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Are We Going to Let the Biggest Financial Fraudsters Keep Their Money and Avoid Jail Time?

The FBI and the DOJ are unlikely to prosecute the elite bankers who ran the enormous fraud that drove the financial crisis.

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The federal regulators have not made any public study of liar’s loans. The FDIC and OTS’ joint data system on mortgages is an anti-study — it uses a categorization system that ignores whether the loans were underwritten. This makes the data base useless for studying loans made without full underwriting — the loans that were overwhelmingly fraudulent and drove the crisis. Credit Suisse reported that mortgage loans without full underwriting constituted 49% of all new originations in 2006. If that percentage is even in the ballpark it indicates that that there were millions of fraudulent loans originated in 2005-2007. It is appalling that the regulators are not studying the facts necessary to understand the crisis and hold the perpetrator accountable.

Fortunately, the state attorneys general have studied these mechanisms and they have found that it was the lenders and their agents that overwhelmingly (1) prompted the false loan application data and (2) coerced appraisers to inflate market values. An honest lender would never engage in either practice or permit its agents to do so. The federal regulators, however, have spent their passion trying to preempt state efforts to protect borrowers. The federal regulators took no effective action in response to the State AGs’ findings.

The combined effect of these private sector, regulatory, and criminal justice failures has created a set of intellectual blinders that have caused DOJ to mischaracterize the nature of mortgage fraud. Attorney General Mukasey famously dismissed the epidemic of mortgage fraud as “white-collar street crime.” He did so in the context of refusing to establish a national task force against mortgage fraud. A national task force is essential in this crisis because of the national lending scope of many of the worst accounting control frauds. Attorney General Holder has maintained Mukasey’s passive approach to the elite frauds that drove the crisis.

The U.S. needs to take three major steps to be effective against the epidemic of accounting control fraud. First, DOJ needs to realize that it is dealing with accounting control fraud. That task is not terribly difficult. The criminology, economics, and regulatory literature — as well as the data on fraud and analytics are all readily available. The FBI must end its “partnership” with the MBA.

Second, the regulators need new leadership picked for a track record of success as vigorous regulators and a willingness to hold elites accountable regardless of their political allies. The regulators need to make assisting prosecutions, and bringing civil and enforcement actions, against the senior officers that led the control frauds their top priority. The regulators need to make detailed criminal referrals, enforce vigorously the regulatory mandate that insured depositories file criminal referrals, and prioritize banks that made large numbers of nonprime loans but few criminal referrals. The regulators need to work with DOJ to prioritize the cases. In the S&L debacle we used a formal process to create our “Top 100″ priority cases. The regulators need to investigate rigorously every large nonprime lending specialist by creating a comprehensive national data base. We have unique opportunities given the massive holding of nonprime paper by the Fed and Fannie and Freddie to create a reliable data base and use it to conduct reliable studies and investigations.

Third, the regulators and the DOJ need to partner with the SEC and the state AGs to share data (where appropriate under Grand Jury rule 6e). The federal regulators need to end their unholy war against state regulatory efforts and the SEC needs to end its disdain for the state AGs. The SEC needs to clean up accounting and the Big Four audit firms. The bank control frauds’ “weapon of choice” is accounting. The Big Four audit firms consistently gave clean opinions to even the most egregious frauds. Provisions for losses (ALLL) fell to farcical levels. Losses were not recognized. Clear evidence of endemic fraud was ignored.

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