Leverage For Main Street? It’s In Front Of Your Nose., Daily Kos, March 3, 2011, by Bob Swern, used with permission, quoted verbatim:

A week ago, I posted a diary about the government’s proposed $20B “Mortgage Fraud Whitewash,” wherein we learned it was being floated by the Obama administration, the soon-to-be-official Consumer Financial Protection Bureau staff, and others that Wall Street would receive a $20 billion wristslap for pillaging Main Street via the mortgage industry for the past decade, and bankers would end up in a “…get-out-of-jail-free program…” and they would “…be excused for the abundant mortgage fraud they’ve committed.”

In a lead story in the Business section of (Thursday) morning’s NY Times (SEE: “Officials Disagree on Penalties for Mortgage Mess“), we’re once again reminded that when one initiates negotiations with the status quo at such a pathetically low mark–essentially, at a point where it’s a travesty from the get-go–it’s all downhill from there.

After we review this latest status quo turd, we’ll do a slightly deeper dive on a fairly simple proposal by Yves Smith which would actually enable our government to–at the very least–put a very real threat of incarceration on the table for many of these assh*les, virtually overnight; and, if nothing else, humiliate these sociopaths in $4000 suits into ponying up a few hundred billion to cover some real mortgage relief for us poor and unwashed types on Main Street, too.

What? Leverage for Main Street? It’s right in front of our collective nose.

In between, some background from my diary from last week; words that give us hope that at least one of President Obama’s new appointees to the Federal Reserve might just have the spine we’ve been looking for; and then coverage of this latest Wall Street bullsh*t (i.e.: the feigned indignation(s) of a financial services sector that comprehensively owns the agencies that regulate it); and, finally, Yves Smith, with an awesome, Wall-Street-ass-kicking concept.

As I noted in >my diary, (Wednesday), it is now widely-acknowledged that the U.S. mortgage/residential real estate sector is in a double-dip recession which has already reached and/or eclipsed levels set during our country’s Great Depression. When one realizes that equity in one’s home — not stock market investments, where over 95%+/- of all marketable securities are owned by the top 10% of our society — represents the largest single asset for most Americans,  one may begin to achieve some factual context for the state of our economy and the housing industry’s depressing effect upon Main Street, today.Late yesterday, as Naked Capitalism’s Yves Smith and FireDogLake’s Marcy Wheeler note, below, the Obama administration proposed a $20 billion “…get-out-of-jail-free program…” so, in the words of FDL’s Wheeler, “…banks could be excused for the abundant mortgage fraud they’ve committed.”

HAMP II: The $20 Billion Get Out of Jail Free Card

By: emptywheel
FireDogLake
Wednesday February 23, 2011 6:44 pmA day after the Case-Shiller Index confirmed that the housing market is in a double dip, the Powers that Be (a subsidiary of the Masters of the Universe, currently CEOed by one Barack Obama) have floated their proposal for a mortgage fraud settlement.

The settlement terms remain fluid, people familiar with the matter cautioned, and haven’t been presented to banks. Exact dollar amounts haven’t been agreed on by U.S. regulators and state attorneys general.

For the low, low price of $20 billion, the Administration proposes, banks could be excused for the abundant mortgage fraud they’ve committed….

…$20 billion won’t even begin to compensate those victims of fraudulent appraisals for the fraud committed on them.

IMHO, in light of the fact (as I also noted in my diary, Wednesday) that it’s projected by some of our country’s most highly-respected housing finance experts that approximately half of all U.S. mortgageholders will be underwater (owing more to the bank than the value of their home) on their mortgages by mid-year, this represents the equivalent of a minor wristslap to Wall Street, as our country’s middle class faces ongoing pillaging at the hands of a status-quo-gone-wild; all thanks to the unbridled, ongoing support of our bought-and-paid-for federal government…

So, a week passes, and here we have the already-pathetic narrative becoming an even greater travesty than it was just a week ago: “Officials Disagree on Penalties for Mortgage Mess.”

