Michael Meeropol: A Proposal To Jail Bankers Who Perpetuate Fraud

Some of you listening to me might remember the Savings and Loan Crisis of the late 1980s.  Over 1000 Savings and Loan Associations (S & Ls) went bankrupt between 1986 and 1995 because they made high risk investments in a period (after 1980) when they were artificially valuing their assets at historical (original) values rather than at current values.   Mortgages issued in the low interest 1960s had, in the high interest 1970s, fallen in resale value.   Had these institutions been forced to write down the value of these mortgages, their liabilities would have exceeded their assets – they would have been forced into bankruptcy.   [For details of the causes of the problem see Meeropol, Surrender, How The Clinton Administration Completed the Reagan Revolution:  188-190].  

Financial deregulation, which began in 1980 with the Depository Institutions Deregulation and Monetary Control Act and was completed for S & Ls with the passage of the Garn-St.Germaine Act in 1982, permitted S & Ls to issue high interest bonds to attract large depositors while expanding the amount of deposits insured by the FSLIC (the Federal Savings and Loan Insurance Corporation) from $40,000 to $100,000.   This created a win-win situation for the owners of these institutions.  They could engage in high risk investment activity knowing that if they  to bail out their depositors.   In fact, beginning in the late 1980s, they failed in large numbers (over 1000) and, yes, the taxpayers were left holding the bag – to the tune of $132 billion between 1989 and 1995.  (That was just the direct cost to taxpayers.   There were other costs imposed on the economy in terms of losses suffered by investors who were not insured depositors plus costs to the economy because of interest rate gyrations.)  After extensive investigations of the behavior of many executives in the failed S & Ls, over 1000 executives were convicted of felonies and over 800 spent time in prison.

In one specific case, Lincoln Savings, owned by the notorious Charles Keating, 23,000 bondholders lost everything they had invested in that institution – those losses totaled more than $250 million.  Before the fraudulent nature of the supposed profitability of Lincoln, its assets had grown from the $50 million purchase price in 1984 to an apparent (but fictitious) $5.46 billion in 1989.   But it all had been built on fraud.   As early as 1985, the San Francisco Office of the Federal Home Loan Bank Board (tasked with regulating S & Ls) had begun to investigate Keating’s business practices.  He successfully fought them off with the help of members of Congress, later to be known as the “Keating Five.”  But everything came crashing down in 1989.  Keating, himself, was convicted of defrauding his investors and served four years in prison before his convictions were overturned by an Appeals Court.  He never admitted any wrong-doing.

One of the regulators who oversaw the efforts by the government to find and punish the perpetrators of hundreds of frauds was a lawyer-economist named William Black.   From 1984 to 1987 he was the litigation director of the FSLIC, and in 1988 became Senior Deputy Chief Counsel for Enforcement and Litigation, in the Office of Thrift Supervision.  In a four page biography available from Black at the University of Missouri-Kansas City  he describes his work in bringing fraudsters to justice in the wake of the S & L crisis:

“At the staff level, he [Black] led the reregulation and resupervision of the S&L industry and was instrumental in creating and training agency, FBI agents, and AUSAs [Assistsant US Attorneys] on sophisticated financial fraud techniques, particularly “accounting control fraud.”  Black developed the concept of “control fraud” --- frauds in which the leader [i.e. the head of an organization – the CEO or CFO] uses the entity as a “weapon.”   Control frauds cause greater financial losses than all other forms of property crime combined and kill and maim thousands.  In finance, accounting is the “weapon of choice.”  Black develop the concept by serving like the chief coroner of the agency.  He and his staff “autopsied” every failure and looked for patterns to undersand the rapidly evolving nature of the debacle.  The patterns they discovered allowed them to confirm hat the crisis had become an epidemic of control fraud.  The patterns also allowed regulators to target for closure the worst frauds while they were still reporting record (albeit fictional) profits.   The autopsies also revealed the frauds’ Achilles “heel” – the need to grow extremely rapidly.  The agency adopted rules restricting growth to target that “heel” of the frauds.”

His unstinting opposition to efforts by members of Congress and regulators to sweep the criminality and danger to the economy under the rug earned him the enmity of Charles Keating himself who in a memo wrote that it was essential to “GET BLACK … KILL HIM DEAD.”  [The written memo from Keating was in caps --- we assume Keating was venting metaphorically.]   Keating sued Black and another whistleblower in an effort to bankrupt them with legal costs.

But Black and his staff had the upper hand.  --  Using the techniques to “autopsy” failing S & Ls they were able to document the extent of criminality involved in the S & L crisis.  And they had the integrity not to coddle the fraudsters – unlike too many regulators and members of Congress.

[The story is told in Black’s book The Best Way to Rob a Bank is to Own One which is out in a new updated edition where the 2008 financial meltdown is described as the biggest case of control fraud in history.]

The concept of control fraud is most interesting.  If you head an organization (a business or a government entity) you are in a position to thwart the usual checks and balances that would prevent an employee from stealing from his own business.   If you are a bank teller and you stick your hand in the till and put money into your pocket, there are safeguards at the bank (audits, cameras, etc.) to reveal not only the loss but where the loss occurred.  However, if you are the president of the bank and, therefore, can manipulate the books so that it looks like the bank is profitable while it is losing money hand over fist, you can take large compensation packages until the falsity of the profit picture is revealed.  At that point, the business can declare bankruptcy and stiff the creditors and you walk off with your ill-gotten gains.   Even better, if the institution is insured by the federal government (as all S & L’s were) the taxpayers will bail out the institution.   In 2008, Congress was stampeded (despite strong opposition at first) into passing a retroactive bail-out of major financial institutions whose misbehavior had caused that year’s financial crisis.

