Banks Weren’t Meant to Be Like This. What Will their Future Be – and What is the Government’s Proper Financial Role?

By Michael Hudson
This article first appeared at FAZ

The inherently symbiotic relationship between banks and governments recently has been reversed. In medieval times, wealthy bankers lent to kings and princes as their major customers. But now it is the banks that are needy, relying on governments for funding – capped by the post-2008 bailouts to save them from going bankrupt from their bad private-sector loans and gambles.


Yet the banks now browbeat governments – not by having ready cash but by threatening to go bust and drag the economy down with them if they are not given control of public tax policy, spending and planning. The process has gone furthest in the United States. Joseph Stiglitz characterizes the Obama administration’s vast transfer of money and pubic debt to the banks as a “privatizing of gains and the socializing of losses. It is a ‘partnership’ in which one partner robs the other.”[1] Prof. Bill Black describes banks as becoming criminogenic and innovating “control fraud.”[2] High finance has corrupted regulatory agencies, falsified account-keeping by “mark to model” trickery, and financed the campaigns of its supporters to disable public oversight. The effect is to leave banks in control of how the economy’s allocates its credit and resources.


If there is any silver lining to today’s debt crisis, it is that the present situation and trends cannot continue. So this is not only an opportunity to restructure banking; we have little choice. The urgent issue is who will control the economy: governments, or the financial sector and monopolies with which it has made an alliance.


Fortunately, it is not necessary to re-invent the wheel. Already a century ago the outlines of a productive industrial banking system were well understood. But recent bank lobbying has been remarkably successful in distracting attention away from classical analyses of how to shape the financial and tax system to best promote economic growth – by public checks on bank privileges.


How banks broke the social compact, promoting their own special interests

People used to know what banks did. Bankers took deposits and lent them out, paying short-term depositors less than they charged for risky or less liquid loans. The risk was borne by bankers, not depositors or the government. But today, bank loans are made increasingly to speculators in recklessly large amounts for quick in-and-out trading. Financial crashes have become deeper and affect a wider swath of the population as debt pyramiding has soared and credit quality plunged into the toxic category of “liars’ loans.”

The first step toward today’s mutual interdependence between high finance and government was for central banks to act as lenders of last resort to mitigate the liquidity crises that periodically resulted from the banks’ privilege of credit creation. In due course governments also provided public deposit insurance, recognizing the need to mobilize and recycle savings into capital investment as the Industrial Revolution gained momentum. In exchange for this support, they regulated banks as public utilities.

Over time, banks have sought to disable this regulatory oversight, even to the point of decriminalizing fraud. Sponsoring an ideological attack on government, they accuse public bureaucracies of “distorting” free markets (by which they mean markets free for predatory behavior). The financial sector is now making its move to concentrate planning in its own hands.

The problem is that the financial time frame is notoriously short-term and often self-destructive. And inasmuch as the banking system’s product is debt, its business plan tends to be extractive and predatory, leaving economies high-cost. This is why checks and balances are needed, along with regulatory oversight to ensure fair dealing. Dismantling public attempts to steer banking to promote economic growth (rather than merely to make bankers rich) has permitted banks to turn into something nobody anticipated. Their major customers are other financial institutions, insurance and real estate – the FIRE sector, not industrial firms. Debt leveraging by real estate and monopolies, arbitrage speculators, hedge funds and corporate raiders inflates asset prices on credit. The effect of creating “balance sheet wealth” in this way is to load down the “real” production-and-consumption economy with debt and related rentier charges, adding more to the cost of living and doing business than rising productivity reduces production costs.

Since 2008, public bailouts have taken bad loans off the banks’ balance sheet at enormous taxpayer expense – some $13 trillion in the United States, and proportionally higher in Ireland and other economies now being subjected to austerity to pay for “free market” deregulation. Bankers are holding economies hostage, threatening a monetary crash if they do not get more bailouts and nearly free central bank credit, and more mortgage and other loan guarantees for their casino-like game. The resulting “too big to fail” policy means making governments too weak to fight back.

The process that began with central bank support thus has turned into broad government guarantees against bank insolvency. The largest banks have made so many reckless loans that they have become wards of the state. Yet they have become powerful enough to capture lawmakers to act as their facilitators. The popular media and even academic economic theorists have been mobilized to pose as experts in an attempt to convince the public that financial policy is best left to technocrats – of the banks’ own choosing, as if there is no alternative policy but for governments to subsidize a financial free lunch and crown bankers as society’s rulers.

The Bubble Economy and its austerity aftermath could not have occurred without the banking sector’s success in weakening public regulation, capturing national treasuries and even disabling law enforcement. Must governments surrender to this power grab? If not, who should bear the losses run up by a financial system that has become dysfunctional? If taxpayers have to pay, their economy will become high-cost and uncompetitive – and a financial oligarchy will rule.


The present debt quandary

The endgame in times past was to write down bad debts. That meant losses for banks and investors. But today’s debt overhead is being kept in place – shifting bad loans off bank balance sheets to become public debts owed by taxpayers to save banks and their creditors from loss. Governments have given banks newly minted bonds or central bank credit in exchange for junk mortgages and bad gambles – without re-structuring the financial system to create a more stable, less debt-ridden economy. The pretense is that these bailouts will enable banks to lend enough to revive the economy by enough to pay its debts.

Seeing the handwriting on the wall, bankers are taking as much bailout money as they can get, and running, using the money to buy as much tangible property and ownership rights as they can while their lobbyists keep the public subsidy faucet running.

The pretense is that debt-strapped economies can resume business-as-usual growth by borrowing their way out of debt. But a quarter of U.S. real estate already is in negative equity – worth less than the mortgages attached to it – and the property market is still shrinking, so banks are not lending except with public Federal Housing Administration guarantees to cover whatever losses they may suffer. In any event, it already is mathematically impossible to carry today’s debt overhead without imposing austerity, debt deflation and depression.

This is not how banking was supposed to evolve. If governments are to underwrite bank loans, they may as well be doing the lending in the first place – and receiving the gains. Indeed, since 2008 the over-indebted economy’s crash led governments to become the major shareholders of the largest and most troubled banks – Citibank in the United States, Anglo-Irish Bank in Ireland, and Britain’s Royal Bank of Scotland. Yet rather than taking this opportunity to run these banks as public utilities and lower their charges for credit-card services – or most important of all, to stop their lending to speculators and gamblers – governments left these banks operating as part of the “casino capitalism” that has become their business plan.

There is no natural reason for matters to be like this. Relations between banks and government used to be the reverse. In 1307, France’s Philip IV (“The Fair”) set the tone by seizing the Knights Templars’ wealth, arresting them and putting many to death – not on financial charges, but on the accusation of devil-worshipping and satanic sexual practices. In 1344 the Peruzzi bank went broke, followed by the Bardi by making unsecured loans to Edward III of England and other monarchs who died or defaulted. Many subsequent banks had to suffer losses on loans gone bad to real estate or financial speculators.

By contrast, now the U.S., British, Irish and Latvian governments have taken bad bank loans onto their national balance sheets, imposing a heavy burden on taxpayers – while letting bankers cash out with immense wealth. These “cash for trash” swaps have turned the mortgage crisis and general debt collapse into a fiscal problem. Shifting the new public bailout debts onto the non-financial economy threaten to increase the cost of living and doing business. This is the result of the economy’s failure to distinguish productive from unproductive loans and debts. It helps explain why nations now are facing financial austerity and debt peonage instead of the leisure economy promised so eagerly by technological optimists a century ago.

So we are brought back to the question of what the proper role of banks should be. This issue was discussed exhaustively prior to World War I. It is even more urgent today.


How classical economists hoped to modernize banks as agents of industrial capitalism

Britain was the home of the Industrial Revolution, but there was little long-term lending to finance investment in factories or other means of production. British and Dutch merchant banking was to extend short-term credit on the basis of collateral such as real property or sales contracts for merchandise shipped (“receivables”). Buoyed by this trade financing, merchant bankers were successful enough to maintain long-established short-term funding practices. This meant that James Watt and other innovators were obliged to raise investment money from their families and friends rather than from banks.

It was the French and Germans who moved banking into the industrial stage to help their nations catch up. In France, the Saint-Simonians described the need to create an industrial credit system aimed at funding means of production. In effect, the Saint-Simonians proposed to restructure banks along lines akin to a mutual fund. A start was made with the Crédit Mobilier, founded by the Péreire Brothers in 1852. Their aim was to shift the banking and financial system away from debt financing at interest toward equity lending, taking returns in the form of dividends that would rise or decline in keeping with the debtor’s business fortunes. By giving businesses leeway to cut back dividends when sales and profits decline, profit-sharing agreements avoid the problem that interest must be paid willy-nilly. If an interest payment is missed, the debtor may be forced into bankruptcy and creditors can foreclose. It was to avoid this favoritism for creditors regardless of the debtor’s ability to pay that prompted Mohammed to ban interest under Islamic law.

Attracting reformers ranging from socialists to investment bankers, the Saint-Simonians won government backing for their policies under France’s Third Empire. Their approach inspired Marx as well as industrialists in Germany and protectionists in the United States and England. The common denominator of this broad spectrum was recognition that an efficient banking system was needed to finance the industry on which a strong national state and military power depended.


Germany develops an industrial banking system

It was above all in Germany that long-term financing found its expression in the Reichsbank and other large industrial banks as part of the “holy trinity” of banking, industry and government planning under Bismarck’s “state socialism.” German banks made a virtue of necessity. British banks “derived the greater part of their funds from the depositors,” and steered these savings and business deposits into mercantile trade financing. This forced domestic firms to finance most new investment out of their own earnings. By contrast, Germany’s “lack of capital … forced industry to turn to the banks for assistance,” noted the financial historian George Edwards. “A considerable proportion of the funds of the German banks came not from the deposits of customers but from the capital subscribed by the proprietors themselves.[3] As a result, German banks “stressed investment operations and were formed not so much for receiving deposits and granting loans but rather for supplying the investment requirements of industry.”

