Among others, I have written long and hard about the Too Big to Jail problem--how our federal government, beginning with the Justice Department, the Federal Reserve and the SEC, has failed to prosecute what is almost certainly the biggest fraud in American history: the decade-long confidence game that Wall Street played with the public, as well as investors, in subprime mortgage securitization. There has been little hope until now that Wall Street would get the whipping it deserves from Washington. (On the other hand, some of the better state attorneys general, such as Martha Coakley of Massachusetts, are doing their best, at least in civil court.) But now President Obama's recess appointment of Richard Cordray, a tough and savvy former attorney general in one of the worst-off underwater-mortgage states, Ohio, to head the Consumer Financial Protection Bureau, opens up new legal possibilities.
Let's sketch out what these legal possibilities are, so an "informed 99 percent" can demand that their government exercise its authority over Wall Street at last.
In his first speech today at the Brookings Institution, Cordray did little but hint at these new legal avenues, saying that " the first time, we can exercise the full authorities granted to us under the new law." Cordray was talking about the Dodd-Frank requirement that the CFPB acquire a director before it can oversee and enforce nonbanks, that is, the vast "shadow banking" sector that was responsible for generating and bundling so many of the fraudulent loans as well as the CDOs (collateralized debt obligations) and other securities that were based on them. What Cordray didn't say was that under the legal theory being used by Coakley and other attorney generals, the CFPB can now hold the big Wall Street banks accountable for the criminal nonbanks they were in bed with, the liability-laden firms that the banks often bought up as the mortgage bubble expanded. And for the first time, the documentation scandal that has cropped up in the last year or so--raising doubts about whether investment trusts ever obtained proper ownership of many of the loans and whether they can foreclose on mortgages--can be used to pin liability on these "vertically integrated" Wall Street giants and cost them some serious money in fines.
That's according to Kathleen Engel of Suffolk University Law School, who in a forthcoming article in the Harvard Business Law Review argues, along with her co-author, Thomas Fitzpatrick, an economist at the Federal Reserve Bank of Cleveland, that there is a way through the current legal morass. In the paper, they lay out in perhaps the clearest terms yet the legal case for Wall Street liability. “The environment is ripe for consumers, state attorneys general, and federal agencies to pursue claims against entities further up the securitization food chain, especially given increasing evidence that Wall Street failed to observe the formalities that might have insulated arrangers and investors from most consumer claims,” Engel and Fitzpatrick write. “The designers of securitization sought to insulate investors and arrangers by erecting legal structures that would shield them from liability arising from the actions of loan originators.” But “those structures are not as solid as investors and arrangers expected.”
Why? In an interview, Engel, who while at Cleveland State wrote some of the earliest and most prescient articles on predatory lending, explained that bit by bit, the sheer greed of the Wall Street firms opened them up to more consumer and investor liability. "When they were completely separate entities, and the investment banks were just buying loans that had already been made, it was easy for them to maintain they had no involvement" in fraud, she said. "But over time what happened was that the investment banks, as market makers, would go to the investors and ask them what kind of products they were looking for. They even made loans to the [loan] originators so that the originators would be able to make more loans. And then the originators would pay off those loans [to Wall Street] with their loans." Finally the Wall Streeters began to buy up the originators altogether.
The attorneys-general lawsuits are just beginning to test the extent of this liability. But what has been missing until now has been a fearless national champion, this generation's Ferdinand Pecora, the scourge of Wall Street in the 1930s. If he survives the latest Republican onslaught, Cordray could be that person.
Like others, Engel suggests there has been a conspiracy of silence among Wall Street firms about the depth of their liability, through forcing confidentiality agreements on ex-employees and other tactics. Meanwhile, she says, the weak sisters in the federal regulatory agencies have "forgotten the age-old tactic" of pursuing lower-level operatives to negotiate plea-deals that would implicate their superiors.
But all evidence is that Cordray is no weak sister. Indeed, in one his last acts as Ohio attorney general Cordray went after robo-signing and demanded that major Wall Street banks halt foreclosure. And the CFPB--thanks to one of the Obama administration's few moments of real toughness, securing an independent funding stream for the bureau--is less susceptible to industry lobbying. Engel says she's hopeful that with a director, the CFPB will be more aggressive. Cordray only hinted at that today. "We took over a number of investigations from other agencies in July, and we are pursuing some investigations jointly with them," he said. "We have also started our own investigations."
There is, for the first time in many months, hope that Wall Street will face some small measure of justice.
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