Robert Shiller - one of the top housing experts in the United States
- says that the mortgage fraud is a lot like the fraud which occurred
during the Great Depression. As Fortune notes:
said the danger of foreclosuregate -- the scandal in which it has come
to light that the biggest banks have routinely mishandled
homeownership documents, putting the legality of foreclosures and
related sales in doubt -- is a replay of the 1930s, when Americans lost
faith that institutions such as business and government were dealing
The former chief accountant of the S.E.C., Lynn Turner, told the New York Times that fraud helped cause the Great Depression:
amount of gimmickry and outright fraud dwarfs any period since the
early 1970's, when major accounting scams like Equity Funding surfaced,
and the 1920's, when rampant fraud helped cause the crash of 1929 and led to the creation of the S.E.C.
Economist Robert Kuttner writes:
In 1932 through 1934 the Senate Banking Committee, led by its Chief Counsel Ferdinand Pecora, ferreted out the deeper fraud and corruption that led to the Crash of 1929 and the Great Depression.
Similarly, Tom Borgers refers to:
The 1930s’ Pecora Commission, which investigated the fraud that led to the Great Depression ....
Professor William K. Black writes:
The original Pecora investigation documented the causes of the economic collapse that led to the Great Depression. It ... established that conflicts of interest and fraud were common among elite finance and government officials.
Pecora investigations provided the factual basis that produced a
consensus that the financial system and political allies were corrupt.
the Glass Steagall Act was passed because of the fraudulent use of
normal bank deposits for speculative invesments. As the Congressional
Research Service notes:
the Great Depression after 1929, Congress examined the mixing of the
“commercial” and “investment” banking industries that occurred in the
1920s. Hearings revealed conflicts of interest and fraud
in some banking institutions’ securities activities. A formidable
barrier to the mixing of these activities was then set up by the Glass
Economist James K. Galbraith wrote in the introduction to his father, John Kenneth Galbraith's, definitive study of the Great Depression, The Great Crash, 1929
The main relevance of The Great Crash, 1929
to the great crisis of 2008 is surely here. In both cases, the
government knew what it should do. Both times, it declined to do it.
In the summer of 1929 a few stern words from on high, a rise in the
discount rate, a tough investigation into the pyramid schemes of the
day, and the house of cards on Wall Street would have tumbled before its
fall destroyed the whole economy. In 2004, the FBI warned publicly of
"an epidemic of mortgage fraud." But the government did nothing, and
less than nothing, delivering instead low interest rates, deregulation
and clear signals that laws would not be enforced. The signals were
not subtle: on one occasion the director of the Office of Thrift
Supervision came to a conference with copies of the Federal Register and
a chainsaw. There followed every manner of scheme to fleece the
This was fraud, perpetrated in the first instance by the government on the population, and by the rich on the poor.
The government that permits this to happen is complicit in a vast crime.
As the Great Crash, 1929
documents, there were many fraudulent schemes which occurred in the
1920s and which helped cause the Great Depression. Here's one example of a pyramid scheme in Florida real estate:
enterprising Bostonian, Mr. Charles Ponzi, developed a subdivision
“near Jacksonville.” It was approximately sixty-five miles west of the
city. (In other respects Ponzi believed in good, compact neighborhoods
; he sold twenty-three lots to the acre.) In instances where the
subdivision was close to town, as in the case of Manhattan Estates,
which were “not more than three fourths of a mile from the prosperous
and fast-growing city of Nettie,” the city, as was so of Nettie, did not
exist. The congestion of traffic into the state became so severe that
in the autumn of 1925 the railroads were forced to proclaim an embargo
on less essential freight, which included building materials for
developing the subdivisions. Values rose wonderfully. Within forty
miles of Miami “inside” lots sold at from $8,000 to $20,000; waterfront
lots brought from $15,000 to $25,000, and more or less bona fide
seashore sites brought $20,000 to $75,000.”
As DoctorHousingBubble notes:
Mr. Ponzi of course is the man who gave name to the “Ponzi scheme”
that many use today. He laid the groundwork for many of the criminals
today in the housing industry. Yet during the boom he wasn’t seen as a
criminal but a player in the Florida real estate bubble. Here’s a nice
picture of the gentleman:
James Galbraith recently said
that "at the root of the crisis we find the largest financial swindle
in world history", where "counterfeit" mortgages were "laundered" by the
As he has repeatedly noted, the economy will not recover until
the perpetrators of the frauds which caused our current economic
crisis are held accountable, so that trust can be restored. See this, this and this.
No wonder James Galbraith has said economists should move into the background, and "criminologists to the forefront."
Note 1: I asked Professor Black to comment on this essay, and he said the following:
amount of fraud that drove the Wall Street bubble and its collapse and
caused the Great Depression is contested [keep reading to see what Black
means]. The Pecora investigation found widespread manipulation of
earnings, conflicts of interest, and insider abuse by the nation's most
elite financial leaders. John Kenneth Galbraith's work documented these
abuses. Theoclassical economic accounts, however, ignore or excuse
these abuses. The Justice Department did not respond effectively to the
crimes that helped spark the Great Depression so we have far fewer
facts available to us.
decisive role that "accounting control frauds" played in driving the
current crisis is clear. The FBI warned of an "epidemic" of mortgage
fraud in 2004 and predicted that it would cause an economic crisis if it
were not stopped. The mortgage lending industry's own experts reported
that "liar's" loans were "an open invitation to fraudsters" and fully
warranted their name -- "liar's" loans -- because fraud was endemic in
such loans. Lenders and their agents led these lies. They led the lies
for an excellent reason -- the strategy is a "sure thing" (Akerlof
& Romer 1993 -- Looting: the Economic Underworld of Bankruptcy for
Profit). It guarantees record (albeit fictional) profits, which
maximize the CEO's bonuses. The same strategy for maxmizing fictional
income maxmizes real losses in
the longer term. When many lenders follow the same fraudulent strategy
the result is a hyper-inflated bubble followed by a severe crisis.
fraud epidemics also produce "echo" epidemics of fraud in other fields.
For example, when lenders are control frauds the CEO establishes
perverse incentives ("Gresham's dynamics") that corrupt other industries
rewarding professionals who are willing to inflate asset values, and
refusing to hire honest professionals, control frauds cause the
unethical to drive the ethical out of the markets. When one combines
deregulation, desupervision, and the perverse incentives of modern
executive and professional compensation the result is recurrent,
3: Of course other factors, such as excess leverage and
counterproductive actions by the Federal Reserve, also contributed to
the 1930s Depression and the current crisis.