government, banks to blame for crisis_ fcic panel - marketwatch

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Opinion Journal: History of the financial

crisis

WSJ Europe editorial page editor Brian Carney responds

to the final report of the Financial Crisis Inquiry

Commission.

Jan. 27, 2011, 10:22 a.m. EST

Government, banks to blame for crisis: FCIC panelYears of deregulation and bank self-regulation cited for meltdown

By Ronald D. Orol, MarketWatch

WASHINGTON (MarketWatch) The financial and economic crisis that shook the economy to the brink in September 2008 was caused by

failures of 30 years of deregulation and a banking industry eager to trade in toxic subprime mortgages but blind to the attendant dangers,

according to the conclusions of a federal fact-finding panel released on Thursday.

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, according to the conclusions of a much-anticipated book released after a one-year

examination by the Financial Crisis Inquiry Commission.

Throughout the book, criticism focused on government, the banking industry and over-leveragedborrowers each receiving much of the blame for hardships and difficulties that continue to ripple

through the economy.

The book is being delivered to President Barack Obama and Congress and is scheduled to become

available on the commissions Web site and as a paperback and an e-book.

Much 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, achairman 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 banks collapse and

its acquisition by J.P. Morgan Chase & Co. (NYSE:JPM)

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.

Too big to manage

It repeatedly raised concerns that large financial institutions were too big to manage, pointing out examples of interviews with executives at Citigroup

Inc. (NYSE:C) 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 didnt know what the other part was doing.

In one such case, Susan Mills, a managing director in Citigroups 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 banks collateralized debt obligation desks 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 desks 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

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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 statutes 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. (NYSE:AIG) , 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 (NYSE:GS) 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 unknownin 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.

Once-mighty firms

The Financial Crisis Inquiry Commissions 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 (NYSE:MS) 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 (OBB:FNMA) and Freddie Mac (OBB:FMCC) also testified.

Partisan squabbles

The statute creating the panel sought to have the report completed by Dec. 15, but Democrats sought more time to complete it.

The panels 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 commissions Web site.


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government, banks to blame for crisis_ fcic panel - marketwatch

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