Private contracts may not undermine, violate, and contradict bylaw-granted rights of unit owner property

The “licensing” scheme at this condominium is a fraud that rips everyone off solely to benefit former dominant board member Defendant One.

All rights to shaft space are bylaw defined. The effect of it on the abandoned freight elevator shaft in the building, is to divide it evenly among everyone.

This fraud is an ongoing crime, rectifiable on an ongoing basis, by any or all unit owners.

Since 2007, the board encouraged shaft build ins, even repeatedly promising that these build ins would be done for all in common. The Offer did the exact opposite. The condominium attorney—and now, sadly, others in the New York City real estate bar, for whom such schemes only manufacture transactional and dispute fees—wrongly thinks that Cohen v. Perry St. Board is about a condo board “selling” common element space “to” unit owners. The case does nothing of the kind. The Perry St. unit owner who wanted to enclose a small piece of adjacent hall into his unit made a donation to grease a board approval. This was on his initiative, not the board’s. A harmless bribe given for approval. The Perry St. board “sold” nothing. It merely took cash given to it. In no way does this imply that a fiduciary board can turn around and, on its initiative, forcibly “sell” a common element to unit owners, at a declared entity “profit,” discriminatory among unit owners. That is extortion. Condominiums are based on cost. Not profit.

I believe this is an instance of rising enterprise corruption in New York, given a sad assist by judicial abdication to a class of overprivileged board malfeasors who now find it all too easy to evade accountability—and which echoes the move toward corporatized fascism which the late Obama administration famously viewed as more of a feature than a bug, basing its experimentation on recent anti-libertarian legal-academic trends. This experiment in delegation to corporate entities by the state is not going well anywhere in America—including in the sexual harassment kangaroo courts lately instituted at contemporary American campuses.

Fair market value (sale or rental) is merely a valuation. It is not a “sale.” Real estate is valued when a board, pursuant to its duty to the common interest, acts within its power. It had no such power here.

In this situation the condominium board simply has no power to “sell real estate.” Fair market valuation in pursuit of a common purpose is all the board—which is a manager, not an owner—has any authority to do.

This licensing scheme sought to sell board approvals. This is inherently corrupt. No common purpose was served by it. Defendant One merely served himself—to everyone else’s money and property, abusing board power and common funds to steal others’ property by fabricating a faux appearance of legality in a flurry of private contracts. A condominium “profit” motive adverse to unit owners, selling to them, is on its face a conflict of interest.

When you look at this closely, it is all unethical, illegal, and worst of all, economically irrational.

Everyone but he was charged four times their cost to build in while he got to pay his cost. Everyone was forced to subsidize him.

By grouping shaft with roof under a “price” list, the Offer deceitfully implied that the roof was part of the shaft. It is not. To use the common roof, Defendant One must pay fair market value rent. On the roof, everyone else is being deprived of that valuable, highly limited, common roof real estate. No one is deprived of anything if a unit owner uses their part of the shaft.

Defendant One never got proper permission for any of his roof constructions. All are illegal. To be legal, the documents must be followed and they were not. Every owner affected by a change in a common element must approve.

The Offer fraudulently recharacterized roof rentals as “common interest share monthly payments” to use “the shaft.” To do this, the Offer made everyone in the building liable to pay a monthly charge to use the shaft—all so that Defendant One could pretend that his taking of the roof was part of the shaft. The only relevant building precedent for shaft use inside the building is no charge. (Defendant One’s use of it since 1997).

Comically, Defendant One also gets his common interest share of “profit” from these monthly “common interest share shaft” payments, and the fake “sales” gouged out of everyone in the building except him.

When the Offer was first sent out, Defendants Three and One were already building in the shaft and on the roof. They had broken into our loft from there, three weeks before the Offer arrived on all doorsteps.

In charging everyone new “common interest shares” for the shaft, common interest shares have changed. This violates RPL §339-m.

Under §2.2 or its §2.2.3 limited residual powers, there was no board power to lease a common element. These clauses align with Bylaw §6.15.4 which grants the sole prerogative to initiate an enclosure of an adjacent common element to the unit owner specified in that bylaw as eligible to do so. It does not grant such prerogative to the board. Defendant Three is not eligible under the bylaw terms. Nor is Defendant One. They are not adjacent to the space and their units are not appurtenant to it. Only ours is.

The term-shuffling alone in this “licensing” scheme—swapping out “selling,” “leasing,” or “licensing” at will—was a large clue of a fraud afoot.

