Full text of Financial Crisis Inquiry Commission : Documents Relating to the Financial Crisis of 2007-2009 : Session 1 : Overview of Mortgage Fraud, William K. Black

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Testimony before the Financial Crisis Inquiry Commission
Miami, Florida September 21, 2010
William K. Black
Associate Professor of Economics and Law
University of Missouri-Kansas City
Honorable Commissioners:
You have asked that I testify about the role of fraud in the financial crisis. Thank you for the
opportunity.
Background:
Primary appointment: economics, joint appointment: law. I am a white-collar criminologist and
a former financial regulator. I was the executive director of the Institute for Fraud Prevention. I
have developed anti-fraud systems for the World Bank and field tested them in India. I was an
expert witness for the federal regulatory agency bringing an administrative action against the
former CEO of Fannie Mae.
My duties as a regulator included:
 Served as what we informally referred to as the “chief coroner” – my staff reviewed
every failure to determine its causes
 Led the re-regulation of the S&L industry at the staff level
 The primary agency spokesperson on the role of fraud in the debacle
 Trained our staff, FBI, Secret Service and IRS agents, AUSAs, and state prosecutors to
identify, investigate, and prosecute frauds
 Served as an expert witness for several high priority prosecutions
 Investigated and brought civil and administrative actions
 Filed criminal referrals – Suspicious Activity Reports (SARs)
 Met with AUSAs and FBI agents in task forces
I also served as the executive staff director of the National Commission on Financial Institution
Reform, Recovery and Enforcement (NCFIRRE) and authored over ten staff reports.
I have testified before Senate twice with regard to the ongoing financial crisis (on financial
derivatives and the role of fraud in the crisis) and the House twice (on Lehman’s failure and the
related regulatory actions of the SEC and Federal Reserve and on executive and professional
compensation).
My primary research foci are “control fraud,” financial regulation, and financial crises.

Overview of Key Findings:
The conventional wisdom about mortgage fraud is logically incoherent, contrary to the
established facts, and created as a smokescreen by the leading frauds – the nonprime specialty
lenders.
1. “Adverse selection” is suicidal for an honest mortgage lender – it produces a “negative
expected value” (i.e., it is certain to produce net losses). Millions of nonprime loans were
made under conditions known to create intense adverse selection. There were millions of
liar’s loans. The mortgage industry’s own fraud specialists wrote that stated income loans
were an open “invitation to fraud” and justified the industry term (“liar’s loans”).
2. The data demonstrate conclusively that most liar’s loans were fraudulent, which means that
there were millions of fraudulent mortgage loans because liar’s loans became common
(Credit Suisse estimates that they represented 49% of new originations by 2006). The data
also demonstrate that even minimal underwriting of the loan files was sufficient to detect the
overwhelming majority of such fraudulent liar’s loans. No honest, rational lender would
make large numbers of liar’s loans. The epidemic of mortgage fraud was so large that it
hyper-inflated the housing bubble, which allowed refinancing to further extend the life of the
bubble (and the depth of the ultimate Great Recession.
3. The claim that lenders made honest liar’s loans because they did not want to lose market
share to competitors is nonsensical (and oxymoronic). When a competitor makes a liar’s
loan the competitor loses money (that’s what “adverse selection” and “negative expected
value” mean).
4. The claim that lenders made honest liar’s loans because they intended to honestly sell the
loan to a third party is oxymoronic and false. Liar’s loans were overwhelmingly sold under
representations and warranties that they were not fraudulent and typically had “put”
provisions under which the buyer could require the seller of the fraudulent loans to make
good any losses due to fraud. In the cases where there have been even minimal
investigations (New Century, Aurora/Lehman, Citi, WaMu, Countrywide, and IndyMac)
senior lender officials were aware that liar’s loans were typically fraudulent. The lenders
could not make an honest business out of selling overwhelmingly fraudulent mortgages.
5. Liar’s loans were done for the usual reason – they optimized (fictional) short-term
accounting income by creating a “sure thing” (Akerlof & Romer 1993). A fraudulent lender
optimizes short-term fictional accounting income and longer term (real) losses by following a
four-part recipe:
A. Extreme Growth
B. Making bad loans at a premium yield
C. Extreme leverage
D. Grossly inadequate loss reserves
6. Note that this same recipe maximizes fictional profits and real losses. This destroys the
lender, but it makes senior officers that control the lender wealthy. This explains Akerlof &
Romer’s title – Looting: The Economic Underworld of Bankruptcy for Profit. The failure of
the firm is not a failure of the fraud scheme. (Modern bailouts may even recapitalize the
looted bank and leave the looters in charge of it.)
7. The first two “ingredients” are related. Home lending is a mature, reasonably competitive
industry. A lender cannot grow extremely rapidly by making good loans. If he tried, he’d

have to cut his yield and his competitors would respond. His income would decline. But he
can guarantee the ability to grow extremely rapidly by being indifferent to loan quality and
charging weaker credit risks, or more naïve borrowers, a premium yield.
8. In order to become indifferent to loan quality the officers controlling the lender must
eviscerate its underwriting.
9. A control fraud can ensure this result. The senior officers can hire, fire, and transfer
employees. More importantly, they can devise and implement the compensation system to
suborn internal and external “controls.”
10. When the frauds that control the lender eviscerate the underwriting and controls they also
create a criminogenic environment that attracts opportunistic frauds – these are the rings that
the Justice Department targets instead of the control frauds.
11. Deliberately create a “Gresham’s dynamic” (Akerlof 1970) in which bad ethics drives good
ethics out of the workplace. Classic example is coercing appraisers to inflate appraisals.
There is no honest reason for a secured lender to seek or permit inflated appraisal values.
This is a sure marker of accounting control fraud – a marker that juries easily understand.
12. These Gresham’s dynamics are precisely what we observe at each nonprime specialty lender
that has been subjected to even a material investigation. (If you don’t investigate, you don’t
find.) Coercion of appraisers and the use of volume/yield “performance” compensation
systems for loan officers and brokers is the norm where nonprime specialty lenders have
been investigated.
13. The “primary” control fraud epidemic by the nonprime lenders was criminogenic – it was
sufficient to create an “upstream” “echo epidemic” among loan brokers, mortgage bankers,
appraisers, and allied mortgage personnel. This upstream epidemic fed the primary
epidemic, allowing them to optimize their fictional accounting income through extraordinary
growth of high yield product.
14. The banking regulators have to serve as the “Sherpas” for the FBI. We have the expertise
(and, once, we had the numbers). We have to do the heavy lifting and act as the expert
guide. Our criminal referrals have to provide the detailed trail map. None of that is
happening according to reports from the OCC and OTS – no criminal referrals.
15. In the absence of the regulators serving as the vital Sherpas, but FBI turned to its “partner” –
the Mortgage Bankers Association (MBA) – the trade association of the “perps.”
16. Naturally, the MBA wanted to picture its members as the “victims” and to ignore the
existence of control fraud.
17. The MBA created the purported division of mortgage fraud into two exclusive
categories (“for housing” v. “for profit”) – and neither category permits control fraud.
The MBA admits that junior officers engage in mortgage fraud. The MBA, implicitly,
defines the senior officers that control the lender as inherently honest. There is no basis
for that implicit assumption. It has never proven true in any prior crisis.
18. The primary mortgage control fraud inherently leads to downstream accounting control fraud
by those that hold or securitize fraudulent nonprime mortgage instruments. Adverse
selection inherently produces severe losses. If the primary epidemic of mortgage fraud is
large enough to hyper-inflate the bubble the resultant losses will be catastrophic. The holders
of liar’s loans will have strong incentives to engage in accounting control fraud to avoid
recognizing these losses.
19. Conversely, to the extent upstream purchasers of fraudulent loans (e.g., Merrill Lynch)
engage in the financial equivalent of “don’t ask; don’t tell” they will eviscerate their

underwriting and purchase fraudulent nonprime paper because it will pay a higher yield and
maximize their bonuses. The environment can be criminogenic in both directions.
20. Control fraud epidemics of mortgage fraud also explain other characteristics of the crisis that
are otherwise nonsensical. The spread and allowance for loan and lease losses (ALLL) on
nonprime loans fell even as (A) the FBI warned of an epidemic of mortgage fraud, (B) there
was ever greater concern that housing values were being inflated by an enormous bubble, and
(C) there was universal agreement that loan quality was falling precipitously. Logically, the
spread should widen and the ALLL should be increased dramatically in these circumstances.
The spread narrows because the fraudulent lenders have to compete increasingly for a
diminishing supply of borrowers. They compete by reducing yield, which reduces the
spread. General loss provisions fall as the collapse nears because delinquencies increase as
soon as bubble’s expansion slows. As delinquencies on bad loans increase reported income
falls and the officers fear that they will not maximize their bonuses. By reducing the
provisions for losses the controlling officers can increase reported income.
21. A criminal justice response that focuses on the opportunistic junior insiders that take
advantage of the senior officers’ evisceration of underwriting and suborning of controls
cannot succeed. It can produce hundreds of convictions, but it will fail to sanction and deter
the control frauds. History demonstrates that if the control frauds get away with their frauds
they will strike again.
22. By allowing the banks to use their political power to gimmick the accounting rules to permit
them to hide their massive losses on liar’s loans we have made it far harder to take effective
administrative, civil, and criminal sanctions against the elite frauds that caused the Great
Recession. Hiding the losses also adopts the dishonest Japanese approach that cripples
economic recovery and public integrity.
23. Prosecuting the elites control frauds can be done successfully. Create a new “Top 100”
priority list and appoint regulators that will make supporting the Justice Department a top
agency priority. That’s how we obtained over 1000 priority felony convictions of elite S&L
criminals. No controlling officer of a large, non-prime specialty lender has been convicted of
running a control fraud. Only one has even been indicted.
24. The FBI has written that any discussion of the crisis that ignores the role of mortgage fraud is
“irresponsible.” The current FCIC staff draft memoranda on the crisis, mortgage
instruments, and securitization all fail to even discuss fraud – a principal cause of the
problems discussed in those memoranda. The existing memoranda on these three subjects
cite none of the criminology literature and ignore the work of George Akerlof on control
fraud – a Nobel Prize winner in economics and the expert on this subject in his field.
(Curiously, one of the memos cites “lemons” problems without citing his article.) The entire
discussion of the crisis before FCIC has been framed in a manner that almost entirely
excludes control fraud.

