Michael Hudson on GE Capital, WMC and Fraud

There’s a 1998 Brookings book by Bob Litan and Jonathan Rauch, American Finance for the 21st Century. Originally prepared as a report to Congress by the Treasury Department, it provides the arguments that were used as the justification for the repeal of Glass-Steagall.  I think it’s a great document for how Washington people saw the remaining parts of the New Deal-era financial regulatory architecture going into the housing bubble:

To use a transportation analogy, the twentieth-century model of financial policy has, for the most part, set a slow speed limit, specified a few basic models for cars, separated different kinds of cars into different lanes, and demanded that no one leave home without a full tank of gas and a tune-up.  Better suited for the mercurial financial world now emerging is a model that, while not abandoning all that went before, focuses less on preventing mishaps and more on ensuring that an accident at any one intersection will not paralyze traffic everywhere else.

Those two focuses, preventing fraud (mishaps) and contagion (paralyzed traffic) is exactly what the financial system and regulators turned out to be worst at in the 2000s.

What kind of new cars were going to hit the road?  There’s one company that gets particular attention, GE.

In the recent past, for example, newcomers in the credit business, such as GE Capital and GMAC, were offshoots of manufacturing companies that discovered-learning, in effect, by doing-that they could see credit as profitably as could the traditional providers.  Tomorrow’s companies “spinning” in to financial services will be drawn from the sectors holding the keys to the information revolution: software and communications.

Another key they held was the ability to destroy the careers of internal people flagging fraud and abuse.  It paid to be outside the formal regulatory architecture and also outside the informal ethics network put them in a place where anything went.

The excellent financial reporter Michael Hudson, author of the book The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America–and Spawned a Global Crisis, wrote a fantastic piece investigating fraud and abuse at WMC, the subprime mortgage wing GE purchased.  GE Capital (and its bailout) is a particular fascination of mine, so I was excited to read this piece.  I wasn’t disappointed.

Here’s Fraud and folly: The untold story of General Electric’s subprime debacle.  Here’s an excerpt:

Dave Riedel, a former compliance manager at WMC, says sales reps intent on putting up big numbers used falsified paperwork, bogus income documentation and other tricks to get loans approved and sold off to Wall Street investors…

Riedel, who worked as quality-control manager for the lender’s largest production division, claims that after he informed a GE official about fraud inside the lender, WMC’s management demoted him — reorganizing him out of his job, taking away his office and his staff and forcing him to sit at a desk for months without a job title…

Questions about WMC’s lending tactics were also raised by an academic study that looked at a pool of 5,610 loans the company had made around the country in 1998. By December 1999 almost 25 percent of the loans were facing foreclosure or were seriously delinquent — more than five times the rate for loans originated by other major subprime lenders, the study found….

He helped put together a presentation in May 2006 aimed at giving GE officials a sense of how serious WMC’s fraud problems were. Riedel says an audit of soured loans that investors had asked WMC to repurchase indicated that 78 percent of them had been fraudulent; nearly four out of five of the loan applications backing these mortgages had contained misrepresentations about borrowers’ incomes or employment.

 By October 2007 — as Riedel had predicted — WMC Mortgage was effectively out of business, dead after having pumped out roughly $110 billion in subprime and “Alt-A” loans under GE’s watch, according to industry data tracker Inside Mortgage Finance…

A study by federal regulators, “Worst Ten in the Worst Ten,” found WMC’s loans accounted for the second-highest number of foreclosures on subprime and “Alt-A” mortgages in the nation’s 10 hardest-hit foreclosure hotspots, trailing only New Century Financial.

I do like happy endings – what happened to the person who put $110 billion dollars worth of poison into the capital markets?

 WMC’s former CEO had a 30-acre ranch outside Los Angeles where she kept a dozen horses. She’d used some of the millions she’d earned at the lender, the magazine said, to start an independent record label, YMA Music Group, which signed such artists as former Limp Bizkit guitarist Wes Borland. She’d also become CEO of Vantium Capital, a private equity fund that planned to make money off distressed mortgages.

