This is the second in my series of articles based on the FBI's most (2010) "Mortgage Fraud Report."
In my first column I began the explanation of how many analytical conclusions one can draw from a close reading of what is left out of the FBI report.
In particular, I emphasized the dearth of criminal referrals by the SEC and the banking regulatory agencies. The FBI report implicitly confirms the investigative reporting of David Heath that first quantified the dearth of criminal referrals by the banking regulatory agencies.
Because banks will not make criminal referrals against their own CEOs, this means that criminal referrals have virtually vanished against the "accounting control frauds" that drive our recurrent, intensifying financial crises. As George Akerlof and Paul Romer explained in their famous 1993 article ("Looting: The Economic Underworld of Bankruptcy for Profit") the dearth of prosecutions of the controlling officers of banks will lead to accounting control fraud becoming a "sure thing."
"[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution? (1993: 4-5).
In criminology jargon, the dearth of criminal referrals has created an intensely criminogenic environment which creates incentives so perverse that accounting control fraud can become epidemic.
The central puzzle is how the largest epidemics of elite white-collar crime in history, frauds that drove the ongoing financial crisis and made the Wall Street banksters wealthy beyond their most avaricious dreams, resulted in not a single conviction of those elite frauds. The FBI report allows us to figure out some of the key missing puzzle pieces that explain this tragic mystery.
This article (and the next) focus on the brilliant con that the mortgage lending industry was able to pull on the FBI because the banking regulatory agencies and the SEC failed to provide the FBI with the expertise and investigative findings of fraud essential for the FBI and the Department of Justice (DOJ) prosecutors to succeed in investigating and prosecuting the officers controlling complex frauds. Three key facts are essential for the public to understand the FBI's total dependence on criminal referrals from the banking regulatory agencies. First, "control frauds" cause greater financial losses than all other forms of property crime - combined. "Accounting control frauds" must gut their underwriting process and internal controls in order to make massive amounts of bad loans. That is equivalent to hanging a sign on the front door inviting thieves to rob the bank with impunity.
Second, the FBI has roughly 2,300 white-collar specialists and our Nation has over 1,300 industries. That means that the FBI "specialists" will rarely have expertise in the industry they are investigating. It also means that FBI agents do not "walk a beat." They only investigate when they receive a criminal referral alerting them to a possible white-collar crime. The only sure (and generally safe) means by which they can gain the essential expertise about the industry and its fraud schemes is from the federal regulators.
Third, banks virtually never make criminal referrals against the people who control them. This means that only the regulators will make criminal referrals against the elite banksters. If the regulators do not make criminal referrals the FBI agents will never learn of the control frauds. The (minor) exception is whistleblowers. Whistleblowers, however, are rare and typically are too low in the food chain to have direct evidence of the controlling officers' frauds. Whistleblowers cannot stop or even impede materially an epidemic of control fraud. Only the regulators can bring the necessary expertise, resources, relentless attention, and vigor to make the criminal referrals (and take a vast range of other actions) essential to stem an epidemic of control fraud and prosecute many hundreds of elite white-collar criminals. In the vastly smaller S&L debacle our agency, the Office of Thrift Supervision (OTS), made over 30,000 criminal referrals and produced over 1,000 felony convictions in cases designated as "major" by DOJ.
So we return to the question this column addresses - how could the DOJ make zero criminal prosecutions of the elite banksters that caused this crisis through the twin epidemics of accounting control fraud by lenders (appraisal fraud and fraudulent "liar's" loans)? The FBI Report shows (indirectly) that the answer is an exceptionally effective con run by the mortgage industry on the FBI. The con could have never succeeded had the banking regulators not ceased making criminal referrals and providing their expertise to the FBI and DOJ on accounting control fraud schemes. The OTS was supposed to regulate Countrywide, Washington Mutual (WaMu), and IndyMac - three of the most notorious fraudulent lenders in the world. The OTS made zero criminal referrals in this crisis - which was over 70 times worse than the S&L debacle in terms of losses and fraud.
The FBI's Perverted "Partnership" with the Perps' Lobbyists
In the absence of the banking regulators providing the essential criminal referrals and expertise, the FBI took two seemingly logical, but disastrous steps. First, they focused on the criminal referrals they did receive - from the lenders. My fourth column in this series will explain why that proved so harmful. Second, in 2007 as the fraudulent mortgage lenders began to collapse on a twice weekly basis the FBI formed what it called a "partnership" with the Mortgage Bankers Association (MBA) - the trade association of the "perps."
The bottom of the MBA press release, in small print boilerplate, revealed the financial tsunami that was devastating the industry. In April 2006, the same boilerplate stated that the MBA had over 3,000 members employing over 500,000. By the March 8, 2007 press release the number was "over 2,200" lenders employing over 280,000. The industry and the MBA were being crushed by the twin (appraisal and "liar's" loans) epidemics of mortgage fraud origination that became endemic in the industry and that the MBA fought tenaciously to protect from effective regulation.
