What the Mafia can teach us about corporate fraud

William K. Black - Professor of Economics and Law
Executive Director of the Institute for Fraud Prevention from 2005-2007 and author of The Best Way to Rob a Bank is to Own One.

From Slate’s The Big Money The Bust-Out
What the Mafia can teach us about corporate fraud.
By Mark Gimein
Posted Sunday, March 21, 2010

Excerpts:
On a rainy day in New York last week, a man named William Black stood in front of a roomful of fellow law professors trying to sum up in a minute what had gone wrong with financial regulation over the last two decades. Actually, Black didn’t have even a minute. His breathless spiel had (obviously as usual) already gone over its allotted period, leaving Black with just enough time to toss at his audience a number that encapsulated how slipshod and generally crazy-making federal efforts at dealing with fraud in the financial markets had become.

The number that Black practically shouted out was the grand total of mortgage and securities fraud related convictions the government had managed to secure in the wake of the financial crisis. It was zero. With that startling statistic Black sat down, politely if impatiently waited for the other panelists to finish their brief speeches, and immediately ran off to catch a flight back to Kansas City, trailing a half-open umbrella and a jumble of bags.

…..

The work of Bill Black—who spent a decade as a federal bank regulator—is about how bad economic theory has given people whose jobs should be understanding fraud a screwy sense of how fraud works in the real world. One way of seeing this, as Black describes in a terrific article, is to think about the mob “bust-out.”

The bust-out is what happens when the mob moves in to take control of a business that’s heavily indebted to a loan shark. As Black tells it, why the heck a mobster would ever want to take over a bar or liquor store in this way is incomprehensible to a classical economist. Why take over the business when you’re already getting every cent of profit and more in your weekly vig?

Except that in the real world, things don’t work that way, explains Black, a professor at the University of Missouri-Kansas City. The reason to take over the business is to loot it 1,000 ways to Sunday, from buying vast amounts of liquor on credit to, ultimately, torching the place for the insurance money. Prosecutors and mobsters know this. Economists who think the mob operates like a bank that happens to charge high interest rates miss it.

The problem here is that none of the ugly realities of how a business can be stripped of everything valuable make their way into the economic and regulatory theories that have been ascendant for the last two decades. How did we get to this point? Well, here’s a story: