Nevada Attorney General Catherine Cortez Masto Cracks Open the Financial Crisis

Learn the name Catherine Cortez Masto, because she just took a big leap in front of every public servant in the country in terms of restoring faith in government. As Nevada AG, she actually indicted someone for blowing up our housing system. Specifically, she handed down 606 counts of felony or gross misdemeanor indictments on robo-signing against two employees of big bank subcontractor Lender Processing Services.

It’s pretty clear from the indictment that these are mid-level employees, one level up supervisors of fraud rather than top CEOs. And yet, even if this were as far as it goes, it would still be a big deal. These would be the only charges served involving the housing crisis and its link with the structurally corrupt securitization chain so far. By itself, these indictments signify that the fraudulent foreclosure game is over for the big mortgage servicers in Nevada, which is the center of the foreclosure epidemic. It says the rule of law matters, in at least one corner of the country. But you don’t throw 606 counts against someone if all you’re going for is jail time for that person; this is about starting at the bottom, and flipping people. It could be the takedown of the mortgage servicer mafia, and then back to the origination.

The Nevada AG office has said they will follow the trail as far as it goes.

The AG’s office has not made allegations against banks themselves, he said. “We simply don’t know if the major banks were aware of what these individuals were doing,” according to Kelleher.

If banks sanctioned the alleged robo-signers’ activities, Kelleher said, they could be the subject of future actions. “Our charge is to prosecute criminal activity by whomever may be committing it,” he said. “There’s no provision under the law for an industry to collectively decide to circumvent Nevada statutes.”

Masto has been by far the most aggressive AG on the civil side, suing Bank of America for multiple violations of a consent order on mortgage servicing, and even making the dreaded nuclear chain of title claim on foreclosures. It’s no surprise she’s taking the lead on criminal matters. Given that her office basically has no native resources or sector expertise in mortgage backed securities, it does make me wonder just what every other AG in the country and DOJ official is doing now that she’s proved bringing charges for fraud is not in fact impossible.

At this point, Masto has gone further than any other official in terms of restoring some sort of social contract. And that’s saying something. Leadership can come from anywhere, especially when the corruption seems to be everywhere. And with California AG Kamala Harris putting immense pressure on Fannie/Freddie on foreclosures, it suggests the tide is turning on this issue somewhat.

Our essential economic problem is that our economy allocates resources through a mediating system of banks that are broken and/or corrupt. If you look at a chart of the recession, and then the recovery, you’ll notice that business investment perked up, but residential investment did not. The Fed lowered rates, bought Treasury bonds, and bought mortgage backed securities to lower rates for homeowners. But it’s not really working, because the monetary channel is corrupt. This indictment gets to that problem, it alleges tens of thousands of forged documents (or as a friend told me sarcastically, an afternoon’s worth of work for LPS). These documents represent foreclosures, economic loss, and clouded title. The indictments handed down, and the ones to come, show that corrupting our property laws and the basis of our economy is a crime.

First President Bush, and then President Obama, tried to reconstruct an economic system based on a corrupted transmission mechanism from the Fed to the real economy. This was the financial crisis, it’s why abstract derivatives based on subprime mortgages knocked trillions of productive output off of the economy. Corruption is really inefficient.

Let’s bring this back to Attorney General Eric Holder, and President Obama. Right now, the narrative of the Obama administration is being written, just in case he’s a one-term President. Factions want to put pen to paper and make sure they escape blame by showing they understand how things went wrong.

Ezra Klein has an essay in the New York Review of Books on Ron Suskind’s Confidence Men, which is basically such an assessment. Klein asks an important question – could Obama have done better, with different advisors? That is after all the central premise of Suskind’s book, that Obama was taken in by experienced Wall Street charlatans, namely Geithner and Summers. Klein concludes his review by essentially saying, not really. At the margins, he argues, Obama could have appointed a different Fed Chair perhaps, and filled empty seats on the Fed. But Obama had to deal with a Congress that was unlikely to deliver a bigger stimulus, or any other meaningful policy change.

Klein furthered his critique in the Washington Post with an explanation that the Presidency just, well, isn’t that powerful.

If you believe that the state of the economy drives the electorate’s evaluations of our political leaders — and you should believe that — then you have to grapple with the fact that the president is primarily responsible for economic conditions and needs either Congress or the Federal Reserve to join him in making economic policy.

