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Interview with Bill Black

Transcript – Le Show Interview with Bill Black

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HARRY SHEARER: This is Le Show, and you may have heard the interview I did on this broadcast a little while ago with Yves Smith, who introduced us to some of the complexities of what I’m calling The New F-bomb, foreclosure. But today in a studio in Kansas City is an author and an authority who’s going to amplify that story and add a new F-bomb to the equation, namely fraud. Bill Black is an Associate Professor of Economics and Law at the University of Missouri, Kansas City, and, Bill, welcome to Le Show.

BILL BLACK: Thank you.

HARRY SHEARER: Let’s start with what initially got me interested in your writing, which is your background in the cleaning up of the savings and loan mess some many years ago now. What was your role in that?

BILL BLACK: I had many different roles at different times. I was the litigation director at the agency, so I sued folks.

HARRY SHEARER: And the agency was?

BILL BLACK: The agency changed its names and it had different places. I was litigation director of the Federal Home Loan Bank Board, and that was the agency regulating savings and loans.

HARRY SHEARER: Mm.

BILL BLACK: I quickly morphed into being the staff leader of the re-regulation of the industry. This is in the heart of the Reagan administration, and that was the biggest swear word you can imagine.

HARRY SHEARER: Re-regulation? Yeah.

BILL BLACK: Re-regulation. And I pretty quickly became the lead spokesperson for the agency in dealing with fraud, which was the dominant cause of the second phase of the savings and loan crisis, and helped train assistant U.S. attorneys and FBI agents and our own personnel to find the fraud, to investigate it, to prosecute it, and served as an expert witness for the Justice Department in successful prosecutions against CEOs that had looted “their” S&Ls, as they would have called it.

HARRY SHEARER: Yeah. The only reason I asked is because when somebody says, “I was working for the agency,” you know what people think.

BILL BLACK: [laughs]

HARRY SHEARER: So how many people were prosecuted at the end of the savings and loan debacle?

BILL BLACK: We had over a thousand felony convictions in what are called major cases by the Justice Department. And even that understates it a bit, because we worked on a very serious process to create the Top 100 priority list. That was the 100 worst institutions, so it meant about 700 individuals. So out of that a thousand, it was the worst of the worst that caused the crisis that were prosecuted in that savings and loan debacle by 1993, which is when pretty much the Clinton administration shut down the effort and transferred resources to try to deal with health fraud.

HARRY SHEARER: And just by comparison, the financial disaster we’ve just been living through recently – how many people have been successfully prosecuted so far?

BILL BLACK: Of the ones who actually helped cause the crisis, seven. And they’re all from a single case.

HARRY SHEARER: And, given your background, how do you explain the disparity? Is it because this is so much less serious a disaster than the savings and loan disaster?

BILL BLACK: [laughs]

HARRY SHEARER: There’s a setup for you.

BILL BLACK: [laughs] Yeah. That was about 30 miles an hour over the heart of the plate, you can’t even hit it very far.

HARRY SHEARER: That’s right.

BILL BLACK: Umm… no. This crisis is – there was 10 trillion dollar loss of wealth in the United States alone. A trillion is a thousand billion. By contrast, the savings and loan debacle cost 150 billion and didn’t cause any recession. This caused a great recession and cost 10 million Americans their jobs and another roughly 10 million Americans their ability to work full-time. So this is a massively greater crisis, and the role of fraud in this crisis is far greater than in the savings and loan crisis.

HARRY SHEARER: Well I’ve been reading your writing and your contention, your point, is that fraud is at the basis of all of this, that fraud is embedded and woven into the heart of this crisis, so why don’t you just explain how the fraud started and who perpetrated it?

BILL BLACK: Well, these frauds – it’s the old saying that fish rot from the head, and these massive frauds come from the people who control organizations. We call them control frauds in criminology, and that’s actually where my doctorate is and what I primarily study. They can cause vastly more damage because they are the CEO and control a seemingly legitimate organization. So in finance their weapon of choice is accounting. And it has a simple four-ingredient recipe:

1. Grow like crazy.

2. Make really bad loans, preposterously bad loans, but at a premium yield or interest rate.

3. Have extreme leverage. That means that the lender has tremendous debt compared to its supposed equity.

And 4. Provide virtually no loss reserves up against the coming tsunami of losses.

So this recipe has been called by the Nobel Prize winner in economics, George Akerlof, and his coauthor Paul Romer, way back in 1993, “a sure thing.” And that’s what we try to emphasize. If you follow these four steps, you are mathematically guaranteed in the short term to report not just profits, but record, off-the-scale, home-run, out-of-the-ballpark profits. Now, all of them are fictional, because you’re actually losing money with every bad loan you make.

