[Pages H7724-H7727]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

MF GLOBAL

The SPEAKER pro tempore. The Chair recognizes the gentlewoman from
Ohio (Ms. Kaptur) for 5 minutes.
Ms. KAPTUR. Mr. Speaker, thank goodness some Americans continue to
analyze the real causes of job loss and turmoil in our economy. While
all eyes are on Europe, the problem just isn't in Greece.
On October 31, U.S.-based MF Global Holdings, Limited filed for
chapter 11. It reportedly is the eighth largest bankruptcy in U.S.
history. Its failure, like the crash in 2008, revolves around the
actions of money traders using slick instruments called ``credit
derivatives.'' As analysts try to piece together what happened at MF
Global, one word seems to keep popping up: fraud.
I would like to include in the Record a few recent articles on the
Wall Street perpetrators of this crisis.

[From Reuters, Nov. 7, 2011]

Frustration Mounts for MF Global Clients

(By Lauren Tara LaCapra)

The sudden collapse of MF Global Holdings Ltd is leaving
some small and independent futures traders angry and
frustrated.
Customers of the bankrupt firm are starting to complain
about getting checks that bounced, having requests to
transfer funds denied and receiving inaccurate account
statements.
The growing litany of woes is adding to the tasks for the
receiver assigned to liquidate MF Global and causing some
investors to voice concern about the basic plumbing of the
financial services system.
Steve Meyers, an independent futures trader in Florida,
said he asked for $500,000 from his MF Global account to be
wired back to him on October 28 because he was concerned
about the firm filing for bankruptcy.
The money never was wired.
Instead, on November 2, Meyers received several checks from
MF Global that were dated October 28. By the time he went to
deposit the checks, MF Global had filed for bankruptcy on
October 31 and the checks were not honored for payment.
Between himself and several clients he manages money for,
Meyers said he has several millions of dollars still tied up
with MF Global.
``I am sitting with hundreds of thousands of dollars in
returned checks,'' said Meyers. ``I just think the industry
has suffered irreparable damage from this.''
Other clients of the firm led by former New Jersey Governor
Jon Corzine are telling similar stories.
Chris Ries, who co-manages a commodities brokerage and
grain dealer in Iowa that cleared trades through MF Global,
said several clients had checks bounce even though they
deposited them before MF Global's bankruptcy on October 31.
The situation has been made worse, he said, because
customers' account balances appear as though they received
the cash even though the checks did not clear.
``Eventually it may all get cleared up,'' said Ries, ``but
for now, accounts with bounced checks don't reflect the
balance that they should.''
Missing $600 Million
Some clients' checks were drawn on an MF Global account
held at a Harris Bank branch in Illinois. Harris Bank is a
subsidiary of Bank of Montreal.
Jim Kappel, a spokesman for Harris, said the bank began
denying payment and returning checks on November 1, at the
direction of the bankruptcy trustee. While some checks might
have been dated before October 31, he said, they were likely
debited at a later date.
Clients' issues with bounced checks come as MF Global and
its regulators continue to hunt for $600 million in client
money that has gone missing. It is not clear if some of the
bounced checks are part of the unaccounted money.
It appears MF Global began issuing checks to customers
seeking funds--instead of wiring the money--as a way to buy
some time for the firm, which was hoping to arrange a last-
minute sale to Interactive Brokers, some of the customers
say. The deal fell apart last Monday when the issue of the
missing customer money arose.
A week later, regulators have yet to provide an answer on
what became of the missing $600 million, although some money
has been located in an account with JPMorgan Chase.
Brokers who cleared through MF Global say they have been
allowed to move some of their money to new firms, but not all
of it. They have been waiting for guidance from the trustee
or regulators on when they will get access to all of their
funds.
Frustration
MF Global's trustee, James Giddens, had frozen 150,000
accounts when the firm filed for bankruptcy protection.
On Monday, Giddens said $1.5 billion worth of client money
had been transferred to other firms. But the trustee and CME
Group Inc, which regulates futures exchanges, have held back
some $1 billion in customer funds as they search for the
missing money, angering clients who can trade again but are
still frozen out of their excess collateral and cash.
``We can understand the frustration of customers,'' Kent
Jarrell, a spokesman for the trustee, told Reuters. ``That is
why we are working around the clock to facilitate the
transfer and return of customer assets. Unfortunately, this
will take time as we conduct our independent and thorough
investigation and maximize the estate for all stakeholders in
a fair process.''
Some traders who tried to move their money from MF Global
to other clearing firms or banks even before the company went
belly-up have also been left in the lurch.
One independent options trader in Chicago said he placed a
wire request on the morning of October 28 to transfer $1.25
million from MF Global to JPMorgan Chase.
The transfer never occurred.
An MF Global representative said JPMorgan rejected the
transfer because of errors in the account number, the trader
said, but upon double-checking the wire request form he found
no mistakes. The funds have remained frozen at MF Global
since its bankruptcy, he said.
``We pretty much have zero clarity,'' said the trader, who
did not want to be identified. ``I have a feeling the wire
instructions probably just got lost in the turmoil.''

