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TEDxUMKC

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

September 9, 2013

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.

William Black - Academic
William Black is a professor of economics and law at University of Missouri, Kansas City. Full bio

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Double-click the English subtitles below to play the video.
So today's top chef class is in how to rob a bank,
00:12
and it's clear that the general public needs guidance,
00:16
because the average bank robbery nets
00:20
only 7,500 dollars.
00:23
Rank amateurs who know nothing
00:26
about how to cook the books.
00:28
The folks who know, of course,
00:30
run our largest banks,
00:32
and in the last go-around,
00:34
they cost us over 11 trillion dollars.
00:36
That's what 11 trillion looks like.
00:40
That's how many zeros?
00:43
And cost us over 10 million jobs as well.
00:44
So our task is to educate ourselves
00:48
so that we can understand
00:51
why we have these recurrent,
00:52
intensifying financial crises,
00:54
and how we can prevent them in the future.
00:56
And the answer to that is
00:59
that we have to stop epidemics of control fraud.
01:02
Control fraud is what happens
01:06
when the people who control,
01:08
typically a CEO,
01:10
a seemingly legitimate entity,
01:12
use it as a weapon to defraud.
01:14
And these are the weapons of mass destruction
01:17
in the financial world.
01:20
They also follow in finance a particular strategy,
01:22
because the weapon of choice in finance
01:27
is accounting,
01:29
and there is a recipe for accounting
01:31
control fraud, and how it occurs.
01:35
And we discovered this recipe
01:37
in quite an odd way that I'll
come back to in a moment.
01:39
First ingredient in the recipe: grow like crazy;
01:41
second, by making or buying really crappy loans,
01:45
but loans that are made at a very high interest rate
01:50
or yield;
01:54
three, while employing extreme leverage --
01:55
that just means a lot of debt --
01:58
compared to your equity;
01:59
and four, while providing only trivial loss reserves
02:01
against the inevitable losses.
02:05
If you follow those four simple steps,
02:07
and any bank can follow them,
02:10
then you are mathematically guaranteed
02:13
to have three things occur.
02:15
The first thing is
02:17
you will report record bank profits --
02:19
not just high, record.
02:22
Two, the CEO will immediately
be made incredibly wealthy
02:25
by modern executive compensation.
02:30
And three, farther down the road,
02:33
the bank will suffer catastrophic losses
02:36
and will fail unless it is bailed out.
02:39
And that's a hint as to how
02:42
we discovered this recipe,
02:46
because we discovered it
through an autopsy process.
02:48
During the savings and loan debacle in 1984,
02:52
we looked at every single failure,
02:57
and we looked for common characteristics,
02:59
and we discovered this recipe was common
03:01
to each of these frauds.
03:06
In other words, a coroner could find these things
03:08
because this is a fatal recipe
03:11
that will destroy the banks
03:14
as well as the economy.
03:15
And it also turns out to be precisely
03:17
what could have stopped this crisis,
03:21
the one that cost us 11 trillion dollars
03:23
just in the household sector,
03:26
that cost us 10 million jobs,
03:28
was the easiest financial crisis by far
03:30
to have avoided completely
03:33
if we had simply learned the lessons
03:36
of epidemics of control fraud,
03:38
particularly using this recipe.
03:40
So let's go to this crisis,
03:42
and the two huge epidemics
03:44
of loan origination fraud that drove the crisis --
03:47
appraisal fraud and liar's loans --
03:51
and what we're going to see
03:54
in looking at both of these is
03:55
we got warnings that were incredibly early
03:57
about these frauds.
04:01
We got warnings that we could
have taken advantage of easily,
04:03
because back in the savings and loan debacle,
04:07
we had figured out how to respond
04:09
and prevent these crises.
04:12
And three, the warnings were unambiguous.
04:14
They were obvious that what was going on
04:17
was an epidemic of accounting control fraud building up.
04:20
Let's take appraisal fraud first.
04:25
This is simply where you inflate the value
04:27
of the home that is being pledged
04:29
as security for the loan.
04:32
In 2000, the year 2000,
04:35
that is over a year before Enron fails, by the way,
04:38
