Black and Barofsky
"The Best Way to Rob a Bank Is to Own One"
"How hard is it to understand that when an industry calls it a 'liar's loan,'
there might be a problem with fraud?"
William K. Black
Here is a post I intended to send out a few months ago, but never got around to. No paywall today. This is just for historians.
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Control Fraud and Contemporary Adaptions
Contemporary control fraud gives sharp definition to situations where a security represents a vehicle for extraction rather than a business that will distribute profits to shareholders. There will always be a tussle over how the economics of a business get distributed (principal-agent problem). At some point the insider enrichment ends up being diametrically opposed to cultivating a sustainable business. Identifying the four key ingredients of control fraud - accounting abuses, rapid growth, ease of gaining control, and lax regulation – is a very strong sign that impact of control fraud is about to felt even if the intent can’t be proven…
It is not difficult to identify a control fraud dynamic at work if you are aware of the concept. The likelihood that benign explanations are correct is very low when all four ingredients are identifiable. The negative implication of each ingredient is individually debatable and open to interpretation, but the benefit of the doubt shrinks as more of the ingredients and should probably disappear when all four are identified.
This is the central paradox of financial crises: What feels just and fair is often the opposite of what’s required for a just and fair outcome.
Tim Geithner, Chairman, Warburg Pincus
The best at explaining control fraud is Bill Black, the author of The Best Way to Rob a Bank Is to Own One.
Black was “litigation director for the Federal Home Loan Bank Board (FHLBB) from 1984 to 1986, deputy director of the Federal Savings and Loan Insurance Corporation (FSLIC) in 1987, and Senior VP and the General Counsel of the Federal Home Loan Bank of San Francisco from 1987 to 1989.” He has experience with this stuff.
His four signs of a fraudulent lender involved in control fraud are:
Extreme Growth
Making bad loans at a premium yield
Extreme leverage
Grossly inadequate loss reserves
Bill Moyers interviewed Bill Black in April 2009.
It is one of the best financial interviews I’ve ever heard, so I’ll quote liberally here but you might as well read the entire interview.
WILLIAM K. BLACK: Fraud is deceit. And the essence of fraud is, "I create trust in you, and then I betray that trust, and get you to give me something of value." And as a result, there's no more effective acid against trust than fraud, especially fraud by top elites, and that's what we have.
BILL MOYERS: In your book, you make it clear that calculated dishonesty by people in charge is at the heart of most large corporate failures and scandals, including, of course, the S&L, but is that true? Is that what you're saying here, that it was in the boardrooms and the CEO offices where this fraud began?
WILLIAM K. BLACK: Absolutely.
BILL MOYERS: How did they do it? What do you mean?
WILLIAM K. BLACK: Well, the way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you're a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there's going to be a disaster down the road.
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.
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.
BILL MOYERS: Yeah. Liars' loans--
WILLIAM K. BLACK: Liars' loans.
BILL MOYERS: Why did they call them liars' loans?
WILLIAM K. BLACK: Because they were liars' loans.
BILL MOYERS: And they knew it?
WILLIAM K. BLACK: They knew it. They knew that they were frauds.WILLIAM K. BLACK: Liars' loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets.
BILL MOYERS: You think they really said that to borrowers?
WILLIAM K. BLACK: We know that they said that to borrowers. In fact, they were also called, in the trade, ninja loans.
BILL MOYERS: Ninja?
WILLIAM K. BLACK: Yeah, because no income verification, no job verification, no asset verification.
BILL MOYERS: You're talking about significant American companies.
WILLIAM K. BLACK: Huge! One company produced as many losses as the entire Savings and Loan debacle.
BILL MOYERS: Which company?
WILLIAM K. BLACK: IndyMac specialized in making liars' loans. In 2006 alone, it sold $80 billion dollars of liars' loans to other companies. $80 billion.
BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?
WILLIAM K. BLACK: No, and that's a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, "Trust, but verify." They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.
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."