Board resolutions range here from nonexistent to inadequate. Nearly everything done here is ultra vires. The records show slovenliness, confusion, and autocracy gone haywire. Highly conflicted board members did not recuse, only madly self-dealt in bad faith.

Worse, the “Offer” was pitched to owners as a condominium profit venture. There is no common interest in profiting off unit owners. The term confused the personal interest in generating profit of Defendant Two, the former King of the Building—who, as an employee of the condominium’s management company had a conflict of interest in performing his King of the Building role—with the condominium’s interest in good management. Profits are worse than irrelevant here. Condominiums are based on cost. “Profit” is only a tax liability. If, as advertised, this is profit, then the last 7 years of tax returns, not only the condominium’s, but everyone’s, must be amended to report profit distributions. To put “profits” into a capital account, as Defendant Two announced that the condominium would do, without reporting those profits as such, is accounting fraud, at both entity and owner levels. For which owners are all now liable to the tax authorities. Fees (which are profits) only serve a common purpose if a board determines, pursuant to orderly investigation, report, and clear board resolution, that a common need exists to, for example, allocate demand to regulate garage parking space rentals that are highly sought after.

The only one ever “profiting” here was Defendant One. Everyone else was charged quadruple their cost, to subsidize the very high cost of valuable benefits that flowed only to Defendant One.  

The Offer pretended to be some kind of notice. But receipt of a deceitful sales pitch does not constitute notice or approval of, much less a vote for, anything.

All of Defendant One’s roof units are illegal. Private contracts do not supplant the documents. Private contracts do not substitute for a required process of due consideration, resolution, or vote. The extreme non-transparency of a process of private contracts accessible only to board members, in itself presents serious questions as to any legal legitimacy.

Perniciously, people felt forced to comply and to “buy” their own shaft spaces, out of fear of losing it, or of being tied up in expensive legal knots. This invested them in the scam. But they should never have been so compelled.

The condominium must now be put on the correct capital cost footing, the shaft and roof separated, and all so-called “licenses” revoked.

Historically, Defendant One cheated the building repeatedly via Defendant Two, who worked at Andrews. For example, Andrews once announced the condominium would pay half of Defendant One’s leak damages from a toilet of his that overflowed. Why would the condominium’s insurer share this cost? Citing no evidence, Andrews said original sponsor Zuberry was to blame because other toilets in the building were believed to be defective, too. This was false, certainly with respect to Defendant One. Defendant One took his loft totally raw. He never had any toilets from Zuberry, so Zuberry was not to blame. (We have four Zuberry toilets, none with any leak issues.) This is not the only example. At the first fractious special board meeting regarding the shaft, Defendant Two told me that the condominium’s insurance had paid half for another Defendant One leak, caused by his having opened the roof to build another roof unit. He explained that this was because the rain had come into the building through a part of the roof that was common. What? The location where rain enters is irrelevant. Who caused it is what matters.

What may have happened here was, Defendant Two was contracting for Defendant One, Defendant One blamed him, so Andrews covered for Defendant Two by allowing him lie to the condominium’s insurer so that they would not be blamed, and so notified all unit owners. Defendant Two also appears to have charged expensive cladding to Defendant One’s secretly installed third roof unit to the condominium. This needs to be investigated.

Defendant Two has made everyone pay Defendant One’s personal costs here for years. Now he engages in maliciously racking up expensive and utterly unnecessary fees from a large architecture firm, his crony, which he bills to us, with no rule or contract authority to do so. We are being harassed as retaliation for our whistle-blowing. We have been put to great personal expense and trouble to expose the frauds ongoing here.

In any contract, each party pays their own respective costs to negotiate it.

Past board members often behaved as if profiting the condominium entity at owner expense was their duty—as if a condominium board were inherently adverse to owners. At least one board member was deceived into supporting the scheme by being tricked into thinking she’d receive a personal financial benefit out of it.

Have you been charged bills unfairly? We’d like to hear about it and correct any abuse.

Under condominium rules, any bad rule can be stricken by majority unit owner vote. No rules have been promulgated since 2005.

To force overreaching contract boilerplate on people is inappropriate.

Condominium rules need to be reviewed. They appear to be mostly reactive. Forbidding anything bad that has ever occurred in the building from ever happening again, in rule form, which is simply silly. Just state basic principles so they are correct, and flexible.

The condominium should not be commandeering individual responsibilities. The basic condominium rule is to distinguish common from individual costs.

“Licensing” in fact, here, is a lawyer fee racket. Reversion to and compliance with the documents is the best and simplest course and far cheaper and better in the long run for everyone.

Democracy and transparency should be enforced all year. An annual unit owner meeting is a good thing, if only to connect once a year with one’s neighbors. But in this day and age of electronic communication it is inadequate. Most or all board meetings should be open and announced with final board minutes regularly circulated. This has been asked for since 1997. But never done.

Better fiscal responsibility is needed here. Common bills may not be charged willy nilly to individual owners not responsible for them. Cost responsibilities are only as agreed, or as rules reasonably provide. Those responsible for bills must monitor them. Do not engineer third party payer problems.

Illegal profit venture wrapped in a fake common cost.

Defendants maliciously and willfully misbehaved to form an illegal profit venture masked by a common cost project solely for the personal gain of board insiders.

This violated condominium rules and NYS condominium laws that require boards to distinguish between individual and group cost responsibilities. A “purchase offer” was misused to defraud owners into believing that the board of the condominium was the property owner of an elevator shaft, as if the common element had been severed from the building, and as such was now the Sponsor of new real estate. It had not been. The board had undertaken none of the formalities and disclosures required by the condominium governing documents or condominium law to accomplish that. This misrepresentation fraudulently induced owners to purchase overpriced personal improvements, for which the condominium governing documents clearly made them solely responsible, in a board-created profit venture that was structured to the sole benefit of the individual defendants. This created a small, utterly economically irrational—and hence arbitrary and capricious—economic subsidy of shaft nonusers by shaft users—and a large and unjust transfer to Defendant One of roof real estate in common use, as well as of shaft real estate that was in multiple exclusive uses within the common element of the interior shaft. The roof and the shaft had nothing to do with one another and should not have been grouped. The grouping was apparently an effort to deceive naive board members into believing that this grouping made the matter a “common” one. The evidence will show that Defendant One engineered this fraud in collusion with his co-defendants and with hired gun “experts” that common funds were misused to retain, at common expense, to create the deceptive paperwork that purported to justify his significant thefts of real property, and to convert the condominium entity into a money laundry to alter owner cost responsibilities in violation of NY RPP §339-m and of the explicit terms of the condominium documents. All acts of this board were ultra vires in a number of respects including basic matters of non-election and violations of rules of order, number and quorum.

Property rights deconstructed in NYS. Another shoe drops in the road to serfdom.

New York State eliminates condominium property rights. Dismisses trespass and breach of duty to greenlight board self-dealing and theft in violation of express rules of governing documents and allocations of individual property rights.

Defendants contrived to steal old elevator shaft space (and common roof space) from their neighbors. Under an express bylaw their neighbors had the exclusive right of use of it and the right to enclose it into their units. The defendants knew this bylaw well.

This was trespass of what was in effect the plaintiffs’ property. The board had the fiduciary duty to seek their permission but used a fraudulent sales scheme to sneak around them. Individuals were simply using board power to self-deal.

A surprise “offer” was emailed to owners purporting to “sell” them shaft space. Plaintiffs were never told anything was first come first served—or, act now or forever hold your peace. The offer itself suggested that one might build in later at one’s own cost. So to the managing agent’s follow up sales call, plaintiffs demurred. After all, the condominium’s governing documents specifically provided that the space was exclusively theirs, should they want it. Board insiders then helped themselves to space set forth in the offer, that was “unsold,” within a stated 30 days. The sole purpose of the offer was to deceive plaintiffs out of their property. There was no common purpose.

The condominium’s governing documents specified plaintiffs’ exclusivity in that space. Plaintiffs therefore did not see that the “sales offer” was calculated to oust them, secretively and permanently.

Board members had hired a lawyer and various “experts” at common expense to rig themselves “bargain” prices to possess others’ real estate “in perpetuity.” In other words, to aid and abet theft.

Condominiums are not supposed to operate in this manner. Collective action is supposed to be open and transparent. Owners have equal rights of notice, informed consent, and vote. Ethical behavior is supposed to be strictly enforced. To sneak around the plaintiffs, failing to ask their permission for an adverse use, under these facts, was a breach of fiduciary duty.

The terms of the proposed contract were kept secret. Plaintiff asked to see a copy, but was told that it would not be shown to anyone who did not pre-agree to the price. Plaintiffs believed it to be a sale of overpriced construction. They were also led to believe that the board agreed that they could build in later at their own cost. So they let it pass. Later, plaintiffs noticed a subtle devaluation of “price” on their floor relative to others. This reflected an existing intrusion.

Before the offer was sent, Defendants One and Two had already been doing construction there.

This case is of significance as a rising form of securities fraud, openly marketed by attorneys as a board insider theft and self-dealing technique. Cf. “Gold Mines in the Halls” citing lawyer Aaron Shmulewitz urging boards to monetize common elements, NY Times.

Lawyer billings on the transaction show only 20 minutes spent on lengthy condominium documents. Instead attorney time is spent on generating complicated, duplicative, self-contradictory paperwork purporting to supersede condominium governing documents—the only owner protection owners will ever have. Board power is excessive. They divert common funds to hire “experts” to help them self-deal.

The structure and economics of the condominium was violated. This changed common interest shares.

Defendant One is a prominent litigation partner in a powerful NYC and global law firm. Defendant Two is a lawyer and real estate agent. Defendant Three was a building manager with the condominium’s building management firm. This was a sophisticated aggregation fraud.

Offering shaft construction to owners was never a common cost. Spaces were only “sold” and paid individually. Favored owners were allowed to bargain their prices down. Disfavored ones were not. It was a profit venture to sell construction to all condominium owners except Defendant One, at irrationally high prices which bore no relation to cost.

Under bylaw § 6.1 only common costs could be divided by common interest share. Instead the condominium board divided the venture’s profits by common interest share.

‘There were no proper board resolutions in place: (1) to insert all floor/ceilings into the shaft at common cost, without which the construction was grossly discriminatory; (2) to rent the roof to Defendant One “in perpetuity” for a grossly undermarket price; (3) to resell unit owners’ real estate to them charging some but not all “common interest shares” for that real estate; (4) that the condominium pay Defendant One’s roof construction costs (bulkhead demolition); (5) that others’ “prices” to use the shaft be charged based on that bulkhead demolition cost; (6) that Defendant One be entitled to pay only his cost while all other owners be charged around four times their cost; and (7) to share these profits, by common interest share.

To agree to any profit venture, including those at arm’s length, participants must contract. Not only with respect to profit sharing but with respect to the parties’ contributions—whether of cash or real estate. With full disclosure, no one would have agreed. People bought because they were ordered to by a faithless fiduciary and out of fear and intimidation. This was an abuse of what is now in New York State, grossly excessive board power.

Under § 2.2’s enumerated powers, the board had no power to lease a common element including under its residual powers; the matter was not “determinable” by it due to bylaw § 6.15.4.

Defendants One and Three were cronies. Defendant One was Defendant Three’s contracting client. At one point in the past, Defendant Three had had the condominium pay half of Defendant One’s costs (leak damage from opening the roof, broken toilet leak damage). Their relationship gave Defendant One undue influence over condominium funds Defendant Three controlled. Defendant Three had another conflict of interest, too. He was an employee of the condominium’s management company and wanted to do large construction.

As the “offer” made plain, there was no common project to insert floors. All the board ever did was sell construction, at enormous profit margins, to everyone individually with the exception of Defendant One, who was privileged to pay only his cost to confiscate common roof from everyone and then massively underpay for it on a fair market rental basis.

The condominium default assumption is that individual costs are the individual’s responsibility.

To convey the roof required unit owner vote. This, of course, was never obtained. The thieves twisted themselves in knots to avoid the scrutiny of a unit owner vote.

Defendant One now rents the roof without paying fair market value for it other than a fake “common interest charge”—obviously a deceptive mischaracterization of his “rents.” As he never paid a cent to rent for his continuous adverse (and exclusive) occupancy of the shaft since 1997, it is horrendously unjust to charge anyone else for it now, and to change all common interest shares. The contraption is a pure, selfish scam enabled by an abuse of fiduciary power.

Demand allocation issues in common elements can be solved with fees, e.g., limited parking spaces or basement storage slots, that can of course be booked as profits. But any legitimate fee charge would take the form of month to month—not lease “in-perpetuity.” These words, here, are clear evidence of malice. There was no common purpose to these acts, nor any economic rationality, whatsoever. There was only an intent to steal to privilege select individuals, discriminating unjustly against select others. The shaft is evenly divisible, so there was no need for any fee collections or profit venture.

This “offer” poses the same risks of aggregated fraud that caused FDR to regulate the securities industry heavily in the early 1930s. The keystones to preventing fraud and breach of trust in business transactions, are (1) legal duties of full disclosure of all material facts, and (2) strict enforcement, making fiduciaries who self-deal liable.