the honest appraisers got together a formal petition
04:42
begging the federal government to act,
04:47
and the industry to act,
04:50
to stop this epidemic of appraisal fraud.
04:52
And the appraisers explained how it was occurring,
04:55
that banks were demanding that appraisers
04:59
inflate the appraisal,
05:02
and that if the appraisers refused to do so,
05:04
they, the banks, would blacklist
05:08
honest appraisers
05:11
and refuse to use them.
05:14
Now, we've seen this before
05:16
in the savings and loan debacle,
05:19
and we know that this kind of fraud
05:20
can only originate from the lenders,
05:22
and that no honest lender would ever inflate
05:25
the appraisal,
05:28
because it's the great protection against loss.
05:29
So this was an incredibly early warning, 2000.
05:32
It was something we'd seen before,
05:36
and it was completely unambiguous.
05:38
This was an epidemic of accounting control fraud
05:40
led by the banks.
05:44
What about liar's loans?
05:45
Well, that warning actually comes earlier.
05:47
The savings and loan debacle is basically
05:51
the early 1980s through 1993,
05:53
and in the midst of fighting that wave
05:57
of accounting control fraud,
06:00
in 1990, we found that a second front
06:02
of fraud was being started.
06:06
And like all good financial frauds in America,
06:09
it began in Orange County, California.
06:11
And we happened to be the regional regulators for it.
06:15
And our examiners said,
06:18
they are making loans without even checking
06:19
what the borrower's income is.
06:23
This is insane, it has to lead to massive losses,
06:25
and it only makes sense for entities engaged
06:30
in these accounting control frauds.
06:33
And we said, yeah, you're absolutely right,
06:36
and we drove those liar's loans
06:38
out of the industry in 1990 and 1991,
06:41
but we could only deal with the industry
06:46
we had jurisdiction over,
06:48
which was savings and loans,
06:50
and so the biggest and the baddest of the frauds,
06:51
Long Beach Savings, voluntarily gave up
06:55
its federal savings and loan charter,
06:58
gave up federal deposit insurance,
07:01
converted to become a mortgage bank
07:03
for the sole purpose of escaping our jurisdiction,
07:05
and changed its name to Ameriquest,
07:09
and became the most notorious
07:11
of the liar's loans frauds early on,
07:13
and to add to that,
07:16
they deliberately predated upon minorities.
07:18
So we knew again about this crisis.
07:23
We'd seen it before. We'd stopped it before.
07:27
We had incredibly early warnings of it,
07:30
and it was absolutely unambiguous
07:34
that no honest lender would
make loans in this fashion.
07:36
So let's take a look at the reaction
07:40
of the industry and the regulators
07:43
and the prosecutors to these clear
07:46
early warnings that could have prevented the crisis.
07:48
Start with the industry.
07:53
The industry responded between 2003 and 2006
07:55
by increasing liar's loans
08:01
by over 500 percent.
08:03
These were the loans
08:09
that hyperinflated the bubble
08:11
and produced the economic crisis.
08:12
By 2006, half of all the loans called subprime
08:16
were also liar's loans.
08:21
They're not mutually exclusive, it's just that together,
08:23
they're the most toxic combination
08:26
you can possibly imagine.
08:29
By 2006, 40 percent of all the loans
08:30
made that year, all the home loans made that year,
08:34
were liar's loans,
08:37
40 percent.
08:40
And this is despite a warning
08:41
from the industry's own antifraud experts
08:44
that said that these loans were an open invitation
08:47
to fraudsters,
08:50
and that they had a fraud incidence
08:52
of 90 percent,
08:54
nine zero.
08:56
In response to that, the industry
08:59
first started calling these loans liar's loans,
09:02
which lacks a certain subtlety,
09:07
and second, massively increased them,
09:11
and no government regulator ever
09:14
required or encouraged any lender
09:17
to make a liar's loan
09:21
or anyone to purchase a liar's loan,
09:22
and that explicitly includes Fannie and Freddie.
09:25
This came from the lenders
09:28
because of the fraud recipe.
09:30
What happened to appraisal fraud?
09:33
It expanded remarkably as well.
09:36
By 2007, when a survey of appraisers was done,
09:39
90 percent of appraisers reported
09:43
that they had been subject to coercion
09:46
from the lenders trying to get them
09:48
to inflate an appraisal.
09:51
In other words, both forms of fraud
09:52
became absolutely endemic and normal,
09:55
