Criminal Charges Must Be Laid – Former Finance Regulator
William Black: Regulations were deliberately weakened to create conditions for systemic fraud
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News. I’m Paul Jay in Washington. The Financial Crisis Inquiry Commission reported on Wednesday, and here’s the headlines of their report: "We conclude the financial crisis was avoidable. . . . We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. . . . We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. . . . We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis. . . . We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets. . . . We conclude there was a systemic breakdown in accountability and ethics. . . . We conclude collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis. . . . We conclude over-the-counter derivatives contributed significantly to this crisis. . . . We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction." Now joining us from Kansas City, Missouri, is Bill Black. Bill once sat on a commission quite like this, looking into the causes of the S&L banking crisis that began in the 1980s. Bill was the deputy director of that commission. He’s now–teaches law, he’s an assistant professor of law at the University of Massachusetts in Kansas City, and he’s an expert in white-collar criminology. And he’s also the author of the book The Best Way to Rob a Bank Is to Own One. Thanks for joining us, Bill.
WILLIAM K. BLACK, ASSOC. PROF. ECONOMICS & LAW, UNIV. MISSOURI-KANSAS CITY: Thank you.
JAY: So what did you think of the work of this inquiry?
BLACK: Well, one clarification. I was deputy staff director. No one is ever going to appoint me to one of these commissions, because they probably wouldn’t like what the result would be. The commission got right a key aspect, and that key aspect is their headline. This crisis could have been avoided, could have been avoided actually pretty easily if you’d had real regulation and real supervisors. And it was the deliberate destruction of real regulation and real supervision that explains why we have this crisis. And that same kind of process, by the way, occurred through much of Western Europe, which help to explain why they too had a crisis at the same time.
JAY: Now, the ten-member commission was appointed by Democrats and Republicans. The Democrats all voted for these conclusions and the Republicans all dissented. What do you make of that?
BLACK: Well, it’s very unfortunate. This is the first one of these major national commissions that I know of where you had this complete partisan divide. And it only takes one party to create this kind of partisan divide. We had nothing like it in the national commission that investigated the causes of the savings and loan crisis. There you had far more unanimity about the facts. It was much more driven by the staff’s finding of the facts. Here the Republican members were deliberately put in an impossible position by the people that appointed them, and that’s the first point. The people that appoint the commissioners are the Republican and Democratic leaderships. And since the Democrats had the presidency, that was mixed in terms of the White House and Congress. But in the case of the Republicans, this means those were the Republican congressional leadership, which is exceptionally extreme and exceptionally committed to deregulation and de-supervision, and of course doesn’t want to be criticized as being the architects of this. So they picked four members, each of whom had been an architect or an active person in voting for the deregulation that they were supposed to be examining. In other words, they were supposed to judge themselves, and that had no chance of occurring.
JAY: Now, when the Democrats passed the financial reform legislation in the last session of Congress, a lot of people, and I think including you, asked the question: why don’t you wait for the results of the Financial Inquiry Commission before you pass this reform legislation, and why preempting the conclusions of this? So, I mean, I guess one could go back and ask that question again. But did that legislation that was passed, does it actually solve any of this list of conclusions the inquiry raises?
BLACK: I, by the way, was not one of those people that asked that, because I knew there was too much danger of exactly what happened to the commission happening. It was obvious that the four Republican members had a mission, and the mission was to defend deregulation, and that that was going to mean the commission was going to split, and it would have, therefore, no impact on the Republican members of Congress in deciding what they ought to do about the reform bill. Now, the reform bill is very poor. The reform bill does not deal effectively with the underlying causes of this crisis. But part of the reason, again, is neither Congress nor this commission–and this includes the Democrats on the commission–are willing to actually use the F word, to actually–
BLACK: —fraud when they see fraud. So you read the conclusions. Those conclusions can only have occurred with endemic fraud from the most senior ranks of the lending institutions and the investment banks, in other words, what we in criminology call accounting control fraud. So they’ve described, they’ve drawn the picture of the horse, but they refuse to put the label "horse".
JAY: Yeah, the closest they get to it is "dramatic failures of corporate governance and risk management".
BLACK: Yeah. And we shouldn’t have commissioners relying on these kinds of euphemisms.
JAY: Once you say that, you’re saying it’s not criminal.
BLACK: No, that’s not the case, but it’s a deliberate obfuscation of the facts. When they say that they breached their ethics and that they breached governance, well, what did they do? They made liars loans. Let’s just take that aspect first. They made millions of liars loans that have an incidence of fraud of 90 percent. And we have known for hundreds of years that if you make these kinds of liars loans–and by the way, it’s the lenders and their agents that put the lies in the liar loans, overwhelmingly.
JAY: And a liars loan essentially is loaning money to someone you know they can’t repay.
