Photographer: Justin Sullivan/Getty Images
Photographer: Justin Sullivan/Getty Images

One of the great “mysteries” of the post-financial-crisis era is why there has been almost no prosecution of obvious criminality, particularly in the mortgage business. We have been told it is more complex than it appears; that the securitization process has made determining exactly who was harmed complicated; that this complexity makes convincing a jury a crapshoot.

All of these arguments fail to withstand even cursory scrutiny when it comes to foreclosure fraud. The robo-signing, document fabrication and mass perjury should have been fish in a barrel for even a newbie prosecutor. Why did the government fail to go after so many perpetrators of mass fraud?

A Justice Department inspector general’s report released this week raises that exact question. It found that: "DOJ did not uniformly ensure that mortgage fraud was prioritized at a level commensurate with its public statements" and that the Federal Bureau of Investigation "ranked mortgage fraud as the lowest ranked criminal threat in its lowest crime category."

A quick reminder: The high-speed, assembly line production of subprime mortgages led to a series of errors in the securitization of these mortgages. This was facilitated by an entity called MERS that facilitated the securitization process with very sketchy behavior (worthy of a column itself). The pressure to push these mortgages rapidly along led to lots of avoidable errors: Missing mortgage notes, bad or outdated information, error-riddled underwriting. Who actually owned the underlying note often was unknown.

As these poorly assembled subprime mortgage began to collapse, banks were faced with an expensive legal issue: How to process a huge number of foreclosures. Rather than perform this in a prudent and legal manner, some banks made the decision to take inexpensive -- and illegal -- shortcuts. They hired firms such as DocX LLC to fabricate documents for court. DocX even published a price list for documents they were for willing to artificially manufacture for trial.

What should have been a legal impossibility -- the wrong house being foreclosed upon because of sloppy errors -- happened far more often then was possible without fraud. The subsequent settlement for this fraud was an embarrassment.

This all took place during an era of limited legal enforcement for white-collar crimes. Prosecutions for financial felonies began falling under the George W. Bush administration, and kept right on doing so during the Barack Obama administration. At least we can't blame this governmental incompetency on partisanship.

I an unsure how much blame we can place on the news media, which has seen both good and bad financial reporting. Prize-winning investigative journalism was all too often offset by bank apologists. See the Baffler’s withering takedown on the silliness of claiming prosecutions were bad for the economy.

Then there was the big lie on foreclosure fraud: that these were merely incidental errors. The inspector general's report puts that nonsense to rest as well.

So why were there so few prosecutions? I have three theories:

1) Endowment Effect & Sunk Cost Fallacies: The TARP, ZIRP and FASB rule changes were not especially popular. The government under both Bush and Obama had spent trillions on these expensive bailouts. They effectively “owned” these politically, and prosecuting those who were bailed out would revisit those unpopular policies.

2) Economic Threat: As observed last year: “The greatest triumph of the banking industry wasn’t ATMs or even depositing a check via the camera of your mobile phone. It was convincing Treasury and Justice Department officials that prosecuting bankers for their crimes would destabilize the global economy.”

With trillions invested in bailing out the banks, the possibility of undoing that might have scared prosecutors out of their roles of enforcers of law, and into the dubious position of economic forecasters. It was a colossal failure of duty, and just plain dumb.

3) The wrong players in key roles: When Obama began his administration, he appointed experienced people to key economic roles. Unfortunately, their resumes included helping to create the financial crisis.

When hospitals identify a surgical error, they send a different team of doctors to repair it. Their job is to fix the damage, with no concern for career risk or reputation. Lawrence Summers and Timothy Geithner -- aka the status quo duo (See this and this) were simply too vested in the financial crisis to facilitate its clean up.

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In the end, we find a system that appears to have been hollowed out. The lack of respect for the rule of law threatens lasting damage to the republic. The exact long-term costs of this structural legal problem are unknown at this time. The failure to fix what is broken is simply a colossal failure of political will. However, we can observe that the virtual lack of prosecution of lawbreakers has left the citizenry disgruntled, and de-legitimized our democracy. The U.S. has been transformed into a corporatocracy.

Moral hazard has set the table for the next crisis, It promises to be unexpected, more difficult to manage, and terribly expensive. All of this could have been avoided throwing a few felons in jail.

To contact the writer of this article: Barry Ritholtz at britholtz3@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.