Some fraud is inevitable, but Cook needs to come clean

The optimal amount of fraud in a system is not zero. I've been thinking about that as the drama surrounding Federal Reserve governor Lisa Cook has unfolded.

Before you get mad, let me explain that I'm not talking about the ideal amount of fraud, which is definitely zero. But cheaters abound in this vale of tears, and it's often cheaper to tolerate some small amount of grift than to make the maximum effort to stop all of it.

That's why your employer doesn't take every possible step to ensure that you're not taking office supplies home, and why most retailers (until recently) left goods on open shelves instead of putting the razors and Tide pods in locked display cases.

Similarly, banks don't want you to commit "occupancy fraud" — where you say you're going to live in a home to get a lower loan rate, though it's actually a vacation or investment property. People are more likely to default on investments or lake cabins than their primary homes. But it would be more effort than it's worth to ensure that everyone who says they're going to live in their new home actually intends to do so.

While technically this kind of lie is a federal felony, in practice individuals are rarely prosecuted, because that would take a lot of time that the bank and prosecutors could more profitably spend doing something else.

Which brings us to Cook, whom the Trump administration is accusing of having committed — or at least created the appearance of — occupancy fraud. The facts published so far raise some troubling questions.

A public records search by Reuters appears to confirm that on June 18, 2021, Cook obtained a mortgage from a Michigan credit union for a property in Washtenaw County, Michigan, which she said would be her primary residence. Two weeks later, she obtained a mortgage from a different credit union for a condo in Atlanta, which she also said would be her primary residence. Obviously, she could not live in two places at once.

Sometimes people buy a house they plan to live in, then unexpectedly have to move — a job loss, a transfer, a health crisis. That's not fraud — it's life happening. But given that these two loans closed in such a short time, that's hard to believe.

I suppose it's possible the banks knew about the other properties and didn't care. Or perhaps she (or her mortgage broker) accidentally checked the wrong box on one of the loan applications. But that would be a surprising mistake for a tenured professor of economics, much less a Fed governor.

Assuming she did engage in some chicanery, though, how outraged should we be? Occupancy fraud is perhaps 2% to 3% of loans. So you might well know, and even respect, someone who has committed it.

You can argue that a Fed governor has to be above reproach. But you can also argue that this is an almost victimless crime, and that the current investigation is a pretextual witch hunt that threatens the Fed's independence. I find that second argument convincing.

That might suggest turning a blind eye even if she did lie to her mortgage lender. The problem is that, though the optimal amount of fraud is not zero, the system can't afford to publicize that fact. We learned that lesson from the shoplifting debacle.

Retailers adopted hands-off policies that prevented employees from stopping thieves, which minimized employee injuries, legal liability and bad publicity from employee mistakes. That trade-off made sense as long as the public didn't realize just how much it could get away with.

When the internet taught us that brazen shoplifting was tolerated, those policies contributed to a shoplifting explosion.

I worry the Trump administration has put us, and Cook, in a similar bind. Protecting the Fed's independence is much more important to the health of the banking system than reducing a small amount of occupancy fraud.

But now that Trump has made it an issue, can we afford to say, "Well, occupancy fraud is really not a big deal"? That's a good way to ensure that occupancy fraud happens all the time.

Unless Cook explains why this wasn't occupancy fraud, we're left with two unpalatable choices: letting a public official get away with something the system can't afford to publicly condone, or letting Trump get away with something that no one can afford to publicly condone. The president appears to be using government agencies to settle political scores.

The only way out of that conundrum is for Cook to tell us why what looks like occupancy fraud was actually no such thing. So I sure hope she does, and soon.