So this same recipe simultaneously maximizes fictional short-term income and real losses. The looter, the CEO, destroys the lender, but he walks away wealthy.

Now that was back in ’93. Since then we’ve improved upon it, because bankers have so much more political power than back in that day, and so now we bail them out and they don’t even have to go through bankruptcy, and they just get to keep doing it again and again.

HARRY SHEARER: Yeah. The other difference that, as a civilian, I noticed between the savings and loan crisis and this one is that the S&Ls that were the worst offenders aren’t around anymore, and it seems like the organizations that did most of the damage may not be freestanding anymore but they’ve been bought up by the Too Big To Fail banks, which are now bigger, right?

BILL BLACK: Yes, and worse than that, many of them are actually still freestanding and they’re under the control of the same CEOs.

HARRY SHEARER: Wow.

BILL BLACK: And they simply got bailed out. And were allowed to stay in control, were allowed to continue to “earn” – which is of course preposterous – these incredible bonuses through the frauds.

Indeed, what we did in this crisis, which is exactly the opposite of what we did in the savings and loan crisis – and we did it, again, because of the political power of banks – is they went to their friends in Congress, who extorted the Financial Accounting Standards Board, which is the entity that sets the accounting rules. And they put a gun, figuratively, to FASB’s head and said, “Unless you change the accounting rules, we will take away essentially your entire reason for existence.”

So FASB promptly caved, and we now have accounting rules where the banks don’t have to recognize their losses! And that means, if you don’t recognize your losses, of course, your income gets enormously inflated, and their bonuses depend on their reported income, so (laughs) we’ve made them spectacularly rich through this second-stage fraud.

And then, in your intro, you talked about the third-stage fraud. All of this has to lead to foreclosure fraud, because they often don’t even have the most basic underlying documents on these bad loans, and so they had to make them up. And the way they made them up was to commit – and this is literally the case – ten thousand cases of perjury a month in these so-called robosigners. And, again, no one has gone to jail. No one’s been arrested. No one’s been indicted. For any of that.

HARRY SHEARER: Let’s go back to why these loans were good business in the first place and how it actually worked. There have been a lot of folks – obviously there’s been a political divide on this issue, as in everything else, and Republicans tend to claim, “Well, it was Fannie and Freddie that were encouraging banks to make loans to people who were not normally creditworthy customers,” and folks on the other side of the fence have said, “No, it’s the securitization industry.” Seen from your point of view, how did this all get incentivized at the beginning?

BILL BLACK: Well it’s none of the above, is the first answer, although both of them contribute to this. So let’s go back in time. See, most people are focused, still, on subprime loans. And the real engine of destruction was liar’s loans in this crisis.

So, liar’s loans begin in 1990 and 1991, and they begin in California savings and loans. And I’m out there as part of the team that is regulating California savings and loans, out of the Federal Home Loan Bank of San Francisco; I’m their general counsel, and then I’m their top lawyer for enforcement and litigation. We look at these things, and we say, “Wait a minute. [laughs] You’re not going to underwrite. That will produce spectacular adverse selection.”

HARRY SHEARER: When you say underwrite, you mean what?

BILL BLACK: Underwrite is checking, does the person really have this income?

HARRY SHEARER: Ah.

BILL BLACK: Do they really have this job?

HARRY SHEARER: Ah.

BILL BLACK: Do they repay their debts? Okay, that’s all the things that you and I had to go through when we bought our first house.

HARRY SHEARER: Mhm.

BILL BLACK: And when it seemed [laughs] like they wanted to know everything, and it took – you know, it was like an inquisition.

HARRY SHEARER: Right.

BILL BLACK: They got rid of all that. That’s what liar’s loans do. Get rid of all that underwriting. There’s just a loan application, and the loan application says, “Your income is this, and your employment is this, and your debts are this.” And they, the lender, don’t take any action to verify, to underwrite that.

Now we have known for centuries that if you do that, you will create massive fraud, and the worst possible borrowers will end up getting the loans, and you will lose money. So this is not bad luck. This is not “They were originally good loans but went bad.” This is born bad. Always, always, always throughout history end up disastrously bad.

And so, you know, in jargon they have a negative expected value. In English that means, “You do this, you lose money, you go bankrupt.”

