Regulator Failure and Intentional Ignoring of Elite Fraud

Yves Smith’s blog post today on Naked Capitalism has more interesting commentary from Bill Black, criminologist, lawyer, professor, and S&L regulator:

Gretchen and Louise’s reporting exposed for the first time two underlying scandals that produced the overall scandal. In 2008, the FBI, belatedly, realized that it had improperly targeted relatively trivial mortgage frauds while ignoring the massive lenders that specialized in making fraudulent mortgages. The FBI developed a plan to reorient its resources towards the “accounting control frauds” that always should have been its priority. We now know that the Department of Justice (DoJ) deliberately, and successfully, sabotaged this effort to investigate the major frauds. We need additional investigative reporting to discover why DoJ did so.

The second underlying scandal that their column disclosed is that two key members of what Tom Frank aptly termed Bush’s “Wrecking Crew” – Geithner and Bernanke – who President Obama chose to promote and reappoint and make his anti-regulatory leaders sought to discourage or limit federal and state prosecutions, enforcement actions, and suits. Geithner’s express rationale was that the financial system extreme fragility made vigorous investigations of the elite frauds too dangerous.

Here is how I responded to Kai Ryssdal, Marketplace’s business journalist, who asked about Geithner’s rationale:

Ryssdal: What about the argument, though, that the financial system is so fragile still, and these cases so complicated, that we can’t really tear things apart with substantive investigations and prosecutions because it will all fall apart again?
Black: Yeah, that’s an excellent point. We should leave felons in charge of our largest financial institutions as a means of achieving financial stability.

Geithner’s “elite frauds go free” plan is not new. Speaker Wright demanded that my colleagues and I go easy on fraudulent Texas S&Ls to save the Texas economy (which the S&L frauds were savaging – but he assumed they were salvaging). The five senators that became known as the “Keating Five” told us that Lincoln Savings was critical to the health of Arizona’s economy. In reality, it was the worst threat to Arizona’s economy. One of my agency’s presidential appointees, Bank Board member Roger Martin, argued that if Keating was a fraud and had made Lincoln Savings insolvent by looting the S&L it was all the more important to keep him in charge so that he could use his exceptional political power to get zoning changes that would reduce losses. He opposed any closures of insolvent, fraudulent Arizona S&Ls on the grounds that the Arizona economy was fragile. Here’s the difference. We, the professional regulators, explained in excruciating detail why leaving frauds in charge of S&Ls would massively increase losses and harm regional economies. Only one of the three Board members (Larry White) listened to us – the other two (Martin and Bank Board Chairman Danny Wall) took the unprecedented action of removing our jurisdiction over Lincoln Savings because we refused to withdraw our recommendation that it be promptly taken over and Keating removed. We told the Keating Five to their faces that they were intervening on behalf of a fraud. Even before Wall and Martin removed our jurisdiction over Lincoln Savings they expressly ordered us to cease our examination of Lincoln Savings, to cancel the upcoming examination (nominally, they ordered us to postpone it indefinitely), and ordered that the formal investigation of Lincoln Savings (which had produced the admissions of fraud) be terminated (nominally, suspended). The result was that Lincoln Savings became the worst S&L failure. Losses increased substantially after our examination, investigation, and supervision of Lincoln Savings were halted. All of this became a national scandal when House banking chairman, Henry B. Gonzalez, over the opposition of the Democratic leadership, conducted a series of intense oversight hearings that exposed the Bank Board’s capitulation to the political extortion of the Keating Five and Speaker Wright. Danny Wall resigned in disgrace as a result of those hearings.

For those readers who doubt that regulators can ever be trusted let me note several facts about the Keating Five meeting (which occurred 24 years and one week ago). Four of the Senators were Democrats, one was a Republican. Speaker Wright was a Democrat. Four of us from the Federal Home Loan Bank of San Francisco met with the Keating Five. To this day, I have no idea what the political affiliations, if any, of my colleagues were. It was irrelevant to us. We detested the frauds and their political allies. Our job was to protect the public. We were constantly abused, sued for hundreds of millions of dollars, investigated, and threatened with being fired. We prioritized the most elite, most destructive frauds for removal from the industry, enforcement actions, civil suits, and prosecutions. We persevered.


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