How to rob a bank (from the inside, that is)

William Black is a former bank regulator who’s seen firsthand how banking systems can be used to commit fraud — and how “liar's loans” and other tricky tactics led to the 2008 US banking crisis that threatened the international economy. In this engaging talk, Black, now an academic, reveals the best way to rob a bank — from the inside.

So today's top chef class is in how to rob a bank,

and it's clear that the general public needs guidance,

because the average bank robbery nets

only 7,500 dollars.

Rank amateurs who know nothing

about how to cook the books.

The folks who know, of course,

run our largest banks,

and in the last go-around,

they cost us over 11 trillion dollars.

That's what 11 trillion looks like.

That's how many zeros?

And cost us over 10 million jobs as well.

So our task is to educate ourselves

so that we can understand

why we have these recurrent,

intensifying financial crises,

and how we can prevent them in the future.

And the answer to that is

that we have to stop epidemics of control fraud.

Control fraud is what happens

when the people who control,

typically a CEO,

a seemingly legitimate entity,

use it as a weapon to defraud.

And these are the weapons of mass destruction

in the financial world.

They also follow in finance a particular strategy,

because the weapon of choice in finance

is accounting,

and there is a recipe for accounting

control fraud, and how it occurs.

And we discovered this recipe

in quite an odd way that I'll
come back to in a moment.

First ingredient in the recipe: grow like crazy;

second, by making or buying really crappy loans,

but loans that are made at a very high interest rate

or yield;

three, while employing extreme leverage --

that just means a lot of debt --

compared to your equity;

and four, while providing only trivial loss reserves

against the inevitable losses.

If you follow those four simple steps,

and any bank can follow them,

then you are mathematically guaranteed

to have three things occur.

The first thing is

you will report record bank profits --

not just high, record.

Two, the CEO will immediately
be made incredibly wealthy

by modern executive compensation.

And three, farther down the road,

the bank will suffer catastrophic losses

and will fail unless it is bailed out.

And that's a hint as to how

we discovered this recipe,

because we discovered it
through an autopsy process.

During the savings and loan debacle in 1984,

we looked at every single failure,

and we looked for common characteristics,

and we discovered this recipe was common

to each of these frauds.

In other words, a coroner could find these things

because this is a fatal recipe

that will destroy the banks

as well as the economy.

And it also turns out to be precisely

what could have stopped this crisis,

the one that cost us 11 trillion dollars

just in the household sector,

that cost us 10 million jobs,

was the easiest financial crisis by far

to have avoided completely

if we had simply learned the lessons

of epidemics of control fraud,

particularly using this recipe.

So let's go to this crisis,

and the two huge epidemics

of loan origination fraud that drove the crisis --

appraisal fraud and liar's loans --

and what we're going to see

in looking at both of these is

we got warnings that were incredibly early

about these frauds.

We got warnings that we could
have taken advantage of easily,

because back in the savings and loan debacle,

we had figured out how to respond

and prevent these crises.

And three, the warnings were unambiguous.

They were obvious that what was going on

was an epidemic of accounting control fraud building up.

Let's take appraisal fraud first.

This is simply where you inflate the value

of the home that is being pledged

as security for the loan.

In 2000, the year 2000,

that is over a year before Enron fails, by the way,

the honest appraisers got together a formal petition

begging the federal government to act,

and the industry to act,

to stop this epidemic of appraisal fraud.

And the appraisers explained how it was occurring,

that banks were demanding that appraisers

inflate the appraisal,

and that if the appraisers refused to do so,

they, the banks, would blacklist

honest appraisers

and refuse to use them.

Now, we've seen this before

in the savings and loan debacle,

and we know that this kind of fraud

can only originate from the lenders,

and that no honest lender would ever inflate

the appraisal,

because it's the great protection against loss.

So this was an incredibly early warning, 2000.

It was something we'd seen before,

and it was completely unambiguous.

This was an epidemic of accounting control fraud

led by the banks.

What about liar's loans?

Well, that warning actually comes earlier.

The savings and loan debacle is basically

the early 1980s through 1993,

and in the midst of fighting that wave

of accounting control fraud,

in 1990, we found that a second front

of fraud was being started.

And like all good financial frauds in America,

it began in Orange County, California.