When the Great War broke out in 1914, Germany’s rapid victories were widely viewed as reflecting the superior efficiency of its financial system. To some observers the war appeared as a struggle between rival forms of financial organization. At issue was not only who would rule Europe, but whether the continent would have laissez faire or a more state-socialist economy.

In 1915, shortly after fighting broke out, the Christian Socialist priest-politician Friedrich Naumann published Mitteleuropa, describing how Germany recognized more than any other nation that industrial technology needed long‑term financing and government support. His book inspired Prof. H. S. Foxwell in England to draw on his arguments in two remarkable essays published in the Economic Journal in September and December 1917: “The Nature of the Industrial Struggle,” and “The Financing of Industry and Trade.” He endorsed Naumann’s contention that “the old individualistic capitalism, of what he calls the English type, is giving way to the new, more impersonal, group form; to the disciplined scientific capitalism he claims as German.”

This was necessarily a group undertaking, with the emerging tripartite integration of industry, banking and government, with finance being “undoubtedly the main cause of the success of modern German enterprise,” Foxwell concluded (p. 514). German bank staffs included industrial experts who were forging industrial policy into a science. And in America, Thorstein Veblen’s The Engineers and the Price System (1921) voiced the new industrial philosophy calling for bankers and government planners to become engineers in shaping credit markets.

Foxwell warned that British steel, automotive, capital equipment and other heavy industry was becoming obsolete largely because its bankers failed to perceive the need to promote equity investment and extend long‑term credit. They based their loan decisions not on the new production and revenue their lending might create, but simply on what collateral they could liquidate in the event of default: inventories of unsold goods, real estate, and money due on bills for goods sold and awaiting payment from customers. And rather than investing in the shares of the companies that their loans supposedly were building up, they paid out most of their earnings as dividends – and urged companies to do the same. This short time horizon forced business to remain liquid rather than having leeway to pursue long‑term strategy.

German banks, by contrast, paid out dividends (and expected such dividends from their clients) at only half the rate of British banks, choosing to retain earnings as capital reserves and invest them largely in the stocks of their industrial clients. Viewing these companies as allies rather than merely as customers from whom to make as large a profit as quickly as possible, German bank officials sat on their boards, and helped expand their business by extending loans to foreign governments on condition that their clients be named the chief suppliers in major public investments. Germany viewed the laws of history as favoring national planning to organize the financing of heavy industry, and gave its bankers a voice in formulating international diplomacy, making them “the principal instrument in the extension of her foreign trade and political power.”

A similar contrast existed in the stock market. British brokers were no more up to the task of financing manufacturing in its early stages than were its banks. The nation had taken an early lead by forming Crown corporations such as the East India Company, the Bank of England and even the South Sea Company. Despite the collapse of the South Sea Bubble in 1720, the run-up of share prices from 1715 to 1720 in these joint-stock monopolies established London’s stock market as a popular investment vehicle, for Dutch and other foreigners as well as for British investors. But the market was dominated by railroads, canals and large public utilities. Industrial firms were not major issuers of stock.

In any case, after earning their commissions on one issue, British stockbrokers were notorious for moving on to the next without much concern for what happened to the investors who had bought the earlier securities. “As soon as he has contrived to get his issue quoted at a premium and his underwriters have unloaded at a profit,” complained Foxwell, “his enterprise ceases. ‘To him,’ as the Times says, ‘a successful flotation is of more importance than a sound venture.’”

Much the same was true in the United States. Its merchant heroes were individualistic traders and political insiders often operating on the edge of the law to gain their fortunes by stock-market manipulation, railroad politicking for land giveaways, and insurance companies, mining and natural resource extraction. America’s wealth-seeking spirit found its epitome in Thomas Edison’s hit-or-miss method of invention, coupled with a high degree of litigiousness to obtain patent and monopoly rights.

In sum, neither British nor American banking or stock markets planned for the future. Their time frame was short, and they preferred rent-extracting projects to industrial innovation. Most banks favored large real estate borrowers, railroads and public utilities whose income streams easily could be forecast. Only after manufacturing companies grew fairly large did they obtain significant bank and stock market credit.

What is remarkable is that this is the tradition of banking and high finance that has emerged victorious throughout the world. The explanation is primarily the military victory of the United States, Britain and their Allies in the Great War and a generation later, in World War II.


The regression toward burdensome unproductive debts after World War I

The development of industrial credit led economists to distinguish between productive and unproductive lending. A productive loan provides borrowers with resources to trade or invest at a profit sufficient to pay back the loan and its interest charge. An unproductive loan must be paid out of income earned elsewhere. Governments must pay war loans out of tax revenues. Consumers must pay loans out of income they earn at a job – or by selling assets. These debt payments divert revenue away from being spent on consumption and investment, so the economy shrinks. This traditionally has led to crises that wipe out debts, above all those that are unproductive.

In the aftermath of World War I the economies of Europe’s victorious and defeated nations alike were dominated by postwar arms and reparations debts. These inter-governmental debts were to pay for weapons (by the Allies when the United States unexpectedly demanded that they pay for the arms they had bought before America’s entry into the war), and for the destruction of property (by the Central Powers), not new means of production. Yet to the extent that they were inter-governmental, these debts were more intractable than debts to private bankers and bondholders. Despite the fact that governments in principle are sovereign and hence can annul debts owed to private creditors, the defeated Central Power governments were in no position to do this.

And among the Allies, Britain led the capitulation to U.S. arms billing, captive to the creditor ideology that “a debt is a debt” and must be paid regardless of what this entails in practice or even whether the debt in fact can be paid. Confronted with America’s demand for payment, the Allies turned to Germany to make them whole. After taking its liquid assets and major natural resources, they insisted that it squeeze out payments by taxing its economy. No attempt was made to calculate just how Germany was to do this – or most important, how it was to convert this domestic revenue (the “budgetary problem”) into hard currency or gold. Despite the fact that banking had focused on international credit and currency transfers since the 12th century, there was a broad denial of what John Maynard Keynes identified as a foreign exchange transfer problem.

Never before had there been an obligation of such enormous magnitude. Nevertheless, all of Germany’s political parties and government agencies sought to devise ways to tax the economy to raise the sums being demanded. Taxes, however, are levied in a nation’s own currency. The only way to pay the Allies was for the Reichsbank to take this fiscal revenue and throw it onto the foreign exchange markets to obtain the sterling and other hard currency to pay. Britain, France and the other recipients then paid this money on their Inter-Ally debts to the United States.

Adam Smith pointed out that no government ever had paid down its public debt. But creditors always have been reluctant to acknowledge that debtors are unable to pay. Ever since David Ricardo’s lobbying for their perspective in Britain’s Bullion debates, creditors have found it their self-interest to promote a doctrinaire blind spot, insisting that debts of any magnitude could be paid. They resist acknowledging a distinction between raising funds domestically (by running a budget surplus) and obtaining the foreign exchange to pay foreign-currency debt. Furthermore, despite the evident fact that austerity cutbacks on consumption and investment can only be extractive, creditor-oriented economists refused to recognize that debts cannot be paid by shrinking the economy.[4] Or that foreign debts and other international payments cannot be paid in domestic currency without lowering the exchange rate.

The more domestic currency Germany sought to convert, the further its exchange rate was driven down against the dollar and other gold-based currencies. This obliged Germans to pay much more for imports. The collapse of the exchange rate was the source of hyperinflation, not an increase in domestic money creation as today’s creditor-sponsored monetarist economists insist. In vain Keynes pointed to the specific structure of Germany’s balance of payments and asked creditors to specify just how many German exports they were willing to take, and to explain how domestic currency could be converted into foreign exchange without collapsing the exchange rate and causing price inflation.

Tragically, Ricardian tunnel vision won Allied government backing. Bertil Ohlin and Jacques Rueff claimed that economies receiving German payments would recycle their inflows to Germany and other debt-paying countries by buying their imports. If income adjustments did not keep exchange rates and prices stable, then Germany’s falling exchange rate would make its exports sufficiently more attractive to enable it to earn the revenue to pay.

This is the logic that the International Monetary Fund followed half a century later in insisting that Third World countries remit foreign earnings and even permit flight capital as well as pay their foreign debts. It is the neoliberal stance now demanding austerity for Greece, Ireland, Italy and other Eurozone economies.

Bank lobbyists claim that the European Central Bank will risk spurring domestic wage and price inflation of it does what central banks were founded to do: finance budget deficits. Europe’s financial institutions are given a monopoly right to perform this electronic task – and to receive interest for what a real central bank could create on its own computer keyboard.

But why it is less inflationary for commercial banks to finance budget deficits than for central banks to do this? The bank lending that has inflated a global financial bubble since the 1980s has left as its legacy a debt overhead that can no more be supported today than Germany was able to carry its reparations debt in the 1920s. Would government credit have so recklessly inflated asset prices?


How debt creation has fueled asset-price inflation since the 1980s

Banking in recent decades has not followed the productive lines that early economic futurists expected. As noted above, instead of financing tangible investment to expand production and innovation, most loans are made against collateral, with interest to be paid out of what borrowers can make elsewhere. Despite being unproductive in the classical sense, it was remunerative for debtors from 1980 until 2008 – not by investing the loan proceeds to expand economic activity, but by riding the wave of asset-price inflation. Mortgage credit enabled borrowers to bid up property prices, drawing speculators and new customers into the market in the expectation that prices would continue to rise. But hothouse credit infusions meant additional debt service, which ended up shrinking the market for goods and services.

