Rent-seeking, Instability and Fraud

This seminar will explore how financial sector innovation and regulatory structures affect inequality, macroeconomic fragility and white collar crime.

Questions to be addressed include:

• What role does the financial sector play in a modern day economy?
• How does financial innovation fit into traditional boom-and-bust accounts of the business cycle?
• What role did fraud play in the global financial crisis?
• How can financial reform effectively reduce the prevalence of rent-seeking, instability and fraud?

• Seminar Introduction0:00
• HARVEY GOLDSCHMID: Moderator Introduction:24
• BILL BLACK: Presentation3:00
• BILL BLACK: Rent Seeking, Instability and Fraud3:36
  • BILL BLACK: Most reputable financial institutions in America, fraudulent4:23
    • BILL BLACK: Rewind to 1993, the great crossroads4:55
    • BILL BLACK: Regulators listened to people closest to the facts; field examiners5:45
      • BILL BLACK: Nat’l Institutes of Justice almost never funds research into white collar crime6:27
  • BILL BLACK: 1980s: Agency did over 30,000 criminal referrals/over 1000 felony convictions6:58
    • BILL BLACK: Developed concept of Control Frauds7:38
      • BILL BLACK: Gresham’s Dynamic bad ethics drive out good8:40
    • BILL BLACK: Control fraud: seemingly legit entity used to defraud others9:23
  • BILL BLACK: In finance weapon of choice is accounting10:00
    • BILL BLACK: Greatest losses of all property crimes; kills people10:20
    • BILL BLACK: Fraudulent CEO the most dangerous10:24
    • BILL BLACK: Fraud is a sure thing if you use crooked accounting11:24
  • BILL BLACK: Recipe for Fraud 11:41:00
    • BILL BLACK: Optimal for hyperinflation of bubbles “rolling loan gathers no loss”12:45
    • BILL BLACK: Akerloff and Romer in ‘93 – we know how to avoid control frauds13:32:00
      • BILL BLACK: But Akerloff and Romer are almost never cited14:23:00
  • BILL BLACK: Private market discipline doesn’t just fail; actually oxymoronic17:31:00
    • BILL BLACK: Regulators unique; only control that CEO can’t hire/fire18:00:00
    • BILL BLACK: Most recent study that backs this: Piskroski, Seru and Witkin18:24:00
    • BILL BLACK: Fraud roughly 1/10 times in sale of mortgage loans studied; tip of the iceberg19:16:00
      • BILL BLACK: 2nd lien fraud MUST come from the lender20:25:00
      • BILL BLACK: Lenders frequetly aware of the risks21:24:00
  • BILL BLACK: Key: significant misrepresentation across all reputable intermediaries involved in mortgages.21:45:00
    • BILL BLACK: Pervasively fraudulent institutions that are supposed to be most reputable22:30:00
    • BILL BLACK: One of the “best” ways to cause info asymetry is to lie through deceit23:45:00
    • BILL BLACK: Utterly ignored possiblity of fraud in most reputable institutions27:30:00
• HARVEY GOLDSCHMID: 80s/90s/recent have commonalities, but substantial differences. Why not more prosecutions?28:30:00
  • BILL BLACK: Most people don’t understand only 2500 white collar crime investigators out of roughly 1 milllion 29:26
  • BILL BLACK: Don’t have expertise, only when criminal referrals exist. Regulators essential30:09
  • BILL BLACK: During S&L Crisis, 30k referrals by Office of Thrift Supervision. Recent crisis: 030:54
• HARVEY GOLDSCHMID: Moderator Introduction31:00
• MIKE NORMAN: Presentation: 32:30
  • MIKE NORMAN: Worked on Wall Street as a trader, managed money, worked as economist35:20
  • MIKE NORMAN: Belief system that regulators cause the problem; take an idea to its logical extreme37:20
    • MIKE NORMAN: Hobbes: war of all against all. To avoid it, people establish civil society38:45
      • MIKE NORMAN: Show me where there is no regulation where it works.39:29
  • MIKE NORMAN: What about the general welfare clause of the Constitution? 40:59
    • MIKE NORMAN: We live in a country of unbelievable abundance, but we talk as if there is lack41:30
  • MIKE NORMAN: Quotes Mosler: “Financial sector more trouble than it’s worth”41:46
    • MIKE NORMAN: Quotes Volker: economy in the ’50s and60s was good without financial innovations42:26
    • MIKE NORMAN: GDP year on year growth peaks were higher before the ’80s43:22
      • MIKE NORMAN: Just increased risk in system, and enriched ppl in biz44:08
    • MIKE NORMAN: Built 2.6 million homes in ‘72. Basic banking. 44:11
    • MIKE NORMAN: Same amount of homes in ‘06, with more population.44:46
    • MIKE NORMAN: In 2007 40% of all corp profits went to financial sector. In ’60s, about 8%45:54
      • MIKE NORMAN: All Wall Street does is redistribute money in the economy. 46:05
      • MIKE NORMAN: Is this [Wall Street] fair? 47.00
