Why an Underfunded FBI Could Hurt You

Federal investigators have stepped up their probes into the subprime crisis.

The investigations go beyond the possible pending indictments stemming from the collapse of two hedge funds at Bear Stearns (BSC) last summer, a collapse that cost investors $1.6 bn and kicked off the subprime meltdown.

The federal investigations now underway also go beyond the investigations into the Swiss bank UBS (UBS), which is thought to have improperly valued its holdings, and potential securities and loan fraud at the country’s biggest mortgage lender, Countrywide Financial Corp., (CFC), amidst class-action lawsuits now proliferating like dandelions.

But despite having to contend with a record number of mortgage fraud cases, along with battling terrorism, the Federal Bureau of Investigation is seriously underfunded. It is not being given the funding and support it needs to do its job.

That means you will continue to be hurt by criminals and hopefully not terrorists. That means, when it comes to white collar crime, despite the best efforts of the bureau's agents, you will continue to lose a lot of money, whether you are defrauded personally or whether you must pay more in tax dollars for federal bailouts and rescues.

Although the country has seen a catastrophic rise in white-collar crimes such as mortgage fraud, the Bush administration's 2009 budget has been criticized for not giving enough support and enough funds to the FBI’s crime fighting squads, and to the bureau in general.

The White House’s proposed budget calls for increasing FBI funding in fiscal 2009 by a mere $594 mn, to $7.1 bn. That is microscopic. 

That equates to the budget for the city of Los Angeles. It’s what the federal government spends on the Head Start program for poor pre-schoolers and what it spends on the federal Health Resources and Services Administration (you ever hear of that one? Me neither—it oversees bone marrow registries and such).

It’s what the state of California wanted to spend on prison health care this year. It’s about what Microsoft annually spends on its research and development. Meanwhile budgets for things like Veteran Affairs are about 13 times as much as the budget for the FBI.

This serious underfunding and lack of support comes as the White House has pushed the FBI to do much more to fight terrorism. The FBI has been left to load up its agents with more duties, instead of hiring enough new agents to complete the work. The FBI has 56 field offices and about 12,000 agents.

It is difficult to dig out subprime securities fraud, given that the accounting rules governing these securitizations involve a lot of subjectivity.

“Finding fraud in a subprime instrument can be exceedingly tough,” says Michael R. Young, a top securities lawyer at Willkie Farr & Gallagher, a New York City law firm. “At root, the determinations of value often turn on judgment calls. It's difficult to turn poor judgment into a criminal act.”

What is going on with the underfunding of the FBI is of a piece with what happened to the Securities and Exchange Commission in its fight against the systematic misstatement of corporate earnings in the late ‘90s.

The federal government weakened the SEC with meager enforcement budgets that in some fiscal periods were less than the budgets for US military bands. The SEC’s arsenal to fight accounting fraud was no match for the bull markets of the ‘90s, when accountants, instead of cracking down on corporations, were aligning themselves with chief executives.

The SEC’s efforts back then were akin to trying to kill a moose with a fly swatter. Instead of the SEC being what U.S. Supreme Court justice William O. Douglas had hoped it would be, "the shotgun behind the door,” the agency became more like a water pistol.

Give the FBI what it needs. Pay its agents more than the meager sums they are paid now. Period.

Because we as a country have been ungrateful to the FBI for far too long when it comes to supporting the bureau’s agents who toil in anonymity protecting us, when all they have to look forward to when they retire are ashtrays with the wrong middle initial and mindless media attacks.

I am mindful here of some media pundits who recklessly attacked the bureau without giving one ounce of thought toward understanding the extraordinarily difficult task the agents must do every day, which includes putting their lives on the line.

I am mindful here of the careless, reckless and juvenile name-calling from some ingrates in the media against the bureau after 9/11, who, carried away by their own manufactured, tedious orgy of self-righteousness, tossed off bits of juvenilia such as calling the bureau names like “the Federal Bureau of Incompetence,” a delightful bit of self-serving throat clearing. Not surprising that you don't hear a word from these individuals on the FBI's myriad successes stopping terrorism on our shores, no matter whether you agree with its modus operandi or not.

I ask these armchair critics, you walk in the agents’ shoes for one day and see if you can survive without, at minimum, a nervous breakdown. Such media mindlessness is the reason why journalists rank lower than oil executives, car dealers and Congress in the public opinion polls.

Any right-thinking citizen who has an IQ above room temperature should grind their teeth into Tic-Tacs upon hearing this ever-gushing hydrant of inflamed egoism, a condition that arises from spending too much time prancing around in a nimbus of narcissism.

Now back to the situation at hand.

