FORECLOSE THE FORELOSURE FRAUDS (Part 1)
William K. Black and L. Randall Wray, UMKC
After a quick review of its procedures, Bank of America announced that it will resume its
foreclosures in 23 lucky states. While the evidence is overwhelming that the entire
foreclosure process is riddled with fraud, President Obama refuses to support a national
moratorium. Indeed, his spokesmen on the issue told the LA Times three key things:
A government review of botched foreclosure paperwork so far has found that the
problems do not pose a "systemic" threat to the financial system, a top Obama
administration official said Wednesday.
Yes, you heard him correctly. HUD reviewed the “paperwork” problem to see whether it
threatened the banks – not the homeowners who were the victims of foreclosure fraud.
But it got worse, for the second point was how the government would respond to the
epidemic of foreclosure fraud.
The Justice Department is leading an investigation of possible crimes involving
mortgage fraud.
That language was carefully chosen to sound reassuring. But the fact is that despite our
pleas the FBI has continued its “partnership” with the Mortgage Bankers Association
(MBA). The MBA is the trade association of the “perps.” It created a facially ridiculous
definition of “mortgage fraud.” Under the definition the lenders – who led the mortgage
frauds – are the victims. The FBI still parrots this long discredited “definition.” That is
one of the primary reasons why – in complete contrast to prior financial crises – the
Justice Department has not convicted a single senior officer of the large nonprime lenders
who directed, committed, and profited enormously from the frauds.
Note that the Justice Department was not investigating foreclosure fraud. HUD Secretary
Donovan’s statement shows why:
"We will not tolerate business as usual in the mortgage market," he said. "Where
there have been mistakes made or errors, we will hold those entities, those
institutions, accountable to stop those processes, review them and fix them as
quickly as possible."
Note the language: “mistakes”, “errors”, “processes” (following the initial use of
“paperwork”). No mention of “fraud”, “felony”, “criminal investigations”, or
“prosecutions” for the tens of thousands of felonies that representatives of the entities
foreclosing on homes have admitted that they committed. Note that Donovan does not
even demand that the felons remedy the harm caused by their past fraudulent
foreclosures. Donovan wants them to “fix” “processes” – not repair the harm their frauds
caused to their victims.
The fraudulent CEOs looted with impunity, were left in power, and were granted their
fondest wish when Congress, at the behest of the Chamber of Commerce, Chairman
Bernanke, and the bankers’ trade associations. This troika successfully extorted the
professional Financial Accounting Standards Board (FASB) to turn the accounting rules
into a farce that allowed the banks (and the Fed, which has taken over a trillion dollars in
toxic mortgages as wholly inadequate collateral) to refuse to recognize hundreds of
billions of dollars of losses. The accounting scam produces enormous fictional “income”
and “capital” at the banks. The fictional income produces real bonuses to the CEOs that
make them even wealthier. The fictional bank capital allows the regulators to evade their
statutory duties under the Prompt Corrective Action (PCA) law to close the insolvent and
failing banks.
The inflated asset values allow the Fed and the administration to ignore the Fed’s massive
loss exposure and allow Treasury’s propaganda claiming that TARP resolved all the
problems – at virtually no cost. Donovan claims that we have held the elite frauds
accountable – we have done the opposite. We have made the CEOs of the largest
financial firms – typically already among the 500 wealthiest Americans – even wealthier.
We have rewarded fraud, incompetence, and venality by our most powerful elites.
If the government does not hold the fraudulent CEOs responsible, who is supposed to
stop the epidemic of elite financial fraud? The Obama administration has the answer – the
fraudulent CEOs – at a time of their choosing. You can’t make this stuff up.
But ultimately resolving the problems is not the government's responsibility, said
Michael Barr, assistant Treasury secretary for financial institutions.
"Fundamentally, this is up to the banks and the servicers to fix," he said. "They
can fix it as fast as they feel like."
So who is Michael Barr and why is saying things on behalf of the Obama administration
that make it appear to be a wholly-owned subsidiary of the fraudulent lenders and
servicers? He’s a Rubin protégé and he’s the senior Treasury official for banking policy.
We have a different policy view. We believe that only the government can stop fraud
from growing to catastrophic levels and that among the government’s highest
responsibilities is to provide the regulatory “cops on the beat” with the competence,
resources, courage, and integrity to take on our most elite frauds. We believe that
anything less is a travesty that causes tens of millions of Americans to be defrauded and
poses a grave threat to our economy and democracy.