The condominium has not paid tax on its venture profits. This is tax fraud. The condominium deposited its profits to the capital, not to an income, account. This is accounting fraud—a grossly malstructured profit venture, masked by the fact that it was imposed by a board under the veil of a “common cost.”

Following the bylaw strictly meant that only owners adjacent to whose units a space was appurtenant were even eligible to ask for board approval of an exclusive enclosure.

To put board approvals up for sale poses an inherent conflict of interest, particularly coupled with rule violations that are intended to force full disclosure, and that affect the common cost sharing structure of the entity. Board approval is a fiduciary duty, not a salable “right.”

The board did not own the shaft, could not pose as its owner, and could not assign arbitrary “prices,” or “common interest share” charges for its use, particularly not as an act of intentional deceit.

Trespass and breach of fiduciary duty, at a high level, covered the case. Trespass invokes both statutory and condominium governance terms, all of which were ascertainable at trial. It was thus error to dismiss on summary judgment. “Each unit, together with its common interest, shall for all purposes constitute real property.” NY RPP. §339-g. There was a ripeness issue to trespass that could have been dealt with by a finding on the unreasonableness of repeated denials and delay to plaintiffs’ requests to enclose the space, that should have been determined at trial.

Exclusive means different things depending on context. A right of exclusive use of a space as if it were a part of one’s unit is in effect one’s “property.” An exclusive type of common use—like residential or commercial—refers to a priorized use of a common element that is in common use. Residential owners are still entitled to use an “exclusively” commercial common element that is in common use. Not all common elements are commonly used. Some are in exclusive use, meaning by only one. The bylaw reserved the space for one owner’s exclusive use, not for common use. In this usage commercial owners do not “own” real estate collectively.

This heavily factual case required a trial and could not be dismissed on summary judgment.

This was a vindictive, malicious theft. It was a conspiracy to benefit Defendant One enlisting the collusion of Defendants Two and Three. It was willful misbehavior.

These were sophisticated thieves—lawyers, a real estate agent, and a building manager, brazenly cheating people by lying to them in a severely ultra vires situation in which cronyism ruled, secrecy was paramount, elections were never held (so boards were rarely if ever elected), rules were never followed, budgets never issued, audits never done, quorums never observed, resolutions not properly recorded, owner email, board meetings and minutes were all closely held, and requests for basic information went unanswered.

Plaintiffs’ reward for respecting others, for following rules, and for whistleblowing, was only to be ripped off. Plaintiffs overthrew much of the board and eventually forced it to comply with a few rules. This case is a gross abdication of judicial responsibility to hold some truly bad actors accountable.

A comment on the GSEs

http://www.propublica.org/thetrade/item/why-the-sec-wont-hunt-big-dogs

Everyone has missed the point.

When invented, Fannie Mae seemed to legitimize the process of mortgage securitization. Later, Wall Street walked off with that process. In doing so it also walked off with Fannie’s exemption from the securities laws. It now was allowed to “compete” with Fannie. This really was not competition. It was a cartel, all members of which emulated a single business model, originated by the government.

Fannie was a national mortgage insurance program, meaning a government-run monopoly. Laudably, FDR intended it to prop up small banks and homeowners after the Depression by massively loosening the credit then available to homeowners. Wholly appropriate at the time. Back then, home mortgages typically required half down, and full payoff within 5 years. Then, in 1968, Fannie was “privatized” by LBJ in a cynical effort to get it off the government’s books to make room for the Great Society and Vietnam.  By 2006, Fannie was found to be trying to manipulate its earnings. The GSEs were now just market animals, emulating the rest of Wall Street. Simultaneously they took their role as government agencies seriously. Yet now, this dual role was conflict of interest. In evaluating the risks to the system at large, Fannie’s corrupt acts in 2006 were probably a self-preservative response to the building risks it saw in the system. Regulatory agencies such as SEC and CFTC were fully engaged with rote institutionally inherited chores. No forest seeking through obstructive trees going on there. Buck passing and bureaucratic games, as usual in large firms, held the priority.

The implications of Wall Street’s walking off with Fannie’s process seems to have gone unnoticed.

