By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Originally published at New Economic Perspectives
This is the fourth and final column in my series that began by focusing on Richard M. Bowen, III. Bowen blew the whistle on Citi’s sale of scores of billions of dollars in toxic mortgages, primarily to Fannie and Freddie, through fraudulent reps and warranties. After Bowen protested and blew the whistle within Citi to its senior management (including Robert Rubin) – Citi’s senior officers’ classic accounting control fraud strategy expanded both in terms of the volume of sales and the incidence of fraudulent reps and warranties – which rose to 80 percent.
I have explained how Bowen and his boss’ banking careers were destroyed by the retaliation of Citi’s senior managers and how the SEC, the Department of Justice (DOJ), and the Financial Crisis Inquiry Commission (FCIC) have followed the disgraceful policy of trying to keep Bowen’s detailed disclosures from becoming public and being used to bring Citi’s criminal controlling officers to justice.
What I have only alluded to in a sentence, however, is the wondrous story of another ethical hero of the saga – Sherry Hunt. Hunt’s story should be made into a movie. She was one of Bowen’s principal lieutenants in underwriting in 2006-2007, and suffered retaliation for her integrity. But Hunt was just getting started and fought not simply tough but very smart and she drove Citi’s corrupt managers into rages so powerful that they dropped their masks and revealed that they were pathetic thugs. Best of all, while I in no way diminish the suffering she experienced at the hands of Citi’s clownish thugs’ (particularly because it occurred while she and her husband were suffering great pain from a crash caused by a reckless driver), she was eventually able to laugh all the way to the bank at the thugs’ expense. To steal a line from Eric Flint, when Citi unleashed its thuggish senior officers to attack Hunt they hit her like a log hits a buzz saw.
Sherry Hunt Drive Citi’s Thugs Crazy
There’s a Northwestern/Kellogg School case study discussing a woman who had been a vital leader in Bowen’s underwriting team. It gets off to a rousing start. (Note to reader: this is happening in 2011 – well after the crisis’ most acute phase in late 2008.)
“On March 22, 2011, Sherry Hunt, vice president and chief underwriter at CitiMortgage, raced down the endless rows of cubicles until she reached her office and closed the door behind her. Her hands were shaking, her heart pounding. Moments before, Jeffery Polkinghorne—an executive three levels above her—had requested an impromptu meeting with Hunt and her colleague in a conference room. His face had reddened as he raised his voice and pointed at her. If the mortgage defect rate reported by Hunt and her quality control unit did not fall substantially and immediately, he said, menacingly, ‘It’s your asses on the line.’”
Citi’s Leadership’s Strategy of Defrauding the FHA
A little background and timeline is in order. The Bush administration, reacting to severe criticism from the right for bailing out Bear when it fails in early 2008, decides not to push Lehman to convert to a bank so that it can be the subject of an FDIC-assisted acquisition. Lehman collapses in a welter of accounting fraud. Its collapse sparks (not causes) a global financial crisis. Fannie and Freddie are also accounting control frauds and fail. AIG would be an accounting control fraud, but the accounting for credit default swaps (CDS) is an open invitation for accounting fraud, so it would be tough to prosecute. (Note to public: the obscene accounting for CDS has not been fixed and is not about to be fixed – seven years later.) Lehman’s collapse triggers the world largest and quickest run at the money market mutual funds. Hundreds of financial markets cease to trade as financial entities no longer trust their counterparties’ honesty in valuing assets.
The secondary market in nonprime loans collapses in mid-2007 as the endemic fraud can no longer be ignored given the bursting of the real estate bubbles in 2006. Fannie and Freddie are crippled. Uninsured home lenders begin to have severe difficulties obtaining lines of credit and hundreds fail in late 2006-2008. Large, FDIC-insured nonprime lenders fail in 2008. Citi is deeply insolvent on any market value basis and is bailed out by Treasury and the Fed. Consumer access to housing credit becomes severely strained.
The government makes strong efforts to gear up the FHA to prevent what is perceived as a serious risk of a drastic reduction in home lending. The FHA agrees to buy very large amounts of home loans to provide a source of home finance.
