Mortgage fraud was one of the main reasons of the collapse of the financial system
Most of the largest fines are in relation to operations carried out by financial institutions in the lead up to, and in the wake of the mortgage-market collapse.
Banking fraud is not a new phenomenon, neither is the fact that government authorities can prosecute corporations as criminals.
What is new, however, are the type of crimes these banks are committing, the monumental size of the fines they are being hit with, and the rate at which these fines are being imposed.
It is no surprise that the financial collapse has brought many lawsuits against financial institutions, but the settlements reached with US authorities has been unprecedented and appears to be on an upward trend, with many of the largest ever banking fines having been handed out this year.
Most of the largest fines are in relation to operations carried out by financial institutions in the lead up to, and in the wake of the mortgage-market collapse, though as investigations into LIBOR-fixing continue, it is likely that more banks will face further and higher pay-outs for their involvement.
The reason why these banks are increasingly being prosecuted for criminal claims alongside civil settlements, is that the operations that have generated these fines are considered to be fraudulent and a form of corporate crime.
- Operations that have generated these fines.
- Selling of mortgage-backed securities.
- Abuse of foreclosure processes.
- Money Laundering.
- Manipulating LIBOR.
- Aiding tax fraud.
- Trade scandals.
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Selling of mortgage-backed securities
One of the main sources of these monolithic fines has been the misrepresentations made when mortgage-backed securities were sold to investors. Whilst the housing market was booming in the years pre-2008, banks were able to provide their most credit-worthy customers with favourable mortgage finance. These loans were then bundled together and sold by the banks to investors as mortgage-backed securities. Because these products initially performed so well, the banks then sought to sell more of these bundles to investors, and in order to do so, eventually had to target customers with bad credit history who were more likely to default, particularly when their fixed-rate offer periods ended and interest rates rose, as they undoubtedly would. Despite knowing the risks associated with these sub-prime mortgages, banks continued to sell the mortgage-backed securities to investors whilst failing to disclose the new risk these products posed.
Mortgage fraud is one of the main reasons for the collapse of the financial system in 2008 and consequently governments are still penalising banks for their actions 6 years on. The US Federal Housing Finance Agency has been ruthless in pursuing financial institutions for the losses suffered by mortgage giants Fannie Mae and Freddie Mac, who have been under a government sponsorship scheme since 2008. The biggest fines imposed on individual banks have been due to this type fraudulent misrepresentation and the US Justice Department can treat this type of fraud as a crime.
Abuse of foreclosure processes
The abuse of foreclosure processes has been at the root of many fines, including the biggest one to be handed out yet (a $25bn combined fine in 2012). Again in 2013, a smaller but still monumental fine ($8.5bn) was footed by 10 financial institutions. These institutions were prosecuted by US authorities, and consequently, the fines have remained under state control. The fine came as a result of the procedural abuses experienced by consumers at the hands of banks when they defaulted on their mortgage payments, and in particular, when banks began foreclosure processes.
In the first instance, banks were at fault in selling sub-prime mortgage finance to customers they knew would be at a high risk of default when interest rates were to rise and the conditions of their loans were to change. When these customers undoubtedly failed to meet their mortgage payments each month, banks made frenzied efforts to sell their homes and recoup losses in a market in which house prices were falling rapidly. The problem was exacerbated by the fact that these banks had sold mortgage-backed securities to investors. When these products were sold to investors, investors often repackaged and sold these loans again and eventually, banks lost sight of who actually owned the legal title to these houses. This meant that in some cases the foreclosures they enforced were actually illegal as the banks were no longer entitled to take the security on the loan.
This fine was also due to abusive practices on the part of bank employees during the foreclosure process, in particular the practice of “robo-signing.” “Robo-signing” involves the use of documents fraudulently signed by employees in order to force an eviction, negating the need for lenders to scrutinize the conditions of each loan individually.
Authorities have fined these banks in order to go some way in correcting the damage suffered by customers who experienced these abusive practices and to penalise banks who foreclosed on borrowers without having the legal right to do so. Of the $25bn fine, the 750,000 homeowners who were evicted received a cheque each for only $2000. The fine was supposedly directed towards helping current homeowners who were facing difficulties meeting their mortgage payments and were in danger of default; they jointly received $13bn from the fine. The remainder went to the US authorities and the federal government to replace public funds that were lost as a result of these abuses.
Aiding tax fraud
Swiss banks have admitted responsibility for managing processes that helped Americans evade US tax authorities. Credit Suisse has had to pay the biggest fine for this type of crime ($2.6bn) as a result of decades of hiding money on behalf of their US clients in false and illegal offshore accounts created solely for the purpose of obscuring funds. Credit Suisse was prosecuted in the criminal courts in the US and it pleaded guilty for the facilitating of tax fraud. Due to Swiss laws on secrecy, the bank’s tax-evading clients did not have to face any legal probing.
