By William K. Black
On December 13, 2011, the Wall Street Journal published an article entitled “Banks in Pushfor Pact.” It was an obscure article buried in the real estatesection. The article contained thisclause: “Under the proposal, banks wouldbe released from legal claims tied to servicing delinquent mortgages as well ascertain mortgage-origination practices….” Opponents of this proposed amnesty for mortgage-origination fraud havecharged repeatedly that the federal government and Tom Miller, the AttorneyGeneral of Iowa, who is leading the settlement negotiations, support theamnesty. Previously, Miller’s keylieutenant, but not the Obama administration, angrily denounced thecharge.
TheFour Levels of Control Fraud Involving Mortgages
Home lenders, particularly those making liar’s loans,typically committed endemic “accounting control fraud” on multiple levels. Control fraud occurs when the personscontrolling a seemingly legitimate entity use it as a “weapon” to defraud. Accounting is the “weapon of choice” forfinancial control frauds. Mortgagefrauds can be grouped into four levels, each of them exceptionallywidespread: loan origination fraud bythe lenders and their agents, the fraudulent sale of fraudulent mortgages, thefraudulent pooling and sale of collateralized debt obligations (CDOs) in whichthe underlying was largely fraudulent mortgages, and foreclosure fraud.
The classic economics article describing such frauds isGeorge Akerlof and Paul Romer’s “Looting: the Economic Underworld of Bankruptcyfor Profit” (1993). The recipe” foraccounting control fraud by a lender (or purchaser) has four ingredients.
- Extreme growth by making (or purchasing)
- Loans of extremely poor quality at a premium yield
- While employing extreme leverage, and
- Providing grossly inadequate allowances for loan and lease losses (ALLL)
Origination fraud involved a series of mutually supportivefrauds: inflating the borrower’s income, inflating the appraised value of thehome, providing grossly inadequate allowances for loan and lease losses (ALLL),and failing to recognize losses on fraudulent loans held in portfolio. It was also common for federally insuredlenders to file false reports with and make false statements to theregulators. Lenders that made liar’sloans were “accounting control frauds.” Their CEOs cause them to create perverse incentives to suborn thesupposedly independent experts to provide opinions that inflate values andunderstate risk in order to aid and abet the underlying accounting fraud. These perverse incentives create a“Gresham’s” dynamic in which bad ethics drives good ethics out of themarketplace. The result is “echo” fraudepidemics. Each of these fraudsconstitutes a federal felony. Most ofthe frauds I have described are also felonies under state law. Collectively, there were millions oforigination frauds with a total dollar amount of fraudulent originations wellin excess of $1 trillion.
TheFraudulent Sale of Fraudulent Loans
The second level of fraud is the fraudulent sale by thelenders of the fraudulent loans. Thisform of fraud required endemic false “reps and warranties.” Roughly 90 percent of liar’s loans were sold,so this second level of fraud also constitutes millions of federal and statefelonies and roughly $1 trillion in fraudulent sales.
TheFrauds involved in Pooling Fraudulent Loans to Create and Sell Fraudulent CDOs
The third level of fraud is the sale of collateralized debtobligations (CDOs) “backed” by fraudulent liar’s loans through falsedisclosures. This level of fraudconstitutes tens of thousands of federal felonies and roughly $1 trillion infraudulent sales.
The fourth level of fraud is foreclosure fraud. The best known of these frauds involved thecommission of hundreds of thousands of felonies through the filing of falseaffidavits to secure foreclosures (inaptly called “robo signing”).
MassiveForeclosure Fraud Generated the Global Settlement Discussions
It was this last level of fraud that prompted the settlementdiscussions. What one must keepconstantly in mind when dealing with lenders that are control frauds is thatthey and their senior officers will be represented by the best criminal defenselawyers. America still does many thingssuperbly, and we do lawyers really well. The fraudulent officers who control banks engaged in control fraud willspend bank funds like water for their defense lawyers. The old joke is that when one is dealt lemonsone should make lemonade. In law school,however, we consider that the “C minus” answer. When dealt lemons; the best lawyers seek to make Dom Perignon.
Consider the setting – you represent a systemicallydangerous institution (SDI) that was the beneficiary of a federal bailout. Your client has made hundreds of thousands offraudulent liar’s loans and fraudulently sold the great bulk of them. If your client is held responsible for thesefrauds it will have to reveal that it is massively insolvent and facereceivership. Your client is also one ofthe largest mortgage loan servicers in the world. A small law firm representing a borrower hastaken the deposition of one of your client’s key employees who signed theaffidavits necessary to support roughly ten thousand foreclosures a month – andadmitted that the key statements she has made in each of those affidavits isfalse. The somnolent federal governmenthad finally been forced to admit that the banks have engaged in endemic foreclosurefraud. The states are alsoinvolved. This would be a nightmarescenario for any normal client. For anSDI, however, it was an opportunity.
L’audace,encore l’audace, toujours l’audace!