Officials Disagree on Penalties for Mortgage Mess
By NELSON D. SCHWARTZ and DAVID STREITFELD
New York Times
March 3, 2011 Even as state attorneys general and regulators in Washington approach the end of their investigation into abuses by the nation’s biggest mortgage companies, deep disputes are emerging over how much to punish the banks as well as exactly who should benefit from a settlement.

The newly created Consumer Financial Protection Bureau is pushing for $20 billion or more in penalties, backed up by the attorneys general and the Federal Deposit Insurance Corporation.

But other regulators, including the Office of the Comptroller of the Currency, which oversees national banks, and the Federal Reserve, do not favor such a large fine, contending a small number of people were the victims of flawed foreclosure procedures.

As the negotiations grind on, there are signs that the banks still have not come to grips with the problems plaguing the foreclosure process….

…The nation’s largest mortgage servicer, Bank of America, is already readying what will be among the industry’s main arguments: that it is unfair to reward homeowners who are delinquent or underwater but cannot point to specific errors in their case…

(It’s definitely worth reading this whole article!)

So, let me get this right…Bank of America, one of the biggest recipients of taxpayer bailouts and ongoing government backstops, to the tune of billions upon billions of dollars, even to this day, is saying it’s unfair to reward homeowners that have been royally screwed over–and moreso by BofA’s own Countrywide Financial subsidiary, perhaps, than any other corporate entity on the planet–but, when it comes to Main Street, f*ck ‘em?

The Times’ piece quotes a spokesman for the bank who’s “concerned” that…“Too broad a rescue package, he said, ‘could forestall the housing market recovery or even create perverse incentives.’”

And, to get a picture of how pathetically “captured” Treasury Secretary Tim Geithner’s former righthand man, Ass’t Treasury Secretary Michael Barr, truly is, we have this gem in the article…

“There has been a tension in this country during the financial crisis,” said Michael S. Barr, a former Treasury official now at the University of Michigan Law School. “People want those who are in economic trouble to get a fair shake. But they don’t want them bailed out for making their own mistakes, like buying too big a home.”

So, in Mr. Barr’s view of the universe (as long as we overlook origination fraud, appraisal fraud, investor fraud, conveyance fraud, ratings agency fraud, foreclosure fraud, and on and on…), it’s okay for the too-big-to-fail, Wall Street banks to get permanent, trillion-dollar taxpayer backstops for committing rampant fraud, but when it comes to Main Street, “…they don’t want them bailed out for making their own mistakes, like buying too big a home.”

Uh, huh.

While regulators worry about how punitive any eventual settlement should be, lawyers and other advocates for the foreclosed who were hoping for criminal charges are set to be disappointed. That sanction, everyone seems to agree, is off the table. In testimony in December about the improper foreclosures by banks, Daniel K. Tarullo, a Federal Reserve governor, floated the notion of imposing fines on individuals found responsible for violations or banning them from banking, but officials involved in the talks said this idea had not gotten much traction either.

Well, Yves Smith has come up with a GREAT idea to obtain some “traction” for our government and for Main Street as far as obtaining some leverage with Wall Street is concerned. It’s a great concept: jail the bastards! (SEE: “A Straightforward Criminal Case Against Wall Street CEOs and Senior Executives.”)

(Or, at least threaten to do so with some real teeth in that effort, for a change!)

(Diarist’s Note: Naked Capitalism Publisher Yves Smith has provided written authorization to diarist to reprint her blog’s posts in their entirety for the benefit of the DKos community.)

A Straightforward Criminal Case Against Wall Street CEOs and Senior Executives
Yves Smith
Naked Capitalism
Wednesday, March 2, 2011 4:04 AM Various people who ought to know better, such as the New York Times’ Joe Nocera, have taken to playing up the party line of the banking industry and I am told, the SEC, that we should resign ourselves to letting senior financial services industry members get away with having looted their firms and leaving the rest of us with a very large bill.

