Alternative Voices – Ep. 3: Prof. William Black on Austerity and Fraud in the Financial Crisis on
Wednesday October 18, 2017
   // Alternative Voices – Ep. 3: Prof. William Black on Austerity and Fraud in the Financial Crisis

Professor William Black joins Greg McInerney to talk about his own background in fraud cases in the US and how the US and Europe are dealing with the financial crisis in different ways. As well as austerity in Ireland and Europe and Germany’s role in all of this.

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Greg McInerney: This is Greg McInerney here for the This is episode three of our Alternative Voices series and we are joined today by Professor Bill Black. Bill is a former bank regulator, a professor of law and economics and also the author of the brilliant book The Best Way to Rob a Bank is to Own One. Bill thanks so much for joining us today.


William Black: Thank you.


GM: Bill your work deals primarily with an F word I guess, fraud. It seems to me that this word has completely disappeared from our vocabulary today, it’s never mentioned in the media, politicians don’t mention it. What has happened to the word “fraud”?


WB: Yeah economists tend to set the tone for the discussion of financial crises, people assume that they have the relevant expertise and economists have a primitive tribal taboo against using the F word. They are pretty much only willing to use “fraud” when enough facts are created on the ground that they simply cannot avoid it anymore and that brings us back to the more fundamental problem and that is the failure to prosecute and indeed even the failure to investigate out of this crisis. In the United States we have the theory, almost seriously floated, that this is the first virgin crisis, conceived without sin in the C-suite, where the CEO and the CFO reside, which would be an absolute first in terms of U.S. financial crises and it would be a first pretty much anywhere in the world. This problem is bad in the United States but it is particularly difficult in countries like Ireland and the United Kingdom because of the laws on libel and slander. So when we prosecuted back in the day in the 1980’s and the 1990’s and got over a thousand felony convictions of the Savings and Loans folks in the Savings and Loans debacle in the United States, and that’s just in cases designated as “major” by the Department of Justice, we were also putting over a thousand times the facts in the public record and those could be quoted by journalists without any fear of libel or slander attacks because they could simply report this is what the government claims happened. Of course once you get the convictions, they could report this is what actually happened and a jury found these facts to be true or they confessed to these facts. The other major thing that happens is that long before you do a thousand of them, simply when you’ve done 20 of them, they sound a lot alike and people begin to understand fraud schemes and that they’re not really all that complicated and that it’s what’s really going on. Again, all of that requires somebody to actually bring the investigations and actually bring the prosecutions and that’s what’s missing from this crisis.

GM: You deal primarily with the theory that you’ve put forward of “control fraud”. It seems to me that this is quite standard across most financial fraud. Could you explain what control fraud is?

WB: Sure, and by the way I also have a doctorate in criminology in addition to your introduction and this is my primary research area. Control fraud is what happens when the person who controls a seemingly legitimate entity uses it as a weapon to defraud. Now what we’ve been talking about mostly is accounting control frauds because in finance the weapon of choice is accounting but there are many other kinds. I know you want to focus on this but I’ll just take 40 seconds. Control fraud also maims and kills in other variants. So for example, when people create fake infant formula that has no nutritional value and then they put in an ingredient designed to spoof the government tests and that ingredients causes kidney stones in kids as young as three months old. Well at least six chinese babies died and 300,000 were hospitalized because of that form of control fraud. So there are multiple kinds of control fraud. They exist in a bunch of different spheres, it’s very common you read about it in the paper all the time except you don’t see the journalist then saying “Aha! This is another variant of control fraud!”, anti-employee control fraud, or anti-consumer control fraud, or what we were discussing, accounting control fraud.


GM: Accounting control fraud seems perhaps, more than any other type, to go unprosecuted. How much of this stuff is down to lack of prosecution and lack of regulation, or how much of it has been conscripted into the actual law itself?

WB: Ah, that’s a particularly good point. There is a famous conservative economist Bastia who said that “when plunder becomes a way of life, inevitably the powerful plunderers change the law to try to make what they do legal and change the system of ethics to praise whatever they do.” So this is scientific Darwinism stuff, that the rich are rich because they must be morally and intellectually superior and work harder etc. and there certainly are a number of people that succeed on merit but there are a whole lot of people that are wealthy because they cheat. So yes, accounting control fraud is not only bad in itself but it can easily create what we call in economics and criminology a “Gresham’s Dynamic” which is named after an ancient British economist named Gresham, and in this variant it says that bad ethics drives good ethics out of the market place. In other words, if you gain a competitive advantage by cheating, then a competitive marketplace will become incredibly perverse and the worst possible folks will win that competition. So when you say you have a winner take all society, that maximises the incentives to cheat. Again, we don’t just see this just in the financial sector, think of the Tour de France, in which every winner for something life fifteen years cheated and it was because the only way to win that bicycle race was to cheat.