In these circumstances, lesser bank executives would step back and consider their amazing fortune for being the unworthy beneficiaries of this government aid. Massive bonuses and bailouts is an astonishing reward for running a frequently fraudulent and bankrupt bank. Lesser bank CEOs might be mortified, chagrined, and even grateful to the people who, while suffering, were bailing out the least deserving recipients of government welfare in history.
But Citi’s leadership – as with the leadership of many other large banks, including foreign banks like Deutsche Bank – have long believed that they are entitled to bountiful bonuses and bailouts as a matter of divine rule. These leaders went back to what they do best – accounting fraud. There was only one obvious target – the FHA. The FHA employees were overwhelmed from working flat out for years with the overriding mission of providing housing finance so that the housing markets would not fall into what was feared to be a long-term death spiral. The FHA, given this mission, did not underwrite the loans it purchased before the purchase. It was wide open to being cheated – by the banks and bankers it was so desperately seeking to help. The elite bankers’ “defraud the FHA” strategy is a worthy contestant in the contest for the most cynical form of moral corruption.
Pandering to Pandit’s “Responsible Finance” Propaganda
Bowen, his boss, and Hunt’s findings had established by 2006 that Citi was the land where loan data went to be waterboarded so that it to confess whatever the senior torturers need confessed. Recall that the date of Polkinhorne threatening Hunt was 2011, so this the Hunt case study discussed the new, improved version of Citi.
Vikram Pandit joined Citigroup as its new CEO in December 2007, and Sanjiv Das became CitiMortgage’s new CEO during 2008. Pandit embarked on a campaign to create a culture of what he called ‘responsible finance’ at Citi. ‘We’re going to stand for the financial services company that practices responsible finance—making sure we’re transparent, making sure we’re honest, making sure we manage our shareholders’ money prudently,’ he pledged to clients and stakeholders in a video on Citi’s blog.
It’s not immediately clear whether Polkinghorne’s crude threat to Hunt was meant to represent Pandit’s promised “transparen[cy]” or “honest[y].” As Bloomberg went on to describe, he was the perfect embodiment of what Pandit actually met by the cynical term “responsible finance.”
Some CitiMortgage employees had pay incentives tied to reducing the number of defective loans, part of a bank-wide effort to practice what Citigroup Chief Executive Officer Vikram S. Pandit calls “responsible finance,” Sanjiv Das, CitiMortgage’s CEO, said in a March 30 interview.
“We pay our people based on defect quality. We are very proud of that,” Das said. “I get compensated based on manufacturing quality. It all comes down to how you make responsible finance effective throughout the company.”
Das declined to comment today.
Houghtalin was in charge of making sure CitiMortgage followed government guidelines so it could continue issuing U.S.-insured home loans. He knew that CitiMortgage had broken the rules when he certified — or caused Polkinghorne to certify — in documents that the opposite was true, according to Hunt’s false-claims suit.
We know that Pandit and Das’ claims were false – and we know it because Hunt documented the real facts, the Department of Justice complaint against Citi affirms the validity of those the facts, and Citi rushed to settle the case with an admission of wrongdoing. (A crappy admission of the kind that Holder has made infamous, but still an admission.)
We need to deconstruct Pandit and Das-speak. When Das claimed that “we pay our people based on defect quality” he actually meant “we pay our people based on [reported] defect quality.” As a result, if the reported number of defects falls – everybody in the relevant Citi unit gets paid more. The reader, as with every Citi employee, understands immediately how perverse and powerful an incentive system this creates among employees who do not share Hunt and Bowen’s ethics. Hunt explained this point in the same Bloomberg column.
“All a dishonest person had to do was change the reports to make things look better than they were,” Hunt said. “I wouldn’t play along.’
Citi’s Perverse Compensation Sparked the First Period of Retaliation Against Hunt
Hunt understood the perverse incentives Pandit was shaping in the cynical name of “honest[y]” because she had seen Citi’s top managers use the same strategy in 2006-2007 to produce an 80% incidence of false reps and warranties to Fannie and Freddie. We need to back up to 2007 to find Citi’s initial act of retaliation against Hunt. Kellogg’s article about the Hunt case study reports.
