting what Obama concedeswas primarily criminal conduct.   


Obama claims that the purported legality of Wall Street’s (unspecified)“least ethical behavior” is “exactly why we had to change the laws.”  He then describes the two specificchanges in the Dodd-Frank law that he asserts make illegal that “least ethical behavior” for the firsttime.  Obama claims that Dodd-Frankmakes it illegal to “take wild riskswith other people’s money” and for bankers to “expect a taxpayer bailout.”  Obama is a lawyer and former lawprofessor, so these are matters as to which he is capable of precision.   Dodd-Frank does not make it illegal for bankers to take “wildrisks.”  Banks inherently takerisks “with other people’s money” so that bit of rhetoric issuperfluous. 
Dodd-Frank does not make it illegal for a banker to “expect a taxpayerbailout.”  Dodd-Frank does not makeit illegal (and could not constitutionally do so) for bankers to lobby for abailout.  We have all seen thesuccess of such lobbying with the Bush and Obama administrations.  Both administrations have refused toorder an end to the “systemically dangerous institutions” (SDIs) (inaccuratelyreferred to as “too big to fail”). Both administrations asserted that when the next SDI failed it was likelyto cause a global systemic crisis. (It is a matter of “when”, not “if” they will fail, or more precisely,when we will admit that they failed.) 


The SDIs are also too big to manage – they are inefficiently large.  We can increase efficiency,dramatically reduce global systemic risk, and reduce the SDI’s exceptionalpolitical dominance by ordering them to shrink over the next five years to apoint that they no longer pose a systemic risk.  Instead, the Obama administration continues the Bushpractice of referring to the SDIs as “systemically important” (as if theydeserved a gold star for putting the world’s economy at risk).  The Bush and Obama administrations haveallowed, even encouraged, the SDIs to grow larger.  That policy is insane. It poses a clear and present danger to the U.S. and global economy andto our democracy.  The SDIs will be“bailed out” when they fail. Indeed, they are being bailed out continuously by policies the Fed andTreasury follow that are designed to provide massive governmental subsidiesprimarily for the benefit of the zombie SDIs that have already failed in realeconomic terms, e.g., Bank of America and Citi.

“Wild risks” are not remotely Wall Street’s “least ethicalbehavior.”  It is impossible, givenObama’s generalities and Kroft’s failure to probe to know what “wild risks”Obama is talking about, but none of the (supposed) risky loans banks made evenapproach lenders’ “least ethical behavior.”  The riskiest loans that banks made were liar’s loans toborrowers with bad credit histories. Credit Suisse reported in early 2007 that, by 2006, 49 percent of loansthat lenders called “subprime” (because they were made to borrowers with known,serious credit defects) were also liar’s loans (loans made without prudentunderwriting).  I agree with Obamathat making a subprime liar’s loan is exceptionally “damaging.”  Such loans damaged the lender, theborrower, the purchaser of such loans, and the purchaser of the collateralizeddebt obligations (CDOs) that were backed by subprime liar’s loans.  (Of course, “backed” deserves to be inquotation marks.)  Such loans wouldbe dumb, but they wouldn’t be among the banks’ “least ethical” actions if theloans were lawful.  Indeed, ifmaking subprime liar’s loans were merely risky, one could argue morepersuasively that the banks were acting altruistically when they made suchloans. 

What Obama missed, and Kroft failed to call him on, is that “wildrisk” by banks are typically frauds. I have explained these matters at length in previous posts, so I willprovide the ultra short version here. Honest home lenders do not make liar’s loans.  In particular, honest lenders do not make subprime liar’sloans.  Honest home lenders do notmake such loans because they create intense “adverse selection” and create a“negative expected value” (in plain English, they will lose money).  No government (here or abroad),required any lender or other entity (i.e., Fannie and Freddie) to make oracquire liar’s loans.  In fact, thegovernment repeatedly criticized liar’s loans.  The FBI warned of an “epidemic” of mortgage fraud inSeptember 2004.  The mortgagelending industry’s own anti-fraud body (MARI) warned every member of theMortgage Bankers Association (MBA) in writing in the 2006 that “stated income”loans were “an open invitation to fraudsters,” had a fraud incidence of 90percent, and deserved the term the industry used behind closed doors todescribe them – “liar’s” loans. Despite these warnings, lenders massively increased the number of liar’sloans they made. 

Home lenders made subprime liar’s loans because they were“accounting control frauds.”  Subprimeliar’s loans were ideal “ammunition” for accounting fraud.  They reduced the paper trailestablishing that the lender knew the loan was fraudulent and they optimizedthe four-ingredient “recipe” for a lender engaged in accounting controlfraud.  (Grow rapidly by making badloans at a premium yield, while employing extreme leverage and providing onlygrossly inadequate allowances for loan and lease losses (ALLL)).  The CEOs of lenders that made subprimeliar’s loans as part of this recipe were not taking risks in the conventionalmanner we discuss in finance (uncertainty).  As George Akerlof and Paul Romer explained in their famous1993 article (“Looting: the Economic Underworld of Bankruptcy for Profit”),accounting control fraud is a “sure thing.”  The lender is guaranteed to report record (albeit fictional)profits in the near term, which makes the CEO wealthy when he uses modernexecutive compensation to loot the lender.  Unfortunately, the same recipe that creates extremefictional income produces massive real losses.

Making liar’s home loans inherently requires lenders tocreate perverse incentives for widespread mortgage fraud.  It was lenders and their agents thatoverwhelmingly put the lies in liar’s loans.  The CEOs of the lenders who made subprime liar’s loanscompounded their initial mortgage origination fraud by making fraudulent repsand warranties to sell the endemically fraudulent mortgages.  The growth in liar’s loans (roughlyhalf of them were also subprime loans) was so extreme – over 500% from 2003 to2006 – that it caused the bubble to hyper-inflate).  Making fraudulent loans that placed millions of workingclass borrowers in loans that they frequently could not afford to repay andwere deeply underwater caused them a massive loss of wealth and wasdistressingly unethical.  Theofficers controlling the lenders that made fraudulent liar’s loans were evenmore unethical because they caused this devastation in order to become exceptionallywealthy.  The most morally depravedof the CEOs running accounting control frauds sought out the least financiallysophisticated borrowers, often minorities, as their victims.    

Obama has unintentionallyproved the accuracy of the plurality of survey responders who concluded that heserves Wall Street’s interests at the expense of the public.  He cynically evaded responding to theprimary reason why the public “gets it” – the abject failure of his administrationto prosecute the elite financial frauds that drove the financial crisis and theGreat Recession.  Obama offered thepathetic (and factually inaccurate) non-excuse that “some” unethical conductmight be legal.  It is time forObama (and Attorney General Holder) to “man up.”  If they refuse to do so and are going to continue to be lapdogs for the elite financial frauds they should at least change the name of theJustice Department. 


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives. 


Follow him on Twitter: @WilliamKBlack

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Watch William K. Black’s Latest Appearance on The Dylan Ratigan Show

Posted on December 16, 2011 by | Comments Off on Watch William K. Black’s Latest Appearance on The Dylan Ratigan Show

http://www.msnbc.msn.com/id/32545640

Visit msnbc.com for breaking news, world news, and news about the economy

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Dante’s Divine Comedy: Banksters Edition

Posted on December 15, 2011 by | Comments Off on Dante’s Divine Comedy: Banksters Edition

By William K. Black
(Cross-posted from Benzinga)

Sixty Minutes’ December 11, 2011 interview of President Obama included a claim by Obama that, unfortunately, did not lead the interviewer to ask the obvious, essential follow-up questions.

“I can tell you, just from 40,000 feet, that some of the most damaging behavior on Wall Street, in some cases, some of the least ethical behavior on Wall Street, wasn’t illegal.”