And we happened to be the regional regulators for it.

And our examiners said,

they are making loans without even checking

what the borrower's income is.

This is insane, it has to lead to massive losses,

and it only makes sense for entities engaged

in these accounting control frauds.

And we said, yeah, you're absolutely right,

and we drove those liar's loans

out of the industry in 1990 and 1991,

but we could only deal with the industry

we had jurisdiction over,

which was savings and loans,

and so the biggest and the baddest of the frauds,

Long Beach Savings, voluntarily gave up

its federal savings and loan charter,

gave up federal deposit insurance,

converted to become a mortgage bank

for the sole purpose of escaping our jurisdiction,

and changed its name to Ameriquest,

and became the most notorious

of the liar's loans frauds early on,

and to add to that,

they deliberately predated upon minorities.

So we knew again about this crisis.

We'd seen it before. We'd stopped it before.

We had incredibly early warnings of it,

and it was absolutely unambiguous

that no honest lender would
make loans in this fashion.

So let's take a look at the reaction

of the industry and the regulators

and the prosecutors to these clear

early warnings that could have prevented the crisis.

Start with the industry.

The industry responded between 2003 and 2006

by increasing liar's loans

by over 500 percent.

These were the loans

that hyperinflated the bubble

and produced the economic crisis.

By 2006, half of all the loans called subprime

were also liar's loans.

They're not mutually exclusive, it's just that together,

they're the most toxic combination

you can possibly imagine.

By 2006, 40 percent of all the loans

made that year, all the home loans made that year,

were liar's loans,

40 percent.

And this is despite a warning

from the industry's own antifraud experts

that said that these loans were an open invitation

to fraudsters,

and that they had a fraud incidence

of 90 percent,

nine zero.

In response to that, the industry

first started calling these loans liar's loans,

which lacks a certain subtlety,

and second, massively increased them,

and no government regulator ever

required or encouraged any lender

to make a liar's loan

or anyone to purchase a liar's loan,

and that explicitly includes Fannie and Freddie.

This came from the lenders

because of the fraud recipe.

What happened to appraisal fraud?

It expanded remarkably as well.

By 2007, when a survey of appraisers was done,

90 percent of appraisers reported

that they had been subject to coercion

from the lenders trying to get them

to inflate an appraisal.

In other words, both forms of fraud

became absolutely endemic and normal,

and this is what drove the bubble.

What happened in the governmental sector?

Well, the government, as I told you,

when we were the savings and loan regulators,

we could only deal with our industry,

and if people gave up their
federal deposit insurance,

we couldn't do anything to them.

Congress, it may strike you as impossible,

but actually did something intelligent in 1994,

and passed the Home Ownership
and Equity Protection Act

that gave the Fed, and only the Federal Reserve,

the explicit, statutory authority to ban liar's loans

by every lender,

whether or not they had federal deposit insurance.

So what did Ben Bernanke and Alan Greenspan,

as chairs of the Fed, do

when they got these warnings

that these were massively fraudulent loans

and that they were being sold
to the secondary market?

Remember, there's no fraud exorcist.

Once it starts out a fraudulent loan,

it can only be sold to the secondary market

through more frauds,

lying about the reps and warrantees,

and then those people are going to produce

mortgage-backed securities

and exotic derivatives

which are also going to be supposedly backed

by those fraudulent loans.

So the fraud is going to progress

through the entire system,

hyperinflate the bubble, produce a disaster.

And remember, we had experience with this.

We had seen significant losses,

and we had experience of competent regulators

in stopping it.

Greenspan and Bernanke refused

to use the authority under the statute

to stop liar's loans.

And this was a matter first of dogma.

They're just horrifically opposed

to anything regulatory.

But it is also the international competition in laxity,

the race to the bottom

between the United States and the United Kingdom,

the city of London, in particular,

and the city of London won that race to the bottom,

but it meant that all regulation in the West

was completely degraded

in this stupid competition to be

who could have the weakest regulation.

So that was the regulatory response.

What about the response of the prosecutors

after the crisis,

after 11 trillion dollars in losses,

after 10 million jobs lost,

a crisis in which the losses and the frauds

were more than 70 times larger

than the savings and loan debacle?