Under normal conditions the effect would have been for rents to decline, with property prices following suit, leading to mortgage defaults. But banks postponed the collapse into negative equity by lowering their lending standards, providing enough new credit to keep on inflating prices. This averted a collapse of their speculative mortgage and stock market lending. It was inflationary – but it was inflating asset prices, not commodity prices or wages. Two decades of asset price inflation enabled speculators, homeowners and commercial investors to borrow the interest falling due and still make a capital gain.

This hope for a price gain made winning bidders willing to pay lenders all the current income – making banks the ultimate and major rentier income recipients. The process of inflating asset prices by easing credit terms and lowering the interest rate was self-feeding. But it also was self-terminating, because raising the multiple by which a given real estate rent or business income can be “capitalized” into bank loans increased the economy’s debt overhead.

Securities markets became part of this problem. Rising stock and bond prices made pension funds pay more to purchase a retirement income – so “pension fund capitalism” was coming undone. So was the industrial economy itself. Instead of raising new equity financing for companies, the stock market became a vehicle for corporate buyouts. Raiders borrowed to buy out stockholders, loading down companies with debt. The most successful looters left them bankrupt shells. And when creditors turned their economic gains from this process into political power to shift the tax burden onto wage earners and industry, this raised the cost of living and doing business – by more than technology was able to lower prices.


The EU rejects central bank money creation, leaving deficit financing to the banks

So the plan has backfired. When “hard money” policy makers limited central bank power, they assumed that public debts would be risk-free. Obliging budget deficits to be financed by private creditors seemed to offer a bonanza: being able to collect interest for creating electronic credit that governments can create themselves. But now, European governments need credit to balance their budget or face default. So banks now want a central bank to create the money to bail them out for the bad loans they have made.

For starters, the ECB’s €489 billion in three-year loans at 1% interest gives banks a free lunch arbitrage opportunity (the “carry trade”) to buy Greek and Spanish bonds yielding a higher rate. The policy of buying government bonds in the open market – after banks first have bought them at a lower issue price – gives the banks a quick and easy trading gain.

How are these giveaways less inflationary than for central banks to directly finance budget deficits and roll over government debts? Is the aim of giving banks easy gains simply to provide them with resources to resume the Bubble Economy lending that led to today’s debt overhead in the first place?


Conclusion

Governments can create new credit electronically on their own computer keyboards as easily as commercial banks can. And unlike banks, their spending is expected to serve a broad social purpose, to be determined democratically. When commercial banks gain policy control over governments and central banks, they tend to support their own remunerative policy of creating asset-inflationary credit – leaving the clean-up costs to be solved by a post-bubble austerity. This makes the debt overhead even harder to pay – indeed, impossible.

So we are brought back to the policy issue of how public money creation to finance budget deficits differs from issuing government bonds for banks to buy. Is not the latter option a convoluted way to finance such deficits – at a needless interest charge? When governments monetize their budget deficits, they do not have to pay bondholders.

I have heard bankers argue that governments need an honest broker to decide whether a loan or public spending policy is responsible. To date their advice has not promoted productive credit. Yet they now are attempting to compensate for the financial crisis by telling debtor governments to sell off property in their public domain. This “solution” relies on the myth that privatization is more efficient and will lower the cost of basic infrastructure services. Yet it involves paying interest to the buyers of rent-extraction rights, higher executive salaries, stock options and other financial fees.

Most cost savings are achieved by shifting to non-unionized labor, and typically end up being paid to the privatizers, their bankers and bondholders, not passed on to the public. And bankers back price deregulation, enabling privatizers to raise access charges. This makes the economy higher cost and hence less competitive – just the opposite of what is promised.

Banking has moved so far away from funding industrial growth and economic development that it now benefits primarily at the economy’s expense in a predator and extractive way, not by making productive loans. This is now the great problem confronting our time. Banks now lend mainly to other financial institutions, hedge funds, corporate raiders, insurance companies and real estate, and engage in their own speculation in foreign currency, interest-rate arbitrage, and computer-driven trading programs. Industrial firms bypass the banking system by financing new capital investment out of their own retained earnings, and meet their liquidity needs by issuing their own commercial paper directly. Yet to keep the bank casino winning, global bankers now want governments not only to bail them out but to enable them to renew their failed business plan – and to keep the present debts in place so that creditors will not have to take a loss.

This wish means that society should lose, and even suffer depression. We are dealing here not only with greed, but with outright antisocial behavior and hostility.

Europe thus has reached a critical point in having to decide whose interest to put first: that of banks, or the “real” economy. History provides a wealth of examples illustrating the dangers of capitulating to bankers, and also for how to restructure banking along more productive lines. The underlying questions are clear enough:
Have banks outlived their historical role, or can they be restructured to finance productive capital investment rather than simply inflate asset prices?
Would a public option provide less costly and better directed credit?
Why not promote economic recovery by writing down debts to reflect the ability to pay, rather than relinquishing more wealth to an increasingly aggressive creditor class?



Solving the Eurozone’s financial problem can be made much easier by the tax reforms that classical economists advocated to complement their financial reforms. To free consumers and employers from taxation, they proposed to levy the burden on the “unearned increment” of land and natural resource rent, monopoly rent and financial privilege. The guiding principle was that property rights in the earth, monopolies and other ownership privileges have no direct cost of production, and hence can be taxed without reducing their supply or raising their price, which is set in the market. Removing the tax deductibility for interest is the other key reform that is needed.

A rent tax holds down housing prices and those of basic infrastructure services, whose untaxed revenue tends to be capitalized into bank loans and paid out in the form of interest charges. Additionally, land and natural resource rents – along with interest – are the easiest to tax, because they are highly visible and their value is easy to assess.

Pressure to narrow existing budget deficits offers a timely opportunity to rationalize the tax systems of Greece and other PIIGS countries in which the wealthy avoid paying their fair share of taxes. The political problem blocking this classical fiscal policy is that it “interferes” with the rent-extracting free lunches that banks seek to lend against. So they act as lobbyists for untaxing real estate and monopolies (and themselves as well). Despite the financial sector’s desire to see governments remain sufficiently solvent to pay bondholders, it has subsidized an enormous public relations apparatus and academic junk economics to oppose the tax policies that can close the fiscal gap in the fairest way.


It is too early to forecast whether banks or governments will emerge victorious from today’s crisis. As economies polarize between debtors and creditors, planning is shifting out of public hands into those of bankers. The easiest way for them to keep this power is to block a true central bank or strong public sector from interfering with their monopoly of credit creation. The counter is for central banks and governments to act as they were intended to, by providing a public option for credit creation.




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[1] Joseph E. Stiglitz, “Obama’s Ersatz Capitalism,” The New York Times, April 1, 2009
http://www.nytimes.com/2009/04/01/opinion/01stiglitz.html.
[2] http://neweconomicperspectives.blogspot.com, and The Best Way to Rob a Bank is to Own One (2005).
[3] George W. Edwards, The Evolution of Finance Capitalism (New York: 1938):68.
[4] I review the literature from the 1920s, its Ricardian pedigree and subsequent revival by the IMF and other creditor institutions in Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy (1992; new ed. ISLET 2010). I provide the political background in Super Imperialism: The Economic Strategy of American Empire (New York: Holt, Rinehart and Winston, 1972; 2nd ed., London: Pluto Press, 2002),

Tuesday, January 31, 2012Holder & Obama’s Propaganda is “Belied by a Troublesome Little Thing Called Facts”

Bill 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.


The Obama administration’s record of prosecuting elite financial frauds is worse than the Bush administration’s record, which is a very large statement. Syracuse University’s TRAC issued a report on November 11, 2011 entitled “Criminal Prosecutions for Financial Institution Fraud Continue to Fall.”

Neither administration has prosecuted any elite CEO for the epidemic of mortgage fraud that drove the ongoing crisis. This contrasts with over 1,000 elite felony convictions arising from the S&L debacle. The ongoing crisis caused losses more than 70 times greater than the S&L debacle and the amount of elite fraud driving this crisis is also vastly greater than during the S&L debacle. Bank CEOs leading “accounting control frauds” now do so with impunity from the criminal laws. They become wealthy through fraud and even if they are sued civilly they almost invariably walk away wealthy with the proceeds of their frauds.


The Obama Administration Prefers Politics and Propaganda to Prosecutions

Elite financial institutions officers engaged in fraud face a dramatically reduced risk of prosecution compared to 20 years ago when financial fraud was far less common. TRAC reports that the number of financial institution fraud prosecutions under Obama is less than one-half the number 20 years ago. Bush (II) was slightly better than Obama in prosecuting non-elite financial institution frauds, but both were pathetically bad.

The New York Times reported on January 23, 2012 that the administration rushed to try to reach a settlement with the five largest banks that engaged in massive foreclosure fraud so that it could take credit for it in the State of the Union (SOTU) address. The headline for the article was “Political Push Moves a Deal on Mortgages Inches Closer.” The administration did not deny the statements made in the article.

“But a final agreement remained out of reach Monday despite political pressure from the White House, which had been trying to have a deal in hand that President Obama could highlight in his State of the Union address Tuesday night.

The housing secretary, Shaun Donovan, met on Monday in Chicago with Democratic attorneys general to iron out the remaining details and to persuade holdouts to agree with any eventual deal. He later held a conference call with Republican attorneys general. But as he renewed his efforts, Democrats in Congress, advocacy groups like MoveOn.org and several crucial attorneys general said the deal might be too lenient on the banks.

In a bid to win support from California officials, Mr. Donovan proposed earmarking $8 billion in aid for beleaguered California homeowners, but that left other state attorneys general incensed, according to an official familiar with the negotiations.”