Obama did not explain what Wall Street behavior he found least ethical or what unethical Wall Street actions he believed was not illegal. It would have done the world (and Obama) a great service had he been asked these questions. He would not have given a coherent answer because his thinking on these issues has never been coherent. If he had to explain his position he, and the public, would recognize it was indefensible. I offer the following scale of unethical banker behavior related to fraudulent mortgages and mortgage paper (principally collateralized debt obligations (CDOs)) that is illegal and deserved punishment. I write to prompt the rigorous analytical discussion that is essential to expose and end Obama and Bush’s “Presidential Amnesty for Contributors” (PAC) doctrine. The financial industry is the leading campaign contributor to both parties and those contributions come overwhelmingly from the wealthiest officers – the one-tenth of one percent that thrives by being parasites on the 99 percent.

I have explained at length in my blogs and articles why:

  • Only fraudulent home lenders made liar’s loans 
  • Liar’s loans were endemically fraudulent 
  • Lenders and their agents put the lies in liar’s loans 
  • Appraisal fraud was endemic and led by lenders and their agents 
  • Liar’s loans could only be sold through fraudulent reps and warranties 
  • CDOs “backed” by liar’s loans were inherently fraudulent 
  • CDOs backed by liar’s loans could only be sold through fraudulent reps and warranties 
  • Liar’s loans hyper-inflated the bubble 
  • Liar’s loans became roughly one-third of mortgage originations by 2006

Each of these frauds is a conventional fraud that could be prosecuted under existing laws. Hundreds of lenders and over a hundred thousand loan brokers were “accounting control frauds” specializing largely in making fraudulent liar’s loans. My prior work explains control fraud, why accounting is the “weapon on choice” for fraudulent financial firms, and why liar’s loans were superior “ammunition” for committing massive accounting fraud. These accounting control frauds caused greater direct financial losses than any other crime epidemic in history. They also drove the financial crisis that produced the Great Recession and cost millions of Americans their jobs.


In considering my scale of unethical conduct it is important to keep in mind that it is highly likely that anyone that causes very large numbers of people to lose their homes will cause multiple suicides and indirect deaths that arise from the greater vulnerability of the homeless and the blue collar crime effects of destroying neighborhoods inherent to widespread foreclosures. I ignore for this purpose the fact that the fraudulent loans caused the bubble to hyper-inflate and drove the financial crisis that caused millions of people to lose their jobs. The financial accounting control frauds are the weapons of mass destruction of wealth, employment, and happiness. I also ignore the fact that the frauds described here made the perpetrators wealthy. My scale, therefore, systematically and dramatically understates the perpetrators’ moral turpitude. I have also excluded the massive foreclosure frauds from my scale because they did not cause the underlying crisis. When Obama reveals the bankers actions he claims to be legal but highly unethical readers should keep my conscious understatement of the moral depravity of the illegal acts by bankers that drove this crisis in mind when they compare the relative ethical failings.

As a criminologist, I do not favor sentencing criminals to the fates they richly deserve. I would never torture prisoners or place them at risk of assault, rape, or psychological trauma. I do not believe that extremely longer terms of imprisonment are desirable except in rare circumstances. As a lawyer and a criminologist I emphasize that any sentence should come only after a conviction in a trial providing due process protections or a guilty plea.My scale provides a label for the comparative moral depravity of the perpetrator, the deserved punishment (which when vicious is not the far more humane one I would actually impose), and a brief description of the specific frauds that are characteristic of this level of immorality and the number of perpetrators falling in each category. My inspiration was Dante’s circles of hell as described in his Divine Comedy.

The Scale of Ethical Depravity by the Frauds that Drove the Ongoing Crisis

Level 10: Septic tank scum

Eternal Hell: these banksters deserve a physical hell of infinite torment and duration

 Officers that directed control frauds that involved making predatory loans to more than 10,000 homeowners who lost their homes as the result of the frauds. Predatory loans in this context mean deliberately seeking out the elderly or minorities for such loans because they were easier to con into taking loans they could not repay – at a premium yield (interest rate). Dozens of CEOs fall in this category.

Level 9: Pond scum

Time in Hell:  These banksters deservea term in hell


Officers that directed control frauds that led to more than 10,000homeowners losing their homes.  Hundredsof CEOs fall in this category.


Level 8:  Generic scum


Gitmo:  Hell’s starkest suburb


Officers that directed control frauds that led to more than 1,000 homeownerslosing their homes.  Thousands of CEOsfall in this category.


Level 7:  Dante’s deserved denizens


Supermax:   No view, and no way out


The professionals that aided and abetted the overall control frauds byinflating appraisals, giving “clean” audit opinions to fraudulent financialstatements, “AAA” ratings to toxic waste, and accommodating legal opinions tothe frauds.  Thousands of professionalsfall in this category.


Level 6:  Aspiring to great wealththrough fraud 


Alcatraz:  Great view, but no way out


The senior lieutenants of the control frauds who committed the frauds thatcaused more than 10,000 homeowners to lose their homes.  Thousands of senior officers fall in thiscategory.


Level 5:  A large cog in a smallerfraud


Generic Hardcore Prison:  A life ofboredom and the almost total loss of freedom


The senior lieutenants of the control frauds who committed the frauds thatcaused more than 1,000 homeowners to lose their homes.   Thousands of senior officers fall in thiscategory.


Level 4:  The banksters who cost usour money instead of our homes – Goldman Sachs & friends


Generic Prison:  A life of boredom anda severe loss of freedom


The officers that led the control frauds who targeted their customers forthe purchase of more than $10 million in fraudulent product.  Dozens of officers fall in this category.


Level 3:  The banksters’ seniorlieutenants who cost us our money instead of our homes


Prisons designed for serious, but less physically dangerous felons


The senior officers of the control frauds who targeted their customers forthe purchase of more than $10 million in fraudulent product.  Scores of senior officers fall in thiscategory.


Level 2:  Banksters who defraudedother bankers (who were willing to be defrauded)


Privatized prisons:  Let them enjoythe consequences of their odes to privatization


The largest control frauds sold tens of billions of dollars of fraudulentloans to each other through fraudulent “reps and warranties.”  The kicker here, as Charles Calomiris hasemphasized, is that the control frauds on both sides of the transactions knew thatthey were engaged in a mutual fraud. Hundreds of senior officers fall in this category.


Level 1:  Small fraudulent fry


Catch and release:  Convict them andput them on probation if they cooperate with the investigations


The small fry are the loan officers, loan broker employees, and borrowerswho knowingly participated in making fraudulent mortgage loans.  Over 100,000 individuals fall in thiscategory.

We Need to End the PAC Doctrine

To date, Bush and Obama have prosecuted none of the mortgage frauds in the top nine levels. I urge reporters to ask him to explain three things about his statements to 60 Minutes.

  • Why are there no prosecutions of the felons that drove the crisis and occupy the nine worst rungs of unethical and destructive acts?

  • Explain the five unethical acts by elite financial institutions that you consider the most destructive and least ethical – but which you believe to be legal. How do you rank the degree of unethical conduct and destruction in those acts?

  • What specific statutory provisions did you propose to make those five unethical acts illegal? As enacted, which provisions of the Dodd-Frank Act made those five unethical acts illegal? Who has been prosecuted for those formerly legal but seriously unethical and destructive acts that were made illegal by the Dodd-Frank Act?

Reporters will have to be persistent in coordinating their follow-up questions to get Obama to provide direct answers to these questions.

I request that private citizens write President Obama to ask him to provide specific, written answers to these three questions. I will be proposing a series of questions that I will urge citizens to demand answers to because it is clear that the regular media will rarely ask demanding questions of elite politicians or bankers. It is up to us to hold them accountable and end the doctrine of Presidential Amnesty for Contributors.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @WilliamKBlack

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Listen to Bill Black on Open Your Mind Ireland Radio.