Make the disease, sell the cure.  Brilliant.  A crucial question: how would this person, or anyone in the article, do anything differently if they had to repeat it all?  The only exception would be the fraud whistleblowers, who wouldn’t even flag what they saw as they would know it would destroy their careers.

I recommend reading the whole article, but expect to wonder why nobody has gone to jail.

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1 Response to Michael Hudson on GE Capital, WMC and Fraud

  1. Blissex says:

    «expect to wonder why nobody has gone to jail.x

    The vast majority of USA voters really want for moralizing spoilsports to be punished and to celebrate those who run whatever fraud they cut a cut of. They want tax-free capital gains, not prosecutions.

    If you want the USA markets to be run more honestly and prudently, you have to persuade the vast majority of rentier voters that honesty and prudence are going to make them richer, while the business community have been working for decades to persuade them that fraud and bubbles are what will make the median voter get rich quick.

    My usual quotes, from Grover Norquist and de Tocqueville:

    «The 1930s rhetoric was bash business — only a handful of bankers thought that meant them.
    Now if you say we’re going to smash the big corporations, 60-plus percent of voters say “That’s my retirement you’re messing with. I don’t appreciate that”.
    And the Democrats have spent 50 years explaining that Republicans will pollute the earth and kill baby seals to get market caps higher.
    And in 2002, voters said, “We’re sorry about the seals and everything but we really got to get the stock market up.

    «Consequently, in the United States the law favors those classes that elsewhere are most interested in evading it. It may therefore be supposed that an offensive law of which the majority should not see the immediate utility would either not be enacted or not be obeyed.
    In America there is no law against fraudulent bankruptcies, not because they are few, but because they are many.
    The dread of being prosecuted as a bankrupt is greater in the minds of the majority than the fear of being ruined by the bankruptcy of others; and a sort of guilty tolerance is extended by the public conscience to an offense which everyone condemns in his individual capacity.

    And from J. K. Galbraith’s “The Great Crash 1929”:

    page 32: «One thing in the twenties should have been visible even to Coolidge. It concerned the American people of whose character he had spoken so well. Along with the sterling qualities he praised, there also displaying an inordinate desire to get rich quickly with a minimum of physical effort.»

    page 68: «For now, free at last from all threat of government reaction or retribution, the market sailed off into the wild blue yonder. Especially after 1 June all hesitation disappeared.

    Never before or since have so many become so wondrously, so effortlessly, and so quickly rich.

    Perhaps Messrs Hoover and Mellon and the Federal Reserve were right in keeping their hands off. Perhaps it was worth being poor for a long time to be so rich for just a little while.»

    page 35: «The Florida boom was the first indication of the mood of the twenties and the conviction that God has intended the American middle class to be rich.

    But that this mood survived the Florida collapse is still more remarkable. It was widely understood that things had gone to pieces in Florida. While the number of speculators was almost certainly small compared with the subsequent speculation in the stock market, nearly every community contained a man who was known to have taken “quite a beating” in Florida. For a century after the collapse of the South Sea Bubble, Englishmen regarded the most reputable joint stock companies with some suspicion.

    Even as the Florida boom collapsed, the faith of Americans in quick, effortless enrichment in the stock market was becoming every day more evident.»

    page 206: «Yet, in some respects, the chances for a recurrence of a speculative orgy are rather good.

    No one can doubt that the American people remain susceptible to the speculative mood — to the conviction that enterprise can be attended by unlimited rewards, which they, individually, were meant to share.

    A rising market can still bring the reality of riches. This, in turn, can draw more and more people to participate.»

    page 25: «Just as Republican orators for a generation after Appomattox made use of the bloody shirt, so for a generation Democrats have been warning that to elect Republicans is to invite another disaster like that of 1929. The defeat of the Democratic candidate in 1952 was widely attributed to the unfortunate appearance at the polls of too many youths who knew only by hearsay of the horrors of those days. It would be good to know whether, indeed, we shall some day have another 1929.»

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