The FBI was desperate to address the mortgage fraud catastrophe in 2007. The irony was that it was vulnerable to political attack because it had been so right, so early about mortgage fraud. The FBI warned publicly in September 2004 that mortgage fraud had become "epidemic" and predicted that it would cause a financial "crisis" if it were not stopped. By 2007, however, the FBI had assigned only 120 FBI agents nationwide to investigate the epidemic of mortgage fraud that had grown massively since the FBI warnings. As I have explained on many occasions (and will reprise briefly in my fourth column in this series) that pittance of agents was assigned to relatively minor mortgage frauds because, as I describe below, the MBA conned the FBI into defining out of existence the control frauds. With no assistance from the banking regulators, and an industry collapsing in an orgy of mortgage fraud that the FBI had warned about but could not understand or effectively stop given the dearth of criminal referrals by the financial regulators an overwhelmed FBI turned for industry expertise to the MBA. It was a disastrous choice - and the FBI has refused to end the partnership with the perps.
The partnership's output consists of two products. This column explains "the Poster." The next column discusses the MBA's faux definition of mortgage fraud that defined control fraud out of existence and transformed the fraudulent loan originators into saintly fraud victims. It is the greatest con of modern U.S. history in its pure audacity.
Be Afraid, be very Afraid: the FBI/MBA Mortgage Fraud Poster
The MBA and the FBI's vaunted partnership produced a poster. The poster only addresses mortgage frauds against banks by the bank's customers. The MBA provides the poster to lenders so that they can display it to its evil, ultra financially sophisticated customers and warn them not to defraud the poor, virginal, honest, and too-trusting lender.
"Fraud against lenders is a rapidly growing problem. It can affect not only lending institutions, but innocent homeowners and the community at large. It is a problem that requires the close cooperation of law enforcement and the real estate finance industry. That cooperation includes educating the general public as to what constitutes mortgage fraud and what the consequences of mortgage fraud are.
To that end, the Federal Bureau of Investigation and the Mortgage Bankers Association have jointly produced a Mortgage Fraud Warning Notice. This Warning Notice makes clear that mortgage fraud is a federal offense with serious penalties, and will be fully investigated and prosecuted by the appropriate authorities. The FBI and MBA strongly encourage lenders to consider integrating the Warning Notice into their loan processes."
You too can print out your very own warning poster.
Please do not alter the FBI seal, and note that the FBI threatens to prosecute you if you create a satirical sign using their seal or name that explains their failure to prosecute the banksters or promises to start prosecuting them. You can, however, provide us at New Economic Perspectives with your proposed revised text that would warn the lenders and their CEOs that some [unstated] entity will investigate and prosecute the control frauds (as soon as we get a real Attorney General).
The poster's existing language talks solely about "person[s]" and warns that it is a federal felony to commit appraisal fraud ("to willfully overvalue any land or property"). How about banks? Borrowers rarely are able to inflate appraisals. Lenders and their agents are the ones that extorted and bribed appraisers to "overvalue" appraisals - and they did so at least hundreds of thousands of times. Only a fraudulent lender would overvalue the collateral. As the poster says, the banks and controlling officers could have been sentenced, respectively, to pay a fine of up to $1 million for every act of mortgage fraud and to 30 years in prison for a single, relatively small act of mortgage fraud. Consider the mirth this poster prompts among the senior officers of the lenders who caused the twin epidemics of appraisal and "liar's" loan frauds, then committed contract and securities fraud by fraudulently selling their fraudulent loans to the secondary market, and topped it off by committing hundreds of thousands of cases of foreclosure fraud. You know - the mortgage fraud "victims" according to the MBA and the FBI.
Given the fact that the CEOs of large fraudulent lenders are criminally liable for tens or even hundreds of thousands of acts of mortgage fraud, we should be seeing our prisons overrun with elite white-collar criminals. Instead, the DOJ has no convictions of the elite bankers who led the control frauds that caused the crisis.
Note that in the second paragraph of its statement quoted above the MBA conflates "mortgage fraud" with "fraud against lenders" by their customers. The concept that the controlling officers of banks defraud customers through mortgage fraud (and that such frauds massively outweigh in magnitude and harm the frauds by mortgage applicants against their lenders) disappears under the MBA/FBI poster. Remember that only fraudulent lenders are vulnerable to material fraud by customers because such lenders must gut their underwriting and internal controls - systems that had proven for many decades that they prevented any material fraud by mortgage borrowers. The largest "victims" of mortgage fraud, therefore, are victims because they are enormous perpetrators of mortgage fraud. The MBA/FBI warning poster might have made sense if it were put in the office of every mortgage lender's CEO. Doing so, however, would have exposed the missing asterisk in the MBA's statement above that should have read "mortgage fraud ... will be fully investigated and prosecuted" * (* "except where it is led by the lender's controlling officers").