Mortgage Fraud - Peddling Theoretical Blame

I recently criticized a piece penned by William K. Black, Associate Professor, University of Missouri - Kansas City, which was posted at the Huffington Post, in a post I titled Subprime Failure Was Not Fraud But “Willful Blindness”.  I even exchanged polite emails with Mr. Black in regards to said post.

Today, in a post titled Screwed, Keith Burgess-Jackson points us to an interview of William K. Black, conducted by Bill Moyers, (you can either watch the interview or read the transcript at the link) where Mr. Black waxes eloquent on his theory of why the financial meltdown occurred, and this theory is simply peddling theoretical blame.

Let’s take a look, and I’ll start with what Mr. Black refers to as “calculated dishonesty.”

BILL MOYERS: So you’re suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?

WILLIAM K. BLACK: Yes.

BILL MOYERS: How do they get away with it? I mean, what about their own checks and balances in the company? What about their accounting divisions?

WILLIAM K. BLACK: All of those checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls, but to suborn them, to turn them into your greatest allies. And the bonus programs are exactly how you do that.

So, according to Mr. Black, bonus, or incentive programs, which are put into place and okayed by CEOs and the board of directors, either wittingly or unwittingly, turns the entire organization into an accessory of the CEO’s “calculated dishonesty.”

While the lure of money can cause certain individuals to turn a blind eye to dishonest practices, I think Mr. Black’s blanket allegation, here, is rather fanciful.

Bill Moyers, who wants to get to the bottom of this continues the interview this way.

BILL MOYERS: If I wanted to go looking for the parties to this, with a good bird dog, where would you send me?

WILLIAM K. BLACK: Well, that’s exactly what hasn’t happened. We haven’t looked, all right? The Bush Administration essentially got rid of regulation, so if nobody was looking, you were able to do this with impunity and that’s exactly what happened. Where would you look? You’d look at the specialty lenders. The lenders that did almost all of their work in the sub-prime and what’s called Alt-A, liars’ loans.

Ah, so it was the “liars’ loans” or “ninga” loans; mortgages where no verification of income, assets or employment is required; and integral to the “calculated dishonesty” of the CEOs, which is the root cause of the subprime lending collapse, and hence the financial market meltdown.

Indeed, mortgages were available where no verification of income, assets or employment was required, and they were, euphemistically, called liars’ loans or ninga loans within the mortgage industry.  But let’s consider these liars’ loans a moment.  In order for an individual to obtain a “liars’ loan,” whether for purchasing a property or refinancing an existing mortgage, the individual applying for the mortage would have had to had at least twenty-five percent (25%) equity in the property to qualify for a “liars’ loan” mortgage program, and a credit score in the high 600s, which historically is a mortgage with limited risk.  Granted, the inflated real estate values during the boom time of subprime financing adversely impacted these “liars’ loans,” but the fact that bubble real estate values were unrealistic, creating illusions of deep equity, does not support Mr. Black’s contention regarding “liars’ loans.”  Neither does the fact that no verification of income, assets or employment was required for these mortgages.  Though not all underwriters at the various players in the subprime mortgage industry considered the validity of the statements made on loan applications in regards to income, assets and employment of the prospective borrowers, most did, i.e. when reviewing the stated income and assets on these “liars’ loans” borrowers, the underwriters would consider if the stated income and assets made sense in relation to the employment stated on the mortgage loan application.

But, according to Mr. Black, these “liars’ loans” were deliberately created to swindle.

BILL MOYERS: Is it possible that these complex instruments were deliberately created so swindlers could exploit them?

WILLIAM K. BLACK: Oh, absolutely. This stuff, the exotic stuff that you’re talking about was created out of things like liars’ loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That’s why it’s toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking, during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it’s scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I’m quoting Fitch, the smallest of the rating agencies, “the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined.”

Further into the interview, William K. Black elaborates on why, if there was indeed widespread “calculated dishonesty,” fraud, taking place in the mortgage lending industry, no one is being prosecuted.

BILL MOYERS: Why are they firing the president of G.M. and not firing the head of all these banks that are involved?

WILLIAM K. BLACK: There are two reasons. One, they’re much closer to the bankers. These are people from the banking industry. And they have a lot more sympathy. In fact, they’re outright hostile to autoworkers, as you can see. They want to bash all of their contracts. But when they get to banking, they say, ‘contracts, sacred.’ But the other element of your question is we don’t want to change the bankers, because if we do, if we put honest people in, who didn’t cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up.

BILL MOYERS: The cover up?

WILLIAM K. BLACK: Sure. The cover up.

BILL MOYERS: That’s a serious charge.

WILLIAM K. BLACK: Of course.