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Senator McCain’s Economist Warns: If you Criticize Banksters They will Prolong Recessions

Posted on November 29, 2011 by | Comments Off on Senator McCain’s Economist Warns: If you Criticize Banksters They will Prolong Recessions

By William K. Black

Steven J. Davis, Senator McCain’s chief economics advisor during his presidential campaign, has written a political hit piece on the man that defeated his candidate.  His co-authors were Scott R. Baker and Nicholas Bloom.  For the sake of brevity I will refer to the authors as “the authors” or “Davis.”  They published the piece in Bloomberg.  The article purports to be a straight scientific piece, but it is a partisan screed relying on faux statistics created by Davis to support his views.  Davis’ statistical methodology is not simply unscientific, it is embarrassingly bad.

Davis’ argument, long discredited by actual surveys of employers, is that unemployment is so high because employers refuse to hire because of Democratic policies.  As Paul Krugman has long noted, employers, when surveyed, have consistently and emphatically refuted this claim.  Given that the employers answering the surveys are disproportionately Republicans and opponents of regulation who have strong incentives to blame the regulations for their failure to hire, their failure to do so makes the survey results particularly compelling.  Davis’ statistical index provides no evidence of why employers are not hiring.  Indeed, it is inherently incapable of providing such evidence. 

Davis is a partisan Republican.  He is a theoclassical economist and a proud representative of the one percent.  He has worked for the Hoover Institution, AEI, and Michael Milken’s foundation (the infamous fraud whose crimes destroyed Drexel Burnham Lambert).  He is a professor at U. Chicago’s business school. 


Davis missed the developing crisis entirely, publishing an article about “the Great Moderation” in 2008 as the financial crisis was ripping across the world.  His ideological blinders are so complete that he cannot even consider the obvious – the crisis was brought on by the criminogenic environment produced by the three “de’s” – deregulation, desupervision, and de facto decriminalization plus perverse executive and professional compensation.  The economists George Akerlof and Paul Romer wrote an article about accounting control fraud entitled “Looting: the Economic Underworld of Bankruptcy for Profit.”  They concluded the article with this passage about the criminogenic environment produced by S&L deregulation in the 1980s.

“Neither the public nor economists foresaw that the [S&L] regulations of the 1980s were bound to produce looting.  Nor, unaware of the concept, could they have known how serious it would be.  Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better.  If we learn from experience, history need not repeat itself (1993: 60).”

The reason we have tragic levels of unemployment is the financial crisis, which was fully preventable had the anti-regulators put in place by Presidents Clinton and Bush simply understood the concepts of looting and criminogenic environments that we had made clear a quarter-century ago.  As I will show, Davis takes the remarkable position that we must not learn from our deregulatory mistakes and close the resulting regulatory black holes.    
 
Absent the restoration of effective financial regulation and prosecutions, and the removal of the perverse compensation systems (which also requires regulation), we will continue to suffer recurrent, intensifying financial crises and the severe unemployment they produce.  Effective financial regulation greatly reduces uncertainty by increasing transparency and by preventing Gresham’s dynamics.  George Akerlof explained to the profession 41 years ago in his famous article on markets for “lemons.”

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”  

Consider the grave “uncertainty” that would exist in a nation without effective police forces.  Somalia is a good example.  The police do not, and cannot, deal with sophisticated financial crimes.  The FBI’s white-collar crime specialists do not patrol a beat and look for crimes.  They sometimes act on anonymous tips or leads from other investigations, but overwhelmingly they depend on criminal referrals from the regulators.  Our principal function as regulators is to serve as the regulatory cops on the beat to prevent the Gresham’s dynamic by aggressively finding the frauds, putting them out of business, and providing the criminal referrals that make it possible to prosecute the elite frauds.  Absent effective regulators, honest firms often face extinction and their employees will lose their jobs.  

In Davis’ world, however, regulation is unnecessary and harmful.  The former U. Chicago professors, Frank Easterbrook and Daniel Fischel, wrote what remains the U. Chicago bible on accounting control fraud.  A generation of American lawyers has been taught this profession of faith from Easterbrook and Fischel’s 1991 treatise: “A rule against fraud is not an essential or even necessarily an important ingredient of securities markets….”  The Economic Structure of Corporate Law (1991).  Markets are self-correcting, bubbles are impossible, and economic crises are impossible.  This was the theoclassical profession of faith in a miraculous trinity.  Each of these dogmas has been repeatedly falsified by real life, but facts cannot trump blind faith.  Senator McCain’s was a member of the “Keating Five.”  Charles Keating, the most infamous S&L fraud, used the Senators to try to intimidate us into not taking any regulatory action against Lincoln Savings’ massive regulatory violation – a violation that led to billions of dollars in losses.  Neither McCain nor Davis learned any useful lesson from this scandal. 

Davis has mounted politically consistent attacks on the Democrats based on the high unemployment caused by the epidemic of accounting control fraud that hyper-inflated the bubble and drove the U.S. financial crisis.  On January 3, 2010 he published an op-ed with Gary Becker and Kevin Murphy in the Wall Street Journal blaming the Democrats for the high unemployment caused by the Great Recession.  This was their tag line:  “A recession is a terrible time to make major changes in the economic rules of the game.”

Consider the logic of that assertion.  The “economic rules of the game” have just led to an epidemic of accounting control fraud, a hyper-inflated bubble, a Great Recession, and severe unemployment and the theoclassical answer to the catastrophe that their faith-based policies have caused is – engrave those rules in bronze.  They literally call on us to repeat the mistakes of the past.  Theoclassical economists take their cue from the White Queen, who bragged to Alice that with practice she had learned to believe “as many as six impossible things before breakfast.” 

The authors acknowledged that the Great Recession had caused severe unemployment, but added the claim that it was the election of Democrats that prevented a prompt recovery.

“Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas.”

Obama’s economic team (Summers, Geithner, and Bernanke) was strongly neoclassical and economically conservative.  The authors then singled out any effort to deal with climate change as particularly undesirable.  Apparently it is now a violation of theoclassical principles to require manufacturers to internalize the cost of negative externalities.  That is contrary to economics and would lead to a poisoned world in which firms that spent money to restrict harmful emissions would be driven out of business by their competitors who avoided such expenses and obtained a decisive cost advantage.  This is another example of a Gresham’s dynamic in which bad ethics drives good ethics from the marketplace.  The authors ended by opposing allowing the Bush tax cuts for the wealthy to expire.  They presented no evidence in support of their partisan attack on Democrats and their ideological attack on “liberals.”

On July 15, 2011, Davis wrote an article entitled “Why Employers Are Slow to Fill Jobs.”  

Davis mentioned “policy uncertainty” as one of the contributors to the employers’ failure to hire workers in this article, but what he stressed was that the Great Recession so depressed private sector demand for goods and services that most employers felt little desire to hire additional workers because they could not sell additional output.  He noted that employers had reduced the intensity of their recruiting because they were in a buyer’s market in which they were deluged with applicants and could afford to hire only the most ideal candidates.  Even when Davis discussed uncertainty his primary emphasis was on economic uncertainty – the Great Recession.  He ended by blaming unemployment on the unemployed.  The long-term unemployed were spending fewer hours looking for jobs.  Davis called for ending unemployment benefits for the long-term unemployed.  The prospect of starving in a fortnight would concentrate their minds wonderfully.  (Yes, Davis’ last argument contradicts his earlier arguments, but this is faith-based callousness posing as science.)  His “summing up” paragraph has one clause referencing “uncertainty” as a purported tertiary contributor to the slow reduction in unemployment.  Again, Davis offered no support for this assertion.