and this is what drove the bubble.
09:59
What happened in the governmental sector?
10:01
Well, the government, as I told you,
10:03
when we were the savings and loan regulators,
10:06
we could only deal with our industry,
10:09
and if people gave up their
federal deposit insurance,
10:11
we couldn't do anything to them.
10:14
Congress, it may strike you as impossible,
10:16
but actually did something intelligent in 1994,
10:19
and passed the Home Ownership
and Equity Protection Act
10:23
that gave the Fed, and only the Federal Reserve,
10:26
the explicit, statutory authority to ban liar's loans
10:30
by every lender,
10:34
whether or not they had federal deposit insurance.
10:36
So what did Ben Bernanke and Alan Greenspan,
10:39
as chairs of the Fed, do
10:42
when they got these warnings
10:44
that these were massively fraudulent loans
10:46
and that they were being sold
to the secondary market?
10:49
Remember, there's no fraud exorcist.
10:52
Once it starts out a fraudulent loan,
10:55
it can only be sold to the secondary market
10:57
through more frauds,
10:59
lying about the reps and warrantees,
11:00
and then those people are going to produce
11:03
mortgage-backed securities
11:04
and exotic derivatives
11:06
which are also going to be supposedly backed
11:07
by those fraudulent loans.
11:10
So the fraud is going to progress
11:12
through the entire system,
11:14
hyperinflate the bubble, produce a disaster.
11:15
And remember, we had experience with this.
11:18
We had seen significant losses,
11:22
and we had experience of competent regulators
11:24
in stopping it.
11:27
Greenspan and Bernanke refused
11:29
to use the authority under the statute
11:32
to stop liar's loans.
11:34
And this was a matter first of dogma.
11:36
They're just horrifically opposed
11:39
to anything regulatory.
11:42
But it is also the international competition in laxity,
11:44
the race to the bottom
11:48
between the United States and the United Kingdom,
11:50
the city of London, in particular,
11:54
and the city of London won that race to the bottom,
11:55
but it meant that all regulation in the West
11:58
was completely degraded
12:02
in this stupid competition to be
12:04
who could have the weakest regulation.
12:06
So that was the regulatory response.
12:08
What about the response of the prosecutors
12:10
after the crisis,
12:14
after 11 trillion dollars in losses,
12:16
after 10 million jobs lost,
12:20
a crisis in which the losses and the frauds
12:22
were more than 70 times larger
12:25
than the savings and loan debacle?
12:29
Well, in the savings and loan debacle,
12:31
our agency that regulated savings and loans, OTS,
12:33
made over 30,000 criminal referrals,
12:37
produced over 1,000 felony convictions
12:41
just in cases designated as major,
12:44
and that understates the degree of prioritization,
12:46
because we worked with the FBI
12:49
to create the list of the top 100 fraud schemes,
12:51
the absolute worst of the worst, nationwide.
12:55
Roughly 300 savings and loans involved,
12:59
roughly 600 senior officials.
13:02
Virtually all of them were prosecuted.
13:05
We had a 90 percent conviction rate.
13:07
It's the greatest success against
13:10
elite white collar criminals ever,
13:12
and it was because of this understanding
13:14
of control fraud
13:17
and the accounting control fraud mechanism.
13:18
Flash forward to the current crisis.
13:21
The same agency, Office of Thrift Supervision,
13:24
which was supposed to regulate
13:26
many of the largest makers of liar's loans
13:28
in the country,
13:30
has made, even today -- it no longer exists,
13:31
but as of a year ago,
13:36
it had made zero criminal referrals.
13:38
The Office of the Comptroller of the Currency,
13:42
which is supposed to regulate
the largest national banks,
13:44
has made zero criminal referrals.
13:47
The Fed appears to have made
13:49
zero criminal referrals.
13:51
The Federal Deposit Insurance Corporation
13:53
is smart enough to refuse to answer the question.
13:55
Without any guidance from the regulators,
13:59
there's no expertise in the FBI
14:05
to investigate complex frauds.
14:08
It isn't simply that they've had
14:10
to reinvent the wheel
14:12
of how to do these prosecutions;
14:14
they've forgotten that the wheel exists,
14:16
and therefore, we have zero prosecutions,
14:21
and of course, zero convictions,
14:25
of any of the elite bank frauds,
14:27
the Wall Street types,
14:30
that drove this crisis.
14:32
With no expertise coming from the regulators,
14:35
