Black: Why CEOs haven’t been busted

“Unless you imprison the fraudsters, sophisticated financial scams grow ever more destructive. It seems as if we have forgotten this lesson,” writes William K. Black for Bloomberg News May 10 in an article headlined “Why CEOs avoided getting busted in meltdown.”

Black, associate professor of economics and law at the University of Missouri-Kansas City and author of “The Best Way to Rob a Bank Is to Own One,” believes in prosecuting fraud.

When he was an S&L regulator during that industry’s scandal, he worked hard to give crooks their day in court. His frustration with today’s regulators knows no bounds.

The two great lessons to draw from this epidemic of fraud is that if you don’t look for it, you don’t find it and that wherever you do look, you do find fraud.  …

The Office of Thrift Supervision, the successor to the S&L regulator where I worked, made no criminal referrals in the latest crisis. The Office of the Comptroller of the Currency and the Federal Reserve made less than a handful. Mortgage and investment banks also made very few referrals — and never against their senior officers.

Now it is true that banks made thousands of criminal referrals, but almost all involved low-level figures. The volume overwhelmed the Federal Bureau of Investigation, which failed to devote adequate resources. As late as 2007, the agency assigned only 120 investigators spread among 56 field offices to probe thousands of cases. More than eight times that number probed the S&L frauds, a far smaller epidemic.

Unlike the S&L debacle, there was no national task force and no comprehensive prioritization. This made it difficult to investigate the huge, fraudulent subprime lenders. And since there were no criminal referrals of these firms, the FBI wasn’t even attempting to pursue them.

To prove his point that failing to prosecute fraud just encourages more fraud, Black points to the recent conviction of CEO Lee Farkas of Taylor, Bean & Whitaker Mortage Corp. in Ocala, Fla., for a $2.9 billion securities and bank fraud.

Farkas used fake loans to get repo loans and to support asset-backed commercial paper sales. If he’d been put out of business nine years ago, when mortgage giant Fannie Mae caught him dummying up loans, the $2.9 million loss might have been avoided, writes Black.

Here are some details from business writer Floyd Norris:

In 2002, when Lee B. Farkas was running a relatively small mortgage company, it got caught selling eight fraudulent mortgages to Fannie Mae. To make things even worse, the mortgages — all of which defaulted without a single payment being made — listed Mr. Farkas as the borrower.

Fannie Mae stopped doing business with the firm, called the Taylor Bean & Whitaker Mortgage Corporation.

For Taylor Bean, it was a crisis. Its checks bounced.

But Mr. Farkas scrambled, and Taylor Bean survived to commit more frauds.

From Black’s Bloomberg column:

Fannie Mae had cited Farkas for multiple violations, but never filed a criminal referral, which would have triggered an investigation. Had it done so, Farkas might have been prosecuted and Taylor Bean shut long before it caused so much damage. Instead, it expanded, then failed, pulling down a bank with it at a cost of $2.8 billion to the Federal Deposit Insurance Corp.

In Black’s April 20 blog, he explains the Farkas case in more detail and notes that the case was brought to the FBI’s attention by the Special Inspector General for the TARP program (SIGTARP) and perhaps tby HUD/FHA inspectors.

The FDIC did not initiate the criminal case or produce the key investigative findings.  The record of the banking regulatory agencies’ failure to identify and make criminal referrals against the fraudulent lenders that drove the crisis remains intact.

To explain the kind of fraud committed by top level executives, Black refers to a ground-breaking study by two economists in 1993:

Nobel laureate George Akerlof and Paul Romer wrote a classic article in 1993. The title captured their findings: “Looting: the Economic Underworld of Bankruptcy for Profit.” Akerlof and Romer explained how bank CEOs can use accounting fraud to create a “sure thing” in the form of record short- term income, generated by making low-quality loans at a premium yield while making only minimal reserve allowances for losses. While it lasts, this fictional income allows the chief executive officer to loot the bank, which then fails, and walk away wealthy.

Adds Black:

In criminology, we call these accounting-control frauds and we know that they destroy wealth at a prodigious rate. There’s no “if” about the losses — the only questions are when they will hit, how big they will be, and who will bear them. The record income produced explains why those involved get away with it for years. Private markets don’t discipline firms reporting record profits. They compete to fund them. Fraudulent CEOs can control the hiring and firing and can create the perverse incentives that produce a dynamic in which bad ethics drive good ethics out of the marketplace.

Sophisticated accounting-control frauds not only sucked in employees who should have known better, but also loan brokers. The result is that the large fraudulent lenders — those making a lot from liar’s loans — produced an echo epidemic of deception.

Fraud, it turns out, begets fraud.

Editor’s Note:

A university economist told me in 1994 that he did not believe S&Ls had been looted, as my colleagues and I had argued in 1989 in “Inside Job, The Looting of America’s Savings and Loans,” until he read the Akerlof and Romer study and finally understood how it could be in a CEO’s best interest to loot his own company.

Here’s one of my co-authors, Stephen Pizzo, writing about Bill Black on May 11:

During the quarter-century I covered the nexus of politics and high finance I met a lot liars and crooks — no surprise there.

But I also met government employees whom I count among some of the finest, most honest and laudable individuals on the planet. These men and women not only knew the difference between right and wrong but burned with a passion to see wrongs righted and those who broke the law sent to jail.

Among one of the best of these was a lawyer in the San Francisco Office of Thrift Supervision. His name is William Black– or as one member of Congress in the pocket of the likes of Charles Keating called Bill, “That little red-haired son-of-a-bitch.”

Bill not only went toe to toe with Keating, but a host of other politically-connected S&L crooks, and took enormous heat from Washington for doing so.

Maybe the highlight (for me, if not Bill) was when Black documented, verbatim, a meeting he was summoned to in Washington with five US Senators in April 1987.

The five senators were, one and each, on Charles Keating’s payroll (so to speak). And they wanted Black and his San Francisco regulator colleagues to lighten up on Keating — who at the time was busy costing US taxpayers a tidy $1.3 billion.

Bill is no longer in government, but continues trying to convince the DOJ and Congress that the fastest way to avoid future banking-related meltdowns is to start treating big-bank crooks the same way they treat small-potato street crooks.

Go, Bill.




One response to “Black: Why CEOs haven’t been busted

  1. Hey maryfricker, Pretty good blog. I will post a link on my facebook page.

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