Looks perfect, I'll take it.

Photographer: Jeff Kowalsky/Bloomberg

Bank Appraiser Does Better as Whistle-Blower

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Here's a little story about water damage.

At the most recent inspection, water had damaged the flooring in the property at 1052 Sandwick Way. 

The floor had been damaged by an unknown water source permeating the subject property’s concrete slab foundation. It was not clear where water had come from or how the problem could be fixed. The source of the water or remediation of the problem could not be determined without invasive investigation. To address the problem, one would have to open the slab and inspect the exposed plumbing first. After repairs were accomplished the slab would then have to be re-poured. If there was leaking plumbing in the slab, or if the slab was defective, or if the water barrier material below the slab was defective, it is conceivable that complete demolition and rebuilding of the dwelling would be the only way to effectively remediate the water problem. 

Relator had been informed by homeowner that multiple houses in the development suffered similar water damage, and other homeowners had filed a class action lawsuit against the builder. 

Per management’s direction, Relator listed a $6000 cost to cure figure for replacement of damaged floors and was subsequently instructed to use the $6 thousand figure as a condition adjustment in the sales comparison approach to value.

Relator -- that is, Robert Madsen, then a real estate appraiser who worked at LandSafe, a subsidiary of Bank of America -- disagreed. Or, I mean, he did it, but he later said that he disagreed:

In this circumstance, logic dictates the appraised value of the property should have been obviously and clearly conditioned on the hypothesis that the source of the water had been found and that work to repair the floor and prevent future problems had already taken place. Such a hypothesis needs to be marked clearly on the Freddie Mac Form 70/Fannie Mae 1004 URAR and the impact that hypothesis had on the opinion of value clearly stated. 

And: 

For example, on the Sandwick Way property, the use of a cost to cure adjustment (based on cost of replacement of the flooring material only) fails to take into account the repair costs of preventing the water from intruding in the first place. Such intrusion could have vastly different sources, and its remediation could vary greatly in price and difficulty. The analysis of “just replace the flooring” fails to address the root cause of the damage and fails to properly address market response to the deficiency.

I know this is boring, but in my defense it is heavily abridged; in the original, this story of water damage stretches to 16 numbered paragraphs (249 to 264) over three and a half pages. And it's not the only one. Madsen tells several stories of water damage, and other stories of rodent infestation, roof bowing, mold issues, rotted decks, missing closet doors, and a swimming pool that "was lifting out of the ground" and therefore created "a significant trip and fall risk." I count 14 stories in all, from 2010 and 2011, though I assume they are meant to be exemplary rather than comprehensive. In any case, it is a fascinatingly boring document. 

The document, of course, is Madsen's lawsuit against Bank of America for mortgage fraud. Each of these defects that he found was, in Madsen's telling, covered up by his bosses so that Bank of America could keep issuing mortgages and keep the mortgage machine running, at the expense of deceived federal mortgage guarantors. Madsen styled himself "Relator," rather than the less hoity-toity "Plaintiff," because he didn't just sue Bank of America on his own behalf. He sued on behalf of the United States of America, and the United States won. And so did he:

Mr. Madsen said federal prosecutors would pay him $56 million, out of the $16.65 billion Bank of America agreed to pay in August to settle claims arising from the investigation into the bank’s mortgage lending and mortgage securitization business. The specific terms of Mr. Madsen’s settlement with the federal government remain sealed.

In an interview on Thursday, Mr. Madsen said he could not talk to many people about his behind-the-scenes cooperation with federal prosecutors, which involved turning over thousands of pages of documents and sitting for many interviews with an agent for the Federal Bureau of Investigation.

Imagine being an FBI agent! "OK now tell me about bowing at the roof ridgeline on the garage at Bonny Knoll Road."   I wonder if they teach you that at Quantico. 

Anyway $56 million for 14 water damaged houses! That's a cool $4 million per house. Buys a lot of slab re-pouring. DealBook has more stories of whistle-blowers getting great gobs of money out of the Bank of America settlements -- some $170 million to four whistle-blowers, out of Bank of America's vast $16.65 billion mortgage settlement from August.

It is possible to overdo the talk of incentives in banking compensation, but, I mean, that's quite an incentive. Appraising some homes properly will get you, let's say, fired by your crooked bosses.   Appraising those homes improperly will get you, let's say, a nice bonus. But appraising them improperly and then calling the FBI will get you a whopping great $56 million.