But why do you do it? Well, it’s the second ingredient in the formula that I just went through. You want to make really, really, really bad loans at a premium yield, and you want to grow really rapidly. Well, if you’re in a reasonably competitive market, and housing finance is, and if you’re in a mature market, and housing finance is – it’s not like some new electronic gizmo, right?, that everybody wants to have worldwide and you can sell two billion of them – the only way to grow really rapidly through making honest loans would be to cut your price, your interest rate, as a lender. And that’s not a good way to make money. But you can grow extremely rapidly, because there are tens of millions of people who cannot repay their loans, after all, and you can charge them a premium yield. And that’s the sweet spot when you’re doing these frauds.

Now people assume that the borrowers must be the liars in the liar’s loans, but that’s not how it works. It’s overwhelmingly the lenders that put the lies into the liar’s loans, and you’re right to ask about incentives, because they did it the good old-fashioned way. The CEO, when he’s the crook, gets to set the incentive structures for the entire system. And so what does he do in a situation like this? Because he only cares about volume and the interest rate on these things, he puts his loan officers on a commission basis where we pay them more money based simply on how many loans they make. Not the quality of those loans. Not whether we actually profit by making those loans. Heck, we lose money on making those loans, in reality.

Second thing, you get an army of loan brokers working for you, and there the liar’s loan is perfect, because you’re going to take many of these loans – this is the secondary market aspect, right?, that you talked about, and you’re going to sell them to others.

HARRY SHEARER: Mm.

BILL BLACK: Now what would they love? They would love the impossible combination, the combination that isn’t supposed to exist in finance. They would like relatively low risk loans with relatively high yield or interest rates paid to them.

HARRY SHEARER: Bingo. Sure.

BILL BLACK: Well, you can make it appear that way, and a liar’s loan is perfect for that. And there are two things that you want to do to scam this process as a loan broker, and the lenders made sure that the incentive fees they paid to the loan brokers maximized both of these perverse incentives.

So the first thing I want to do to make a loan appear less risky is to have the debt-to-income ratio look small, so the debt, of course, is simply the amount of money we’re going to loan these people, and the income is what’s their income. Well how do I make that ratio look really small? It’s easy. I inflate the borrower’s income. And in a liar’s loan, whatever the loan broker put down on the application, the lender agreed to believe. Hey! Easily inflated.

The loan-to-value is the other ratio you want to scam. The loan is again the loan amount, and the value is the market value of the house. And so what you do there is inflate the value of the appraisal. Now step back for a second. You’re a secured lender. The great protection you have against loss is the collateral – the value of this house pledged as collateral or security for the loan. The last thing in the world you would ever do is inflate the value of those appraisals or let anyone else do so. But what do we find in reality?

Well, when then Attorney General Cuomo of New York investigated, he found that lenders routinely inflated the appraisal values and that Washington Mutual, for example, which is the largest bank failure in U.S. history and was a specialist in making liar’s loans – he found that WaMu had a blacklist of appraisers, except you got on the blacklist if you refused to inflate the appraisal. That only occurs in fraudulent entities, and juries can understand that easily, but of course only if the cases are brought, and they’re never brought.

HARRY SHEARER: I’m assuming, from the way you’re using it, that the phrase “liar’s loans” is not your invention. Was this what it was called inside the industry?

BILL BLACK: That’s exactly what it was called inside the industry. And the industry’s own antifraud experts, a group called MARI, put out their eighth periodic report in 2006 and they said these loans, which are formally called Alt-A, Alternative A – A is prime quality –

HARRY SHEARER: Yeah, not quite A.

BILL BLACK: No! Worse than that! This was supposedly they are A quality, they’re simply underwritten through an alternative process, where the alternative process is not underwriting. [laughter]

HARRY SHEARER: Okay.

BILL BLACK: Okay?

HARRY SHEARER: Yeah.

BILL BLACK: And you’re supposed to believe this. This is the bright, shining lie that underlies this entire market. Okay? So they look at these Alt-A loans – this is again MARI, the mortgage industry’s own experts on fraud – and they say, “First, these things deserve the title ‘liar’s loans’ that they’re called in the industry. Second, they are” – and I’m quoting them here – “an open invitation to fraudsters.” Third, they cite an independent study that says that the incidence – in other words, how many liar’s loans are in fact fraudulent – that the incidence of fraud is 90%.

HARRY SHEARER: Wow. Good batting average.

BILL BLACK: Yeah. And after that warning to the industry, the industry massively increased the number of liar’s loans.

HARRY SHEARER: So they misread the report.

BILL BLACK: Yeah, right. [laughs] The FBI warned in September 2004 – that’s 6½ years ago, more than 6½ years ago – that there was an epidemic of mortgage fraud and predicted that it would cause a financial crisis if it were not stemmed.

HARRY SHEARER: To whom did the FBI report this?