The FBI’s economic crimes unit is looking into potential mortgage-related crime such as accounting or securities fraud, with the number of companies it is probing now at 19, up from 14 earlier in the year. FBI Director Robert Mueller told Congress in April that he had seen a ``tremendous surge'' in cases related to subprime loans, loans which are given to borrowers with poor credit.

The number of suspicious activity reports (SARS) filed by financial institutions reporting mortgage fraud soared by 31% in 2007, to more than 46,717 nationwide, a 176% jump in the past five years. In the first half of 2008, there already have been 38,000 reports, which translates into an additional 50% increase this year.

Mortgage fraud has erupted in certain geographic markets.

Twenty-six field FBI offices are now zeroing in on these “hot spots” where field offices have been directed to probe for mortgage fraud.

The FBI says the top 10 mortgage fraud states for 2007 were: California, Florida, Georgia, Illinois, Indiana, Michigan, New York, Ohio, Texas, and Utah. Other areas significantly affected by mortgage fraud include: Arizona, Colorado, Maryland, Minnesota, Missouri, Nevada, North Carolina, Tennessee, and Virginia. The bureau estimates that the worst hit area of the country is in the west, with 37% of mortgage fraud reports filed during fiscal 2007.

Mortgage fraud has gone viral and cascaded down onto Wall Street, hurting financial institutions now facing massive writedowns of epic proportions and causing the stock market to founder.

The subprime crisis has cost about $380 bn in losses and writedowns that have left Wall Street firms in an invertebrate state, with the rest of the country dealing with a record number of foreclosures and a costly federal government (meaning taxpayer) intervention. All of which has acted as a lead blanket on the stock market.

I have told you this after-the-fact refereeing has got to stop. It is reckless and costly to taxpayers. The government needs to put up the guard rails now. Instead, it is crippling the very agencies and bureaus that want to help. Smart, right?

“Investors may lose faith and require higher returns from mortgage backed securities. This may result in higher interest rates and fees paid by borrowers and limit the amount of investment funds available for mortgage loans,” the FBI warns in a report. Wall Street’s increased reliance on “third-party brokers has created opportunities for organized fraud groups” in the mortgage industry.

Through fiscal 2007, the FBI has brought 1,204 cases, resulting in 321 indictments and 260 convictions of mortgage fraud criminals. The bureau delivered $595.9 mn in restitutions, $21.8 mn in recoveries, and $1.7 mn in fines. Those sums are expected to increase.

Many of the cases involve loan-origination fraud, including schemes to flip properties for a quick profit, cheat banks or rip off homeowners facing foreclosure. Targets of investigations can include real-estate agents, home builders, lawyers, appraisers and borrowers.

However, losing hundreds of billions of dollars is one thing. Finding the fraud is another. And that is the pivot of this affair.

About 80% of all reported mortgage fraud losses involve collaboration or collusion by industry insiders, including falsely inflating the value of a property or issuing loans based on fictitious properties.   

While the FBI says it's difficult to gauge the sums lost from mortgage frauds, a study it issued in May said 7% of last year's suspicious activity reports provided loss amounts, which totaled more than $813 mn. Extrapolate that number out and you can see the sums involved are massive.

But the concern is that the FBI is operating beyond full tilt, with insufficient resources and agents who already are underpaid, overworked and overwhelmed.

Despite the fact that police forces across the country get medal ceremonies, the bureau eschews public award ceremonies, and agents toil away in relative anonymity combating problems such as mortgage fraud, terrorism and keeping the nation secure. 

However, the subprime cases, notably the cases involving accounting and securities fraud allegations, are not as straightforward as the accounting frauds investigated by the bureau earlier this decade, beginning with the collapses of Enron Corp. and WorldCom. Those accounting frauds involved uses of off balance sheet vehicles to hide debt, and maneuvers such as abusing line items on the financial statements to hide costs.

Subprime securitization cases involve abstruse accounting rules that are notably grey and shot through with judgment calls. Given that “initial mortgage products are repackaged and sold on secondary markets, the sale of the mortgages in many cases conceal or distort the fraud, causing it not to be reported,” an FBI report warns. “Therefore, the true level of mortgage fraud is largely unknown.”

Meanwhile, the Justice Dept. has not launched a national task force to combat mortgage fraud as the government did with corporate crime after Enron and is instead chasing down fraud cases through interagency regional task forces to fight mortgage fraud, such as the U.S. attorney’s office in Brooklyn with its mortgage task force.

One report notes that only an estimated 250 FBI agents nationwide are investigating the subprime crisis. That means there are 250 agents sifting through an estimated 46,000 potential cases. That is mind-boggling.

That compares to the estimated 1,000 FBI agents who reportedly probed the savings-and-loan scandal of the 1980s and early '90s. 

What the FBI is being asked to do is like trying to drink water from a firehose.

When it comes to giving the FBI what it needs to fight crime, the government’s reality check bounced a long time ago.