At the time, Citi placed a significant corporate emphasis on growth, with all employees of the Real Estate Lending group receiving quarterly memos congratulating them on consecutive quarters of growth in mortgage originations and highlighting their rising rank in market share. Bonuses for all CitiMortgage employees, including its CEO, depended on a high percentage of approved loans.
So instead of managers fixing their underwriters’ mistakes and providing additional training, these managers fought Hunt and her team at every turn. “It ended up being a war every day,” Hunt says. “They didn’t like me very much.”
Meanwhile, by early 2008, Bowen’s direct reports were reduced from 220 people to 2, and he was forced to take administrative leave. Soon Hunt’s direct reports were reduced from 65 to 1. “I was literally put in a corner,” Hunt says, explaining that she was “placed as far away in the office as possible from the underwriters.…They didn’t change my title or my salary, but they changed everything else.”
Under Pandit and Das Citi Achieved Stunning Fraud Levels Against the FHA
After trying for years to clean up Citi from within, Hunt finally resigned, blew the whistle to the SEC and the DOJ and filed a False Claims Act against Citi for defrauding the FHA. Her case, supported by internal documents and conversations with key Citi officers was so compelling that the Department of Justice filed a complaint and adopted her suit – and Citi promptly settled, admitting misconduct. DOJ’s complaint reveals these facts.
This is a civil fraud action by the United States to recover treble damages and civil penalties under the False Claims Act, as amended, 31 U.S.C. §§ 3729 et seq., civil penalties under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), 12 U.S.C. § 1833a, and common-law damages arising from fraud on the United States Department of Housing and Urban Development (“HUD”) in connection with Citi’s residential mortgage lending business. As set forth more fully below, Citi has profited for years from its position as a large HUD-approved residential mortgage lender while submitting false statements to HUD about its underwriting and its quality control. At the same time, Citi failed to implement even the most basic quality control measures that are required by HUD to stop the reckless lending that Citi engaged in. Among other things, Citi failed to conduct the required full review of all early payment defaults (i.e., loans defaulting in the first six months), failed to report to HUD findings of fraud and other serious deficiencies in its loans, and encouraged its business employees to manipulate the reports of its quality control department to conceal the number and severity of deficiencies in Citi’s loans. Not only has Citi’s misconduct cost the United States millions of dollars in insurance claims, with additional losses expected in the future, but also it has led to mortgage defaults and home evictions and foreclosures across the country.
Since 2004, Citi has endorsed nearly 30,000 mortgages for FHA insurance, totaling more than $4.8 billion in underlying principal obligations. Of those loans, 9,636 (or more than 30% percent) have defaulted. Citi’s default rate soared to more than 47% for loans originated in 2006 and 2007. In other words, nearly every other loan Citi endorsed for FHA insurance in the critical years leading up to the financial crisis defaulted, resulting in foreclosures and evictions and ultimately depressed real estate values, all to the detriment of the national housing market and the national economy. Moreover, of the loans Citi originated in 2007, over 10.5% went into early payment default. HUD has already paid nearly $200 million in insurance claims on loans that Citi originated or underwrote since 2004. A substantial percentage of those claims resulted from loans that were ineligible for FHA insurance and never should have been insured. Thousands of other loans are currently in default, which the Government expects to result in additional insurance claims paid by HUD in the future. 7. While Citi made substantial profits through the sale and/or securitization of FHAinsured mortgages, it wrongfully endorsed mortgages that were not eligible for FHA insurance under HUD rules. Notwithstanding the mortgages’ ineligibility, Citi endorsed the mortgages for FHA insurance by falsely certifying that they complied with HUD requirements and that its underwriters had conducted any necessary due diligence required by HUD rules. By endorsing 5 ineligible mortgages and falsely certifying compliance with HUD rules, Citi wrongfully obtained FHA insurance for these mortgages. 