There Oughta Be A Law!

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In another venue, someone argued 'the people who caused the mortgage meltdown be in jail?!'

I don't know if any of you, dear readers, happen to hold that view, but, if you do, would you be so kind as to tell me, in general terms, who you think ought to be in jail, and in specific terms, what you think they should be in jail for?

Let me note two important things at the outset: remember that lying to people is usually only against the law if you're doing so to cheat them out of money (which is why Bernie Madoff is in jail), and it's unconstitutional to make laws that make something retroactively illegal.

Got your moral outrage ready? Go!

Comments

[a-steep-hill.livejournal.com]

I saw this and didn't have time to post an elaborate response. But fortunately someone did my work for me.

At least some of the bigwigs at some of the major dealer/trader banks/departments (which are rightly distinguished from boring old commercial banks) can almost certainly be prosecuted under Sarbanes-Oxley.

Note that the law requires the CEO and CFO (at least) to certify their knowledge of the bank's position and the soundness of its risk practices. Ignorance is no defense: if you didn't know, and you said you did, you're guilty. If you failed to certify, you're guilty.

To this I would also add: criminal prosecution of large chunks of the mortgage origination and securitization industries. The abuse of well-established real estate law (i.e. blowing it off completely) in the securitization and transfer of mortgages is well established and quite widespread, if you read past the MSM version of the situation (a few isolated incidents, my ass). If the (again, well established) laws are taken at all seriously, then quite a few individuals are guilty of selling things as mortgage-backed securities which were nothing of the sort: the transfer of the note was not done according to the law, and so it is invalid, and so the MBS is in fact just an empty piece of paper. So there should be some good opportunities for prosecution there.

There is probably also some opportunity to be found by looking for violations of fiduciary responsibility. I am not an expert on the concept, but selling a client a bunch of securities while simultaneously betting against those same securities (i.e. selling short) seems like it would be a violation of fiduciary responsibility. Perhaps not (in which case, we need to update the definition), but hey, we've got plenty to work with in the first two categories.

All this would be expensive and time consuming, and certainly be a net money loser for the DOJ and everyone else involved - I have no pretense that the fines and clawbacks would be even close to covering the cost of prosecution. But that's not the point. The point is to remind these "masters of the universe" that they are not above the law.

Except that they are. As recent events have made apparent. Welcome to the Plutocratic States of America. Your servant's livery will be delivered shortly.

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Let's see..

There is probably also some opportunity to be found by looking for violations of fiduciary responsibility. I am not an expert on the concept, but selling a client a bunch of securities while simultaneously betting against those same securities (i.e. selling short) seems like it would be a violation of fiduciary responsibility

As the rules are currently written, if you're selling to other qualified investors, you're required to disclose interest, but that's the extent of it. There are a handful of solid cases of the seller failing to make that disclosure, but they're a drop in the bucket (small fractions of a percent of all transactions); those cases are getting SEC attention, and that sort of failure-to-disclose is obviously an act of fraud, no matter what the political stripes of the listener, so our odds of seeing some convictions are high. Of course, this is securities litigation, so we won't see those convictions for several years yet.

criminal prosecution of large chunks of the mortgage origination and securitization industries. The abuse of well-established real estate law (i.e. blowing it off completely) in the securitization and transfer of mortgages is well established and quite widespread, if you read past the MSM version of the situation (a few isolated incidents, my ass)

You bet - I think we can all agree that there are tens of thousands of line mortgage brokers who performed clearly fraudulent acts. The problem is that those people are all bottom-feeders - they're middle class people who were cutting corners because everybody else was doing it, who've now left the business because there's no money there anymore, many of them going bankrupt along the way. They're the garden variety fraud of writing up a totally bogus mortgage application. I think going after a bunch of them is a good idea, and state levels attorneys' general are doing so, but that doesn't sound like who you're thinking about.

If the (again, well established) laws are taken at all seriously, then quite a few individuals are guilty of selling things as mortgage-backed securities which were nothing of the sort: the transfer of the note was not done according to the law, and so it is invalid, and so the MBS is in fact just an empty piece of paper.

Well... that's a lot harder. Until the home-buyers stopped paying, there wasn't any question about the mortgages being valid - the borrowers were paying what they believed were their mortgages every month, the servicers were divvying those payments out to the MBS holders. Pretty much everyone involved seems to have thought those were valid mortgages until the borrower stopped being able to pay.

On a somewhat tangential note, the maker of Inside Job (http://www.imdb.com/title/tt1645089/) is speaking about all this on KQED right now.

