What shall we make of this surprise pronouncement in President Obama’s State of the Union address? A belated investigation has been launched into the role of fraud in the financial crisis.
This much is clear: Despite rampant illegalities, bank fraud and countless cases of perjury, the response to date — at the federal level and from most, but not all, states — has been underwhelming, cowardly even. A few principled holdouts — the attorneys general of Delaware, New York, Nevada and California — refuse to rubber-stamp a pre-investigation settlement with banks, but that’s all. Despite chances to bring crooks to justice, there has been little action.
So, here we are, four years after the great financial collapse, three years after the recovery began and in the last year of Obama’s term — and the president has finally decided to investigate the role of fraud in the great global financial crisis. Hence, this new task force — the unit of Mortgage Origination and Securitization Abuses — begins behind the curve. The statute of limitations is, in many cases, close to elapsing.
Even so, do not dismiss the investigation out of hand because of the timing: History informs us that a serious investigation can begin four years after the fact. Recall that Ferdinand Pecora was the fourth chief counsel for the Senate committee that investigated the Wall Street crash of 1929 and subsequent Depression. He was appointed in 1932 and received broad investigatory powers in 1933. His report ran thousands of pages. Thanks in large part to Pecora’s findings, Congress passed the Glass-Steagall Banking Act, which separated commercial and investment banking; the Securities Act of 1933, which established penalties for filing false information about stock offerings; and the Securities Exchange Act, which created the Securities and Exchange Commission to regulate the stock exchanges. Nearly 50 years of financial stability followed.
The personality in charge can make all the difference. In an encouraging sign, Obama appointed to the task force New York Attorney General Eric Schneiderman, one of the few attorneys general not railroaded into a premature settlement with banks of the robo-signing-foreclosure scandal.
Critics have derided the task force as little more than election maneuvering. The politics are obvious: Both Occupy Wall Street and the tea party were very unhappy with the bank bailouts; they seem even less happy with the lack of prosecution.
It’s fair to ask: Is this new task force a meaningless exercise?
It is too soon to tell, of course. Like good poker players, we can look for “tells” that signal whether this will be a farce or a serious player. We’ll find clues in the structural setup of the office as well as the areas it investigates.
In the setup of the office, four aspects are crucial:
●Does the office have subpoena power (as the New York attorney general’s office has through the Martin Act)?
● Are there going to be public hearings (preferably in the Senate)?
●Will the commission have a significant budget?
● Will it be a forum for whistleblowers and crowdsourcing?
Without such powers, the office would be a farce, helping to shield banks from the fallout of their wrongdoings.
What the office investigates will also reveal how serious this is. Both pre- and post-crisis topics should be investigated, including:
●MERS: Mortgage Electronic Registration Systems was created by banks without any authority or enabling legislation. It allowed the rapid transfer of mortgages, avoiding state and county filing fees amounting to billions of dollars. Without MERS, it’s hard to imagine that the massive volume of mortgage securitizations could have occurred. How were lenders able to circumvent mortgage filings with town and county registrars? Did they engage in illegalities? How many billions of dollars do they owe in fees for transferred notes? And what percentage of MERS assignments were fraudulent, made for entities that did not exist?
●Origination fraud: Why did lenders accept “stated income” loans? Why did they abandon traditional standards? Michael White, a Countrywide subprime unit employee, called this “origination fraud,” observing, “Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default.”
●RMBS: Wall Street’s securitized mortgage pools (residential mortgage-backed securities) contained a broad variety of flaws, some so egregious that they amounted to fraud. In plain English, we’re talking about bad paperwork and misrepresented pools of mortgages to borrowers whose debts were significantly understated and whose median incomes and credit scores were significantly overstated.
● Insurance fraud: Look at a bank tactic in which legitimate home insurance is canceled and new insurance provided at a substantially higher fee through a subsidiary or affiliate of the bank mortgage holder. This extra expense in some cases led to foreclosures.
●“Pyramid” servicing fees: An illegal practice in which current payments are applied to past late fees, generating more late fees and additional interest owed and creating a delinquency where none existed. This tactic also led to foreclosures that were probably unlawful.
●Lost mortgage notes: How is it possible that the most important part of the mortgage contract — the promissory note — was consistently lost or misplaced by banks? It is unfathomable to anyone who has ever handled documents. At best, it’s gross incompetence. At worst, it’s willful document destruction during litigation.
●Document fraud for sale: There were many examples of alleged document fraud, but the one crying out for investigation involves Lender Processing Services’ DOCX subsidiary. The firm seems to have been selling fabricated documents for a fee to lawyers and banks. Indeed, Lender Processing Services, which processes nearly half of all U.S. foreclosures, could require a separate investigation.
●False affidavits, perjury (robo-signing): We do not know who ordered the robo-signing of foreclosure documents, the false notarizations, fraudulent written statements to courts and perjury. This should be easy to investigate, like flipping a nickel-bag dealer to get to the drug kingpin. Astoundingly, this easy-to-investigate felony (via notarized perjurious statements submitted to foreclosure courts) has yet to be prosecuted.
●Foreclosure mills, process servers: Law firms engaged in rampant fraud that corrupted the foreclosure process. If found guilty, those folks should be disbarred and jailed. Same for the “sewer service” process servers who threw away legally required notices to delinquent homeowners.
●Soldiers and Sailors Relief Act: Federal law protects active-duty service members from foreclosure and eviction. I find violation of this law reprehensible. If it were up to me, I would let the Special Forces — Navy Seals and Army Green Berets — handle this as they see fit.
Even with criminal statutes of limitations elapsing, we can achieve some measure of justice against the crisis wrongdoers. Lawyers can be disbarred and corporate insiders banned from serving in publicly held firms again. CEOs and CFOs can be fired. A significant investigation, with subpoena powers, a real budget and public hearings would go a long way toward restoring public confidence.
Schneiderman has an opportunity to create a legacy for himself that lasts far beyond the next election cycle. If he lacks the tools to do so, he should demand them or resign in protest.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture.