Bill Black: Our System is So Flawed That Fraud is Mathematically Guaranteed

[Chris lost his voice this week due to illness, so we were unable to record a new podcast. So while Chris recuperates, enjoy this excellent discussion from the archives with Bill Black, recorded a year ago, on the pervasive control fraud within our current financial system. ~ Adam]

“When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it."  ~ Frederic Bastiat

Bill Black is a former bank regulator who played a central role in prosecuting the corruption responsible for the S&L crisis of the late 1980s. He is one of America's top experts on financial fraud. And he laments that the U.S. has descended into a type of crony capitalism that makes continued fraud a virtual certainty while increasingly neutering the safeguards intended to prevent and punish such abuse.

In this extensive interview, Bill explains why financial fraud is the most damaging type of fraud and also the hardest to prosecute. He also details how, through crony capitalism, it has become much more prevalent in our markets and political system. 

A warning: There's much revealed in this interview that will make your blood boil. For example, the Office of Thrift Supervision. In the aftermath of the S&L crisis, this office brought 3,000 administration enforcement actions (a.k.a. lawsuits) against identified perpetrators. In a number of cases, they clawed back the funds and profits that the convicted parties had fraudulently obtained.

Flash forward to the 2008 credit crisis, in which just the related household sector losses alone were over 70 times greater than those seen during the entire S&L debacle. So how many criminal referrals did the same agency, the Office of Thrift Supervision, make?


Similar dismal action was taken by such other financial regulators as the Office of the Comptroller of the Currency, the Federal Reserve, and the FDIC. 

Where is the accountability? you may be asking. Or perhaps, how did we allow things to get this bad?

Fraud is both a civil wrong and a crime, and it's when I get you to trust me and then I betray your trust in order to steal from you. As a result, there’s no more effective acid against trust than fraud, and, in particular, elite fraud, which causes people to no longer trust folks. Economies break down, families break down, political systems break down, and such, if you don’t have that kind of trust. So that’s what fraud is.

But what my work focuses on is, what kind of frauds are the most devastating? And it turns out that the most kind of problems that we’re seeing, systemic problems and such, arise when we have what we call in criminology 'control fraud.' And control fraud simply means when you have a seemingly legitimate entity and the person who controls it uses it as a weapon to defraud others. And so in the financial sphere, the weapon of choice is accounting, and the losses from these kinds of control frauds exceed the financial losses from all other forms of property crime combined.

So for example, in the current crisis, as with the prior ones, if you’re a lender, there’s an easy recipe for maximizing fake accounting income. And it goes like this. You need four ingredients:

  1. Grow like crazy...
  2. making really, really crappy loans but at a premium yield (yield just means 'interest rate')...
  3. ...while employing extreme leverage, and...
  4. ...while setting aside only the most trivial reserves or allowances for the inevitable losses this kind of behavior produces.

George Akerlof and Paul Romer wrote the classic article in economics about this in 1993. And their title really says it all in terms of the dynamic: Looting the Economic Underworld of Bankruptcy for Profit. The idea is, you have a seemingly legitimate entity, and the person at the top is looting it. They loot it by destroying it, but they walk away wealthy. Of course, in the modern era we don’t necessarily we may bail out the entity. So it may not even fail in that sense.

But here’s what Akerlof and Romer also said that was so critical as an understanding. They said these four steps, these four ingredients: it's just math. It is – and I’m quoting them now “a sure thing.” So you’re mathematically guaranteed, if you do these four things, to report not just substantial income, but record levels of income. 

The big thing about the seemingly legitimate entity when the CEO is the crook is, first, everybody reports to the CEO ultimately, right? So the CEO is the point failure mechanism where if he or she goes bad, almost everything may go bad as well. So all those things that we call internal and external controls, all report to the CEO, and the CEO therefore can, as I’ll describe, use compensation, hiring, firing, praise, and such to produce the environment that will commit create allies for his fraud. Now, note that what I’m saying. The CEO, the art of this is not to defeat your controls. The elegant solution, as in mathematics, is to suborn the controls and turn them into your most valuable allies. And therefore, for example, when you’re running accounting control fraud, where your weapon of fraud is accounting and that weapon of choice in finance is accounting, you’re going to want to hire the most prestigious accountants as your outside auditor, because it is precisely their reputation that is most valuable when you can suborn them. And they give you that clean opinion that you just described that will help you deceive other shareholders. So one enormous advantage is, internal and external controls come to the CEO level.

A second incredible advantage is the CEO can optimize the firm as a weapon of fraud. And the CEO can do that. Basically this falls into two big categories. One, you can put it in assets that have no readily verifiable market value, because then it's a lot easier to inflate asset valuations and to hide real losses. And the second thing you do is grow like crazy. And, of course, that is the essence of something your listeners have all heard about, and that is a Ponzi scheme. And so these accounting control frauds have strong Ponzi-scheme like elements, which is why they tend to cause such catastrophic losses.

Click the play button below to listen to Part I of Chris' interview with Bill Black (58m:28s). Part II can be accessed by clicking here.

This is a companion discussion topic for the original entry at

What a lovely brain. I hope that Bill Black is taking good care of it.

This poor ape, us, is a work in progress. The salient point that Dr Iain McGilchrist makes is that we have two brains. (He is more circumspect. I am not). One brain experiences reality, the other makes up models of reality.

Academics spend their entire lives exercising the modelling brain. Guess what happens then? They confuse their models with reality. In order to have any legitimacy at all DSM5 must recognise this as a malady. It must be medicalised. I live in hope that it can be cured with meditation and being taken for long walks in the rain.

