Posted on 27 Jan 2011
“Thirty years of deregulation” and a banking industry eager to trade in toxic subprime mortgages but blind to the attendant dangers were the cause of the financial and economic crisis that shook the economy to the brink back in September 2008, concluded federal fact-finding panel released today.
According to the conclusions of a much-anticipated book released after a one-year examination by the Financial Crisis Inquiry Commission, the captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public,”
Criticism focused on government, the banking industry and over-leveraged borrowers throughout the book. Each received much of the blame for hardships and difficulties that continue to ripple through the economy.
President Barack Obama and Congress are getting the book today, and it's scheduled to become available on the commission’s webite and as a paperback and an e-book.
A lot of the blame was heaped on the Federal Reserve, with a focus on both current Chairman Ben Bernanke and predecessor Alan Greenspan.
The report argues that the U.S. central bank failed to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. It also points out that the Securities and Exchange Commission failed in its responsibility at the time to require that big banks hold enough capital.
The SEC also allowed large financial institutions to become over-leveraged. Christopher Cox, a chairman of the SEC under President George W. Bush, said he was comfortable with the capital cushions at Bear Stearns in March 2008 — days before the troubled investment bank’s collapse and its acquisition by J.P. Morgan Chase & Co.
“More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Fed chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had stripped away key safeguards, which could have helped avoid catastrophe,” the report said.
The Financial Crisis Inquiry Commission also focused in its report on financial institutions, insisting they made, bought and sold mortgage securities they “never examined, did not care to examine, or knew to be defective.” It added that large financial institutions relied on “tens of billions of dollars of borrowing” that had to be renewed every night, “secured by subprime mortgage securities.”
It repeatedly raised concerns that large financial institutions were too big to manage, pointing out examples of interviews with executives at Citigroup Inc. and other major firms who were oblivious to risks.
In multiple examples, the book sought to demonstrate how there was a major failure of risk management at major institutions, noting that one part of a large financial institution didn’t know what the other part was doing.
In one such case, Susan Mills, a managing director in Citigroup’s securitization unit, noted rising mortgage defaults between 2005 and 2007 and in response the unit slowed down its purchase of loans for securitization, demanding higher-quality mortgages.
Meanwhile, Murray Barnes, a Citigroup risk officer, approved the bank’s collateralized debt obligation desk’s request to temporarily increase its limits on purchasing CDOs — a type of security composed of the riskier portions of mortgage-backed securities. The risk-management division also hiked the CDO desk’s limits for retaining senior tranches from $30 billion to $35 billion in the first half of 2007.
“What is most remarkable about the conflicting strategies employed by the securitization and CDO desks is that their respective risk officers attended the same weekly meetings,” the report said.
The panel blamed a wide variety of individuals, firms and companies, including both the George W. Bush administration and the Barack Obama administration for allowing lax lending standards to borrowers, troubling packaging and selling of subprime-backed mortgage securities, and risky investments on securities backed by the loans.
Blame was heaped on borrowers as well.
The Financial Crisis Inquiry Commission pointed out that mortgage debt per household rose more than 63% between 2001 and 2007 while earnings remained stagnant. “When the housing downturn hit, heavily indebted financial firms and families alike were walloped,” the report said.
Moreover, government-controlled mortgage giants Fannie Mae and Freddie Mac were “the kings of leverage.” Loans they owned and guaranteed were leveraged by a ratio of fully 75 to 1, the report said.
The Clinton administration also came under fire, for having approved the controversial Commodity Futures Modernization Act in December 2000. The statute, passed by a Republican-controlled Congress and signed into law by a Democratic president, was criticized by the panel for failing to adequately regulate the then-burgeoning market in credit default swaps, or CDS.
The panel described the statute’s approval as a key turning point “in the march toward the financial crisis.” CDS are insurance products for mortgage securities that contributed to the financial crisis and led to a $180 billion bailout of American International Group Inc. on the heels of the collapse of Lehman Brothers in September 2008, to keep the financial crisis from spiraling out of control.
The report argues that CDS were essential to the creation of synthetic Collateralized Debt Obligations — essentially bets on the performance of real mortgage securities. The study said synthetic CDOs “amplified” the losses from the collapse of the housing bubble, highlighting that Wall Street powerhouse Goldman Sachs packaged and sold $73 billion in synthetic CDOs from July 2004 to May 2007.
The report noted that AIG had not been required to put aside capital as reserves for the protection it was selling, which eventually led to the necessity of the bailout. “The existence of millions of derivatives contracts of all types between systemically important financial institutions — unseen and unknown in this unregulated market — added to uncertainty and escalated panic,” the report said.
The report also trained its focus on the role of the three main credit-rating agencies, arguing they were “key enablers” of the crisis because the mortgage securities at the heart of the meltdown could not have been sold without first getting their seal of approval.
The Financial Crisis Inquiry Commission’s book discusses how large and stable firms had deteriorated significantly during the height of crisis. It points out that Goldman Sachs borrowed $18.5 billion from two Federal Reserve liquidity facilities in September 2008 while Morgan Stanley did likewise for more than $67 billion from two government facilities.
In the course of its research and investigation, the commission reviewed millions of pages of documents, interviewed more than 700 witnesses, and held 19 days of public hearings in New York, Washington and other communities hit by the crisis. At the hearings, the panel heard from current and former top regulators, including Treasury Secretary Timothy Geithner and his predecessor, Henry Paulson, among others.
Leading witnesses included Chuck Prince, a former CEO of Citigroup, and Greenspan. Officials from top banks and government-controlled mortgage giants Fannie Mae and Freddie Mac also testified.
The statute creating the panel sought to have the report completed by Dec. 15, but Democrats sought more time to complete it.
The panel’s conclusions were beset by partisan squabbles. The final report was only approved by the six Democratic members of the ten-person panel.
The four Republicans last month released their own dissenting reports on the cause of the financial crisis.
Peter Wallison, a fellow at the American Enterprise Institute and a senior Treasury Department official in the Reagan administration, has argued the crisis was caused by low-quality and high-risk loans, engendered by government policies, failing in “unprecedented numbers.”
The dissenters focused their concerns on government policies, with Wallison pointing out that Fannie and Freddie played key roles because they had “acquired large numbers of subprime and other high-risk loans” to meet Department of Housing and Urban Development goals for promoting affordable housing.
In their Dec. 15 report, Wallison and other dissenters argued that the mortgage refinance giants, as public companies, contributed to the crisis by investing in and guaranteeing mortgages of “increasingly lower quality and higher risk to the taxpayer.”
Their report also argues that mortgage-related losses at big banks that were undercapitalized had a hand in the financial panic.
The dissenters’ report argues that Fannie and Freddie attracted private investors and increased their risky mortgage investments, in part, because shareholders understood the companies retained an implicit government guarantee. The two companies also were encouraged by both the Clinton and
Bush administrations to meet affordable housing goals, which also contributed to their embrace of riskier investments, the GOP report said.
The commission also released a massive package of data on Thursday it collected from the financial industry through requests and subpoenas. The data are available on the crisis commission’s Web site.