About CWF

In 2006, my law office began seeing many clients alleging that they were victims of predatory lending. Inevitably, I would have the following conversation with the borrower(s) who had brought the loan in:

"Do you earn $150,000 per year?"

"No."

"Did you initial next to this statement in your loan application that says that you earn $150,000 per year?"

"Yes."

"That's fraud."

"Well it's a predatory loan. The payment increases after 3 years."

"Did you sign here where it says that the payment amount will increase after 3 years?"

"Yes."

I probably was not entirely sympathetic to those clients. But I could not believe my eyes when those loan documents were placed in front of me. Almost every loan I saw contained blatantly inflated income. And it wasn't just a few thousand dollars off. I had people on Supplemental Social Security (ie income a little over $11,000 per year) who stated they were earning in the hundreds of thousands of dollars. I could not understand how banks were allowing this.

I have learned a lot since 2006. The banks were, and are, tolerating this fraud because they too were committing fraud. In fact, practically every party involved in the lending, purchasing, packaging, and profiting off of mortgages and real estate were arguably committing some form of fraud (deceit perpetrated for profit).

Borrowers were committing fraud when they signed off on incomes they did not have. Brokers were committing fraud when they falsified incomes and submitted loan applications they knew to contain falsehoods to banks. Banks were committing fraud when they sold loans they knew to contain lies (over 90% of such loans contained false information) to other institutions. Those other institutions were committing fraud when they sliced and diced those loans, bought AAA ratings from a corrupt ratings agency, and then sold collateralized debt obligations that were not what they seemed. Ratings agencies were committing fraud when they sold AAA ratings on financial instruments that were junk. I could go on.

Fraud was rampant - from the lowliest lender, all the way up the fraud chain, to the Executives running the companies that ultimately were bailed out by taxpayers. And, arguably, politicians and bureaucrats were aiding and abetting all of those dishonest people when they bailed out the companies that had defrauded themselves into the ground - and then also failed to hold anyone accountable for what they had done. No jail sentences. No fines. No mass firings. Not even a serious wave of civil lawsuits based on fraud.

At the time, there were a number of things that particularly disturbed me about how events were unfolding:
  1. No one was being held accountable. Once the fraud began to be exposed, the reaction from our leaders was to initially ignore it. That was followed by pouring massive amounts of public money into supporting the people that had committed fraud - reinforcing the compromised institutions and people.
  2. Ratings agencies were not liable for their compromised ratings, based on a free-speech defense. Even though the entire world relied on their conflicted ratings, and hundreds of billions of dollars were lost because of those ratings, the ratings agencies continue to provide ratings based on the same corrupted and conflicted system that created the problem.
  3. The response of the Republican Administration that was in power at the time - self-proclaimed staunch free market ideologues - was to use public money to bail out private enterprise. Those self-proclaimed free market ideologues, President Bush included, decided that although free markets are infallible on the way up, a decline warrants massive government (read: taxpayer) support, and redistribution of wealth... to the wealthy.
  4. The subsequent administration, Democratic this time, was also a major disappointment in the economics and justice departments. President Obama had an opportunity to ensure that at least some of the people that had committed fraud would be held accountable. He has demonstrated that he has no interest in making that happen. As a fellow lawyer and officer of the court, I am offended. As an American citizen, I am disappointed. As a capitalist, I am shocked. The day I lost faith in Mr. Obama's economic understanding was Feb 29, 2009, when he gave this speech. It was on that day that he announced that the age of irresponsibility was behind us, when, in fact, the bailouts he was supporting were re-enforcing the structures that had permitted and encouraged irresponsibility and fraud to take place.
  5. All of the companies that were bailed out continued to pour massive amounts of money into lobbying - in many cases vastly increasing what they were spending on lobbying - while they were operating using public money. Even more egregious was the fact that Fannie and Freddie, government sponsored enterprises, had spent hundreds of millions of dollars lobbying legislators and had given over $16 million in contributions to various political campaigns. It is outrageous for companies receiving billions of dollars in taxpayer support to be spending massively to influence how legislators are treating them. That legislators were allowing that public money to end up in lobbying activity and campaign contributions is unconscionable.
  6. The Financial Accounting Standards Board changed the accounting rules to no longer require mark-to-market accounting - since honest accounting was exposing bank insolvency. Instead, we decided to allow banks to value their assets at unrealistic values. You have heard of liars' loans? This is the modern version of liars' loans - liars' asset valuations.
Which brings me to 2011. It does appear as though the pervasive fraud has been successfully ignored by law enforcement, legislators, courts, and much of mainstream media. Let us consider what bad actors in in this story have learned: Everyone that was committing fraud during the go-go days leading up to the crisis has been taught that there are no individual repercussions for fraud. On the contrary, many of them have profited handsomely from their bad behavior. Another term for this kind of reinforcement of bad behavior is moral hazard. We are awash with moral hazard.

Moral hazard is insidious. It lurks in people's minds and stealthily causes them to make ever riskier, and less principled, decisions. It also fosters Gresham's Dynamics. A Gresham's Dynamic describes an environment in which unethical behavior crowds out ethical behavior. For example, analysts in ratings agencies prior to the crisis had to decide whether they would inflate their ratings to please their customers. Those agencies were, and are, paid for their ratings by the financial institutions that are seeking to have their products rated as highly as possible. The result was that analysts that gave inflated AAA ratings were promoted. Analysts that refused to inflate, were fired. Gresham's Dynamics were omnipresent in the institutions that brought our economy crashing down.

Here is what we now face:
  1. The structural problems and Gresham's Dynamics in our political economy have been preserved and reinforced.
  2. The same people that drove us to the brink are still, for the most part, our decision makers.
  3. We have infused enormous moral hazard into all levels of our economy.
  4. The majority of politicians and regulators - regardless of party affiliation - are complicit.
When incompetent and dishonest market participants get in over their heads and fail, they leave behind opportunities for entrepreneurs. If we prevent the failure from taking place - for example with bailouts - it is vital that we then clean house - as in prosecute the fraud rigorously. Not only does this diminish the moral hazard that bailouts create, but it acts as a shot across the bow for anyone else considering fraud as a business model. Investigations and prosecutions never took place. What we are left with is a form of Lemon Socialism (a.k.a. Ersatz Capitalism) that benefits only massive corporations and the people within those untouchable institutions. Everyone else is left to their own devices, to manage as best they can until the next crisis threatens their existence.

CapitalismWithoutFailure.com is my attempt to ensure both that we do not lose sight of what has happened to us, and that we pursue policy that stops rewarding the irresponsible, the reckless, and the criminal. Accounting tricks, socializing losses, providing public guarantees for private lending, and debasing our currency are not long term solutions. But they have resulted in a temporary, and priceless, respite.

Jaime Falcon

CWF