BILL MOYERS: So if your assumption is correct, your evidence is sound, the bank, the lending company, created a fraud. And the ratings agency that is supposed to test the value of these assets knowingly entered into the fraud. Both parties are committing fraud by intention.
WILLIAM K. BLACK: Right, and the investment banker that — we call it pooling — puts together these bad mortgages, these liars' loans, and creates the toxic waste of these derivatives. All of them do that. And then they sell it to the world and the world just thinks because it has a triple-A rating it must actually be safe. Well, instead, there are 60 and 80 percent losses on these things, because of course they, in reality, are toxic waste.
BILL MOYERS: You're describing what Bernie Madoff did to a limited number of people. But you're saying it's systemic, a systemic Ponzi scheme.
WILLIAM K. BLACK: Oh, Bernie was a piker. He doesn't even get into the front ranks of a Ponzi scheme...
BILL MOYERS: Why is it so hard to prosecute? Why hasn't anyone been brought to justice over this?
WILLIAM K. BLACK: Because they didn't even begin to investigate the major lenders until the market had actually collapsed, which is completely contrary to what we did successfully in the Savings and Loan crisis, right? Even while the institutions were reporting they were the most profitable savings and loan in America, we knew they were frauds. And we were moving to close them down. Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic...
BILL MOYERS: Who did?
WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis.
BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?
WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.
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...
BILL MOYERS: What do you mean?
WILLIAM K. BLACK: Well, Geithner has, was one of our nation's top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he's a failed legacy regulator.
BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?
WILLIAM K. BLACK: Absolutely.[…]
WILLIAM K. BLACK: What we're doing with -- no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson's firm, that he had come from being CEO. It got the largest amount of money. $12.9 billion. And they didn't want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.
Where Congress said, "We will not give you a single penny more unless we know who received the money." And, you know, when he was Treasury Secretary, Paulson created a recommendation group to tell Treasury what they ought to do with AIG. And he put Goldman Sachs on it.
BILL MOYERS: Even though Goldman Sachs had a big vested stake.
WILLIAM K. BLACK: Massive stake. And even though he had just been CEO of Goldman Sachs before becoming Treasury Secretary. Now, in most stages in American history, that would be a scandal of such proportions that he wouldn't be allowed in civilized society.
BILL MOYERS: Yeah, like a conflict of interest, it seems.
WILLIAM K. BLACK: Massive conflict of interests.
BILL MOYERS: So, how did he get away with it?
WILLIAM K. BLACK: I don't know whether we've lost our capability of outrage. Or whether the cover up has been so successful that people just don't have the facts to react to it.
[…at the end, Bill Black makes some suggestions, all of which were ignored, and things are now infinitely worse…]
BILL MOYERS: When you wake in the middle of the night, thinking about your work, what do you make of that? What do you tell yourself?
WILLIAM K. BLACK: There's a saying that we took great comfort in. It's actually by the Dutch, who were fighting this impossible war for independence against what was then the most powerful nation in the world, Spain. And their motto was, "It is not necessary to hope in order to persevere."
Now, going forward, get rid of the people that have caused the problems. That's a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers, that caused the problems? That's facially nuts. That's our current system.So stop that current system. We're hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what's failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they've had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.
Eleven years later…
Bill Moyers asks Neil Barofsky “to recollect his experience with TARP oversight and how he would safeguard the two trillion dollar government program (the CARES act) passed last week by Congress to rescue an economy crippled from the coronavirus.”
Here is Barofsky talking about TARP:
Bill Moyers: Your job was to see that this massive corporate bailout would be managed in such a way that it would accomplish its mission. And remind us of what that mission was.
Neil Barofsky: When it was described to the American people, and when it ultimately passed Congress — and if you may recall, the first time the legislation that enabled the TARP to exist, it failed in Congress. And eventually, it was passed. And I think one of the reasons why it failed was as originally envisioned, it was really all about helping Wall Street.
And a number of members of Congress didn’t like that, and weren’t supportive of that. And so it came back to the administration, and [they] said that this would help Main Street as well as Wall Street. And the two big promises that were made were 1) that yes, banks would receive this money. But they would do so in order to increase lending.