{time} 1100

In a recent posting, attorney William Black describes the failure of
our justice system to investigate ``accounting control fraud as a
systemic risk that underlies the damage still being done.''
The collapse of MF Global has garnered massive attention, partly
because Jon Corzine sat at its helm. Mr. Corzine is a former chief
executive officer of infamous Goldman Sachs. He is also a former U.S.
Senator and former

[[Page H7725]]

Governor of New Jersey. Mr. Corzine's firm even held a special status
as a primary dealer at the New York Federal Reserve. That's like the
Good Housekeeping stamp of approval. Mr. Corzine isn't the only former
government leader whose cozy relationship with the financial services
industry is being publicly questioned.
Former Speaker of this House Newt Gingrich appears to have had a
significant financial relationship with Freddie Mac, one of the
mortgage industry giants led by its management into financial ruin.
Freddie Mac played a key role in the financial meltdown. As countless
American families have lost their homes, Freddie Mac assumed the toxic
assets that were handed to it from the banks. And it is now under
conservatorship of the Federal Government, living off the taxpayer
dime. Mr. Gingrich is apparently $1.8 million richer, though he claims
he isn't sure how much Freddie paid him.
I now see why Congress has consistently failed to investigate what
happened at Freddie Mac along with Fannie Mae to determine exactly what
decisions, by whom--by whom and when led to this financial ruin. I have
a bill to do just that. H.R. 2093, the Fannie Mae and Freddie Mac
Commission Act. It's well past time to pass it, and I invite Members to
join me in this effort.
The allegations against MF Global are serious. Mr. Corzine's firm had
essentially placed a $6.3 billion bet on the sovereign debt of several
European governments. After its most recent quarterly returns showed
almost $200 million in losses, MF Global's stock lost 67 percent of its
value. But this is not just a case of an investment firm being lured by
the higher returns of riskier bonds. CME Group, Inc., who audited MF
Global's accounts, found that Mr. Corzine's company violated key
requirements to keep its accounts separate from its clients'. The
details are still being sorted out, but as much as $600 million appears
to be missing from customer accounts.
The financial press is reporting a staggering amount of malfeasance
in the days before MF Global filed for bankruptcy. In an apparent
effort to buy themselves time, MF Global sent checks instead of wiring
money. The checks turned out to be bogus. There are stories of requests
to transfer funds being denied and even inaccurate account statements
being issued. Even more egregious are accounts of people receiving
bounced checks, going back and finding that their accounts were also
altered inappropriately. If this isn't fraud, what is?
What should concern all of us is the knowledge that fraud is not
limited to a case here or there. In the financial services sector,
fraud has become systemic. In 2009, the FBI testified before the House
Judiciary Committee, ``The current financial crisis has produced one
unexpected consequence: It has exposed prevalent fraud schemes that
have been thriving in the global financial system. These fraud schemes
are not new, but they are coming to light as a result of market
deterioration.''
This isn't the first time our country has seen a massive crime wave
in the financial services industry. In the 1980s, it was the savings
and loan crisis, and the FBI responded with a staff of 1,000 agents and
forensic experts based in 27 cities. That crisis was much smaller than
what we are seeing today, yet today the FBI only has a couple hundred
agents able to investigate. I have a bill, H.R. 1350, that asks that
number to be increased by 1,000. I ask my colleagues to help cosponsor
it, and let's bring some reason and prudence back to the financial
markets of our country and let's exact real justice for the American
people.