Davis’ latest (October 5, 2011) partisan attack is entitled “Policy Uncertainty Is Choking Recovery.”  In five months, Davis’ tertiary, minor asserted contributor to the slow recovery has suddenly morphed into a monster that is the cause of the problem.  You might think that the survey results showing that businesses have repeatedly falsified this claim would pose a problem for this meme, but the authors hit on the obvious answer to inconvenient truths – they ignored them.  Lest you think that this was due to tight space limits placed on a Bloomberg op ed, check their academic paper, which, also ignores the actual surveys.  “Measuring Economic Policy Uncertainty” (October 10, 2011).   This begins to explain why their work is embarrassingly bad.

The partisan slanting of the article is also embarrassing, as is the failure to identify Davis’ role as McCain’s principal economics advisor.  Here is the authors’ thesis:

“But the persistence of policy uncertainty wasn’t inevitable. Rather, it reflects deliberate policy decisions, harmful rhetorical attacks on business and “millionaires,” failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.”

Their thesis boils down to the claim that capitalists are wusses.  The reality is that politicians of both parties fall all over themselves saying nice things about business and that the criticisms are addressed to corporate criminals and the wealthy who pay what the vast bulk of Americans view as grossly inadequate taxes.  Moreover, according to the neoclassical economics canon these authors purport to believe raising taxes on the wealthy would be a valuable change that would reduce “fiscal imbalances.”  The authors, instead, assert that any increase in taxes on the wealthy destroys jobs.  By their logic, we should eliminate taxes on the wealthy.  By entitlement “reforms” they mean reducing Social Security benefits – that will do wonders for private sector demand and robust jobs growth. 

Indeed, the authors’ thesis is eerily reminiscent of Jon Stewart’s famous riff when Dick Cheney shot his elderly hunting companion in the face.  Stewart noted that Cheney was so powerful that the victim apologized to Cheney for being shot – by Cheney.  The authors want us to apologize to the elite financial frauds that became wealthy through the accounting control fraud epidemic that drove the crisis, the Great Recession, the great bulk of the federal budget deficit, the state and local government financial crisis, and severe unemployment.  It wasn’t enough that we bailed them out and gimmicked the accounting rules at their demand to ensure that “their” banks could continue to pay them massive bonuses even though they were in economic reality insolvent.  How dare we make “harmful rhetorical attacks” on the frauds!  We should all apologize immediately to the productive class.

Speaking of “rhetorical attacks,” consider this partisan assault by the authors:

“The Patient Protection and Affordable Care Act that President Barack Obama signed into law in March 2010 is another example. Rather than simple reforms aimed at efficiency improvements and cost savings, the law seeks to remake the U.S. health-care delivery system, dramatically expanding the role of government and imposing new burdens on businesses and individuals. Even in narrowly economic terms, the measure adds to the uncertainty facing households and businesses.

Moreover, its political durability is in doubt. The Democratic leadership in Congress opted to pursue the most radical plan that could muster the necessary 60 votes in the Senate and a thin majority in the House. As a result, the legislation failed to attract a single Republican vote in either chamber. That political strategy ensured the act would become the focus of future electoral battles and rollback efforts. “

The authors then go on to complain that the lawsuits challenging the constitutionality of the Act (which they do not note were brought by Republicans) add to uncertainty.  Whatever, the Act is, it is assuredly not “radical.”  It is modeled on a scheme created by a then conservative Republican Governor, Mitt Romney.    


In reality, the Obama administration made obsessive efforts to craft a bill with bipartisan support – substantially weakening an already weak bill and taking out, at the demand of Republican and “blue dog” Democrats, the central “cost savings” provision in the bill – the public option.  The “simple reform” that would vastly increase efficiency and cost savings – and boost the international competitiveness of U.S. firms – is single payer health care funded by the public rather than (largely) through tax-subsidized but still expensive private health insurance provided by employers.  The Republicans and “blue dog” Democrats promised to kill any such bill.  The authors’ dread “liberal Democrats” favored a bill that would produce superior health care at a far lower price in line with other developed nations.  The private health insurers promised to bury such a bill, so the Obama administration went for the ultra conservative alternative developed by Romney.  The authors’ partisan slant causes them to deliberately and comprehensively misstate the facts.

The authors then move to describing their uncertainty “index.”

“We constructed our index by combining three types of information: the frequency of newspaper articles that refer to economic uncertainty and the role of policy, the number of federal tax code provisions set to expire in coming years, and the extent of disagreement among forecasters about future inflation and government spending.” 

To which the obvious first question is:  why?  I begin my analysis with their tax provisions component.  They know that a historically unusual number of tax provisions are set to expire in coming years, so they know that when they use that component they will produce at index showing a surge in uncertainty. 

“Scheduled expirations of federal tax code provisions were rare before 2000 but have grown rapidly. More than 130 provisions are slated to expire in 2011 and 2012, in many cases setting the stage for new political battles.”

Davis wants to report high uncertainty to fit his priors that he has been asserting without any proof.  This is a hopelessly unsound means to produce an index.  Any of us could pick a variable that would “prove” our priors.  The psychological temptation to prove we are right (especially for theoclassical economists who have gotten everything important horribly wrong) is overwhelming.  The bad news is that the tax expirations are the least embarrassing aspect of their index.


An even more ludicrous component is: “the frequency of newspaper articles that refer to economic uncertainty and the role of policy.”  First, the authors know, because Davis has been a part of promoting this meme, that Republicans have organized a coordinated campaign to claim that “regulation” and “taxes” are causing the weak recovery from the recession.  To now use the publicity that one political party, and at least one of the framers of the index, is generating for partisan purposes as purported objective evidence of the harms of ending the regulatory black holes is so unprincipled as to be beneath contempt.  Indeed, the absurdity of this component is demonstrated by the fact that their effort to publicize their index in the form of a partisan op ed and a partisan academic paper has already had the effect of driving their index higher and “proving” their point.  Moreover, this is not a new Republican strategy.  They followed the same strategy of attacking regulation and regulators for years, but the coordinated attacks on regulation emanating from the right’s “think tanks” (funded by firms that wish to prevent effective regulation) have increased greatly since the passage of Sarbanes-Oxley.  Self-generated attacks on regulation become “policy uncertainty,” which becomes a purported empirical basis for preventing effective regulation.  The index provides an elegant solution to the Koch brothers’ policy goals.     


The authors’ third component is almost humorously bad:  “the extent of disagreement among forecasters about future inflation and government spending.”  We have a vastly more reliable means to judge the risks of future inflation in the U.S.  It is called the U.S. bond market.  It prices the risk of inflation continuously.  It already incorporates “government spending” because such spending can affect inflation.  The U.S. bond markets have consistently been telling us since the crisis became public knowledge that there is no material risk of inflation.  Why do the authors believe that “forecasters” are more reliable than bond markets?  Why do they believe that businesses are failing to hire because they are concerned that the inflation hawks have remained delusional in their claims that hyper-inflation is just around the corner?  What does any of this have to do with regulation?  If CEOs were worried about hyper-inflation because they remained in thrall to some inflation hawk analyst who had been proven grotesquely wrong in every forecast over the last five years, wouldn’t those CEOs be happy that the Bush tax cuts were set to expire?  Why do CEO’s base their decision to hire on the variance among analysts as to the size of the federal budget instead of the size of the federal budget deficit?  The authors do not address these issues in their formal paper or op ed.  


The authors then assigned arbitrary weights to their three components.  The news stories measure is weighted one-half, while the tax repeals and both forms of variance in forecasts (inflation and government spending) each receive an individual weight of one-sixth. 

The authors claim in their op ed (but not in their paper, which claims only “some suggestive evidence on causation”) that their index somehow establishes causality and confers the ability to quantify the jobs that would be created if the Republicans would stop their media campaign of blaming “radical” regulation for the slow recovery.  (Of course, the authors don’t phrase it that way, but given the extreme weight they gave to this single component of their index and the fact that the senior author of the paper is a Republican activist pushing this meme in the media, that is how circular and perverse “causality” is in their index.)