GM: And what do you think plays more of a role in fostering fraud, do you think it is the incentives put forward to the CEO himself or herself, or is it systemic within the market economy and within operating as a publically liable company?


WB: Ah, well that is for folks who have a sense of history, they will know that Adam Smith famously warned that corporations should not exist because the officers who ran the corporations would have an incentive to loot them and to use them as accounting control frauds basically for the reasons we’ve gone through. So yes there is an inherent problem in the system of a corporation with limited liability. This used to be better in some of the professions where you had true joint and several liability. What that means is as a general partner you are responsible for all the debts of a company, even if you had nothing to do with the failure. That caused the partners in the old days of say, an investment bank, to look over each other’s shoulders all the time to try and make sure they weren’t screwing something up but we’ve gotten rid of that with limited liability, that’s part of it. So we’ve loosened private restraints that used to exist through joint and several liability, we have weakened fiduciary restraints, those are the fiduciary duties of care and loyalty. In the United States you can actually now do away with the fiduciary duty of care, in the the state of Delaware which your listeners may know is our primary state of incorporation because it has won the race to the bottom. Speaking of race to the bottom, we’ve also changed the public structures to create the most perverse incentives and that of course is that executive compensation provides the carrot, in other words it allows the CEO to loot the organization, convert firm assets to his personal benefit with very limited risk of prosecution but simultaneously what we call the three D’s: Deregulation, De-supervision, De-Facto Decriminalization, mean that you’re not going to be held accountable. So if you create a system where there are immense rewards to cheating, where cheating is a sure-thing, it’s not a risk right, if you use accounting control fraud recipe you are mathematically guaranteed to report record profits, under modern executive compensation you are mathematically guaranteed to be made wealthy almost immediately and the institution of course will suffer huge losses. So we have the same race to the bottom in the international competition in laxity in regulation. In the Irish reports they cited this. Throughout the Eurozone there was a destruction of regulation, the Brits call it various things like “light touch regulation”. What all of it means is no regulation. Even if you find a problem you go “ahum”. The Irish reports say that there were no meaningful crackdowns, even when the Irish banking regulators found that there were violations of the law. You see the same in the United States. So we go from over a thousand felony convictions in the Savings and Loans debacle, which is one seventieth the size of the current U.S. crisis and the current U.S. fraud schemes that drove the current crisis, and you come to this crisis and you have zero prosecutions of the elite bankers who actually drove the crisis.


GM: Bill the recent film The Wolf of Wall Street, I don’t know if you saw it, it concerned itself with pretty minor, what we might term small-fish fraud. Did you experience that culture from within the regulatory bodies of chasing these small fish and letting the big banks get away with fraud essentially?

WB: That is the temptation. That’s easy to get numbers. So the Security and Exchange Commission, in the U.S. context, is infamous for going after tiny companies that are already dead and of course they are not going to fight you, they have no resources to fight you and you are asking them for nothing, you’re asking for a consent decree that doesn’t require them to admit anything, that doesn’t require them to do anything, so of course they are willing to sign. But what we did in the Savings and Loans crisis was exactly the opposite. We worked for weeks on a very serious process with our Federal Bureau of Investigation to hyper-prioritize the cases that were actually prosecuted, created the list of the hundred worst fraud schemes in the entire industry, that was 300 savings and loans involved and over 600 hundred individuals. Virtually all of them were prosecuted, as I say we prioritized them, and we got a 90% conviction rate against the best criminal defence lawyers in the world. We still do some things well in the United States and law is one of them, or at least lawyering is one of them, maybe not law. That can be done. These are hard convictions, nobody should tell you it’s easy, it takes an immense investment to do it right. At peak, we had a thousand FBI agents just investigating savings and loan cases. There were only, and I know this number will sound huge for Ireland but in the U.S. context you can use the word “only”, 2300 FBI white collar specialists. So to take a thousand of those 2300 and to put them in one industry, and by the way there are over a thousand industries in the United States, you can see the degree of resources and how serious that was. Then, as I said, they were actually aimed not at the minnows, but against the killer whales, the orcas in that case. In the current crisis, as recently as fiscal year 2007, there were a 120 FBI agents nationwide assigned to all cases of mortgage fraud. In the year before there were over two million cases of mortgage fraud so you know, if you send 120 FBI agents and you have them do the Dick and Mary cases, the tiny little ones, my metaphor for this is it’s like going to San Diego and throwing handfuls of beach sand in the Pacific Ocean and wondering when you’re going to be able to walk to Hawaii.