(Audacity,more audacity, always audacity: the white collar defense lawyer’s creed)
One of the secrets to being an extraordinarily effectiveelite criminal is also true of their lawyers – audacity. Elite white-collar criminals can frequently getaway with grotesque criminal conduct if they use their exceptional advantagesprovided by wealth, privilege, and seeming legitimacy. Even within the ranks of elite white-collarcriminals, however, the CEOs who control SDIs – particularly during a financialcrisis that they caused – are unique in their power to commit crimes withimpunity. They hold the national, evenglobal, economy hostage. TreasurySecretary Geithner has made this strategy simple by displaying the “StockholmSyndrome.” He has fallen in love withthe criminals that are holding our economy hostage. Geithner claims that the fraudulent SDIs areso fragile that they would collapse if they were even investigated seriouslyfor fraud. He conveniently ignores thefact that the primary reason for the SDIs’ fragility is that their CEOs lootedthe banks.
They can also use “their” bank to buy the modern equivalentof indulgences for even the most destructive frauds. There are two non-exclusive means of buyingindulgences. The most obvious means ispolitical contributions. The financeindustry is the leading funder of both political parties. The less obvious means of buying immunity arises from thedysfunctional nature of DOJ policies for (not) prosecuting major firms forserious felonies and the ability of the CEO to use corporate funds to purchasepersonal immunity from criminal prosecutions. Five facts about the criminal defense of large firms must be keptprominently in mind when considering the defense of banksters. First, the CEO will gladly trade off billionsof dollars in payments by the bank and its liability insurers in order tosecure immunity from criminal charges against the CEO and the senior officerswho could implicate the CEO.
Second, the Department of Justice (DOJ) has essentiallyceased to prosecute large firms for serious felonies. DOJ was so traumatized by the consequences ofprosecuting Arthur Andersen that it has decided to allow large firms to enterinto “deferred prosecution” agreements (in which prosecution is, in reality,perpetually deferred). Arthur Andersenhad entered into two deferred prosecution agreements, and DOJ offered it athird, when AA refused the agreement and went to trial.
Third, while I have referred to the firm as the “client” andthe firm and its insurers typically pay for the attorney fees and fines, it isthe CEO that can hire and fire outside counsel. Outside counsel, therefore, are chosen by fraudulent CEOs because theyare willing to aid and abet the CEO in looting the real client (the firm). This is a classic example of the fraudulentbank CEO deliberately creating a Gresham’s dynamic in which the least ethicalmembers of the “independent” profession drive the most ethical out of lucrativerepresentations. In criminology jargon,control frauds are criminogenic. Fraudulent CEOs use their ability to make compensation for officers,employees, and independent professionals perverse in order to createenvironments that cause widespread frauds that aid and abet the lender’s fraudscheme. To put it in plainer, biblicalEnglish: fraud begets fraud.
Fourth, the settlement payments are typically deductiblefrom taxes. This means that thedefendant’s actual burden of paying the fine is much smaller than the announcedamount of the fine.
Fifth, defense counsel typically promise to pay some portionof the fines to the victims of the fraud. This is a brilliant tactic. Itmakes the government attorneys feel good about the settlement and it allowsthem to bash opponents of the settlement as blocking relief for the victims. The tactic, of course, is cynical and dishonest. The weak settlement is what prevents a fargreater recovery for the victims of the fraud. The government does not have to wait for a settlement to aid the victimsof foreclosure fraud.
Settlement discussions by counsel for control frauds withthe government and shareholders are all about exceptionally able and zealouslegal representation of the CEO at the expense of the client, its shareholders,and the public. Only vigorous regulatorsand prosecutors can protect the firm, shareholders, and public from looting bythese CEOs and the allies they generate.
TheProposed Deal: The $1 Trillion Lagniappe
The obvious deal that criminal defense counsel for banksalways seek is to trade a showy amount of fines for de facto or even formal immunity for the CEO and other seniorofficers who led the frauds and became wealthy through the frauds. Here, the defense counsel were far moreaudacious – they are demanding immunity not only from prosecution, but even frominvestigation, and they are demanding immunity for crimes they committed thathave never been investigated by the state and local prosecutors. The foreclosure fraud cases, while enormous,are by far the least of the banksters’ worries. The potential loss exposure from the foreclosure fraud is measured inthe tens of billions of dollars. Thepotential loss exposure from fraudulent home loan originations is in thetrillions of dollars – and a trillion is a thousand billion. The banks’ CEOs are demanding, for a puny $25billion, a release from liability for foreclosure fraud. That is obscene on multiple levels. Even President Obama concedes that the bankstreat such fines as a mere “cost of doing business” (by which he means the“small tax on the wealth obtained by elites through doing fraudulentbusiness”). The senior officers involvedin the fraud should be imprisoned. Giving them immunity, allowing them to keep their bonuses “earned”through fraud, and keeping them in leadership roles are all despicable actsthat should be anathema to every prosecutor.
But what came next went beyond scandal as usual. The banks then demanded a lagniappe – a little something extra,for free, in a New Orleans restaurant – they wanted immunity for loanorigination fraud. The slight differenceis that this lagniappe is worthtrillions of dollars to the frauds. Itsickens me to inform the reader that the Obama administration is eager toprovide the frauds with this lagniappe. The Department of Housing and UrbanDevelopment (HUD), led by Secretary Shaun Donovan, is actively pushing thisscandalous deal, with strong support in the background from Treasury SecretaryGeithner. The silence of AttorneyGeneral Holder, and President Obama, on this travesty is exceptional.