“So how much near-term improvement could we gain from a stable, certainty-enhancing policy regime? We estimate that restoring 2006 levels of policy uncertainty would yield an additional 2.5 million jobs over 18 months. Not a full solution to the jobs shortfall, but a big step in the right direction.”

They make no such claim in their paper.  “Yield” is a statement of causality.  Their study inherently cannot establish causality.  Further, as they admit, even they see at best only “some suggestive evidence on causation” – and they are being remarkably over-generous to themselves even in going that far for their study does not present any such “suggestive evidence.” 


They also do not explain how we could undo “uncertainty” – as “measured” under their index.  As long as the right generates attacks on regulation and claims that it causes uncertainty and those complaints are repeated by their array of web sites the index will “measure” high uncertainty.  We went through a remarkable period of radical deregulation, desupervision, and de facto decriminalization that created the criminogenic environments that produced three major crises in 25 years and one party is still demanding that we make the three “de’s” far worse.  Are we supposed to repeal Dodd-Frank?  Would the repeal increase or decrease “policy uncertainty”?  How are we supposed to prevent analysts from being hyper-inflation hawks?  Would making the tax laws longer remove uncertainty?  Congress could still change them at will.  The repeal as of a date certain was meant to reduce uncertainty. 


Every aspect of this index is farcical and a naked partisan weapon of attack on the regulations and prosecutions essential to preventing our recurrent, intensifying financial crises.  Theoclassical economists were the architects of these crises.  They were the great destroyers of jobs and wealth.  The claim that we can never undo their criminogenic designs and that any attempt to even criticize the elite frauds will lead to job losses is pure extortion.  Their index does not allow any statements about causality, and they know that the claims of causality and quantification that they made in their op ed are indefensible.  The direct surveys of employers do allow us to evaluate causality because they are statements (largely) against the political interests of the business people being surveyed.  Those surveys refute the argument. 


Restoring effective regulatory cops on the beat will increase transparency and reduce the Gresham’s dynamic that is the bane of honest firms.  Both effects reduce uncertainty and increase employment.  For example, there were far more aggressive regulatory and prosecutorial responses to the S&L debacle than the current crisis.  We convicted over 1,000 elites in cases designated by the Justice Department as “major” and we brought thousands of civil and enforcement actions against S&L executives.  We largely ended nonprime lending, particularly liar’s loans by S&Ls in 1990-1991.  We placed many hundreds of S&Ls and banks in receivership.  We consistently wiped out the shareholders and subordinated debt holders in those resolutions.  We greatly boosted capital requirements, got rid of junk accounting, and put formal requirements for prompt corrective action in place.  We rapidly sold the bad assets in our liquidating receiverships.  None of these things has been done in Bush and Obama administrations’ tepid response to the current crisis.  The recovery from the recession in the early 1990s was relatively rapid.  Our aggressive regulatory actions added greatly to certainty because our actions were consistent, added to transparency, and helped honest firms.  That result would be consistent with the authors’ purported theory (gratuitous uncertainty poses an undesirable risk that slows recovery), but not with their ideological blinders that cause them to see regulation as inherently adding to uncertainty.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.


Follow him on Twitter: @WilliamKBlack

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“Greedy Bastards”: A Review of Dylan Ratigan’s Views on the Financial Crisis

Posted on November 22, 2011 by | Comments Off on “Greedy Bastards”: A Review of Dylan Ratigan’s Views on the Financial Crisis

By William K. Black
(Cross-posted from Benzinga)

Dylan Ratigan, MSNBC’s financial expert, has writtena book about how markets have become perverse. It is an interesting example of how strange “competition” hasbecome.  One oddity presented itself onthe cover of the package in which the book arrived.  The cover proclaimed “Simon & Schuster: ACBS Company.”  The author works forNBC.  Only in America!

I was concerned by the title (“Greedy Bastards”).  I thinkthat greed is unlikely to have changed greatly over the last quarter century inwhich the U.S. has suffered three recurrent, intensifying financialcrises.  I don’t call people bastards,even the self-made ones, because my mother reacted poorly to Speaker Wrightreferring to me as the “red-headed SOB.” Ratigan’s view on these points turns out to be similar to mine.  He argues that the issue is not greed, butperverse incentives.  When CEOs haveincentives adverse to the public and their customers they tend to act on thoseincentives and harm the public and their customers.  This observation is one of those obvious butessential points so often overlooked.  ACEOs’ principal function is creating, monitoring, and adjusting thecorporation’s incentive structures. There is a massive business literature on this function and CEOsuniformly believe that incentive structures for officers and employees arecritical in shaping their behavior.

There is only one (disingenuous) exception to thisrule – when officers and employees act criminally because the CEO has createdperverse incentive structures.  Suddenly,the CEO is shocked that his officers and employees acted criminally in responseto the CEO’s incentive structures that encourage criminal conduct.  Ratigan focuses on precisely thisexception.  Anyone that has had themisfortune to listen to compulsory business ethics training by his or heremployer will have learned that the key is the “tone at the top” set by theCEO.  True, but that always ends the discussion.  No employee is going to be trained by hisemployer as to what to do when the tone at the top set by the CEO is pro-fraud.

As Ratigan demonstrates, our most elite financialCEOs typically created and maintained grotesquely perverse incentive structuresthat encouraged their officers and employees as well as “independent”professionals to act criminally in a manner that harmed customers, the public,and shareholders – but made the controlling officers wealthy.  Is there any CEO of a lender incapable ofunderstanding that the loan officers and brokers’ compensation depends onvolume and yield – not quality – the result will be catastrophic?  Is there any CEO of a lender incapable ofunderstanding that if the loan brokers’ fees depend as well on the reported debt-to-income andloan-to-value ratios and the broker is permitted to make liar’s loans theresult will be that the brokers will engage in endemic, severe inflation of theborrowers’ incomes and their homes’ appraised values?  Is there any reader that doubts that the CEOsintended to produce precisely what their perverse incentives were certain toproduce?  A CEO cannot send a memo to50,000 loan brokers instructing them to inflate appraisals and use liar’s loansto inflate the borrowers incomes’ but he can, and does, send the same messagethrough his compensation system.  None ofthese perverse incentives produces an unexpected result.

Ratigan gets right two of the three essentials tounderstand why we suffer recurrent, intensifying financial crises.  First, cheating has become the dominantstrategy in finance.  Second, cheating isdominant because finance CEOs create such intensely perverse incentives thatfraud becomes endemic.  The BusinessRoundtable (the largest100 U.S. corporations), had to react to the Enron erafrauds.  It chose as its spokesperson aCEO who embodied the best of American big business.  This was the response he gave to Business Week when their reporter askedwhy so many top corporations engaged in accounting control fraud:

“Don’t just say:”If you hit this revenue number, your bonus is going to be this.” Itsets up an incentive that’s overwhelming. You wave enough money in front ofpeople, and good people will do bad things.”

How did the CEO know about the “overwhelming” effectof creating incentives so perverse that they would routinely cause “good people[to] do bad things”?  He knew because hedirected and administered such a perverse compensation system.  An SEC complaint would soon identify thatcompensation system as driving accounting control fraud at his firm.  His name was Franklin Raines, CEO of FannieMae.