BILL BLACK: It said this in open testimony in front of the House of Representatives, and it was reported in major papers. I cannot find a single document demonstrating that any regulatory agency took any notice, much less action, in response to this. Can you imagine that? The FBI tells you there’s a disaster coming, there’s already an epidemic of fraud, the industry follows it and says, “You know, they’re right. There’s an epidemic of fraud, and we’re causing it as lenders. We are creating an open invitation to fraud. We have 90% fraud in a huge category of loans, and we’re pretending that that category of loans is equivalent to prime, to A. Again, that Alt-A concept.

HARRY SHEARER: Mhm.

BILL BLACK: Right? And nothing constructive is done that’s remotely effective. In fact, I can’t find anything that even says we took an ineffective action in response to it.

HARRY SHEARER: So, normally what would happen in that case would be the Justice Department would set up a task force or something like to go into this and investigate, or tell the FBI to go in and investigate?

BILL BLACK: Yes, that’s exactly what would happen. That’s what we did back in the savings and loan crisis for a – again, compared to this? A teeny tiny crisis. Here, Bush’s Attorney General, Mukasey – and this is way late in the game, this is in 2008 – refuses to create a national task force and says that these frauds are simply the equivalent of “white collar street crime.” In other words, it’s picayune stuff not worth worrying about.

HARRY SHEARER: Except the street was Wall Street.

And more of our conversation with Bill Black moments from now here on Le Show.

* * * * *

HARRY SHEARER: This is Le Show, and we’re talking to Bill Black of the University of Missouri in Kansas City, an authority on fraud in the financial system.
Just to put more pieces of this puzzle together in my own mind, the incentive for making all these bad loans is that then they can be packaged into Triple A-rated securities and larger and larger pyramids of debt can be built up around them – is that right?

BILL BLACK: No. No. That can be one of the incentives, but the incentive is back to the sure thing. You report record short-term income, or profit. Under modern executive compensation, that makes you incredibly wealthy, and it does so within two years.

HARRY SHEARER: Hmm.

BILL BLACK: That’s what Akerlof and Romer were talking about. They were talking about a period dynamic that had no secondary market sales.

HARRY SHEARER: Wow. So that’s purely the enriching of the CEO-level executives then?

BILL BLACK: That’s right. That’s sufficient to do it. And places like Ireland, by the way, did the same type of scam without securitization.

HARRY SHEARER: Hmm.

BILL BLACK: Now, you are correct that if I’m also selling it, I can keep the game going longer. What I’ve described, of course, is in essence a variant upon a Ponzi scheme, and so the longer I can grow very rapidly, the longer I can keep this up. And if I can sell these things, great. And that’s why I was describing, you could get, as a California loan broker – where they have lots of really expensive houses?

HARRY SHEARER: Mhm.

BILL BLACK: If you’d sold what we call a jumbo – so this is like an $800,000 house – you could get $20,000 as a fee as a loan broker, if it hit the magic ratios on debt-to-income and loan-to-value that I was talking about.

HARRY SHEARER: Mhm.

BILL BLACK: Which is, by the way, why they wouldn’t leave it to the lender to engage in fraud. Because they’re the ones who knew the magic ratios and were going to make darn sure that the loan met those ratios so they’d get their maximum fee. And these loan brokers literally frequently had been flipping burgers in their prior jobs.

HARRY SHEARER: Well, you know, I– I remember in the golden age of all this that you’d turn on the news station on the radio and hear these guys who sounded like they’d just graduated from college, if that, offering these mortgage deals from companies you’d never heard of before, and more than one of them would say at the end of the commercial, “Come on! This is a no-brainer!” And I thought, yeah, right. But why is it in the interest of the banks to let these people be making their loans for them?

BILL BLACK: Oh, it’s completely contrary to the interest of the banks, but banks aren’t animate. Officers run banks, and the officers – in jargon, they’re called “unfaithful agents,” and that pretty much captures it, although it’s not very strong, right? The CEO acts in his benefit. That’s – again, the whole idea of looting – that’s the looting, the CEO loots the corporation, but it’s bankruptcy for profit. The corporation fails. The CEO walks away wealthy.

And you are correct, if I add securitization to this mix, I can keep it going longer, and so instead of making five or six million dollars, I can keep this going and make $120 million if I grow really rapidly. And so, yes, the securitization adds to the mix, but it’s not a necessary condition to get these frauds going.

HARRY SHEARER: Now, in the theory of our system, aren’t at some point shareholders supposed to get wise and say, “Hey, hold on, you’re not being faithful to your fiduciary duty to the corporation, Mr. CEO”?

