Thursday, April 22, 2010
Economist James Galbraith: Economists Should Move into the Background, and "Criminologists to the Forefront"
University of Texas economics professor James K. Galbraith previously said that fraud caused the financial crisis:
You had fraud in the origination of the mortgages, fraud in the underwriting, fraud in the ratings agencies.Senator Kaufman said last month:
Fraud and potential criminal conduct were at the heart of the financial crisis.Congresswoman Marcy Kaptur says that there was rampant fraud leading up to the crash (see this and this).
TARP overseer Elizabeth Warren suspects fraud as the cause of the crisis.
Yves Smith has shown that fraud largely caused the subprime crisis.
Janet Tavakoli says that rampant fraud and Ponzi schemes caused the financial crisis.
According to economist Max Wolff:
The securitization process worked by "packag(ing), sell(ing), repack(aging) and resell(ing) mortages making what was a small housing bubble, a gigantic (one) and making what became an American financial problem very much a global" one by selling mortgage bundles worldwide "without full disclosure of the lack of underlying assets or risks."William Black - professor of economics and law, and former head of prosecution during the S&L crisis - says that massive fraud by is what caused this economic crisis. Specifically, he says that companies, auditors, rating agencies and regulators all committed fraud which helped blow the bubble and sowed the seeds of the inevitable crash. And see this.
Buyers accepted them on good faith, failed in their due diligence, and rating agencies were negligent, even criminal, in overvaluing and endorsing junk assets that they knew were high-risk or toxic. "The whole process was corrupt at its core."
Black and economist Simon Johnson also state that the banks committed fraud by making loans to people that they knew would default, to make huge profits during the boom, knowing that the taxpayers would bail them out when things went bust.
As Black told Congress on Tuesday:
Let’s start with the repos. We have known since the Enron in 2001 that this is a common scam, in which every major bank that was approached by Enron agreed to help them deceive creditors and investors by doing these kind of transactions.So who should we talk to about fixing the economic crisis?
And so what happened? There was a proposal in 2004 to stop it. And the regulatory heads — there was an interagency effort — killed it. They came out with something pathetic in 2006, and stalled its implication until 2007, but it ’s meaningless.
We have known for decades that these are frauds. We have known for a decade how to stop them. All of the major regulatory agencies were complicit in that statement, in destroying it. We have a self-fulfilling policy of regulatory failure
because of the leadership in this era.
We have the Fed, the Federal Reserve Bank of New York, finding that this is three card monty. Well what would you do, as a regulator, if you knew that one of the largest enterprises in the world, when the nation is on the brink of economic collapse, is engaged in fraud, three card monty? Would you continue business as usual?
That’s what was done.
Not the economists.
As economist James Galbraith told Dan Froomkin this week:
"Once you understand the implications of massively fraudulent practices, it changes the professional community that has the principal say about interpreting the crisis."
Economists, he said, should move into the background -- and "criminologists to the forefront."
Bill Black agrees:
Criminologists, Black said, are trained to identify the environments that produce epidemics of fraud -- and in the case of the financial crisis, the culprit is obvious.
"We're looking at incentive structures," he told HuffPost. "Not people suddenly becoming evil. Not people suddenly becoming crazy. But people reacting to perverse incentive structures."
CEOs can't send out a memo telling their front-line professionals to commit fraud, "but you can send the same message with your compensations system, and you can do it without going to jail," Black said.
Criminologists ask "fundamentally different types of question" than the ones being asked.
"First we ask: Does this business activity, the way they're conducting it, make any sense for an honest firm? And we see many activities that make no sense for an honest firm."
One example is the "liar's loans." With something like 90 percent of them turning out to be fraudulent, they are not profitable loans to make -- unless you're getting paid based on volume, and unless the idea is to sell them off to someone else.
"We also ask: How it is possible that they were able to sell this stuff?" When it comes to toxic assets -- or securities built on top of them -- "all standard economic explanations say it should have been impossible to sell them."
The answer, in this crisis, is "the financial version of Don't Ask Don't Tell," Black said. Incentives for short-term profits and the resulting bonuses were so great that buyers preferred booking the revenue than looking too closely at what they were buying.
Black is concerned that the financial legislation currently being debated on Capitol Hill doesn't change the rules enough. He's concerned about loopholes in derivative regulation and thinks that demanding "skin in the game" won't actually help curb fraud.
Yes, "skin in the game" means that companies could go bankrupt if they place bad bets. But, he said. "if the corporation gets destroyed, that's not a failure of the fraud scheme." Former Lehman Brother CEO Richard Fuld, for instance, "walked away with hundreds of millions of net worth that would never have been created but for the fraud."
Black would like to see reform that ends regulatory black holes and that "requires not just rules" but approving regulators with teeth, to enforce them. Regulators should not be cozy with the entities they regulate; they should be skeptical. "Some of us have to stay skeptical, so that everyone else can trust," he said.
He also thinks it's important to address compensation -- both for executives and professionals. Black isn't calling for limits on executive pay, just for executives to keep their own promises to make bonuses based on long-term success, rather than short term. And he means really long-term. "The big bonuses, they come after 10 years, when they show it's real," Black said.
"Professional compensation has to be changed to prevent conflicts of interest," he said. Appraisers, accountants, ratings agencies and the like need to be rewarded for accuracy rather than amenability. Right now, Black said, "cheaters prosper."
Forget the economists ... call in the criminologists.