To some, this reads like a subtler defense of Barack Obama. An attempt not so much to defend his record but to distract from it, to offer an explanation for low approval numbers and high unemployment that doesn’t impinge on the president’s decision making. So perhaps it would help to start by stating my opinion on Obama’s presidency more clearly.

I think, from 2009 to 2010, the Obama administration operated on the frontier of the policy possible. They did about as much, and perhaps a bit more, than they could reasonably have been expected to do. The stimulus, health-care reform, financial regulation, the end of “don’t ask, don’t tell,” the passage of the START treaty, the expansion of the Children’s Health Insurance Program, the imposition of new regulations on tobacco, the stress tests, the SERVE America Act … that’s quite a lot for a two-year period. That’s not to say there weren’t mistakes, of course. Their housing policies were insufficient, and they were absurdly slow with nominations. But I would grade their first two years fairly highly given my estimation of what was achievable.

Mike Konczal has a gentle rebuttal premised on certain fiscal arguments by the Obama administration showing that it wasn’t political constraints preventing more aggressive fiscal actions, but intrinsic belief. And the argument, no doubt, will go on.

But I think it’s important to begin considering criminal justice as a core element of economic policy. I’d like to hear from Suskind, Klein, Krugman, and others just where they think allowing massive systemic fraud fits into the analysis of what went wrong. After all, Eric Holder had ample prosecutorial discretion, so none of the usual arguments about political constraints apply. Allowing the corrupt monetary channel to continue was simply a policy choice. If the under-resourced Nevada Attorney General could make such a different policy choice, then a powerful by comparison White House and Justice Department could make it as well. And this sort of show of power does not operate in a vacuum. Taking on, and taking down, corrupt members of the elite would also have exposed all sorts of fracture lines, and would likely have change the Congressional dynamics that people argue is immutable. Bank executives would have had a strong personal incentive to fix housing problems and excessive debt loads, and politicians react differently when an act is officially deemed a crime.

The demand for justice, for a society to place certain activities outside of the bounds of socially acceptable, is not just about satisfaction of the public for wrongs committed. I get the sense that fraud for most economists is considered something of a side issue, a kind of aesthetic political problem to be ignored in favor of more significant questions of stimulus and regulatory policies. This is a baffling attitude. One of my favorite financial legal bloggers, Carolyn Sissiko, has pointed out that fraud actually can have significant macro-economic impacts by distorting bank balance sheets.

A more significant attempt to look at this problem comes from a paper by Claudio Borio and Piti Disyatat of the Bank of International Settlements. They attempt to fill in some of the gap between how financial systems work in practice, with bankruptcy, lending, and different institutional arrangements, and the macro-economic models that assume no friction and a natural interest rate.

The felony indictments from the Nevada AG’s office are the first sign that the law enforcement community can take financial crimes seriously, that blowing up the economy through financial mismanagement can carry costs. There’s a lot of research to be done on the costs of fraud, and the costs of foreclosures. We don’t know that much about these costs, because there haven’t been investigations and there isn’t a lot of good public data. After all, we mostly just take our property rights system for granted, the notion that clouded titles or a broken $10 trillion mortgage market could inhibit growth simply was not imaginable a few years ago. What is clear is that there is a deep public hunger for justice. And I suspect, that if that hunger had been satiated a few years ago and if Holder had begun handing down indictments, mortgage servicer executives would have begun a serious loan workout program.

And our economy would probably be in much better shape. When you throw your capital into the hands of people who have no incentive to use it wisely, the economy suffers. When you enforce the rule of law, sound business models prevail and ordinary citizens have more confidence in the system and spend and invest accordingly. As an economic policy, justice works.

This post originally appeared at naked capitalism and is reproduced with permission.

3 Responses to "Nevada Attorney General Catherine Cortez Masto Cracks Open the Financial Crisis"

  1. liljohny   November 20, 2011 at 3:45 pm

    Technical errors on foreclosing on deadbeats is the wrong area for focus…that just stretches the pain our for a decade. The real focus should be on those who originated toxic crap and securitized it spreading the contagion throughout the economy. Robo signing is a technical flaw. If someone is truly foreclosed and not a deadbeat they have plenty of remedies available under civil statutes. It was sloppy but the excitement of this article over pursuing technical perfection under foreclosure statutes that are obsolete in many cases due to securitization in many cases is misplaced. There is plenty of guilt (real estate brokers and mortgage brokers being high on the guilt list along with the gurus who gamed the willing whores at the ratings agencies) but this is just treeing a coon while wolves continue to eat the sheep.

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