The NYT did not make the point, but these facts represent multiple disgraces on the administration’s part that go beyond the substance of deal. First, there is the obvious impropriety of pressuring state attorney generals (AGs) who are Democrats to approve a deal so that the President can claim credit for it in the SOTU. Second, it is disgraceful that HUD Secretary Donovan met separately with Democratic AGs. Prosecutions and suits against banks must have nothing to do with political affiliation. Holding separate meetings with AGs based on their party affiliation brings the entire system into disrepute. Third, the idea of offering California a unique earmark in order to buy AG Harris’ support for a deal is as stupid as it was offensive. The administration thinks that everything is about politics. As a former Department of Justice attorney I regret the administration’s bringing the department into disgrace. I can personally assure the nation that nothing like this ever occurred during the S&L debacle in our prosecutions, civil lawsuits, and agency enforcement actions.
Here is what Obama said in his SOTU address:

“One of my proudest possessions is the flag that the SEAL Team took with them on the mission to get bin Laden. On it are each of their names. Some may be Democrats. Some may be Republicans. But that doesn’t matter. Just like it didn’t matter that day in the Situation Room, when I sat next to Bob Gates – a man who was George Bush’s defense secretary; and Hillary Clinton, a woman who ran against me for president.

All that mattered that day was the mission. No one thought about politics. No one thought about themselves.”

The President was, of course, correct. The same logic applies to everything that government attorneys do. No one should think about politics or themselves. Political party “doesn’t matter.” Party, politics, and the pursuit of financial contributions not only matter, but are controlling for the administration in their non-pursuit of the fraudulent elite CEOs that drove the ongoing crisis.

The fact that a NYT story could reveal this outrage without the authors even mentioning the impropriety of the actions described, without the administration feeling any need to respond to the impropriety, and without any scandal demonstrates how badly we have fallen as a society. While the President was reviewing drafts of a major address to the nation that emphasized that politics should never have a role in government service two of his cabinet officers, Attorney General Holder and HUD Secretary Donovan, were devising a partisan lobbying strategy aimed at getting the state AGs to approve a disgraceful surrender to five of the nation’s largest banks. He either did not notice the contradiction or did not feel any need to end the impropriety. Have we lost our capacity for outrage?

The failure of the article to generate a scandal reflects badly on both parties. The candidates for the Republican Party’s nomination have been searching for every conceivable issue as a potential basis for attacking Obama. The administration’s conduct as described by the NYT article provides the perfect club to the Republican candidates, yet none of them will use it. Why? The Republican candidates could not oppose a settlement that, substantively, was so exceptionally favorable to the largest banks. Finance is the largest contributor to both parties. The only criticism in the article came from liberal Democrats (Senator Brown and Representative Miller).

The administration recognized that the only threat to the disgraceful settlement came from liberal Democrats. The administration devised a sophisticated propaganda campaign to counter this opposition. It bore fruit immediately. The day after the NYT story ran, the Center for Responsible Lending (CRL) issued a press release entitled “AGSettlement: Not Perfect, but Significant Reform of Mortgage Servicing.”

The press release was based on a friendly leak, presumably from the administration, of the terms of the settlement as of January 24, 2012. The settlement had two express, related substantive defects. The amount of money the banks would pay was grossly inadequate, relative to the claims being released by the federal and state governments. The third substantive defect is not contained in the written release, but it is one of the keys to the governmental surrender to the fraudulent financial CEOs who caused the crisis. The federal government does not intend to prosecute criminally the large financial firms and their senior officers who committed hundreds of billions of dollars in fraudulent mortgage originations. That figure only counts the fraudulent liar’s loans the five large banks made. The total amount of mortgage origination fraud through liar’s loans exceeds $1 trillion. The five banks’ civil liability for mortgage origination fraud is vastly larger than their civil liability for their endemic foreclosure fraud. I have explained in detail in prior articles and testimony why only fraudulent banks made material amounts of liar’s loans.

Here is how the administration successfully spun the deal to CRL.

“Banks remain accountable. While the state AGs would not be able to bring additional origination or servicing claims against the participating banks, the settlement would preserve the ability of homeowners to pursue claims against banks. Moreover, the settlement would not shield banks from prosecution related to criminal activities, claims based on mortgage securities violations, fair lending suits, or claims against MERS. Finally, the settlement would be enforceable in court by an independent monitor.”

As of January 24, the deal the administration was desperate to conclude prior to the SOTU required the state and federal governments to release civil claims for mortgage origination fraud.

The administration’s efforts to pressure the state AGs (all Democrats) to withdraw their opposition to this cynical deal to immunize expressly the largest banks from civil liability for their mortgage origination fraud and, implicitly, to immunize them from criminal liability for mortgage origination fraud failed. The administration responded to the failure through an elaborate symbolic creation of a new task force and a renewed propaganda campaign designed to neutralize liberal opposition to its proposed surrender to the largest banks. The maneuver, however, required an important substantive change in the proposed deal that reveals how bad for the public the administration’s proposed deal of January 24 was.

The administration is good at spinning, and this effort had a clever twist and a substantive change that added to its credibility. To date, the spin has been largely successful with liberal commentators. The clever twist was adding the AG leading the opposition to the surrender, NY AG Eric Schneiderman, to the newly created working group. Schneiderman has great credibility with liberals because he blocked the administration’s proposed grants of immunity to the five large banks (which were apparently far broader and included express terms raising crippling barriers even to criminal prosecutions). The administration needed Schneiderman on the task force to grant it any credibility. The need for credibility became even more intense after Scot Paltrow’s January 20 expose in Reuters (Insight: Top Justice officials connected to mortgage banks). The article revealed that U.S. Attorney General Holder and Lanny Breuer, head of DOJ’s criminal division, had been partners at the law firm Covington & Burling, which represented many of the largest banks and had provided key legal opinions to the infamous MERS (Mortgage Electronic Registration System) that has contributed greatly to foreclosure fraud.

Schneiderman apparently recognized the great leverage he had over the administration and insisted on the modification of the deal’s release of the big banks’ civil liability for their mortgage origination fraud. The administration used Schneiderman’s willingness to serve on the new task force and the reduced grant of immunity for the big banks’ mortgage origination fraud as the centerpiece of its effort to spin liberals. It promptly leaked a description of the new proposed deal terms to several liberals – and was immediately rewarded with praise from liberals. Given the fact that Holder and Breuer have no credibility with liberals, this was an exceptional achievement that has delighted the administration. Mike Lux, who has consistently and strongly opposed the administration’s earlier proposed settlement drafts, broke the story of the substantive improvements to the deal on January 27. His story explains that two sources he trusts leaked the terms of the new deal to him. He entitled his article “Settlement Release Looks Tight.” I encourage reading Lux’s entire article, but here is the key excerpt.

“Big breaking news about the long-fought over bank settlement: senior sources high up in the negotiations have outlined the terms of the legal release. Here's what I was told:

***
No release on the "vast majority" of origination claims.
No release on the "vast majority" of securitization claims, including all claims of state pension funds.

***
According to these (two) sources, the release is almost entirely confined to robosigning cases.

Now, I haven't seen the actual language, so I can't verify all this, and I don't know what the phrase "vast majority" means. I also don't know if every player in the negotiations is 100 percent signed off on it. But I have a lot of trust in my sources that this real and that they wouldn't be trying to BS me on how narrow this is. If the language is indeed as tight as my sources are telling me, this is very big news.

All along in this battle, there have been two things progressives working on this issue have been fighting hardest for: one was that we got a broad, deep, well-resourced, and serious investigation of the big financial fraud issues that have gone down in this country over the last decade; the other was that if there was a settlement, that the legal releases the banks got was drawn as narrowly as it could be drawn, as tight as a drum. That combination, in the view of New York Attorney General Eric Schneiderman and those of us fighting by his side, would create real potential of finally holding the Wall Street bankers who wrecked our economy and abused us all accountable for their actions, and for getting a serious amount of money for writing down underwater mortgages. While there are still legitimate questions in both areas, it is looking like we may be achieving both of these huge goals.

One other big question remains in all this: with a release this narrow, will the big banks actually settle? JP Morgan Chase CEO Jamie Dimon and unnamed bank lobbyists are already threatening to walk away, and are clearly really unhappy, so that isn't clear. If they walk away, though, progressives can certainly live very well knowing that they will be prosecuted aggressively by AGs like Schneiderman, Beau Biden of Delaware, Kamala Harris of California, and hopefully others, so it's a win-win for us. My view is: anything that makes Jamie Dimon and big-bank lobbyists unhappy is good for the rest of us.”

Lux obviously recognizes that there are important outstanding questions about the proposed deal. I write to add several cautions.

1. There is no reason for granting any civil immunity on mortgage origination or securitization frauds and the grant of even limited immunity for such frauds can only create future problems.

2. The state AGs do not have the resources to investigate mortgage origination fraud. It isn’t even close. Collectively, the 50 state AGs could investigate Countrywide’s frauds if they took every investigator with expertise in financial institutions and assigned them to the case for five years.

3. The state AGs are not investigating mortgage origination fraud by major lenders.

4. The new working group will not investigate mortgage origination fraud. Obama described the task force in these words in his SOTU address.

“And tonight, I am asking my Attorney General to create a special unit of federal prosecutors and leading state attorneys general to expand our investigations into the abusive lending and packaging of risky mortgages that led to the housing crisis. This new unit will hold accountable those who broke the law, speed assistance to homeowners, and help turn the page on an era of recklessness that hurt so many Americans.”