BILL BLACK: Yeah, well nobody thinks that shareholders can effectively do that, but you are correct that the ultra-rightwing economic theology – we call them theoclassical –

HARRY SHEARER: [laughs]

BILL BLACK: – economists – and I’m going to now quote from the leading law and economics folks in this area: “A rule against fraud is not necessary or even particularly important in securities markets.” Think how radical a statement that is. We don’t need criminal laws. We don’t need the Justice Department, the FBI. We don’t need regulations. The SEC, Securities and Exchange Commission, we don’t need. We don’t even need the right to sue against fraud. The markets will simply automatically exclude frauds.

Now that is, of course, significantly insane. It has no basis in reality. The people that wrote it, one of them had been the leading consultant to Charles Keating, the most notorious fraud in the savings and loan industry, and he had tried, he the academic, had tried applying his theories in the real world and praised Lincoln Savings as the best savings and loan in America. Which is only a 3,000 position error, since it was only the worst of 3,000 S&Ls. Right? Then he writes the book and never mentions that he tried his theories in the real world and they were a disaster. Now academics are one thing, but this is something that Alan Greenspan believed.

HARRY SHEARER: There was a phrase I remember hearing when this all started bursting out, what were called NINA mortgages – NINA? No income, no assets?

BILL BLACK: Yeah. Or even better, NINJA – no income, no job, no assets.

HARRY SHEARER: Ah. And those were knowingly made by loan brokers at this time at the peak of this?

BILL BLACK: Sure. You got more money for those kinds of loans, right? Because they pay you a higher premium and then you could – the way I explained – you could inflate the appraisal and you could inflate the income and make it look like it was a relatively safe loan with a huge yield premium. Hey, again, that’s nirvana from these people’s standpoint.

HARRY SHEARER: But a normal person is going to think – what do you expect is going to happen when such a person can’t pay their mortgage?

BILL BLACK: Yeah.

HARRY SHEARER: So what is the system designed to do at that point? What was this system designed to do at that point?

BILL BLACK: Well, no one designed the system to do this. What you have – in economics we call it a Gresham’s dynamic. It’s when bad ethics drive good ethics out of the marketplace. Because cheaters prosper. If cheaters prosper, then a market system will let the cheaters drive the honest people out. And that’s what this did. You know, they didn’t have to convert everybody to be a fraud. If you wanted to be an honest loan broker, you could be. Right? And you’d get $2,000 instead of $20,000.

But appraisers – they did this same thing with appraisers. We have really good evidence. We have polls, you know, surveys of appraisers, and 90% of them report that in a given year they were subjected to efforts to intimidate them, again always to inflate the value of the appraisal, and almost always coming from the lender and the lender’s agents. Virtually never – because of course as borrowers we don’t have this kind of leverage over appraisers.

HARRY SHEARER: Banks are regulated, right?

BILL BLACK: Commercial banks are regulated. Mortgage banks are not. And that’s a huge part of the story. And so let me tell you about 1990, 1991 again. We are the regulators out in California, and all good insanity begins in Orange County, California, as you may know?

HARRY SHEARER: [laughs]

BILL BLACK: Right? It seriously is the fraud capital of America. And I went to school [laughs] at UC Irvine, so I know it well. They were doing liar’s loans. And so we said, “This is nuts! You can’t do this!” We killed it, by normal supervisory means, in 1990 and 1991 – a long time ago, in other words. We didn’t think that we deserved any credit for that. [laughs] That was – you know, talk about no brainers in your ad – this was a no brainer. You do this, you will fail.

What happened? The leading liar’s loan entity, which was a place called Long Beach Savings, gave up its federal charter as a savings and loan, changed its name and became a mortgage bank for the sole purpose of escaping our regulation. Because as a mortgage bank it would not be subject to federal regulation. Now, footnote, the Fed and only the Fed, had authority to regulate even mortgage banks, and Alan Greenspan refused to use that authority, and Bernanke did as well until August of 2008, which was, you know of course, after all the horses were out of the barn on this thing.

HARRY SHEARER: But now, growing up, I thought, well there’s two kinds of institutions. There’s banks, which are regulated by the FDIC, and then there were these things called savings and loans which were supposedly set up to lend money for housing, which were regulated by the, what, FSLIC?

BILL BLACK: Right.

HARRY SHEARER: Where did mortgage banks come from? I mean, had they been around all this time?

BILL BLACK: Mortgage banks existed on the periphery but couldn’t effectively compete with savings and loans, so they were small players. Once we forced the S&Ls out of these – as I say, the leading liar’s loans folks go create mortgage banks and they change the name. They changed the name to Ameriquest. You may have heard – I don’t know whether you’ve heard of them.

