This is the transcript for Bill Black: Our System is So Flawed That Fraud is Mathematically Guaranteed – Part 2
Chris Martenson: You know there’s a point of view I have which is that one lends by which I can understand nearly everything that Bernanke, and his predecessor Greenspan, have done so far in response to the crisis was simply to bail the banks out. So we’ve all heard about how they’re punishing savers and pension funds, endowments are all like struggling with zero percent interest rates and that’s a predictable consequence of running interest rates down to these abnormally low levels. The real thing that they’re trying to do here is just get the banks back to health. And so my question is I’ve never really been satisfied that we’ve had a proper accounting what the losses are and where they are, and kind of these mark to model, mark to fantasy sort of asset jubilees going on over there on the bank balance sheets where we don’t – I’m not convinced we really understand where these losses are. So you’ve just described systemic controls fraud. It extended to ninety percent of all the loans that were being made at a certain period of time. It was just extraordinary. This is totaling in the hundreds and hundreds and hundreds of billions of dollars of losses. Where are those losses? Have they all been accounted for or are they still lurking out there somewhere?
Bill Black: Oh no, in the savings and loan crisis we actually put entities through receiverships and that meant that you had – the bad guys lost control, you brought in honest people and honest auditors, and you found out what the real losses were and then you saw the entity back into private commerce, right, with governmental assistance. But first, you wiped out the shareholders and the subordinated debt holders, the people that are supposed to be risk capital. That’s how the system is supposed to work. There were very few receiverships, conservatorships of large institutions. Here instead, they were given open assistance. In other words, you don’t do the conservatorship or receivership, you leave the folks in charge who were the frauds who led the fraud, and you give them a ton of money, and you don’t wipe out the shareholders and you don’t wipe out the subordinated debt holders. That’s insane. And then what we did at the instance, and this is when you knew the Obama administration was going to go bad, the people that led the attack on accounting were the Chamber of Commerce. But of course, the Chamber of Commerce is the leading opponent of the Obama administration except here where they work together implicitly with a strong wink by a key speech that Bernanke made calling for changing the accounting rules. So they changed the accounting rules. And the way it happened is that congress called, FASB, the Financial Accounting Standards Board, in for a hearing and threatened to essentially destroy FASB if they didn’t change the rules. The explicit threat was they would remove their accounting rules standard authority. Since the only thing FASB does is set accounting rules, they were going to take out a gun and shoot FASB. So FASB caved, changed the accounting rules so that the banks didn’t have to recognize their losses, which, by the way, is a large part of the foreclosure game and the why there’s no receivership because if you put them through receiverships you have to recognize losses.
Chris Martenson: Right.
Bill Black: And if you foreclose and actually sell the asset then you have to recognize the loss. Ad so there’s a reason the shadow inventory has built up to unprecedented levels is that bankshave been typically, I mean they’re not consistent in this, but they’ve often been delaying the foreclosures actually so that they don’t have to recognize the losses. Okay, so accountability, back to that question. So we made our top priority back in the savings and loan crisis, the reregulation of the industry, and we begin it the year after deregulation has passed the house and the senate with only one descending vote in each house, each chamber. So think of how much, and in your face this is, this is the heart of the Reagan administration, which has celebrated this bill, our own agency under the predecessor, an academic economist named Dick Pratt who modeled the federal deregulation on Texas deregulation, alright We, our agency was the entity drafting the bill. And a year later we’re saying the bill we drafted, that the president pushed, that you folks in congress passed with only two descending votes total, it’s a disaster, it’s producing a disaster, and we need to, and we are going to reregulate the industry despite what you said. Can you imagine something like that happening in the modern era?
Chris Martenson: No, I can’t actually.