[a-steep-hill.livejournal.com]

I find it interesting you don't have any response to the S-O angle. The details of that stuff are way out of my area of expertise, so I can't really assess the details, but assuming their interpretation of S-O is right, everything else hangs together.

Regarding
Well... that's a lot harder. Until the home-buyers stopped paying, there wasn't any question about the mortgages being valid - the borrowers were paying what they believed were their mortgages every month, the servicers were divvying those payments out to the MBS holders. Pretty much everyone involved seems to have thought those were valid mortgages until the borrower stopped being able to pay.


I have to say, "so what?". The bundles were created on false pretenses. They looked good on the outside, but they were rotten on the inside. The entire purpose of this sort of law is to establish a way of doing things that is supposed to keep things from going south, and to resolve the problems if they do. No one cares, as long as things are good. But just because the flaws don't show, doesn't mean they aren't there, or that criminal intent/incompetence was not present.

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I find it interesting you don't have any response to the S-O angle. The details of that stuff are way out of my area of expertise, so I can't really assess the details, but assuming their interpretation of S-O is right, everything else hangs together.

I don't think that Sarbox is really relevant. That is, while it's entirely possible that people who are fundamentally far from culpability could be nailed on Sarbox issues, the problem really wasn't the kind of thing that Sarbox was written to solve. Sarbox mandates that you actually write down the reasons for decisions, and that they have some basis, and that you expose the reasons to the parts of your organization that perform oversight. The thing is, these deals were not being done without internal organizational visibility. Moody's was giving ratings that were higher than they should have been, but they were exposing that possibility to their customers, who were then acting on the rating just like everyone else on the market. And it's really hard to argue, as required for a Sarbox violation, that someone was taking an inappropriate risk when a) everyone in the industry is doing it, and b) it's been making rafts of money for much of the prior decade. Banks and retirement funds that bought products that were pitched to them inappropriately have a cause of action, but those people are really way at the periphery of the system, and they're already suing the majors. Where we got into trouble was AIG promising to insure against a slowing of the US economy, which looks stupid on its face when looked at from that macro perspective, but each decision leading up to it looks reasonable. Until you have a whole string of decisions in a row that amplify risk, run out of room on the very first one, and the whole thing comes crashing down.

The bundles were created on false pretenses. They looked good on the outside, but they were rotten on the inside.

Some bundles looked good on the outside and were rotten on the inside. You're conflating the ones that collapsed with the ones that didn't. The ones that collapsed are a large number, but your statement seems roughly analogous to 'Some people bounce overdraw checking accounts. To protect the financial system, we shouldn't have them.'

just because the flaws don't show, doesn't mean they aren't there, or that criminal intent/incompetence was not present.

You bet. So, how do you tell if a practice is risky or not?
No one had seen an economy-wide drop in housing prices in close to a hundred years.
That looks like a pretty good track record.
Most of the structured securities that have collapsed collapsed because they were designed to perform even if the mortgage default rate was double the rate that had been observed for the prior forty years. That looked like a really solid bet, at the time.
I'm not even sure that it was a bad bet, really - the pain we've gone through in the last three years was the result of suppressing the economic realignment we needed to go through in 2001, which we suppressed by dropping interest rates to the floor. Which made housing look like a better investment than it is. And staved off realigning the economy for nearly a decade. Now we're going through not just that realignment, but having to shift everyone who built careers and lives around the bubble out into profitable parts of the economy instead. And since we're now a lot more in debt than we were at the beginning of that decade, that's going to be even more unpleasant than it would have been a decade ago.

[a-steep-hill.livejournal.com]

Some bundles looked good on the outside and were rotten on the inside. You're conflating the ones that collapsed with the ones that didn't. The ones that collapsed are a large number, but your statement seems roughly analogous to 'Some people bounce overdraw checking accounts. To protect the financial system, we shouldn't have them.

No, I'm saying that some people abuse the system and that's why there are rules, and those rules need to be followed, and there should be penalties for breaking the rules (particularly wholesale, with intent), and there should be no exceptions.

Many of these packages that haven't fallen apart are still rotten on the inside -- there are lots of losses in the system which have not yet been recognized (e.g. 80% of the value of second mortgages is basically fiction at this point).

But that's STILL not the point. The point is that the rules apply, and it shouldn't matter if you're a financial elite, and it shouldn't matter if some of your products aren't crap. Even if you're producing 100% good deals, it shouldn't matter, your ass should still be in a sling (though granted in that case, probably nobody notices that you broke the rules).