The government has a duty to ensure the integrity of the overall markets and regulate them appropriately. These are the securities laws. These laws beget others like the commodities laws, which are different enough from securities to have their own regulatory package. Are our government level regulators attentive and skilled enough today? Wall St. hasn’t much incentive to blow whistles on themselves, much less shoot their profits in the foot. Mortgage packaging was enterprise formation. Critically, it was not being done at arms’ length. The packager had no incentive to inspect the quality of the stuff in the package. It was just a flip. All risk could be offloaded, and fees simply collected. What a racket!

Fannie itself originally could package debt securities safely because at the time it was created it was a monopoly. Also, systemically, all of the risks of the 1930s were super low, given credit conditions then as compared to today. But the public at large is still on the hook. The privatization of the GSEs in the 1960s just turned the mortgage packaging monopoly into a cartel. This is very far from pure theoretical free markets under conditions of infinite competitive diffusion.

In copying Fannie’s business model, Wall Street’s derivatives products priced slightly higher to account for higher risk. What did this reflect? Fannie’s greater likelihood of government guarantee—its greater crony intimacy with its fellow Washingtonians. But as Wall St. has discovered in recent decades, crony intimacy with Washington can be replicated. By them.

How to get the rules right? And how to ensure that they are followed? Markets have to have rules. Right structure, competent government oversight and most important, enforcement of the rules, plus adequate disclosure and thus, informed consent in the making of contracts. These are the basics. The more detailed you get, the more your rules require tweaks to fit particular alternate circumstances. Our markets were set up to be suckers after the long sleepy ride with the Good Housekeeping Seal of approval of the GSEs. In reality there is a lot of fraud and junk everywhere, and it is not at all clear that government is keeping up with it in any respect whatsoever.

Regulation is to correct imperfect markets. But sometimes the cure can be worse than the disease. Cures have side effects, i.e., unintended consequences. Monopoly is the classic “imperfect market” that requires checks and balances, usually in the form of regulation. But regulation has its limits. It can work well in some situations, but not others, particularly if it tries to rig outcomes or there is too much of it.

Too much power generates abuse. Unfair trade practices are one example. Complicated law is also hard to enforce. Markets work in conditions of either liberty or constraint. Either way they need to have a stable backdrop of rules that don’t fluctuate wildly, because this changes outcomes unfairly—people expect to rely on rules that are broadly consistent and fair. America has a solid common law foundation, but also so much legal complexity that everything becomes hard. And expensive. Regulators are often behind the curve. They are hard to replace. Their replacements might not be better, they might be worse! In general, bureaucrats tend not to be big thinkers and not to be entrepreneurial. They don’t like change.  Even Brooksley Born could not trigger any change despite solid effort. Sometimes government works at cross purposes, or duplicatively, inefficiently or wastefully.

As a very young law associate in NYC, I was once tasked to explain for the CFTC, “What Is a Security?” I spent the summer of 1981 on it. The question was whether the new derivatives that Wall St was in the process of dreaming up (futures on options and vice versa) were securities.  Given the broad antifraud intent of the law as structured to deal with the issues raised by the Depression, I said they were, and that they needed large scale regulatory thought by the government.  I was told later by a junior partner of the firm that my interpretation had touched off a fight between the older partners and the younger ones eager to speed off to make big bucks on Wall St. It was a go-go period in the markets at the time, and the memo held plenty of wiggle room since deregulation was all the rage then.

You can’t very well try history and bad policy in retrospect, in courtrooms.  And you can only fix what’s broke when it breaks. The government took responsibility for the markets in the early 1930s, so it had to fix what went wrong with them that came to a peak in 2008. Wall St. copied the government model (of monopoly). Congress pretended to restore competition in 1968. But it was still a monopoly, just now in the form of a cartel. Congress seems to have lost adequate understanding of the larger meaning of the securities laws. Instead it just abandoned the task of regulating to newly cocked up “markets” that were in fact malstructured and in some cases improperly, even dangerously, rigged.  Wall St. might have behaved honorably and blown whistles on itself, but from its point of view, why should it? Rent-seeking, after all, is its middle name.

Where Republicans go very wrong is in thinking that mere declarations of a return to free markets is somehow self-executing. There Democrats have a point in directing a hate routine at them except that I don’t trust any of them to be anything other than Marxist-Leninists or self-appointed celebrities these days. You don’t have people in that party like Daniel Patrick Moynihan anymore. More likely you get the pattern seen in the collapse of the USSR—a handful of oligarchs running off with pieces of the government’s former exclusive business.

Where the few remaining sane and moderate Democrats go wrong is in thinking that for every perceived market failure, there is a new law that must be passed to correct it. All they are doing at this point is making a mess. To wit, Obamacare.

