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Belmont Club

Bean Counters

June 30th, 2011 - 2:15 pm

The conviction of Lee Farkas, one time head of the Taylor, Bean and Whitaker mortgage company exposes many of the elements of the housing debacle of the last decade. It also prompts the question: what’s changed?  Farkas who probably did not act alone, defrauded stakeholders of $3 billion dollars and caused many more billions in damage by placing fake mortgages. His actions led directly to the collapse of a major bank. How did he do it? He lied.

He lied in a manner calculated to escape being caught. To do this, Farkas hired former executives in Freddie Mac and Fannie Mae so that he  knew exactly what buttons to push.  Long after these agencies began to suspect that Taylor, Bean and Whitaker was founded on fictitious mortgages they declined to act decisively for fear of causing mistrust in a system that deserved to be mistrusted. Only after the whole gimcrack scheme had demolished whole swathes of the economy did the story of what everyone suspected all along come out.

The basic story is that after Fannie Mae found out that Taylor, Bean and Whitaker were playing dirty, they simply severed their relationship with the firm and covered up the dirt, allowing the scam to continue to create further damage. “Fannie Mae officials never reported the fraud to law enforcement or anyone outside the company. Internal memos, court papers, and public testimony show it sought only to rid itself of liabilities and cut ties with a mortgage firm selling loans “that had no value,” as Smith, the former vice president of Fannie Mae’s single family operations, said in a 2008 deposition. ”

“If there had been a criminal referral, Farkas would have gone to jail in 2002,” William Black, who served as deputy director of the Federal Savings and Loan Insurance Corp. during the S&L crisis of the 1980s, said in an interview.

Seven more years passed before federal regulators shut down Ocala, Florida-based Taylor Bean and prosecutors charged Farkas with orchestrating the $3 billion scam. He had duped some of the country’s largest financial institutions, sought federal bank bailout funds and contributed to the failures of Montgomery, Alabama-based Colonial Bank and its parent, Colonial BancGroup, once among the nation’s 25 biggest depository banks.

…The decision to keep Farkas in business was made by top Fannie Mae officials such as Smith and Zach Oppenheimer, then senior vice president for single family mortgage business, according to Smith’s deposition and a Fannie Mae memorandum.

A confidential agreement between Fannie Mae and Taylor Bean’s Farkas unwinding their relationship was negotiated by lawyers from the general counsel’s office, overseen at the time by Thomas Donilon, now Obama’s national security adviser, according to the documents.

…Fannie Mae officials were also concerned that an immediate termination of the relationship would have “a devastating effect on TBW’s ability to continue as a viable company,” according to an undated Fannie Mae memo filed as part of a related lawsuit.

Francine McKenna, blogging for Forbes argues it boggles the mind to deduce who else knew. “Can anyone deny that there are four firms – KPMG, Deloitte, PricewaterhouseCoopers (PwC), and Ernst & Young (auditor to Lehman) – who knew all along what was going on and never told a soul, including the SEC?”

Fannie Mae is now audited by Deloitte, who took over for KPMG in 2005 after the firm was fired and sued over an accounting scandal.

GMAC has always been audited, like its former parent GM, by Deloitte.

KPMG was also the auditor for two other fraud-ridden mortgage originators – Countrywide, bought by Bank of America who just announced a multi-billion dollar settlement with investors over bad loans and New Century who went bankrupt over bad loans.

Deloitte, Fannie Mae’s auditor ,was also auditor of three other housing related companies that had issues: Beazer, Novastar, and American Home. Deloitte settled to get out of those messes. And Deloitte audited three no-longer-independent large firms sunk by bad mortgages: Merrill Lynch, Bear Stearns, and Royal Bank of Scotland. …

Countrywide, as already mentioned, was audited by KPMG before being absorbed by Bank of America during the crisis period.

Citigroup is also audited by KPMG.

Freddie Mac, who picked up on the TBW business where Fannie Mae left off, is audited by PwC, who also audits Bank of America and JP Morgan Chase.

PwC also audits the Federal Home Loan Banks (FHLB). They ended up with many of the flawed Fannie Mae and Freddie Mac mortgage backed securities packaged from these fraudulent originator loans. FHLB members are now suing the big banks to force repurchases under representation and warranties clauses and other claims.

But of course Francine is wrong. A lot of people have no memory of nothing. Like Franklin Raines, who headed Fannie Mae at the time when things should come out in the open. He could give Sergeant Schultz lessons. “Franklin Raines, who was chairman and CEO at Fannie Mae from 1999 through 2004, said in an interview that he has ‘no memory’ of the Taylor Bean matter.” Raines said Fannie Mae’s regional offices manage terminations to get the largest recovery, and such an event wouldn’t be publicly disclosed.

Markets work by valuing objects based on available information. The financial meltdown is from one point of view a crisis of information. The databases which should describe the risk, value and beneficial claims that people have over assets has been corrupted. For most of us, the sum total of our life’s work is a number on a financial institution’s datafile. Imagine running an audit on a database only to find that nothing adds up; entries that are impossible have been made. Transactions that were specifically forbidden have happened all the time. And worse, the DBAs and Sysadmins are all involved. This is what the Taylor, Bean and Whitaker affair suggests.

If value is nothing but a database entry then corrupting the database is equivalent to destroying value. So here’s the question. Which of the entries in the world economic database should be regarded as true now that whole swathes of it have been discovered to be false? Writing down an asset entry is simply telling the truth about it once you’ve discovered it.

But who can survive the truth? Can you rollback transactions to their last known point if that point is 2002? How many lives are going to be totally destroyed by the adusting entries? Is the database worth saving or should we just scrap the whole thing and tell everyone that all the bets are off and you can keep whatever you can loot in the next twelve hours?

Worse, who can you trust? How do you “reform the system” if the regulators are themselves suspected of being in cahoots with the bandidos? If you want to fire the current DBAs and Sysadmins, where do you recruit the new ones from? These are the problems of systems which are Too To Fail. They are also too big to understand, too big to rollback.

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