GM: Just tying in with that, one thing we are particularly familiar with here in Ireland is this very simplistic media narrative presented. It’s typically people got greedy, involved themselves in the housing market, inflated a bubble and it blew up but that doesn’t really take into account the financial institutions’ role in creating the property bubble we had here in particular, in terms of the secondary market for securities and derivatives on top of mortgages and also that banks make their money now from speculative lending, they don’t really lend to industry anymore, it’s purely speculation.


WB: So all nations have some variant of this that gets in the way of holding the big banks accountable but on my travels, by far the worst place in the world is Ireland. In terms of all this “oh it’s all us and we should suffer”. Guilt is a wonderful thing and some of the cliches about Catholics and Jews and guilt seem to be true in these cases but it really gets in the way of effective public policy. It’s fine to re-examine your lives and such, and greed isn’t a wonderful thing, but these crises do not emerge because of some clever Dick and Mary conning some poor banker into making a loan. The absolute opposite is coming about and the record in Ireland is replete with evidence of accounting control fraud where again, the lending practices make no sense for an honest banker. Whenever they were confronted with the fact that the loan practices made no sense, they made them worse as opposed to better and they did this repeatedly in Ireland. Even something as pathetically weak as the Nyberg Report documents these things although Nyberg wouldn’t be able to spot a fraud if it was committed against him in open daylight.


GM: When we look at Europe compared to the United States oddly enough one could argue that the United States has been more progressive in its policies dealing with the economic crash. The quantitative easing in the US for example is effectively a subsidy for wall street. Whereas in Europe instead of printing money we’ve decided to take money from the tax paper. Why has the US been as I said more progressive than Europe on this?


WB: Because we’ve exported so many terrible economists from our grad program. And they seem to be the worst of the worst in their attachment to austerity, which has never worked. And you know to cite Ireland as their success case, thank you, I would say good if that’s your success case. You’ve further proved how disastrous it is. So this is the equivalent of bleeding a patient to make him better, and it greatly delays the recovery. The good news is that Europe while it claims it is engaged in austerity, and it has in Spain and Italy and in Greece and of course Cyprus, engaged in really acute austerity that has proven disastrous and pushed those nations into great depression levels. Let me say that again. These nations at the periphery are not in recession they are in great depression levels of unemployment, have been for years and you have to the top EU officials, these are the ones bragging about the supposed success of austerity, I’m talking about Ollie Rehn saying that Spain is going to take another ten years just to recover from the crisis stage not to get to full employment, just to get out of crisis and remember this crisis began in 2006 when the housing boom busted in virtually everywhere in Europe and the United States. you know you’re talking about 16 to 18 years of a crisis as to what they say austerity is going to produce. The United States always, since the great depression, responded to  recessions with two things. one are what we call in the econ biz automatic stabilisers. and what that means is that federal budgetary revenues automatically decline in our context and expenditures automatically increase. So you automatically run a substantial deficit. which is exactly what you wanna to do to recover much more swiftly from one of these crises because the problem is inadequate demand that’s why you have recessions and you have great depressions. So austerity further takes away demand and limits the recovery slows it down and makes it weaker. The good news in most of Europe is that while they are running austerity and they call it austerity relative to the United States, they are actually still running deficits. Indeed I think Germany is maybe one of the few nations that wasn’t running a budgetary deficit and Germany is only able to succeed because of it’s incredible strong exports and of course we can’t all be net exporters. You know this small bit of logic and indeed to the extent Germany exports more it’s harder for Ireland to export not easier for Ireland to export. Anyhow there’s that plus the fact that the euro is inherently screwed up in it’s design, now in some nice statements about economists, many economists warned in advance , including my colleague, the chair of our department, Stephanie Kelton, so we’re talking about warning 12 years ago that this could not work well and would work horribly when you got a situation where the periphery of Europe in a much more severe recession than the core of Europe. because the three things you want do, and these are not mutually exclusive, you can do all three of them if you have a sovereign currency is you can devalue that currency when you find yourself in a severe recession, you can have stimulative monetary policy and you can have a stimulative fiscal policy. But you can’t do those as easily with the euro because you no longer have a sovereign currency and you’re subject to the attacks of the bond vigilantes. Now that’s not something that you can’t cope with, it’s a bit of a weird fix required, but the European Central Bank (ECB) could effectively act like a super parliament and monetary authority in other words it could create money and it could therefore reduce this crisis dramatically but of course whether the nominal head of the ecb is an Italian or a Frenchman they’re all at heart, well actually there is no heart, German.


GM: And how subservient is the ECB and the EU  in general to the dictates of the US treasury?