It is one thing to point out a sorry reality, that the rich and powerful often get away with abuses while ordinary citizens seldom do. It’s quite another to present it as inevitable. It would be far more productive to isolate what are the key failings in our legal,
prosecutorial, and regulatory regime are and demand changes.

The fact that financial fraud cases are often difficult does not mean they are unwinnable. And a prosecutor does not need to prevail in all, or even most, to serve as an effective cop on the beat.

Contrary to prevailing propaganda, there is a fairly straightforward case that could be launched against the CEOs and CFOs of pretty much every US bank with major trading operations. I’ll call them “dealer banks” or “Wall Street firms” to distinguish them from very big but largely traditional commercial banks like US Bank.

Since Sarbanes Oxley became law in 2002, Sections 302, 404, and 906 of that act have required these executives to establish and maintain adequate systems of internal control within their companies. In addition, they must regularly test such controls to see that they are adequate and report their findings to shareholders (through SEC reports on Form 10-Q and 10-K) and their independent accountants. “Knowingly” making false section 906 certifications is subject to fines of up to $1 million and imprisonment of up to ten years; “willful” violators face fines of up to $5 million and jail time of up to 20 years.

The responsible officers must certify that, among other things, they:

(A) are responsible for establishing and maintaining internal controls; (B) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared; (C) have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days prior to the report; and

(D) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;

These officers must also have disclosed to the issuer’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):

(A) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer’s ability to record, process, summarize, and report financial data and have identified for the issuer’s auditors any material weaknesses in internal controls; and (B) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal controls

The premise of this requirement was to give assurance to investors as to (i) the integrity of the company’s financial reports and (ii) there were no big risks that the company was taking that it had not disclosed to investors.

This section puts those signing the certifications, which is at a minimum the CEO and the CFO, on the hook for both the adequacy of internal controls around financial reporting (to be precise) and the accuracy of reporting to public investors about them. Internal controls for a bank with major trading operations would include financial reporting and risk management.

It’s almost certain that you can’t have an adequate system of internal controls if you all of a sudden drop multi-billion dollar loss bombs on investors out of nowhere. Banks are not supposed to gamble with depositors’ and investors’ money like an out-of-luck punter at a racetrack. It’s pretty clear many of the banks who went to the wall or had to be bailed out because they were too big to fail, and I’ll toss AIG in here as well, had no idea they were betting the farm every day with the risks they were taking.

Not surprisingly, it isn’t difficult to find widespread shortcomings in risk management at major dealer banks. Risk management deficiencies most relevant to Sarbanes Oxley are related to pricing. The accuracy of the accounts, meaning the valuations, is the primary focus. Risk management weaknesses that impact reportable disclosures (in the accounts or the notes) have highest relevance. However, crappy risk management that leads to poor positioning may not be germane to the Sarbanes Oxley violations issue.

We discussed the issue at some length in ECONNED. Risk management was kept weak; if push came to shove, it was subordinate to the producers. Richard Bookstaber, a former chief risk officer, discussed at some length how most chief risk officers were engaged in what amounted to busywork. While they might indeed prevent particularly egregious excesses, their form over substance exercises also provided useful cover for the top brass and the board of directors. As he noted in 2007:

If you are the Chief Risk Officer and everything blows up, don’t you bear some responsibility?…In the CRO job 99% of the days there is nothing going wrong. The only test you get of how well you are doing – short of pouring out risk reports and looking ponderous and prudent in meetings – is what happens to the firm during times of market crisis. Every few years something calamitous happens in the market; if the firm gets blown away, that suggests you did not do a very good job.

Readers may have better suggestions of where to start, but I’d target Lehman. First, it already has a smoking gun: a May 2008 letter written by former senior vice president Michael Lee to senior management, including the CFO Erin Callan. It describes numerous accounting shortcomings, none of which look to be new and many of which look to be Sarbanes Oxley violations.

