William K. Black, JD, PhD is an Associate Professor of Economics at the University of Missouri. Dr. Black took the notes of the meeting that led to the Senate Ethics investigation of the Keating Five, including Senator John McCain (R-Arizona).
In the Huffington Post (aka HuffPost), Dr. Black recently wrote an article that reviews an academic paper published in February 2013 by Tomasz Piskorski (Columbia Graduate School of Business), Amit Seru (University of Chicago and NBER) and James Witkin. Titled Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market (PSW 2013), the three financial scholars argue that over time, the regulations that require both disclosure by financial institutions regarding the quality of their financial products as well as prohibition of misleading information have been degraded as more agents and intermediaries have entered the “supply chain” of credit. Their research looks specifically at RMBS products (residential mortgage-backed securities) and the effect that this weakening of regulation and controls has had on capital markets.
The findings of the study’s authors are that the RMBS market, which was $2 trillion in 2007, was rife with “instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets,” rather than simply being the result of the sellers of these products having more information than the buyers. They found further that the “propensity to misrepresent loans is pervasive among reputable firms.”
In his HuffPost article that discusses PSW 2013, Dr. Black describes these misrepresentations as control fraud, a term he coined which describes deception or manipulation in an organization by a person or persons with a high level of responsibility (C-Suite, Senior VPs) for the purposes of personal gain. I interpret personal gain as to also include the gain of the organization, i.e., banks. It is obviously the highest form of white-collar crime in that the stakes and rewards are astronomical in comparison with the losses that occur with most white-collar crimes.
As further examples of the control fraud he believes are being perpetuated by financial institutions, Dr. Black refers to page 2 of PSW 2013 and comments “The definitive evidence of control fraud that PSW2013 identifies is by mortgage lenders who made, or purchased, mortgages and then resold them to “private label” (non-Fannie and Freddie) financial firms who were creating mortgage backed securities (MBS). The deceit they documented by the firms selling the mortgage loans consisted of claiming that the loans did not have second liens. The lenders knowingly sold mortgages they knew had second liens under the false representations (reps) and warranties that they did not have second liens.”
Why am I writing about this in the California Real Estate Fraud Report? Very simply, local, state and federal authorities have investigated and prosecuted thousands of mortgage fraud and loan fraud (application) cases by individuals since the real estate market soured in early 2007. While many of these were “liar’s loans” in which the applicant fabricated his/her financial standing, Black argues that “it was lenders and their agents who “deliberately” put the lies in liar’s loans,” driven by upper-management sales pressure, profitability and lots and lots of bonuses. One story of such bonuses is related in my ebook “How to Commit Short Sale Fraud . . . and Get Away with It.” It means that the feds ultimately have a “hands-off” policy when it comes to large-scale institutional fraud and restrict themselves to the low-hanging fruit that most likely has a significantly smaller impact in the fight against fraud and a similar smaller impact on the economy and real estate markets. In other words, being effective in combating mortgage fraud is not a goal of the U.S. Department of Justice.
Further, if control fraud is as “pervasive” as both Black and the authors of PSW 2013 contend, this then brings to mind the March 2013 hearings in which Sen. Elizabeth Warren (D-Mass.) challenges Attorney General Eric Holder’s statements that some banks are too big to prosecute and their executives (=Presidential campaign donors) too big to jail.
You can read a summary of Senator Warren’s questioning of AG Holder in the Huffington Post.
William K. Black also wrote a presentation of control fraud using RiteAid as the company of discussion.