WB: Not much at all or it would be very different. The US treasury has been urging Europe not to follow these policies. Now that’s sometimes hypocritical, because our treasury secretary Jacob Lew just lauded the act that our deficit had come down to a record low in recent years, but that’s not good news right. We’re pushing towards austerity and you can see what’s happened to the slowing of our growth rate in response to all of that. So there’s a bit of hypocrisy but in general our US treasury has been saying the right thing to the ECB. What is completely clear is that Germany has become a normal nation. Remember when Germany wasn’t treated as a normal nation and therefore it had to operate always under the cover that it was working together with France. They don’t bother with that anymore. Germany dominates the European organs and it completely dominates the ECB and even when German politicians potentially show some flexibility the German constitutional court has been fairly active in limiting any of that discretion.


GM: And can you describe something that’s also missing from the media narrative is the extent of which the German banks are implicated in this and how as a creditor nation they are extremely dependent on countries like Ireland repaying these loans?


WB: Sure, so you didn’t bail out Ireland, you tried to bail out the German banks which bankrupted Ireland. And put it in a completely untenable situation. It wasn’t only German banks, but it was very heavily foreign banks, and those foreign banks made a business deal and the business deal was they got a higher interest rate for making loans that were not insured by the government of Ireland.


GM: These are the unguaranteed bond-holders.


WB: Right, and indeed some of them were subordinated. which is supposed to be wiped out anytime there is a problem. they get a much higher interest rate for taking that risk. So they got what they bargained for, they got a much higher interest rate in the case of subordinated debt and in the straight debt, they got a higher interest rate. and then on top of that they got bailed out. they got bailed out in this utterly gratuitous move by the Irish government. which shows again the immense cost of having crappy regulation. Because at least according to all the stories they asked the regulators and the regulators said “Oh sure no problem here. our banks our great.” which you have to be completely delusional, this is so far beyond fraud. they were massively insolvent and anyone who had a functioning brain as a regulator would have known this, but that’s the cost of destroying regulation. You will note that Germany is the one that has been delaying the Basel III requirement to increase capital requirement for banks. Germany has been the one that has been upset at any kind of vigourous stress test of its banks because Germany’s banking sector, which today again is eight years since this crisis was kicked off by the collapse of the property bubbles, they are still in very poor shape. Again this whole theory that again the irish are guilty, we’re greedy we got ourselves into trouble and were bailed out by Germany. No you bailed out German banks, or you tried to, which was of course impossible for a country the size of Ireland compared to the losses of these German and other banks and that’s the reason that Merkel has allowed these bailouts of these countries because they’re not really bailouts of the countries, they are really bailouts of the major banks. and in particular the German banks and she does pay some political cost from it, although we have just seen her re-elected heavily. She bears a much smaller political cost when she can phrase it in this fashion we had to save the EU as opposed to saying i’m going to come to the German tax payers and want them to vote a bailout of German banks. that would have been politically devastating and she might not have won re-election had she done that.


GM: We had Michael Hudson on a few weeks ago Bill, and he made the point that he very much see’s austerity as a guise to privatise public wealth and public assets. how much of that is a motivating force?


WB: Well it’s no guise, they’ve been clear that the cost that they first again, they being the Troika, so the Troika is the EU commission, the ECB and the IMF, so they again sell this as hey we’re bailing out these ne’er do well states that lack the discipline of the north, right. And we’re the good guys and you’re the guys that have screwed up. And in return for this bailout we want the following things: one, we want very extensive privatisation, two, we want much lower wages, and the rubric again is “hey you’ve gotta be all like Germany and net exporters.” I’ve already said that can’t happen, but again you have a race to the bottom where the Irish our supposed to cut their wages to be able to compete with the Portuguese who are supposed to cut their wages to compete with Spain etc etc. We call this the Road to Bangladesh Dynamic.


GM: And when we talk about this privatisation is there any alternative within the current European structures. are we destined just to stagger on towards another inevitable crisis.


WB: Well there’s going to be another crisis under the current system. I mean no, theoretically the European people could take back control of the European Union. but the Irish for example have a government that think because they get patted on the head by the Troika think that that’s a good thing. Oh Ireland’s the good pupil and such doing  just what we said, and it’s really pathetic the degree to which a significant portion of the Irish people buy into this, after all there was a referendum in which the Irish people decided not to have an investigation of the crisis.


GM: And for our listeners who don’t know Bill is of Irish descent. So Bill if I were to offer the unfortunate job of a post in the current Irish government, what would Bill Black’s economic policies look like?


WB: First we would re-establish regulation and it’s probably too late in terms of the statute of limitations unfortunately in Ireland to do much but we’d be ready to try avoid the next crisis which is the most productive thing that we could do at this point. I would certainly, you’ve come out of this alleged bailout, i know it’s not attractive to the irish people. I think you should get out of the Euro. So you know that would allow you to have rational economic policies and recover your sovereignty.


GM: OK Bill that’s all we have time for today thanks so much for joining us today we really appreciate it.


WB: Thank you so much take care.


GM: That was episode three of our Alternative Voices series for more check out


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