Because if you may remember, credit had just come to a standstill at that time. And so the idea of injecting this money would increase lending to make sure that the wheels of capitalism could keep turning. And the second promise was to help struggling homeowners…
Bill Moyers: Were those two goals accomplished — to jumpstart bank lending, and to protect homeowners from foreclosure?
Neil Barofsky: Sadly, no...
The concern was never really about helping homeowners or helping small businesses. It was only about saving the banks for the sake of saving the banks…
Bill Moyers: So President Bush appointed you in the last year of his administration, as the economy fell apart, the banks were crashing. And you then served under President Obama when he came in. Was the pressure greater from the Bush people than it was from the Obama people?
Neil Barofsky: I think the overall feel of everything really didn’t change that much. I think when I was there, I would sort of remember circling January 20, 2009 on the calendar because I thought, “Okay, once we get past the Bush administration and the Obama administration people come in, this is gonna be completely different. Everything’s going to change. There’s gonna be more of a focus on worrying about the Main Street, and people who are supposed to benefit.”
And, of course, when that day came and went, very little had changed. Some of the personnel stayed the same. But even the new people who came in running the program really had that same philosophy as those in the Bush administration of prioritizing saving the banks over everything else.
Neel Barofsky on Liars in Washington, DC:
I think one of the interesting things of Washington for someone who had not previously been there was the comfort and frequency with which people lie to one another. It is not something that I had experienced. And I had spent eight years as a prosecutor prosecuting fraud cases and narcotics cases.
And the lies were almost like a currency in Washington. People would lie to you, and, I mean, people within the government would lie to you. And you would know they were lying. And they would know that you knew they were lying.
One of the interesting things of Washington… was the comfort and frequency with which people lie to one another.
And they would lie nonetheless, as this is just the normal way people communicate with each other. And I guess it was a somewhat — I mean, I would hate to describe myself as being naïve. Because, you know, I’d spent eight years in the trenches with some truly horrific human beings, and fraudsters who committed billions of dollars of fraud.
But I’d not seen anything like it, where just the presumption level of dishonesty, that really permeated the town. And so it took me a little bit to realize it, and to realize that government officials who were presidentially appointed, and you ask them for information, and they give you information, where they tell you something, and they’re not telling you the truth.
And you almost have to, at least include in your calculus the possibility that somebody’s lying to you all the time.
Back to the CARES Act:
Bill Moyers: Doesn’t this new bailout, include a provision which allows the Fed to meet in secret with no records kept? I mean what the hell is that about?
Neil Barofsky: It’s not encouraging, Bill. It is not encouraging. To put it mildly.
Here’s Barofsky, in his book Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street, on the Home Affordable Modification Program (HAMP), a federal program between 2009 and 2016 designed to help homeowners avoid foreclosure:
For a good chunk of our allotted meeting time, Elizabeth Warren grilled Geithner about HAMP, barraging him with questions about how the program was going to start helping home owners. In defense of the program, Geithner finally blurted out, “We estimate that they can handle ten million foreclosures, over time,” referring to the banks. “This program will help foam the runway for them.”
A lightbulb went on for me. Elizabeth had been challenging Geithner on how the program was going to help home owners, and he had responded by citing how it would help the banks. Geithner apparently looked at HAMP as an aid to the banks, keeping the full flush of foreclosures from hitting the financial system all at the same time. Though they could handle up to “10 million foreclosures” over time, any more than that, or if the foreclosures were too concentrated, and the losses that the banks might suffer on their first and second mortgages could push them into insolvency, requiring yet another round of TARP bailouts. So HAMP would “foam the runway” by stretching out the foreclosures, giving the banks more time to absorb losses while the other parts of the bailouts juiced bank profits that could then fill the capital holes created by housing losses.
Testimony before the Financial Crisis Inquiry Commission, September 21, 2010, William K. Black, Associate Professor of Economics and Law University of Missouri-Kansas City:
The Federal Reserve had unique statutory authority to regulate all mortgage lenders under the Home Ownership and Equity Protection Act of 1994 (HOEPA), but Greenspan and Bernanke refused to use it.
