Rent-seeking, Instability and Fraud

Challenges for Financial Reform

Feb 26, 2013


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


William K. Black
Associate Professor of Law and Economics
University of Missouri-Kansas City
Michael Norman
Economist and veteran trader
Lynn E. Turner
Managing Director Focusing on Forensic Accounting
Harvey J. Goldschmid

Core Reading

Former Treasury Official: Let’s Keep Running Big Deficits

Tully, Shawn. “Former Treasury official: Let’s keep running big deficits.” Fortune (2013).

Former Deputy Secretary Of The U.S. Treasury Department Endorses Modern Monetary Theory (MMT)

Kelton, Stephanie Former Deputy Secretary of the U.S. Treasury Department Endorses Modern Monetary Theory (MMT). New Economic Perspectives, 2013.

Former Dept. Secretary Of The U.S. Treasury Says Critics Of MMT Are “Reaching”

Kelton, Stephanie Former Dept. Secretary of the U.S. Treasury Says Critics of MMT are “Reaching”. New Economic Perspectives, 2013.

Should The U.S. Be More Like China?

Newman, Frank Should the U.S. be More Like China?. Fox Business, 2012.

Author Examines Six Myths About U.S. Economy

Rapoza, Kenneth. “Author Examines Six Myths About U.S. Economy.” Forbes (2011).

William K. Black

Jacob Lew: Another Brick In The Wall Street On The Potomac

Black, William K. Jacob Lew: Another Brick in the Wall Street on the Potomac. Huffington Post, 2013.

The Dangerous Myth That Financial Regulation Is Unrelated To Financial Crime

Black, William K. The Dangerous Myth that Financial Regulation is Unrelated to Financial Crime. New Economic Perspectives, 2012.

The War Against The Regulatory Cops On The Bank Beat

Black, William K. The War against the Regulatory Cops on the Bank Beat. New Economic Perspectives, 2012.

Why Aren’t The Honest Bankers Demanding Prosecutions Of Their Dishonest Rivals?

Black, William K. Why aren’t the honest bankers demanding prosecutions of their dishonest rivals?. Naked Capitalism, 2011.

Testimony Before House Financial Services Committee On 2008 Lehman Brothers Failure

Black, William K. Testimony Before House Financial Services Committee on 2008 Lehman Brothers Failure., 2010.

The Two Documents Everyone Should Read To Better Understand The Crisis

Black, William K. The Two Documents Everyone Should Read to Better Understand the Crisis. Huffington Post, 2009.

Mike Norman

Mike Norman Interviews Yale Law Professor, Jonathan Macey

Norman, Mike Mike Norman interviews Yale law professor, Jonathan Macey. YouTube, 2013.

Wall Street Criminality Out Of Control!

Norman, Mike Wall Street criminality out of control!., 2012.

Lynn E. Turner

Statement Before The Senate Committee On Banking, Housing And Urban Affairs On Spurring Job Growth Through Capital Formation While Protecting Investors

Turner, Lynn E. Statement Before the Senate Committee on Banking, Housing and Urban Affairs on Spurring Job Growth Through Capital Formation While Protecting Investors., 2012.

 Statement Before the Senate Committee on Banking, Housing and Urban Affairs on Spurring Job Growth Through Capital Formation While Protecting Investors.pdf

Statement Before The Senate Subcommittee On Securities, Insurance And Investment On The Role Of The Accounting Profession In Preventing Another Financial Crisis

Turner, Lynn E. Statement Before the Senate Subcommittee on Securities, Insurance and Investment on the Role of the Accounting Profession in Preventing Another Financial Crisis., 2011.

 Statement Before the Senate Subcommittee on Securities, Insurance and Investment on the Role of the Accounting Profession in Preventing Another Financial Crisis.pdf

“The Banks Own Us” – Former Chief Accountant Of The SEC Lynn Turner

“The Banks Own Us” – Former Chief Accountant of the SEC Lynn Turner. YouTube, 2011.

Statement Before The Senate Committee On Banking, Housing And Urban Affairs On Enhancing Investor Protection And The Regulation Of Securities Markets

Turner, Lynn E. Statement Before the Senate Committee on Banking, Housing and Urban Affairs on Enhancing Investor Protection and the Regulation of Securities Markets., 2009.

 Statement Before the Senate Committee on Banking, Housing and Urban Affairs on Enhancing Investor Protection and the Regulation of Securities Markets.pdf

Related Materials

The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?

Rakoff, Jed S. The Financial Crisis: Why Have No High-Level Executives Been Prosecuted?. The New York Review of Books, 2014.

Everything Is Rigged: The Biggest Price-Fixing Scandal Ever

Taibbi, Matt Everything Is Rigged: The Biggest Price-Fixing Scandal Ever. Rolling Stone, 2013.

Detecting, Investigating And Documenting Fraud

Seefer, Chris Detecting, Investigating and Documenting Fraud. New Economic Perspectives, 2012.

A Dream SEC Chief

Stoller, Matt A Dream SEC Chief. Salon, 2012.

Looting: The Economic Underworld Of Bankruptcy For Profit

Akerloff, George A., and Paul M. Romer Looting: The Economic Underworld of Bankruptcy for Profit. Brookings Papers on Economic Activity. Brookings Institution, 1993.

 Looting The Economic Underworld of Bankruptcy for Profit.pdf

The Market For “Lemons”: Quality Uncertainty And The Market Mechanism

Akerloff, George A.. “The Market for “Lemons”: Quality Uncertainty and the Market Mechanism.” The Quarterly Journal of Economics. 84.3 (1970).

 The Market for Lemons Quality Uncertainty and the Market Mechanism.pdf