(By Vic Hartman)

In a previous post, we considered the recent Standard & Poor’s settlement with the federal government concerning charges the company had knowingly misrepresented the risk level in securities backed by mortgages (RMBs, or Residential Mortgage-Backed Securities and CDOs, or Collateralized Debt Obligations).  The Department of Justice accused S&P of illegally putting business interests above investor interests.  Relying on terminology from the book, “A.B.C.s of Behavioral Forensics,” we raised the question of whether the S&P issues were limited to a bad Crop (the company) or were symptomatic of a bad Farmer’s Market (the entire mortgage service industry)?

The mortgage service industry and its stakeholders consist of at least seven elements, each with its own mission and each with its own perceived risks and incentives:

What all this means is that Wall Street uses complex financial instruments that distribute the trust and risk involved with mortgages around the world with investors who now own the mortgages as part of their mutual funds and retirement nest eggs.  These investors may not even be aware of this ownership.  And, everyone trusts that the risk has been accurately and impartially judged by the rating agency.  That is the trust betrayed by S&P.  But every element of this industry structure, operating in the cultural ecosystem of the mortgage industry, passed impaired financial instruments (in farm terminology, manure) on to the next level.  Note that no one in this Farmer’s Market has meaningful incentive to assure the accuracy of the information on which risk level is assessed.  Some are accountable, but no one has the motivation (other than to comply with federal law).  This is The Farmer’s Market.  I call it a crazy market full of “ninja” loans…subprime mortgage contracts without anything as a foundation—no income, no jobs, no assets.  Produce without nutritional value.

We now know what happened.  In the “crazy market,” even S&P, a credit rating agency acting as a public guardian in this game, had been compromised! Loss of independence of a public guardian—as we saw earlier in the case of Arthur Andersen and Enron—is a lethal and frequently, catastrophic risk for the markets.  It’s as if the protector transmogrified into the predator!   The Market products? A harvest of loss, distrust, bitterness among those suffering from the collapse of a structure missing the foundation timbers of trust. And ultimately, shame.  Every element in the chart above had something to gain.  But when federal authorities put Fannie Mae and Freddie Mac into a taxpayer-bailout conservatorship, every taxpayer had something to lose.

I invite my bringingfreudtofraud colleagues to bring their Freudian insights into a deeper view of what was involved in this Faustian bargain—an exchange of accountability for profit.

Join us for more insights into behavioral forensics (behind fraud and similar white collar crimes) from the authors of ABCs of Behavioral Forensics (Wiley, 2013): Sri Ramamoorti, Ph. D., Daven Morrison, M.D., and Joe Koletar, D.P.A., along with Vic Hartman, J.D.  These distinguished experts come from the disciplines of psychology, medicine, accounting, law, and law enforcement to explain and prevent fraud.  Because we are inspired to bring to light and address the fraud problems in today’s headlines, we encourage our readers to come back and revisit us regularly at BringingFreudtoFraud.com.