Extended Testimony
Rather than reinvent the wheel, I have (barely) modified my Senate Judiciary testimony on the
same subject. I will also provide the Commission with a shorter memorandum on some of the
specific mortgage fraud mechanisms and players in Florida.

Dear Honorable Commissioners:
The criminal justice system needs to work with regulation not only to make regulation more
effective, but also to prevent “private market discipline” from becoming a “criminogenic”
oxymoron. To understand the vital role that the criminal justice system must play if we are to
avoid the recurrent, intensifying financial crises that have beset this and many other nations for
nearly three decades we must begin by understanding the epidemics of “control fraud” that are
driving these crises.
An Introduction to “Control Fraud”
“Control frauds” are seemingly legitimate entities controlled by persons that use them as a
fraud “weapon.” (The person that controls the firm is typically the CEO, so that term is used
in this testimony.) A single control fraud can cause greater losses than all other forms of
property crime combined. Neo-classical economic theory, methodology, and praxis combine
to optimize criminogenic environments that hyper-inflate financial bubbles and produce
recurrent, intensifying financial crises. A criminogenic environment is one that creates such
perverse incentives that it leads to widespread crime. Financial control frauds’ “weapon of
choice” is accounting. Neoclassical theory, which dominates law & economics, is
criminogenic because it assumes that control fraud cannot exist while recommending legal
policies that optimize an industry for control fraud. Its hostility to regulation, endorsement of
opaque assets that lack readily verifiable market values, and support for executive
compensation that creates perverse incentives to engage in accounting control fraud and
optimizes fraudulent CEOs’ ability to convert firm assets to the CEO’s personal benefit have
created a nearly perfect crime. Studies have shown that control fraud was invariably present at
the typical large S&L failure. There is a consensus about the decisive role of control fraud in
the Enron era frauds. The FBI began testifying publicly in September 2004 that there was an
epidemic of mortgage fraud and predicting that it would cause an economic crisis if it were not
contained. Similar widescale control frauds have driven financial crises in other nations. It is
astounding, therefore, that neo-classical economists overwhelmingly ignore even the
possibility of control fraud in the current crisis.
Judge Easterbrook and Professor Fischel are the leading proponent of the naive neoclassical
theory that markets automatically and promptly exclude frauds. They view managers as so
pure that “a rule against fraud is not an essential or even necessarily an important ingredient of
securities markets” (1991: 283). Their book was written after Professor Fischel, as a
consultant to three of the most notorious control frauds of the 1980s, tried out their theories in
the real world – and found that they failed catastrophically. Fischel praised the worst frauds.
Fischel & Easterbrook did not disclose to their readers that their theories were falsified in the
real world.
George Akerlof’s famous article about lemons markets (1970) illustrated one of the worst
problems that asymmetical information could cause and began the research that led to the
award of the Nobel Prize in Economics to him and two other scholars of asymmetrical
information in 2001. The examples of lemons markets that Akerlof explored in that article
were all anti-consumer control frauds in which the deceit hides quality defects in the goods.

Akerlof explained that this could cause a Gresham’s dynamic in which cheaters prospered and
market forces drove honest competitors out of the industry. A Gresham’s dynamic is intensely
criminogenic. Akerlof was one of the first to realize that white-collar criminals didn’t simply
commit crimes – they created the perverse incentives that twisted private market discipline
into a immoral force that harmed markets. Indeed, Akerlof demonstrated that if fraud becomes
serious it can cause markets to fail rather than to clear (a point I will return to shortly).
Epidemics of control fraud are superb devices for hyper-inflating financial bubbles. Akerlof &
Romer and I both warned in 1993 that the S&L control frauds had caused the Southwest
commercial real estate bubble to hyper-inflate (Akerlof & Romer 1993; Black 1993). The
epidemic of mortgage fraud was essential to the creation of the largest bubble in history, the
U.S. housing bubble (Black 2010).
Fraud is instrinsically dangerous to markets in another fashion that can cause crises. At law,
the defining element of fraud that distinguishes it from other forms of larceny is deceit. A
fraudster gets the victim to trust him – and then betrays that trust. Fraud, therefore, is the most
effective acid for destroying trust. Epidemics of accounting control fraud lead to massively
overstated asset values. This can cause bankers to distrust other bankers – which can cause
markets to collapse instead of clear.
Neo-Classical Economic Policies are Criminogenic: They Cause Control Fraud Epidemics
Neo-classical economics failed to build on Akerlof’s work to develop a coherent theory of
fraud, bubbles, or financial crises (Black 2005). It continued to rely on a single
methodological approach (econometrics) that inherently produces the worst possible policy
advice during the expansion phase of a bubble.
Control frauds can cause enormous losses, while minimizing the risk that controlling officers
will be sanctioned because only the CEO can (Black 2005):
 Optimize the firm’s operations and structures for fraud
 Set a corrupt tone at the top, and suborn controls, employees and officers into
becoming allies
 Convert firm assets to the CEO’s personal benefit throught seemingly normal corporate
compensation mechanisms
 Optimize the external environment for control fraud, e.g., by creating regulatory black
holes.
These perverse factors were first identified in connection with the S&L debacle of the 1980s.
The National Commission on Financial Institution Reform Recovery and Enforcement
(NCFIRRE) (1993), report on the causes of the S&L debacle documented the patterns.
The typical large failure was a stockholder-owned, state-chartered institution in Texas
or California where regulation and supervision were most lax…. [It] had grown at an
extremely rapid rate, achieving high concentrations of assets in risky ventures….
[E]very accounting trick available was used to make the institution look profitable,
safe, and solvent. Evidence of fraud was invariably present as was the ability of the

operators to “milk” the organization through high dividends and salaries, bonuses,
perks and other means (NCFIRRE 1993: 3-4).
[A]busive operators of S&L[s] sought out compliant and cooperative accountants. The
result was a sort of "Gresham's Law" in which the bad professionals forced out the good
(NCFIRRE 1993: 76).
James Pierce, NCFIRRE’s Executive Director, explained:
Accounting abuses also provided the ultimate perverse incentive: it paid to seek out bad
loans because only those who had no intention of repaying would be willing to offer the
high loan fees and interest required for the best looting. It was rational for operators to
drive their institutions ever deeper into insolvency as they looted them (1994: 10-11).
A lender optimizes accounting control fraud through a four-part recipe. Top economists,
criminologists, and the savings and loan (S&L) regulators agreed that this recipe is a “sure thing”
– producing guaranteed, record (fictional) near-term profits and catastrophic losses in the longerterm. Akerlof & Romer (1993) termed the strategy: Looting: Bankruptcy for Profit. The firm
fails, but the officers become wealthy (Bebchuk, Cohen& Spamann 2010).
 Extremely rapid growth
 Lending at high (nominal) yield to borrowers that will frequently be unable to repay
 Extreme leverage
 Providing grossly inadequate reserves against the losses inherent in making bad loans
Nonprime mortgage lenders followed the same recipe. Growth was extreme.
In summary, the bank in our analysis pursued an aggressive expansion strategy relying
heavily on broker originations and low-documentation loans in particular. The strategy
allowed the bank to grow at an annualized rate of over 50% from 2004 to 2006. Such a
business model is typical among the major players that enjoyed the fastest growth during
the housing market boom and incurred the heaviest losses during the downturn (Jiang,
Aiko & Vylacil 2009: 9).
Loan standards collapsed. Cutter (2009), a managing partner of Warburg Pincus, explains:
In fact, by 2006 and early 2007 everyone thought we were headed to a cliff, but no one
knew when or what the triggering mechanism would be. The capital market experts I was
listening to all thought the banks were going crazy, and that the terms of major loans
being offered by the banks were nuttiness of epic proportions.
Leverage was exceptional. Unregulated nonprime lenders had no meaningful capital rules.
Honest lenders would establish record high loss reserves pursuant to generally accepted
accounting principles (GAAP). “The industry's reserves-to-loan ratio has been setting new
record lows for the past four years” (A.M. Best 2006: 3). The ratio fell to 1.21 percent as of
September 30, 2005 (Id.: 4-5). Later, “loan loss reserves are down to levels not seen since 1985”

(roughly one percent) (A.M. Best 2007: 1). It noted that these inadequate loss reserves in 1985
led to banking and S&L crises. In 2009, IMF estimated losses on U.S. originated assets of $2.7
trillion (IMF 2009: 35 Table 1.3) (roughly 30 times larger than bank loss reserves).
Fraud Warnings
The claim that no one could have foreseen the crisis is false. Unlike the S&L debacle, the FBI
was far ahead of the regulators in recognizing that there was an “epidemic” of mortgage fraud
and that it could cause a financial crisis. The FBI warned in September 2004 (CNN) that the
“epidemic” of mortgage fraud would cause a “crisis” if it were not contained. The FBI has
emphasized that 80 percent of mortgage fraud losses occur when lending industry insiders are
part of the fraud scheme. The FBI deserves enormous credit for sounding such a strong,
accurate, and public warning. Special praise should also go to Inman News, which put out a
series of reports about mortgage fraud that culminated in a compendium in 2003 entitled: “Real
Estate Fraud: The Housing Industry’s White-Collar Epidemic.” The warnings about appraisal
fraud were equally stark – “Home Insecurity: How Widespread Appraisal Fraud Puts
Homeowners at Risk” (Demos 2005). The remarkable fact is that the private sector, the
regulators, and the prosecutors failed to take effective action despite these warnings. The failure
to act is all the more troubling because the nonprime lenders followed the distinctive four-part
recipe for lenders optimizing accounting control fraud that regulators, economists, and
criminologists had documented and explained in the S&L debacle, during financial privatization
(e.g., tunneling), and in the Enron-era control frauds.
Fraud Markers
S&L regulators (in the 1980s) and criminologists and economists (in the 1990s) had identified
fraud “markers” (a term borrowed from pathology) that only fraudulent lenders would employ.
Gutting underwriting is essential for lenders engaged in accounting control fraud because they
have to make massive amounts of bad loans in order to grow extremely rapidly and charge
premium interest rates in order to optimize near-term accounting “profits.” Banks (and
economists) have known for centuries that gutting mortgage underwriting leads to “adverse
selection” (lending to borrowers that will often not be able or willing repay their loans). The
“expected value” of adverse selection is sharply negative, i.e., the lender will invariably lose
money (once the losses become manifest).
S&L regulators looked for fraud “markers”, such as deliberately lending to uncreditworthy
borrowers by inflating appraisals or by ignoring a track record of defaults that no honest lender
would commit (Black, Calavita & Pontell 1985; Black 2005).
S&L regulators used these markers to identify and close the accounting control frauds while they
were reporting record profits and minimal losses in the 1980s before they could cause a
nationwide financial bubble, a general economic crisis, or recession. The most obvious marker
is when lenders do not even take prudent steps to prevent fraud, but rather cover it up.
There is no honest reason for deliberately failing to establish adequate loss reserves, yet the
typical nonprime lender slashed general loss reserves while risk was surging and GAAP