Ratigan can add tothe effectiveness of his explanation by adding a description of the thirdessential driving our perverse incentives. Accounting control fraud, as criminologists, economists, and (competent)financial regulators recognize is a “sure thing”.  See GeorgeAkerlof and Paul Romer, “Looting: the Economic Underworld of Bankruptcy forProfit” (1993).  It produces guaranteed,record (albeit fictional) short-term reported profits if one follows the fraud“recipe” for a lender, which produces guaranteed, extreme compensation for thecontrolling officers, and causes catastrophic losses.  It is trifecta of guaranteed results that causesCEOs to adopt the perverse incentives they know will cause their officers andemployees to follow the fraud recipe.  Itis the three “de’s” – deregulation, desupervision, and de facto decriminalization that allow the CEOs to put theseperverse incentives in place with impunity and produce the criminogenicenvironments that drive our recurrent, intensifying financial crises.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.


Follow him on Twitter: @WilliamKBlack

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Germany puts the EU through the Wood Chipper – and Theocrats Cheer

Posted on November 21, 2011 by | Comments Off on Germany puts the EU through the Wood Chipper – and Theocrats Cheer

By William K. Black

Those of you who have seen the film Fargo have the wood chipper scene indelibly seared into your memory.  (If you have not seen Fargo please remedy this deficiency promptly.)  I return to the scene at the end of this piece.

Walter Russell Mead, a recovering liberal, has crafted a crude ode to purported German national character and insult to purported French national character.  The defective purported national character of the French is leavened with equally crude stereotypes of the purported superior religious character of Huguenots and Jews.  It is all set within a broader, cruder attack on purported ethnic “Latin” character.  Mead’s piece ran in opinion pages of the Wall Street Journal, which embraces these prejudices and considers them the height of intellect.

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Best Satire of Faux Austrian Economics Ever

Posted on November 15, 2011 by | Comments Off on Best Satire of Faux Austrian Economics Ever
By WilliamK. Black
Someone has created a fabulous, richly detailedparody of Austrian economics.  They callit The Daily Bell and claim that itsperspective reflects Austrian economics. In reality, it satirizes faux Austrian economics’ sycophancy towardelite white-collar criminals. 
 
I was delighted to learn that they used my recentcolumn: The Virgin Crisis: Systematically Ignoring Fraud as a Systemic Risk as the vehicle for their send-up.
 
The send-up captures precisely faux Austrianeconomists’ disdainful response to adverse data – they ignore it. 
The article hits its peak in capturing the servileapologies that Austrian economists offer in defense of the elite white-collarcriminals who make a mockery of Austrian claims of “free markets.”  The satirist emphasizes the Austrians’hypocrisy (they love police enforcing a “rule of law” and “property rights”against blue-collar folks), by calling the FBI the “Stasi” (the East German’ssecret police) when they enforce the rule of law and property rights againstelite white-collar criminals.  Thesatirist then mocks the Austrians by picturing them as eager to prevent theimprisonment of elite white-collar felons. Faux Austrian economists’ heroes have always been elite felons.  The author of the satire ridicules theJustice Department’s (DOJ) abject failure to investigate, much less prosecute,the elite felons of finance that drove our ongoing crisis.  He skewers DOJ for going AWOL during thiscrisis by employing over-the-top mockery. The author states that DOJ is so effective in prosecuting the elite white-collarcriminals that drove this crisis and sanctions them so viciously that they havecreated an “ever-expandinggulag of slave-laborers.”  One man’s“Club Fed” is a faux Austrian’s “gulag.” The reality, of course, is that no Wall Street bankster inhabits thisnon-existent white-collar gulag.  Thatgap between reality and the hysterical claims of tortured banksters is whatmakes the passage hilarious.
 
The authorof the satire of Austrian economics uses the nom de plume of Anthony Wile, which is a fabulous insiderjoke.  The real Anthony Wile was theinfamous subject of an SEC action for securities fraud.  What a brilliant conceit – assuming the nameof a man identified by the SEC as one of the perpetrators of a crudewhite-collar fraud to advance the proposition that only fascists wouldprosecute elite white-collar frauds. Here are the lowlights of what the SEC investigation of the real AnthonyWile and his colleagues found:

U.S. SECURITIES AND EXCHANGE COMMISSION

Litigation Release No. 21696 / October 15, 2010

Securities and Exchange Commission v. Brian N. Lines, Scott G.S. Lines, LOM (Holdings) Ltd., Lines Overseas Management Ltd., LOM Capital Ltd., LOM Securities (Bermuda) Ltd., LOM Securities (Cayman) Ltd., LOM Securities (Bahamas) Ltd., Anthony W. Wile, Wayne E. Wile, Robert J. Chapman, William Todd Peever, Phillip James Curtis, and Ryan G. Leeds, 1:07-CV-11387 (DLC) (S.D.N.Y., filed Dec. 19, 2007)

Court Enters Final Judgments against Brian N. Lines, Scott G.S. Lines, Anthony W. Wile, Wayne E. Wew (formerly Wayne E. Wile), Lines Overseas Management Ltd., LOM Securities (Bermuda) Ltd., LOM Securities (Bahamas) Ltd., LOM Securities (Cayman) Ltd., and LOM Capital Ltd. in Market Manipulation Case

The Securities and Exchange Commission today announced that the Honorable Denise Cote of the United States District Court for the Southern District of New York entered judgments of permanent injunction and other relief against Brian N. Lines, Scott G.S. Lines, Anthony W. Wile, Wayne E. Wew, Lines Overseas Management Ltd., LOM Securities (Bermuda) Ltd., LOM Securities (Bahamas) Ltd., LOM Securities (Cayman) Ltd., and LOM Capital Ltd. on October 15, 2010. (The LOM companies collectively are referred to hereinafter as the “LOM Entities”). All of the foregoing defendants, with the exception of LOM Securities (Bahamas) Ltd. and LOM Securities (Cayman) Ltd., were enjoined by the Court from violating certain of the antifraud provisions of the federal securities laws, as described below. The Court also ordered broad ancillary relief against the defendants, including as to certain defendants, disgorgement, civil money penalties, and compliance with undertakings to not trade in penny stocks quoted on certain U.S.-based electronic quotation services and, for the LOM Entities, to not maintain accounts for U.S.-resident customers. Brian and Scott Lines and the LOM Entities were ordered to disgorge over $1.9 million in profits and prejudgment interest and pay civil penalties totalling $600,000.


Without admitting or denying the Commission’s allegations, the defendants consented to the entry of the judgments against them. These judgments resolve the Commission’s claims against these defendants in a civil action that was filed on December 19, 2007, in which the Commission alleged that that these defendants had participated in a fraudulent scheme to manipulate the stock price of Sedona Software Solutions, Inc. (“SSSI”), and, except for Wile and Wew, also had participated in a second stock manipulation scheme involving SHEP Technologies, Inc. (“SHEP”) f/k/a Inside Holdings Inc. (“IHI”).


In addition to entering permanent injunctions, the Court ordered Brian and Scott Lines, who are brothers and during the relevant time were the controlling persons of the LOM Entities, to pay, jointly and severally with the LOM Entities, disgorgement of $1,277,403, prejudgment interest of $654,918. The Court also imposed civil penalties in the following amounts: $450,000 for the LOM Entities, $100,000 for Brian Lines; and $50,000 for Scott Lines. In addition to entering permanent injunctions against Anthony Wile and Wayne Wew, the Court ordered Wile to pay a civil penalty in the amount of $35,000, and Wew to disgorge approximately $8000 and pay a $10,000 civil penalty.
In its Complaint in the civil action, the Commission alleged that, in early 2002, Brian and Scott Lines assisted two LOM customers, defendants William Todd Peever and Phillip James Curtis, to secretly acquire a publicly-traded OTCBB shell company named Inside Holdings, Inc. (“IHI”). Peever and Curtis then arranged for a reverse merger of IHI with SHEP Ltd., a private company that purportedly owned certain intellectual property. Peever and Curtis paid three touters to publish a series of highly positive reports recommending investments in the newly-merged entity, SHEP Technologies, Inc. The Commission’s complaint alleged, in pertinent part, that during the first half of 2003, Peever, Curtis, and the Lines brothers sold over three million SHEP shares into this artificially-stimulated demand in an unregistered distribution of SHEP stock. As part of the alleged scheme, the Lines brothers, Peever, and Curtis failed to file required reports regarding their beneficial ownership of IHI and SHEP stock, and Brian Lines caused several false reports to be filed with the Commission in order to conceal that Peever and Curtis, among others, owned substantial positions in, and had been selling, SHEP stock.


