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By William K. Black
On January 25, 2013, I made this comment on Frontline’s web site discussing its documentary: “The Untouchables” and an accompanying (January 22, 2013) article by Jason Breslow entitled: Were Bankers Jailed In Past Financial Crises?
I addressed two statements in that article. The first statement reads:
“Equally important in the S&L crisis was a much tougher framework of banking laws, according to Black, who is critical of the deregulation that began during the Clinton administration.
‘Deregulation was bound to produce widespread fraud,’ he said. ‘We know better. If we learn the lessons from this, we need not have these fraud epidemics.’”
I responded in my comment that:
“The quotation at the end that the reporter attributes to me was actually me quoting the famous concluding paragraph of George Akerlof and Paul Romer's 1993 article entitled ‘Looting: the Economic Underworld of Bankruptcy for Profit.’"
[Here is the full quotation from Akerlof & Romer.
“Neither the public nor economists foresaw that [S&L deregulation was] 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” (George Akerlof & Paul Romer.1993: 60).]
The second statement in the Frontline article that I commented reads:
“One key tool used during the S&L crisis was criminal referrals from regulators to government prosecutors, explained William Black, who served as the government’s point man for litigation in the S&L crisis. Such referrals ‘are absolutely essential,’ said Black, because they provide a road map for a Justice Department already short-staffed in the area of white-collar crime. According to Black, criminal referrals have been missing in the response to the 2008 crisis.
Black, now a professor of law at the University of Missouri at Kansas City, said the Federal Home Loan Bank Board — the predecessor to the Office of Thrift Supervision (OTS) — passed along thousands of referrals to prosecutors. ‘Flash forward in the current crisis, the same agency made zero,’ he said.
In a statement, a spokesman for the Office of the Comptroller of the Currency, which merged with OTS in 2011, said that referrals are a ‘poor indicator of the quality of supervision’ because they ignore the Suspicious Activity Report process, in which banks are required to report known or suspected criminal offenses.
The statement said that ‘using the number of referrals to compare the crisis of the 1980s to the most recent economic crisis is comparing apples to oranges.’ It continued: ‘A significant number of thrifts failed in the 1980s because of fraud and insider abuse. That has not been the major factor behind the most recent crisis.’”
[I actually told the reporter that we made over 30,000 criminal referrals as an agency during the S&L debacle. The remainder of this document is the comment I posted on the Frontline web site discussing the OCC claims in their statement to Frontline.]
“The OCC statement about SARs (the technical jargon for "criminal referrals"), is sad. Banks virtually never make criminal referrals against their senior officers, so the number of SARs filed by banks is not relevant to the subject being discussed. The OTS made over 30,000 criminal referrals during the peak years of the S&L debacle. It made zero in this crisis -- a crisis in which the losses and the frauds by senior managers were roughly 70 times larger than during the debacle. Apparently, the OTS and the OCC are trying to excuse their failure to examine, supervise, regulate, and investigate, much less make referrals on the claim that this is the first Virgin Crisis.
Readers are invited to read my testimony before the FCIC and the Senate. The ultra brief version is (1) by 2006 roughly 40% of total mortgage loans originated were "liar's loans", (fyi, roughly half of all loans called "subprime" were also liar's loans -- the categories are not mutually exclusive, (2) the incidence of fraud among liar's loans is 90%, (3) an honest real estate lender would not make pervasively fraudulent loans because doing so would inevitably cause the firm to fail (absent a bailout), (4) liar's loans, however, are optimal "ammunition" for "accounting control fraud", (5) investigations (and logic) have confirmed that it was overwhelmingly lenders and their agents who put the lies in liar's loans, (6) no lender was ever required or encouraged by the government to make or purchase liar's loans -- the opposite was true, the government discouraged such loans and industry documents confirm this fact, (7) liar's loans make an excellent "natural experiment" because even Fannie and Freddie were not encouraged to make these loans -- because they did not aid them in meeting the "affordable housing goals", (8) Fannie and Freddie, eventually, purchased enormous amounts of liar's loans for the same reason that the investment banks (not subject to the CRA or any affordable housing goals did) they created massive (albeit fictional) short-term accounting income, which flowed through to the bonuses of many Fannie and Freddie executives. Let me put these data in another format -- by 2006, lenders were making over two million fraudulent liar's loans annually. Fraudulent liar's loans grew massively because lenders (and purchasers) created perverse incentives to make and purchase massive amounts of these fraudulent loans.
