Fraud and Cover Up In the Banking Scandal

The fraud that has brought our economy to the brink of collapse occurred at every level, from the borrowers, to the mortgage lenders, to the investment bankers pooling the loans, to the ratings agencies, to the government regulators themselves.  It is time to ask yourself why after at least fifteen (15) months since the public became aware of the crisis (which started 2 years ago) have there been no fact finding investigations in Congress as to the roots of the crisis?  Sure, Congress called in some of the ratings agencies, but where is the fact finding investigation about the practices, who was involved, who knew what when?The Senate engages in endless debate about political appointees, but passes bailout legislation without even understanding why the money is needed.  Ask why have there been no prosecutions for the fraud yet?  The answer may very well be that our senior elected officials from both parties and the top regulators are involved in covering up the extent of how bad the crisis is.

On April 3, 2009, PBS's Bill Moyers interviewed William K. Black, a professor of law and economics at the University of Missouri-Kansas City School of Law, and author of The Best Way to Rob a Bank Is to Own One .  (Hat tip to Economic Populist and Market Ticker.) Black was a former prosecutor and chief regulator in for the Federal Home Loan Bank Board during the Savings and Loan crisis in the 1980's.  Black understands bank fraud and how it occurs.  He was instrumental in setting up laws that would prevent such crises in the future - laws that are now being ignored.    The interview is about 20 minutes, but it is worth watching if you want to understand the extent of the fraud.  If you don't want to watch, read the transcript here.  

Black points out that the roots of the fraud extend back to the Clinton administration, and were exacerbated by the Bush administration diversion of regulatory attention from white collar crime to homeland security.  What is worse is that current Treasury Secretary Timothy Geitner was the chief regulator of the New York banks while he was President of the New York Federal Reserve District.  In recent testimony before Congress, Geitner denied that he had regulatory authority.  In September 2004 the FBI warned that this crisis was occurring and the fraud was building.  The FBI warning was ignored on every level.  

It is time that we insist that our Government Hold Those Responsible Accountable.  If the Department of Justice will not prosecute those involved, then Congress needs to pass a law allowing private rights of action to enable individuals to prosecute fraud actions on behalf of the government.  We have laws dating back to the Civil War, called Qui Tam actions, that permit private citizens to sue and recover on behalf of the Government when there is fraud against the government - typically a whistle blower actions involving misuse of government funds.  It is time that we expand those laws to allow private individuals to act on behalf of the government to pursue those who were involved in the fraud.

THE ORACLE OF OMAHA SPEAKS

Berkshire Hathaway, the company chaired by Warren Buffet, released its annual report today.  Mr. Buffet's annual letter to stockholders is always a good read, if not prescient.  Because the letter is dense and has many topics, this post will be longer than usual, but it is worth it.  

Buffet noted that the US economy is in shambles:

"We're certain, for example, that the economy will remain in shambles throughout 2009 - and for that matter, probably well beyond - but that conclusion does not tell us whether the stock market will rise or fall."

And we are not out of the woods.  Whether the market will yield investable opportunities or not is unknown, even in a downward spiraling economy; however, Buffet offered these words of wisdom:  "When investing, pessimism is your friend, euphoria the enemy."

The government is taking acts to give the appearance that it is taking acts to help the economy, but no one really knows if these actions will work.  We do know that they didn't work during the great depression and they didn't work in Japan.  Nevertheless, we do know that the  government solutions will have unwelcome aftereffects.  Buffet said:

"The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear. This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation."

Aside from inflation, the government spending is making private industries, and municipalities dependent upon government aid.

"[M]ajor industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly."

In other words, be prepared for continuing this extreme level of wealth redistribution far into the future.  Just think how long it has taken us to dismantle the temporary solutions put in place by FDR to get us through the depths of the great depression. (Hint: Those Programs Still Exist.)

What is worse, the government is playing favorites.  After years of trying to level the playing field among various financial institutions (on the theory that competition helps consumers and the economy), the administration's bailout is playing favorites by giving  insolvent banks money at lower cost than banks that didn't act irresponsibly.

"Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be. This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” "

In other words, our government is rewarding bad economic policy.  It is the same  wrong headed message we send when we tell people that if they borrowed money to buy a house, the government will step in to pay the mortgage when the borrower can't pay.  Here we are telling banks that if they make bad loans and become insolvent, instead of letting the banks fail, we will give them a competitive advantage over other banks and lenders by giving them money below market cost.   

