William Kurt Black is an American lawyer, academic, author, and a former bank regulator. Black’s expertise is in white-collar crime, public finance, regulation, and other topics in law and economics.
The average bank robbery nets $7,500, but the really scary thing is when CEOs use dishonest accounting to claim record profits and defraud the economy as a whole. The last time this happened it cost $11 trillion and 10,000,000 jobs were lost. The common ‘recipe’ for this style of fraud is easy to see, and follows the same trends:
- Grow like crazy
- Buy or make crappy loans at a premium yield
- Employ extreme yield
- Keep only trivial loss reserves.
This will give amazing returns to the bank, and easily enough to trigger massive executive bonuses. However a few years down the line, the bank is doomed to take a large hit.
Appraisal fraud is when a bank will over-inflate the value of collateral against a loan. There were warnings of this before Enron collapsed, including a warning to the US government from some appraisers. These honest appraisers had been blacklisted by the banks for refusing to inflate the values of assets. The appraisal is a great defense against losses, so no honest bank should need to do it, but is a clear sign of accounting fraud.
Liars loans are the second issue – where a bank will not check income of a borrower before lending them money. If a borrower overstates their income, it allows the bank to sell them a higher mortgage. Again, no honest bank should do this – it is a recipe for disaster to loan too much to someone who can’t pay.
Between 2003 and 2006, liars loans increased by 500% – by 2006 40% of all loans were ‘liars loans’. This is despite the industry’s anti-fraud experts warning banks that they 90% of the stated incomes are fraudulent. Appraisal fraud was also increasing over the same time period – by 2007 90% of appraisers said they had experienced coersion from the banks to overstate values of assets. Banks were also giving up their federal deposit insurance, so were no longer under the gaze of the federal regulator. There was also the issue of the secondary market for these fraudulent loans- when banks will fraudulently sell the loans onto someone else. To do this it was necessary to hide the true value of the loan, or repackage the loans alongside better loans.
The response after the savings and loans debacle of 1990s included 30,000 criminal referrals from regulators – one of the largest responses to white collar criminals. In response to the current crisis (GFC of 2009?), there were no criminal prosecutions. The FBI alone doesn’t have the expertise to investigate complex accounting fraud on its own – it needs guidance from regulators. In 2007 an alliance was formed between the Mortgage Bankers Association (an industry body) and the FBI to investigate mortgage fraud, but their definition of fraud was one where the banks were always the victim, and industry incapable of committing fraud. This led to criminal prosecutions against small business owners to protect the banks from them.
William’s solution to banking regulation
- abandon the ‘too big to fail’ mantra. They need to be shrunk to the point where their failure will not trigger wider losses.
- we need to rework modern executive professional salaries. It is too big an incentive to defraud the system, and can create a situation where good ethics can be driven out of the system by bad ethics (unscrupulous appraisers).
- deal with deregulation, de-supervision, and defacto decriminalisation. Over time, it has become trendy not to regulate banks, even when the regulators can see what is happening.
By making these changes, we can decrease the frequency and impact of future banking crises. We need to learn what the bankers learned – the recipe to rob a bank.
Could be good if you have an interest in accounting fraud. Personally I found the talk difficult to follow at times – it felt like it was working in circles. The ‘recipe’ itself was interesting, though I wasn’t clear how each of those steps were beneficial to the bank.