required reserves to increase. That constitutes accounting and securities fraud, but it is also a
marker of accounting control fraud. The officers controlling nonprime lenders, by keeping
loan loss reserves at trivial levels, maxmized the lenders’ fictional income – and their
compensation.
Similarly, appraisal fraud is not only a fraud but a “marker” of a broader fraud scheme. An
honest secured lender would never inflate, or permit others to inflate, appraisal values. The
2009 FINCEN report explains why appraisal fraud adds enormously to losses from mortgage
fraud.
Lenders rely on accurate appraisals to ensure that loans are fully secured. The
Appraisal Institute and the American Society of Appraisers testified that “…it is
common for mortgage brokers, lenders, realty agents and others with a vested interest
to seek out inflated appraisals to facilitate transactions because it pays them to do so.
Higher sales prices typically generate higher fees for brokers, lenders, real estate
agents, and loan settlement offices, and higher earnings for real estate investors.
Appraisal fraud has a snowball effect on inflating real estate values, with fraudulent
values being … used by legitimate appraisers….
The Gresham’s dynamic that the accounting control frauds deliberately induced in appraisals has
been established repeatedly in surveys of appraisers.
A new survey of the national appraisal industry found that 90 percent of appraisers
reported that mortgage brokers, real estate agents, lenders and even consumers have put
pressure on them to raise property valuations to enable deals to go through. That
percentage is up sharply from a parallel survey conducted in 2003, when 55 percent of
appraisers reported attempts to influence their findings and 45 percent reported "never."
Now the latter category is down to just 10 percent.
The survey found that 75 percent of appraisers reported "negative ramifications" if they
refused to cooperate and come in with a higher valuation. Sixty-eight percent said they
lost the client -- typically a mortgage broker or lender -- following their refusal to fudge
the numbers, and 45 percent reported not receiving payment for their appraisal.
Control frauds, either directly or indirectly through the perverse incentives their compensations
systems create for loan officers, loan brokers, and mortgage brokers, cause, encourage, and
accede to endemic appraisal fraud.
The New York Attorney General’s investigation of Washington Mutual (WaMu) (one of the
largest nonprime mortgage lenders) and its appraisal practices supports this dynamic.
New York Attorney General Andrew Cuomo said [that] a major real estate appraisal
company colluded with the nation's largest savings and loan companies to inflate the
values of homes nationwide, contributing to the subprime mortgage crisis.

"This is a case we believe is indicative of an industrywide problem," Cuomo said in a
news conference.
Cuomo announced the civil lawsuit against eAppraiseIT that accuses the First American
Corp. subsidiary of caving in to pressure from Washington Mutual Inc. to use a list of
"proven appraisers" who he claims inflated home appraisals.
He also released e-mails that he said show executives were aware they were violating federal
regulations. The lawsuit filed in state Supreme Court in Manhattan seeks to stop the practice,
recover profits and assess penalties.
"These blatant actions of First American and eAppraiseIT have contributed to the growing
foreclosure crisis and turmoil in the housing market," Cuomo said in a statement. "By allowing
Washington Mutual to hand-pick appraisers who inflated values, First American helped set the
current mortgage crisis in motion."
"First American and eAppraiseIT violated that independence when Washington Mutual strongarmed them into a system designed to rip off homeowners and investors alike," he said (The
Seattle Times, November 1, 2007).

Note particularly Attorney General Cuomo’s claim that WaMu “rip[ped] off … investors.” That
is an express claim that it operated as an accounting control fraud and inflated appraisals in order
to maximize accounting “profits.” A Senate investigation has found compelling evidence that
WaMu acted in a manner that fits the accounting control fraud pattern.
http://levin.senate.gov/newsroom/release.cfm?id=323765
Pressure to inflate appraisals was endemic among nonprime lending specialists.
Appraisers complained on blogs and industry message boards of being pressured by
mortgage brokers, lenders and even builders to “hit a number,” in industry parlance,
meaning the other party wanted them to appraise the home at a certain amount regardless
of what it was actually worth. Appraisers risked being blacklisted if they stuck to their
guns. “We know that it went on and we know just about everybody was involved to some
extent,” said Marc Savitt, the National Association of Mortgage Banker’s immediate past
president and chief point person during the first half of 2009 (Washington Independent,
August 5, 2009).
These markers are pervasive in the current crisis and would have allowed effective regulatory
intervention. They can be used to prosecute the senior officials that caused the current crisis and
they can be used to limit future crises. Current regulators and prosecutors did not recognize the
markers and act effectively on the FBI warning. Current regulators and prosecutors have been so
blinded by anti-regulatory ideology that they joined the private sector in failing to act effectively
even against lenders that specialized in what the trade openly called “liar’s loans.”

Echo Epidemics of Accounting Control Fraud
The primary epidemic of accounting control fraud by nonprime lenders produced “echo”
epidemics of upstream and downstream control fraud. The primary mortgage fraud epidemic
created a criminogenic environment that caused the upstream mortgage fraud epidemic. The
downstream epidemic consists of those that purchased the nonprime product. The downstream
epidemic could not have existed without the endemic mortgage fraud the other two fraud
epidemics produced, but the downstream epidemic allowed both of the mortgage fraud
epidemics to grow far larger.
In order to maximize their (fictional) accounting income, the nonprime lenders needed to induce
others to send them massive quantities of relatively high yield mortgage loans with supporting
appraisals, without regard to credit quality. The nonprime lenders created perverse incentives
that produced a series of “Gresham’s” dynamics. This did not require any formal agreement
(conspiracy), which made it far easier to create an upstream echo epidemic and far harder to
prosecute. Traditional mortgage underwriting has shown the ability to detect fraud prior to
lending. The senior managers that controlled nonprime mortgage lenders that were control
frauds, therefore, had to eliminate competent underwriting and suborn “controls” to pervert them
into fraud allies.
When the nonprime lenders gutted their underwriting standards and controls and paid brokers
greater fees for referring nonprime loans they inherently created an intensely criminogenic
environment for loan brokers and appraisers. The brokers’ optimization strategy was simple –
refer as many relatively high yield mortgage loans as possible, as quickly as possible, with
applications and made the borrower appear to qualify for the loan. The nonprime lenders, in
essence, signaled their intention not to kick the tires and weed out even fraudulent loan
applications and appraisals. I call this the financial version of “don’t ask; don’t tell” (a justly
maligned U.S. military policy about gays serving in our armed services).
The downstream epidemic of accounting control fraud could not be created by the nonprime
lenders because they could not create a downstream Gresham’s dynamic. Indeed, the argument
runs the other direction. The nonprime loan purchasers, by adopting “don’t ask; don’t tell”,
produced a criminogenic environment that helped drive the primary mortgage fraud epidemic.
While press accounts have asserted that nonprime lenders had no concern about mortgage quality
because they intended to sell the nonprime loans, that claim assumes away the central problem
that the lender has no power to force someone to purchase the loans. The nonprime lenders were
selling mortgages that were frequently fraudulent and worth dramatically less than lender’s book
value. They were selling in circumstances that the economic theory of “lemon” markets predicts
can only be sold at a significant discount from the original book value (Akerlof 1970).
Neoclassical economic theory predicts that “private market discipline” will prevent any
downstream fraud (Black 2003). Fraudulent downstream investors rationally overpay for assets
in order to obtain greater short-term yield (increasing accounting income) and rationally adopt a
financial “don’t ask; don’t tell” policy with regard to asset quality and losses. Investors overpaid
massively for nonprime CDOs – by 65 to 85 cents on the dollar. This created an overwhelming
incentive to avoid massive loss recognition through a downstream epidemic of accounting fraud.
The bankruptcy examiner’s recent report on Lehman reveals that Lehman employed two

common forms of accounting fraud – it did not recognize huge losses on assets and it used REPO
transactions for the purpose of hiding those losses from creditors, investors, and regulators. Note
that the downstream purchasers – including Fannie and Freddie – were never required to
purchase fraudulent loans. Large numbers of liar’s loans, for example, would not have counted
towards Fannie and Freddie’s regulatory requirement to purchase set percentages of below
median income mortgages precisely because income was commonly grossly inflated. The CEOs
that controlled the large financial players purchased over a trillion dollars in liar’s loans not
because they were required to or because President Clinton and Bush gave speeches favoring
broader home ownership but because purchasing such loans created increased accounting income
(in the near term), which maximized their bonuses.
Mortgage Fraud became Endemic
It is commonly reported that roughly 40% of U.S. mortgage lending during 2006 were nonprime,
evenly split between subprime (known credit defects) and “alt-a” (purportedly high credit
quality, but lacking verification of key underwriting data). “Alt-a” loans, by definition, did not
conduct traditional underwriting (Bloomberg 2007; Gimein 2008). Liar’s loans were sold under
the bright shining lie that the borrowers had excellent credit characteristics essentially equivalent
to prime borrowers. Investment banks typically called their liar’s loans “prime” loans on their
financial statements.
When discussing a category known in the trade as “liar’s loans”, however, it is well to be keep in
mind the likelihood of deliberate misreporting of data. Over time, “alt-a” and “subprime” loans
came to increasingly common features. Lehman, for example, had a subsidiary that specialized
in liar’s loans (Aurora) and one (BNC) that specialized in subprime. Aurora increasingly made
liar’s loans to borrowers that reported substantial credit problems and BNC increasingly made
liar’s loans to its subprime customers. When Lehman finally shut down BNC, Aurora continued
to make liar’s loans to borrowers disclosing defective credit. That is an extraordinary fact, for
these were the borrowers whose incomes were typically grossly inflated. If even after the loan
broker falsified much of the information on the application (Aurora purchased 95% of its liar’s
loans) the application showed obvious credit defects and Aurora still purchased the loans, then
these actions are only rational for an accounting control fraud.
The implications of this are critical. It became the norm for liar’s loans to be made on the basis
of loan applications that, while fraudulent, also showed serious credit defects.
The typical presentation states that almost half of subprime loans, by 2006, did not conduct
traditional underwriting. That percentage may be seriously underestimated. Lenders appear to
have lied increasingly by describing liar’s loan as “prime” loans. Credit Suisse reported in
March 2007 that “we believe the most pressing areas of concern should be stated income (49%
of originations), high CLTV/piggyback (39%), and interest only/negative amortizing loans
(23%).” This is a good example of “layered risk.” The sum of the three percentages exceeds
100% because it was common to make loans that had at least two, sometimes each, of these
characteristics.

