It was almost four years ago that Federal Reserve Board Chairman Ben Bernanke, Treasury Secretary Henry Paul Paulson and then New York Fed Bank President Timothy Geithner ran to Congress warning that the end of the world was near. They told members of Congress that the banks were drowning in bad debt and without a massive bailout they would soon be forced into bankruptcy. Congress quickly coughed up the money in the form of $700 billion in TARP loans. The Fed contributed trillions more.
Undoubtedly, most of the bad debt was due to stupidity, which does not seem to be in short supply on Wall Street despite the high paychecks. The folks running the major banks somehow could not see the largest asset bubble in the history of the world. The fact that house prices had risen by more than 70 percent above their trend level, with no plausible explanation in the fundamentals of the housing market, did not trouble these high flyers.
But there was more than just stupidity involved here. There was an epidemic of mortgage fraud that was identified by the FBI as early as 2004. The general story was that the big subprime issuers were pushing their agents to issue as many mortgages as possible, because they knew that they could sell almost any mortgage the next day in the secondary market. As a result, many mortgage agents put down information that they knew to be false, often changing information provided by applicants, to allow borrowers to get mortgages for which they were not actually qualified.
Clearly, much of this sort of fraud took place. There were many accounts of people who received mortgages with payments that would have taken up their entire income. In some cases, the applicants may have been responsible for the false information. According to the FBI, in most of the cases it was the lenders who put down the false information, so that they would be able to issue a loan that could be sold in the secondary market.
During the bubble years, I had several people send me emails saying that friends or relatives were being told by their supervisors at major lenders to fill in false numbers to allow people to get mortgages for which they were not qualified. While anyone can make up anything in an email, the fact that I got similar accounts from multiple sources suggests that this sort of fraud was actually taking place on a substantial scale. (The alternative explanation, that there was a conspiracy to fool me, hardly seem very plausible.) The question is how high up in the corporate hierarchy did this fraud originate?
A serious investigation would start at the bottom and work up. It would find offices where many of the especially bad mortgages were issued. The investigators would question the mortgage agents about how so much false information ended up on loan forms.
After scaring some number of mortgage agents into talking, they would then talk to the branch managers. If they got two to three branch managers to acknowledge that they had pushed such agents to falsify information, they would then press them to reveal how they decided to engage in mortgage fraud. This practice could lead to the top levels of the bank.
The same policy could be followed with securitization. There have been enough emails uncovered and public statements from insiders to know that some people within the major investment banks knew that many of the mortgages that they were securitizing were fraudulent. It is, of course, against the law to deliberately pass on fraudulent mortgages. It is also against the law to ignore clear evidence of fraud when rating these issues, as appears to have been the practice of the bond-rating agencies.
In short, it seems that there was a lot of crime here, but not much effort at enforcement. In its first three years, the Obama administration did almost nothing to investigate criminal practices that contributed to the bubble and the subsequent meltdown. The attorneys general settlement on robo-signing in January called for a task force to be headed by New York Attorney General Eric Schneiderman.
Almost four months later, there is little evidence that this task force is making much progress. For example, if someone wanted to contact the task force to report evidence of fraud, they would certainly have a difficult time surfing the web to find a phone number to call or an email address.
With the statute of limitation for many possible offences being reached in the near future, if it has not already been reached, there should be a serious sense of urgency about this issue that is altogether lacking. If the Obama administration pursued al-Queda with the same vigor as it’s investigating financial fraud, Osama bin Laden would be sunning himself on some beach in the Caribbean.
This is not just a question of holding the bad guys accountable as a matter of justice. The far more important point is to alter the incentives in the financial industry to change their future conduct. It should not be acceptable for people in the industry to commit fraud and there should be serious consequences for those who do. At the moment, fraud for profit looks like a bet that only has an upside.