From New Economic Perspectives, William K. Black writes – Control Fraud and the Irish Banking Crisis:
The leading cause of catastrophic bank failures has long been senior insider fraud. James Pierce, The Future of Banking (1991). Modern criminologists refer to these crimes as “control frauds.” The person(s) controlling seemingly legitimate entities use them as “weapons” to defraud creditors and shareholders. Financial control frauds’ “weapon of choice” is accounting. The officers who control lenders simultaneously optimize reported (albeit fictional) firm income, their personal compensation, and real losses through a four-part recipe.
- Grow extremely rapidly by
- Making poor quality loans at premium yields while employing
- Extreme leverage and
- Providing grossly inadequate provisions for losses for the inevitable losses
This recipe produces guaranteed, record reported income in the near term. In the words of George Akerlof and Paul Romer in their famous 1993 article – Looting: the Economic Underworld of Bankruptcy for Profit – accounting fraud is a “sure thing.” Even if the firm fails (“bankruptcy”) – which is no longer a sure thing given the bailouts of systemically dangerous institutions (SDIs) the CEO walks away wealthy (the “profit” part of the title). The use of “underworld” also demonstrates that Akerlof & Romer understood how important it was that the bank appears to be legitimate in order to aid the CEO’s “looting.”
Lenders engaged in accounting control frauds will tend to cluster in the most criminogenic environments…