A small sample review of nonprime loan files by Fitch (2007), found that underwriting had to be
eviscerated to permit the endemic fraud that came to characterize nonprime mortgage lending.
Fitch’s analysts conducted an independent analysis of these files with the benefit of the
full origination and servicing files. The result of the analysis was disconcerting at best, as
there was the appearance of fraud or misrepresentation in almost every file.
[F]raud was not only present, but, in most cases, could have been identified with
adequate underwriting, quality control and fraud prevention tools prior to the loan
funding. Fitch believes that this targeted sampling of files was sufficient to determine that
inadequate underwriting controls and, therefore, fraud is a factor in the defaults and
losses on recent vintage pools.
MARI, the Mortgage Bankers Association (MBA’s) experts on fraud, warned that “low doc”
lending caused endemic fraud.
Stated income and reduced documentation loans … are open invitations to fraudsters. It
appears that many members of the industry have little historical appreciation for the
havoc created by low-doc/no-doc products that were the rage in the early 1990s. Those
loans produced hundreds of millions of dollars in losses for their users.
One of MARI’s customers recently reviewed a sample of 100 stated income loans upon
which they had IRS Forms 4506. When the stated incomes were compared to the IRS
figures, the resulting differences were dramatic. Ninety percent of the stated incomes
were exaggerated by 5% or more. More disturbingly, almost 60% of the stated amounts
were exaggerated by more than 50%. These results suggest that the stated income loan
deserves the nickname used by many in the industry, the “liar’s loan.”
The same obvious question (which neither Fitch nor MARI asked) arises: why did lenders fail
to use well understood underwriting systems that are highly successful in preventing fraud –
even when they knew that fraud was endemic and would cause massive losses? The same
obvious answer exists – it was in the interests of the controlling officers to optimize short-term
accounting income. Turning a blind eye to endemic fraud helped optimize reported income
and their executive compensation.
MARI’s reference to the “early 1990s” refers to a number of S&Ls that originated or
purchased “low doc” loans in the early 1990s. These loans caused “hundreds of millions of
dollars in losses.” Those losses were contained because the regulators promptly used their
supervisory powers to halt the practice when they realized that it was growing and becoming
material. We acted because we recognized that not underwriting maximized adverse selection
and guaranteed high real losses (after near-term, fictional, profits). We ordered a halt to the
practice even while many of the lenders were reporting that the lending was profitable.
“Hundreds of millions of dollars in losses” is serious, but if the losses are contained at that
level the number of lender failures will be minimal and there will be no risk of a crisis.
Unfortunately, our regulatory successors had no “historical appreciation” for successful
supervisory policies or the identification of accounting control fraud. They issued ineffective

“cautions” to the industry that “low doc” loans could be risky, but refused to order an end to
the practice and never considered the possibility that the lenders were control frauds.
Thomas J. Miller, Attorney General of Iowa, testimony at a 2007 Federal Reserve Board
hearing shows why fraud losses are enormous:
Over the last several years, the subprime market has created a race to the
bottom in which unethical actors have been handsomely rewarded for their
misdeeds and ethical actors have lost market share…. The market incentives
rewarded irresponsible lending and made it more difficult for responsible
lenders to compete. Strong regulations will create an even playing field in
which ethical actors are no longer punished.
Despite the well documented performance struggles of 2006 vintage loans,
originators continued to use products with the same characteristics in 2007.
[M]any originators … invent … non-existent occupations or income sources, or
simply inflat[e] income totals to support loan applications.
Importantly, our investigations have found that most stated income fraud occurs
at the suggestion and direction of the loan originator, not the consumer.
Because these risks were “layered” – interacting to produce far greater risk (IMF 2008: 4-5 &
n.6) – honest nonprime lenders would have responded by establishing record high general loss
reserves in accordance with generally accepted accounting principles (GAAP). Instead, A.M.
Best reported in February 2006 that: “the industry's reserves-to-loan ratio has been setting new
record lows for the past four years” (A.M. Best 2006: 3). The ratio fell to 1.21 percent as of
September 30, 2005 (Id.: 4-5). One year later, A.M. Best reported: “loan loss reserves are down
to levels not seen since 1985” (roughly one percent) (A.M. Best 2007: 1). A.M. Best went on to
point out that these grossly inadequate loss reserves in 1985 led to a decade-long crisis in
banking and S&Ls. In 2009, IMF estimated losses on U.S. originated assets of $2.7 trillion (IMF
2009: 35 Table 1.3). Total U.S. bank and S&L general loss reserves in 2006 were under $100
billion, so general loss reserves would have had to be roughly 30 times larger to be adequate. If
the lenders had established adequate loss reserves they would have reported that they were
deeply unprofitable, which was the economic reality. The banking regulatory agencies, the SEC,
and “private market discipline” all failed to require even remotely adequate reserves and minimal
honesty in financial reports. The current control frauds used the same optimization techniques as
did the S&Ls – but they did it on steroids. The primary epidemic directly created the upstream
epidemic and was a necessary, but not sufficient, cause of the upstream epidemic.
If You Don’t Investigate, You Won’t Find
Criminologists and financial regulators have long warned that the failure to regulate the financial
sphere de facto decriminalizes control fraud in the industry. The FBI cannot investigate

effectively more than a small number of the massive accounting control frauds. Only the
regulators can have the expertise, staff, and knowledge to identify on a timely basis the markers
of accounting control fraud, to prepare the detailed criminal referrals essential to serve as a
roadmap for the FBI, and to “detail” (second) staff to work for the FBI and serve as their
“Sherpas” during the investigation.
The agency regulating S&Ls made criminal prosecution a top priority. The result was over 1000
priority felony convictions of senior insiders and their co-conspirators. That is the most
successful effort against elite white-collar criminals. The agency also brought over 1000
administrative enforcement actions and hundreds of civil lawsuits against the elite frauds. One
result of this was an extensive, public record of fact that fraud was “invariably present” at the
“typical large failure” (NCFIRRE 1993). The Enron-era frauds were accounting control frauds
and while the effort against them was too late and weaker than the effort against the S&L frauds
it involved scores of prosecutions and provided substantial public documentation.
The FBI, however, after a brilliant start in identifying the epidemic of mortgage fraud, went
tragically astray and its efforts to contain the epidemic failed. The FBI suffered from a horrific
systems capacity problem. It did not have the agents or expertise to deal with the concurrent
control fraud epidemics it faced this decade. Its systems capacity problems became crippling
when 500 white-collar specialists were transferred to national security investigations in response
to the 9/11 attacks and the administration refused to allow the FBI to hire new agents to replace
the lost white-collar specialists.
The most crippling limitation on the regulators’, FBI’s, and DOJ’s efforts to contain the
epidemic of mortgage fraud and the financial crisis was not understanding of the cause of the
epidemic and why it would cause a catastrophic financial crisis. The mortgage banking industry
controlled the framing of the issue of mortgage fraud. That industry represents the lenders that
caused the epidemic of mortgage fraud. The industry’s trade association is the Mortgage
Bankers Association (MBA). The MBA followed the obvious strategy of portraying its members
as the victims of mortgage fraud. What it never discussed was that the officers that controlled its
members were the primary beneficiaries of mortgage fraud. It is the trade association of the
“perps.” The MBA claimed that all mortgage fraud was divided into two categories – neither of
which included accounting control fraud. The FBI, driven by acute systems incapacity, formed a
“partnership” with the MBA and adopted the MBA’s (facially absurd) two-part classification of
mortgage fraud (FBI 2007). The result is that there has not been a single arrest, indictment, or
conviction of a senior official of a nonprime lender for accounting fraud.
One of the most dramatic, and unfortunate differences between the S&L debacle and the current
crisis is that the financial regulatory agencies gave the FBI no help in this crisis – even after it
warned of the epidemic of mortgage fraud. The FBI does not mention the agencies in its list of
sources of criminal referrals for mortgage fraud. The data on criminal referrals for mortgage
fraud show that regulated financial institutions, which are required to file criminal referrals when
they find “suspicious activity” indicating mortgage fraud, typically fail to do so. There is no
evidence that the agencies responsible for enforcing the requirement file criminal referrals have
taken any action to crack down on the widespread violations.

The crippling mischaracterization of the nature of the mortgage fraud epidemic came from the
top, as the New York Times reported in late 2008.
But Attorney General Michael B. Mukasey has rejected calls for the Justice Department
to create the type of national task force that it did in 2002 to respond to the collapse of
Enron.
Mr. Mukasey said in June that the mortgage crisis was a different “type of phenomena”
that was a more localized problem akin to “white-collar street crime.”
The nation’s top law enforcement official swallowed the MBA’s mischaracterization of the
mortgage fraud epidemic and economic crisis hook, line, sinker, bobber, rod, reel, and boat they
rowed out into the swamp. Because Mukasey refused to investigate the elite frauds he created a
self-fulfilling prophecy in which the FBI and DOJ pursued only the “white-collar street
crim[inals]” (the small fry) and therefore confirmed that the problem was the small fry. The
pursuit of the small fry was certain to fail.
The MBA’s success in causing the FBI to ignore the control frauds reminds me of this passage in
the original Star Wars movie where Obi-Wan uses Jedi powers to pass through an Imperial
check point with two wanted droids in plain sight:
Stormtrooper: Let me see your identification.
Obi-Wan: [with a small wave of his hand] You don't need to see his identification.
Stormtrooper: We don't need to see his identification.
Obi-Wan: These aren't the droids you're looking for.
Stormtrooper: These aren't the droids we're looking for.
Obi-Wan: He can go about his business.
Stormtrooper: You can go about your business.
Obi-Wan: Move along.
Stormtrooper: Move along... move along.
Luke: I don't understand how we got by those troops. I thought we were dead.
Obi-Wan: The Force can have a strong influence on the weak-minded.
The FBI isn’t supposed to be “weak-minded” about elite white-collar criminals. It is not
supposed to be misled by “Jedi mind tricks” by the lobbyists for the “perps.” It is not supposed
to fail to understand the importance of endemic markers of accounting control fraud at every
nonprime specialty lender where even a preliminary investigation has been made public.
The FBI, DOJ, banking regulators, SEC, and all the purported sources of “private market
discipline” failed to act against (and even praised) the perverse incentive structures that the
accounting control frauds created to cause the small fry to act fraudulently. Those incentive
structures ensured that there were always far more new small fry hatched to replace the relatively
few small fry that the DOJ could imprison. Accounting control frauds deliberately produce

intensely criminogenic environments to recruit (typically without any need for a formal
conspiracy) the fraud allies that optimize accounting fraud. They create the perverse Gresham’s
dynamic that means that the cheats prosper at the expense of their honest competitors. The result
can be that the unethical drive the ethical from the marketplace. Had Mukasey been aware of
modern white-collar criminological research he would have been forced to ask why tens of
thousands of small fry were able to cause an epidemic of mortgage fraud in an industry that had
historically successfully held fraud losses to well under one percent of assets. Ignoring good
theory produces bad criminal justice policies.
The Size of the Mortgage Fraud Epidemic Swamps the FBI
The size of the current financial crisis and the incidence of fraud in the current crisis vastly
exceed the S&L debacle. The FBI testified that it “increased the number of agents around the
country who investigate mortgage fraud cases from 120 Special Agents in FY 2007 to 180
Special Agents in FY 2008….” Its testimony noted that it employed “1000 FBI agents and
forensic experts” against the S&L frauds (Pistole 2009). It received over 63,000 criminal
referrals for mortgage fraud in the last year for which it has full data (a figure that has risen
substantially every year). The FBI, therefore, can investigate only a tiny percentage of criminal
referrals for mortgage fraud. The FBI reports that 80% of mortgage fraud losses occur when
“industry insiders” are involved in the fraud (FBI 2007).
Only federally insured banks and S&Ls are required to file criminal referrals. Non-insured
lenders made 80% of nonprime mortgage loans (subprime and “alt-a”), and the made the worst
nonprime loans that most invited fraud. These lenders can make criminal referrals and it would
be in the interests of honest lenders to do so, but they rarely do. That means that the first
approximation of the true annual incidence of mortgage fraud would be to multiply 63,000 by
five (315,000). That extrapolation, however, would only be sound if (A) insured lenders spotted
all mortgage fraud and (B) filed criminal referrals when they spotted likely frauds. The FBI
believes that insured entities identify mortgage frauds prior to lending in about 20% on “no doc”
loans (known in the trade as “liar’s loans”) (New York Times, April 6, 2008). Multiplying
315,000 by five produces a product of over 1.5 million.
The data on referrals show that the typical insured lender rarely files when it finds mortgage
fraud. The October 2009 FinCEN report on criminal referrals for mortgage fraud (in jargon,
Suspicious Activity Reports (SARs) found:
In the first half of 2009, approximately 735 financial institutions submitted SARs, or
about 50 more filers compared to the same period in 2008. The top 50 filers submitted 93
percent of all [mortgage fraud] SARs, consistent with the same 2008 filing period.
However, SARs submitted by the top 10 filers increased from 64 percent to 72 percent.
Only a small percentage of mortgage lenders, 75 in total (roughly 10% of federally-insured
mortgage lenders), filed even a single criminal referral for mortgage fraud during a mortgage
fraud epidemic. Of the 735 that make at least one filing, fewer than 200 file more than four
referrals. A mere ten filers provide the FBI with almost three-quarters of all SARs mortgage
fraud filings. We cannot form an appropriate estimate of the degree of under-filing of criminal

referrals when insured banks find fraud, but we can infer that the failure to file is pervasive.
The logical explanation for the widespread failure of lenders to file criminal referrals when
they discover mortgage frauds is that they fear that if they file FBI would come to the lender
and discover its complicity in the fraud.
To sum it up, in FY 2007 the FBI has had less than one-eighth of the resources it had to
investigate the S&L frauds despite the fact that the current crisis is perhaps 30 times worse
than the S&L debacle. It was facing well over a million mortgage frauds annually. It could
investigate under 1000 cases per year. If every investigation was successful the FBI would be
completely ineffective in preventing or even slowing materially the epidemic of mortgage
fraud. Mukasey’s strategy of going after the small fry gave the control frauds a free pass and
had to fail to deter the small fry.
Could this crisis have been prevented?
Yes. Indeed, in many ways this was an easier crisis to contain successfully than many prior
financial crises. The United States had extensive experience with nonprime mortgage lending –
and it always ended badly. This is the third nonprime failure in twenty years. Nonprime
lending, on its face, is inherently imprudent. I quoted MARI about the nonprime losses of the
early 1990s and explained how we used supervisory powers to end those losses. No expensive
failures resulted and there was, of course, no crisis. Those were primarily “low doc” and
(marginally) subprime loans.
Nonprime lenders suffered considerably worse losses (and many failures) in the late 1990s.
These nonprime lenders were also known for their predatory lending practices, which led to
serious (but not criminal) sanctions by the Federal Trade Commission. The most disturbing
aspect of this series of nonprime failures was that elite commercial banks rushed to acquire the
predatory lenders even as they were failing and sued by the FTC. President Bush even appointed
the most infamous predatory subprime lender (and his largest political contributor), as our
ambassador to the Netherlands.
The nonprime loans of the current crisis were an order of magnitude worse than in the early
1990s. They were subprime loans with severe credit defects and “no doc” (“liar’s loans”). I’ve
explained why that produces severe adverse selection. Adverse selection is criminogenic. It can
produce fraud epidemics.
I noted the how the “layered” nature of the risk of nonprime loans surged during the crisis.
These risks interact, the whole is far riskier than the sum of the parts – and the sum of the parts
would have been terrifying to any honest lender. By 2006 and 2007, it was common for
nonprime loans to include each of these characteristics:

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

A trivial, or even no, downpayment
The minimal downpayment was funded by another loan
The purported loan-to-value (LTV) ratio was substantial


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The actual LTV was far higher, often >100%, because the appraisal was inflated
The loan was occurring during the worst financial bubble in history, so the LTV once the
bubble burst would greatly exceed 100%
The loans were increasingly secured by junior liens
The loan was “no doc” and the representations were not verified
The information on the loan application was false
The lender “qualified” the borrower for the loan on the basis of whether he could pay the
initial, far lower (“teaser”) interest rate rather than the fully indexed rate
The borrower could not afford to pay the fully indexed interest rate (even if the borrowers
“stated income” was accurate – it was typically inflated)
The loan payments were less than the interest due (negative amortization)
The home was not being purchased by someone who would occupy the home (despite a
contrary representation on the application)
While it was never typical, it became common for the mortgage term to be 40 years

Any experienced lender, investment banker, accountant, regulator, or rating agency official
would recognize that this was a formula for disaster. They would also understand that packaging
a thousand of these toxic mortgages together in a collateralized debt obligation (CDO) in which
80 percent of the derivative was structured as top “tranche” and was supposedly worthy of a
“AAA” rating was too good to be true. CDOs are no better than the underlying mortgages (the
various “credit enhancements” proved ephemeral). I learned by reading here in Reykjavik a
recently released governmental report on Iceland’s banking crisis, that large amounts of
worthless debt instruments of Iceland’s “Big 3” banks were put into CDOs because their debt
carried relatively high credit ratings. It should not be necessary to add that the ratings for the
(deeply insolvent and massively fraudulent Icelandic banks) bore no relationship to reality and
that this debt did not adequately “enhance” CDO credit quality.
I’ve discussed the warnings of an “epidemic” of mortgage fraud, which began in 2003, were
embraced by the FBI in 2004, and were supplemented by warnings of endemic appraisal fraud in
2005. “Stated income” loans became known throughout the industry as “liar’s loans” and grew
to roughly 30% of total new mortgages by early 2007. Many lenders made liar’s loans their
primary product. How difficult was it for a regulator (or purchaser of nonprime mortgages or
CDOs) to figure out that a business strategy of making “liar’s loans” was imprudent?
The nonprime market also made no sense on other dimensions. As I’ve just explained, the risk
of loss rose spectacularly during the decade as loan quality collapsed, fraud became endemic in
nonprime loans, and the bubble hyper-inflated. Logically, this should have caused a dramatic
increase in loss reserves and should have caused nonprime “spreads” to widen substantially.
Instead, the officers controlling the lenders reduced loan loss reserves to ridiculous levels – and
spreads narrowed. The first dimension demonstrates endemic accounting and securities fraud.
The second dimension demonstrates that markets were not only “inefficient”, but also became
increasingly inefficient throughout the growing crisis.
While Greenspan and other failed regulators have claimed that no one warned of the coming
crisis; that was truer of the S&L debacle than the current crisis. I’ve shown that there were

strong, early warnings of endemic fraud and predictions that it would cause a crisis. Nonprime
loans, as I’ve explained, had a consistently bad track record and their problems were sufficiently
recent that they should have been well known to both private and public sector leaders. The
Enron-era control frauds and New York Attorney General Spitzer’s investigations were fresh in
Americans’ minds. Those frauds made clear that:
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The most elite corporations engaged in fraud
Those frauds were led from the top
Accounting fraud produced exceptional deception – firms such as Enron that were
grossly insolvent and unprofitable purported to be immensely profitable
The large frauds were able to get “clear opinions from top tier audit firms
Executive compensation was a major driver of the frauds
Banks funded the accounting control frauds rather than exerting effective “private
market discipline” against them
Effective regulation was essential to limit such frauds