The working group will not “investigate … abusive lending” and it will not “hold accountable those who broke the law … [by defrauding] homeowners.” It will not “speed assistance to homeowners.” It will not “turn the page on an era of recklessness” – and fraud, not “recklessness” is what prosecutors should prosecute. The name of the working group makes its crippling limitations clear: the Residential Mortgage-Backed Securities Working Group. Attorney General Holder’s memorandum about the working group makes clear that the name is not misleading. The working group will deal only with mortgage backed securities (MBS) – not the fraudulent mortgage origination that drove the crisis (the only exception is federally insured mortgages).

Fraudulent mortgage originators engaged in fraudulent sales of the mortgages, mostly to Wall Street and, eventually, Fannie and Freddie. As I stressed earlier, the administration is continuing to grant de facto immunity to CEOs at the large lenders whose massive mortgage origination frauds drove the crisis. The working group’s mandate helps confirm the administration’s continued refusal to prosecute elite mortgage origination fraud.

5. The working group is a symbolic political gesture designed to neutralize criticism of the administration’s continuing failure to hold accountable the elite frauds that drove the crisis. Neither the Bush nor the Obama administration has convicted a single elite fraud that drove the crisis. This is a national disgrace and represents the triumph of crony capitalism. Remember that the FBI warned in September 2004 that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial “crisis.” There are no valid excuses for the Bush and Obama administrations’ failures. The media have begun to pummel the Obama administration for its failure to prosecute. The administration could not answer this criticism with substance because it has nothing substantive to offer in prosecuting elite mortgage origination frauds. The ugly truth is that we are three full years into his presidency and Holder could not find a single indictment to bring that Obama could brag about in his SOTU address. Who doubts that Holder and Obama would have done so if they had anything in the prosecutorial pipeline? Why do Holder and Obama have nothing in the pipeline? There are three fundamental problems, and the working group has not even addressed, much less resolved, any of the three fundamental defects.

One, criminal prosecutions of elite financial criminals have to come from investigations initiated by those with the expertise and resources to detect and investigate “accounting control fraud” (the form of fraud that can hyper-inflate financial bubbles and cause catastrophic losses and financial crises). Only the federal banking regulators have this capability. The absolute essential to achieving broad success is superb criminal referrals from those regulators. The central difficulty with such referrals should be that roughly 75% of the fraudulent mortgage loans were made by entities not regulated by the federal (or state) banking regulators. They were primarily made by mortgage bankers. Sadly, that did not prove to be the central difficulty with federal banking regulators’ criminal referrals. The federal banking regulators essentially ceased making criminal referrals last decade.

Banks will not file criminals against their CEOs – the people who run the accounting control frauds that produced the epidemics of mortgage fraud. Police and detectives do not investigate elite accounting control frauds. The FBI does not patrol a beat. Unless the regulatory cops on the beat (e.g., the banking regulators) make the criminal referrals the DOJ and the FBI will never investigate or prosecute the fraud. Indeed, because accounting control fraud is inherently complex and requires specialized knowledge to recognize, the DOJ will rarely recognize accounting control fraud even when the facts are only consistent with accounting control fraud (as opposed to bad luck or optimism). Absent high quality criminal referrals from the banking regulatory agencies, DOJ may have episodic successes but it will fail utterly to prosecute any epidemic of elite accounting control fraud. Criminal referrals provide the road map that allows effective investigations and prosecutions.


Two, DOJ has not provided remotely enough resources to investigate the large accounting control frauds. Three, DOJ has adopted a self-serving definition of mortgage fraud that implicitly defines accounting control fraud out of existence. DOJ has violated the central rule of investigating elite white-collar crime – if you don’t look; you don’t find.

We have forgotten the successes of the past. During the S&L debacle, Congress responded to the S&L crisis, once the presidentially-ordered cover up of the scope of the crisis ended in 1989, by ordering and funding a dramatic increase in DOJ resources dedicated to prosecuting the S&L accounting control frauds that drove the second phase of the debacle. President Bush (II), President Obama, and Congress have each failed to emulate the policies that proved so successful in prosecuting elite frauds that caused prior crises. DOJ and the S&L regulators made the prosecution of the elite frauds a top priority by their deeds as well as their words. Contrast that with Holder’s press release announcing the formation of the working group:

“Over the past three years, we have been aggressively investigating the causes of the financial crisis. And we have learned that much of the conduct that led to the crisis was – as the President has said – unethical, and, in many instances, extremely reckless. We also have learned that behavior that is unethical or reckless may not necessarily be criminal. When we find evidence of criminal wrongdoing, we bring criminal prosecutions. When we don’t, we endeavor to use other tools available to us – such as civil sanctions – to seek justice.”

Holder was even more dismissive of criminality in his memorandum to the financial fraud task force officially informing it of the creation of the working group: “To the extent there was any fraud or misconduct in the RMBS market, we remain committed to discovering it….” This phrase indicates his doubt that there was any fraud – he is saying that they have not “discover[ed]” any fraud. That is a remarkable statement on three grounds. It is a statement made without any credible DOJ investigation. It is a statement contrary to all recent experience with financial crises. Accounting control frauds caused the largest losses in the Enron-era frauds and the S&L debacle. It is also extraordinary because other federal agencies have documented endemic fraud and charged many of the world’s largest financial institutions with intentionally selling loans they knew to be fraudulent through false reps and warranties.

Holder consistently emphasizes the lack of criminality. Indeed, since he has prosecuted no elite CEO involved in causing this crisis, he is actually saying that he believes this is our first Virgin Crisis. Countrywide and its ilk made millions of fraudulent mortgage loans – yet Holder thinks that Countrywide’s CEO was a victim of the fraud.

I have concluded that the entire working group gambit upsets me so much because it rests on such crude propaganda. Holder decided to embellish the gambit with the illusion of concrete action. Reuters reported Holder’s claims at his press conference on the working group.

“The Justice Department issued civil subpoenas to 11 financial institutions as part of a new effort to investigate misconduct in the packaging and sale of home loans to investors, Attorney General Eric Holder said on Friday.

Holder declined to provide specifics, including the names of the firms.

"We are wasting no time in aggressively pursuing any and all leads," Holder said at a news conference announcing details of a new working group to investigate misconduct in the residential mortgage-backed securities (RMBS) market, "you can expect more to follow."”

One assumes that reporters were so stunned by Holder’s audacity that they failed to challenge his claim that “we are wasting no time in aggressively pursuing any and all leads.” Let us review only the most obvious reasons why this statement is preposterous. The subpoenas are civil subpoenas, not grand jury subpoenas. There is no indication that Holder is serious even now about conducting any criminal investigation of elite banks or bankers.

The question is not whether the Working Group wasted a day or two in issuing civil subpoenas. The Obama administration has wasted three years before issuing these subpoenas. (The Bush administration wasted eight years. The total waste is cumulative.) Civil subpoenas are the most preliminary form of investigation. DOJ should have been issuing grand jury subpoenas to every lender making liar’s loans and every entity packaging liar’s loans no later than September 2004 when the FBI warned that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial “crisis.”

The Obama and Bush administrations have consistently failed to “pursu[e] any and all leads.” Let us count the ways DOJ has typically failed to pursue leads against the elite officers whose frauds drove this crisis: they have not used grand juries, they have not issued civil subpoenas, they have not used electronic surveillance, they have not used undercover investigators, they have not “wired” cooperating witnesses who they have “flipped”, they have not appealed for whistleblowers to come forward, they have not called elite witnesses before grand juries, they have not convened grand juries, they have not sent FBI agents to their homes or offices to conduct formal interviews, they have not retained expert witnesses or consultants with expertise in accounting control fraud, they have not demanded that the banking regulatory agencies produce high quality criminal referrals, they have not asked those agencies to “detail” examiners and other skilled staff to the FBI to serve as internal experts, they have not trained AUSAs, special agents, and banking regulators in how to detect, investigate and prosecute accounting control frauds, they have not prosecuted where other federal agencies, after investigation, have charged that financial elites committed fraud, and they have not flipped intermediate officers and gone up the chain of command, they have not assigned remotely adequate staff to investigate and prosecute frauds, they have not assigned any meaningful number of their staff to investigate the elite frauds, and they have not made strong, consistent demands that Congress fund adequate staff to end the ability of financial elites to commit fraud with impunity. Conversely, DOJ has assigned its inadequate staff almost exclusively to non-elite mortgage fraud, has formed a “partnership” with the Mortgage Bankers Association (MBA) – the trade association of the “perps”, and has adopted the MBA’s absurd “definition” of mortgage fraud that implicitly defines accounting control fraud out of existence. How does Holder expect to get “leads” against elite frauds when he gets no criminal referrals from the banking regulatory agencies, “defines” the leading fraud perpetrators of mortgage fraud as the “victim” of mortgage fraud, conducts no credible investigation of elite frauds, takes no proactive steps to investigate (e.g., using undercover FBI investigations), makes no plea for whistleblowers to come forward with evidence on the elite frauds, and provides training for regulators, FBI agents, and AUSAs that implicitly denies the existence of accounting control fraud? I understand that he inherited a disaster and a disgrace from his predecessor, but he has made it worse.

Collectively, the Bush and Obama administration have provided de facto impunity from the criminal laws for our largest financial firms and their elite officers who drove our crisis. DOJ has had episodic successes against financial elites not involved in creating the crisis (e.g., Madoff and a prominent insider trader). These “successes” were bittersweet. Madoff conducted a Ponzi scheme that last for decades. DOJ only learned about the scheme because Madoff confessed to his family. He only confessed because the Ponzi scheme was about to collapse. The government learned of the insider trading through a whistleblower and found key facts through electronic surveillance and “wiring” “flipped” participants in the insider trading. The insider trading fraud went on for many years and likely would have gone on for many more years without the government learning of it but for the whistleblower. Both of these frauds were elite financial control frauds, so it is bizarre that Holder simultaneously takes credit for their successful prosecution while implicitly denying that control fraud could exist in elite financial institutions in the mortgage fraud context.