    • MIKE NORMAN: Used to believe in Chinese lending US money. Then met Mosler.49:00
    • MIKE NORMAN: I realized I had been wrong this entire time. 50:00
  • MIKE NORMAN: Personal story: Goldman Sachs admit to fraud, and pay a little fine.50:31
    • MIKE NORMAN: Then it blows up, that’s how Paulson made his billions52:13
    • MIKE NORMAN: Personal story: Worked at S&P in 2000, got fired for negative analytical piece on GM. 52:30
      • MIKE NORMAN: Then GM goes bankrupt.53:50
• HARVEY GOLDSCHMID: Moderator Intro of Lyn Turner. Currently principal of a forensic accounting firm. Former chief accountant at the SEC, started in 1998. Thoughtful, one of the great figures in accounting. Formerly of Coopers and Lybrand.54:32:00
• LYNNE E. TURNER: Presentation55:37
  • LYNNE E. TURNER: Harvey was one of the best GC’s of the SEC ever.55:50
  • LYNNE E. TURNER: Study from GAO re: impact of crisis on Americans. Stunning numbers.56:38
    • LYNNE E. TURNER: Value of homes in US was far less than amount of debt taken out.57:45
    • LYNNE E. TURNER: IMF calculates losses to GDP around 13 trillion58:25
      • LYNNE E. TURNER: If we shut down the economy totally, it would take a year and a half to equal the damage done.58:45
      • LYNNE E. TURNER: Problem is no one views themselves as accountable.59:47
  • LYNNE E. TURNER: It’s not just the bankers.1:00:15
    • LYNNE E. TURNER: Problems at DOJ1:01:59
    • LYNNE E. TURNER: We aren’t going to have prosecution.1:03
    • LYNNE E. TURNER: Lacked: transparency of loan quality, conflicts at S&P/credit rating agencies, accountability1:03:44
    • LYNNE E. TURNER: Everyone got lost in the notion of the greater buck, forgot about the greater good.1:04:20
    • LYNNE E. TURNER: If you don’t build the fences, people will walk out with the money.1:05:00
      • LYNNE E. TURNER: Only way to have orderly markets is thoughtful regulation.1:06:00
  • LYNNE E. TURNER: Bankers incented for volume not quality. 1:06:48
    • LYNNE E. TURNER: People saw it. Regulators ignored it. 1:07:10
      • LYNNE E. TURNER: If you don’t have regulations to slow down the train it always happens1:07:54
      • LYNNE E. TURNER: Worse: federal government sued N. Carolina to stop the state from slowing this down.1:09
      • LYNNE E. TURNER: SEC and CFTC failed. Went to a gunfight with a waterpistol1:09:30
    • LYNNE E. TURNER: Attorneys faciliated. 1:09:58
    • LYNNE E. TURNER: Auditors also part of the problem1:10:45
      • LYNNE E. TURNER: Personal Story: Morgan Stanley – short due diligence process1:11:45
      • LYNNE E. TURNER: Personal Story: Director at Merill Lynch after things went wrong said they’d do it all the same. 1:12:50
      • LYNNE E. TURNER: Personal Story: Executive commitee of AIG. Tuaranteed not a dollar of loss. But lost 100 billion. 1:13:47
    • LYNNE E. TURNER: Investors also at fault. For example, Abacus. 1:16:00
  • LYNNE E. TURNER: Fixes: Transparency 1:17:00
    • LYNNE E. TURNER: Dodd-Frank. Half of it not in place – amazed banks claim it costs so much. 1:17:22
    • LYNNE E. TURNER: Glass-Steagal. Spoke with chair of audit committe at JPM who said break up the banks.1:17:44
    • LYNNE E. TURNER: Need accountabliity. Take banks to trial. 1:18:59
    • LYNNE E. TURNER: Need regulators who are independent of banks. 1:19:30
      • LYNNE E. TURNER: Should strip the examination/supervisory out of the Fed and OCC, put it in a new agency. 1:20:22
    • LYNNE E. TURNER: Need more disclosures on credit quality. 1:21:11
    • LYNNE E. TURNER: Regulator reports should be public.1:21:57
    • LYNNE E. TURNER: Congress constantly beats regulators to death. 1:22:50
    • LYNNE E. TURNER: Fixes won’t happen. Expect repeat of the crisis. 1:23:27
• HARVEY GOLDSCHMID: Begin Q&A1:24:00
  • AUDIENCE MEMBER: Why isn’t SARBOX enforced against Jamie Dimon? 1:25:00
    • LYNNE E. TURNER: General Counsel for Dimon is fmr director for enforcement at SEC. 1:25:27
    • HARVEY GOLDSCHMID: These things are complex; picking any individual for liability is very hard.1:27:57
    • LYNNE E. TURNER: Critical report on JPM by OCC and no action by SEC highlights how far off track enforcement is. 1:30:00
    • MIKE NORMAN: The system controls the government; Dimon is able to get away with it.1:30:30
    • BILL BLACK: JPM case would not be the first case to bring1:31:00
      • BILL BLACK: At 100s of lenders there were insiders who opposed control fraud, harrassed by management.1:33:00
      • BILL BLACK: After you bring thousands of those cases, public realizes there is a problem.1:34:19
      • BILL BLACK: Pick off the people who are absolutely plain/Establish precendent1;35:00
