FDL Special Book Salon Welcomes Byron Georgiou, The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States
[As a courtesy to our guests, please keep comments to the FCIC's report. Please take other conversations to a previous thread. - bev]
The Financial Crisis Inquiry Commission was created to look into the causes of the Great Crash of 2008, what happened, how it happened and why it happened. The six Democrats on the FCIC signed off on the majority report, and the four Republicans produced dissents. We welcome Byron Georgiou, a member of the FCIC who signed the Final Report. A brief biography is here.
The preface sets out the conclusions reached by the Majority. The main body contains a detailed history of the events that led to the Great Crash, supported by excerpts from testimony and fascinating details. It is a great story, but the Majority recognizes that it is much more than that, it has had tragic consequences for millions of our fellow Americans and for people around the world.
The Majority says that the leading cause of the disaster was the collapse of housing bubble, which led to a string of failures of financial institutions, exacerbated by derivatives including synthetic CDOs. The increasing losses suffered by financial institutions with massive exposure to the residential mortgage markets culminated in the failure of Lehman Brothers.
The conclusions are sharply drawn:
1. We conclude this financial crisis was avoidable.
2. We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets.
3. We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.
4. We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis.
5. We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets.
6. We conclude there was a systemic breakdown in accountability and ethics.
7. We conclude collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.
8. We conclude over-the-counter derivatives contributed significantly to this crisis.
9. We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction.
The Final Report rejects three other possible causes. There was excess liquidity, but that did not cause the disaster. Properly used, it offered the possibility of economic expansion and growth. This is a heavy indictment of Wall Street, which claims that its role in the economy is to allocate capital to its highest and best use.
Fannie Mae and Freddie Mac contributed to the problem, but they were not a cause. Their loans held value much better than loans made by their private competitors. The Final Report concludes that government affordable housing policies, such as the Community Reinvestment Act, were not a significant factor:
Research indicates only 6% of high-cost loans—a proxy for subprime loans—had any connection to the law. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law.
P. 27 (references are to the .pdf page, not the pages in the Final Report.) Each regulator and every part of the financing business gets its share of the blame for the Great Crash. And it isn’t just mistakes, the Final Report asserts directly that intentional acts were an important part of the disaster. Among those are mortgage fraud and securities fraud.
Here are the Final Report’s discussions of some of the matters we have covered here at FDL.
Timothy Geithner. In May 2005, Geithner’s New York Fed was criticized for its supervision of Citigroup in a review conducted by other Federal Reserve banks. The on-site staff wasted time did poorly, and resources were inadequate. The next peer review in 2009 reached the same conclusions. That contrasts with the supervisory reports of the Office of the Comptroller of the Currency, which criticize Citi for its inadequate risk management, especially in management of its CDO portfolio. Geithner admitted that the NY Fed did not do enough to control Citi. (P. 331).
Jim Wikinson. Wilkinson was Treasury Secretary Henry Paulson’s chief of staff. He sent this to public affairs officer Michelle Davis: “We need to talk….I just can’t stomach us bailing out lehman….Will be horrible in the press don’t u think.” [Sic].
Alan Greenspan. In written testimony, Greenspan said that no regulator could ever have foreseen the crash in the housing market. “History tells us [regulators] cannot identify the timing of a crisis, or anticipate exactly where it will be located or how large the losses and spillovers will be.” P. 31. Among the many failures traced to Greenspan’s Fed, this one stands out: the Fed did not begin routinely examining subprime subsidiaries for predatory practices until Greenspan left the Fed. P. 123.
Ben Bernanke. At several places in the Final Report, the Fed Chair admits to missing the housing bubble. For example, in the Spring of 2006, Bernanke saw a “correction” in the price of housing, and thought the goal of the Federal Open Market Committee should be to make sure that it didn’t affect the rest of the economy. P. 242.
Abacus. These are the synthetic CDOs issued by Goldman Sachs. There is a thorough discussion of these beginning at p. 170.
CDOs. The Final Report provides a detailed look at one CDO, CMLTI 2006-NC2, beginning on p. 99. This deal centered on 4,499 subprime mortgages generated by New Century Financial, which eventually collapsed into bankruptcy amidst allegations of fraud. The CDO had 19 tranches. Turn to page 144 to see the investors, which include an investment fund in China, US and foreign banks, other CDOs, hedge funds, asset managers and even 3 retail investors. By September 2010, 1,917 of the loans were in foreclosure, 579 were seriously past due, and 729 had started loan modifications. P. 430.
Moody’s. Moody’s rated the CMLTI CDO. One of its models assumed that home prices would increase at about 4% per year, and put little weight on the possibility of a decline. P. 148. Moody’s was paid $208,000.
Synthetic CDOs. One of the tranches of the CMLTI CDO, sold for $12 million, was referenced in at least three synthetic CDOs, enabling people to bet on the performance of the fund. P. 173.
Anthony Mozilo. “Even after Countrywide nearly failed, buckling under a mortgage portfolio with loans that its co-founder and CEO Angelo Mozilo once called “toxic,” [p. 48] Mozilo would describe his 40-year-old company to the Commission as having helped 25 million people buy homes and prevented social unrest by extending loans to minorities, historically the victims of discrimination….” P. 133.
Obama. The Majority does not mention the President. The Dissent complains that Dodd-Frank, the bill that tried to mend the disrepair in the regulatory structure, was “unnecessary” and seriously overreaching, and “will almost certainly have a major adverse effect on economic growth and job creation in the United States during the balance of this decade.” P. 561.
The Final Report and the evidence the Commission gathered will be a valuable tool for researchers and for civil and criminal cases.
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