BILL MOYERS: Who’s covering up?

WILLIAM K. BLACK: Geithner is charging, is covering up. Just like Paulson did before him. Geithner is publicly saying that it’s going to take $2 trillion — a trillion is a thousand billion — $2 trillion taxpayer dollars to deal with this problem. But they’re allowing all the banks to report that they’re not only solvent, but fully capitalized. Both statements can’t be true. It can’t be that they need $2 trillion, because they have masses losses, and that they’re fine.

These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because…

Ah, so now this “calculated dishonesty” is reaching right into the White House, to the very pinnacle of power, and since the tentacles of calculated dishonesty entwine the highest of the high, we shall never know the truth.

I’ve stated the truth of the failure of the subprime lending industry, and the resultant financial industry collapse, on a number of occasions, here, but I will state it again.

The stage was set for the collapse of the subprime lending industry with the origination of the individual subprime loan underwritten to foolish; one could say incompetent; underwriting guidelines.  As more and more of these structurally deficient loans piled up in lenders’ servicing portfolios, to be mined again and again for any remaining equity subprime borrowers may have retained in their homes, the swiftness of the final collapse lacks any astonishment.  The subprime lending business model was fundamentally flawed and myopic.

The remainder of Bill Moyers interview of William K. Black should also be read, but I would not put much faith into Black’s accusations or assumptions.

Posted by .(JavaScript must be enabled to view this email address) on 04/07 at 10:48 AM

  1. Why is it such a stretch to imagine that the level of systemic fraud that Mr. Black alleges was in fact taking place? It seems quite reasonable to expect considering that the players were primarily morivated by profits and bonuses, and not by a regard for the stability of the financial system. Most of us don’t think about “the system” in our daily jobs; we think about our pay checks and bonuses. I recall hearing some transcripts of conversations between traders during the Enron debacle that would suggest that this kind of systemic fraud is quite plausible. But let’s not get bogged down with how and who got us here; we are here now, and Mr. Black made some comments about what the government should be doing, which sounded very reasonable to me. If the CEO of GM is asked to step down, why not CEOs in the banking and finance industry? I mean, they have admitted that they screwed up…what the heck?!

    Posted by .(JavaScript must be enabled to view this email address)  on  04/09  at  01:18 PM

  2. kiymus,

    Why is it such a stretch to imagine that the level of systemic fraud that Mr. Black alleges was in fact taking place?

    In your question, here, you answer your own question.

    One may “imagine” what one wishes, but it is facts which rule the day.

    If indeed what Professor Black theorizes; “calculated dishonesty” and “systemic fraud;” actually did take place, with various CEOs as the helmsmen of such a course, other parties in the financial industry as a whole, from the lowliest loan processor, to the highest of the derivative traders, would have had to been in collusion, and that is hardly what the facts of the matter support.

    When the product being sold; mortgages to borrowers with rotten debt repayment records; it is a known fact that the mortgages are HIGH risk, regardless of the fact that ratings agencies were grading the mortgage backed securities and derivatives as Triple A.  It was a house built on extreme, and known, risk.

    If the CEO of GM is asked to step down, why not CEOs in the banking and finance industry?

    The CEO of GM should not have been asked to step down by Obama, or any other politician.  Such a request, which in this case appears to have been enforced by the power of the State, is a fascist action.

    It is the stockholders of GM, and/or GM’s board of directors, which should have forced such an action, and if the stockholders of banks and other financial institutions desire to forcibly remove CEOs, they should so act, without the State.

    I am not so naive as to maintain that no fraudulent actions took place in the financial industry, but I am definitely not gullible enough to maintain that a conspiracy of calculated dishonesty has brought the financial markets to the state they are currently in.

    Posted by John Venlet  on  04/09  at  02:55 PM

  3. You Say Mr. Black’s opinions are far fetched,
    and without merit,then what fact’s are you baseing his being wrong ? You gave none !

    Posted by .(JavaScript must be enabled to view this email address)  on  04/11  at  11:28 AM

  4. Buckley,

    You are correct, within this post I did not provide any facts.

    What facts I can currently provide would be in a series of posts I titled Stripped Bare - Beneath the Feel Good Veneer of Subprime Lending.  You’ll have to scroll down a bit in the provided link to the series of posts (14 posts in all) wherein I discuss my fact based experiences in the subprime lending industry.

    If, after that, you feel additional facts are warranted, I’d be happy to attempt to address that lack.