    • HARVEY GOLDSCHMID: Dimon is safe because Cutler knows lawyers in enforcement. 1:35:49
      • HARVEY GOLDSCHMID: Must develop cases over time, use approach of turning people, like a mafia prosecution.1:36:35
    • LYNNE E. TURNER: Most troubling: whistleblowers come forward but still no prosecutions.1:37:43
    • BILL BLACK: Whistleblowers make great witnesses because they resisted the fraud.1:40:30
      • BILL BLACK: Disagree with Lynne; there was skin in the game. 1:41:00
      • BILL BLACK: Sellers knew how bad the loan packages were.1:42:00
      • BILL BLACK: In one case: internal review noted 40% of loan packages were bad. 1:43:00
    • LYNNE E. TURNER: SEC did bring a case against Mozillo but was paid by Countrywide’s insurance policy. 1:45:50
  • AUDIENCE MEMBER: Are these frauds symptomatic of financial cycles, or driver of financial cycles?1:46:00
    • BILL BLACK: Definite driver of 2nd phase of S&L debacle1:46:30
      • BILL BLACK: Liar’s loans mostly driven by fraud, subprime also.1:47:30
      • BILL BLACK: There are other areas of fraud, such as appraisal fraud1:48:36
    • BILL BLACK: Macro people say imbalances drive it. Micro people say fraud drives it.1:49:30
    • HARVEY GOLDSCHMID: Fed can be faulted for not using its authority to regulate mortgage industry.1:50:00
      • HARVEY GOLDSCHMID: SEC & FINRA did hold things in check in securities industry1:51:00
      • HARVEY GOLDSCHMID: Greenspan didn’t understand that mortgages were being passed on via CDOs etc1:52:50
      • HARVEY GOLDSCHMID: Naive belief at the Fed that markets will be self-correcting somehow1:53:00
      • BILL BLACK: Fed ended liars loans a year after markets ended them1:53:30
  • AUDIENCE MEMBER (MICHAEL HUDSON): AIG brought a lawsuit against the government over the loans– opinions?1:54:00
    • LYNNE E. TURNER: The board revolted against Greenberg (of AIG).1:54:30
      • LYNNE E. TURNER: Greenberg was out of line for suing the government for taking over.1:56:00
      • LYNNE E. TURNER: Greenberg could have prevented problems by cooperating.1:56:35
  • AUDIENCE MEMBER: Not enough public outrage to prosecute money laundering banks? Or not enough will? 1:57:00
    • HARVEY GOLDSCHMID: Nothing like a CEO in prison to send a message. 1:58:20
    • HARVEY GOLDSCHMID: Must find ways to reach more individuals1:59:00
    • BILL BLACK: We know that Lanny Breuer worried about consequences of jail, but not about job loss.1:59:40
    • MIKE NORMAN: The system is corrupt and it is obvious. Money controls politics.2:00:30
  • AUDIENCE QUESTION: Why don’t we license people to remove the sociopaths from the system?2:01:55
    • BILL BLACK: Active literature in biz schools (Stanford) defending narcissism by CEOs as ideal trait. 2:03:19
  • AUDIENCE QUESTION: Is it possible for us to talk about a post-capitalist system? 2:03:47
    • LYNNE E. TURNER: American people have elected and re-elected people who sign off on these things. 2:05:59
    • MIKE NORMAN: We could create a near utopian society but we don’t because of destructive belief systems. 2:07:27
  • AUDIENCE QUESTION: New kind of control fraud: mathematics itself is being twisted. Do you agree, and how to fight it? 2:10:54
    • HARVEY GOLDSCHMID: SEC doesn’t have a big spend on IT, but finance firms spend billions. 2:13:34
    • BILL BLACK: Math is a large problem. Risk is endogenous not exogenous. 2:14:00
      • BILL BLACK: Any modelling techniques that assume exogenous are disaster.2:14:30
      • BILL BLACK: Therefore easily manipulable by those who get bonuses by understanting risk2:14:40
      • BILL BLACK: Discussions of black swans and fat tails are absurd. These models are not real.2:15:07
    • BILL BLACK: Credit rating agencies called toxic waste, AAA. Should be driven out of respectable society.2:16:30
      • BILL BLACK: The more that SEC people were trained in econometrics, the more they believed the lie.2:16:53
      • BILL BLACK: Wall Street guru will say something untrue, you nod, and then they know they have you. 2:17:39
    • BILL BLACK: The idea you could look at systemtic risk through quant techniques is wrong.2:18:35
  • AUDIENCE QUESTION: Is any part of the process more susceptible to pressure?2:19:37
    • BILL BLACK: Regulatory arbitrage really kicked off when FSA started in City of London2:20:36
    • HARVEY GOLDSCHMID: Deregulatory period was part FSA, but also atmosphere in Washington D.C.2:21:11
    • HARVEY GOLDSCHMID: Worried about Dodd-Frank– will it work?2:22:29
    • BILL BLACK: During Congressional testimony on Lehman Brothers, never a single question about fraud.2:23:00