During the S&L debacle, by contrast, only one economist (Ed Kane) warned publicly of a
coming crisis arising from bad assets – and he did not warn about the wave of control fraud.
Economists virtually unanimously opposed our reregulation of the industry (Paul Volcker was
the leading exception). Economists, including Alan Greenspan, were leading allies of the worst
S&L accounting control frauds.
The most difficult aspect of the current crisis to contain was that roughly 80% of nonprime loans
were made by entities not subject to direct federal regulation (primarily mortgage bankers).
(Note that this also meant they were not subject to the Community Reinvestment Act (CRA) and
to requirements to file criminal referrals.) The Federal Reserve (Fed), however, had unique
statutory authority to regulate all mortgage lenders under the Home Ownership and Equity
Protection Act of 1994 (HOEPA), but Greenspan and Bernanke refused to use it. Finally, over a
year after the secondary market in nonprime loans (CDOs) collapsed, and after Congressional
pressure to act, the Fed used its HOEPA authority to order an end to some of the most abusive
nonprime lending practices. Prior to that time, the federal regulatory agencies acted aggressively
throughout the decade to assert federal “pre-emption” of state regulation as a means of
attempting to prevent the states from protecting their citizens from predatory nonprime lenders.
All the regulators needed to do to prevent the crisis was ban lending practices that were rational
only for control frauds engaged in looting. The regulators consistently refused to do so because
of their anti-regulatory ideology. Traditional mortgage underwriting practices are highly
effective against fraud. The regulators knew what reforms would work, but refused to mandate
the reforms.
By the time this crisis began economists (Akerlof & Romer 1993), regulators (Black 1993); and
criminologists (Calavita, Pontell & Tillman 1997; Black 2003; Black 2005) had developed
effective theories explaining why combining financial nonregulation and modern executive and

professional compensation produced criminogenic environments that led to epidemics of
accounting control fraud. We also explained why these were near perfect frauds and explained
how control frauds used their compensation and hiring and firing powers to create a “Gresham’s”
dynamic that allowed them to suborn the “independent” professionals that were supposed to
serve as “controls” and transform them into allies. (This is similar to HIV’s ability to infect the
immune system.)
One of the important practical aspects of control fraud research findings is the existence of fraud
“markers.” These can be used to identify the frauds even while they are reporting record profits
and minimal losses. The fraud markers also make it possible to prosecute successfully complex
frauds because jurors can understand that it makes no sense for honest firms to engage in such
practices but makes perfect sense for frauds.
Equally importantly, our research showed how to contain a spreading epidemic of accounting
control fraud. These policies were exceptionally effective in containing the S&L debacle. The
existence of these research findings and our regulatory record of successful efforts against the
accounting control fraud should have made it far easier for our regulatory successors (and any
honest bankers) to identify the frauds at an early date and take effective action against them.
What if We Had Looked?
Within the last month, facts have been revealed about three massive nonprime players that show
the strong evidence of elite criminality that would have been revealed – in some cases, five years
ago – had there been real investigations.
WaMu
Readers interested in reading the Senate Permanent Subcommittee on Investigations’ report and
the underlying documents can find them through this link:
http://levin.senate.gov/newsroom/release.cfm?id=323765
WaMu was an obvious disaster. Its advertising campaign mocked prudent bankers and made it
clear that WaMu’s answer to potential borrowers would be “yes.” Here are the high points
picked up by the New York Times and the Huffington Post in two recent columns:
http://www.nytimes.com/2010/04/13/business/13wamu.html?hpw
April 12, 2010
Memos Show Risky Lending at WaMu
By SEWELL CHAN
WASHINGTON — New documents released by a Senate panel show how entrenched
Washington Mutual was in fraudulent and risky lending, and highlighted how its top
executives received rewards as their institution was hurtling toward disaster.

The problems at WaMu, whose collapse was the largest in American banking history,
were well known to company executives, excerpts of e-mail messages and other internal
documents show.
The documents were released on Monday by the Senate Permanent Subcommittee on
Investigations, which began an inquiry into the financial crisis in November 2008. The
panel has summoned seven former WaMu executives to testify at a hearing on Tuesday,
including the former chief executive Kerry K. Killinger.
The panel called WaMu illustrative of problems in the origination, sale and securitization
of high-risk mortgages by any number of financial institutions from 2004 to 2008.
“Using a toxic mix of high-risk lending, lax controls and compensation policies which
rewarded quantity over quality, Washington Mutual flooded the market with shoddy
loans that went bad,” the panel’s chairman, Senator Carl Levin, Democrat of Michigan,
said.
Mr. Killinger was paid $103.2 million from 2003 to 2008. In WaMu’s final year of
existence, he received $25.1 million, including a $15.3 million severance payment.
In fairness to the reporter, I note that reporters rarely write their headlines. The headline,
however, exemplifies the weak analysis and lack of candor that dominates coverage of this crisis.
WaMu’s failure was caused by fraudulent lending practices, not “risky lending.” “Risk”, as we
conventionally use that word in economics and finance, had nothing to do with any of the three
epidemics of accounting control fraud. WaMu’s senior managers deliberately put in place
incentive structures that produce massive fraud – then gutted the protections (underwriting and
controls) that honest lenders use (successfully) to limit fraud. In combination with providing
trivial loss reserves and an executive compensation system based largely on short-term
accounting “income”, this produced a “sure thing.” It was certain that the strategy would
produce record (albeit fictional) short-term profits. If other lenders followed similar practices (as
was extremely likely), it was also certain hyper-inflate the bubble. That meant WaMu’s bad
loans could be masked for years through refinancings (WaMu also delayed the recognition of
losses by making primarily option ARM loans that allowed extremely low mortgage payments
for up to a decade – payments so low that they produced serious negative amortization.) By
masking the inevitable defaults for many years the senior executives were able to be become
exceptionally wealthy. It was also certain that this would lead to disaster for the firm. But the
failure of the firm does not represent a failure of the fraud scheme.
Criminologists view WaMu as a “vector” spreading the fraud epidemic through the financial
system. But one should have limited sympathy for the purchasers of WaMu’s fraudulent loans

for the reasons the Fitch study demonstrated. The fraudulent mortgages were typically obvious
on the face of the document. Had the purchasers of WaMu’s mortgages, typically (allegedly)
sophisticated parties, engaged in due diligence they would have found widespread fraud. Indeed,
that is one of the weaknesses of endemic mortgage fraud – it is relatively easy to spot. The
purchasers, however, engaged in “don’t ask; don’t tell” because their senior officers knew that
purchasing relatively high yield nonprime loans would produce record short-term accounting
income (and extraordinary compensation).
Killinger was made rich by the lending policies that destroyed WaMu. The fact that he is
complaining in his Congressional testimony that it was “unfair” that the taxpayers didn’t bail out
WaMu after he trashed it epitomizes the demise of elite accountability and its replacement with a
sickening sense of absolute entitlement of the group that Simon Johnson and Peter Kwak aptly
refer to as the financial “oligarchs” (2010).
http://www.huffingtonpost.com/2010/04/13/kerrykillinger-exwamu-ce_n_535749.html
Kerry Killinger, Ex-WaMu CEO, It's 'Unfair' Bank Didn't Get Bailed-Out
MARCY GORDON | 04/13/10 11:35 AM |
WaMu was one of the biggest makers of so-called "option ARM" mortgages. They
allowed borrowers to make payments so low that loan debt actually increased every
month.
The Senate subcommittee investigated the Washington Mutual failure for a year and a
half. It focused on the thrift as a case study on the financial crisis.
Senior executives of the bank were aware of the prevalence of fraud, the Senate
investigators found.
The investors who bought the mortgage securities from Washington Mutual weren't
informed of the fraudulent practices, the Senate investigators found. WaMu "dumped the
polluted water" of toxic mortgage securities into the stream of the U.S. financial system,
Levin said.
In some cases, sales associates in WaMu offices in California fabricated loan documents,
cutting and pasting false names on borrowers' bank statements. The company's own probe
in 2005, three years before the bank collapsed, found that two top producing offices – in
Downey and Montebello, Calif. – had levels of fraud exceeding 58 percent and 83 percent
of the loans. Employees violated the bank's policies on verifying borrowers' qualifications
and reviewing loans.

Citicorp
The full prepared statement of Mr. Richard Bowen, Former Senior Vice President and Business
Chief Underwriter of CitiMortgage Inc. before the Financial Crisis Inquiry Commission on April
7, 2010 can be found here:
http://www.fcic.gov/hearings/04-07-2010.php
Mr. Bowen’s testimony received far less attention because he testified on the same day as Alan
Greenspan and Citi’s former top officials. This is unfortunate because he was far more candid
about Citi’s operations than were its former senior officials. Mr. Bowen disclosed that Citi was
also a massive vector, selling roughly $50 billion annually in mostly bad mortgages (primarily to
Fannie and Freddie).
The delegated flow channel purchased approximately $50 billion of prime mortgages
annually. These mortgages were not underwriten by us before they were purchased. My
Quality Assurance area was responsible for underwriting a small sample of the files postpurchase to ensure credit quality was maintained.
These mortgages were sold to Fannie Mae, Freddie Mac and other investors. Although
we did not underwrite these mortgages, Citi did rep and warrant to the investors that the
mortgages were underwritten to Citi credit guidelines.
In mid-2006 I discovered that over 60% of these mortgages purchased and sold were
defective. Because Citi had given reps and warrants to the investors that the mortgages
were not defective, the investors could force Citi to repurchase many billions of dollars of
these defective assets. This situation represented a large potential risk to the shareholders
of Citigroup.
I started issuing warnings in June of 2006 and attempted to get management to address
these critical risk issues. These warnings continued through 2007 and went to all levels of
the Consumer Lending Group.
We continued to purchase and sell to investors even larger volumes of mortgages through
2007. And defective mortgages increased during 2007 to over 80% of production.
Lehman Brothers
The bankruptcy examiner conducted an investigation of Lehman Brothers. The report reveals
that Lehman Brothers was engaged in large scale accounting and securities fraud by failing to
recognize losses so large that it had failed as an enterprise. Lehman’s senior executives sought
to cover up its failure with a series of very large ($50 billion) quarter end REPO transactions.
Curiously, the report puts no emphasis on the underlying fraud that drove the fraud concentrates
on the second-stage REPO cover up.