8. Citi also failed to implement the quality control measures designed to protect HUD and the public from reckless lending. For instance, although HUD required Citi to conduct a full review of every loan that went into early payment default, for years Citi did such a review on only approximately half of its EPDs, giving the remainder nothing more than a cursory review. Further, even when Citi’s quality control department did conduct the required reviews of loans, its findings were not used, as HUD requires, to improve underwriting standards and loan quality. Instead, Citi’s quality control reports became—and remain—a battleground within Citi, with those in Citi’s business production units applying what they describe as “brute force” to pressure Citi’s quality control managers to downgrade their findings. Indeed, Citi’s own director of quality control described the business personnel’s conduct as “nothing short of abuse and bordering on fraudulent actions.” As a result, Citi’s quality control program lacks the basic independence from business unit control that is required by HUD. 9. Citi also prevented its quality control department from reporting to HUD when it found fraud or other material violations in mortgage loans previously endorsed for HUD insurance. A lender is required to report such findings to HUD within sixty days of discovery so that the violations—and especially patterns of violations—can be identified and corrected and losses minimized. Citi, however, has essentially failed to maintain a self-reporting system. From 2005 to 2010, Citi failed to report even a single loan that it had originated or underwritten itself. Instead, in the rare cases where Citi did actually self-report a loan, the loan was always one that Citi had purchased from another lender. The loans that Citi failed to report to HUD 6 include ones in which Citi had even confirmed fraud in the form of fabricated bank statements and other misrepresentations. Citi’s failure to self-report prevented HUD from auditing and scrutinizing the practices that allowed Citi to underwrite fraudulent and other deficient loans in the first place.
Citi’s reported loan quality deliberately and enormously inflated Citi’s actual loan quality. Citi covered up the massive quality defects found by Citi’s honest underwriters such as Hunt and sought to use “brute force” to report false information for the purpose of defrauding the FHA. That was the real, but carefully hidden, face of “responsible finance” under Pandit of which Das was so “very proud.”
By 2008, No One at Citi Could Deny that Bowen and Hunt Were Right
By 2011, everyone that worked for Citi had known for years that Bowen, his boss, and his underwriting leaders like Hunt had been correct about Citi’s toxic loans and that Polkinghorne wanted to reprise all of Citi’s senior managers worst actions. Once more, it was the best people at Citi risking their careers to try to protect the bank from the senior officers who were looting it.
How DOJ and Citi Handled the FHA Litigation
Citi’s top managers were furious at Polkinghorne for violating the City’s cardinal rule – don’t leave a record of your crimes that get the C-suite denizens prosecuted. But Citi’s controlling officers could not jettison Polkinghorne until they could be confident that the feckless Attorney General of the United States, Eric Holder would not prosecute Polkinghorne, Citi, or any Citi officer. If they threw him to the wolves he might cut a deal with DOJ and implicate the C-Suite leaders of Citi’s crimes. Bloomberg reports that after Citi’s lawyers were able to cut a sweetheart deal that led to no prosecution of Citi and Citi’s officers for defrauding FHA, no civil liability for Citi’s officers for defrauding FHA, and a useless corporate fine for Citi that was one-sixth the fine JPMorgan was assessed for defrauding FHA Citi showed Polkinghorne the door with the standard insincere thanks.
“Jeffery Polkinghorne, a senior risk manager at the CitiMortgage division, is leaving after 16 years of ‘dedicated service,” according to an internal memo obtained by Bloomberg News and confirmed by Mark Rodgers, a spokesman for the New York-based bank. Donald Houghtalin, a compliance officer at the unit, has already left, he said in a phone interview. Neither man was sued by the government.
And, of course, neither man was prosecuted even though Hunt brought the Department of Justice (DOJ) its dream case.
A Personal Note That May Help Interpret the Strength of the FHA Fraud Case
I will slip in a personal word here. We all think we are terribly complicated, but as I get older I increasingly admit that I am pretty simple and old-fashioned product of a middle-class Midwest family. I despise powerful people bullying those that cannot fight back to try to force them to act unethically or simply to embarrass them. We all hate hypocrisy. And most of us were raised to be outraged by a powerful Citi executive’s effort to bully a woman – a woman who had demonstrated for many years that she had every desirable quality that the Citi executives so palpably lacked.
Many of us, therefore, had we been in the room when Polkinghorne threatened Hunt would have gotten in his grill as soon as he started and shut him down before he could treat a woman and a much more junior officer in this manner. Had this testimony been presented to a jury in a criminal case against Citi and the officers involved in defrauding the FHA, there would have been twelve pairs of eyes boring in to Polkinghorne’s eyes and making it clear that it was his ass that was on the line. Hunt’s testimony, facts, data, and the thuggish acts of Citi’s senior managers made the “jury appeal” of the criminal case stellar. Citi’s reaction to the case being filed demonstrated how much its attorneys feared a prosecution. This was a case of bank receiving a massive bailout and then turning around and deliberately and massively defrauding the people of America. If DOJ refuses to prosecute a case this compelling then one knows that trial judgments are not the reason, nor can considerations of justice be the reason to refuse to prosecute. Federal prosecutors would normally be salivating at the prospect of prosecuting a case like this.
DOJ’s Treatment of Hunt in the FHA Case Was Disgraceful
I have explained many times, including in this series of articles, why given the death of criminal referrals by the banking regulatory agencies the only way DOJ can successfully prosecute even a small number of elite bankers is to make a nationwide priority effort to recruit whistleblowers. (The same is true of the SEC.) DOJ was not so insane that it refused to join Hunt’s False Claims Act suit against Citi’s defrauding of the FHA, but this press release it put out about the settlement shows exactly what I’ve been arguing for years. When it comes to whistleblowers who sacrificed their careers to try to protect the FHA from Citi’s leaders’ frauds, DOJ’s prepared press release cannot even summon the minimal politeness we expect from our four year-old children. At DOJ, a simple “thank you” is reserved only for other government employees at HUD who sacrificed nothing, but are feted as providing “extraordinary” aid to DOJ.
Mr. Bharara thanked HUD and HUD-OIG for their extraordinary assistance in this case. He also expressed his appreciation for the support of the Commercial Litigation Branch of the U.S. Department of Justice’s Civil Division in Washington, D.C.
The existence of a whistleblower, whose name is not worth mentioning, is barely noted.
By filing its Complaint, the Government joined a private whistleblower lawsuit that had been filed against CITIMORTGAGE under the False Claims Act in August of last year.
I’m happy DOJ thanked the HUD employees. I say simply two things. If the HUD employees’ help was “extraordinary,” what word would we have to invent in the English language to describe Hunt’s help to DOJ and the FHA? The other point is practical. DOJ knows where to find HUD’s folks. It is clueless about where to find whistleblowers of the quality of Bowen and Hunt. It should be using every possible opportunity to praise whistleblowers, ask them to come forward, show them how to do so quickly and easily, and prosecute their cases wherever desirable.
One Stands in Awe of How Corrupt a Culture Citi’s Chieftains Crafted
Kellogg’s article about the case study reports on how determined Citi’s senior officers were to stamp out ethics.
Blowing the Whistle
Now Hunt began to record her troublesome findings in a spreadsheet on her home computer: the defective mortgages she found in late 2009 that Citi had failed to report to the FHA, despite having been flagged as containing evidence of fraud two years earlier; the email in 2010 from a senior executive recommending others use “brute force” on Hunt’s team to drive down the defect rate; the day in 2011 an executive three levels above Hunt told her and a colleague that their “asses [were] on the line” if they did not change their reports.
Hunt also watched as members of the Quality Rebuttal Committee—a new team that CitiMortgage had formed to review and potentially refute the mortgage defects identified by Hunt’s team—received employee-of-the-month awards.
Having witnessed Bowen’s unfortunate fate, Hunt attempted to report these issues anonymously. She submitted information through the reporting mechanism on the website of the U.S. Department of Housing and Urban Development (the FHA’s parent department). When there was no response, she did the same on the FBI’s website. Still seeing no evidence of investigations, Hunt told CitiMortgage HR, who took no significant action.”