Bill Black: Yeah and this occurs in the height of the Reagan administration and they go nuts. The administration goes nuts, congresses goes nuts, the majority of the members of the House of Representatives cosponsor a resolution calling on us not to go forward. And, that includes both a democratic and republican leadership of the house particularly Jim Wright, about to become the speaker of the house, and one Newt Gingrich, mind you, alright. The five U.S. senators who become known as the Keating five go against this. The administration is so furious that the OMB, Office of Management and Budget, threatens to file a criminal referral against the head of our agency on the grounds that he has closed too many insolvent savings and loans.
Chris Martenson: What?
Bill Black: Yeah, have you seen that problem again. The theory of this, you got to love it for inventiveness, is there is an obscure law called the anti-deficiency act that says as a government official I can’t spend or I can’t commit the federal government to spend more than is budgeted to me. So if I closed a savings and loan I implicitly put the government on the hook. Of course, the governments on the hook anyway. This is all insane. But this how extreme they were willing to do. They weren’t prosecuting any savings and loan criminals in that era yet but they were threatening to prosecute the head of the agency because he was willing to take them on. More bizarre, and this is just off the charts, the administration attempted to appoint two members to the Federal Home Loan Bank Board, that was the regulatory agency, and it only had three members, right. So these are three federal officials appointed by the president with the advice and consent of the senate who run the federal agency. The Reagan administration attempted to appoint two members to that agency chosen by Charles Keating. And they got one of them appointed who promptly served as a mole for Lincoln Savings, and was secretly doing his bidding to try to change the rules to immunize Lincoln Savings for this massive violation of the direct investment rule that then the Keating five will take up that effort when I blow the whistle on him and expose his role as a mole. And, of course, the media was against us, the business press, and, of course, economists were universally against us, and the trade association, which political scientists called the third most powerful in the United States of America. So the correlation of forces, as the military would phrase this, was kind of adverse to us.
Chris Martenson: I’ll say.
Bill Black: And despite that fact, we went forward with the head of our agency, Ed Gray, predicting contemporaneously that it would make him unemployed and unemployable, which he remains to this day, by the way. He is the person that by reregulating the industry prevented it from becoming an economic crisis, saved a trillion dollars for the United States of America and that promptly made him unemployed and unemployable. That’s when things were getting real perverse. But here’s – it’s the accountability that changed things for a while because what we did was actually start making the criminal referrals. Gray made our top priority closing the fraudulent entities so we could remove the fraudulent CEOs running these control frauds from power but he made the second priority the agency changing the rules to prevent these entities that we couldn’t close from causing ever-greater crises. And this is a real clever thing. He adopted a rule restricting growth. Pilots have a saying, speed is life. For a Ponzi scheme growth is life. So when you restrict growth you doom the Ponzi that hasn’t had the funds from congress to close. And by the way, they wouldn’t give us an extra penny of money during Gray’s term. The chairman Ed Gray was the person that reregulated so that we could close more of these frauds. Alright, so he did change that rule and that doomed the frauds even when his successors caved to the political pressure. Fortunately, his successors didn’t understand that these entities were frauds and couldn’t survive a continuation of the rule restricting growth. And the rule restricting growth was so weak that it only restricted you, you couldn’t grow more than twenty-five percent a year that it sounded completely non-controversial. But the frauds all knew it was the Death Valley. It attacked their Achilles heel, alright.
So Gray’s third priority was to prosecute and bring civil actions and enforcement actions against the frauds. And the agency geared up and made a massive effort along these lines. In the savings and loan crisis, in just five years, we made over thirty thousand criminal referrals.
Chris Martenson: Wow.
Bill Black: Just our agency – that produced over three thousand convictions, over a thousand of those felony convictions were in cases designated as major by the justice department. And, that understates the degree of prioritization because we work really intensively and constructively with the FBI and the justice department to create the top one hundred list of the worst savings and loans. So that is about five to six targets on average per savings and loan, and we prosecuted virtually all of those five hundred to six hundred people who ran the worst frauds. We had a ninety percent conviction rate and these people have the best criminal defense lawyers in the world, and they’re willing to spend money like water and they have a lot of money to defend themselves. When we brought those prosecutions, you get a news story when you arrest them or indict them, you get a news story when the trial starts, you get a news story when something juicy happens during the trial, you get a news story when you convict them, when you sentence them, and when they go to prison. And you get national news stories and you get regional news stories. So collectively you’re getting thousands and thousands of press reports. And after a while, the public realized the same thing that we realized, there was a distinct pattern to these four frauds, which was, of course, the fraud recipe that I described earlier. They looked like they were from a template because they largely were from a template because there’s an optimal way to run these frauds and people over time gravitate closer to the optimal fraud scheme, right. it’s easy to mimic this fraud scheme because it isn’t hard to make bad loans. In fact, it’s quite easy. So the most mediocre CEOs in the country were able to mimic the fraud schemes. And this drumbeat between the criminal cases, between the civil cases, we’ve got about eight hundred lawsuits against many of the most elite banks, savings and loans, auditors, the top, at that time, big eight audit firms and even top law firms of the country, got immense publicity in deterrence value. And we brought, somewhere in the order of, three thousand administrative enforcement actions. So clawed back when people took money and they still had it. Okay, flash forward to this crisis. The same agency, Office of Threat Supervision, in this crisis and, by the way, just in the household sector the losses in this crisis are seventy times larger than the cost to resolve the savings and loan crisis.
Chris Martenson: Seventy times…
Bill Black: Seventy times larger, just the household sector, and, of course, that’s just one of the sectors that was devastated. The same agency made zero criminal referrals in this crisis.
Chris Martenson: Say that number again…
Bill Black: Zero – it’s an easy number. It was actually a hard concept mathematically to come to but the agency got it a couple thousand years ago, the concept of adding zero really helps mathematics, and the Office of the Comptroller of the Currency, which regulates national banks or is supposed to regulate national banks, depending on which spokesperson you believe, made zero or three. The federal reserve made three. And the FDIC was smart enough not to answer the question. So the Germans have a phrase, einmal ist nie, once is never, three is never as well in this context. When you have one-third of all loans by 2006, one-third of all new mortgage loans or liars’ loans that they have a ninety percent fraud incidence, you have over two million fraudulent mortgage loans a year, and no one is making you make these loans. Everybody is discouraging you from making these loans, and it’s only sensible for frauds to make or purchase these loans. And, no, this isn’t just because there was a secondary market you could sell it to because virtually all those sales were with recourse. In other words, the lenders did keep skin in the game. They do this because of the fraud recipe. It’s really hard in a competitive, mature marketplace to grow rapidly by making good loans. You have to be exceptionally talented, one or two members of the industry at the most might be able to do that. But everybody can make bad loans. And what happens if a bunch of us follow the same strategy? We mimic this strategy. Then we hyper inflate the financial bubble. And this is something that Akerlof and Romer and we and the national commission investigating the causes of the savings and loan crisis all warned about back in 1993. But here we acted like fraud bubbles, what?
So they took no action whereas we, back in 1986, deliberately burst the commercial real estate bubble in Dallas/Fort Worth area. But they refuse to do anything like that. They refuse to regulate, and the office of thrift supervision was supposed to regulate Countrywide, Washington Mutual, and IndyMac, three places that did extraordinary of liar’s loans. All of the investment banks – you mentioned Lehman Brothers. Well, all of the big five investment banks had affiliates that made enormous amounts of liar’s loans. Lehman Brothers had Aurora, which was one of the biggest entities making liars loans in the country originally, and it did this for years. And, by the way, many people assume, they still call this the subprime crisis, but you can be both subprime and liars loans. And by 2006, half of the loans called subprime were also liar’s loans, which again, the income is not – the borrower’s income was not verified. So this was overwhelmingly a crisis brought on by these fraudulent liars’ loans, not exclusively but overwhelmingly, this was the weapon of choice for these kinds of frauds. So that kind of fraud is going to cause really catastrophic losses directly. It’s going to – well, think of the recipe again, grow like crazy by making really crappy loans with extreme leverage with next to no reserves. Well, that’s a formula for maximizing losses, right. So it simultaneously maximizes short-term fictional income, real long-term losses, that’s stage one. Stage two, you then sell the loans, which were fraudulent, and the only way to sell the loans is to engage in additional fraud. Stage three, they then take these loans that they’ve purchased and they pool them and create fraudulent CDOs, collateralized debt obligations. And step four, onceyou’re foreclosed on, then you engage in foreclosure fraud. And by the way, we haven’t talked about appraisal fraud, which is also endemic in which only borrowers can do.
Chris Martenson: Well, you’re describing a world that’s not close to what I learned about in grade school about how my country works. And, you’re describing something that sounds rather than like there were two separate incidents where there was a savings and loan crisis and now a more recent subprime crisis, that really it’s a continuum. And the spectrum of fraud has always been there. It went into hiding for a little while because of some very aggressive and bold and career ending moves, as it turned out, by Gray. But here we are, and my final question for you is, as a private individual, as somebody who has money in the system or invests. I mean we’re all told that investments or stock and bonds and you have your money in the system. Where – how do you – okay, let me default to one of my favorite sayings, which is that it’s from Texas as well. If you’re in a card game and you don’t know who the sucker is, it’s you, right.
Bill Black: Yeah, if within five minutes of joining a card game and you don’t know the fool, you are the fool.
Chris Martenson: It’s you, right. So a lot of people listening to this have money in the system with big institutions, many of which have been named here, some of which haven’t been named but were also participants. And we are – we have to trust because we are all creditors of those institutions in essence. We don’t have money in the bank. We’re creditors. So we have balance sheet risk. We don’t – if I can’t see where the risk is what do I do? What do you do?
Bill Black: Well, unfortunately this leads to this thinking, which is purely rational, of course, leads to exacerbating the problem because the obvious answer is to put your money with entities that are too big to fail, entities that we insist on calling systemically dangerous institutions. The administration, of course, wants to call them systemically important like they should get a gold star. But what their definition is is that if a single one of them fails and they’re roughly the top twenty in the United States, the administration believes it’s likely to cause a global financial crisis. And as a result the government will, in fact, bail them out. Now, our point is, A, these entities are dramatically inefficient. In other words, if you shrank them to the level that they no longer pose this systemic risk they’d actually be more efficient. So that’d be a win-win. If you shrunk them you’d made things a lot better in terms of systemic risk and you’d made them more efficient. And of course, the third win is that it’s these SDIs, these systemically dangerous institutions that are the face of American crony capitalism that completely control large aspects of our political system. So we would also defeat that power. So I would – my emphasis is not on where to invest but on the need to destroy the SDIs, not by blowing them, but by saying, A, you can’t grow anymore, period. and, B, within five years you have to shrink to a level that you no longer pose a systemic risk. and, C, during the interim we’re going to regulate you ultra-intensively.
Chris Martenson: Well, that all sounds perfectly rational which means it has almost no chance of success. And I’m sorry to say. So thank you. you’ve been so generous with your time. This has been absolutely fabulously interesting to me and I’m sure many other people. I want to remind everybody that you can, I’m sure, read finer details in a book called, The Best Way to Rob a Bank is to Own One.
Bill Black: And can I also say it’s the University of Missouri at Kansas City is the name of the institution. And you should look for our writings, which are available free online at new economic perspectives.
Chris Martenson: New economic perspectives – I’m sorry I left the city off of there. So yes, University of Missouri at Kansas City and I’ll see if I can fix that in the intro too. So thank you so much and I certainly hope we can talk again sometime.
Bill Black: Thank you. Take care.
Chris Martenson: Bye-bye.
Bill Black: Bye-bye.