Here is a link to the full series of the bankruptcy examiner’s reports:
http://lehmanreport.jenner.com/
My oral and written testimony before House Financial Services on April 20, 2010 provides a
detailed description of the evidence indicating accounting control fraud at Lehman. Lehman was
one of the principal vectors of liar’s loans in the world. The links are:
http://c‐spanvideo.org/program/id/222787

http://www.house.gov/apps/list/hearing/financialsvcs_dem/black_4.20.10.pdf
Goldman Sachs
Now, we learn that the SEC charges that Goldman Sachs should be added to the list of elite
financial frauds. It is a tale of two (unrelated) Paulsons. Hank Paulson, while Goldman’s CEO,
had Goldman buy large amounts of collateralized debt obligations (CDOs) backed by largely
fraudulent “liar’s loans.” He then became U.S. Treasury Secretary and launched a successful
war against securities and banking regulation. His successors at Goldman realized the disaster
and began to “short” CDOs. Mr. Blankfein, Goldman’s CEO, recently said Goldman was doing
“God’s work.” If true, then we know that God wanted Goldman to blow up its customers.
Goldman designed a rigged trifecta: (1) it secured additional shorting pressure from John
Paulson (CEO of a hedge fund that Goldman would love to have as an ally) that aided
Goldman’s overall strategy of using “the big short” to turned a massive loss caused by Hank
Paulson’s investment decisions into a material profit, (2) helped make John Paulson a massive
profit – in a “profession” where reciprocal favors are key, and (3) blew up its customers that
purchased the CDOs. Paulson and Goldman were shorting because they believed that the liar’s
loans were greatly overrated by the rating agencies. Goldman let John Paulson design a CDO in
which he was able to help pick the nonprime packages that were most badly overrated (and,
therefore, overpriced). Paulson created a CDO “most likely to fail.” Goldman constructed, at
John Paulson’s request, a “synthetic” CDO that had a credit default component (CDS). The CDS
allowed John Paulson to bet that the CDO he had constructed (with Goldman) to be “most likely
to fail” would in fact fail – in which case John Paulson would be become even wealthier because
of the profit he would make on the CDS.
Now, any purchaser of the “most likely to fail” CDO would obviously consider it “material
information” that the investment was structured for the sole purpose of increasing the risk of
failure (and helping Goldman “big short” strategy designed to offset losses on Hank Paulson’s
worst investments). The SEC complaint says that Goldman therefore defrauded its own
customers by representing to them that the CDO was “selected by ACA Management.” ACA
was supposed to be an independent group of experts that would “select” nonprime loans “most

likely to succeed” rather than “most likely to fail.” The SEC complaint alleges that the
representations about ACA were false.
The obvious question is: did John Paulson and ACA know that Goldman was making these false
disclosures to the CDO purchasers? Did they “aid and abet” what the SEC alleges was
Goldman’s fraud? Why have there been no criminal charges? Why did the SEC only name a
relatively low-level Goldman officer in its complaint? Where are the prosecutors?
The Rating Agencies
The Senate has released documents from the rating agencies that demonstrate that they were
willingly manipulated by perverse compensation arrangements to give grotesquely inflated
ratings to liar’s loans. At the barest minimum, the rating agencies were leading enablers of the
downstream epidemic of accounting control frauds.
Fannie and Freddie
The SEC found accounting control fraud at Fannie and Freddie and forced large restatements of
their financial statements. If they won their bet on interest rates they gained. When Fannie lost
on its interest rate risk gambles it used fraudulent “hedge” accounting to avoid recognizing its
losses. When Freddie won on its interest rate gambles it used fraudulent “hedge” accounting to
defer recognizing the gain until it had a bad quarter that would lead the executives to fail to
obtain their maximum bonus. Freddie’s managers could then make the gain magically appear so
that they would receive their maximum bonus. (This is a variant on “cookie jar reserves.”)
When the SEC found that Fannie and Freddie had engaged in accounting fraud their financial
regulator, which was then OFHEO, forced CEO changes. OFHEO also (finally) limited what
had been the rapid growth of their portfolio (which they used primarily to take interest rate risk
prior to the SEC action.)
Because Fannie and Freddie were privatized, their officers designed their compensation system
in the same perverse manner as most firms (Bebchuk & Fried 2004), they stood to gain
enormous compensation if they inflated short-term accounting income. As Mr. Raines explained
in response to a media question as to what was causing the repeated scandals at elite financial
institutions:
We've had a terrible scandal on Wall Street. What is your view?
Investment banking is a business that's so denominated in dollars that the temptations are
great, so you have to have very strong rules. My experience is where there is a one-to-one
relation between if I do X, money will hit my pocket, you tend to see people doing X a
lot. You've got to be very careful about that. Don't just say: "If you hit this revenue
number, your bonus is going to be this." It sets up an incentive that's overwhelming. You
wave enough money in front of people, and good people will do bad things.

http://msnbci.businessweek.com/magazine/content/03_20/b3833125_mz020.htm1

Raines learned that the unit that should have been most resistant to this “overwhelming”
financial incentive, Internal Audit; had succumbed to the perverse incentive. Mr. Rajappa,
1

Raines’ observation about the perverse impact of such compensation systems has been confirmed by statistical
tests. As Bebchuk & Fried, the leading experts on compensation systems, observed in their study of Fannie Mae’s
compensation system:
As we noted at the outset, we do not know whether Raines and Howard were in any way influenced by the
incentives to inflate earnings created by their compensation packages. There is a growing body of evidence,
however, that in the aggregate, the structure of executive pay affects the incentive to inflate earnings.10 For
example, pay arrangements that enable executives to time the unwinding of equity incentives have been
correlated with attempts to increase short-term stock prices by inflating earnings. Thus, the problem of
rewards for short-term results is of general concern.
n. 10 See, e.g., Scott L. Summers & John T. Sweeney, Fraudulently Misstated Financial Statements
and Insider Trading: An Empirical Analysis, 73 Acct. Rev. 131 (1998). For further discussion of this
problem, see [Lucian Bebchuk & Jesse Fried, Pay Without Performance: The Unfulfilled Promise of
Executive Compensation (2004):] at 183-85.
Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and
Camouflage. Lucian A. Bebchuk and Jesse M. Fried. Journal of Corporation Law, 2005, Vol. 30, pp. 807-822 (at
p. 811).
Even scholars opposed to many aspects of financial regulation have noted the endemic nature of these perverse
incentives and their close ties to accounting and securities fraud. Markham, Jerry W. Regulating Excessive
Executive Compensation – Why Bother? (available on SSRN: See, e.g., pp. 20- 21). The depth of consensus on
this issue is shown by the strong concurrence of the intellectual father of executive bonus systems, Michael Jensen,
who has concluded that (as implemented) they have caused pervasive perverse incentives and led to endemic
accounting and securities fraud. Jensen concludes:




When managers make any decisions other than those that maximize value in order to affect reporting to the
capital markets they are lying
And for too long we in finance have implicitly condoned or even collaborated in this lying. Specifically I
am referring to “managing earnings”, “income smoothing”, etc.
When we use terms other than lying to describe earnings management behavior we inadvertently encourage
the sacrifice of integrity in corporations and in board rooms and elsewhere
Recent Evidence from Survey of 401 CFO’s Reveals Fundamental Lack of Integrity






Graham, Harvey & Rajgopal survey (“Economic Implications of Corp. Fin. Reporting”
http://ssrn.com/abstract=491627) of 401 CFOs find:
78% of surveyed executives willing to knowingly sacrifice value to smooth earnings
Recent scandals have made CFOs less willing to use accounting manipulations to manage earnings, but
Perfectly willing to change the real operating decisions of the firm to destroy long run value to support
short run earnings targets

Jensen, Michael. Putting Integrity Into Finance Theory and Practice: A Positive Approach (June 9, 2007)
(available on SSRN).

Senior Vice President for Operations Risk and Internal Audit instructed his internal auditors in a
formal address in 2000 (and provided the text of the speech to Raines). ($6.46 refers to the
earnings per share (EPS) number that will trigger maximum bonuses.)
By now every one of you must have 6.46 branded in your brains. You must be able to say it
in your sleep, you must be able to recite it forwards and backwards, you must have a raging
fire in your belly that burns away all doubts, you must live, breath and dream 6.46, you must
be obsessed on 6.46…. After all, thanks to Frank [Raines], we all have a lot of money riding
on it…. We must do this with a fiery determination, not on some days, not on most days but
day in and day out, give it your best, not 50%, not 75%, not 100%, but 150%. Remember,
Frank has given us an opportunity to earn not just our salaries, benefits, raises, ESPP, but
substantially over and above if we make 6.46. So it is our moral obligation to give well
above our 100% and if we do this, we would have made tangible contributions to Frank’s
goals (emphasis in original).
In addition to allowing the CEO to convert firm assets to his personal benefit through seemingly
normal corporate means, executive compensation has two additional advantages to accounting
control frauds. The CEO of a large corporation cannot send a memorandum to 5000 employees
instructing them to commit accounting fraud – but he can send the same message with near
impunity through the compensation system. The CEO ensures that the compensation system
creates a criminogenic environment that produces powerful incentives for subordinated to
engage in accounting fraud in order to maximize their bonuses (which will maximize the CEO’s
bonus and the value of his stock) – all with complete deniability from the CEO. Generous
bonuses for even lower level managers also provide a powerful social pressure against whistle
blowers coming forward and leading all their peers to lose their bonuses.
Fannie and Freddie CEOs caused them to purchase huge amounts of nonprime assets because,
with their growth restricted the way to create fictional accounting income and maximize their
bonuses was to purchase for their portfolio the highest yield assets. This is the same strategy that
most of the investment banker CEOs followed. OFHEO had ample regulatory power to order
that an end to this strategy. It failed to do so because it did not believe that regulating assets
purchases was an appropriate regulatory policy prior to those assets causing serious losses. The
bubble masked those losses by allowing refinancing. The CEOs of Fannie, Freddie, Bear
Stearns, Citi, Wachovia, Merrill Lynch, and Lehman followed similar strategies for the same
perverse reasons (and that list is not exhaustive).
Other Nations Suffering from Control Fraud during this Crisis
Very recent reports by governmental authorities in Ireland, Afghanistan, and Iceland provide
strong support for concerns that control fraud played a role in their bank failures.
Specific Proposals to Reduce and Deter Accounting Control Fraud
1. Eliot Spitzer, Frank Partnoy and I proposed in our December 19, 2009 op ed in the New
York Times – that AIG’s emails and key deal documents be made public so that we can

investigate the elite control frauds. (I have called for the same disclosures of Fannie and
Freddie’s key documents.) Goldman used AIG to provide the CDS on these synthetic
CDO deals and Hank Paulson used our money to bail out Goldman when AIG’s CDS
deals drove it to failure. Treasury also used AIG to secretly bail out UBS – a massive
Swiss bank engaged in a conspiracy with wealthy Americans to commit tax
evasion/fraud. In essence, Americans paid UBS’ fine – and gave it over $4 billion is
walking away money. AIG was not federally insured. The U.S. had no responsibility to
bear its losses. AIG’s managers, directors, and trustees have failed to make any response
to our requests that they assist these vital investigations by releasing the documents. (I
have received no response to my similar open requests to Fannie and Freddie.)
2. Clarify that investors and creditors may pursue a private right of action against those that
“aid and abet” relevant frauds under the securities laws.
3. Enact Representative Kaptur’s bill to authorize, fund and direct the FBI to hire 1000
additional white-collar crime specialists as FBI agents to replace those transferred to
national security and add resources necessary to take on the backlog of control frauds.
4. The regulators, FBI, and DOJ should follow a successful strategy used during the S&L
debacle and create a “Top 100” priority list of the most significant criminal cases arising
from the Great Recession.
5. All home lenders should be required to file criminal referrals (SARs) when they discover
a reasonable suspicion of a federal crime.
6. The regulatory agencies should revitalize their criminal referral processes (which
effectively ceased to exist with regard to control frauds).
7. The regulatory agencies should “detail” experienced examiners and supervisors to the
FBI and DOJ so that they can serve as “Sherpas” to aid the investigations and
prosecutions and have access to “6e” grand jury materials.
8. DOJ/FBI should create a national task force to investigate the systemically dangerous
institutions (SDIs) and other major originators, sellers, and purchasers of nonprime paper
and financial derivatives.
9. Where appropriate, the FBI should use undercover investigators and electronic
surveillance in investigating control frauds.
10. The FBI should terminate immediately its “partnership” with the MBA.
11. The regulatory agencies should reinstate requirements for full underwriting of income,
assets, liabilities, credit ratings, and appraised values for all mortgage lenders. They
should, by rule, require that this underwriting be evidenced contemporaneously in writing