Second, its derivatives books were by all accounts an utter disaster at the time of its collapse:  multiple non-integrated systems, to the point where the bank did not even have a good tally of how many positions it had (bankruptcy overseers Alvarez & Marsal first said the bank had 110,000 positions; they later changed their tally to 120,000). This is important because despite all the efforts to identify why the Lehman losses were so massive, most analysts have focused on the asset side, and the numbers don’t add up. That means understatement of positions and/or gross understatement of risk on the liability side is the probable culprit.

This is an egregious accounting 101 control breakdown, It indicates that the most basic operatonal controls, reconciliation of accounts, were not effective (see here for further support). Lehman would have to take the position that its basic control weaknesses were all immaterial. At all times there’s an inventory of control weaknesses that exist. That inventory must be constantly monitored and reviewed (and attested to in the 404 internal control assessments signed by the responsible officers). Materiality determinations are decided by managers, internal and external audit and ultimately the CFO and CEO. Dick Fuld also made statements in Congressional testimony about his ignorance of his ignorance of Repo 105 and a failure to include commercial real estate in stress tests starting with the end of 2007 that also seems consistent with a lack of adequate risk controls.

At other banks, prosecutors will probably need to proceed in a bottom’s up manner. The structured credit and CDO desks are targets even now for criminal securities fraud actions (the statue of limitations has not expired). These units, as Bloomberg’s Jonathan Weil has pointed out, were also ground zero of misreporting at Citigroup. The bank’s defenders claim it has a free pass by virtue of a letter from the bank lapdog OCC that did not rise to the level that would force disclosure but its basis was that the valuations Citigroup used were with market ranges. This seems a dubious argument.

The fact that a defective speedometer happened to provide a 60 mile per hour reading when the car was going 57 miles per hour does not prove the device was reliable.

Moreover, anyone with an operating brain cell knows “market prices” were being gamed by dealer banks passing small trades between them or with friendly clients, typically hedge funds who might also like to show high valuations, to establish flattering marks. If the marks Citi was relying on were the result of collusion, and the bank was either involved in or aware of the collusion, this undermines the OCC view of the validity of the marks at Citi and other banks. If yours truly knew of this practice, it had to be widespread and well known at the firms themselves.

My understanding (and reader input is welcome here) is that the authorities could file a civil suit for Section 302 certification violations. If they prevailed in that, a criminal case under Section 902 should be an easy win. The 906 certification basically says the reports are fully compliant with all regulations, including those specifically certified in the 302.

(Note that the SEC initiated a criminal case against HealthSouth CEO Richard Scrushy which included Section 302 charges. Scrushy was acquitted in a jury trial, but having followed the proceedings a bit, and also seeing another example of a trail in Birmingham, I’d be careful of generalizing from Alabama courts to other jurisdictions. The deck, even more than in other jurisdictions, is stacked in favor of the local bigwigs).

Will any of this happen? Of course not. The decision was made at the time of the TARP, and reaffirmed early in the Obama administration when there was serious talk of resolving Citigroup and Bank of America, that no one at the helm of the senior banks would be subject to serious scrutiny, much the less actually expected to be held accountable for actions that wrecked the economy and have imposed serious costs on ordinary Americans.

The case we described above is relatively simple to explain to a jury and has the advantage of being the sort where the plaintiffs could build on their experience in one action in subsequent cases.

But that sort of truth, that most, probably all, of the major Wall Street banks were engaged in the same sort of misconduct and the violations extended to the very top of the firms, would expose numerous other parties as complicit. So we’ll permit the cancer in our society to metastasize rather than threaten the power structure. But at least we citizens can make it clear, even if we cannot change the outcome, that we are not buying the canard that nothing can be done to fight this disease.

Leverage for Main Street?

It’s more than just a concept.

In fact, it’s staring us in our face.

Please feel encouraged to visit Bob Swern’s blog on Daily Kos.