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  • 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