    Posted by John Venlet  on  04/11  at  05:35 PM

  5. John:
    Not sure I agree with all elements of your critique of William Black’s comments on the Moyers program. While you are correct in discounting his suggestions of a premeditated cover-up,  there are other ways to lie and deceive.  I agree with Black that it was to the benefit of banking industry leaders to perpetuate fraud incrementally, if you will.  No, there was never any grand conference or major memo in which policy positions and strategems were offered…rather, as in most instances of deviant behavior, a code of mutual silence, mutual deceit, and mutual denial evolved without any CEO or ranking VP having to articulate or enforce it.  All that was required to ‘join’ the conspiracy was having something to hide, in accounting terms of course, and as we are seeing daily, there was plenty to overlook, paper over, misrepresent.  I enjoy your take on many of these matters, but I find that Black’s logic here is compatible with what I know of organizational behavior and self-interest, Alan Greenspan notwithstanding !  I think any Congressional investigation will bear out Black’s claims. BTW is that a MT brownie in your photo?  Nice fish!

    Posted by .(JavaScript must be enabled to view this email address)  on  04/15  at  05:36 PM

  6. Greg, thank you for your comment.

    In regards to the following:  ...rather, as in most instances of deviant behavior, a code of mutual silence, mutual deceit, and mutual denial evolved without any CEO or ranking VP having to articulate or enforce it.  All that was required to ‘join’ the conspiracy was having something to hide, in accounting terms of course, and as we are seeing daily, there was plenty to overlook, paper over, misrepresent.

    I think what you are referencing, here, is what is referred to as control fraud (pdf document of 12 pages), which is concept articulated by Professor Black.

    Individual “control frauds” cause greater losses than all other forms of property crime combined. They are financial super-predators. Control frauds are crimes led by the head of state or CEO that use the nation or company as a fraud vehicle. Waves of “control fraud” can cause economic collapses, damage and discredit key institutions vital to good political governance, and erode trust…

    which is enabled by, per Professor Black, “incentive structures,” i.e. performance bonuses.

    Gresham’s Law, “bad money drives out good,” would also be at play, here, as would the concept of “willful blindness.”

    While I understand how the above referenced concepts support Professor Black’s theories in regards to the subprime and financial market meltdowns, I find it difficult to accept that criminal motivations were intended, specifically because not one individual employed in the business of subprime mortgages was ignorant of the fact that the mortgages were high risk.

    I am dubious that Congressional investigations will bear out Professor Black’s claims, but, we shall see.

    As for that fish you mentioned, while it is a brown, it is not a MT brown, it is a MI brown.

    Posted by John Venlet  on  04/16  at  08:10 AM

  7. German Chancelor Merkel got it, I believe, right when she - with not a small degrre of courage - stated last summer that this crisis (2+ months before LB collapse) is (yet another) failure of AngloSaxon financial model. Sexy HDP growth of 3.2 APR here, compared to 1,6 APR at EU in first half of this decade, touted as Maestro Greenspan’s setting the system up toward a permanent prosperity, is a “proof” of free market, dereg, hands-off efficiency compared to “socialist bureaucratic” EU. Now we know (or at least some do) what the real situation was, i.e. monetary, credit and fin innovation expansion on steroids with bubble burst bringing slowly bringing things back to reality. Robbing the rest of the world since Bretton Wood by abusing dollar printing monopoly, with tens of trillions of dollars outside of US borders with goodies brough in this country at a cost of paper and ink printing them (actually not even that as electronic entries took care of even that inconvenience) will cease to improve an ilusion of economical proveness the US have been fooling themselves (and for too long big part of the world too). Chicken will come to roost. In my own blog I distributed the hypothetical 100% of the blame for this fiasco and crisis as follows: Gramm-Leach 15%, monetary expansion, 44-yr record in low APR under Greenspan - 30%, Bush “hands of” oversight plus w Greenspan defending derivates and innovation - 20%, US Congress - responsible when Fed and exec branch do not do their job - 15%, Wall Street and banking bosses, who do what invisible hand and stockholders forces themn to do if given the oppportunity: maximize profit as much as possible - 12%, Mortgage originators, evaluators, pedlers, real estate agents and appraisers, producing to get their, compared to Wall Street smaller commissions and bonuses and keping selves from being fired for not producing - 5%. Those who overextended selves via too big or adjustable etc mortgages: 2% as Mr. Greenspan inflation in housing prices (average house almost doubled in price in 5 yrs) gave many, even responsible people feeling that their families will miss the American Dream of being able to live in their own house. To close: I DONT believe that the ruling class in the US (1% owning 42% of anational wealth) will give up: They will continue in earnest to do anything possible to allow the system to work better, be more equitable, to give people universal healtcare. They will again use demagoguery, the fact that Obama is half black, that he is introducing socialism etc.

    Posted by .(JavaScript must be enabled to view this email address)  on  04/17  at  06:07 AM

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