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by Robyn Blumner
As the financial reform bill wends its way through the
Black, a former senior banking regulator during the S&L crisis and now a professor of economics and law at the
To illustrate just how rotten the investment banks had become during the last decade, Black laid out in prepared testimony before
A central part of Lehman's business was making and selling "liar's loans," under its Aurora subsidiary. It was a suicidal enterprise. These kinds of loans, where borrowers are incentivized to inflate income or assets, are set up to fail. Black estimates that every dollar lent on a liar's loan loses
In the short term, making these loans produces significant apparent but fictional income -- and correspondingly huge bonuses for executives. Only later do the loans create real catastrophic losses for those holding them.
Lehman was the world leader in originating these loans -- in the first six months of 2007, Aurora was lending more than
Undoubtedly top executives knew that fraudulent loans were the firm's primary source of income. But Lehman assiduously attempted to hide that fact, classifying its liar's loans as "prime" loans in disclosures, Black says. Had Lehman disclosed the true nature of the loans it was selling, no one would buy them, and the firm have been found out as insolvent.
To various degrees this kind of deceit was the business model of every player in the subprime mortgage lending and securities market: every bank that loaned money without documenting a borrower's credit worthiness, every firm that securitized loans without examining the lender's loan files, every accounting and law firm that helped fudge disclosures, and every credit rating agency that rated a mortgage-related security as safe without sampling the underlying loans.
It was a game of financial "don't ask, don't tell," as Black dubs it, that at its core was an epidemic of corruption.
Why was this allowed to continue even though the FBI had warned as early as 2004 that mortgage fraud was massive? Because, Black says, officials at the Federal Reserve and
This recurring problem of regulators cozy with the industry they regulate means that financial reform must go beyond giving regulators more power and tools. It needs to impose clear legal duties on the financial sector, with stiff consequences for failure that don't currently exist.
Two amendments offered by Sen. Arlen Specter of Pennsylvania would do just that. The first would impose a fiduciary duty on broker-dealers to act in the best interest of their investor customers, with criminal penalties for willful violations. The second would make those who aid and abet securities fraud civilly liable, a way to hold accountable all the professionals -- appraisers, lawyers, accountants and others -- who help cover the tracks of fraud.
Despite the recent swipe at
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A Culture of Criminality on Wall Street | Politics
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