As further alleged in the Commission’s Complaint, in late 2002, Anthony Wile and another individual formed Renaissance Mining Corporation (“Renaissance”) and thereafter engaged in substantial promotional activities that created the misleading impression that Renaissance had acquired three Central American gold mines and was the “Leading Gold Producer in Latin America.” In fact, Renaissance had only executed a non-binding Letter of Intent to acquire those mines and lacked the funding necessary to consummate the acquisition. The Complaint further alleges that Wile acted in concert with the Lines brothers, who acquired a publicly-traded shell, Sedona Software Solutions, Inc., using LOM accounts in the names of nominees to disguise their ownership of the Sedona shell, as part of a plan to merge Sedona with Renaissance.


The Complaint alleges that, in early 2003, Wile and his associate primed the market for Renaissance/Sedona by disseminating materially false and misleading information that misrepresented the ownership of the gold mines and created the impression that the Renaissance/Sedona merger had been completed. Wile and his associate also arranged for the Renaissance/Sedona offering to be touted to prospective investors by Robert Chapman, the publisher of an on-line investment newsletter, and three other newsletter writers, all of whom purchased Renaissance shares for nominal sums. Through this deceptive promotional campaign, Wile and his associate informed the market that there would be an opportunity to invest in Renaissance by acquiring Sedona stock at approximately $10 per share beginning on January 21, 2003.


According to the Complaint’s allegations, on that date, Wile orchestrated a pre-arranged manipulative trade between his uncle, defendant Wayne E. Wile (who subsequently changed his name to Wayne Wew), and Brian Lines to artificially drive up the price of Sedona stock from $.03 per share to over $9.00 per share and stimulate trading in the stock. The Complaint alleged that Scott Lines solicited investors, including at least one LOM customer in the United States, to purchase Renaissance stock in anticipation of the merger between Renaissance and Sedona, without disclosing that he and Brian Lines owned the Sedona shell corporation. The Complaint further alleged that, after Renaissance and Sedona had announced their pending merger, the Lines brothers sold 143,000 shares of Sedona stock in an unregistered distribution to numerous public investors at between $8.95 and $9.45 per share, reaping over $1 million in illegal profits. On January 29, 2003, the Commission suspended trading in Sedona’s stock.


Final judgments were entered by the Court against each defendant and provide the following relief, respectively:

(i) Brian Lines is permanently enjoined from violating the antifraud, securities offering registration, and securities ownership disclosure provisions of the federal securities laws, Sections 5 and 17(a) of the Securities Act of 1933 (“Securities Act”) and Sections 13(d) and 16(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rules 13d-1, 13d-2, and 16a-3 thereunder; (2) ordered to pay disgorgement, jointly and severally with Scott Lines and the LOM Entities, in the amount of $1,277,403, plus prejudgment interest thereon in the amount of $654,918; (3) ordered to pay a civil penalty in the amount of $100,000; and (4) ordered to comply with an undertaking to not trade for a period of three years in penny stocks that are quoted or displayed on the OTC Bulletin Board Montage, Pink Sheets, or the ArcaEdge Electronic Limit Order File;
 
(ii) Scott Lines is permanently enjoined from violating the antifraud, broker-dealer registration, securities offering registration, and securities ownership disclosure provisions, Sections 5 and 17(a)(2) and (3) of the Securities Act and Sections 13(d), 15(a), and 16(a) of the Exchange Act and Rules 13d-1, 13d-2, and 16a-3 thereunder; (2) ordered to pay disgorgement, jointly and severally with Brian Lines and the LOM Entities, in the amount of $1,277,403, plus prejudgment interest thereon in the amount of $654,918; (3) ordered to pay a civil penalty in the amount of $50,000; and (4) ordered to comply with an undertaking not to trade for a period of two years in penny stocks that are quoted or displayed on the OTC Bulletin Board Montage, Pink Sheets, or the ArcaEdge Electronic Limit Order File;
 
(iii) Lines Overseas Management Ltd. is permanently enjoined from violating the antifraud, securities offering registration, and securities ownership disclosure provisions, Sections 5 and 17(a)(2) and (3) of the Securities Act, and Section 13(d) of the Exchange Act and Rules 13d-1, 13d-2, and 16a-3 thereunder; (2) ordered to pay disgorgement, jointly and severally with Brian Lines, Scott Lines and the other settling LOM Entities, in the amount of $1,277,403, plus prejudgment interest thereon in the amount of $654,918; (3) ordered to pay a civil penalty in the amount of $450,000, jointly and severally with the other settling LOM Entities; and (4) ordered to comply with an undertaking to: (a) not trade for a period of two years in penny stocks that are quoted or displayed on the OTC Bulletin Board Montage, Pink Sheets, or the ArcaEdge Electronic Limit Order File; (b) not accept or maintain any account for or on behalf of any United States customer for a period of two years; and (c) hire an independent consultant for two years to monitor compliance with these undertakings;
 
(iv) LOM Capital Ltd. and LOM Securities (Bermuda) Ltd. are permanently enjoined from violating the antifraud and securities offering registration provisions, Sections 5 and 17(a)(2) and (3) of the Securities Act and, in addition, LOM Securities (Bermuda) is permanently enjoined from violating the broker-dealer registration provision, Section 15(a) of the Exchange Act; (2) ordered to pay disgorgement, jointly and severally with Brian Lines, Scott Lines and the other settling LOM Entities, in the amount of $1,277,403, plus prejudgment interest thereon in the amount of $654,918; (3) ordered to pay a civil penalty in the amount of $450,000, jointly and severally with the other settling LOM Entities; and (4) ordered to comply with an undertaking to: (a) not trade for a period of two years in penny stocks that are quoted or displayed on the OTC Bulletin Board Montage, Pink Sheets, or the ArcaEdge Electronic Limit Order File; (b) not accept or maintain any account for or on behalf of any United States customer for a period of two years; and (c) hire an independent consultant for two years to monitor compliance with these undertakings;
 
(v) LOM Securities (Bahamas) Ltd. and LOM Securities (Cayman) Ltd. are permanently enjoined from violating the securities offering registration provision, Section 5 of the Securities Act; (2) ordered to pay disgorgement, jointly and severally with Brian Lines, Scott Lines and the other settling LOM Entities, in the amount of $1,277,403, plus prejudgment interest thereon in the amount of $654,918; (3) ordered to pay a civil penalty in the amount of $450,000, jointly and severally among the settling LOM Entities; and (4) ordered to comply with an undertaking to: (a) not trade for a period of two years in penny stocks that are quoted or displayed on the OTC Bulletin Board Montage, Pink Sheets, or the ArcaEdge Electronic Limit Order File; (b) not accept or maintain any account for or on behalf of any United States customer for a period of two years; and (c) hire an independent consultant for two years to monitor compliance with these undertakings;
 
(vi) Anthony Wile is permanently enjoined from violating the antifraud and securities offering registration provisions, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 5 and 17(a) of the Securities Act; (2) ordered to pay a civil penalty in the amount of $35,000; (3) barred from serving as an officer or director of a public company for a period of five years; and (4) barred from participating in an offering of penny stock for a period of three years;
(vii) Wayne Wew (formerly Wayne E. Wile) is permanently enjoined from violating the antifraud provisions, Sections 17(a)(2) and (3) of the Securities Act; (2) ordered to pay disgorgement in the amount of $5,422, plus prejudgment interest thereon in the amount of $2,608; and (3) ordered to pay a civil penalty in the amount of $10,000.
 