You then go on to discuss the risk mis-management that were used, like that has anything to do with the questions at hand. (As an aside, what they did was model their failure scenario on twice as bad as the best time the industry has seen since the 20's, on a ten, not forty year time scale. Garbage in, garbage out. Unless you believe that infinite growth is both possible and happening, yeah, it was stupid. And if you believe in the Infinite Growth Fairy, then you're not a member of the reality based community.)

The point is that these deals were constructed while completely ignoring decades of well established precedent, because the requirements of precedent were inconvenient. Partly as a consequence of this, some percentage of the deals went bad. But all the deals so constructed were fraudulent and illegal. It doesn't matter what the outcome was in a particular case. Lots of people played fast and loose with the rules, and there need to be serious penalties for them (or, better, for their bosses who instructed them to do so. Legal discovery is a powerful tool.)

What's so hard to understand about this?

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The point is that the rules apply, and it shouldn't matter if you're a financial elite, and it shouldn't matter if some of your products aren't crap. Even if you're producing 100% good deals, it shouldn't matter, your ass should still be in a sling (though granted in that case, probably nobody notices that you broke the rules).

But there weren't rules against the things that people did that broke the system.
I don't dispute that rule-breakers exist who have not been prosecuted for breaking rules. But the rules that people broke, by and large, and the people who broke them, have little or nothing to do with the problem we're talking about. If we apply the Sarbox test you suggested, the loans you're angry about were perfectly reasonable.

The point is that these deals were constructed while completely ignoring decades of well established precedent, because the requirements of precedent were inconvenient. Partly as a consequence of this, some percentage of the deals went bad. But all the deals so constructed were fraudulent and illegal.

Please clarify what you mean by 'all the deals' - Are you arguing that any sub-prime mortgage anywhere is illegal? That a no-income-no-down-payment loan is illegal?

It doesn't matter what the outcome was in a particular case. Lots of people played fast and loose with the rules, and there need to be serious penalties for them (or, better, for their bosses who instructed them to do so. Legal discovery is a powerful tool.)

Do you think their bosses told them to break rules? Or did they just go where the money was?

[a-steep-hill.livejournal.com]

You seem to be missing my point. I'm not talking about issues with loan origination at all at this point (that's an issue, but not the point of the last couple of posts). I'm talking about all the malfeasance that happened around the transfer and bundling of the loans into derivatives of various sorts. In MSM terms, robosigning, though that's just the tip of the iceberg. Forged alonges, misuse of MERS, etc.

There was tremendous pressure to do these deals at an accelerated rate during the boom. As a result corners were cut to the point that the square became a circle. This behavior appears to have been very widespread, and the result is that mortgages were by and large never legally conveyed to the derivative vehicles that carried them. The fact that half the mortgages were crap is secondary to the fact that, good mortgage or not, if the conveyance was not done legally then the mortgage-backed security was never actually backed by a mortgage. Thus, fraud against investors and violation of real estate law to the detriment of homeowners.

The people who actually committed these acts were, for the most part, wage slaves. But they acted on orders - yes, I do believe their bosses told them to do these things, because following the rules would have taken too long and slowed down the system. If the fraud were being prosecuted as such, it would not take long for this pattern to come to light. But it's not going to happen, because the overriding imperative of this administration is to return to business as usual (however slimy, illegal, or unsustainable that might be) as quickly as possible. Actually prosecuting the bad actors would slow that down, and cast a pall on the system as the depth and widespread nature of the misbehavior became apparent.

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You're right, I was missing your point - you're, fundamentally, flaming people like Countrywide much more than you're flaming people like, say, Lehman, which I'd missed.

Except that Mr Mozilo, the relevant executive, has received the largest SEC fine ever ($67.5 Million), and been permanently barred from being an officer or board member of a public company. Which may not be the same as 'imprisoned for life,' but does seem rather a far cry from 'slap on the wrist,' nu?

Actually prosecuting the bad actors would slow that down, and cast a pall on the system as the depth and widespread nature of the misbehavior became apparent

Well, prosecuting the bad actors would cast a pall on the system as everybody who wasn't violating the law got swept up into discovery as well. There's an awful lot of baby in that bathwater.

[a-steep-hill.livejournal.com]

I think that the Lehman's and AIG's also have plenty to answer for, that just wasn't my point in this thread.

I don't know if Mr. Mozilo's penalty really amounts to much. What was his net worth? What's left after the fine? If he's still more than middle-class, the fine wasn't nearly large enough.

And all the major banks have extensive problems with their mortgage paper trails. So Mozilo may have been made the fall guy, but there are folks at BofA, Wells Fargo, Citibank, etc who need to go through the same ringer.