Prompt Corrective Action
First, it is time to stop the foreclosures until the banks and servicers adopt corrective
steps, certified as adequate by FDIC, that will prevent all future foreclosure fraud. They
must also adopt plans to remedy the injuries their foreclosure frauds have already caused,
and assist the FBI, Department of Justice, and legal ethics officials investigations of their
officers’ and attorneys’ frauds and ethical violations.
Second, it is time to place the financial institutions that committed widespread fraud in
receivership. We should remove the senior leadership of the banks and replace them with
experienced bankers with a reputation for integrity and competence, i.e., the honest
officers that quit or were fired because they refused to engage in fraud. We should
prioritize the receiverships to deal with the worst known “control frauds” among the
“systemically dangerous institutions” (SDIs). The SDIs’ frauds and fraudulent leaders
endanger the global economy.
We propose Bank of America for the first receivership. In the last few weeks, the SEC
has obtained a large (albeit grossly inadequate) settlement of its civil fraud charges
against the former senior leaders of Countrywide. (Bank of America acquired
Countrywide and is responsible for its frauds.) Fannie and Freddie’s investigations (with
their findings reviewed by their regulator, the Federal Housing Finance Agency (FHFA))
have identified many billions of dollars of fraudulent loans originated by Countrywide
that were sold fraudulently to Fannie and Freddie through false representations and
warranties. The Fed, BlackRock, and Pimco’s investigations have identified many
billions of dollars of fraudulent loans provided by Countrywide under false reps and
warranties. Ambac’s investigation found that 97% of the Countrywide loans reviewed by
Ambac were had false reps and warranties. Countrywide also engaged in widespread
foreclosure fraud. This is not surprising, for every aspect of Countrywide’s nonprime
mortgage operations that has been examined by a truly independent body has found
widespread fraud – in loan origination, loan sales, appraisals, and foreclosures. Fraud
begets fraud. Lenders that are control frauds create criminogenic environments that
produce “echo” epidemics of control fraud in other professions and industries.
We have been amazed – as one financially sophisticated entity after another found
widespread fraud by Countrywide in the entire gamut of its operations – that the
administration, the industry, and the financial media act as if this is acceptable.
Countrywide made hundreds of thousands of fraudulent loans. It fraudulently sold
hundreds of thousands of loans through false reps and warranties. It fraudulently
foreclosed on large numbers of loans. It victimized hundreds of thousands of people and
hundreds of financial institutions, causing hundreds of billions of dollars of losses. It has
defrauded more people, at a greater cost, than any entity in history.
Bank of America chose to purchase Countrywide at a point when it – and its senior
leaders -- were infamous. Bank of America made some of these Countrwide leaders its
senior leaders. Yet, Bank of America is not treated as a criminal entity. Obama, Holder,
Donovan, and Barr cannot even bring themselves to use the “f” word – fraud. They
substitute euphemisms designed to trivialize elite criminality. The administration officials
do not call for Bank of America to be the subject of a criminal investigation. They do not
demand that Fannie, Freddie, Ambac, the FHFA, and Pimco file criminal referrals about
Countrywide’s frauds. They do not demand that Fannie, Freddie, and the Fed refuse to
purchase or take as collateral any mortgage instrument from Bank of America. No one at
the Harvard club in New York moves to kick Bank of America’s officers out of their
club! The financial media treats Bank of America as if it were a legitimate bank rather
than a “vector” spreading the mortgage fraud epidemic throughout much of the Western
world.
For the sake of our (and the global) economy, our democracy, and our souls this
willingness to allow elite control frauds to loot with impunity must end immediately. The
control frauds must be taken down and their officers removed promptly. Receivership is
the way to begin to reclaim our souls, our economy, and our democracy and Bank of
America has the track record that makes it a good place to start. It is sufficiently large and
powerful that its receivership will send the credible signal that America is restoring the
rule of law and that even the most elite frauds will be held accountable.
Next we need to remove the rest of the SDIs to reduce the global systemic risks that they
pose. We are rolling the dice with disaster every day. The SDIs are inefficient, so
shrinking them will reduce risk and increase efficiency. We need to follow three types of
policies with respect to SDIs.
