Tuesday, April 07, 2009

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?


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 John Venlet on 04/07 at 11:48 AM
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