Feds find little fraud at big Wall Street firms

While the American public and Capitol Hill lawmakers appear to blame wrongdoing on Wall Street as the primary cause of the global financial crisis, federal law enforcement agencies have had little success in finding and prosecuting instances of fraud at the nation’s major investment firms.

Attorney General Eric H. Holder Jr.s testimony before the Financial Crisis Inquiry Commission last week, while boasting of thousands of cases against small-time defrauders running mortgage scams, was notable for the absence of a single example of successful prosecution of crimes by the big firms on Wall Street.

The Justice Department last year lost the only case it has brought against Wall Street executives involving suspected fraud in connection with risky subprime mortgage securities. A U.S. District Court last year acquitted two Bear Stearns hedge fund managers whom the government accused of fraud.

The Justice Department and other federal agencies have beefed up the administration’s financial crimes task force to ferret out more wrongdoing, but the cases thus far overwhelmingly target small, local operators — including mortgage brokers, appraisers and real estate agents — as well as borrowers who lied to get home loans.

The department has opened 2,800 investigations of mortgage fraud throughout the country. Hundreds of cases are pending in states that were tied to the housing bubble, such as Florida and California. Criminal charges have been filed against 826 suspects, but only two of whom — the Bear Stearns traders — worked on Wall Street.

While public outrage has largely targeted Wall Street, the government has consistently said that fraudulent operations were spread across the country and encompassed every sector related to housing and mortgage finance.

“Mortgage fraud has swept through our economy,” Assistant Attorney General Lanny A. Breuer told the commission, and it has continued in the aftermath of the financial crash. New scams, he said, are taking advantage of people who are in default on their mortgages and in danger of losing their homes to foreclosure.

Steven Malanga, a senior fellow at the Manhattan Institute, said the department’s findings show that pervasive cheating helped create the housing crisis. Some borrowers, he said, lied to obtain loans or took on risky mortgages to make quick profits but walked away from their obligations when the market turned.

“During the housing bubble, cheating became so commonplace that those who did it were barely considered to be engaging in fraud,” he said. “It is possible that hundreds of thousands, and even millions, of borrowers, brokers and salespeople cheated over the space of just a few years, helping to bring down themselves and an entire industry, and contributing mightily to the economic and fiscal predicaments in which we find ourselves.”

The public frenzy against Wall Street has resulted in proposals in Washington for hefty new taxes on bonuses and securities transactions and for breaking up the biggest financial firms.

The Securities and Exchange Commission has had more success than the Justice Department at taking on the big banks. The SEC continues to pursue a civil fraud case against the Bear Stearns bankers, hoping to meet the lower standards of evidence needed for a conviction in civil courts, SEC Chairwoman Mary Shapiro told the commission.

Most of the SEC’s cases involve charges that are less serious than fraud. Instead, they have focused on accusations that the investment banks failed to disclose to investors the risks posed by the exotic mortgage securities they created.

“Originating risky mortgages on its own does not violate the federal securities law,” Ms. Shapiro said, so the agency has gone after lending officers and companies for the SEC equivalent of “parking violations,” such as failing to disclose risks to investors, using questionable accounting practices and engaging in insider trading of company stock.

One obstacle is that most of the companies that originated the riskiest subprime and exotic mortgages and sold them to Wall Street investment houses have gone out of businesses or been absorbed by larger firms.

Countrywide Financial, for example, was the largest mortgage lender in the United States and the biggest originator of subprime loans until it teetered toward collapse in late 2007. The company boasted in its heyday that it was not a bank but rather an independent operator not hobbled by bank regulations. It was rescued from bankruptcy by Bank of America, the largest bank in the country.

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