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