Revisiting the 2008 coup d'état: TARP
“There’s a very popular conception out there that the bailout was done with a tremendous amount of firepower and focus on saving the largest Wall Street institutions but with very little regard for Main Street,” said Neil Barofsky, the former federal watchdog for the Troubled Assets Relief Program, or TARP, the $700 billion fund used to bail out banks. “That’s actually a very accurate description of what happened.”
Later in the same article:
A recent study by two professors at the University of Michigan found that banks did not significantly increase lending after being bailed out. Rather, they used taxpayer money, in part, to invest in risky securities that profited from short-term price movements. The study found that bailed-out banks increased their investment returns by nearly 10 percent as a result.
The fact that the abysmally unqualified Kashkari led the bailout brigade while Bair was systematically excluded from the process speaks volumes as to how completely public policy had fallen into the clutches of Wall Street.
Kashkari and his posse had no sense whatsoever about the requisites of sound public finance. So in the fog of Washington’s panic, prevention of private losses quickly and completely supplanted any reasoned consideration of the public good.
Secrets and Lies of the Bailout
Whatever you may think of Matt Taibbi (I like him), I can vouch that he was one of the very best and very few honest chroniclers of the 2008 coup. He has a way with words that I admire. This January 2013 piece is an excellent example. e.g.,
IT HAS BEEN four long winters since the federal government, in the hulking, shaven-skulled, Alien Nation-esque form of then-Treasury Secretary Hank Paulson, committed $700 billion in taxpayer money to rescue Wall Street from its own chicanery and greed. To listen to the bankers and their allies in Washington tell it, you’d think the bailout was the best thing to hit the American economy since the invention of the assembly line. Not only did it prevent another Great Depression, we’ve been told, but the money has all been paid back, and the government even made a profit. No harm, no foul – right?
Wrong.
It was all a lie – one of the biggest and most elaborate falsehoods ever sold to the American people. We were told that the taxpayer was stepping in – only temporarily, mind you – to prop up the economy and save the world from financial catastrophe. What we actually ended up doing was the exact opposite: committing American taxpayers to permanent, blind support of an ungovernable, unregulatable, hyperconcentrated new financial system that exacerbates the greed and inequality that caused the crash, and forces Wall Street banks like Goldman Sachs and Citigroup to increase risk rather than reduce it.
The result is one of those deals where one wrong decision early on blossoms into a lush nightmare of unintended consequences. We thought we were just letting a friend crash at the house for a few days; we ended up with a family of hillbillies who moved in forever, sleeping nine to a bed and building a meth lab on the front lawn.
“So much of what’s wrong with Dodd-Frank is it trusts the regulators to be completely immune to the corrupting influences of the banks. That’s so unrealistic. Congress has to take a meat cleaver to these banks and not trust regulators to do the job with a scalpel.”
Neil Barofsky, July 21, 2012
I was amused to read this back-cover review of Bill Black's "The Best Way to Rob a Bank Is to Own One," by Mr. Janet Yellen, considering Greenspan's role in the S&L debacle, as well as the abysmal bank regulation by Akerlof's wife's outfit that later led to Great Depression 2:
Great stuff. Terrific compilation, if infuriating. Underscores your premise that the failure to reckon with the banksters (and the WMD lies, I’d add) brought us Trump, while also bolstering the popularity of Bernie. In my estimation, the burn-it-all-down impulse remains strong within the electorate, maybe strong enough to catapult Trump back into office. Pity that RFK is such a flawed candidate. If ever an independent or third party could get traction, 2024 is the year. Oh well, wait until ‘28.
"We estimate that they can handle ten million foreclosures, over time,” referring to the banks. “This program will help foam the runway for them.”
The scale of the lies is unbelievably infuriating as someone who had to try and save a company by attempting to manage the mess they created. And the borrowers were hurt the worst. This one made me very angry today, but I will be reading Barofsky's book. The anger gives me energy.