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May 29, 2013
Editor's note: This article is part of an ongoing AlterNet series, "The Age of Fraud.
do you get when you throw together economic fraudsters, plutocrats and
opportunistic criminals? A financial crisis, that’s what. If you look
back over the massive frauds that have swept the country in recent
decades, from the savings and loan crisis of the 1980s to the 2007-'08
financial crash, this deadly combination always appears.
dangerous cycle begins when prominent economists pander to plutocrats
and bought politicians, who reward them with top posts, where they
promote the perverse economic policies that cause fraud epidemics.
Crises develop, and millions of people are ripped off. Those who fight
for truth are ignored or ruined. The criminals get wealthier, bolder and
more politically powerful, and go on to hatch even more devastating
The three most recent financial crises in U.S. history were
driven by a special type of fraud called “control fraud” -- cases where
the officers who control what look like legitimate entities use them as
“weapons” to commit crimes. Each time, Alan Greenspan, former chairman
of the Federal Reserve, played a catastrophic role. First, his policies
created the fraud-friendly (criminogenic) environment that produces
epidemics of control fraud, then he failed to identify those epidemics
and incipient crises, and finally, he failed to counter them.
the heart of Greenspan’s failure lies an ethical void in the brand of
economics that has dominated American universities and policy circles
for the last several decades, a brand known as “free market
fundamentalism” or the “neoclassical school.” (I call it “theoclassical
economics” for its quasi-religious belief system.) Mainstream economists
who follow this school assert a deeply flawed and controversial concept
known as the “efficient market hypothesis,” which holds that financial
markets magically regulate themselves (they automatically
“self-correct”) and are thus immune to fraud. When an economist starts
believing in that kind of fallacy, he is bound to become blind to
reality. Let’s take a look at what blinded Greenspan:
knew that markets were “efficient” because the efficient market
hypothesis is the foundational pillar underlying modern finance theory.
- Markets can’t be efficient if there is control fraud, so there must not be any.
- Wait, there are control frauds! Tens of thousands of them.
- Then control fraud must not really be harmful, or markets would not be efficient.
- Control fraud, therefore, must not be immoral. As crime boss Emilio Barzini put it in The Godfather, “It’s just business.”
delusional and immoral as this “logic” chain is, many elite economists
believe it. This warped perspective has spawned policies so perverse
that they turn the world of finance into the optimal environment for
criminals. The upshot is that most of our elite financial leaders and
professionals have thrown integrity out the window, and we end up with
recurrent, intensifying financial crises, de facto
our most elite criminals, and the rise of crony capitalism. Let’s do a
little time travel to see exactly how this plays out.
How to stoke a savings and loan fiasco
Lincoln Savings and Loan Association of Irvine, California was at the
center of the famous crisis that rocked the financial world in the
1980s. A once prudently run company morphed into a casino when S&L
associations became deregulated and started doing risky business with
depositors’ money. Businessman, GOP darling, and anti-pornography
crusader Charles Keating, ironically nicknamed “Mr. Clean,” took over
Lincoln in 1984 and got the casino rolling. (It was a special kind of
casino where the games were rigged – and not in favor of newlywed brides
who were the subject of sexual extortion in Casablanca
.) In a
classic case of control fraud, Keating devoted himself to turning the
company into a weapon of mass financial destruction and a source of
wealth for his family. Keating’s “weapon of choice” for his frauds was
Keating went on a spree buying land, taking equity
positions in real estate projects, and purchasing junk bonds. In 1985,
the Federal Home Loan Bank Board (FHLBB), where I was the staffer
leading the regulation efforts, grew alarmed at the new activities of
savings associations like Lincoln. So we made a rule: S&Ls could not
put more than 10 percent of company assets in "direct investments” – an
activity that led to very large losses.
Alan Greenspan, chairman
of an economic consulting firm at the time, urged us to permit Lincoln
Savings to go full steam ahead. His memo supporting Lincoln’s
application to make hundreds of millions of dollars in direct
investments praised the company’s management (Keating) and claimed that
Lincoln Savings “posed no foreseeable risk of loss.”
rejected Lincoln’s request to exceed the rule’s threshold because direct
investments were a superb vehicle for accounting fraud – they made it
easy to hide losses and to create fictional income. Nevertheless,
Lincoln continued to violate the rule and created fictional (backdated)
board consents with hundreds of forged signatures to make it appear that
the investments were “grandfathered” under the rule. The hundreds of
millions of dollars in unlawful direct investments were used for
fraudulent purposes by Lincoln Savings’ controlling officers and caused
enormous losses – many of them to elderly citizens who were conned into
buying the junk bonds of Lincoln Savings’ holding company. The massive
losses on Lincoln’s illegal direct investments were a major reason those
bonds were worthless.
