Former Regulator: Clear Fraud in Financial Crisis -- Why Isn't Anyone in Jail?

[Beet]

 Posted Nov 21, 2008 12:47pm EST by Aaron Task  in Newsmakers, Banking
Related: BAC, WM, CFC, XLF, JPM

In the aftermath of the corporate scandals earlier this decade, investor confidence was (partially) restored by a parade of "perp walks" of fallen chieftains like Ken Lay, Bernie Ebbers, and Dennis Kozlowski.

But nearly two years into the bursting of booms in housing and mortgage securities, scant few related arrests have been made — and most of those have been focused on individual mortgage brokers vs. major industry leaders.

"There is no poster child [for the housing scandal] because you need to investigate, and you need to bring cases and we haven't done either against the major players," says William Black, Associate Professor of Economics and Law at the University of Missouri — Kansas City and a former federal regulator.

Black, who was counsel to the Federal Home Loan Bank Board during the S&L Crisis and blew the whistle on the "Keating Five" in 1989, says investigations have shown fraud incidence of 50% at (once) major subprime lenders like IndyMac and Countrywide.

But even though the FBI warned of an "epidemic" of mortgage fraud in 2004, they subsequently made a "strategic alliance" with the Mortgage Bankers Association, which serves the major industry players.

In this case, the foxes truly were guarding the hen house.

Black notes it was only this year that the total number of FBI agents devoted to mortgage-fraud investigations rose to more than 200. By comparison, during the S&L and Enron investigations in the 1980s and '90s, respectively, multiple task forces totaling hundreds of agents were employed.

"The DOJ has refused to emulate its successes in the S&L debacle, and even dealing with Enron, by creating a large task force that would take on the major fraud participants," Black said. "In this context, that would mean creating a large task force to investigate major, nonprime lenders."

[MODU]

I'm sure there will be hearings after all of this is settled out.  Trying people for fraud at the moment is not a high priority or use of resources.

[Beet]

I'm sure there will be hearings after all of this is settled out.  Trying people for fraud at the moment is not a high priority or use of resources.

That's pretty much what I said to Carlhayden a while back. But I suspect another reason is the sheer scale... there are so many more people involved in the improper actions here, and there isn't a clear line between improper, but legal, and improper and illegal. Besides, when so many people are involved a "I was just following orders/going with the crowd" dynamic takes in.

However, these people who profited from the bubble cannot be allowed to get away with their riches.

[A18]

What does the alleged "fraud" consist of, and what provisions of federal law are at issue?

[Beet]

What does the alleged "fraud" consist of, and what provisions of federal law are at issue?

Starting with the originator side only...
http://en.wikipedia.org/wiki/Mortgage_fraud
That is just the tip of the iceberg. The bigger fish are executives who sold off at the top and made millions, credit rating agencies who changed their standards to attract business, and CDO packagers who misrepresented the risk to investors.

[A18]

I was looking for specific practices, and for the laws that made them illegal. The link is just a general discussion of mortgage fraud.

I don't know what being an "executive[] who sold off at the top and made millions" has to do with fraud. Perhaps there's an odd statutory definition? The last two sound like they might be getting at something, but on their face don't mean a whole lot.

Could you cite a concrete accusation or two?

[Beet]

I was looking for specific practices,

A specific practice:

Occupancy fraud: This occurs where the borrower wishes to obtain a mortgage to acquire an investment property, but states on the loan application that the borrower will occupy the property as the primary residence or as a second home. If undetected, the borrower typically obtains a lower interest rate than was warranted. Because lenders typically charge a higher interest rate for non-owner-occupied properties, which historically have higher delinqency rates, the lender receives insufficient return on capital and is over-exposed to loss relative to what was expected in the transaction. It is considered fraud because the borrower has materially misprepresented the risk to the lender in order to obtain more favorable loan terms.

