Pathetic Justice Department Proves Wall Street Fraud by Accident

It’s no secret that the Justice Department’s handling of Wall Street fraud has been pathetic.

Less noticed has been the Fed’s vigorous prosecution of borrowers for mortgage fraud. If you didn’t know better, you’d be sure that a bunch of average Joes got together and tanked the economy be all lying on their mortgage applications, tricking those innocent banksters.

So, why were a group of those ne’er do well borrowers acquitted recently on charges brought by the Justice Department in a Sacramento case? Because they proved that it was the lenders who were committing the fraud.

If you’re interested in the subject, Thomas Frank’s piece in Salon today, Finally, Wall Street gets put on trial: We can still hold the 0.1 percent responsible for tanking the economy, is a must-read. There’s more to it than this, but essentially the defense prevailed by arguing, successfully, that fraud is more than an untruthful statement, it’s an untruthful statement that is intended to and actually does deceive. So, if a mortgage lender doesn’t care whether the contents of a mortgage application are true, no fraud. Frank:

The defense wanted the jury to hear Black’s theory because the essence of our government’s law-enforcement work on mortgage fraud is that banks were the victims. Those poor unfortunate financiers were tricked by little people like the “neighbor” that Rick Santelli once ranted against, trying to get an extra bathroom that he didn’t deserve.

What the defense team sought to prove was that this picture was completely upside-down—that the banks didn’t care if people lied on liar’s loans. According to the legal definition of fraud, the lie in question has to be “material,” meaning it has to influence the decision-makers. When a bank is honest, that is an easy thing to show. But it’s different if the decision-makers are themselves trying to crank out lousy (but profitable) loans. Bill Black again, on the control-fraud formula:

“Not only are they not distressed by crappy loans, they must make crappy loans. That’s the fraud recipe. . . . If the decision-makers are running a fraud in which they want this outcome, then they’re going to approve these loans. And they will create a system designed to approve loans that are 90 percent fraudulent.”

What would such a system look like? Well, indiscriminately handing out stated-income loans is part of it. A weak underwriting system is another element. In the case in Sacramento, the court heard testimony from an underwriter at one of the mortgage firms in question and learned that in certain cases she was actually forbidden to ask the borrower’s employer how much the borrower made—in other words, forbidden to check on the income that was stated in the stated-income loan.

Here’s a taste of how the Justice Department helped prove the case for the defense:

The obvious way for the federal prosecutors to head off this argument would have been to describe the lender’s business practices and show that its executives were not, in fact, simply churning out vast numbers of super-high-risk liar’s loans in order to ring some bonus bell. That, in truth, the bankers really cared that facts be represented accurately on loan applications. Unfortunately, the Federal agent who had investigated the case—a man with plenty of experience detecting mortgage fraud—told the court that he had not talked to executives at the firms in question and, indeed, had not interviewed any top mortgage executives, ever.

Q. People in control of a company. So the person who calls the shots at the very top of a company. How many of those have you interviewed in your career?

A. As relates to mortgages?

Q. As to mortgages, yeah.

A. I can’t recall any.

A while later, with a different defense attorney asking questions, here is what the Federal agent had to say about the subprime mortgage lenders:

Q. So you were not concerned at all about the people who were loaning the money and their conduct; is that right?

MR. COPPOLA [the Federal prosecutor]: Objection. Argumentative.

THE COURT: Overruled. You may answer.

THE WITNESS: No. I would consider — they’re the victims in this case. That’s how I consider them.

What kind of snarky remark can I append to that, reader? Sarcasm fails me.

Conclusion: Contrary to what the Justice Department would have us believe, the a conspiracy of thousands of lying borrowers was not what crashed the mortgage market. The fraud was perpetrated by the banking industry. Who knew?