The Virgin Crisis: Systematically Ignoring Fraud as a Systemic Risk

(By William K. Black)

One of the most revealing things about this crisis is the
unwillingness to investigate whether ``accounting control
fraud'' was a major contributor to the crisis. The refusal to
even consider a major role for fraud is facially bizarre. The
banking expert James Pierce found that fraud by senior
insiders was, historically, the leading cause of major bank
failures in the United States. The national commission that
investigated the cause of the S&L debacle found:
``The typical large failure [grew] at an extremely rapid
rate, achieving high concentrations of assets in risky
ventures. . . . [E]very accounting trick available was used.
. . . Evidence of fraud was invariably present as was the
ability of the operators to ``milk'' the organization.''
(NCFIRRE 1993) Two of the nation's top economists'' study of
the S&L debacle led them to conclude that the S&L regulators
were correct--financial deregulation could be dangerously
criminogenic. That understanding would allow us to avoid
similar future crises. ``Neither the public nor economists
foresaw that [S&L deregulation was] bound to produce looting.
Nor, unaware of the concept, could they have known how
serious it would be. Thus the regulators in the field who
understood what was happening from the beginning found
lukewarm support, at best, for their cause. Now we know
better. If we learn from experience, history need not repeat
itself' (George Akerlof & Paul Romer. ``Looting: the Economic
Underworld of Bankruptcy for Profit.'' 1993: 60).
The epidemic of accounting control fraud that drove the
second phase of the S&L debacle (the first phase was caused
by interest rate risk) was followed by an epidemic of
accounting control fraud that produced the Enron era frauds.
The FBI warned in September 2004 that there was an
``epidemic'' of mortgage fraud and predicted that it would
cause a financial ``crisis'' if it were not contained. The
mortgage banking industry's own anti-fraud experts reported
in writing to nearly every mortgage lender in 2006 that:
``Stated income and reduced documentation loans speed up
the approval process, but they are open invitations to
fraudsters.'' ``When the stated incomes were compared to the
IRS figures: [90%] of the stated incomes were exaggerated by
5% or more. [A]lmost 60% were exaggerated by more than 50%.
[T]he stated income loan deserves the nickname used by many
in the industry, the `liar's loan' '' (MARI 2006).
We know that accounting control fraud is itself
criminogenic--fraud begets fraud. The fraudulent CEOs
deliberately create the perverse incentives that that suborn
inside and outside employees and professionals. We have known
for four decades how these perverse incentives produce
endemic fraud by generating a ``Gresham's'' dynamic in which
bad ethics drives good ethics out of the marketplace.
``[D]ishonest dealings tend to drive honest dealings out of
the market. The cost of dishonesty, therefore, lies not only
in the amount by which the purchaser is cheated; the cost
also must include the loss incurred from driving legitimate
business out of existence.'' George Akerlof (1970).
Akerlof noted this dynamic in his seminal article on
markets for ``lemons,'' which led to the award of the Nobel
Prize in Economics in 2001. It is the giants of economics who
have confirmed what the S&L regulators and criminologists
observed when we systematically ``autopsied'' each S&L
failure to investigate its causes. Modern executive
compensation has made accounting control fraud vastly more
criminogenic than it once was as investigators of the current
crisis have confirmed.
``Over the last several years, the subprime market has
created a race to the bottom in which unethical actors have
been handsomely rewarded for their misdeeds and ethical
actors have lost market share. . . . The market incentives
rewarded irresponsible lending and made it more difficult for
responsible lenders to compete.'' Miller, T. J. (August 14,
2007). Iowa AG.
Liar's loans offer what we call a superb ``natural
experiment.'' No honest mortgage lender would make a liar's
loan because such loans have a sharply negative expected
value. Not underwriting creates intense ``adverse
selection.'' We know that it was overwhelmingly the lenders
and their agents that put the lies in liar's loans and the
lenders created the perverse compensation incentives that led
their agents to lie about the borrowers' income and to
inflate appraisals. We know that appraisal fraud was endemic
and only agents and their lenders can commit widespread
appraisal fraud. Iowa Attorney General Miller's
investigations found:
``[Many originators invent] non-existent occupations or
income sources, or simply inflat[e] income totals to support
loan applications. Importantly, our investigations have found
that most stated income fraud occurs at the suggestion and
direction of the loan originator, not the consumer.''
New York Attorney General (now Governor) Cuomo's
investigations revealed that Washington Mutual (one of the
leaders in making liar's loans) developed a blacklist of
appraisers--who refused to inflate appraisals. No honest
mortgage lender would ever inflate an appraisal or permit
widespread appraisal inflation by its agents. Surveys of
appraisers confirm that there was widespread pressure by
nonprime lenders and their agents to inflate appraisals.
We also know that the firms that made and purchased liar's
loans followed the respective accounting control fraud
``recipes'' that maximize fictional short-term reported
income, executive compensation, and (real) losses. Those
recipes have four ingredients:
1. Grow like crazy
2. By making (or purchasing) poor quality loans at a
premium yield
3. While employing extreme leverage, and
4. Providing only grossly inadequate allowances for loan
and lease losses (ALLL) against the losses inherent in making
or purchasing liars loans
Firms that follow these recipes are not ``gamblers'' and
they are not taking ``risks.'' Akerlof & Romer, the S&L
regulators, and criminologists recognize that this recipe
provides a ``sure thing.'' The exceptional (albeit