the FBI formed what it calls a partnership
14:37
with the Mortgage Bankers Association in 2007.
14:40
The Mortgage Bankers Association
14:44
is the trade association of the perps.
14:46
And the Mortgage Bankers Association
14:50
set out, it had the audacity and the success
14:52
to con the FBI.
14:56
It had created a supposed definition
14:58
of mortgage fraud, in which, guess what,
15:01
its members are always the victim
15:04
and never the perpetrators.
15:06
And the FBI has bought this hook, line, sinker,
15:08
rod, reel and the boat they rode out in.
15:12
And so the FBI,
15:16
under the leadership of an attorney general
15:19
who is African-American
15:22
and a president of the United
States who is African-American,
15:24
have adopted the Tea Party definition of the crisis,
15:26
in which it is the first virgin crisis in history,
15:30
conceived without sin in the executive ranks.
15:33
And it's those oh-so-clever hairdressers
15:37
who were able to defraud the poor, pitiful banks,
15:40
who lack any financial sophistication.
15:43
It is the silliest story you can conceive of,
15:46
and so they go and they prosecute the hairdressers,
15:49
and they leave the banksters alone entirely.
15:53
And so, while lions are roaming the campsite,
15:57
the FBI is chasing mice.
16:00
What do we need to do?
16:03
What can we do in all of this?
16:05
We need to change the perverse incentive structures
16:07
that produce these recurrent epidemics
16:11
of accounting control fraud
16:14
that are driving our crises.
16:15
So we have to first get rid
16:17
of the systemically dangerous institutions.
16:20
These are the so-called too-big-to-fail institutions.
16:23
We need to shrink them to the point,
16:26
within the next five years,
16:28
that they no longer pose a systemic risk.
16:30
Right now, they are ticking time bombs
16:33
that will cause a global crisis
16:35
as soon as the next one fails --
16:38
not if, when.
16:41
Second thing we need to do is completely reform
16:42
modern executive and professional compensation,
16:45
which is what they use to suborn the appraisers.
16:48
Remember, they were pressuring the appraisers
16:53
through the compensation system,
16:55
trying to produce what we call a Gresham's dynamic,
16:56
in which bad ethics drives good ethics
16:59
out of the marketplace.
17:02
And they largely succeeded,
17:03
which is how the fraud became endemic.
17:05
And the third thing that we need to do
17:08
is deal with what we call the three D's:
17:10
deregulation, desupervision,
17:13
and the de facto decriminalization.
17:16
Because we can make
17:20
all three of these changes, and if we do so,
17:22
we can dramatically reduce
17:25
how often we have a crisis
17:28
and how severe those crises are.
17:30
That is not simply critical to our economy.
17:34
You can see what these crises do to inequality
17:37
and what they do to our democracy.
17:40
They have produced crony capitalism,
17:43
American-style,
17:46
in which the largest financial institutions
17:47
are the leading financial donors of both parties,
17:50
and that's the reason why
17:54
even after this crisis,
17:56
70 times larger than the savings and loan crisis,
18:00
we have no meaningful reforms
18:05
in any of the three areas that I've talked about,
18:08
other than banning liar's loans,
18:11
which is good,
18:13
but that's just one form of ammunition
18:14
for this fraud weapon.
18:17
There are many forms of ammunition they can use.
18:18
That's why we need to learn
18:22
what the bankers have learned:
18:24
the recipe for the best way to rob a bank,
18:26
so that we can stop that recipe,
18:29
because our legislators,
18:32
who are dependent on political contributions,
18:34
will not do it on their own.
18:37
Thank you very much.
18:39
(Applause)
18:41

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William Black - Academic
William Black is a professor of economics and law at University of Missouri, Kansas City.

Why you should listen

William Black is an associate professor of economics and law. He was the executive director of the Institute for Fraud Prevention from 2005-2007. He previously taught 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. Black 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 2005 book The Best Way to Rob a Bank Is to Own One has been called “a classic.” Professor Black recently 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 and economics, and Latin American development.

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