What really caused the financial crisis (Wall St walked off with securitization sans regulation)

The best way to get a handle on the causes of the financial crisis is to read two books, one a little hard for the lay reader, the other not at all—Gretchen Morgenson and Joshua Rosner’s Reckless Endangerment is a fun read; the Financial Crisis Inquiry Commission Report more of a slog—but still a barrel of monkeys for lawyers, accountants, and crisis aficionados. For a government report it is a veritable tour de force (if not as page-turning as The Starr Report).

Some in Washington want to pin blame for the financial crisis on “Fannie and Freddie.” To be sure, these State Owned Enterprises are a part of the story but it is grossly misleading to blame them, or laws like the Community Reinvestment Act, as the “cause” of the crisis. The FCIC Report found that the bad loans generated by these initiatives comprised an insignificant portion of all faulty loans, and that Fannie and Freddie’s loan standards, while joining the general lowering, were higher than the rest of the market. Fannie and Freddie are at the root of the crisis only in the broad, historical sense that we inherited them and the reality they reconstructed from the New Deal—not because during the 80s (Reagan) or the 90s (Clinton), as the partisans say, these companies ruined lending standards. In fact, Fannie and Freddie were the last gasp of holding lending standards up. Unless you believe in a purely literalist, fundamentalist sense that no government is the best government, and that this has been and always will be true at all times and in any and all circumstances, Fannie and Freddie were not the cause of the financial crisis—certainly not its proximate cause.

There is much to dislike about how Fannie and Freddie were run. As Reckless Endangerment recounts, in 2006 America discovered that Fannie was flagrantly violating the rules for public companies—having cooked the books and massaged their financials through the (no) good auspices of Goldman Sachs. Fannie’s richly paid CEO, Franklin Raines, seems not to have understood basics about how public companies are supposed to operate, putting in question the rationale for his massive executive comp. How could this be? By 2006, Fannie and Freddie had long been public companies. Originated as government programs, they just continued on as such, with all the lawlessness (l’etat, c’est moi!) inherent in all government action, particularly when government processes become disconnected from a commitment to the public good.

By definition a government program is not a business. It is a subsidy. Government programs do not function by market logic or subject to market discipline. They are the “nation.” They are backstopped by the taxpayer by simple legal pronouncement. Their liabilities are potentially a dangerous blank check.

Reckless Endangerment shows how Wall Street, in theory a market disciplined machine, gradually took on the essentially lawless character of Washington, especially its hardball political tactics. Wall Street proceeded to reform the securities laws to wipe out that aspect of its public utility function for the country that was interfering with their profit maximization. They had good cover, because the glut of banking, securities, commodities, and insurance laws and regs in fact did need significant updating—had for decades in light of the vast changes in finance, particularly its gargantuan aggregation (having evaded antitrust scrutiny during a period in which antitrust was unpopular), and most consequentially, computerization.

Like any good empirical scientist, Wall Street observed Fannie’s operations closely—and quietly replicated it. Yet Wall Street knew it was subject to the securities laws in all enterprise packaging operations. Wall Street is the world’s expert on the securities laws. Fannie, by contrast, as a government operation (yet now, confusingly, a “public company” that nevertheless did not operate as one), had not been. Fannie securitized but had forgotten why. Having been coded to do what it did, it just did it. Originally, to FDR, mortgage securitization was national insurance, a post-Depression development program set in place for the nation—for, and structured to be strictly limited to, small savers and homeowners. Limitation of its potential costs to the taxpayer was one reason for the stovepiping of all the laws, which formed subject matter boundaries around, in effect, business operations. This stovepiping would later become obsolete and confused, with large but hidden economic consequences.

Apart from unregulated securitization, Fannie’s process also revolved around political fixers and tactics to get whatever it wanted when it wanted it—hiring the best schmooze operators to grease wheels by hook or crook. Pure politics is Standard Operating Procedure for government bureaucracies. They survive in this way by nature, and one can’t really blame them for that—it’s the nature of the beast. The good will of government is supposed to take care of ethics. No market discipline is present, or required, in government.

The other component of this witches’ brew is that Congress today does not seem to take its job seriously as an intellectual matter. Its staffs are quite adroit at p.r., and word spinning, and general b.s., but complicated business and legal legislation requires a more sophisticated level of competence. Big banking is about as complicated as it gets, requiring expertise in many difficult areas of law. Complexity serves the banks’ (and lawyers’) purpose—that of obscurantism, and hours churned.