[[Page H7726]]

fictional) income, real bonuses, and real losses are all sure
things for accounting control frauds.
Liar's loans are superb ``ammunition'' for accounting
control frauds because they (and appraisal fraud) allow the
fraudulent mortgage lenders and their agents to attain the
unholy fraud trinity: (1) the lender can charge a substantial
premium yield, (2) on a loan that appears to relatively lower
risk because the lender has inflated the borrowers' income
and the appraisal, while (3) eliminating the incriminating
evidence of fraud that real underwriting of the borrowers'
income and salary would normally place in the loan files. The
government did not require any entity to make or purchase
liar's loans (and that includes Fannie and Freddie). The
states and the federal government frequently criticized
liar's loans. Fannie and Freddie purchased liar's loans for
the same reasons that Merrill, Lehman, Bear Stearns, etc.
acquired liar's loans--they were accounting control frauds
and liar's loans (and CDOs backed by liar's loans) were the
best available ammunition for maximizing their fictional
reported income and real bonuses.
Liar's loans were large enough to hyper-inflate the bubble
and drive the crisis. They increased massively from 2003-
2007.
``[B]etween 2003 and 2006 . . . subprime and Alt-A [loans
grew] 94 and 340 percent, respectively.
The higher levels of originations after 2003 were largely
sustained by the growth of the nonprime (both the subprime
and Alt-A) segment of the mortgage market.'' ``Alt-A: The
Forgotten Segment of the Mortgage Market'' (Federal Reserve
Bank of St. Louis 2010).
The growth of liar's loans was actually far greater than
the extraordinary rate that the St. Louis Fed study
indicated. Their error was assuming that ``subprime'' and
``alt-a'' (one of the many misleading euphemisms for liar's
loans) were dichotomous. Credit Suisse's early 2007 study of
nonprime lending reported that roughly half of all loans
called ``subprime'' were also ``liar's'' loans and that
roughly one-third of home loans made in 2006 were liar's
loans. That fact has four critical implications for this
subject. The growth of liar's loans was dramatically larger
than the already extraordinary 340% in three years reported
by the St. Louis Fed because, by 2006, half of the loans the
study labeled as ``subprime'' were also liar's loans. Because
loans the study classified as ``subprime'' started out the
period studied (2003) as a much larger category than liar's
loans the actual percentage increase in liar's loans from
2003-2006 is over 500%. The first critical implication is
that it was the tremendous growth in liar's loans that caused
the bubble to hyper-inflate and delayed its collapse.
The role of accounting control fraud epidemics in causing
bubbles to hyper-inflate and persist is another reason that
accounting control fraud is often criminogenic. When such
frauds cluster they are likely to drive serious bubbles.
Inflating bubbles optimize the fraud recipes for borrowers
and purchasers of the bad loans by greatly delaying the onset
of loss recognition. The saying in the trade is that ``a
rolling loan gathers no loss.'' One can simply refinance the
bad loans to delay the loss recognition and book new fee and
interest ``income.'' When entry is easy (and entry into
becoming a mortgage broker was exceptionally easy), an
industry becomes even more criminogenic.
Second, liar's loans (and CDOs ``backed'' by liar's loans)
were large enough to cause extreme losses. Millions of liar's
loans were made and those loans caused catastrophic losses
because they hyper-inflated the bubble, because they were
endemically fraudulent, because the borrower was typically
induced by the lenders' frauds to acquire a home they could
not afford to purchase, and because the appraisals were
frequently inflated. Do the math: roughly one-third of home
loans made in 2006 were liar's loans and the incidence of