1. They cannot grow larger and compound the systemic risk they pose
2. They must create an enforceable plan to shrink to a level and functions such that
they no longer pose a systemic risk within five years
3. Until they shrink to the point that they no longer pose systemic risks they must be
regulated with far greater intensity than other banks. In particular, control fraud
poses so severe a risk of triggering another global financial crisis that there must
be no regulatory tolerance for control frauds at the SDIs. One of the best ways
to reduce their risks is to mandate that high levels of executive compensation be
paid only after sustained and superior performance (at least five years), and with
“claw back” provisions if compensation was obtained by fraudulent reported
income or seriously inadequate loss reserves.
Appointing a receiver for an SDI will be a major undertaking for the FDIC, but it is also
well within its capabilities. Contrary to the scare mongering about “nationalizing” banks,
receivers are used to returning failed banks to private ownership. Receiverships are
managed by experienced bankers with records of competence and integrity rather than the
dread “bureaucrats.” We appointed roughly a thousand receivers during the S&L and
banking crises of the 1980s and early 1990s under Presidents Reagan and Bush.
Here is how it works. A receiver is appointed on Friday. The bank opens for business as
normal (from the bank’s customers’ perspective) on Monday. The checks clear, the
ATMs work, and the branches all open. The receiver’s managers direct the business
operations, find the true facts about the bank’s operations, senior managers, and financial
condition, recognize the real losses, and make the appropriate referrals to the FBI and the
SEC so that the frauds can be investigated and prosecuted.
The receiver is also a well proven device for splitting up banks that are too large and
incoherent by selling units of the business to different bidders who most value the
operations.
Dealing with the “Dirty Dozen” Control Frauds
Simultaneously, we should put in place a system to replace the existing cover up of the
condition of other banks with vigorous investigations and honest accounting. The
priority for these investigations should be the “dirty dozen”—the twelve largest banks.
The Fed cannot conduct a credible investigation. It has taken so many fraudulent
nonprime loans and securities as collateral that it is the leading proponent of covering up
these losses.
The FDIC should lead the investigations (it has “backup” regulatory authority over all
banks), but it should hire investigative experts to add expertise to its Dirty Dozen
examination teams. The priorities of the teams will be identifying existing losses and
requiring their immediate recognition (the regulatory authorities have the authority to
“classify” assets that can trump the accounting scams that Congress extorted from
FASB). The FDIC should prioritize the order of its examinations of the largest SDIs on
the basis of known indicia of fraud. For example, Citi’s senior credit manager for
mortgages testified under oath that 80% of the loans it sold to Fannie and Freddie were
made under false reps and warranties. The Senate investigation has documented endemic
fraud at WaMu (acquired by Wells Fargo). The FDIC should sample nonprime loans and
securities held by Fannie, Freddie, the Federal Home Loan Banks, and the Fed to
determine which nonprime mortgage players originated and sold the most fraudulent
loans. This will allow the FDIC to prioritize which SDIs it examines first.
We should also create a strong incentive for financial entities to voluntarily disclose to
the regulators, the SEC, and the FBI their frauds, their unrecognized losses, and the
officers that led the frauds and to fire any officer (VP level and above) that committed (or
knew about and did not report) financial fraud. Any SDI that originated or sold more than
$2 billion in fraudulent nonprime loans or securities should be placed in receivership
unless it has conducted a thorough investigation and made the voluntary disclosures
discussed above prior to the commencement of the FDIC examination, and developed a
plan that will promptly recompense fully all victims that suffered losses from mortgages
that were fraudulently originated, sold, or serviced.
We make three propositions concerning what we believe to be institutions that are run as
“control frauds”. To date, this situation has been ignored in the policy debates about how
to respond to the crisis. The propositions rest on a firm (but ignored) empirical and
theoretical foundation developed and confirmed by white-collar criminologists,
economists, and effective financial regulators. The key facts are that there was massive
fraud by nonprime lenders and packagers of fraudulent nonprime loans at the direction of
their controlling officers. By “massive” we mean that lenders made millions of fraudulent
loans annually and that packagers turned most of these fraudulent loans into fraudulent
securities. These fraudulent loans and securities made the senior officers (and corrupted
professionals that blessed their frauds) rich, hyper-inflated the bubble, devastated
millions of working class borrowers and middle class home owners, and contributed
significantly to the Great Recession—by far the worst economic collapse since the 1930s.