It goes without saying that if I were engaged in high level fraud I would be desperate to control the conversation. Hence the fairy floss and happy smiley faces that we see and hear on the box.

I guess… Bill Black lays it on the line. When I first heard about him and saw his testimony in congress I tracked down just about aeverything I could find out about him.  I had forgotten how much they were fighting againt the system to get the S and L prosecutions to happen.  They sure locked that down to make sure that it would never happen again.  The level of corruption he describes is beyond most of our comprehensions.  You hear it, but almost doesn't sink in because it is so beyond belief. Although when you hear the approval rating of congress, it's always down in single digit territory. Washington has turned into Sodom and Gomorrah.  Send in the flood waters.
I still do vote out of some odd sense of obligation, like cleaning off you plate at diner, mom did her job, but what is the point.  As bad as most cynical americans think it is, it's much worse.  Even if we were to elect mother Teresa president, she would probably get swallowed in corruption.  Croney Capitalism pretty much sums it up. A money centric system gone mad.

You think about all those innocent grade school school kids looking at the cherry blossoms and walking through all those monuments. Lambs to the slaughter.  I've got to stop thinking about this. Just when you had forgotten about this all and thought that it was safe to back into the water again.

Big day to get the garden planted tomorrow. I've got to order the row cover before the birds start to eat the ripening strawberries.  But wait, not wanting to face or deal with this, isn't that the problem?

How did we allow things to get this bad?
It is nothing new. Has "always" been this way. Gustavus Myers wrote several books a century ago. Among others "History of the great american fortunes". Find here It was/is beyond belief.  


It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress,

Mark Twain, 1885


This fellow says that you loan your money to the banks. Therefore your unsecured loan is at the bottom of the Totem pole when the banks go belly up. (Yes. I mean the money in your everyday bank account.)
Allocated 1oz bars are also a loan to the holding entity. 1 Kg bars are not. (So far)

$10 000 gold will be an 8 fold rise in value. 8 fold rises in gold are not unprecedented. He says 5 years give or take.

This fellow says that you loan your money to the banks. Therefore your unsecured loan is at the bottom of the Totem pole when the banks go belly up. (Yes. I mean the money in your everyday bank account.)
From The mystery of banking:

Five years later, in the key follow-up case of Devaynes v. Noble, one of the counsel argued, correctly, that “a banker is rather a bailee of his customer’s funds than his debtor . . . because the money in . . . [his] hands is rather a deposit than a debt, and may therefore be instantly demanded and taken up.” But the same Judge Grant again insisted—in contrast to what would be happening later in grain warehouse law—that “money paid into a banker’s becomes immediately a part of his general assets; and he is merely a debtor for the amount.”7

The classic case occurred in 1848 in the House of Lords, in Foley v. Hill and Others. Asserting that the bank customer is only its creditor, “with a superadded obligation arising out of the custom (sic?) of the bankers to honour the customer’s cheques,” Lord Cottenham made his decision, lucidly if incorrectly and even disastrously:

Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it. . . . The money placed in the custody of a banker is, to all intents and purposes, the money of the banker, to do with it as he pleases; he is guilty of no breach of trust in employing it; he is not answerable to the principal if he puts it into jeopardy, if he engages in a hazardous speculation; he is not bound to keep it or deal with it as the property of his principal; but he is, of course, answerable for the amount, because he has contracted.8

Thus, the banks, in this astonishing decision, were given carte blanche. Despite the fact that the money, as Lord Cottenham  conceded, was “placed in the custody of the banker,” he can do virtually anything with it, and if he cannot meet his contractual obligations he is only a legitimate insolvent instead of an embezzler and a thief who has been caught red-handed. To Foley and the previous decisions must be ascribed the major share of the blame for our fraudulent system of fractional reserve banking and for the disastrous inflations of the past two centuries.

Even though American banking law has been built squarely on the Foley concept, there are intriguing anomalies and inconsistencies. While the courts have insisted that the bank deposit is only a debt contract, they still try to meld in something more. And the courts remain in a state of confusion about whether or not a deposit—the “placing of money in a bank for safekeeping”—constitutes an investment (the “placing of money in some form of property for income or profit”). For if it is purely safekeeping and not investment, then the courts might one day be forced to concede, after all, that a bank deposit is a bailment; but if an investment, then how do safekeeping and redemption on demand fit into the picture?

Hmm. And how do I stand if my employer insists that he pay my wages into my bank account because it is more convenient for him?
I did not loan the money to the bank. My employer loaned it to the bank.

I have never agreed that my employer has my permission to loan my money to the Bank. As a matter of fact my employer does not own my wages. He has no right to distribute them as he sees fit.

My employer would counter that it is common practice and that any reasonable man would concede that the chances of the banks defaulting are impossible. 

If however, my employer does loan my money to the bank and the bank then defaults, would I be able to claim that I never recieved the money?

I will have to think about this a bit more.

But I doubt that you will come up with any scenario- realistic, logical, fair, or economic- that would lead to anything other than you being- if a bank failure happened- SOL.  Interesting idea though.  Guess you'd only loose a pay period's worth of wages…as how previous wages most likely were spent on bottom paint and other marine jewelry…Aloha, Steve.

A fish rots from the head. Yes, the founding fathers realized that monarchy was a bad thing and that power needs to be widely distributed among the people directly affected by it. When will we create a "constitution" for business as we did for government? We the people control our government, but businesses are run like monarchies, with CEOs as the kings and queens. How did we let things get so bad? We overlooked that little detail.

They work diligently and expend much energy to maintain their motto: "No consequences, no problem."TREASON: "Treason doth never prosper; what's the reason? For if it prosper, none dare call it treason." Sir John Harrington, 1561-1612
Walter Burien -