HARRY SHEARER: Yes.

BILL BLACK: They’re absolutely infamous. They get sued by 49 state attorney generals and the Federal Trade Commission. They settle for hundreds of millions of dollars. And then of course this being a place where we have great respect for the rule of law and such, the head of Ameriquest of course was disgraced and was never heard of again. Um. Well, not really. What really happened is we promptly made him our ambassador to the Netherlands. We made him the representative of our nation.

HARRY SHEARER: Under which administration?

BILL BLACK: Under the Bush administration. This is Roland Arnall, and we did it because he was the leading contributor to George W. Bush. That’s bad, but you know we know that kind of badness in politics. What’s really bad is – okay, so Ameriquest is 1000+ employees who every day as the normal part of their job engage in predatory lending where they seek to abuse minorities and engage in fraudulent lending. That’s what they do. That’s their market niche.

HARRY SHEARER: Mhm.

BILL BLACK: Citicorp and Washington Mutual decide to acquire them. This is, again, after the 49 state AGs sue them and the Federal Trade Commission and they settle for hundreds of millions for this fraud and predatory lending. So our most elite financial institutions looked at this and said, “Oh, great opportunity!” [laughs] “Those are the kind of guys we want representing us!” Just like when Countrywide – absolutely notorious – goes down, Bank of America goes, “Yes! Yes! Those are the people we want servicing our loans,” and then is shocked, shocked that they continue their frauds in the mortgage foreclosure process.

So, Roland Arnall goes out of the savings and loan industry to escape federal regulation, his leading competitors are folks we removed and prohibited from Guardian Savings, another Orange County area savings and loan, and they went and formed a mortgage bank as well. So the great bulk of the liar’s loans were made by entities that were not subject to federal regulation. Many of them were mortgage banks, but many of them were also subsidiaries of bank holding companies.

HARRY SHEARER: So the bank holding companies held a federally regulated bank and then they held one of these things on the side?

BILL BLACK: That’s correct. And these “things on the side” were expressly put that way so that the Feds wouldn’t examine them.

HARRY SHEARER: You made a point in one of the pieces I’ve read – we hear a lot from both parties these days about what’s helping to create jobs and what’s helping to kill jobs in this country. And you tied all this to that.

BILL BLACK: Yeah, I mean the antiregulators cost 10 million Americans their jobs and 10 million Americans the ability to work full-time on top of that. And they did so by creating an environment that was, to quote the industry, “an open invitation to fraudsters.” So, in our era that I described, we saw this, we immediately saw that it was a scam and that it would cause failures, we immediately acted, and there was no crisis at all in 1990 and 1991. There were some losses, but there was no economic crisis, there weren’t bank failures, all those type of things. Right?

Now you go forward in time. I used to work, in the stretch when we stopped them in 1990, 1991, I was part of the Office of Thrift Supervision. What’s happened to the Office of Thrift Supervision?

Well, Bush’s first appointment to run the Office of Thrift Supervision was James Gilleran. James Gilleran is informally known as Chainsaw Gilleran, and he’s known as Chainsaw Gilleran because of the iconic photo of this crisis. Gilleran’s holding a chainsaw. He’s standing next to the three leading bank lobbyists in America, who are holding pruning shears – you know, the big kind where you can chop off the significant twig type stuff – and he’s standing next to the deputy head of the FDIC, the Federal Deposit Insurance Corporation, who will be his successor as head of the Office of Thrift Supervision. And they are poised and posed over a pile of federal regulations. And in case you don’t get the message, that pile of federal regulations is tied up in red tape – got it?

HARRY SHEARER: Mhm.

BILL BLACK: And so they’re going to demonstrate their intention to cut through all federal regulation. And Gilleran wants to make it clear, this is not going to be any surgical process, he’s taking a chainsaw to regulation and he’s just going to rip his way through it. Well, mission accomplished, boys. And instead of being furtive, they were proud of this and put it in their annual report of the Federal Deposit Insurance Corporation in 2002. Everyone can go on the web and take a look at these grinning fools and the disaster that they wrought.

HARRY SHEARER: Are you saying all this because you’re a lifelong Democrat?

BILL BLACK: Well, you see the people I blew the whistle on in the savings and loan debacle were Speaker of the House Jim Wright and the Keating Five, and as I recall Speaker Wright was the Democratic leader of the House and four of the five members of the Keating Five were Democrats. So, no, I don’t think so. You know, I don’t care what party the scum are. I care that they do the right thing, and if they do the wrong thing I criticize them.

HARRY SHEARER: But then that leads us to a fairly dire prognosis here, because if this is not a partisan issue, this means that both political parties have been sitting by watching this happen to our financial system.