Our first proposition is this – the entities that made and securitized large numbers of
fraudulent loans must be sanctioned before they produce the next, larger crisis. Second,
the officers and professionals that directed, participated in, and profited from the frauds
should be sanctioned before they cause the next crisis. Third, the lenders, officers, and
professional that directed, participated in, and profited from the fraudulent loans and
securities should be prevented from causing further damage to the victims of their frauds,
e.g., through fraudulent foreclosures. Foreclosure fraud is an inevitable consequence of
the underlying “epidemic” of mortgage fraud by nonprime lenders, not a new, unrelated
epidemic of fraud by mortgage servicers with flawed processes. We propose a policy
response designed to achieve these propositions.
S&L regulators, criminologists, and economists recognize that the same recipe that
produced guaranteed, record (fictional) accounting income (and executive compensation)
until 2007 produced another guarantee – massive (real) losses, particularly if the frauds
hyper-inflated a bubble. CEOs that loot “their” banks do so by perverting the bank into a
wealth destroying monster—a control fraud. What could be worse than deliberately
growing massively by making loans likely to default, converting large amounts of bank
assets to the personal benefit of the senior officers looting the bank and to those the CEO
suborns to assist his looting (appraisers, auditors, attorneys, economists, rating agencies,
and politicians), while simultaneously providing minimal capital (extreme leverage) and
only grossly inadequate loss reserves, and causing bubbles to hyper-inflate?
This nation’s most elite bankers originated and packaged fraudulent nonprime loans that
destroyed wealth – and working class families’ savings – at a prodigious rate never seen
before in the history of white-collar crime. They created the worst bubble in financial
history, echo epidemics of fraud among elite professionals, loan brokers, and loan
servicers, and would (if left to their own devices) have caused the Second Great
Depression.
Nothing short of removing all senior officers that directed, committed, or acquiesced in
fraud can be effective against control fraud. We repeat: foreclosure fraud is the necessary
outcome of the epidemic of mortgage fraud that began early this decade. The banks that
are foreclosing on fraudulently originated mortgages frequently cannot produce
legitimate documents and have committed “fraud in the inducement”—only fraud will let
them take the homes. Many of the required documents do not exist, and those that do
exist would provide proof of the fraud that was involved in loan origination,
securitization, and marketing. This in turn would allow investors to force the banks to
buy-back the fraudulent securities. In other words, to keep the investors at bay the
foreclosing banks must manufacture fake documents. If the original documents do not
exist the securities might be ruled no good. If the original docs do exist they will
demonstrate that proper underwriting was not done—so the securities might be no good.
Foreclosure fraud is the only thing standing between the banks and Armageddon.
We will deal with objections to our proposal in the next piece.
FORECLOSE THE FORELOSURE FRAUDS (Part 2)
William K. Black and L. Randall Wray, UMKC
Spurious Arguments Against Holding the Fraudulent Lenders, Securities Sellers
and Servicers Accountable
Our call for closing down control frauds and stopping the foreclosure frauds typically
meets with three objections. First, it is claimed that while there were some bad apple
lenders, much of the fraud was committed by borrowers. Our proposal would let
fraudulent borrowers remain in homes to which they are not entitled, punishing the banks
that were duped. Second, the biggest banks are too important to foreclose. And third, it is
not possible to resolve a “too big to fail” institution.
Who is Guilty?
Let us deal with the “borrower fraud” argument first because it is the area containing the
most erroneous assumptions. There was fraud at every step in the home finance food
chain: the appraisers were paid to overvalue real estate; mortgage brokers were paid to
induce borrowers to accept loan terms they could not possibly afford; loan applications
overstated the borrowers’ incomes; speculators lied when they claimed that six different
homes were their principal dwelling; mortgage securitizers made false reps and
warranties about the quality of the packaged loans; credit ratings agencies were overpaid
to overrate the securities sold on to investors; and investment banks stuffed collateralized
debt obligations with toxic securities that were handpicked by hedge fund managers to
ensure they would self destruct.
That homeowners would default on the nonprime mortgages was a foregone conclusion
throughout the industry—indeed, it was the desired outcome. This was something the
lending side knew, but which few on the borrowing side could have realized.
The homeowners were typically fraudulently induced by the lenders and the lenders’
agents (the loan brokers) to enter into nonprime mortgages. The lenders knew the “loan
to value” (LTV) ratios and income to debt ratios that they wanted the borrower to (appear
to) meet in order to make it possible for the lender to sell the nonprime loan at a
premium. LTV can be gimmicked by inflating the appraisal. The debt to income ratios
can be gimmicked by inflating income. “Liar’s” loan lenders used that loan format
because it allowed the lender to simultaneously loan to a vast number of borrowers that
could not repay their home loans, at a premium yield, while making it look to the
purchaser of the loan that it was relatively low risk. Liar’s loans maximized the lender’s
reported income, which maximized the CEO’s compensation.