Well, in the savings and loan debacle,

our agency that regulated savings and loans, OTS,

made over 30,000 criminal referrals,

produced over 1,000 felony convictions

just in cases designated as major,

and that understates the degree of prioritization,

because we worked with the FBI

to create the list of the top 100 fraud schemes,

the absolute worst of the worst, nationwide.

Roughly 300 savings and loans involved,

roughly 600 senior officials.

Virtually all of them were prosecuted.

We had a 90 percent conviction rate.

It's the greatest success against

elite white collar criminals ever,

and it was because of this understanding

of control fraud

and the accounting control fraud mechanism.

Flash forward to the current crisis.

The same agency, Office of Thrift Supervision,

which was supposed to regulate

many of the largest makers of liar's loans

in the country,

has made, even today -- it no longer exists,

but as of a year ago,

it had made zero criminal referrals.

The Office of the Comptroller of the Currency,

which is supposed to regulate
the largest national banks,

has made zero criminal referrals.

The Fed appears to have made

zero criminal referrals.

The Federal Deposit Insurance Corporation

is smart enough to refuse to answer the question.

Without any guidance from the regulators,

there's no expertise in the FBI

to investigate complex frauds.

It isn't simply that they've had

to reinvent the wheel

of how to do these prosecutions;

they've forgotten that the wheel exists,

and therefore, we have zero prosecutions,

and of course, zero convictions,

of any of the elite bank frauds,

the Wall Street types,

that drove this crisis.

With no expertise coming from the regulators,

the FBI formed what it calls a partnership

with the Mortgage Bankers Association in 2007.

The Mortgage Bankers Association

is the trade association of the perps.

And the Mortgage Bankers Association

set out, it had the audacity and the success

to con the FBI.

It had created a supposed definition

of mortgage fraud, in which, guess what,

its members are always the victim

and never the perpetrators.

And the FBI has bought this hook, line, sinker,

rod, reel and the boat they rode out in.

And so the FBI,

under the leadership of an attorney general

who is African-American

and a president of the United
States who is African-American,

have adopted the Tea Party definition of the crisis,

in which it is the first virgin crisis in history,

conceived without sin in the executive ranks.

And it's those oh-so-clever hairdressers

who were able to defraud the poor, pitiful banks,

who lack any financial sophistication.

It is the silliest story you can conceive of,

and so they go and they prosecute the hairdressers,

and they leave the banksters alone entirely.

And so, while lions are roaming the campsite,

the FBI is chasing mice.

What do we need to do?

What can we do in all of this?

We need to change the perverse incentive structures

that produce these recurrent epidemics

of accounting control fraud

that are driving our crises.

So we have to first get rid

of the systemically dangerous institutions.

These are the so-called too-big-to-fail institutions.

We need to shrink them to the point,

within the next five years,

that they no longer pose a systemic risk.

Right now, they are ticking time bombs

that will cause a global crisis

as soon as the next one fails --

not if, when.

Second thing we need to do is completely reform

modern executive and professional compensation,

which is what they use to suborn the appraisers.

Remember, they were pressuring the appraisers

through the compensation system,

trying to produce what we call a Gresham's dynamic,

in which bad ethics drives good ethics

out of the marketplace.

And they largely succeeded,

which is how the fraud became endemic.

And the third thing that we need to do

is deal with what we call the three D's:

deregulation, desupervision,

and the de facto decriminalization.

Because we can make

all three of these changes, and if we do so,

we can dramatically reduce

how often we have a crisis

and how severe those crises are.

That is not simply critical to our economy.

You can see what these crises do to inequality

and what they do to our democracy.

They have produced crony capitalism,

American-style,

in which the largest financial institutions

are the leading financial donors of both parties,

and that's the reason why

even after this crisis,

70 times larger than the savings and loan crisis,

we have no meaningful reforms

in any of the three areas that I've talked about,

other than banning liar's loans,

which is good,

but that's just one form of ammunition

for this fraud weapon.

There are many forms of ammunition they can use.

That's why we need to learn

what the bankers have learned:

the recipe for the best way to rob a bank,

so that we can stop that recipe,

because our legislators,

who are dependent on political contributions,

will not do it on their own.

Thank you very much.

(Applause)