When you think of the financial crisis of 2007-2008, you probably recall the financial ruin caused by Wall Street, with banking executives (often criminally) mismanaging investments, causing profound damage to the economy that continues today. Ordinary people around the world struggled to survive the “Great Recession” and the effects that followed. But you might not know that taxpayers were hurt twice over: once by the direct effects of the economic downturn, and again by the damage to federal, state, and local government funds.
Many mortgages or loans are insured by the federal government, even though they are issued by private banks. If the borrower can’t pay, the government steps in to make sure the lender gets its money back. Sometimes, those banks conduct shoddy underwriting or lie about the ability of the borrower to repay the loan, and the government ends up paying for high-risk, low-quality loans it shouldn’t have insured. In addition, government pension plans often invest in financial instruments established by private banks. When the bank lies about the quality of those instruments, the value of the government’s investment decreases. In both of these cases, the government loses money—money that comes from taxpayers like you.
Types of Financial Fraud
Financial fraud comes in so many forms that it would be impossible to list them all in one place. After all, whenever the government pays a significant amount of money, fraudsters are likely to appear. However, the following categories have led to high-profile enforcement actions in recent years:
- Fraudulent loan underwriting. In the wake of the 2007-2008 financial crisis, it was revealed that banks across the country had lied to the government about the underwriting practices for their mortgages, inducing the government to issue insurance policies for thousands of ineligible loans. When the borrowers defaulted, the government was left on the hook for these inordinately risky loans. Whistleblower lawsuits have led to billions of dollars in recoveries against banks engaging in these practices.In 2017, Allied Home Mortgage Corp. was ordered to pay $296 million after a jury found it engaged in this type of fraud. Similarly, in 2018, an accounting firm agreed to pay $149.5 million to resolve allegations that it looked the other way while conducting audits of a mortgage lender that fraudulently collected federal insurance payments for ineligible loans.
- Fraudulent investment instruments. Federal, state, and local retirement funds often invest in securities. These government investors rely on the seller’s assurances that the securities are of sufficient quality and do not carry too high a risk. However, financial firms will sometimes lie about the quality of their securities, causing the government to invest in instruments it otherwise would not have. For example, in 2019, California settled with Morgan Stanley for $150 million to resolve allegations that the bank fraudulently sold low-quality mortgage-backed securities to two state retirement systems.In other situations, financial institutions will issue financial instruments that fraudulently misrepresent key data, resulting in investors paying more or earning a lower investment than they should. 42 state Attorneys General collectively recovered over $420 million in settlements related to this type of misconduct.
- Student loan/financial aid fraud. Federal financial aid provides a boon to schools, which use the funds to enroll more students. However, these schools must abide by strict rules to remain eligible for this aid. For instance, the University of Phoenix paid $67.5 million to resolve allegations that it paid admissions counselors incentive-based compensation tied to the number of students recruited, which is illegal.Federal student loans are administered by private lenders, which also must act honestly in their dealings with the government. In 2010, four student aid lenders paid nearly $58 million after the government alleged they created billing systems that allowed them to receive improperly inflated interest rate subsidies from the Department of Education.