The problem is that only the most sophisticated nonprime borrowers (the speculators who
bought six homes) (1) knew the key ratios they had to appear to meet, (2) had the ability
to induce an appraiser to inflate substantially the reported market value of the home, and
(3) knew how to create false financial information that was internally consistent and
credible. The solution was for the lender and the lender’s agents to (1) instruct the
borrower to report a certain income or even to fill out the application with false
information, (2) suborn an appraiser to provide the necessary inflated market value, and
(3) create fraudulent financial information that had at least minimal coherence.
When the overburdened homeowner began missing payments, late fees and higher
interest rates kicked-in, boosting the stated income of mortgage servicers and the value of
the securities. Not coincidentally, the biggest banks own the servicers and could
maximize claims against the mortgages by running up the late fees. It was quite
convenient to “misplace” mortgage payments, so even homeowners who were never
delinquent could get hit with fees and higher rates. And when payments were received,
the servicers would (illegally) apply them first to the late fees, meaning the homeowners
were unknowingly still missing mortgage payments. The foreclosure process itself
generates big fees for the SDI banks.
And, miracle of miracles, the banks would end up with the homes and get to restart the
whole process again—from resale of the home through the financing, securitizing, and
fee-for-servicing juggernaut.
Unfortunately, it did not go quite as smoothly as planned. The SDIs were supposed to act
like neutron bombs – killing the homeowners but leaving the homes standing, to be
resold. The problem is that wiping out borrowers lowered the value of real estate,
crushing not only the real estate market but also construction and through to all
associated sectors from furniture and home restoration supplies to big ticket purchases
that rely on home equity loans. It also led to questions about the value of the securitized
toxic waste manufactured and held directly or indirectly by financial institutions.
Next, a few judges began to question the foreclosures, as they saw case after case in
which the banks claimed to have lost the paperwork or submitted amateurishly forged
documents. Or, several banks would go after the same homeowner, each claiming to hold
the same mortgage (Bear sold the same mortgage over and over). Insiders began to offer
depositions exposing fraud and perjury. It became apparent that in many and perhaps
most cases, the trusts responsible for the securities (often these are “special purpose”
subsidiaries of the banks) never received the “notes” signed by the borrowers—as
required by both IRS tax code and by 45 of the US states. Without the notes, billions of
dollars of back taxes could be due, and the foreclosures violate state law. Finally, the
Attorneys General of all fifty states called for a foreclosure moratorium.
What to do? We suggest an immediate moratorium on foreclosures and a requirement
that all notes be produced by purported holders of mortgages within a reasonable length
of time. If they cannot be found, the mortgages—as well as the securities that pool
them—are no longer valid. That means that the homeowners are not indebted, and that
the homes are owned free and clear. And that, dear bankers, is a big, big problem. It is
also the law—without evidence of debt, there is no debtor and no creditor.
Commentators are horrified that a foreclosure moratorium would let “deadbeat”
borrowers remain in their homes while delinquent in their payments. The speculators that
purchased “MacMansions” and stated on six separate loan applications that each house
was their principal dwelling are frauds. The moratorium would (briefly) reward
fraudulent borrowers while (briefly) punishing the fraudulent banks. This is true.
It is not possible to separate “worthy” borrowers who were duped by banks from all
“unworthy” borrowers who knew the loan applications were false. Indeed, given the
millions of borrowers that received liar’s loans, even if the borrowers were all frauds we
could not possibly prosecute all of them due to lack of resources. We currently prosecute
roughly 1000 mortgage fraud cases annually at the federal level. If we used all of our
resources to investigate and prosecute fraudulent mortgage borrowers exclusively we
would be able to prosecute less than one-tenth of one percent of those frauds.
The losses that the fraudulent nonprime lenders caused are vastly greater than the losses
caused by fraudulent borrowers, so no rational prosecutor would use his scarce resources
to prosecute individual nonprime borrowers. Moreover, prosecutions of individual
borrowers for alleged fraud in the applications would be difficult to win against
competent defense counsel because it will not be possible to infer the borrower’s intent
and knowledge and whether the loan agent instructed him to enter specified information
on the application. We are not arguing that the speculator who committed fraud while
buying six homes should be allowed to walk free. We are simply arguing that it makes no
sense to use limited judicial resources to go after owner-occupier households where it
will be almost impossible to prove intent to defraud.