fraud in such loans was 90%. We are talking about an annual
fraud rate of over one million mortgage loans from 2005 until
the market for liar's loans collapsed in mid-2007.
Third, the industry massively increased its origination and
purchase of liar's loans after the FBI warned of the
developing fraud ``epidemic'' and predicted it would cause a
crisis and then massively increased its origination and
purchase of liar's loans after the industry's own anti-fraud
experts warned that such loans were endemically fraudulent
and would cause severe losses. Again, this provides a natural
experiment to evaluate why Fannie, Freddie, et alia,
originated and purchased these loans. It wasn't because ``the
government'' compelled them to do so. They did so because
they were accounting control frauds.
Fourth, the industry increasingly made the worst
conceivable loans that maximized fictional short-term income
and real compensation and losses. Making (or purchasing)
liar's loans that are also subprime loans means that the
originator is making (or the purchaser is buying) a loan that
is endemically fraudulent to a borrower who has known,
serious credit problems. It's actually worse than that
because lenders also increasingly added ``layered'' risks (no
downpayments and negative amortization) in order to optimize
accounting fraud. Negative amortization reduces the
borrowers' short-term interest rates, delaying delinquencies
and defaults (but producing far greater losses). Again, this
strategy maximizes fictional income and real losses. Honest
home lenders and purchasers of home loans would not act in
this fashion because the loans must cause catastrophic
losses.
To sum it up, the known facts of this crisis refute the
rival theories that the lenders/purchasers originated/bought
endemically fraudulent liar's loans because (a) ``the
government'' made them (or Fannie and Freddie) do so, or (b)
because they were trying to maximize profits by taking
``extreme tail'' (i.e., an exceptionally unlikely risk). The
risk that a liar's home loan will default is exceptionally
high, not exceptionally low. The known facts of the crisis
are consistent with accounting control frauds using liar's
loans (in the United States) as their ``ammunition of
choice'' in accordance with the conventional fraud ``recipe''
used that caused prior U.S. crises.
It is bizarre that in such circumstances the automatic
assumption of the Bush and Obama administrations has been
that fraud isn't even worth investigating or considering in
connection with the crisis. It is as if millions of liar's
loans purchased and resold as CDOs largely by systemically
dangerous institutions are an inconvenient distraction from
campaign fundraising efforts. Instead, we have the myth of
the virgin crisis unsullied by accounting control fraud.
Indeed, contrary to theory, experience, and reality, the
Department of Justice has invented the faith-based fiction
that looting cannot occur.
Benjamin Wagner, a U.S. Attorney who is actively
prosecuting mortgage fraud cases in Sacramento, Calif.,
points out that banks lose money when a loan turns out to be
fraudulent. ``It doesn't make any sense to me that they would
be deliberately defrauding themselves,'' Wagner said.
Wagner's statement is embarrassing. He conflates ``they''
(referring to the CEO) and ``themselves'' (referring to the
bank). It makes perfect sense for the CEO to loot the bank.
Looting is a ``sure thing'' guaranteed to make the CEO
wealthy. ``Looting'' destroys the bank (that's the
``bankruptcy'' part of Akerlof & Romer's title) but it
produces the ``profit'' for the CEO. It is the deliberate
making of masses of bad loans at premium yields that allows
the CEO to profit by looting the bank. When the top
prosecutor in an epicenter of accounting control fraud
defines the most destructive form of financial crime out of
existence he allows elite fraud to occur with impunity.
As embarrassing as Wagner's statement is, however, it