A specific instance of this practice:

Scott William Hilgers, 34, and Todd Jeremy Rice, 34, both of Helena, Montana, were sentenced in connection with their guilty pleas to conspiracy to scheme to defraud mortgage companies/wire fraud.  Hilgers was sentenced to a term of 60 months in prison, a special assessment of $100, restitution in the amount of $1,539, and 5 years supervised release.  Rice was sentenced to a term of 12 months in prison, a special assessment of $100, restitution in the amount of $1,539, a $15,000 fine, and 5 years supervised release...

A borrower who is going to use the purchased property for his own personal residence can, under certain circumstances, qualify for 100% financing.  For the purchase of the four aforementioned properties, Rice represented on Fannie Mae Forms 1003, Occupancy Statements and Loan Applications, that each residence would be his primary home. ...

http://www.mortgagefraudblog.com/index.php/weblog/comments/3412/

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This is covered under Title 18, United States Code, Section 1014:

"The violation of making a false statement to a financial institution is also a commonly used criminal law used to prosecute people for making misrepresentations to fact to a bank. The crime of making a false statement is often utilized when federal prosecutors are investigating a person for bank fraud or violations concerning a financial institution.  Under Title 18, United States Code, Section 1014, it is a federal crime to make a false statement to a financial institution. 18 U.S. C. §1014 reads as follows (in summary):


False Statements to a Financial Institution –

Whoever knowingly

1) Makes a false statement, or overvalues any property

2) For the purpose of influencing an anyway

3) The action of a financial institution

shall be fined not more than $1,000,000 or imprisoned for more than 30 years, or both.

 The link is just a general discussion of mortgage fraud."

http://www.teakelllaw.com/CM/Custom/bank-fraud-false-financial-statements.html

http://www.law.cornell.edu/uscode/uscode18/usc_sec_18_00001014----000-.html

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Obviously, executives have inside information. They could have misrepresented the status of their companies to outsiders, instead of attempting to run the company for long term success, in hopes of driving up the price of the stock, so that they could then cash out before the inevitable decline came. They could also have been the decline coming but chose not to prepare their company adequately; but instead chose to sell the company to another institution while misrepresenting its value.

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Here is some information on laws regarding securities fraud
http://www.endfraud.com/whatisfraud.html

Here is an example of an indictment for securities fraud, among others-
http://www.usdoj.gov/usao/nye/pr/2008/2008jun19.html

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Credit rating agencies played a huge role in the financial crisis. Had they adequately evaluated the risk or said honestly "we can't rate this", a lot of the failed CDO market would not have occurred. Equally, one would have to be naive to believe that those that were actually structuring the CDOs themselves have no idea of the risks they were taking on behalf of others.

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[A18]

The first part of your post is a bit odd. The one concrete case you point to is obviously not of much worth; I wanted to know who you wished to see prosecuted, and for what actions. I took it that you thought something "big" was at play--a suspicion the rest of your post confirms.

That said, I appreciate your elaboration on the rest. Of course, I still don't see any real evidence of wrongdoing; that would require actual evidence of people's cognitive states. But at least I know what sorts of things you're talking about.

[Fmr President & Senator Polnut]

The slippery slope.

I don't think they want to make the situation any worse yet.

[Beet]

The first part of your post is a bit odd. The one concrete case you point to is obviously not of much worth;

Why not? This is a specific instance of a specific mortgage crime. Whether it is of much worth depends on why you wanted the information in the first place.

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I'd like to see the following people prosecuted:

Angelo Mozilo, who realized $471 million during the five-year period as he piloted Countrywide Financial Corp. into a leading subprime lender. Amid huge losses, Countrywide was sold earlier this year to Bank of America Corp. Mr. Mozilo defended his pay before Congress earlier this year, saying his compensation was tied to performance and he had built up equity over decades as a founder. Possible crime(s) Securities fraud.

R. Chad Dreier, 61, chairman and chief executive of Ryland Group Inc., a Calabasas, Calif., home builder, made $181 million over the five-year period. Specializing in mid-range homes, Ryland did well in the boom, entering into hot markets, such as Las Vegas and Ft. Myers, Fla. Most of its buyers financed homes through Ryland's in-house mortgage unit, some through controversial interest-only mortgages.