Hunt turned out to be a bad target for Citi’s “brute force” attack.
Finally, in August 2011, she filed a false claims lawsuit against Citi for defrauding the FHA. A few months later, she received word that an attorney would be joining her case on behalf of the Department of Justice. By February, Citi admitted wrongdoing and paid a $158.3 million settlement to Hunt and the DOJ.
So, we know Hunt continued to warn after Citi forced out Bowen and his boss. We know that Citi’s senior managers retaliated against Hunt because she did the job they had assigned her to do so well.
We also see a glimpse of how many ways corrupt controlling officers can seek to suborn the staff. As I explained in my first article, there are four basic strategies: buy, bully, bamboozle, and butcher. Citi’s managers decided to unleash all four strategies simultaneously against its customers, including the FHA, and Citi’s most ethical, brave, and competent underwriters.
Citi’s unethical senior managers take your breath away. They are running a criminal enterprise that must maintain an appearance of respectability to make its frauds successful. You can see the managers chafe at that restriction and fantasize about being able to use “brute force” in the form of a blackjack (rather than a metaphor) against those hick Midwesterners like Hunt who grew up in Michigan (as I did) and live in Missouri (as I largely do) and Texans who, heaven forfend, live in Irving like Bowen and take ethics seriously.
While Citi’s loan and risk managers plainly have no clue what the “4 Cs” of mortgage loan underwriting are, they knew their variant: Citi’s crooks are creatively corrupt. There is something quite wondrous about having the chutzpah to organize, incent, and honor a group dedicated not simply to fraud – but to defeating the efforts of Citi’s honest employees to prevent fraud. And to name it the “Quality Rebuttal Committee” and name its members the “employees of the month” – that is sheer fraudulent, brazen FU genius! But it gets better, for Citi’s corrupt officers’ program to single out its least ethical staff for special honors did not have a boring name like “employee of the month.” No, this is Citi, where fraud, as Reuters reported, is a high art form.
In January 2011, for example, CitiMortgage held a ‘Star Players Award’ ceremony for the efforts of some workers to challenge defects reported by the quality control unit.
Yes, at Citi the staff willing to pander to Pandit by obstructing the honest people at Citi who were trying to prevent frauds are honored as the corporate “stars” of the future. These are the people who float to the top of the septic tank that is Citi’s C-Suite.
After Citi’s senior managers made Bowen’s boss, Bowen, and Hunt’s lives so miserable they felt the need to leave Polkinghorne (“your asses [are] on the line”) was still a moderately senior Citi officer. As I explained, they only discarded him when they were sure Holder would continue his record of refusing to prosecute the elite bankers that led the fraud epidemics that caused the crisis. Holder refused to prosecute even though Citi’s managers deliberately cheated the American people by defrauding the FHA and even though Hunt sacrificed her banking career to deliver a case so to Holder for prosecuting Citi and its corrupt managers that was so strong that any real prosecutor would have cried out “Hallelujah!”
Given that DOJ finds it so difficult, I’ll end by saying you to Bowen and Hunt. Americans appreciate your sacrifices on our behalf. And Mr. President, we are fast approaching the most beautiful time of the year in Washington, D.C. when the cherry blossoms emerge. You have a beautiful rose garden that would be the perfect site to award the whistleblowers medals, praise them, call on other Americans to follow their lead, explain exactly how to do so, and promise that DOJ and the SEC will act on any reliable case brought by the whistleblowers. An excellent means of showing your commitment to change would be to announce that you were ordering the immediate restoration of the government banking regulators criminal referral coordinator system, directing the SEC to release all of the information Bowen provided it, and order the release of Bowen’s interviews with the FCIC and his full, original written testimony.
Everyone in America, other than the inhabitants of the C-suites of a few dozen Wall Street banks knows you should do this. There’s only one reason you wouldn’t do so, and that reason is unworthy of our Nation.