Berkshire Hathaway also has a division that is involved in housing, mainly through manufactured homes.  While not immune from credit risk, Buffet's company is in a far better position to weather the storm because of sensible lending practices. 

Here is what Buffet had to say:

Commentary about the current housing crisis often ignores the crucial fact that most foreclosures do not occur because a house is worth less than its mortgage (so-called “upside-down” loans). Rather, foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay. Homeowners who have made a meaningful down-payment – derived from savings and not from other borrowing – seldom walk away from a primary residence simply because its value today is less than the mortgage. Instead, they walk when they can’t make the monthly payments. 

*  *  * 

The present housing debacle should teach home buyers, lenders, brokers and government some simple lessons that will ensure stability in the future. Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified. Putting people into homes, though a desirable goal, shouldn't be our country’s primary objective. Keeping them in their homes should be the ambition.

There are many more tidbits in the annual report, but this post is lengthy enough so I will move on.  Please go to the Berkshire Hathaway site to read the entire annual report.  Enjoy the read.

The Rant Heard Around the World

Rick Santelli's now famous rant on CNBC in reaction to the President's mortgage plan has resonated with America.  Evidence of how he hit home comes from the White House response, which shamelessly attacked Rick in a most undignified manner.  Well, Rick and CNBC are not taking the attack sitting down.  Rick defended himself and once again explained how Obama's plan to use our tax dollars to pay for bad loans so banks don't have to take a loss and the borrower can keep houses they can't afford is simply bad policy and unfair to the nation.  

I encourage Rick and CNBC to tour across the country to rally the 92% of us who play by the rules to make Obama and Congress act in a fair and prudent manner, especially with our tax dollars.  If the government continues on this course, history will look back at Rick at view his rant as the shot heard around the world.  (I have never owned a pitchfork, but if Rick has a rally, I may just go buy one.)

What Is Wrong With Deflation?

Fed Chair Ben Bernanke strongly believes that deflation is a very bad thing, and is using all the resources of the central bank (even some beyond its authority) to prevent deflation from setting in.  Is deflation really that bad for most of us?  Let's take a quick look.

First, the arguments that deflation is a bad thing center around the debt burden of individuals and businesses.  The theory is that it is more expensive to repay debt with deflated money, than it would be otherwise.  As a result, businesses would go bankrupt (as they did during the great depression) because they could not handle the relative increase in  the debt burden.  In addition, deflation slows the pace of commerce because consumers delay purchases today because deflation makes goods cheaper tomorrow.

While the drum has continually beaten those arguments to support monetary policy that continually devalues the dollar, they ignore reality.  To begin with, deflation is a good thing for the 95% of our society that lives within their means.  When the price of a new car falls, that is a good thing.  Commodities are cheaper, finished goods are cheaper, food and necessities are cheaper.  I am not an economist, but it seems to me that having lower prices helps me out.  Our trade deficit keeps growing because we can't price goods and services competitively.  If prices are lower, exports may grow.  Indeed, maybe there will be a return to manufacturing right here in the States!  Creat a few jobs.  That's a thought - using American ingenuity to produce better, faster, cheaper products at home.  But, I am not an economist.  Besides, it makes all the pennies I have been collecting in my jar more valuable.  I might even spend them someday.

So, what of the argument that debt is more expensive?  The fear is that companies will be wiped out.  What the protagonists ignore is modern bankruptcy law that restructures debt.  If prices (and consequently income) falls to a level where debt can't be serviced, the debt will be lowered through bankruptcy.  Indeed, as long as we are on the path to nationalizing our insolvent banks, once we take them over, we can just restructure everyone's debt with legislation.  For years the banking industry has lobbied to make bankruptcy laws tougher, and in fact successfully convinced Congress to "reform" the bankruptcy laws by making it tougher for individuals to get out from under their debt.  It is time to rethink that strategy.  If lenders must suffer a lost from bad credit decisions, then it is more likely that they will force themselves to make better credit decisions and not lend to people who can't afford to repay.  But that is prospective.  We need to authorize bankruptcy courts to reduce everyone's debt - even home mortgages.  Better yet, just calculate the rate of deflation and reduce everyone's debt by that amount!