Mr. Dreier's bonuses, many tied to short-term profits, totaled $31.2 million in 2005 and 2006 alone. Ryland paid him another $20.5 million over the five years to cover some of his tax bills. He made another $85 million from stock sales, most of them regularly scheduled. Possible crime(s) Conspiracy, mortgage fraud

Daniel Meyers, First Marblehead

Wall Street once had a voracious appetite for student-loan debt. Ten insiders at First Marblehead Corp. seized the opening, receiving a total of about $660 million, mostly through stock sales over five years.

Based in Boston, First Marblehead specializes in "private student loans." Students take out the loans if they've exhausted the cheaper government-backed variety. As with subprime mortgages, those with poor credit histories must pay higher interest rates.

First Marblehead helped big banks, such as Bank of America and J.P. Morgan Chase & Co., put together student-loan programs. First Marblehead earned rich fees assembling and servicing packages of the debt sold to investors.

Chief Executive Daniel Meyers, a 46-year-old former arbitrage and derivatives trader, received almost $96 million in cash compensation and proceeds from stock sales over five years. Lee Jacobson, a First Marblehead spokesman, notes that Mr. Meyers co-founded the company in 1991 and didn't sell any shares until First Marblehead's October 2003 initial public offering. Possible crime(s) conspiracy to abet false statements to financial institutions

Leslie Alexander, the 65-year-old owner of the Houston Rockets and until recently a First Marblehead director, cashed out $288 million in stock over the five-year period. Possible crime: conspiracy to abet false statements to financial institutions

Robert K. Cole, Edward Gotschall and Brad Morrice, three mortgage industry veterans, founded New Century Financial Corp. in 1995. By the peak of the boom, it was the nation's second-largest subprime lender.

The Irvine, Calif.-based company promoted mortgages that customers could apply for by merely stating their income with no documentation.

Over four years, the three executives received cash compensation and stock proceeds totaling $74 million, including estimates of their 2006 pay cited in a report by a court-appointed investigator after the company filed for bankruptcy protection. Mr. Cole, who was CEO for some of the period, lives in a 9,200-square-foot oceanfront home in Laguna Beach, Calif., that has a tax value of $30 million.

New Century Financial executives have been known as generous philanthropists in California. Mr. Gotschall's foundation gave $3 million in 2005 to a local hospital, which is naming a trauma center after his family.

In 2007, New Century filed for bankruptcy protection. New Century has said its accounting is under investigation by the Securities and Exchange Commission and the Justice Department. Possible crimes: Securities fraud, mortgage fraud, improper accounting

Michael Gooch made a fortune from the booming trade in credit-default swaps and other complex financial instruments now being blamed for fueling the financial crisis.

Mr. Gooch, 50, is chief executive of GFI Group Inc., a leading broker of credit-default swaps. An immigrant from England, Mr. Gooch founded New York-based GFI two decades ago. It went public in 2005, and its stock nearly quintupled by late 2007.

Credit-default swaps are private contracts, similar to insurance, that pay investors when a bond or company defaults. While boosters say swaps are a valuable hedging tool, critics call them a toxic invention that fanned the flames of the mortgage meltdown. With the swaps market contracting and Congress calling for regulation, GFI's stock price has tumbled, recently closing nearly 90% below its high of last November.

Mr. Gooch, through a holding company, sold about $77 million in stock, most of it in May 2006. He says the aim was to diversify his personal investments. "In May 2006, nobody could have predicted the credit bust," he says. He also notes that his holding company still owns 43% of GFI's stock, and that trading credit derivatives is only a part of GFI's business. Possible crimes: conspiracy, securities fraud

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I think there's no question something big is at play. Very big.

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Which is why there needs to be investigations. Of course you're not going to find anything if you don't look. There certainly is the appearance of impropriety across the industry.

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Trillions of dollars have been basically stolen from the taxpayer. That's money out of our pockets and into the bankers'. How do you expect any democracy to work if a small minority of individuals can gamble, effectively, a huge chunk of the nation's GDP and then hold its purse hostage in lieu of systemic economic collapse when their pyramid scheme inevitably collapses?