BILL BLACK: Oh, no. That doesn’t begin to capture it. They didn’t sit by. They made things actively worse. And they did so in big ways near the end of the Clinton administration. The entire Rubin wing of the Democratic Party is incredibly close to finance. And what did they do in particular? Well, they got rid of Glass-Steagall, which had tried to prevent conflicts of interest and the agglomeration of immense power by separating commercial banks from investment banks.

HARRY SHEARER: And I believe Glass-Steagall was passed and they said, “This is to try to prevent the Great Depression from ever happening again.”

BILL BLACK: That’s right. Because we actually did real investigations on the frauds – many of the frauds at least – that helped caused the Great Depression, and we learned some things from them. And they worked really well for about 50 years, which is why we got rid of them, because we were so much more clever and we knew theoclassical economics and that markets regulated themselves.
And that’s the second one, the Commodities Future Modernization Act of 2000. The context was Brooksley Born, who was chair of the Commodities Futures Trading Commission, and she looked around at this enormous growth of financial derivatives and in particular credit default swaps – these are the things that are going to destroy AIG in future years – and she says, “This is a coming crisis. We need to regulate this area.” And she proposes a regulation.

The industry goes berserk. The Rubin wing of the Democratic Party goes berserk. Key Republicans go berserk. Alan Greenspan goes berserk. He has the meeting with her in which he tells her that fraud is no reason to regulate. They pass a law that says not only can she not – the agency, Commodities Futures Trading Commission – not adopt this particular regulation to protect us from derivatives, it removes their authority to pass any regulation to protect us from derivatives, and it preempts state laws against bucket shops.

Now bucket shops are frauds. Can you imagine passing a law that says you can’t use your antifraud laws? That’s how bad the government was, and that was bipartisan, but it certainly was the lead of the Clinton administration.

HARRY SHEARER: So, if you’re Brooksley Born – I mean, her name was sort of distantly familiar to me before all this started coming up, but I could have been burned at the stake and not told you who she was – why aren’t you out publicly getting on every television show you can in 2002 screaming bloody murder, saying, you know, the house is going to fall down? Or did she, and I missed it?

BILL BLACK: No, she didn’t. But she has – you know, people have different personalities and such. She’s a wonderful, brilliant person. You know, she wasn’t going to go to war with the administration. But she did serve on the Financial Crisis Inquiry Commission, for example, and she has been a strong voice for reforms in all of these areas. You know, on a human personality basis, she’s just not an in-your-face type person.

HARRY SHEARER: So, if you were running the world, Bill Black, would you be just at this point organizing a task force and starting prosecutions?

BILL BLACK: Well, it all has to start with criminal referral process. The regulators have to serve as the Sherpas to get us to the top of the mountain. And I mean it in both of the senses that the Sherpas do. A, the Sherpas do the heavy lifting. We have the resources and we have to do the great bulk of the investigation. The second thing is, we’ve got to be the guides. The FBI can’t possibly be experts in banking and finance and all the other industries, and so they need that road map or that trail map from the regulators to be able to have a successful investigation.

In the savings and loan crisis, here’s the good news. If you had looked in 1986, it looked pretty much the same as now. There were only a literal handful of successful prosecutions. If you looked in 1993, you’d see over a thousand felony convictions in major cases, overwhelmingly oriented to the most elite frauds, which is the greatest success against elite white collar criminals anywhere at all time in prosecution. And that’s because the head of the agency said, “Our top priority is going to be, A, getting the frauds out of the business by putting them in receivership, and, B, putting them in a federal prison once we have removed them.

And we institutionalized what had to be done. We put specific people in charge and mandated, and we, you know, their performance was evaluated on whether they succeeded in these areas. So we did, as an agency, well over 10,000 criminal referrals. We were the Office of Thrift Supervision. Again, some different names and time periods but the Office of Thrift Supervision in the current crisis, under the leadership of James Gilleran and such, did zero criminal referrals.

And I can tell you, because I prompted these stories, from talking to the investigative reporter who talked to the Office of Thrift Supervision people, they were incredulous that anyone expected them to make criminal referrals. It was like “We don’t do windows.” Except that their view was, doing criminal referrals is something that the savings and loans are supposed to do. The concept that a savings and loan wasn’t very likely to do a criminal referral on its CEO was beyond their ability to comprehend, and the reason is, they can’t conceive of somebody wearing a nice suit and having a fancy title being a criminal.

The other agencies were a little better. The Office of the Comptroller of the Currency appears to have done three [laughs] criminal referrals.