Hoping to use his political clout to
continue the fraud, Keating hired Greenspan to lobby the senators who
eventually became the known as the “Keating Five.” I remember well when
these senators intervened at Keating’s request to try to prevent me and
my colleagues from taking an enforcement action (or conservatorship)
that would have saved over a billion dollars. (I took the notes of that
meeting, which led to the Senate ethics investigation of the Keating
Five.) The cronyism was so thick in Washington that William Weld, then a
top Department of Justice official and later the Republican governor of
Massachusetts, actually tried to gin up a criminal investigation of the
regulators rather than Keating at the request of Lincoln’s lawyers who
had just left the DOJ! Eventually, Keating and many of the senior
managers of Lincoln Savings were convicted of felonies and Lincoln
Savings became the most expensive failure of the S&L debacle.
you look back on this expensive fiasco, you see that the work of
respected professional economists was frequently called upon to support
the fraudulent activities. One of the ways Greenspan tried to advance
Keating’s effort to have the courts strike down the direct investment
rule was to use a study conducted by a less famous economist, George
Benston, who showed that S&Ls that violated the direct investment
rule earned higher profits than those who didn’t. So he recommended the
rule be dropped. Small problem: In less than two years all 33 of the companies Benston studied had failed
. Most were accounting control frauds in which executives cooked the books to show fictional profits.
had a talent for obtaining endorsements from prominent economists. He
got Daniel Fischel to conduct a study that purported to show that
Lincoln Savings was the best S&L in America. Fischel invoked the
efficient market hypothesis to opine that our examiners provided no
useful information because the markets had already perfectly taken into
account any information to which we had access. In reality, of course,
this was nonsense, and Lincoln Savings was the worst S&L in the
Economists who pander to plutocrats have a great
advantage over scholars in other fields: There is no reputational
penalty among your peers for being dead wrong. Benston got an endowed
chair at Emory, Fischel was made dean of the Univerisity of Chicago’s
Law School, and Greenspan was made Chairman of the Fed. Those who got
control fraud right and fought the elite scams and their powerful
political patrons – people like Edwin Gray, head of the FHLBB, and Joe
Selby, head of supervision in Texas – saw their careers ended.
Consider what that perverse pattern indicates about how badly ethics have fallen in the both economics and government.
How to create a regulatory black hole
Greenspan was Ayn Rand’s protégé, but he moved radically to the wacky
side of Rand on the issue of financial fraud. And that, friends, is
pretty wacky. Greenspan pushed the idea that preventing fraud was not a
legitimate basis for regulation, and said so in a famous encounter
with Commodities Futures Trading Commission (CFTC) Chair Brooksley
Born. “I don’t think there is any need for a law against fraud,” Born
recalls Greenspan telling her. Greenspan actually believed the market
would sort itself out if any fraud occurred. Born knew she had a
powerful foe on any regulation.
She was right. Greenspan, with the
rabid support of the Rubin wing of the Clinton administration, along
with Republican Chairman of the Senate Banking Committee Phil Gramm,
crushed Born’s effort to regulate credit default swaps (CDS). The
plutocrats and their political allies deliberately created what’s known
as a regulatory black hole – a place where elite criminals could commit
their crimes under the cover of perpetual night.
another Fed economist, Patrick Parkinson, to testify on behalf of the
bill to create the regulatory black hole for these dangerous financial
instruments. Parkinson offered the old line that efficient markets
easily excluded fraud -- otherwise, they wouldn’t be efficient markets!
(Parkinson would later tell the Financial Crisis Inquiry Commission in
2011 that the “whole concept” of a related financial instrument known as
an “ABS CDO” had been an “abomination”). Greenspan’s successor richly
rewarded Parkinson for being stunningly wrong in his belief: Ben
Bernanke appointed Parkinson -- who had no experience as a supervisor or
examiner -- as the Fed’s head of supervision.
former chief accountant of the SEC, told me of Greenspan’s infamous
question to his group of senior officials who met at the Fed in late
1998 or early 1999 (roughly the same time as Greenspan’s conversation
with Born): "Why does it matter if the banks are allowed to fudge their
numbers a little bit?" What’s wrong with a “little bit” of fraud?
often support the “broken windows” theory of criminal activity, which
asserts that you stop serious blue-collar crime by cracking down on
minor offenses. Yet mysteriously, they never apply the concept to
white-collar financial crimes by elites. The little-bit-of fraud-is-ok
concept got made into law in the Commodities Futures Modernization Act
of 2000, which created the regulatory black hole for credit default
swaps. That black hole was compounded by the Commodity Futures Trading
Commission under the leadership of Wendy Gramm, spouse of Senator Phil
Enron’s fraudulent leaders were delighted to exploit that
black hole, because they were engaged in a massive control fraud. They
appointed Wendy Gramm to their board of directors and proceeded to use
derivatives to manipulate prices and aid their cartel in driving
electricity prices far higher on the Pacific Coast. In a bizarre irony,
the massive increase in prices led to the defeat of California Governor
Gray Davis (the leading opponent of the cartel) and his replacement by
Governor Schwarzenegger – a man who was part of the group that met
secretly with Enron’s leadership to try to defeat Davis’s efforts to get
the federal regulators to kill the cartel.