The Reuters story records Holder’s effort to claim that DOJ is vigorously prosecuting elite corporate frauds.

“[Holder] responded to criticism that federal enforcers have brought few marquee cases in the aftermath of the financial crisis. Holder said the department has brought around 2,100 mortgage-related cases.

"The notion that there has been inactivity over the course of the last three years is belied by a troublesome little thing called facts," Holder said.”

It is Holder whose claims are “belied by a troublesome little thing called facts.” He was responding to the factual critique that he has not indicted or prosecuted any elite banking officers of the large fraudulent lenders that drove the financial crisis. That critique is true. Holder, however, implied that it was an untrue critique by deliberately making a non-responsive response. His answer was that he has indicted 2,100 defendants in mortgage-related cases (roughly 700 annually). By 2006, lenders made roughly two million fraudulent liar’s loans. In 2005, they made over one million fraudulent liar’s loans. Prosecuting roughly 700 (or 7,000) smaller mortgage fraud cases annually is, at best, a symbolic act that cannot possibly have any material effect in slowing an epidemic of mortgage fraud, bringing to justice the elite frauds that caused the ongoing crisis, or deterring future crises. If Holder had led any elite prosecutions of the senior officers of the huge, fraudulent lenders and investment bankers that drove the crisis he would have used them to refute the criticism. Instead, he tried misdirection.

In January 1993, the GAO released a report entitled: Bank and Thrift criminal Fraud” prepared at the request of Senate Judiciary Committee Chairman Biden, who is now Obama’s Vice-President. Here are key excerpts from that report that demonstrate how real investigations and prosecutions occur:

“In 1984, Justice, along with the federal financial regulatory agencies, formed the Interagency Bank Fraud Enforcement Working Group in an effort to facilitate interagency communication and coordination between Justice and each of the regulatory agencies.

[WKB note: the key deregulatory law that created the criminogenic environment that led to the epidemic of accounting control fraud by roughly 300 S&Ls was the Garn-St Germain Act of 1982. By 1984, DOJ and the banking regulatory agencies realized (with the aid of a vigorous kick to their rears from the House of Representatives administered by Chair man Doug Barnard (D. Georgia)) that there was a fraud crisis and had formed the working group to investigate and prosecute bank frauds.]

Renamed the National Bank Fraud Enforcement Working Group, the group included officials from Justice (including the Criminal Division’s Fraud Section, the Attorney General’s Advisory Committee of Attorneys, and FBI), OTS, FDIC, occ, the Fed, NCUA, the Farm Credit Administration, the Secret Service, the Department of the Treasury, and the Securities and Exchange Commission.

[WKB note: Contrast this membership with Holder’s announcement of the members of his working group:

“The mission of the group — to hold accountable those who violated the law and provide relief for homeowners struggling from the collapse of the housing market — will be furthered through the active participation of the following members:

• Executive Office for United States Attorneys
• Federal Bureau of Investigation
• Financial Crimes Enforcement Network
• Internal Revenue Service - Criminal Investigation
• Consumer Financial Protection Bureau
• Federal Housing Finance Agency's Office of Inspector General
• United States Department of Housing and Urban Development
• United States Department of Housing and Urban Developments Office of Inspector General”]

Notice the conspicuous (except that no one I have read mentions it) failure to include any of the banking regulatory agencies – the entities that should have the expertise and should be making the vital criminal referrals. The administration will eventually be forced to add the banking regulatory agencies to the working group to quell criticism. The administration’s failure to name them originally is revealing. Any serious effort would start with the banking regulatory agencies. The more fundamental problem is, that unlike the S&L debacle, when the banking regulatory agencies led the demand for criminal prosecution of the elite frauds, the current crop of regulatory leaders under Bush and Obama have been notoriously silent and have failed to take even the most basic, essential step – reestablishing a superb criminal referral process and vigorous regulatory investigations of the largest frauds. There is no excuse for this continuing failure.]

In 1990, in testimony before the House Committee on the Judiciary, the Assistant Attorney General of the Criminal Division noted that the group had a number of accomplishments. Among other things, he noted that it produced a uniform criminal referral form….

[WKB note: this may seem a small, bureaucratic step if you have never created a system that resulted in the most successful prosecution of elite white-collar criminals. It is in fact the absolute essential place to start. The bank working groups engaged in what we would now call “continuous improvement.” The banking regulators responsible for making criminal referrals got feedback from the FBI on what aspects of our referrals were most useful and what aspects failed to meet the FBI’s needs. Our criminal referral specialists took that knowledge back to our staff and, through training and editing of draft referrals, continuously improved the quality of our referrals.]

The criminal financial institution fraud investigative workload in FBI has continued to grow. As of July 31, 1992, FBI had 9,669 investigations pending, an increase of about 46 percent from 1987. More than half of those investigations were classified as “major” fraud cases….

Table 2.1: [Number of criminal referrals filed by the banking regulatory agencies]
Federal Home Loan Bank Board/OTS [WKB note: the Office of Thrift Supervision (OTS) was the successor agency to the FHLBB.]
1987: 6,100
1988: 5,114
1989: 5,014
1990: 6,393
1991: 7,861

[WKB note: these figures do not include criminal referrals made by OTS after 1991, criminal referrals by the RTC (which resolved failed S&Ls’ bad assets), and criminal referrals by S&Ls placed into receiverships by OTS). Collectively, the federal agencies regulating S&Ls and dealing with S&L failures filed well over 30,000 criminal referrals during the S&L debacle.]

[WKB note: number of criminal referrals filed by OTS in the ongoing crisis: 0.]

Following enactment of FIRREA, the Attorney General designated criminal fraud in financial institutions a top enforcement priority. He announced but did not implement plans to address this “enormous and unprecedented challenge” by establishing task forces in 26 cities around the country modeled after the Dallas Bank Fraud Task Force. The Crime Control Act of 1990 authorized more than a doubling of available Justice resources and focused responsibility for the overall effort in Justice’s new Office of Special Counsel for Financial Institutions Fraud.

[WKB note: the Dallas Bank Fraud Task Force was staffed with nearly 100 FBI and IRS agents and other analytical support staff and 38 attorneys.]

FBI has relied on the cooperation of staff from the regulatory agencies to provide information and expertise needed for investigations.

Between October 1, 1988, and June 30, 1992, Justice charged 3,270 defendants through indictments and informations [in “major cases”] and convicted 2,603 defendants (110 defendants were acquitted, establishing a conviction rate near 96 percent). The courts sentenced 1,706 of 2,205 offenders to jail (77.4 percent).

The major difference between working groups and task forces is that task forces investigate and prosecute cases, while working groups do not.

As of July 31, 1992, FBI had 9,669 financial institution fraud cases pending, an increase of 11.3 percent over the 8,678 pending at the end of fiscal year 1991 and 45.3 percent over the 6,649 pending at the end of fiscal year 1987.

In 1989 and 1990, Congress passed two major pieces of legislation that shaped the government’s approach. The Financial Institutions Reform, Recovery, and Enforcement Act (FIRRRA) of 1989 and the Crime Control Act of 1990 (Crime Control Act) provided Justice with additional powers and resources to investigate and prosecute financial institution fraud.

The House report accompanying FIRREA reflects the belief that Title IX of FIRREA was “absolutely essential to respond to a serious epidemic of financial institution insider abuse and criminal misconduct and to prevent its recurrence in the future.”

Title XXV of the Crime Control Act [was] entitled the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990….

Appropriations following FIRREA and the Crime Control Act nearly tripled the investigative and prosecutive resources that had previously been available to Justice to address the mounting volume of criminal bank and thrift fraud. The Crime Control Act also authorized additional appropriations to support more IRS resources important to fraud investigations. In addition, the act appropriating funds for the Department of the Treasury in fiscal year 1991 also authorized the Secret Service to participate in financial institution fraud investigations.

Appendix III: FBI and U.S. Attorney Resource Allocations Under FIRREA

[Additional staffing resources made available to aid the prosecution of S&L and bank frauds pursuant to the Financial Institution Reform, Recovery and Enforcement Act of 1989]

FBI: Special Agents: 219; Accounting technicians: 100
U.S. Attorney office: AUSAs: 121; Auditors: 22; Support: 120


Appendix IV: FBI and U.S. Attorney Resource Allocations Under the Crime Control Act [of 1990]

FBI: Special Agents: 289

U.S. Attorney Office: AUSAs: 228; Support: 198 [WKB note: this category included paralegals and auditors]

Table 2.4: Increased Justice Authorized Staff Positions
Fiscal years 1990 to 1992 (special agent, attorney, and other support positions)

FBI (total positions): 1621
U.S. Attorneys (total positions): 772
Criminal Division (total positions): 116
Tax Division (total positions): 65
Civil Division (total positions): 46
Total [DOJ] positions 2,620

[WKB note: these figures do not include IRS, Secret Service, Postal Service, and banking regulators working on the S&L and bank fraud task cases.]