BLACK: That’s correct, but will agree to nominally pay you a high yield. And that will produce–this is that standard recipe for gimmicking accounting income in the short term. Grow like crazy is the first element. Make really bad loans at a premium yield is the second ingredient. The third is extreme leverage. The fourth is providing only trivial loss reserves. If you do that, you have what the Nobel prize-winning economist George Akerlof, and with his co-author Paul Romer, warned about in 1993, a long time ago, that this creates a, quote, "sure thing", unquote, you know, guarantees record fictional accounting profits that flow through with modern executive compensation to make the people rich. The bank fails, but the CEO walks away rich. That’s why the title of Akerlof and Romer’s article is "Looting: the Economic Underworld of Bankruptcy for Profit." That’s why the title of my book is, you know, The Best Way to Rob a Bank Is to Own One. And so the only reason you would have millions of liars loans, when they were guaranteed to lose money for the banks–and, again, the banks all knew this and known it for hundreds of years–was to create this fictional accounting income and loot the institutions. And that’s exactly what they did. And we know this also because we know that there was an epidemic of appraisal fraud, and only the lenders and their agents can induce appraisers to create this kind of endemic fraud.
JAY: These are the rating agencies that give them the AAA ratings for these buckets [inaudible]
BLACK: No, this is the home appraisers. This is the guy or gal that goes out and says your house is worth $400,000. You deliberately inflate these appraisals so that you make the loan look safer, and then you can sell the loan for a higher price by reducing what we call the loan-to-value ratio. In other words, if you increase the supposed market value, it looks like the loan is safer. And you could get–as a loan broker in California doing a big mortgage, say a $600,000 mortgage, you could get a $20,000 fee if you could get the appraiser to lie and if you could create a phony loan application that inflated the borrower’s income.
JAY: So if the issue is they didn’t use the word fraud and they should have, should there not have been in the conclusions an explicit conclusion, recommendation that some people should then be prosecuted? ‘Cause there’s nothing–there’s certainly nothing explicit.
BLACK: Of course there should be exactly that. Any individual can make a criminal referral. The Financial Crisis Inquiry Commission didn’t do a lot of investigation of specific facts, unfortunately. Had it done so, it certainly would be in a position to make more criminal referrals. Look, just take one example. There have been investigations. Then-attorney general [Andrew] Cuomo, attorney general of New York, did an investigation, found that Washington Mutual had a blacklist of appraisers. But you got on the blacklist if you refused to inflate an appraisal. That’s immensely important, because there is no reason in life why an honest lender would ever inflate an appraisal. But we know that happened endemically. So we know these actions were fraudulent, we know that they came from the top of the organization, and we know that people are now able to, again, loot (Akerlof and Romer’s phrase) with impunity. Where in the savings and loan crisis over 1,000 elite officers and principal borrowers of these banks were convicted of felonies, you have zero convictions of any of the senior lender officers that made these liars loans at the major institutions. You have no criminal referrals out of two of the major agencies, versus over 11,000 criminal referrals in our era.
JAY: But were there any criminal referrals that came out of this inquiry?
BLACK: We don’t know, and they wouldn’t normally tell us. But one of the things people have to understand is how incredibly difficult the job of this commission was compared to the savings and loan crisis. Here’s why. The savings and loan commission reported in 1993. By that time, there were these 1,000 felony convictions. So you had the detailed records developed in the investigation of 1,000 cases, all of which had been made in large part public because of the prosecutions. In addition to that, you had several thousand major enforcement actions by us, the regulators, all of which had therefore become part of the public record, at least in substantial part, as well. You have nothing like that today. In our era you also have nearly 1,000 civil suits that, again, were after detailed investigations and made all kinds of very specific facts public and in the record. In the current crisis, when the Financial Crisis Inquiry Commission was looking, it had no prosecutions, next to no enforcement actions, and next to no civil actions by the regulators. So they were starting so far behind the eight ball compared to where we were that it was a nightmare. And, of course, Congress put them on a very quick time period when they had to get their report done, with very little budget to have a staff. So the Financial Crisis Inquiry Commission knows maybe 1/100th as much about this crisis as we knew about the savings and loan crisis.
JAY: Do you think it would have been appropriate for them in this headline list of conclusions to have one that called for more intense or more deeper criminal investigations? ‘Cause if one read this report, one would not think the attorney general would take a cue from this that there’s some heat on him to go further?
BLACK: I agree, and the failure to put heat on the attorney general is particularly damaging in these circumstances, because stories also ran today that one of the areas of significant budgetary cuts is going to be the Justice Department. So we’re going to–but we already have grotesquely inadequate numbers of FBI agents and prosecutors working all the cases, but in particular white-collar crime. As recently as about a year and a half ago, we had, nationwide, 120, roughly, FBI agents working on all mortgage fraud. There were over a million cases of mortgage fraud a year. To give you a contrast, in the savings and loan crisis we had 1,000 FBI agents working those. And this crisis is, you know, maybe 40 times as large as the savings and loan crisis. When 9/11 hit, 500 white-collar specialists in the FBI were transferred out of investigating white-collar crimes and put in national security. And, again, we can understand that, but we can’t understand why the Bush administration refused to allow the FBI to hire agents to replace those. And now, in addition to that loss of the 500 FBI agents and a number of prosecutors, we’re going to lose still more agents, still more prosecutors. Elites can now commit white-collar crimes with near impunity. Yeah, there are exceptions, like the Galleon case and [Bernie] Madoff, but that is the teeniest, tiniest percentage of these elite frauds have any risk of being prosecuted. And the result is catastrophic for our nation, and of course not just our nation: we’re seeing these epidemics of control fraud in many other nations. Wherever you look, you find. And, of course, if you don’t look, you don’t find.
JAY: Thanks very much for joining us, Bill.
BLACK: Thank you.
JAY: And thank you for joining us on The Real News Network.
End of Transcript
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