Well, prosecuting the bad actors would cast a pall on the system as everybody who wasn't violating the law got swept up into discovery as well. There's an awful lot of baby in that bathwater.

Maybe so, but I think they would find lots and lots of rotten bathwater. But even if they didn't, we have a choice: prosecute the banksters, or keep paying Danegeld. Whatever the damage, it's going to be cheaper to clean up the rot now than to keep sweeping it under the rug.

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I don't know if Mr. Mozilo's penalty really amounts to much. What was his net worth? What's left after the fine? If he's still more than middle-class, the fine wasn't nearly large enough.

Um, being permanently barred from employment is peanuts? Do you really mean that?

So Mozilo may have been made the fall guy, but there are folks at BofA, Wells Fargo, Citibank, etc who need to go through the same ringer.

BofA's mortgage trail is Countrywide's. And the reason that Mozilo went down was because he was the founder of Countrywide. Y'know, the people who brought us subprime mortgage securitization in the first place?

Maybe so, but I think they would find lots and lots of rotten bathwater. But even if they didn't, we have a choice: prosecute the banksters, or keep paying Danegeld. Whatever the damage, it's going to be cheaper to clean up the rot now than to keep sweeping it under the rug.

So, what's your test? How would you be able to tell if the banksters were being prosecuted?
(I'm going to assume that you don't actually mean 'I would be willing to entirely crash the US economy to root out any fraud in the financial system')

[a-steep-hill.livejournal.com]

And it's really hard to argue, as required for a Sarbox violation, that someone was taking an inappropriate risk when a) everyone in the industry is doing it, and b) it's been making rafts of money for much of the prior decade.

So if one company does something dumb it's a crime, but if they all do it together with predictable and obviously forseeable bad consequences, it's OK?
That's insane.

And, yes, they should have seen this coming. I'm not a financial professional, and I saw it coming. It doesn't require much sophistication to see that nothing grows forever, particularly when it is built a foundation of sand.

But that shouldn't matter. Holding a reserve against bad times is a basic element of fiscal responsibility. The fact that all the financial elites decided as a group that this was not necessary doesn't change this.

Basically, the argument that criminal negligence was NOT involved boils down to:
1) Our models said it was OK. Everyone elses' models did too. So we did it, even though it defies logic and common sense.
2) Well, obviously our models were bad. But we all acting according to our models which we thought were good. Even though they were obviously founded on fiction. So because everyone is guilty, no one is.

It's just an excuse to rationalize groupthink greed-seeking behavior. Nothing more and nothing less. And I want to see the arrogant pricks who thought this was a reasonable way to run a business taken down a few notches. Because as it stands, they will do it again. Very soon.

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So if one company does something dumb it's a crime, but if they all do it together with predictable and obviously forseeable bad consequences, it's OK?

When the law says 'must be reasonable and customary,' well, yes, we're sorta stuck, unless we decide we're ok with post facto law-making.

Holding a reserve against bad times is a basic element of fiscal responsibility. The fact that all the financial elites decided as a group that this was not necessary doesn't change this.

Indeed. And what happened was not 'no one held a reserve against bad times.' What happened was 'everyone simultaneously held too little reserve, because they had progressively backed into it, because it hadn't blown up yet and appeared to be working.' The only ways to prevent that are either to never do anything we haven't always done, or to have an effective system that creates a counter-vailing control mechanism. We used to think that Federal Banking regulators were the way to create that control mechanism, but I'm not convinced - it looks to me like responsive democracies make regulatory agencies not just vulnerable to capture but practically subject to it. Which means we need different ways to balance the feedback system.

Basically, the argument that criminal negligence was NOT involved boils down to:
1) Our models said it was OK. Everyone elses' models did too. So we did it, even though it defies logic and common sense.
2) Well, obviously our models were bad. But we all acting according to our models which we thought were good. Even though they were obviously founded on fiction. So because everyone is guilty, no one is.

You're leaving out the element of time. No one woke up on August 8th, 2007 and said 'I think I'll push the world financial system off a cliff.' They didn't even set out in 2000 to create a housing bubble by lowering US interest rates. What did happen was that a lot of decisions were made in a row, by entirely unrelated people, many of whom weren't communicating with each other, which added together made the system much more synchronized and much more fragile. And if we spend our time trying to find out 'Who decided to push the financial system off the cliff?' and bring them to justice, instead of spending our time addressing the fact that we have a regulatory system that can't work, we're going to have financial crises more frequently (approaching historical levels) rather than less.