Is it too obvious and cynical to point out the optimal course of conduct here, from a strictly personal-financial perspective? (That is: Sign up to do bad stuff. Do bad stuff. Call the FBI. Profit.) A weird fact is that Madsen's stories are all from 2010 and 2011, after the financial crisis, when everyone at least had an inkling about the misdeeds in the mortgage market (especially at Countrywide, now a part of Bank of America), and their financial impact. If you were looking for a lucrative place to blow a whistle in 2010, mortgage underwriting at Bank of America would be at the very top of the list.

But that is probably too cynical. The Bank of America whistle-blowers got paid a lot, sure, but they couldn't have expected that going in -- these are historically high whistle-blower payments -- and the whole process is random and time-consuming and just sort of a pain.  You'd have to be quite a diabolical genius to go to work doing bad things just to one day reap the whistle-blowing rewards.

The more plausible effect on incentives is a good one: If you want to commit evil at your banking job, you now know that your co-conspirators have big incentives to rat you out. And they have incentives to do things -- like preserving evidence and explicitly memorializing misconduct -- that make prosecution of your evildoing easier. So your best bet is just not to commit evil in the first place. Eight-digit whistle-blower payments are detrimental to honor among thieves.

But this, too, might be overstated. Here is a Wall Street Journal story about the prosecutor who found a $37 billion memo. Here's how he did that:

Assistant U.S. Attorney Richard Elias was leafing through a pile of J.P. Morgan Chase & Co. documents while tending to his newborn son in 2012 when he found something that came back to haunt the three largest U.S. banks.

In a memo, one J.P. Morgan employee warned her bosses they were putting bad loans into securities being created before the financial crisis hit.

And this inspired other prosecutors to leaf through other piles of documents to find other incriminating things. Like: 

In a 2007 email, a Bank of America trader complained about efforts to add low-quality loans to one deal. Traders faced risk if problems erupted with the underlying loans. “Like a fat kid in dodgeball, these need to stay on the sidelines,” the trader wrote.

And those memos and e-mails led to almost $37 billion in mortgage settlements, including $13 billion from JPMorgan. It is surely an overstatement to say that the banks paid $37 billion for putting bad words in e-mails, but there's a certain truth to it. That "fat kid in dodgeball" quote is immortal, but Bank of America didn't actually securitize those fat-kid mortgages. The quote is famous because it sounds bad, not because it reveals wrongdoing. It prevented wrongdoing.

One lesson -- which we learn every day in this modern world of ours -- is that people will always write dumb things in e-mail and memos and chat rooms and really any other venue for writing and preserving things, and that no amount of warning or risk or deterrence can stop them. So the prospect of being narc'ed on by a whistle-blower looking for a $56 million payday seems unlikely to deter people from doing or saying or permanently recording dumb or evil things. Though it will make them easier to catch.

But the main impression I get from these stories is just the contingency of all of this, the pointillism of the national reckoning with the financial crisis. The way the mortgage settlements were built was on a water-damaged garage here, a decaying swimming pool there, a dumb phrase in an e-mail over there. The bad anecdotes accreted into a bad story, but never quite into a systematic summing up of what happened. And the banks paid vast arbitrary gobs of money to make the bad stories go away. And then somewhat less vast, though perhaps even more arbitrary, gobs of money will be handed out to the real estate appraisers and operations executives who provide the anecdotes. 

  1. Though I also assume that he sometimes appraised houses that were fine?

  2. That's paragraph 267.

  3. See paragraphs 243 to 245 of Madsen's complaint for his story of worrying about being fired. 

  4. As DealBook puts it, "Mr. Madsen’s cooperation is particularly interesting because the misconduct he cites in his lawsuit occurred mostly after the financial crisis -- he worked at LandSafe from 2007 to early 2013 -- and is not directly tied to sale of mortgage-backed bonds." The other big whistle-blowers seem to be mostly pre-crisis, and while the BofA settlement is itself mostly pre-crisis-focused, there are some bits relating to post-crisis conduct, including things like scamming the Federal Housing Authority.

  5. "It’s not a fun and pleasant experience," says Madsen, though presumably he's talking about the period before he got his eight-figure check. And "I did not go into this with the mindset that I would get some money," though, again, presumably he's talking about the period before he filed a qui tam action seeking a share of the money that the government collected.

    A more basic point. If you are a whistle-blower you are necessarily out of step with everyone around you. Everyone else thinks stuff is fine, and you're like, "No no stuff is illegal." So you go to the government for action and your reward. But in expectation, you are wrong and everyone else is right. (That's always true: If everyone disagrees with you, it is probable -- not certain! -- that you are wrong.) So the probability is that you won't get any money, and everyone will laugh at you. Some people in this situation are right, but some people win the lottery too.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net