Why Banks Make Better Criminals Than People

Pedestrians walk past an embossed Bank sign at the entrance of a branch of the Swiss banking giant UBS on October 13, 2012 in Zurich. UBS could shed 10,000 jobs in the near future, according to a report in the Tages Anzeiger daily. The company could announce the layoffs when it presents its quarterly results on October 30, the newspaper said. (Photo by Afabrice Cofrini/AFP/Getty Images)

Pedestrians walk past an embossed Bank sign at the entrance of a branch of the Swiss banking giant UBS on October 13, 2012 in Zurich. UBS could shed 10,000 jobs in the near future, according to a report in the Tages Anzeiger daily. The company could announce the layoffs when it presents its quarterly results on October 30, the newspaper said. (Photo by Afabrice Cofrini/AFP/Getty Images)

People are pretty bad at robbing banks. According to the most recent Bank Crime Report from the U.S. Federal Bureau of Investigation, there were 5,014 attempted or successful robberies, 60 burglaries, and 12 larcenies at financial institutions in 2011. Most of these (4,495, about 90%) were at commercial banks, with a handful committed at credit unions, savings and loans institutions, and mutual savings banks.

Some sort of loot (mostly cash) was taken in 89% of the 5,086 total incidents, and all told, people took off with $38.4 million worth of stuff. This may seem like an impressive haul at first glance, but it works out to about $7,500 per incident. Consider that the conviction rate for bank robbery is over 50%, and it’s starting to look like your average bank robber is just hopelessly inept. You couldn’t even make minimum wage as a bank robber without all but guaranteeing your arrest.

So if you really want to rob a bank, you need to go above and beyond the scope of traditional robbery, burglary, or larceny. If movies have taught us anything, it’s that most great crimes are inside jobs orchestrated by calm and calculating wolves in sheep’s clothing. Instead of using firearms or brute force, these criminals have found a way to hide in plain sight and have figured out how to use the system against itself, to the detriment of many and for the benefit of the few.

This, at least, is how William Black, formerly a top banking regulator and now a professor at the University of Missouri, Kansas City, put it in a 2013 TEDx talk. The people who really know how to pull a heist — who can get away clean with millions — are not outsiders, they are the very people in control of the bank. They are the people responsible for executive decision making and they commit what Black calls control fraud.

“Control fraud is what happens when the people who control, typically a CEO, a seemingly legitimate entity, use it as a weapon to defraud,” Black says.

It’s dramatic and a not a little conspiratorial, but repeated financial crises have helped build a strong base of evidence for the argument made by Black and others. The United States (the whole world, really) suffers from a chronically ill financial system. Every few decades we’re hit with a major financial crisis and after each of them the economy is littered with the corpses of failed financial institutions. The most recent crisis in the late 2000s produced the most severe recession since the Great Depression and cost us, according to Black, $11 trillion and 10 million jobs.

In light of this, “our task is to educate ourselves so that we can understand why we have these recurrent, intensifying financial crises, and how we can prevent them in the future,” says Black. “And the answer to that is that we have to stop epidemics of control fraud.”

The first step to stopping the problem is to understand the problem, which is something that Black has about a good as grasp on as any. Black played a critical role in exposing both public and private corruption during the savings and loans crisis in the late 1980s and early 1990s. In that time frame, nearly one in four savings and loans associations in the U.S. failed. These institutions perform the familiar function of turning long-term savings deposits into economically and socially valuable loans like mortgages as well as carry out other banking and financial services, and their aggregate failure was the backbone of the S&L crisis.

All told, the number of federally insured S&L associations declined by about 50% — from 3,234 to 1,645 — between the beginning and end of the crisis. Taxpayer losses have been estimated at $123.8 billion, which at that time was considered by the Federal Deposit Insurance Corporation to be the greatest collapse of financial institutions since the Great Depression.

But then the late-2000s financial crisis tore through the global economy and left a path of ruin in its wake. The S&L crisis quickly became the second greatest collapse of financial institutions since the Great Depression; the financial institutions of the 21st century proved to have a much greater capacity to cause economic damage because of their immense size and interconnectedness.

But aside from their size, there wasn’t much about the recent crisis that was different from the S&L crisis. In his talk, Black spells out the recipe for accounting control fraud that he uncovered during the S&L crisis and which held true to the recent crisis as well.

  1. Grow like crazy
  2. Make or buy really crappy loans with a very high interest rate
  3. Employ leverage
  4. Provide only trivial reserves against inevitable losses

“If you follow those four simple steps, and any bank can follow them, then you are mathematically guaranteed to have three things occur,” argues Black. “The first thing is you will report record bank profits — not just high, record. Two, the CEO will immediately be made incredibly wealthy by modern executive compensation. And three, farther down the road, the bank will suffer catastrophic losses and will fail unless it is bailed out.”

This last thing — the catastrophic losses — is what Black says allowed regulators like him to discover the recipe. Black argues that if regulators had studied the recipe and evaluated the behavior of big banks in the early 2000s, the late-2000s crisis may have been avoidable. Regulators may have been able to step in and curb, if not end, institutional appraisal fraud and the issuance of liar’s loans that fueled the crisis.

But without sufficient regulatory tools, and without the willpower to use what regulatory tools were available to them, financial regulators such as the Federal Reserve failed to act in a way that addressed the crisis before it arrived, despite all of the warnings.

“Greenspan and Bernanke refused to use the authority under the [Home Ownership and Equity Protection Act] to stop liar’s loans. And this was a matter first of dogma. They’re just horrifically opposed to anything regulatory. But it is also the international competition in laxity, the race to the bottom between the United States and the United Kingdom, the city of London in particular, and the city of London won that race to the bottom, but it meant that all regulation in the West was completely degraded in this stupid competition to be who could have the weakest regulation,” said Black.

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