Worse, the banks are seeking immunity even frominvestigation of the over trillion dollars in mortgage origination fraud – andthe Obama and Bush administrations’ supposed “investigations” of mortgageorigination fraud by the large lenders that made the mass of liar’s loans areall unworthy of the word “investigations.” It would take roughly 100 investigators, working for years, to do aserious investigation of any of the largest liar’s loan lenders. There has never been, remotely, such aninvestigation by the federal government of the any large liar’s loan lender. The Obama administration is reported tosupport the fraudulent financial CEOs’ dearest dream – de facto immunity even from investigation of over a trilliondollars in fraudulent liar’s loans origination.
The Republican Party and its candidates for the Party’spresidential nomination are not criticizing Obama’s proposed formal surrenderto crony capitalism. They only wish theywere in complete power and could cash in even more heavily on the tidal bore ofcampaign contributions flowing out of the finance industry.
Miller,and everyone involved, knows there was endemic origination fraud
Miller no longer denies that he has joined theadministration in favoring the banks’ most cherished dream – amnesty fororiginating a trillion dollars in fraudulent home loans. Indeed, the settlement is designed toprevent even investigations of themortgage origination fraud.
I confess that I am so naïve that I would have believed itimpossible that any federal or state governmental entity would enter into suchan abject surrender to crony capitalism. Once I learned that they were seriously contemplating such a travesty Icould not believe that Miller would support it. I believed his lieutenant’s (Mr. Madigan’s) denunciation of criticism ofthe proposed amnesty. (I have reviewedMadigan’s comments in preparing this piece and I see that they were artfullycrafted to be disingenuous.)The testimony of Thomas J. Miller, Attorney General of Iowa, at a 2007Federal Reserve Board hearing shows that he knows that the lenders engaged inmassive origination fraud.
Over the lastseveral years, the subprime market has created a race to the bottom in whichunethical actors have been handsomely rewarded for their misdeeds and ethicalactors have lost market share…. The market incentives rewarded irresponsiblelending and made it more difficult for responsible lenders to compete. Strongregulations will create an even playing field in which ethical actors are nolonger punished.
Despite thewell documented performance struggles of 2006 vintage loans, originatorscontinued to use products with the same characteristics in 2007.
[M]anyoriginators … invent … non-existent occupations or income sources, or simplyinflat[e] income totals to support loan applications. A review of 100 statedincome loans by one lender found that a shocking 90% of the applicationsoverstated income by 5% or more and almost 60% overstated income by more than50%. Importantly, our investigations have found that most stated income fraudoccurs at the suggestion and direction of the loan originator, not theconsumer.
Miller, T. 2007. “Comments to the Federal Reserve Board ofGovernors on Adopting Regulations to Prohibit Unfair and Deceptive Acts andPractices under the Home Ownership and Equity Protection Act (HOEPA).” (August14). Miller was correct. We know that it was overwhelmingly lenders andtheir agents that put the lies in “liar’s” loans. We know that 90 percent of liar’s loans werefraudulent. We know that the industrymassively increased the number of liar’s loans after warnings that the loanswere endemically fraudulent. The growthrate of liar’s loans was so rapid (over 500% from 2003-2006) that thesefraudulent loans caused the housing bubble to hyper-inflate. We know that no government entity ever causedany entity to make or purchase (and that includes Fannie and Freddie) liar’sloans. Indeed, the government repeatedlywarned of the dangers of liar’s loans. We know that by 2006 roughly one-third of all home loans made that yearwere liar’s loans – which means there were millionsof fraudulent loans made annually and, collectively, trillions of dollars in fraudulently originated home loans.
Whatmust be done
Our economy and our democracy cannot succeed under cronycapitalism. Please join me in writing toCongress, the administration, your state attorney general, the media, and anycourt that must approve this proposed settlement. It is a disgrace. President Obama is, of course, correct thatsome actions can be illegal but exceptionally unethical and damaging. He is about to take precisely such an actionin derogation of his oath of office to defend and protect the constitution ofthe United States of America. Thefraudulent CEOs of the banks that became wealthy by causing the financialcrisis and the Great Recession are treating us as fools who will give trilliondollar plus gifts to the least deserving, most arrogant, and least ethicalelites. Have we fallen so low as apeople that we will allow this to happen?
Please join me in supporting the Attorney Generals of NewYork, Delaware, and California who have opposed this settlement.
As for President Obama, I hope that he will make this NewYear’s resolution: “I resolve to honormy oath of office and faithfully execute the laws of the United States anddefend its constitution, which is premised on justice and the rule of law. No person, no matter how elite, is above thatlaw. I have today asked Messrs.Bernanke, Geithner, and Donovan for their resignations because oftheir support for bailing out the elite banks and granting de facto amnesty to fraudulent financial CEOs. I, and my new Attorney General and newSecretary of the Treasury, have mutually resolved to make the vigorousprosecution of the elite financial frauds that drove the ongoing crisis ourmission. ”