As part of a global settlement with the LOM Entities, Brian Lines, and Scott Lines, the Commission agreed to dismiss with prejudice the pending civil enforcement action against LOM Holdings Ltd., which is the parent holding company for the LOM Entities.
The Court previously had entered permanent injunctive relief against defendants Peever, Curtis, and Chapman. The Commission’s claims for monetary relief against those defendants remain pending before the Court.


For additional information, please see Litigation Releases Nos. 20407 (Dec. 17, 2007); 20733 (Sept. 22, 2008); and 21577 (June 28, 2010).”
 
http://www.sec.gov/litigation/litreleases/2010/lr21696.htm
The faux Austrian satirical web site uses thispathetic episode as another opportunity for humor when it presents a faux bioof the not-as-wily-as-he-thought Wile: 
 
“He has put thisknowledge to good use, working with top mining executives and ventureentrepreneurs to generate some of the most successful business efforts of the2000s.” 
 
There is a similar gem prominently featured on theweb site: the admonition that the key to a successful society is “personalaccountability.”  What a perfectaccompaniment to an article demanding that the elites who grew wealthy throughfraud not be prosecuted.  The satiristhas a great gift for irony.
 
Prior variants of Wile’s website contained thisdefense of Wile.
http://thedailybell.com/2012/Anthony-Wile
(accessed 11/13/2011)
“In 2000, Wile experienced a brief role as the CEO of astart-up junior mining company that became the subject of a civil attack by theSEC. Wile and others fought for more than seven years at greatpersonal and financial expense before eventually settling the case withoutadmitting any wrongdoing. The assets of the company in question weresubsequently purchased by a New York Stock Exchange listed company and theproperties have now produced more gold than was initially suggested. Hundredsof investors lost literally tens of millions in deserved future profits becausethe SEC accused the company of over-promising a merger that was actually takingplace. Perhaps this experience adds to Wile’s fervor to expose the power eliteand their societal manipulations.”
 [Perhaps? This is supposed to be Wile’s web site. Why is Wile guessing at the source of Wile’s “fervor?”  For that matter, why is Wile referring tohimself as “Wile” rather than “I?”  Whyaren’t Wile’s actions (as found by the SEC staff’s investigation) nasty“societal manipulations?”  Why isn’t Wilepart of the “power elite?”  Note that theSEC’s characteristic failure to actually litigate its cases or get admissionsof the facts means that Wile gets to pose as the victim of some kind of evilconspiracy.  The Department of Justice,equally characteristically, failed to prosecute despite SEC staff investigationfindings that should have led to felony charges.  Some gulag!]
 
It is time for a word about real Austrianeconomists.  They hate elite frauds andwant them prosecuted vigorously.  Ludwigvon Mises and Friederich Hayek are the two most famous Austrian economists.
 
Hayek, F.A.  The Road to Serfdom
 
“To create conditionsin which competition will be as effective as possible, to prevent fraud anddeception, to break up monopolies— these tasks provide a wide and unquestionedfield for state activity.”
 
The Constitution of Liberty
 
“There remains,however, one other kind of harmful action that is generally thought desirableto prevent and which at first might seem distinct.  This is fraud and deception.  Yet, though it would be straining the meaningof words to call them ‘coercion,’ on examination it appears that the reasonswhy we want to prevent them are the same as those applying to coercion.  Deception, like coercion, is a form ofmanipulating the data on which a person counts, in order to make him do whatdeceiver wants him to do.  Where it issuccessful, the deceived becomes in the same manner the unwilling tool, servinganother man’s ends without advancing his own. Though we have no single word to cover both, all we have said ofcoercion applies equally to fraud and deception.
 
With this correction,it seems that freedom demands no more than that coercion and violence, fraudand deception, be prevented, except for the use of coercion by government forthe sole purpose of enforcing known rules intended to ensure the bestconditions under which the individual may give his activities a coherent, rationalpattern.”  
 
“Liberty not only means that the individual has boththe opportunity and the burden of choice; it also means that he must bear theconsequences of his actions….  Libertyand responsibility are inseparable.”
 
Mises, L.
 
“Governmentought to protect the individuals within the country against the violent andfraudulent attacks of gangsters, and it should defend the country againstforeign enemies.”
 
The faux Austrian website and the faux (or real, whocan tell) Wile piles layer upon layer of satire.  The website contains articles that make theterm “bizarre” deeply inadequate.  One ofthe site’s favorite motifs is that an international conspiracy of the topbankers that caused the ongoing global crisis is using the Occupy Wall Street(OWS) movement to demand that the fraudulent bop bankers that caused the crisisbe prosecuted.  The dastardly OWS personcarrying the water for this conspiracy of international bank elites is DavidDeGraw.
 
“[T]hereis an Anglo-American power elite trying to establish a world government. Wecannot necessarily explain WHY anyone would want to do such a thing. Butapparently someone does. Actually more than a “someone” – a handfulof impossibly wealth banking families, located mainly in the one-square-mileCity of London.
 
These families – and one family in particular – apparentlyhave control of a worldwide central banking apparatus. With the ability toprint money-from-nothing around the world, the Rothschilds have amassed afortune that may be in excess of US$300 trillion. (Nobody really knows.)”
 
This too is a wonderful satiric technique.  I particularly like the “Nobody really knows”parenthetical as a modifier for a (gigantic) number that has already been madea non-number by the use of the word “may” (with a lead-in sentence renderedimpotent by the use of “apparently”).  Atrue Austrian-school economist, however, would never admit that central bankscould create over $300 trillion in money (over 15 times the GDP of the U.S.)without producing even material inflation over the last 30 years.  So, where do the Rothschilds invest ordeposit their over $300 trillion?  Giventhe fact that the Austrian school considers even massive income disparities irrelevant,it must be a very good thing for the world (from an Austrian perspective) thatthe Rothschilds have created such a massive increase in societal wealth withoutproducing anything that even approached hyper-inflation.    
 
David DeGraw must be the most skilled operative inthe world if the Rothschilds have chosen him to run their “false flag”operation that recruited the OWS as their secret ally.  Indeed, the Rothschilds are so clever thatthey doubtless picked DeGraw as their operative because he has been apersistent critic of central banks (the devils incarnate in this satire), thenpicked me because I am a persistent critic of central banks and want us toprosecute the elite banksters that drove the crisis.  Why?  Wecan’t explain WHY.   
 
I learned that the Rothschilds hate and wish todestroy the largest banks.  The largestbanks, however, are the central banks leading supporters.  Why? We can’t explain WHY.  All of thiswould be confusing if the blog had any pretense to rationality or reality.
 
The web site and interviews on the web with whoeverplays Mr. Wile are so loopy, with such vibrant excursions into multipleTwilight Zones that it is hard to pick a favorite satirical delusion.  In an hour of bemused perusing I learned thatOsama bin Laden had been dead for years (the raid on his compound in Pakistanwas a fake), it is likely that we used military force in Libya because theywere about to mint a gold coin that would become their national currency, theWorld Trade Center towers were blown up by the U.S., and hyper-inflation isabout to go global any minute. 
 
I grew up largely in Dearborn, Michigan (home ofFord Motor Company).  Henry Ford wasinfamous for distributing The Protocolsof the Learned Elders of Zion (the Czarist forgery exposing the Jewishconspiracy to rule the world), so I found that reading the Rothschild rant waslike noshing on comfort food. 
 
Sorry, have to cut this short, but I just received acall from the City of London.  Mr.Rothschild may be calling (nobody really knows).  And if nobody really knows, it could be true.  Why? We don’t know WHY. 


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.Follow him on Twitter: @WilliamKBlack

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