Yet legislators today are famous for not even reading the laws they advocate. They will not parse the creative sophistry a sentence may engender in the future, or a law’s potential for unintended consequences, or the interactive effects with other laws outside the categories of the one presently under discussion. Congress rarely if ever revisits a law after it is passed to assess its failures, its negative impacts, with an eye to revision. Their egos prevent them from ever admitting error of any kind. Congress focuses on “results” in the form of numbers of photo ops, the inspirational spin of the words in the press release describing each latest national legal panacea. It is a sort of “volume sales” approach to the law, ironically echoing the attitudes today of banks toward lending, or that of the police in 1960’s toward convictions (leading famously to ignoring drug kingpins while padding prosecution numbers with hordes of inconsequential street dealers). The media then lap up such press releases with little analysis or skepticism apart from tacking on what they today consider to be “selling” left-right narratives. More fodder for the daily copy grind.

Marketing was the true rocket-science fueling the “masters of the universe” over the last 20 years—that and computerization. What slogan pleases the ears of Republicans? Easy: “deregulation.” What pleases Democrats? “Housing for all.” Slam dunk. Wall Street rolled Washington with its favorite taglines and a fantastical promise of ever-expanding national wealth through securitization without end. A growth industry in financial innovation, with no limits! Wall Street profits seemed to validate the new, claimed reality. For politicians it was easy to believe the claim of the “rocket scientists” to have discovered the goose with golden eggs. Breathless paeans in the press to financial innovation and the magic of code glittered up Wall Street’s dog and pony show, probably adroitly manipulated by Wall Street’s p.r. efforts, since they have the cash to afford the best. Some individuals knew the truth, but they weren’t talking. The longer it all went on, the more money they’d make, in one form or another (legal fees, big shorts).

Wall St. is in fact a public utility. You can tell it’s a public utility just from the mass of regulations around it—a mind-blowing panoply of banking, securities, antitrust, housing, commodities, insurance and (even) gambling laws overseen by dozens of regulatory bureaus. The “regulators” almost never do anything cross-disciplinary or “systemic.” By definition what they do is bureaucratic and routine. If the regulatory alphabet soup were even asked to coordinate among themselves, they might have no time left over for their regular chores. Creative systemic oversight isn’t something it is even reasonable to expect of most bureaucrats.

As a public utility, what Wall Street does never strays far from what government says it’s supposed to do.

What this means is, if Wall Street is being evil, then government is necessarily complicit.

Deregulation had been botched early on. It was grossly irresponsible of Congress to pitch Fannie and Freddie into the private sector and let Wall Street just ape their processes without scrutinizing the precise economics. It was absurd for the government and the Fed to just blithely assume that Fannie and Freddie’s operations were honed by sound economics. (A mental error that too much study of pure theory such as the efficient market hypothesis can sometimes trick the literal-minded into.) Fannie and Freddie had never been in the market, and their operations had never been subjected to any market rationality or sustainability screens. Fannie and Freddie were never conceived as an investment bank to package and resell mortgage backed securities to begin with at all, but a national insurance pool to be run as a government monopoly. Fannie/Freddie’s actuarial risks had never been evaluated because the US simply stood behind them, come what may.  The taxpayer paid for this as a straight subsidy to the banks and to homeowners through the banks. And for the 1930’s, it worked beautifully: ordinary terms for mortgages improved tremendously for people as a result of this government subsidy: from 50% down and 5 years to pay in the 1930’s, to the 20% down and 15-30 years to pay of today. (See Raghuram Rajan, Fault Lines.) But no racket works forever.

With FDR’s subsidy, banks could grow very large. Banks also shifted their focus from evaluating loan quality in competition with other banks to generating maximum loan volume. For generations, the banks reaped huge financial benefits from the US government’s willingness to stand as ready buyer of all mortgage debt the banks could generate. But the system also bred a laxity that later would have grave consequences.

“Deregulation” as a slogan invited Wall Street to cheat Congress. Instead of wise, fully thought through regulatory reform, ideally involving massive simplification—blinded by the law’s very clutter—Congress and the regulators let Wall Street persuade them to “deregulate” the securities laws’ core—antifraud. This was accomplished less by any one legal smoking gun, but by indirection, a strategic progress by which key facts were at the right moment hidden, or masked, and dropped between stools. The arrangement of the stools itself had become obsolete, permitting a game of hide and seek by all manner of mischief-makers.