The systemically dangerous institutions (SDIs) are inaccurately called “too big to fail” banks. The administration calls them “systemically important,” and acts as if they deserve a gold star. The ugly truth, however, is what Wall Street and each administration screams when the SDIs get in trouble. They warn us that if a single SDI fails it will cause a global financial crisis. There are roughly 20 U.S. SDIs and about the same number abroad. That means that we roll the dice 40 times a day to see which SDI will blow up next and drag the world economy into crisis. Economists agree that the SDIs are so large that they are grotesquely inefficient. In “good times,” therefore, they harm our economy. It is insane not to shrink the SDIs to the point that they no longer hold the global economy hostage. The ability — and willingness — of the CEOs that control SDIs to hold our economy hostage makes the SDIs too big to regulate and prosecute. It also allows them to extort, dominate, and degrade our democracies. The SDIs pose a clear and present danger to the U.S. and the world.
It takes a global effort against the SDIs because they constantly put nations in competition with each other in order to generate a “race to the bottom.” We are always being warned that if the U.S. adopts even minimal regulation of its SDIs they will flee to the City of London or be unable to compete with Germany’s “universal” banks. The result of the race to the bottom, however, as Ireland, Iceland, the UK, and U.S. all experienced is that we create intensely criminogenic environment that creates epidemics of “control fraud.” Control fraud — frauds led by CEOs who use seemingly legitimate entities as “weapons” to defraud — cause greater financial losses than all other forms of property crime — combined. Because of the political power of the SDIs and the destruction of effective regulation these fraudulent SDIs now commit endemic fraud with impunity.
Effective financial regulation is essential if markets are to work. Regulators have to serve as the “cops on the beat” to keep the fraudsters from gaining a competitive advantage over honest firms. George Akerlof, the economist who identified and labeled this perverse (“Gresham’s”) dynamic was awarded the Nobel Prize in 2001 for his insight about how control fraud makes market forces perverse.
“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.” George Akerlof (1970).
One of the most perceptive observers of humanity recognized this same dynamic two centuries before Akerlof.
“The Lilliputians look upon fraud as a greater crime than theft. For, they allege, care and vigilance, with a very common understanding, can protect a man’s goods from thieves, but honesty hath no fence against superior cunning. . . where fraud is permitted or connived at, or hath no law to punish it, the honest dealer is always undone, and the knave gets the advantage.” Swift, J. Gulliver’s Travels
We are the allies of honest banks and bankers. We are their essential allies, for only effective regulation permits them to exist and prosper. Think of what would happen to banks if we took the regular cops off the beat and stopped prosecuting bank robbers. That’s what happens when we take the regulatory cops off the beat. The only difference is that it is the controlling officers who loot the bank in the absence of the regulatory cops on the beat. It is the anti-regulators who are the enemy of honest banks and bankers.
Top criminologists, effective financial regulators, and Nobel Laureates in economics have confirmed that epidemics of control fraud, such as the FBI warned of in September 2004, can cause financial bubbles to hyper-inflate and drive catastrophic financial crises. Indeed, the FBI predicted in September 2004 that the developing “epidemic” of mortgage fraud would cause a financial “crisis” if it were not stopped. It grew massively after 2004. The fraudulent SDIs (who were far broader than Fannie and Freddie, indeed, they only began to dominate the secondary market in sales of fraudulent loans after 2005) ignored the FBI and industry fraud warnings for the most obvious of reasons — they were leaders the frauds. The ongoing U.S. crisis was driven overwhelmingly by fraudulent “liar’s” loans. Studies have shown that the incidence of fraud in liar’s loans is 90% (MBA/MARI 2006) and that by 2006 roughly one-third of all mortgage loans were liar’s loans (Credit Suisse 2007). Rajdeep Sengupta, an economist at the Federal Reserve Bank of St. Louis, reported in 2010 in an article entitled “Alt-A: The Forgotten Segment of the Mortgage Market” that:
“[B]etween 2003 and 2006 … subprime and Alt-A [loans grew] 94 and 340 percent, respectively. The higher levels of originations after 2003 were largely sustained by the growth of the nonprime (both the subprime and Alt-A) segment of the mortgage market.”
Sengupta’s data greatly understate the role of “Alt-A” loans (the euphemism for “liar’s loans”) for they ignore the fact that by 2006 half of the loans called “subprime” were also liar’s loans (Credit Suisse: 2007). It was the massive growth in fraudulent liar’s loans that hyper-inflated and greatly extended the life of the bubble, producing the Great Recession. The growth of fraudulent loans rapidly increased, rather than decreased, after government and industry anti-fraud specialists warned that liar’s loans were endemically fraudulent. No one in the government ever told a bank that it had to make or purchase a “liar’s” loan. No honest mortgage lender would make liar’s loans because doing so must cause severe losses. Criminologists, economists aware of the relevant criminological and economics literature on control fraud, and a host of investigations have confirmed the endemic nature of control fraud in the ongoing U.S. crisis.
But the banking elites that led these frauds have been able to do so with impunity from prosecution. Take on federal agency, the Office of Thrift Supervision (OTS). During the S&L debacle, the OTS made well over 10,000 criminal referrals and made the removal of control frauds from the industry and their prosecution its top two priorities. The agency’s support and the provision of 1000 FBI agents to investigate the cases led to the felony conviction of over 1,000 S&L frauds. The bulk of those convictions came from the “Top 100” list that OTS and the FBI created to prioritize the investigation of the worst failed S&Ls. In the ongoing crisis — which caused losses 40 times larger than the S&L debacle, the OTS made zero criminal referrals, the FBI (as recently as FY 2007) assigned only 120 agents nationally to respond to the well over one million cases of mortgage fraud that occurred annually, and the OTS’ non-effort produced no convictions of any S&L control frauds. OTS’ sister agencies, the Fed and the OCC, have the same record of not even attempting to identify and prosecute the frauds. The FDIC was better, but still only a shadow of what it was in fighting fraud in the early 1990s. If control frauds can operate with impunity from criminal prosecutions, then the perverse Gresham’s dynamic is maximized and market forces will increasingly drive honest banks and firms from the marketplace.
The Financial Crisis Inquiry Commission reported on the results of the Great Recession that was driven by this fraud epidemic:
“As this report goes to print, there are more than 26 million Americans who are out of work, cannot find full-time work, or have given up looking for work. About four million families have lost their homes to foreclosure and another four and a half million have slipped into the foreclosure process or are seriously behind on their mortgage payments. Nearly $11 trillion in household wealth has vanished, with retirement accounts and life savings swept away. Businesses, large and small, have felt the sting of a deep recession.”
It is the fraudulent SDIs that are the massive job killers and wealth destroyers. It is the Great Recession that the fraudulent SDIs produced that caused most of the growth in the federal deficits and made the fiscal crises in our states and localities acute. The senior officers that led the control frauds are the opposite of the “productive class.” No one, without the aid of an army, has ever destroyed more wealth and dreams than the control frauds. It is essential to hold them accountable, to help their victims recover, and to end their ongoing frauds and corruption that have crippled our economy, our democracy, and our nation.
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