Going After the Perpetrators of the Housing Bubble

Talk to almost anyone about the financial crisis -- or at least anyone who doesn't work in the financial sector -- and sooner or later you'll hear it: "How come nobody's in jail for this stuff yet?"

It's not an absurd question. Most people recall the criminal charges associated with the Enron and WorldCom frauds a decade ago. Already, investigators of our current crisis have been able to determine that fraud was rampant in the sub-prime mortgage bubble that catalyzed the current recession.

But we still haven't seen major charges of white-collar crime. This is in part because, at the federal level, resources for those kinds of criminal investigations were gutted during the Bush administration -- more focus was placed on national security, and budgets were cut at the Department of Housing and Urban Development. Though federal regulators often have close ties to industry, their jurisdiction prevents action by officials more likely to respond to consumers. But the main problem, as described by officials who are looking to change this, is that so much of what was done is legal that it's hard to pinpoint criminal intent.

"So many people were doing just what the industry allowed," Massachusetts Attorney General Martha Coakley told me. "When everybody is doing it on such a large scale, it becomes somewhat of a norm."

Coakley's work today, though, is anything but the norm – she's still finding ways to hold lenders accountable for predatory loans. Her office issued emergency regulations last year to prevent criminals from taking advantage of troubled borrowers with schemes that rob of them of their cash and their homes while offering to protect them from foreclosure. Her team has also investigated mortgage lenders, securing a $50 million settlement from Goldman Sachs to modify predatory loans owned by the bank, along with a $10 million payment to the commonwealth. Her team also secured an injunction to prevent Fremont Investment & Loan, a lender that offered predatory loans, from foreclosing on its customers.

The Goldman Sachs settlement disappointed some because it doesn't include an admission of wrongdoing on the part of the bank, but such judgment would be cold comfort to borrowers who might have been left without homes if litigation dragged out over years. Investigations into other lenders continue.

"When you're looking at what is a widespread, major crisis, we think the civil regulatory tools are more effective in the short run to mitigate the damages," Coakley says. "And from those investigations you do start to see if there are individuals or businesses with that specific intent that should be indicted and charged."

Coakley, a long-time state prosecutor, is one of few law enforcement officials on any level to take such substantive action against mortgage lenders who made loans they knew -- or should have known -- would never be repaid. It isn't an easy task, either. Massachusetts has no predatory mortgage lending laws -- only seven states do -- and Coakley's office doesn't have jurisdiction over Massachusetts's banks or securities sales; she's also federally preempted from any kind of oversight of national banks and credit card companies.

But in 2007, shortly after she was sworn in, Coakley's office received numerous complaints from people who felt they were being taken advantage of by lenders. Her team, who had been looking into these abuses even before Coakley became attorney general, hit upon a way to go after those responsible. They were able to draw on their own resources, including a retired bankruptcy judge who worked on staff. They also consulted with local academics, including widely lauded law professor Elizabeth Warren, then of Harvard and now in charge of Congress' financial rescue oversight board. Warren's key insight was that loans ought to be regulated as consumer products, and that's exactly how Coakley's office approached predatory lending -- as a consumer problem.

Her office issued emergency regulations designed to prevent common foreclosure rescue schemes under the authority of the Massachusetts' Consumer Protection Act, which Coakley calls the "little FTC" because it is analogous to the authority underlying the Federal Trade Commission. The team also launched investigations into mortgage lenders and securitizers under similar auspices.

"We became intrigued with how this system worked," Coakley says. "There were plenty of people profiting from this, as the loans were sold sooner rather than later. We started to do an investigation, which is ongoing, around what role securitizers played in providing a market for [mortgage loans], in some instances providing financing for loans. They should at a minimum be responsible for mitigating the damage these loans caused."

Although Coakley has had the largest early returns on her investigations, a few other state law enforcement officials are involved in the paper chase as well. Richard Cordray, Ohio's attorney general, is also taking action against foreclosure rescue schemers and recently hired an attorney who formerly headed up the Cuyahoga County Foreclosure Prevention Program, a group dedicated to helping consumers avoid foreclosures that has become a national model. Iowa Attorney General Tom Miller launched a hotline to provide consumers access to fair loan modifications, and led an investigation by 49 state attorneys general into now-defunct mortgage broker Ameriquest that netted a $325 million settlement in 2006. Similar efforts are on-going in Florida and North Carolina.

But Coakley also makes clear that despite the ability of law enforcement to play a role mitigating the damage of white-collar crime on consumers, it's not a substitute for effective regulation; a point she has also made testifying before Congress in support of federal legislation to prevent bad lending practices and foreclosure rescue schemes.

"It's much cheaper to build in the safeguards than to try and send out subpoenas and bring out a criminal charge against someone who had violated the law," she says. She doesn't buy the argument that smart regulations prevent an efficient financial system; when her office issued consumer protection regulations in 2007, a number of banks protested, but only one stopped doing business in the state altogether because of the new requirements. That bank was Indymac, which would soon go under completely as a result of its bad practices and risky mortgage portfolio.

Though Coakley and her fellow attorney generals are focused on figuring out exactly how lenders did business and hope to mitigate the damage caused by risky mortgage lending through regulatory enforcement and investigation, their efforts don't rule out criminal prosecution, either. The discovery of criminal intent in the course of those investigations could lead to indictments. Coakley's office has charged small-time mortgage schemers, but it's much more difficult to battle the pernicious institutional structures at the top of the system. But like the rest of the country -- Congress seems ready to authorize a special commission to investigate the financial crisis -- she wants, more than anything, to get to the bottom of this mess.

"You cannot prevent this from happening again in the future without doing an autopsy," she says.

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