[WKB (very long) note: in FY 2007 the FBI had 120 agents assigned to mortgage fraud cases. By FY 2009 that number rose to 300.

http://www.fbi.gov/stats-services/publications/financial-crimes-report-2009

The ongoing crisis caused losses over 70 times greater than the S&L debacle and the number of frauds in this crisis is vastly greater than during the S&L debacle. The best estimate is that there were roughly two million new cases of mortgage fraud in 2006. (The estimate arises from two facts explained at length in my prior work. Roughly one-third of all mortgage loans originated in 2006 were liar’s loans and the incidence of fraud in liar’s loans is roughly 90 percent.) Worse, DOJ formed a “partnership” with the Mortgage Bankers Association (the MBA) – the trade association of the “perps” and adopted the MBA’s contrary-to-fact definition of “mortgage fraud” in which the lender originating the fraudulent mortgages is always the victim of the fraud. Accounting control fraud is, implicitly, defined out of existence. The DOJ repeats this self-serving definition of mortgage fraud repeatedly, without any critical consideration. After the dominant role of accounting control fraud in the second phase of the S&L debacle and the Enron-era frauds we are faced with the conclusive assumption (unsullied by any real investigation or analytics) that the current crisis is the Virgin Crisis. Because they know that the lender is the victim, virtually every FBI agent has been assigned to investigating relatively minor mortgage frauds in which the lender is the purported victim. There has been no meaningful criminal investigation of any of the large fraudulent lenders. Given the pathetically low number of FBI agents assigned to mortgage frauds and their assignment to review staggering numbers of relatively small mortgage fraud cases there were never, remotely, adequate numbers of FBI agents to conduct a real investigation of Countrywide or Washington Mutual (WaMu). Each of these S&Ls made hundreds of thousands of fraudulent mortgage loans. Each of these S&Ls is substantially larger and more complex to investigate than Enron. Each of the S&L originated their hundreds of thousands of fraudulent mortgages by crafting perverse incentives for a vast network of mortgage brokers that induced them to commit endemic mortgage fraud. It took roughly 100 DOJ professionals several years to investigate Enron, so a comparable competent investigation of Countrywide or WaMu would require well over 100 DOJ professionals for several years. Any credible investigation of Countrywide or WaMu would have also required a group of OTS examiners to be “detailed” to work with the FBI investigation and serve as their internal experts. There is no evidence that either of these events ever occurred. Any purported FBI investigation of those massive shops was a sham.

The Working Group continues the sham and political symbolism at the expense of substance. Holder’s press release explained its staffing levels.

“Attorney General Holder announced that the new Working Group will consist of at least 55 Department of Justice attorneys, analysts, agents and investigators from around the country. Currently, 15 civil and criminal attorneys are part of the Working Group, along with 10 FBI agents and analysts who will be assigned to the Working Group efforts. An additional 30 attorneys, investigators and other staff around the country will join the Working Group efforts in the coming weeks. This team will join existing state and federal resources investigating similar misconduct under those authorities.”

Compare that staffing with the staffing levels we know from experience are required to be successful against elite accounting control frauds. The Working Group does not pass even the most generous laugh test. No one who has ever been involved in a successful, complex criminal investigation of a large organization could take this Working Group seriously. It lacks the capacity to conduct a competent investigation of any of the largest financial frauds – and there are scores of huge institutions engaged in MBS frauds and hundreds of large mortgage banks engaged in MBS frauds.]


The Settlement is too good, or too bad to be true

Lux notes that Jamie Dimon (JP Morgan Chase’s CEO) has expressed skepticism about whether the five large banks will continue to support the settlement now that its substance has been changed (assuming the accuracy of the leaks) to remove the “great majority” of the grants of immunity from civil liability and all grants of criminal immunity. The banks considered the earlier drafts of the deal that offered substantial immunity for mortgage origination fraud to be worth far more than the $25 billion they would pay in return to secure the immunity. Their civil liability exposure for mortgage origination fraud is in the hundreds of billions of dollars, so being released from both mortgage origination and foreclosure fraud for $25 billion would have been a spectacular win for the banks. Even if they received no express immunity from criminal prosecutions, it was clear that the administration was implicitly signaling that it would prosecute their mortgage origination frauds. By eliminating civil liability for mortgage origination fraud, the banks also would have made civil suits far less likely or even impossible and that would greatly reduce the risk that civil investigations would disclose criminal conduct that DOJ could not avoid prosecuting, particularly in an election year.

If the revised settlement has virtually no releases from civil liability for mortgage origination fraud and none for criminal actions, then it should be a no brainer that the deal no longer makes any sense for the banks. Their civil liability for their foreclosure fraud should be far less than $25 billion. It will be instructive to see whether the banks walk away from the deal or the government sweetens the deal for the banks by reducing the settlement amount or broadening again the releases from civil liability. If the banks sign the revised deal, as it is has been represented to Lux, then we will know that the big banks realize that they have such rotten skeletons in their foreclosure fraud closets that it is imperative that they settle the suits and prevent the civil suits from going forward and bringing the skeletons to light.

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Another Law That Doesn't Apply To "Big People"

by Karl Denninger

How many more examples do we need to see before the people demand handcuffs -- and threaten that if they don't see them applied to the pigmen they'll take matters into their own hands?

Nearly three months after MF Global Holdings Ltd. collapsed, officials hunting for an estimated $1.2 billion in missing customer money increasingly believe that much of it might never be recovered, according to people familiar with the investigation.

As the sprawling probe that includes regulators, criminal and congressional investigators, and court-appointed trustees grinds on, the findings so far suggest that a "significant amount" of the money could have "vaporized" as a result of chaotic trading at MF Global during the week before the company's Oct. 31 bankruptcy filing, said a person close to the investigation.

Nonsense. Money does not "vaporize." It goes somewhere through someone. In this case...

As money poured out of MF Global, much of it likely passed through J.P. Morgan Chase & Co. and other banks where the securities firm had accounts, as well as trade-clearing partners such as Depository Trust & Clearing Corp. and LCH.Clearnet Group Ltd., people familiar with the matter said.

Now here's the scam. Try receiving stolen property as any ordinary business or person and then claim that you don't have to give it back (even if it's gone later on) and see how well that works.

You'll lose and be forced to give it back -- even if you don't have it any more.

There are, of course, exceptions that various entities have managed to get written into the law. One of the more-outrageous in recent years has been pawn shops, where you can find your stolen property, be able to prove it's yours, and yet be forced to buy it back -- even though the pawn shop has no legal title to it as the seller (who stole it) never had title to convey.

Common business balance and in fact the law in virtually every other case requires that if the title to whatever you receive is defective your recourse is against the person who sold it to you -- you can't acquire title to something that the seller never lawfully had!

But when it comes to segregated funds, which are allegedly held in escrow for customers and are represented as same by every brokerage in the land, it appears this principle doesn't apply. If it did then banks would be really careful about taking moved funds proffered in response to a margin call or other "stress" situation and require proof that the funds were in fact owned by the firm tendering them, lest they be forced to cough them back up.

That in turn would stop these frauds cold.

And make the pigmen legally and financially responsible for their scams.

The only way we're ever going to see these schemes and scams stopped is when we, the people, demand and are willing to back up our demand to whatever degree is necessary that the same laws that apply to you and I when we accept transfer of some property -- that we cannot acquire title to something if the seller does not have lawful title himself -- be applied to the pawn shops, the banksters and other "connected" institutions and people.

Occupy DC -- Police tase innocent protester

So Why Hasn’t SEC Enforcement Chief Robert Khuzami Resigned? SEC Only Now Investigating CDOs Created on his Watch at Deutsche Bank

by Yves Smith

I’d heard from German speaking readers about the Der Spiegel report of an SEC investigation in its German edition over the weekend and they’ve now released it in their English language version.

Der Spiegel is careful about its sourcing, so readers should take this account seriously. The story is about the overall litigation risks facing the German powerhouse, the SEC investigation is a mention in passing (hat tip reader Mary L):

Meanwhile, the US Securities and Exchange Commission is also investigating Deutsche Bank, SPIEGEL reports. According to financial regulatory sources, the bank launched one CDO transaction called “START” in which it allegedly allowed the hedge fund of US speculator John Paulson to choose junk mortgage securities against which he could speculate — without the other investors knowing about it.

Goldman Sachs settled a suit with the SEC in a similar case for $550 million, SPIEGEL reported.

Why is there probably less here than meets the eye? For this investigation to be taken seriously, SEC enforcement chief Robert Khuzami would have to resign. He was the general counsel for the fixed income area at the time when the deals in question were undertaken (contra Der Spiegel, START was a program of synthetic CDOs, not just a single deal, just the Goldman Abacus trade that was the focus of an SEC lawsuit was actually just one of 25 Abacus trades). It would not be sufficient for Khuzami to recuse himself from this investigation. Staff would still be concerned about how the probe might affect their ultimate boss.

In addition, the fact that Paulson approached Deutsche Bank has been in the public domain since October 2009, when Greg Zuckerman’s book, The Greatest Trade Ever, was released. It discussed in detail how Paulson approached Goldman, Deutsche Bank, and Bear Stearns about constructing synthetic CDOs so Paulson could bet against the subprime market cheaply. This is how Scott Eichel, a senior Bear Stearns trader, saw it:

“We had three meetings with John, we were working on a trade together,” says Eichel. “He had a bearish view and was very open about what he wanted to do, he was more up front than most of them.

“But it didn’t pass the ethics standards; it was a reputation issue, and it didn’t pass our moral compass. We didn’t think we should sell deals that someone was shorting on the other side,” Eichel says.

If this conduct was so questionable that the SEC thought it made sense to sue Goldman in April 2010, why was Deutsche not sued then or shortly thereafter? Why is the SEC only “investigating” nearly two years later?

Banker Bonuses – A quick comment

By Golem XIV

Just a quick comment on banker bonuses and specifically the bonus of Mr Hester at massively bailed out but STILL loss making RBS.

The argument I have heard frequently in the media (most recently this morning on the Today Programme on radio 4 this morning) is that the bonus really has to be paid because it is the necessary recognition that Mr Hester is doing a good job at making the bank less disastrously awful than it was. We should also pay him because otherwise he and others might leave. We, the tax payers, would then find we could not retain the best people. They would leave to go to better paying banks.

There are so many stupidities in this line of reasoning it boggles my brain that they are all so blithely acepted without comment or question by the journalists, broadcasters and generla chip munching morons .