How damaging was
Greenspan’s dogmatic and delusional defense of elite financial frauds in
the case of Enron? If you look closely, you can see that Enron brought
together all the critical elements of a financial crisis: big-time
accounting control fraud, derivatives, cartels, and the use of
off-balance sheet scams to inflate income and hide real losses and
leverage. On top of all that, many of the world’s largest banks aided
Enron and its extremely creative CFO Andrew Fastow to create frauds. The
Fed could have responded by adopting and enforcing mandates to end the
criminal practices that were driving the epidemic, but it didn’t.
Instead, Greenspan and other Fed economists championed Enron’s
leadership and cited the company as proof that regulation was
unnecessary to prevent control fraud. They were so extreme that they
attacked their own senior supervisors for daring to criticize the banks’
role in aiding and abetting Enron’s activities.
Later, when risky
derivatives activities and control frauds at large financial
institutions were pushing us toward the catastrophic crash of 2007-2008,
the Fed took no meaningful action based on the lessons learned from
Enron. Greenspan and the senior leadership of the Fed had learned
absolutely nothing, which shows how disabling economic dogma is to
regulators – making them worse than simply useless. They become harmful,
again attacking their supervisors for criticizing the banks’ fraudulent
“liar’s” loans. When Bernanke placed Patrick Parkinson (an economist
blind to fraud by elite banksters) in a supervisory role at the Fed, he
sealed the fate of millions of Americans whose financial well-being
would be sucked right into that regulatory black hole – and removed the
ability of the accursed supervisors to criticize the largest banks.
How to protect predatory lenders
we come to the mortgage meltdown of 2008, when the entire housing
industry went into freefall. Central to this crisis is the story of the
liar's loan -- mortgage-industry slang for a mortgage that a lender
gives without checking tax returns, employment history, or anything else
that might reliably indicate that the borrower can make the payments.
Fed, and only the Fed, had authority under the Home Ownership and
Equity Protection Act (HOEPA) to ban liar’s loans by all lenders. At a
series of hearings mandated by Congress, dozens of witnesses
representing home mortgage borrowers and state and local criminal
investigators urged the Fed to do this. The testimony included a study
that found a 90 percent incidence of fraud in liar’s loans.
What did Greenspan and Bernanke do? Exactly nothing. They consistently refused to act.
went so far as to refuse pleas to send Fed examiners into bank holding
company affiliates to find the facts and collect data on liar’s loans.
Simultaneously, the Fed’s economists dismissed the warnings from
progressives about fraudulent liar’s loans as “merely anecdotal.” In
2005, the desperate Fed regulators, blocked by Greenspan from sending in
the examiners to get data from the banks, resorted to simply sending a
letter to the largest banks requesting information. The Fed supervisor
who received the banks’ response to that letter termed the data “very
If you suspect that the banks would typically respond
to such requests by understating their problem assets significantly,
then you have the right instincts to be a financial regulator.
2003, loan quality was so bad that it could only be explained as the
inevitable product of endemic accounting control fraud and it continued
to collapse through 2007 until the bubble burst. By 2006, over two
million fraudulent liar’s loans were originated annually. We know that
it was overwhelmingly lenders and their agents who put the lies in
liar’s loans. Liar’s loans make the perfect “natural experiment” because
no governmental entity ever required a lender or a purchaser (and that
includes Fannie and Freddie) to make or purchase a liar’s loan. Banks
made, and purchased, trillions of dollars in liar’s loans because doing
so lined the pockets of their controlling officers.
leadership, dominated by economists devoted to false theory, was enraged
when the Fed’s supervisors presented evidence of endemic control fraud
by the most elite lenders, particularly in the making of fraudulent
liar’s loans. How dare the supervisors criticize our most reputable bank
CEOs by showing that they were making hundreds of thousands through
Bernanke finally acted under Congressional pressure on July
14, 2008 to ban liar’s loans. He cited evidence of endemic fraud
available since early 2006 – evidence which would have been available
way back in 2001 had Greenspan moved to require examiners to study
liar’s loans. Even in the face of overwhelming evicence, Bernanke
delayed the ban for 18 months -- one would not wish to inconvenience a
fraudulent lender, after all.
We did not have to suffer this
crisis. Economists who were not blinded by neoclassical theory, like
George Akerlof (who won the Nobel Prize in 2001) and Christina Romer
(adviser to President Obama from 2008-2010), had warned their colleagues
about accounting control fraud and liar’s loans, as did criminologists
and regulators like me. But Greenspan (and Timothy Geithner) refused to
see the obvious truth.
Alan Greenspan had no excuse for assuming
fraud out of existence, and his exceptionally immoral position on fraud
and regulation proved catastrophic to America and much of the world. We
cannot afford the price, measured in many trillions of dollars, over 10
million jobs, and endless suffering, of unethical economists.
William Black is the author of The Best Way to Rob a Bank Is to Own One
and an associate professor of economics and law at the University of
Missouri-Kansas City. He spent years working on regulatory policy and
fraud prevention as executive director of the Institute for Fraud
Prevention, litigation director of the Federal Home Loan Bank Board and
deputy director of the National Commission on Financial Institution
Reform, Recovery and Enforcement, among other positions.
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