UBS was also fined $780m in 2009 for aiding tax fraud, but did not plead guilty to charges. The bank helped 17,000 Americans evade tax in the US by hiding funds in Swiss accounts that were again protected by secrecy laws. However, when UBS was fined, the arrangement agreed with the justice department required them to pass over the details of 4500 secret accounts to US authorities. The US Department of Justice has since been pursuing Swiss banks and putting pressure on the secrecy privileges they provide for their account holders.
Manipulating LIBOR
Many of the world´s largest banks have been at the front of the controversy surrounding the manipulation of lending-rate references, in particular, LIBOR. This index is central to the global economy as it determines the price at which products are bought and sold. Traders from the 16 banks that enter the daily statistics that determine LIBOR were able to fix this index by entering artificial statistics. This had repercussions in the mortgage, pensions and credit card markets.
To this day, UBS has footed the biggest fine for LIBOR manipulation ($1.5bn), followed closely by Rabobank ($1bn). These immense fines reflect the gravity of this abuse of the system. The UK Financial Services Authority described the actions of UBS over LIBOR manipulations as “extensive and routine,” whilst Rabobank failed to respond when an employee notified a group of its auditors that his submissions were based on instructions given by other traders. Further to the fines imposed by UK and US authorities, the European Commission has conducted an investigation into the manipulation of LIBOR, basing its enquiry in competition law. There are criminal investigations underway against individual traders involved in this issue, with the first UK trader to plead guilty to these charges this month, though some traders have already been sentenced in the US. The Financial Services Act 2012 brings LIBOR under UK regulatory oversight and introduces a new law that criminalises the manipulation of LIBOR. The civil investigations are currently continuing alongside the criminal charges, with Barclays reaching a $20m settlement with an investor over LIBOR-related issues this month.
The idea that banks have been taking advantage of their positions of power to mislead their clients has been an important issue throughout the financial crisis. The collusion amongst these institutions for their own benefit has been considered a fraud against the public and other businesses, and as a consequence, the fines have been very grave. This scandal has had much publicity because it highlights the imbalance between the financial giants and the public.
Trade scandals
Though trade scandals are not a new occurrence, the aftermath of the financial crisis has brought to light various schemes enacted by rogue traders, and banks have been held responsible for the actions of their employees in different ways.
The bank JP Morgan was responsible for paying a $1.7bn fine for its associations with Bernard Madoff. In 2009 the banker Madoff confessed to 11 counts of fraud, theft and money laundering through his firm Madoff Investment Securities LLC, which left many families and businesses ruined. Although this ruin was at the hands of Madoff, JP Morgan had to pay this fine because, being the bank largely utilised by Madoff for holding and investing his illicit gains, it failed to notify US authorities when they suspected fraudulent activity in his accounts.
Perhaps more controversially, banks have had to cough up for fines received on top of the losses they accrued at the hands of rogue trader employees. JP Morgan was again responsible for a $920m fine as a result of the “London Whale,” the nickname given to rogue trader Bruno Iksil. Part of the fine was paid as a result of violating US federal securities laws, the failure of internal controls and allegedly misleading regulators. Two ex-traders face criminal charges, but Iksil himself did not face prosecution as the losses in themselves were not considered to be a crime, and further to this he cooperated with the authorities. His former boss and a junior trader, however, were prosecuted because of attempts to hide Iksil’s losses.
Kweku Adoboli, an ex-trader for UBS, has been in the public eye after incurring losses of $2.3bn after conducting unauthorised trades. Adoboli received a 7-year prison sentence for two cases of fraud in connection with his losses for the abuse of a position of power. UBS had to pay a $47.5m fine to the UK FSA for failing to block these transactions. The FSA stated that the risk-management system was weak and the trade processing system was inefficient, and as a result, UBS were handed this fine.
Money Laundering
The US treasury department have in place financial sanctions against various countries, making it illegal for banks to deal with certain assets from these countries dependent on the terms of the sanctions. Various banks were caught processing such transactions, including BNP Paribas, who was fined almost $9bn for violating sanctions put in place against Sudan, Iran and Cuba. Allowing the entry of money into the US from a sanctioned country is a form of money laundering, and thus considered a crime.
BNP took responsibility for claims that it facilitated the movement of funds from Iran, Sudan and Cuba and that it made vast efforts to conceal these transactions from the federal government. On top of paying this fine to US authorities, BNP Paribas pleaded guilty to criminal charges for falsifying documents, violating the International Emergency Economic Powers Act and conspiring to violate the Trading with the Enemy Act. As a result of this, BNP Paribas has had their dollar-changing operations blocked for a year starting from 1st January 2015. This is likely to detrimentally affect BNP’s oil and gas finance business.
HSBC was also fined $1.9bn for money laundering. Its actions with an affiliated bank in Mexico were put under scrutiny as well as its services for banks in Saudi Arabia. The US Senate Investigation described the bank’s operations as a conduit for “drug kingpins and rogue nations.” HSBC signed a Deferred Prosecution Agreement for its various violations of US laws, which the BBC´s Robert Peston describes as having the effect of “putting the bank on probation.” If HSBC were to be charged as criminals, the US would have to block all its associations with the bank and this would prove more economically damaging to the country.
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