Deflation would not slow real consumption.  To be sure, people will not finance purchases of goods they cannot afford, but that is not real consumption.  If we have needs, we will purchase goods at market prices, even when they will be less expensive later.  I will still go to the grocery store weekly to buy food.  I will still go to the barber shop.  I will still purchase a new car when my existing one dies.  (I have 7 tvs in my house, I doubt I will purchase a new one in a long time.)  Just take a look at computer prices.  Over the past 10 years (or longer), computer prices have continually fallen.  Has that stopped the flow of money into computer purchases?  Other than cyclical demand issues, deflation has not affected the computer industry.  (Of course, the Government in its infinite wisdome ignores price declines in calculating CPI and instead imputes the "hedonistic" value of better products into the equation to make deflation look like inflation.)  Deflation in products has spurred a culture of improvement to provide more value in order to induce purchases.  To me, that is a good thing.  But, I am not an economist.

Great Chart from EconompicData!

The Econompic Data blog (http://econompicdata.blogspot.com/) has a great graphic on the moral hazard of Obama's mortgage bailout plan.  Very pithy, but it also points out exactly why the majority of us are so outraged by having our government steal our money to pay for property other people can't afford.  The chart is reproduced below, but you can see more at the above link.

Click on the above chart for a bigger picture

Hold Those Responsible Accountable!

Outright bank fraud and fraudulent and reckless banking practices contributed to the current economic meltdown.  Everyone involved in the process - from the borrowers to the brokers to the bankers to the underwriters and ratings agencies - should be held accountable.  How?  Existing fraud laws are sufficient, but Congress should expressly authorize private individuals to pursue these bad actors for a cut of the recovery.  Authorize the public to bring the equivalent of a qui tam  action in the name of the People of the United States against those  involved in this massive fraud and reckless conduct.  Until these individuals are pursued, the country will not be able to put the crisis behind and will not be able to have faith in the markets or banking system.   

As we well know by now, borrowers falsified mortgage applications to get loans they could not repay in order to buy houses they could not afford.  Mortgage brokers assisted and guided these borrowers into lying in order to get qualified so the mortgage broker could get a commission from the banks.  The banks, in turn, knew and understood that they were approving loans with less security and lower ratios than they usually required, and they knew that noone to that point had verified the information on the mortgage applications.   Knowing these loans were substandard, the banks packaged the mortgages for sale and colluded with the ratings agencies to give the collective pool of loans a higher rating than the individual loans in that pool deserved.  That was only the start of the chain, but that chain is oozing with culpability.

Instead of bailing out the banks that were at the very least collusive with the reckless conduct and/or using my tax dollars to pay my neighbor's mortgage, spend the tax dollars to pursue and hold accountable those truly responsible or authorize the private sector to do so.  Create an army of private attorneys general to pursue those who participated in this fraud.  Start with the borrowers who lied on thier applications.  Not all borrowers lied on thier applications and not all borrowed beyond their means.  Recover what you can from the ones that are culpable and leave the rest alone.  Some estimates are that these liars are less than 8% of the mortgage borrowers.  Hold these thieves accountable!

After ferreting out the dishonest borrowers, use discovery or whatever practical leverage can be applied to encourage the lying borrowers to identify the mortgage broker involved and the process used.  Then pursue the mortgage brokers.  With a vengence.  Like borrowers, not all mortgage brokers are evil.  Many were actually doing a great job placing legitimate credit with lenders.  As an aside, it is a shame that the governments are moving to over regulate the mortgage brokerage industry based on the fruadulent actions of a relatively small minority.  Focus on the small minority of mortgage brokers.  Discover how the brokers encouraged (or misled) borrowers into misstating accurate information on their application.  (Did you ever use a mortgage broker - you filled out forms by hand and they input the numbers into the computer on their forms - - the trouble is the broker never put the same numbers onto the form - - but I digress.)  These brokers were instrumental in perpetrating the fraud.  Either they failed to input the correct information in order to fudge the numbers, and/or they encouraged the borrower to misstate their financial information and/or they turned a blind eye to obviously false information.  Ferret these brokers out and recover from them the money defrauded out of the system by these loans.  Hold these thieves accountable!