and be maintained on site for at least five years (and off site for ten years from the date of
the loan being made). While violating such rules is not a crime, this requirement is one
of the most effective means of establishing the necessary intent of those that seek to
evade the requirement.
12. The agencies should immediately review every significant nonprime lender under their
jurisdiction to determine whether they have made roughly the number of criminal
referrals that would be expected given the epidemic of mortgage fraud. Where lenders
have filed far too few referrals they should be priorities for special purpose examinations
to determine whether their failure to file referrals is an indicator that they are a control
fraud.
13. The regulatory agencies, including the CFTC, SEC, FBI, and DOJ, should create a
position of the “Chief Criminologist” staffed by someone tasked with remaining current
with white-collar criminological findings and ensuring that such findings, where relevant,
be provided as input to senior decision-makers.
14. Create minimum federal requirements for fiduciary duties, which have been badly eroded
by state “competition in laxity.” Delaware corporations, for example, have generally
eliminated the duty of care.
15. Take conflicts of interest exceptionally seriously. Forbid financial institutions to make
any loans to their employees, officers, boards, and professionals (e.g., senior personnel of
their outside auditors and rating agencies).
16. Remove the perverse incentive caused by compensation not tied to demonstrated, longterm performance. This is one of the leading criminogenic environments globally.
17. Reform professional compensation to remove the perverse incentives and “Gresham’s
dynamic” now common.
Biography of William K. Black
Bill Black is an Associate Professor of Economics and Law at the University of Missouri – Kansas City
(UMKC). He is a white‐collar criminologist. He was the Executive Director of the Institute for Fraud
Prevention from 2005‐2007. He has taught previously at the LBJ School of Public Affairs at the
University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar
in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.
He was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and
General Counsel of the Federal Home Loan Bank of San Francisco, and Senior Deputy Chief Counsel,
Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution
Reform, Recovery and Enforcement. His regulatory career is profiled in Chapter 2 of Professor Riccucci's
book Unsung Heroes (Georgetown U. Press: 1995), Chapter 4 (“The Consummate Professional: Creating
Leadership”) of Professor Bowman, et al’s book The Professional Edge (M.E. Sharpe 2004), and Joseph M.

Tonon’s article: “The Costs of Speaking Truth to Power: How Professionalism Facilitates Credible
Communication” Journal of Public Administration Research and Theory 2008 18(2):275‐295.
George Akerlof called his book, The Best Way to Rob a Bank is to Own One (University of Texas Press
2005), “a classic.” Paul Volcker praised its analysis of the critical role of Bank Board Chairman Gray’s
leadership in reregulating and resupervising the industry:
Bill Black has detailed an alarming story about financial ‐ and political ‐ corruption. The specifics
go back twenty years, but the lessons are as fresh as the morning newspaper. One of those
lessons really sticks out: one brave man with a conscience could stand up for us all.
Robert Kuttner, in his Business Week column, proclaimed:
Black's book is partly the definitive history of the savings‐and‐loan industry scandals of the early
1980s. More important, it is a general theory of how dishonest CEOs, crony directors, and
corrupt middlemen can systematically defeat market discipline and conceal deliberate fraud for
a long time ‐‐ enough to create massive damage.
Black developed the concept of “control fraud” – frauds in which the CEO or head of state uses the
entity as a “weapon.” Control frauds cause greater financial losses than all other forms of property
crime combined and kill and maim thousands. He helped the World Bank develop anti‐corruption
initiatives and served as an expert for OFHEO in its enforcement action against Fannie Mae’s former
senior management.
He teaches White‐Collar Crime, Public Finance, Antitrust, Law & Economics (all joint, multidisciplinary
classes for economics and law students), and Latin American Development (co‐taught with Professor
Grieco, UMKC – History).

References and Suggested Readings
Akerlof, G. 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism".
Quarterly Journal of Economics 84 (3), pp. 488–500.
Akerlof, G., Romer P., 1993. “Looting: The Economic Underworld of Bankruptcy for Profit,”
in: Brainard, W., Perry, G. (Eds.), Brookings Papers on Economic Activity 2: 1-73.
A.M. Best. 2006. “U.S. Banking Trends for 2005 – Signaling End of Peak Industry Cycle.”
www.ambest.com/banks/reports/ambest-bankingtrends2005.pdf
A.M. Best. 2007. “Are Loss Reserves Adequate in Light of Rising Delinquencies?”
www.ambest.com/banks/reports/AMBEST-usissues.pdf
Bebchuk, L. and Fried, J. 2004. Pay Without Performance. Harvard Univ. Press.
Bebchuk, L. Cohen, A. & Holger Spamann. 2010. „The Wages of Failure: Executive Compensation at
Bear Stearns and Lehman 2000‐2008.“ (Revised 2/2010).

http://ssrn.com/abstract=1513522

Black, W., 1993. „ADC Lending“ Unpublished Staff Report No. 2, National Commission on
Financial Institution Reform, Recovery and Enforcement.
The Savings and Loan Debacle of the 1980's: White-Collar Crime or Risky Business? (with K. Calavita
and H. Pontell) Law and Policy. Vol. 17, No. 1 (January 1995: 23-55).

Black, W., 2003. “Reexamining the Law-and-Economics Theory of Corporate Governance.”
Challenge 46, No. 2 March/April, 22-40.
Black, W., 2005. The Best Way to Rob a Bank is to Own One: How Corporate Executives and
Politicians Looted the S&L Industry. University of Texas, Austin.
Black, W., 2007. “When Fragile Become Friable: Endemic Control Fraud as a Cause of
Economic Stagnation and Collapse,” in White Collar Crimes: a Debate, K. Naga Srivalli, ed.,
Hyderabad, India, The Icfai University Press (2007: 162-178).
Bloomberg. July 24, 2007. “Defaults on Some ‘Alt A’ Loans Surpass Subprime Ones.”
Black, W., forthcoming. Epidemics of “Control Fraud” Lead to Recurrent, Intensifying
Bubbles and Crises.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aeWSvfvHw3cQ&refer=home
Calavita, K., Pontell, H., Tillman, R., 1997. Big Money Crime. University of California Press,
Berkeley.
CNN. 2004. "FBI warns of mortgage fraud 'epidemic': Seeks to head off 'next S&L crisis'"
(Sept. 17).
Credit Suisse. 2007. “Mortgage Liquidity du Jour: Underestimated No More (12 March).
Cutter, B. November 24, 2009. “Keep Tim Geithner.” http://www.newdeal20.org/?p=6569
Demos. 2005. “How Widespread Appraisal Fraud Puts Homeowners at Risk.”
Easterbrook, F., Fischel, D., 1991. The Economic Structure of Corporate Law. Harvard
University Press, Cambridge, Mass.
FBI. 2007. “Mortgage Fraud: New Partnership to Combat Problem” (March 9).
http://www.fbi.gov/page2/march07/mortgage030907.htm
Financial Crimes Enforcement Network (FinCEN). October 2009. “The SAR Activity Review.”
http://www.fincen.gov/news_room/rp/files/sar_tti_16.pdf

Fischel, D. 1995. Payback: The Conspiracy to Destroy Michael Milken and His Financial
Revolution. HarperBusiness.
Fitch. 2007. “The Impact of Poor Underwriting Practices and Fraud in Subprime RMBS
Performance” (November 28).
Gimein, M. 2008. “Inside the Liar’s Loan: How the Mortgage Industry Nurtured Deceit.” Slate
(July 24).
http://www.slate.com/id/2189576/
Gormley, Michael. November 1, 2007. “Cuomo: Appraisers pressured to inflate subprime
mortgage values.”
http://seattletimes.nwsource.com/html/businesstechnology/2003987769_webwamu01.html
Harney, Kenneth R. February 3, 2007. “Appraisers Under Pressure to Inflate Values.”
http://www.washingtonpost.com/wp-dyn/content/article/2007/02/02/AR2007020200712.html
Inman News. 2003. “Real Estate Fraud: The Housing Industry’s White-Collar Epidemic.”
http://www.docstoc.com/docs/3927640/Real-Estate-Fraud-The-Housing-Industry-s-WhiteCollar-Epidemic
MARI. 2006. “Eighth Periodic Case Report to the Mortgage Bankers Association.”
http://www.marisolutions.com/pdfs/mba/MBA8thCaseRpt.pdf
National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE),
1993. Origins and Causes of the S&L Debacle: A Blueprint for Reform. A Report to the
President and Congress of the United States. Government Printing Office, Washington, D.C.
New York Times. 2008. “F.B.I. Looks Into 4 Firms at Center of the Economic Turmoil.”
(September 24.)
http://www.nytimes.com/2008/09/24/business/24inquiry.html
Jiang, W., A. Aiko, Vytlacil N., 2009. “Liar’s Loan? Effects of Origination Channel and Information
Falsification on Mortgage Delinquency.” Working Paper, Columbia University, August 2009.

Pierce, J., 2004. Causes of the S&L Debacle. Unpublished paper presented at the annual
meeting of the Allied Social Sciences Association. On file with author.
Pistole, J. February 11, 2009. Testimony before the United States Senate Committee on the
Judiciary. “The Need for Increased Fraud Enforcement in the Wake of the Economic
Downturn.”

Pummer, C. April 24, 2007. “Real-Estate Appraisers Feel Pressure to Inflate Home Values.” In
Market Watch.
http://www.realestatejournal.com/buysell/markettrends/20070424-pummer.html
Wheeler, S., Rothman, M. 1982. The Organization as Weapon in White Collar Crime. Michigan
Law Review 80, No. 7: 1403-1426.