Fraud wasn't a problem, it was the business plan
Was Bernie Madoff the Exception or the Rule?
Check out the damage done by speculation in land. From a Bloomberg article, Apr 15, by Dan Levy: “Foreclosure filings in the US rose 16% in the first quarter from a year earlier and bank seizures hit a record. A total of 932,234 homes, or one out of every 138 households, received a default or auction notice, or were repossessed by banks. Bank repossessions climbed to 257,944 in the quarter. Scheduled auctions totaled 369,491, also the most” ever. Heck, some quarters, there’s not even that many nondistressed sales! Despite these stats and high unemployment, sales and prices are picking up; we’re into our second straight jobless recovery, moving us closer to a two-class society. As land values rise, they'll lure future banker to repeat the recent looting. This 2010 article is from Huffington Post, Apr 14.
by Robert Borosage, Co-Director, CAFWere the big banks all knowingly running Ponzi schemes? That's the question that arises from the hearings held this week by the Senate Permanent Committee on Investigations, chaired by Senator Carl Levin, on the collapse of Washington Mutual, the largest thrift failure in the US. Faced with looking like fools or knaves, the barons of the big banks -- from Robert Rubin to Lloyd Blankfein to WaMu's Kerry Killinger -- have chosen the fool. But the WaMu hearings -- and Zach Carter's stunning running commentary on them -- suggest that while Bernie Madoff may have been the extreme, he wasn't the exception.
Fraud wasn't a problem; it was the business plan.
According to the FBI, 80% of mortgage fraud is committed by the lender. We're not talking about stupid loan officers allowing borrowers to get away with something crazy that is bad for the bank. We're talking about clever loan officers pushing fraudulent documents in order to score bigger paychecks, and bank executives looking the other way so that they can keep getting big paychecks from the securitization machine. This isn't a problem unique to WaMu. This is how the US mortgage system operated for half a decade.
WaMu actively trained its personnel to convince skeptical borrowers to take risky loans because option-ARMS received a very high yield when packaged into securities. So WaMu's compensation schemes rewarded loan officers for the quantity of loans sold, not the quality of the loans. Levin cited internal memos showing that loan officers under investigation for fraud were rewarded with trips to Hawaii and the Bahamas for their high production.
Even after WaMu's own internal audits reported that a high percentage of the loans were fraudulent, WaMu still sold them to investors, or peddled the loans to investment banks that did the same. As Carter reports, "They not only packaged existing option-ARM loans into securities, they issued as many new option-ARMs as possible, in order to score securitization profits before the market collapsed." CEO Kerry Killinger testifies that he doesn't know if it would have been appropriate to tell investors what the company knew about default rates.
As Carter summarizes, this was essentially a Ponzi scheme, similar to Madoff's:
Making truckloads of fraudulent loans can only end in disaster, but WaMu [executives weren't] really interested in the long-term picture. They were only interested in their ability to book these loans for big, short-term profits. Even when those bad loans finally took the company under, it had been, in a sense, a success. Its executives had already made millions.
The company was trying to counter inevitable losses with the short-term profits from issuing more risky loans. That's basically how Bernie Madoff's scam worked, except he wasn't using make-believe loan profits, he was using make believe stock returns.
The one divergence from the Ponzi scheme is securitization -- dumping the bad loans off its books. [The executives] were deceiving and abusing their buyers.
Why run this scheme that would lead to the ruin of the bank? Because the executives were making out like, well, like bandits. Killinger, the CEO of WaMu, was taking home 11 to 20 million a year during the housing boom.
As Carter ponts out, what WaMu was doing with securities isn't much different than what Goldman Sachs was doing with CDOs -- creating securities that it knew would fail in order to bet against them, while selling them to investors without notice.
These guys weren't fools. They knew what they were doing. They knew that the reckoning would come, or more likely, the Feds would and bail them out. (Killinger is still outraged that WaMu wasn't bailed out rather than put out of business). They kept dancing because they were cleaning up along the way.
The Financial Crisis Inquiry Commission and the Levin Hearings provide a stunning picture of the industry. The good cop, FCIC, treats the bankers as experts, listens to their opinions, and lets them claim the role of fools. "We didn't know." "We didn't realize housing prices wouldn't always go up." " We weren't responsible."
The bad cop -- the Levin committee -- exposed a business model based upon fraud as central to its profitable operations. It is hard to believe that WaMu or Madoff is an exception. Levin should probe every major bank engaged in the securitization of mortgages. Is it likely that their bank officers were fools? Ignorance is their defense, not their condition. They knew what they were doing. The rest is for a prosecutor to sort out.
JJS: If they went to jail for their crimes, then future bankers might be able to resist the same temptation. Of course, we should remove the temptation by having our governments recover the socially-generated values of land and resources then disburse the revenue back to citizens as dividends or truly desired programs or a combination of the two. Sharing “rents” plus de-taxing our efforts, that's the essence of geonomics.
Jeffery J. Smith runs the Forum on Geonomics.
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