When the S & L crisis struck in 1989, the federal government took over the failed institutions, some executives (and bought regulators) were forced to resign in disgrace and 800 fraudsters went to prison.

In 2008 and subsequently, by contrast, when the much bigger epidemic of control fraud almost destroyed the economy, as dramatized in the movie THE BIG SHORT, not one single perpetrator of this latest round of criminality was even indicted, let alone jailed.  

To remedy this, Black and three other expert whistleblowers (Gary Aguirre, Richard Bowen, and Michael Winston) have formed Bank Whistleblowers United, an organization which has come up with a series of recommendations for actions that the PRESIDENT COULD TAKE WITHOUT CONGRESS’s approval.  The President can order the Justice Department to hire staff that is mandated to find examples of control fraud in financial institutions and prosecute the thieves.

The heart of their proposal is a request that every Presidential candidate promise to implement 19 changes during his or her first 60 days in office.   Those 19 changes are:

1. Restore the mandatory criminal referral process and Criminal Referral Coordinators at every financial regulatory agency
2. Require that all new hires agree to conditions that will end the “revolving door” – with no provision for waivers.
3. The FBI and the Department of Justice (DOJ) will publicly terminate their “partnership” with the Mortgage Bankers Association – the industry trade association which has a clear conflict of interest and harms prioritization by pushing solely for the prosecution of what should be far lower priority cases of crimes v. banks and never for the prosecution of what should be the highest priority cases of frauds led by banks’ senior officers
4. Ban DOJ from making deferred prosecution agreements with elite white-collar criminals
5. Reassign 500 FBI agents to the white-collar crime section
6. Request authority from Congress to hire 3,000 FBI agents, 250 DOJ attorneys, 250 SEC investigators and enforcers. This is the only portion of our plan requiring legislation.
7. Stop prosecuting the mortgage fraud “mice” and use all DOJ and FBI resources against the fraud “lions”
8. Rescind the FBI’s false claim on its web site that asserts:

“Ethnic groups involved in mortgage loan origination fraud include North Korean, Russian, Bulgarian, Romanian, Lithuanian, Mexican, Polish, Middle Eastern, Chinese, and those from the former Republic of Yugoslavian States.”
This false ethnic claim, again, leads the FBI to prioritize the fraud “mice” rather than the “lions.”

9. Prioritize FBI and DOJ resources by creating a “Top 100” list of the worst financial fraud schemes
10. Revamp the federal treatment of whistleblowers and False Claim Act complainants to encourage their efforts and use them to hold financial elites personally accountable
11. Make public a list of exemplary financial whistleblowers and set forth in writing what they have done for the Nation. (The President should, of course, do this for whistleblowers in each field, not just finance.)
12. The President should hold a public event at which he or she presents appropriate awards in person to these exemplary whistleblowers. We are not talking about financial awards and we are willing to be excluded from consideration for these Presidential awards lest we be charged with self-aggrandizement.
13. Review the backlog of whistleblower and False Claims Act complaints with fresh eyes committed to finding any useful source of information to assist in deciding whether to bring enforcement, civil, or criminal actions against elite financial frauds.
14. Make public the Clayton reports on secondary market sales. These reports document pervasive secondary mortgage market fraud.
15. Federal banking regulators will:
    1. Impose individual minimum capital requirements (IMCR) for all systemically dangerous institutions (SDIs) commensurate with the risk they pose because of their size
    2. Impose IMCRs for all SDIs commensurate with the risk they pose because of their non-commercial bank activities
    3. Impose IMCRs for all banks commensurate with the risk posed by their executive compensation systems
    4. Impose IMCRs for all banks commensurate with the risk posed by their hiring, retention, and compensation systems for purportedly independent professionals such as outside auditors, appraisers, and credit rating agencies
    5. Announce that it is the policy of the United States never to engage in a regulatory “race to the bottom” with any other government
16. Direct each major federally regulated bank to conduct and publicly report a “Krystofiak” study on samples of “liar’s” loans that they continue to hold. Krystofiak studies quantify the extent of loan origination and secondary market fraud by lenders.
17. Appoint new, vigorous heads of each federal financial regulatory agency
18. Promptly train federal banking and securities regulators, the FBI, and DOJ on sophisticated fraud schemes, particularly fraud via accounting
19. End the use of deliberately unenforceable financial regulatory “guidelines”

For details go to the New Economic Perspectives website and look for links to Bank Whistleblowers United.   http://neweconomicperspectives.org/?s=Bank+Whistleblowers+United

There is an interesting article in the NY Times that introduces this group.   See http://www.nytimes.com/2016/02/12/business/dealbook/wall-st-whistle-blowers-often-scorned-get-new-support.html?ref=business&_r=0

William Black has specifically proposed that candidates Hilary Clinton and Bernie Sanders adopt the 19 point proposal.  The details of his suggestion is available at the Bank Whistleblowers United website.

Every Presidential candidate should be confronted with these proposals and asked if they will pledge to implement them should he or she be elected.

The proposals are eminently reasonable.   Nothing would concentrate the mind of a potential bank executive intent on robbing his own bank more than the prospect of real prison time.

 
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