This level of fraud is massively greater than during the S&L debacle, where accounting control fraud never became a dominant national lending strategy. Liar's loans grew so rapidly, and became such a large share of the market that they constituted the loans "on the margin" that hyper-inflated the financial bubble, which drove the Great Recession.
The S&L debacle was halted by vigorous reregulation that was successful precisely because we targeted the accounting control frauds as our top priority to shut down, remove their senior managers, and prosecute those managers. The liar's loans "crisis" of 1990-1992 in Orange County, California was stopped in its tracks without any expensive failures because we (the OTS West Region) realized that such loans inherently would lead to endemic fraud and losses. We drove entities like Long Beach out of the industry (it became a mortgage banker, and gave up its federal depositi insurance) for the sole purpose of escaping OTS jurisdiction). The OCC and the OTS not only failed to regulate the accounting control frauds they had jurisdiction over -- they engaged in a vigorous "competition in laxity" with each other that included a heavy focus on which agency could most aggressively "preempt" state efforts to stop the fraudulent lenders.
Beginning with Federal Home Loan Bank Board Chairman Gray in 1984 (through 1993), the S&L regulatory agency made one of its top priorities the prosecution of fraudulent senior officers who led the accounting control frauds. The agency did so because it understood that criminal prosecutions were the only remedy that CEOs really fear. The OCC's head, Mr. Curry, has a very different view:
"Curry said bank regulators were more focused on getting problems corrected rather than criminal penalties. 'From our standpoint, as a bank regulatory agency, our job is to, one, identify the problems and then mandate that they get fixed,' he said. 'I don't think it's our role to avenge or to punish per se.'"
We secured over 1,000 felony convictions in cases designated as "major" by the Justice Department. We worked with the FBI and DOJ to prioritize the 100 worst fraud schemes. Those schemes involved roughly 300 S&Ls and over 600 elite targets for prosecution. Virtually all of them were prosecuted. We secured over a 90% conviction rate -- against the best criminal defense lawyers in the world.
One of our mantras in white-collar criminology is: "if you don't look, you won't find." The Frontline documentary begins the process of explaining what those of us who are aware of what a real investigation is and what it requires have been saying for years -- neither the Bush nor the Obama administration has been willing to conduct a real investigation of the elite banksters whose frauds made them wealthy and drove the financial crisis and the Great Recession. This is one of the hallmarks of crony capitalism. It cripples our economy, our democracy, and our integrity. The statue of Lady Justice is blindfolded to symbolize that justice is blind to power. No one is above the law. The Department of Justice is now, officially, an oxymoron given its senior officials' admissions that they deliberately refuse to hold accountable (or even investigate) the systemically dangerous institutions (SDIs) and their senior officers because of fears of causing a global financial crisis. As a former senior regulator, an effective regulator, I am astounded that anyone believes that the route to financial stability is leaving elite frauds in charge of many of our banks. Any bank that is too big to fail and to prosecute is a clear and present danger that should be promptly shrunk to the point that it can no longer hold the global economy hostage in order to extort immunity from the criminal laws for the controlling officers who became wealthy by being what Akerlof and Romer aptly described as "looters."
Congratulations to everyone at Frontline involved in producing the documentary. I urge Frontline to revisit this issue because it is one of defining matters that will decide whether our Nation will restore the rule of law and return to greatness.
William K. Black
Associate Professor of Economics and Law