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Mortgage Fraud Sweep Nets Hundreds of Arrests

June 19, 2008 at 6:10 PM EDT
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The Justice Department and the FBI announced hundreds of arrests Thursday for mortgage fraud, which is blamed for sparking a national credit crisis and nationwide housing crisis. An NPR correspondent and Columbia Law professor examine the government crackdown.

JUDY WOODRUFF: The government’s crackdown on mortgage fraud. Ray Suarez has our story.

RAY SUAREZ: It was just about a year ago when the collapse of two large hedge funds first alerted Wall Street and the broader public to a subprime meltdown already under way.

The failure of those Bear Stearns funds foreshadowed what was to come: hundreds of billions of dollars in mortgage-backed losses around the world; record foreclosures in a number of communities; a bailout of Bear Stearns; and the beginning of a larger credit crisis throughout the financial system.

Early this morning, the federal government indicted the two former hedge fund managers. And then, in the afternoon, it announced the separate arrests of hundreds of defendants connected with mortgage fraud.

For more on this, we turn to Dina Temple-Raston, who has been covering the indictments for NPR, and John Coffee, a professor of securities law at Columbia Law School.

Suspicions of widespread scamming

RAY SUAREZ: Dina Temple-Raston, first to that nationwide sweep called Operation Malicious Mortgage. Who are the defendants? And what does the government say they did?

DINA TEMPLE-RASTON, National Public Radio: Well, what they're looking at is there have been a number of mortgage fraud scams that have basically been going on for a couple of years now.

The latest scams are things called foreclosure rescue scams, in which someone who's about to lose their house, for example, would have someone come in and say, "I can be a consultant to you. I will help you get your credit OK'd. I will make sure that you don't lose your house. You need to pay me this sum of money and maybe temporarily sign over the title of your house."

This was happening all over the country. And it was very prevalent. And there were a lot of suspicious activity reports that went to the FBI, and the FBI started checking into this.

That's just one of many scams that they are seeing now that part of this sweep was meant to stop.

RAY SUAREZ: Professor Coffee, are mass arrests -- in this case, hundreds over the last several weeks -- common in a white-collar investigation from the FBI?

JOHN COFFEE, Columbia Law School: Not at all. And these aren't necessarily white-collar executives. They're more at the regional, local level.

I think all you see uniting these cases and the Bear Stearns case today is the common gravitational pull of the subprime mortgage crisis, which is certainly beginning to direct and orient federal prosecutorial behavior. It's now a priority.

RAY SUAREZ: Dina, you talked about that house-saving scam. Was there a large umbrella here? Are these defendants charged with a wide range of misdeeds involving people who were in subprime trouble?

DINA TEMPLE-RASTON: Well, not even necessarily subprime trouble, maybe people who just got in a little over their heads.

For example, there were schemes in which they would try and take your home from you by signing your title away, or there were schemes in which they said they could get you a better mortgage rate, and then you would pay them money to go and do that, and then they would disappear.

There were schemes in which people would set up straw buyers, basically people who had a name and a good credit rating, and they would put their name on the mortgage papers to buy a house that they never intended to live in, wait for the price of the house to go up, and then flip the house. That was very common.

The reason why I was talking about foreclosure rescue scams is because now, with house prices actually falling, the scams you're seeing now have much more to do with what the current economic problems are for homeowners, which is foreclosure.

Charges of hypocritical advice

RAY SUAREZ: And, Dina, were the Bear Stearns arrests the fruit of a totally separate case and separate investigation?

DINA TEMPLE-RASTON: No, I would actually go back to what Mr. Coffee said, which is these are all of a piece of one fabric, and that fabric being the subprime mortgage crisis.

I mean, the Bear Stearns guys were the sort of marquee names that they arrested today. I don't think it's any coincidence that they announced both these things on the same day. The morning starting with a perp walk of these two gentlemen, former hedge fund managers from Bear Stearns, and ended with some very high-profile press conferences, in which they said, "Mortgage fraud. Get the message: Mortgage fraud is something that that the FBI is going to start focusing on. And if you have any intention of doing these sorts of things, you should think twice or we're going to prosecute you."

This is really tough talk from the FBI director, Robert Mueller. I mean, he hates these kinds of big press conferences. He's actually known for scratching out the words "I want to announce" in his speeches because he wants to be more low-key. So they clearly wanted to send a message today.

RAY SUAREZ: But, Professor, in the case of the Bear Stearns execs, the nature of the accusations were very different, weren't they?

JOHN COFFEE: Oh, these cases are not factually or legally connected, but they are part of the same high drama, the same tapestry.

