27 May 2010
It is astonishing that none of the bank executives who defrauded their own banks for personal gain before bringing down the financial system have yet been prosecuted — and that many are still working in the financial sector.
Before the crisis, the authorities turned a blind eye to “control fraud” — defrauding one’s own company for personal gain. This was largely because silvery-tongued lobbyists for Wall Street and the City persuaded President George W Bush and Prime Minister Gordon Brown, and indeed their predecessors, that creating a regulatory vacuum would allow banks and hence the wider economy to thrive.
As Nouriel Roubini and Stephen Mihm write in their new book Crisis Economics: A Crash Course in the Future of Finance, economists and politicians allowed themselves to be seduced by “fairy tales about the wonders of unregulated markets and the limitless benefits of financial innovation.”
In fact, the removal of regulatory barriers led to a dystopian “Wild West” where, for example, banks were not stopped from actively encouraging mortgage borrowers to lie about their incomes, before bundling these “liar loans” into opaque securitized parcels and passing them off as ‘Triple A’. In the hellish financial world that was ushered in by Brown and Bush, this and other more extreme forms of skulduggery and corporate crime were deemed perfectly acceptable.
In the above video — which I strongly recommend you watch — William K. Black associate professor of economics and law at the University of Missouri, Kansas City, explains how this was allowed to happen and why the consequent epidemic of fraud that so nearly brought down the financial system has never been properly investigated.
Black says the crisis, which he says was 1,000 times worse than the US Savings and Loan crisis of the 1990s, owes its origins to “calculated dishonesty” by people at the top of banks and other financial institutions. From about 2003 onwards they, for the most part, ran their businesses in ways that delivered maximum bonuses in the short term; but which were bound to jeopardize their business’s long term future.
Black (and the interesting part commences about two minutes into the above programme) says:
“The way that [the CEOs and boards of banks and other financial institutions] do it is to make really bad loans, because they pay better. Then you grow extremely rapidly. In other words you’re a Ponzi-like scheme. And the third thing you do is, we call it leverage, which means you borrow a lot of money.
“The combination creates a situation where you have guaranteed record profits in the early years. That makes you rich through the bonuses that modern executive compensation has produced; it also makes it inevitable that there is going to be a disaster down the road. All of the checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls but to suborn them; to turn them into your greatest allies and the bonus programs are exactly how you do that.”
Black, a former regulator, teaches white-collar crime, public finance, antitrust, law and economics. He is author of The Best Way to Rob a Bank is to Own One.