On the other hand, we can infer a lender’s fraudulent intent because it is financially
sophisticated and has expertise in lending. An honest mortgage lender would not make
“liar’s loans” because absence of proper underwriting inherently produces loans that are
expected to default. Yet, in 2006 just about half of all mortgages originated were liar’s
loans. Banks happily advertised specialization in “no doc” and NINJA loans. There can
be no question about intent—the intent was fraud, plain and simple. Fraud on the part of
credit raters is equally easy to infer—we have the internal emails that document intent to
defraud securities purchasers by “pay to play” schemes. And the fraud committed by the
investment banks that pooled the mortgages is also well documented. These entities
committed tens of thousands and even millions of frauds each. For obvious efficiency
reasons, that is where our judicial resources ought to be directed.
Macro Effects and Culpability
There is one other consideration that biases the case in favor of borrowers. Many
homeowners were sold on the idea that “real estate values only go up”—and quite a few
planned to refinance on better terms, or even to flip the house at a price that would allow
them to pay-off a mortgage they could not otherwise afford. We realize that it is not easy
to shed tears for speculators foiled by the market, and that is not our point.
What is important to understand, however, is that the financial sector is largely culpable
for generation of the speculative frenzy, the creation of the “financial weapons of mass
destruction”, and the transformation toward financial fragility that finally collapsed in
2007. In the aftermath we lost 10 million jobs and millions of homeowners lost their
homes. The “collateral damage” inflicted by the SDIs is now endangering tens of millions
of American families—most of whom played no role in the speculative euphoria. Almost
half of American homeowners are already underwater or on the verge of going under. In
short, it was Wall Street that turned our homes over to a financial casino—and so far
virtually all the losses have been suffered on Main Street.
This culpability is at the aggregate scale and of course no individual bank can be held
liable in court for the collapse of the financial system. Rather, each bank’s guilt must be
assessed according to its own fraud. However, a national moratorium on foreclosures
must be evaluated at the macro level, and justified on the basis of the aggregate costs,
benefits, and moral implications. And certainly at the aggregate level that must be
considered by President Obama, the benefits to the majority of Americans clearly
outweigh the costs imposed on the relatively few. And the morality is also on the side of
homeowners and clearly against the banks.
Closing the control frauds would actually benefit honest bankers by eliminating the
“Gresham dynamics” created by fraudulent institutions—a race to the bottom in
underwriting. Since fraudulent banks use accounting fraud to manufacture high profits,
they do not actually have to use a viable business model. By eliminating control fraud
from the financial sector, it will be much easier for honest banks to succeed.
Further, the financial system has massive excess capacity—as evidenced by the need to
create bubble after bubble to find outlets for capacity. Almost all of the innovations in
practice and instruments of the past two decades were spurred not by demand but rather
by excess capacity. Downsizing the financial sector is critical to restoring it to a size that
is commensurate with the needs of the economy.
The cost of not closing control frauds, by contrast, can be staggering. The business
practices that maximize the fictional reported income (e.g., making “liar’s loans to people
who cannot repay their loans) maximize real losses and hyper-inflate financial bubbles.
Control frauds destroy wealth at a prodigious rate. The one thing we certainly cannot
afford is leaving the control frauds under the control of fraudulent CEOs.
Can the Frauds be Foreclosed?
The assertion that the SDIs cannot be resolved because of their size is unsupported. Very
large institutions have already been resolved both in this country and abroad. The “too
big to fail” (TBTF) doctrine has always been unproven, dangerous, and counter to the
law. An institution that is not permitted to fail faces obvious adverse incentive problems.
It also destroys healthy competition with institutions that are not considered TBTF. It
encourages risk-taking and fraud. And it subverts the law, which requires that insolvent
institutions must be resolved.
As we write this piece, the markets are taking it upon themselves to begin to close down
the control frauds—with homeowners fighting the foreclosures and investors demanding
that the banks take back the toxic waste. Unfortunately, following the market solution
will be a long-drawn-out and costly process—both in terms of tying up the judicial
system but also in terms of the uncertainty and despair that will persist. At the end of that
process, the banks will have to be resolved. No matter how much the politicians dislike it,
they will end up with the banks in their hands—either now or later. Taking them now is
the right thing to do.