You Better Regulate

Ben Bernanke announced at the recent American Economics Association meeting that we need stronger regulation in order to prevent another financial bubble. Most critics attributed the problem to the low interest rates.

One topic that has not received much attention is what William K. Black calls control fraud, in which a person who “controls a seemingly legitimate business or government agency uses it as a ‘weapon’ to defraud.” The essence behind fraud is deceit. Essentially, I create trust between you and me, then I break that trust.

Professor Black noted in a blog entry in the Huffington Post that back in September 2004, the FBI had warned of an “‘epidemic’ of mortgage fraud” where 80% were initiated by lenders. Dr. Black continues on to describe how Fitch, upon reviewing a sample of nonprime loans, found “fraud or misrepresentation in almost every file.” It’s not a surprise considering that “rating agencies never reviewed samples of loan files before giving AAA ratings to nonprime mortgage financial derivatives.” So essentially, rating agencies were rubber stamping every loan file as good even though they were not good at all.

Mr. Bernanke is correct in that we need stronger regulation to prevent another bubble, but I think it should begin with addressing the fraud taking place at not just the lending companies, but also with the rating agencies giving fraudulent ratings.

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