cannot compete on this dimension with that of his boss,
Attorney General Holder. I was appalled when I reviewed his
testimony before the Financial Crisis Inquiry Commission
(FCIC). Chairman Angelides asked Holder to explain the
actions the Department of Justice (DOJ) took in response to
the FBI's warning in September 2004 that mortgage fraud was
``epidemic'' and its prediction that if the fraud epidemic
were not contained it would cause a financial ``crisis.''
Holder testified: ``I'm not familiar myself with that [FBI]
statement.'' The DOJ's (the FBI is part of DOJ) preeminent
contribution with respect to this crisis was the FBI's 2004
warning to the nation (in open House testimony picked up by
the national media. For none of Holder's senior staffers who
prepped him for his testimony to know about the FBI testimony
requires that they know nothing about the department's most
important and (potentially) useful act. That depth of
ignorance could not exist if his senior aides cared the least
about the financial crisis and made it even a minor priority
to understand, investigate, and prosecute the frauds that
drove the crisis. Because Holder was testifying in January
14, 2010, the failure of anyone from Holder on down in his
prep team to know about the FBI's warnings also requires that
all of them failed to read any of the relevant criminology
literature or even the media and blogosphere.
In addition to claiming that the DOJ's response to the
developing crisis under President Bush was superb, Holder
implicitly took the position that (without any investigation
or analysis) fraud could not and did not pose any systemic
economic risk. Implicitly, he claimed that only economists
had the expertise to contribute to understanding the causes
of the crisis. If you don't investigate; you don't find. If
you don't understand ``accounting control fraud'' you cannot
understand why we have recurrent, intensifying financial
crises. If Holder thinks we should take our policy advice
from Larry Summers and Bob Rubin, leading authors of the
crisis, then he has abdicated his responsibilities to the
source of the problem. ``Now let me state at the outset what
role the Department plays and does not play in addressing
these challenges'' [record fraud in investment banking and
securities].
``The Department of Justice investigates and prosecutes
federal crimes. . . .''
``As a general matter we do not have the expertise nor is
it part of our mission to opine on the systemic causes of the
financial crisis. Rather the Justice Department's resources
are focused on investigating and prosecuting crime. It is
within this context that I am pleased to offer my testimony
and to contribute to your vital review.'' Two aspects of
Holder's testimony were preposterous, dishonest, and
dangerous.
``I'm proud that we have put in place a law enforcement
response to the financial crisis that is and will continue to
be is aggressive, comprehensive, and well-coordinated.''
DOJ has obtained ten convictions of senior insiders of
mortgage lenders (all from one obscure mortgage bank) v. over
1000 felony convictions in the S&L debacle. DOJ has not
conducted an investigation worthy of the

[[Page H7727]]

name of any of the largest accounting control frauds. DOJ is
actively opposing investigating the systemically dangerous
institutions (SDIs).
Holder's most disingenuous and dangerous sentence, however,
was this one:
``Our efforts to fight economic crime are a vital component
of our broader strategy, a strategy that seeks to foster
confidence in our financial system, integrity in our markets,
and prosperity for the American people.'' Yes, the
``confidence fairy'' ruled at DOJ. It is the rationale now
for DOJ's disgraceful efforts to achieve immunity for the
SDIs' endemic frauds. The confidence fairy trumped and
traduced ``integrity in our markets'' and ``prosperity for
the American people.'' Prosperity is reserved for the SDIs
and their senior managers--the one percent.

____________________