On the Daily Politics and the Sunday Politics recently, Andrew Neil has referred to how journalists do not report on the financial sector.  That he feels this to be a lack was also suggested by his treating Max Keiser with much respect.  The online community is relatively familiar with the Keiser Report but amongst academics, Professor Bill Black is a rare creature…  a former financial regulator and now, Associate Professor of Law and Economics at the University of Missouri-Kansas City. This post presents some of his findings about the abundance of fraud in the financial sector, and a video clip of his recent speech in Davos.

What is a criminogenic environment?

Criminogenic environments produce such intense and perverse incentives that they generate epidemics of control fraud. (1) 

Large, individual accounting control frauds cause greater financial losses than all other forms of property crime – combined.  Accounting control frauds are weapons of mass financial destruction.  Epidemics of accounting control fraud drove the national crises that produced the Great Recession.  We have reliable information on this in the United States, the United Kingdom, Ireland, and Iceland…. These accounting control fraud epidemics drove crises that caused a loss of over $20 trillion in wealth and cost roughly 20 million workers their jobs. (1)

How do we know that the City of London is a criminogenic environment?

Most of the major financial and banking scandals have originated in London.  Incredibly, the belief amongst neoclassical economists and the World Economic Forum is that

‘Malfeasance and outright fraud [in finance] are extraordinarily damaging but also, fortunately, extremely rare.’(1)  

Without evidence, the markets are assumed to be ‘self-cleansing’ and therefore, ‘self-regulating’.. hence, it is argued that there is no need to have regulation and supervision.

However, Akerlof & Romer explain why deregulation encouraged control fraud:

“[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution?” (Akerlof & Romer 1993: 4-5). (1)

In fact, the dishonest practices of some institutions, invited a ‘race to the bottom’.  It is very difficult to ‘honestly’ compete with a dishonest broker… so effectively a ‘market’ was set up as to who could be the most successfully ‘fraudulent’.  The inevitable corollary was the pressure to remove as much supervision and regulation as possible:

The “race to the weakest supervisor” did not occur only within the U.S.  Brooksley Born and a former senior SEC official have confirmed to me that UK regulators directly pitched U.S. financial firms to relocate operations to the City of London in order to obtain weaker supervision.  “Fed lite” supervision was a competitive response to the FSA’s “reg lite” system of deliberately weak supervision.  The City of London became the most criminogenic environment in the world for financial fraud, which is why so many UK banks and units of foreign banks located in the City have caused the major scandals in the UK and globally. (1)

I have quoted extensively from Professor William K Black’s articles on New Economic Perspectives because they are essentially the keynote speech that he gave at the ‘Public Eye’ shame award in Davos.  As he says in the video clip below, economists know nothing about fraud and law students very little.  Of course, anyone familiar with Max Keiser will also be familiar with the levels of ‘decriminalised’ fraud that Bill Black describes in the financial markets.  For example, 40% of the mortgages issued in the US in 2006 were ‘liar’s loans’ in which the lenders deliberately chose not to verify the borrower’s income.  90% of ‘liar’s loans’ have been shown to be fraudulent, but the incentives offered to the agents were huge.  In the UK, 45% of the mortgages at that time were also ‘liar’s loans’.

This year, the annual “Public Eye” “shame prize” was awarded to Goldman Sachs for its abuses.  Bill Black writes:

The shame prize award was made in Davos during the World Economic Forum as a counter-WEF event.  Shell also “won” a shame prize, but I spoke on Goldman Sachs, the role of epidemics of accounting control fraud, and the WEF’s anti-regulatory and pro-executive compensation policies.  I explained that the anti-regulatory policies were intended to fuel the destructive regulatory “race to the bottom” and why the executive and professional compensation policies maximized the incentives to defraud.  I also explained that WEF was a fraud denier.  Collectively, these three WEF policies contributed to creating the intensely criminogenic environments that produce the epidemics of accounting control fraud driving our worst financial crises.

http://neweconomicperspectives.org/2013/01/the-handmaiden-of-capitalism-v-the-swamp-denizen-of-detroit.html#more-4614

William K. Black’s speech at the Public Eye Awards 2013 World Economics Forum