 Don't stop at the mortgage brokers.  The fraud gets worse and the pool of wrongdoings is not empty.  Go after the executives and everyone in the chain at the banks who recklessly or intentionally encouraged the mortgage brokers to lie.  There is a now famous "Cheats and Tips" memo from Chase that circulated instructing its brokers how to lie on loan applications.  (Isn't that bank fraud?)   Many more examples will surface if we stop protecting those responsible and hold them accountable.  Hold these thieves accountable!

There is further to go too!  We have the ratings agencies that packaged and sold these junk bond grade assets as the highest grade assets.  That is fraud too.  It isn't just an errant opinion on value, it is systemic fraud.  Hold these thieves accountable!

Authorizing private actions and an army of private attorneys general will remove the burden of prosecution from the government and remove the recovery from the spectre of government corruption.   Part of the problem with arresting the downward slide of the economy is that noone has any faith in the system - with good reason.  It was a rigged game.  Until the government is willing to prosecute the people that raped our banking system with fraudulent and reckless practices to line their own pockets, no faith will ever be restored in the system.  (With all this fraud out their, maybe we should just forget about authorizing private actions and use the stimulus money to hire every attorney out there to purse the perpetrators - nah  - we need the private attorneys general. ) 

The Outrage Is Beginning

Mr. President - Pay Attention To The Person On The Street!  

I do not live in a sheltered environment.  Nearly everyone I speak to has a comment about the government spending program.  While there is some debate as to whether spending will stimulate anything (I don't think so, but I could be wrong), everyone uniformly criticizes the plan to subsidize mortgage payments so people can stay in houses they can't afford.  There is sheer outrage when discussing the mortgage bailout plan.  

Most of us work hard and play by the rules.  We spend our money wisely.  We bought houses that we could afford with 30 year fixed mortgages (well, most of the people I know).  We didn't move up into the $1,000,000 - $2,000,000 McMansions because we knew the monthly payments ate up too much of our monthly income.  We bought on credit, but we paid the credit back.  Now, we want to punish people like us for living responsibly and reward those that took a risk and failed.  Instead of making them pay for thier mistakes,  our governement is making us pay for our neighbor's mortgage.  This goes beyond a liberal-socialist wealth redistribution plan.  It is pure stupidity.  It turns my stomach.  It is the stuff that foments rebellion.  It is acts like those that will be cited as one of the reasons for the Second Boston Tea Party.  

Not only is it morally wrong - and even liberals have morals (I know, I was a knee-jerk liberal in my younger days) - but it is being funded with money we don't have.  Ultimately the $275,000,000,000 mortgage subsidy plan will cost much more, and will be funded either with a substantial increase in taxes paid by those who worked hard, saved and played by the rules, or will be funded by the cruelest tax of all - the devaluation of the dollar.  We know this; we understand this.  Don't let it happen.  Taking my money to line your friends pockets is not only undemocratic, but it will lead to the downfall of our form of government.  You are starting a rebellion Mr. President.  Let's have some change we can believe.

Does Anyone Really Know The True Cost of the Mortgage Bailout?

How much is Obama's mortgage bailout plan anyway?  The New York Times and Wall Street Journal report the plan costs $275 billion; the Washington Post claims just $75 billion (links to articles below).  That is a huge spread people!  Does anyone really know the true cost?  If they do, are they telling us?  

What do we get for that money anyway?  Our tax dollars are being used to let people keep property they bought when they borrowed money they couldn't repay.  Instead letting these borrowers work themselves out of their own debt (like selling property they can't afford or filing for bankruptcy), the government is appropriating OUR money to keep these people in the life style they can't afford.  

Obama claims the program will  support real estate prices.  Haven't we learned that government interference with the free market doesn't work.  Real estate prices were unrealistically high (caused by an increase in the monetary supply through credit expansion) and now must fall to true pricing levels.  Prices are determined by supply and effective demand.  The market is bigger than the government.  Supporting artificially high prices does what exactly?  It may postpone the inevitable fall in prices, but it will not stop the decline.  Does anyone know what they are doing?

http://www.nytimes.com/2009/02/19/business/19housing.html?hp

http://online.wsj.com/article/SB123496582087411241.html

http://www.washingtonpost.com/wp-dyn/content/article/2009/02/18/AR2009021801081.html?hpid%3Dtopnews⊂=new