HARRY SHEARER: Wow.

BILL BLACK: And they regulate the largest national banks. Or they don’t regulate.

HARRY SHEARER: Mhm.

BILL BLACK: They’re supposed to regulate. So, without criminal referrals you’re never going to be effective.
So, here are the two great rules of investigating sophisticated financial frauds when they’re occurring in large numbers:

1. If you don’t look, you don’t find.

2. Wherever you do look, you will find.

And that’s why the guide function was so critical. Without the guide function, with essentially zero criminal referrals, what was the FBI supposed to do? Well, you know, it would have some particular mortgage banker come to them and say, “Fred defrauded me.” And so they’d go look at Fred maybe, type of thing, and they frequently would find that Fred had in fact defrauded them. And so what evidence came back? Well, that it was a bunch of little guys named Fred. Hence it was equivalent to white collar street crime, just like Mukasey said, because they only investigated little guys, so they only found evidence on little guys, so they concluded that it was only a problem of little guys.

If they had been sent to investigate the major frauds, of course they would have reached the opposite conclusion, but they would have needed support from the regulators, and they got none of that support from the regulators.

So what did they do instead, for industry expertise? The FBI formed what it refers to as a “partnership” with the Mortgage Bankers Association. And the Mortgage Bankers Association is the trade association of the perps! And so the Mortgage Bankers Association created a definition of mortgage fraud. Supposedly all mortgage fraud is divided into two categories. And guess what? In both of them, the mortgage banker is the victim and somebody else is the terrible perpetrator. And so they simply defined away – it couldn’t exist! – that the CEO could be the crook.

Now, that’s obviously understandable from the standpoint of the Mortgage Bankers Association, but why the FBI bought it hook, line and sinker for years is a little unclear.

Now to give some credit to the FBI, the FBI ultimately, by 2008, figures out that this is nuts, that the WaMus of the world, the Countrywides of the world, are making literally a million fraudulent loans a year and nobody’s putting a gun to their head and telling them to do that. They’re doing it for the good old-fashioned reason of making the executives rich, looting bankruptcy for profit.

And so the FBI proposes a nationwide task force and the FBI proposes to concentrate a major part of their investigative efforts on the biggest lenders. This is when Mukasey steps in to kill that effort. Again, Mukasey was Bush’s attorney general, and said, “No, we’re not going to do that.

So what were we left with instead? So we got agents from the FBI with no expertise on sophisticated financial frauds at this time, with no guidance from the regulators, where they’re getting actively misguided by the industry doing their old, you know, Obi Wan Kenobi stuff? “These aren’t the droids we’re looking for [laughs] – go look at those droids,” you know? Go look at the little guys, not looking at us.

And on top of that, because after all these cases are trivial, you wouldn’t want to send many FBI agents out to investigate them. So as recently as Fiscal Year 2007, there were 120 FBI agents nationwide working on all mortgage-related cases. By way of contrast, there were 1,000 FBI agents working on the savings and loan crisis.

HARRY SHEARER: Mm.

BILL BLACK: So this is fewer than 1/8 as many people to deal with a crisis that’s somewhere on the order of 40 times bigger, and where the frauds are roughly 1,000 times larger than in the savings and loan crisis.

HARRY SHEARER: Bill Black, before we wrap up, given the sets of perverse incentives that you’ve outlined, and given the fact that the people who’ve, in your analysis, perpetrated these frauds, they seem to have not only prospered but continue to run institutions – if you were a betting man – I don’t know if you are or not – what would be your bet as to the likelihood of another financial crisis in the next 10 years?

BILL BLACK: Oh, they’ve greatly upped the probability and the severity of the crisis. It is now more likely than not that they will do so. And notice that one of the critical things President Obama did was take the people that had been the leaders under Bush – what Tom Frank in his book aptly calls The Wrecking Crew? – and made them his own leaders, and in some cases – for example, Timothy Geithner – actually promoted them. So we have pathetic regulatory leaders. And we have pathetic regulatory leaders for a reason. That that’s what the industry wanted and got. Until we change that and fix the leadership, we are doing everything possible to make the next crisis come more quickly and make it kick us in the teeth far harder.

HARRY SHEARER: All right then. Bill Black, from the University of Missouri, Kansas City, thank you so much for sharing your experience and your expertise with us on today’s program.

BILL BLACK: Thank you.

HARRY SHEARER: By the way, do you have accounts in major banks? Savings accounts?

BILL BLACK: [laughs] Um, I have an account in a local bank out here in the Midwest that seems to be soundly done.

HARRY SHEARER: Excellent choice. Thanks again.

BILL BLACK: Thank you