The case against the two Bear Stearns executives is essentially pivoting around the fact that they simultaneously told investors that there were, quote, "awesome buying opportunities out there" in March of 2007, while the founder of this fund, who was telling investors this, was bailing out himself and moving $2 million of his own money out of the fund.

That looks like hypocrisy, and I think you can present that to a jury. Without that key fact, I think prosecutors would have been nervous about trying to prove beyond a reasonable doubt that an individual saw the subprime mortgage crisis as early as March 2007. But when you see him behaving like a hypocrite, that really resonates with a jury.

RAY SUAREZ: So, Professor, the government's case hinges on proving to a jury that these men knew things were bad with the funds they managed, even as they were telling them they were a good buy?

JOHN COFFEE: Exactly. Their behavior contradicts their defense. They knew it was bad, because they took their own money out, while they told others to put their money in.

Now, of course, the defendant will have a possible rebuttal. They may have left lots of their own money in these funds, and then they have other reasons by which they could show they were still committed to these funds.

But it's a fact that really sticks in a jury's craw when it looks like you're doing better than the people you owe a fiduciary duty to.

Case hinges on e-mails

RAY SUAREZ: Well, Dina, saying one thing and doing another, what's the government pointing to as evidence?

DINA TEMPLE-RASTON: Well, they have quite a bit of circumstantial evidence. And a lot of this is e-mail going back and forth between people within Bear Stearns, where they were saying one thing to each other and saying quite another to investors.

The problem is, is that e-mails, when you read them out of context, look very bad. And when you read them in the context of things, they are less so. I mean, we write e-mails and say, "I feel some deal is toast," which is one of the expressions one of them used--Tannin used this--and you might feel that way on Monday, but you don't feel that way on Friday.

And at that time, the markets were very volatile. So it's possible that there were some mood swings going on, as well. And that might be why, say, if you wrote an e-mail like this on Monday, on Friday you wouldn't say to investors, "Hey, I think we're toast."

RAY SUAREZ: Well, Professor, how about that as a defense, saying, "Look, the market took a bad swing that afternoon, I was in a lousy mood, so on my personal e-mail account I sent a message to my colleagues saying, 'Boy, this looks bad'"?

JOHN COFFEE: I think that is a fair statement about e-mails. But I'll point out to you that Eliot Spitzer had e-mails against a securities analyst about five years ago today and none of those major investment banking firms ever dared to go to trial.

The evidence can be striking. These are words from the defendant's own mouth, and it's corroborated by their behavior. When you sell $2 million of your own money out of the fund, and deny that you've done that to investors, and tell them there are awesome opportunities, I think a jury that's already skeptical about the market right now will view that in the most skeptical light possible.

RAY SUAREZ: But, Professor, aren't these by their very nature risky investments? And when you invest, aren't you warned upfront that the value of things can go up and down, past performance is no guarantee of future returns, and on and on and on? Don't those indemnify managers?

JOHN COFFEE: Well, you're exactly correct that you know these were high-risk securities. But the charges in the indictment deal with very specific denials. They denied that anyone had redeemed their position in the fund, but they knew some of their largest investors had denied.

They told investors they had maintained their own stake in the funds, while they had moved their own stake out and it bailed out.

It's correct that you can look at e-mails different ways from different perspectives and that's what a good trial is about. But the behavior here and the statements point in a manner that's very adverse to these defendants. And it would not surprise me that we see one or more of them plea-bargained before trial.

Not as clear-cut as Enron

RAY SUAREZ: Well, Dina, the professor cited the Eliot Spitzer cases, prosecutions he brought while attorney general of New York. Do we have at the federal level a track record for the use of e-mails as evidence?

DINA TEMPLE-RASTON: Well, I think it's very sketchy. Again, I think what's important about e-mails is that, in isolation, they look very bad and, in context, sometimes they look less bad.

Particularly now, I think, that e-mail, so many people use it, and people know they put things in e-mails that they wish they hadn't committed to electronic mail, I think that works to their advantage.

I would also just try to put a finer point on pulling their money out of the actual funds. And I've read the indictment and I've spoken to the defense attorneys. And what they are saying is that, in fact, while he did pull $2 million out of the fund and put it into another fund, $4 million of his dollars were still in that fund.

And if you were really trying to liquidate, say the same way Enron did, when you had Enron executives who were saying one thing to employees and investors, while quietly trying to sell as much as they could while the price was still good, that's not what happened here.

Cioffi, who is one of the two Bear Stearns men who was handling this fund, actually still had $4 million of his own money in there. He took a third of it out. Clearly, that's going to need explaining. But if he was really liquidating, wouldn't he have taken everything out?

RAY SUAREZ: We'll have to leave it there. NPR's Dina Temple-Raston, Columbia's Professor John Coffee, thank you both.