First let’s just apply the argument to another profession. Let’s say a teacher who is doing a very good, top flight job in her classroom. Not only does she not have a the kind of bonus scheme that we are told is absolutely necessary for bankers, but more importantly, no matter how brilliant our teacher is, she is currently being told that because of the economic situation she can’t have even an at inflation pay rise never mind a bonus.

So Mr Hester and his like must be rewarded extravagantly (his basic salary, before any bonus, is about £1 million) but teachers and the rest of us must accept real terms cuts to our earnings. The logic for Mr Hester that it is absolutely necessary to reward those who do a good job far above and beyond the basic salary which they are being paid presumably for doing…a good job?! The same logic is NOT applied to the rest of us because …well.. you understand we’d love to reward you but times are tough and well..we are all in this together.

Have I got that right? Have I missed something?

Then there is the – “Oh. Well. I see why you’re upset at this but if we don’t just swallow this unfortunate inequality then we risk losing the best people “- argument. Once again let’s apply this to our teacher. If this line of argument is so very important and persuasive WHY have none of the people who make it EVER been heard to worry that teachers and nurses and Police detectives and thousands of other rather skilled people will leave their professions because they are NOT being paid bonuses, or even decent salaries, for doing their jobs well?

Speak up Tory boys! I can’t hear you. Little louder please so we can all hear.

Why do bankers have a ‘basic’ salary and then a bonus. While the rest of us just have a ‘salary’. It seems that a mere ‘salary’ for them is just too ‘basic’. While for us, it’s all there is. No one questions.

The argument is that bankers need to be rewarded or they will leave, but neither our leaders nor the bankers give a stuff if good teachers leave their profession nor highly qualified nurses? Because their children aren’t taught by those common sort of teachers in state schools? Perish the thought of mixing with the ‘un-bonus-ed’!

Or maybe it just never occured to our leaders and ‘betters’ that the same logic should be applied to us all. You see forigve me for getting a little angry but I could have sworn I heard someone say we were all in this together.

Obama to Use Pension Funds of Ordinary Americans to Pay for Bank Mortgage “Settlement”

by Yves Smith

Obama’s latest housing market chicanery should come as no surprise. As we discuss below, he will use the State of the Union address to announce a mortgage “settlement” by Federal regulators, and at least some state attorneys general. It’s yet another gambit designed to generate a campaign talking point while making the underlying problem worse.

The president seems to labor under the misapprehension that crimes by members of the elite must be swept under the rug because prosecuting them would destablize the system. What he misses is that we are well past the point where coverups will work, and they may even blow up before the November elections. If nothing else, his settlement pact has a non-trivial Constitutional problem which the Republicans, if they are smart, will use to undermine the deal and discredit the Administration.

To add insult to injury, Obama is apparently going to present his belated Christmas present to the banking industry as a boon to ordinary citizens. He refused to appoint a real middle class advocate, Elizabeth Warren, to the Consumer Financial Protection Bureau, but he’s not above stealing her talking points.

We and other commentators have discussed how the mortgage settlement negotiations nominally led by Iowa attorney general Tom Miller had descended into farce. Almost nothing the Miller camp said was believable. They were presented as “attorney general” discussions when the Administration was pulling the strings. They’ve described a deal as weeks away for over a year. They kept claiming that they had undertaken investigations when not a single subpoena was issued by the AGs still involved in the negotiations. They’ve argued from the get go that a pact will be good for homeowners when the deal reached by under-resourced Nevada attorney general Catherine Cortez Masto with a single servicer, Saxon, resulted in a payout that is 10 to 20 times what the Administration is calling a victory. And that assumes that the banks will live up to their side of the deal when past settlements of servicing abuses have shown that they don’t.

The administration has finally woken up to the fact that the housing mess is almost certain to get worse before it gets better, and Obama must therefore be armed with better propaganda. The Miller-led talks have become a bit of an embarrassment and needed to be put out of their misery. So Team Obama and Federal banking regulators have agreed on terms and as we discussed last Friday, are upping the pressure on state attorneys general to fall into line. As reported by Shahien Nasiripour of the Financial Times:

Banks and government negotiators have cleared a big hurdle in efforts to resolve allegations of widespread mortgage-related misdeeds, agreeing on terms for a settlement that are being circulated to the 50 US states for approval, state officials and a bank representative say.

The proposed pact would potentially reduce mortgage balances and monthly payments by more than $25bn for distressed US homeowners…

State prosecutors have already received a set of documents detailing new mortgage servicing standards that the banks and the government negotiators have agreed to. The states were also being sent documents detailing other main components of the deal, such as the liability release for the banks, the so-called “menu” of options describing the various forms of aid to be given to borrowers, as well as the precise language of the so-called “most favoured nation” clause, which spells out how participating states in the deal would be eligible to receive more advantageous terms should a holdout state strike a more favourable deal on its own with the five targeted banks.

The story did not outline terms, but previous leaks have indicated that the bulk of the supposed settlement would come not in actual monies paid by the banks (the cash portion has been rumored at under $5 billion) but in credits given for mortgage modifications for principal modifications. There are numerous reasons why that stinks. The biggest is that servicers will be able to count modifying first mortgages that were securitized toward the total. Since one of the cardinal rules of finance is to use other people’s money rather than your own, this provision virtually guarantees that investor-owned mortgages will be the ones to be restructured. Why is this a bad idea? The banks are NOT required to write down the second mortgages that they have on their books. This reverses the contractual hierarchy that junior lienholders take losses before senior lenders. So this deal amounts to a transfer from pension funds and other fixed income investors to the banks, at the Administration’s instigation.

Another reason the modification provision is poorly structured is that the banks are given a dollar target to hit. That means they will focus on modifying the biggest mortgages. So help will go to a comparatively small number of grossly overhoused borrowers, no doubt reinforcing the “profligate borrower” meme.

But those criticisms assume two other things: that the program is actually implemented. The experience with past consent decrees in the mortgage space is that the servicers get a legal get out of jail free card, a release, and do not hold up their end of the deal. Similarly, we’ve seen bank executives swear in front of Congress in late 2010 that they had stopped robosigning, which turned out to be a brazen lie. So here, odds favor that servicers will pretty much do nothing except perhaps be given credit for mortgage modifications they would have made anyhow.

There are two clever features of the deal, but neither look intended to benefit ordinary citizens. One is that the deal throws some funding at chronically cash stressed mortgage counselors. They are thus certain to voice approval of the pact. The other is (per the FT story) the deal’s “most favored nations clause” is designed to reduce the bargaining leverage of any AGs that go their own way. It means that any servicer will have the incentive to fight hard against giving any state a better deal because it will automagically trigger improved terms across the states that signed on to the Federal deal. But this may have interesting perverse effects, since banks that refuse to settle with breakaway AGs will ultimately have damages awarded by a court. That means longer and most costly fights by the states, but in most cases, ultimately bigger awards (frankly, the fact set is so bad that all the state AGs need to do is focus on fairly conservative legal theories to have good odds of scoring big wins).

Dave Dayen seemed to think that the AG rebellion was likely to stay firm, given how few of the Democrats were going to Chicago on Monday for an arm-twisting meeting with HUD head Shaun Donovan and an unnamed emissary from the Department of Justice. I would not be so certain. With states so budget starved, I don’t see how anyone can justify sending a live body to Chicago when a phone briefing would work just as well. More important, the most favored nation clause is nasty, and may nudge some fence-sitters over the line.

And I have also been told that Donovan was on the Hill late last week pressuring Congressmen to support the deal. Since this is a regulatory measure that does not require Congressional approval, this move is meant to deprive dissenting state AGs from any support in local media from sympathetic Congressmen. For instance, 31 California representatives wrote the Justice Department, the Federal Reserve and the Office of the Comptroller of the Currency calling on them to “investigate possible violations of law or regulations by financial institutions in their handling of delinquent mortgages, mortgage modifications and foreclosures.” Clearly they could be expected to support California attorney general Kamala Harris’ withdrawal of the deal. Donovon is trying to get them and like minded solons speaking from the Obama script.

But the Administration’s scheme may not be playing out according to script. Senator Sherrod Brown sent a letter last week to associate attorney general Thomas Perelli, Donovan, the CFPB’s Richard Cordray and Tom Miller criticizing the settlement pact. It could have been written by Naked Capitalism readers. Key section:



Now while Republicans may relish the specter of Democrats infighting, the fact is no one is going to want to be seen to be undermining the leader of the party in an election year. So that will put a damper on how aggressive the opponents will be. And media outlets have been amplifying Obama’s efforts to take credit for gravity. For instance, the Administration is touting the fall in foreclosures as an indicator of success when their policies have ranged from do nothing to disasters like HAMP. The fall in foreclosures is actually a sign of failure, as banks are attenuating the process more and more, in some cases due to their inability to come up with necessary documentation, in others out of a desire to wring even more fees out of investors (when a borrower can’t pay, the bank’s fees come first out of the eventual sale of the house).

Either a Gingrich nomination or Romney getting too dented during Republican primary fights increase the odds of what heretofore seemed impossible: an Obama win in November. So if the Republicans were smart, they’d take advantage of a serious weakness in this deal: that it violates the 5th Amendment takings clause. I am told by Bill Frey of Greenwich Financial that a servicer safe harbor provision in HAMP, which was supposed to shield servicers from investor lawsuits over mortgage modifications, was passed by both the House and Senate but was removed in reconciliation because that provision would have run afoul of the 5th Amendment. This settlement is intended to have servicers engage in even more aggressive mortgage modifications and would thus seem to have precisely the same Constitutional problem.

As I urged last week, please call your state attorney general and tell them you think taking from your pension to enrich banks for abusing homeowners is a lousy idea and they should therefore refuse to sign on to the settlement. You can find their phone numbers here. Please call today if you haven’t already. Thanks!