By Adam Shell and Paul Davidson
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| Financial Crisis Inquiry Commission Vice Chairman Bill Thomas, left, and Chairman Phil Angelides. |
A congressionally appointed panel reported Thursday that the financial crisis that set off the Great Recession was avoidable, casting a wide net of blame over regulators and financial giants alike.
The report — the government's first comprehensive review of what caused the crisis — offers a detailed and compellingly written narrative of an epic financial tailspin. It also raises an unavoidable question: More than two years after the financial crisis and more than six months after Congress passed sweeping financial reform, is it relevant?
Some say its impact will be muted because it was not supported by Republican members of the Financial Crisis Inquiry Commission. Others say much of the ground it covers was hashed out in previous hearings or reports.
The report is flawed, critics say. After more than a year of analysis costing $10 million, the 10-member Financial Crisis Inquiry Commission could not agree fully on the factors behind the crisis, issuing three different versions of the story told along partisan lines.
"The impact is diminished by the political nature of the report," says Arthur Levitt, former Securities and Exchange Commission chief. "The fact it had a divided authorship is never very constructive."
Yet, Ed Mierzwinski of U.S. PIRG, a consumer group, says the report vindicates the financial-regulatory reforms passed by Congress last year. Wall Street firms are trying to delay or weaken some of the rules, saying it will harm U.S. competitiveness. "The main takeaway is, don't let Wall Street roll back Wall Street reform," he said. It "should be implemented as quickly and strongly as possible."
Majority findings:
"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," the nearly 600-page report says.
As a result of the crisis, the nation fell into the deepest economic slump in 70 years, sending millions into unemployment and costing taxpayers trillions.
The financial crisis was fueled by low interest rates and a booming housing market. As the subprime mortgage market boomed, so did demand for packages of risky mortgage-backed securities. Lenders eagerly made high-risk, subprime loans and sold them into the burgeoning mortgage-backed securities market. When the housing bubble burst, the value of mortgage-backed securities tumbled, taking down some of the nation's biggest financial firms: Bear Stearns, Fannie Mae, Freddie Mac, Countrywide Financial andLehman Bros., among others.
The FCIC's analysis included a review of millions of pages of documents, interviews with more than 700 witnesses and 19 days of public hearings in parts of the country that were hard hit by the crisis.
The committee's final report, approved by the six Democratic commissioners, said the crisis was evident long before Lehman Bros. fell in September 2008.
The report says industry and government players at every layer of the financial system saw brightly flashing warning signs at every turn but chose to ignore or downplay them. The commission singles out the Federal Reserve as "the one entity" that could have stemmed the flow of toxic mortgages but failed to do so.
Although the Federal Reserve held hearings on predatory mortgages as early as 2000, it failed to follow through on proposals to require lenders to verify that borrowers could repay their mortgages.
"We want to encourage the growth in the subprime lending market," Fed GovernorEdward Gramlich said in early 2004.
Fed General Counsel Scott Alvarez told the commission: "There was concern that if you put a broad rule, you would stop things that were not unfair and deceptive." Ultimately, the Fed toughened its rules in 2002 but only modestly.
Mortgage lenders were aware of the dangers. In 2004 and 2005, Countrywide Financial CEO Angelo Mozilo e-mailed senior managers that subprime loans could bring "financial and reputational catastrophe" to the company. But that didn't stop Countrywide.
Financial giants, meanwhile, were snapping up the loans and packaging them into securities, despite the risks, to keep pace with rivals. "A decision was made that we're going to have to hold our nose and start buying the stated product if we want to stay in business," Citigroup banker Richard Bowen told the commission.
American International Group, which sold investors derivatives known as credit default swaps — insurance in case the mortgage securities defaulted — was similarly worried about impending doom. Former AIG CEO Maurice Greenberg told the commission that when the firm lost its AAA rating for the swaps in spring 2005, "it would have been logical for AIG to have exited or reduced its business." Instead, the company issued another $36 billion in credit default swaps.
Government-backed mortgage giant Fannie Mae was on a mission to perk up profits. As early as 2005, Thomas Lund, Fannie's head of single-family lending, told colleagues that risk had "accelerated dramatically." Yet, the firm widened its exposure to risky mortgages to compete.
The commission, in fact, concluded that Fannie Mae and Freddie Mac "followed rather than led Wall Street" and so were not a "primary cause" of the crisis. That contradicts the view of some economists and Republican lawmakers who blame the giants, which bought the lion's share of mortgages and were placed in a federal conservatorship in 2008.
The report also spotlights credit-rating agencies, "essential cogs in the wheels of financial destruction," as they awarded high ratings to securities that they barely investigated. The rub: Moody's was paid by the very companies it assigned ratings for. After Moody's went public in 2000, it went "from (a culture) resembling a university academic department to one which values revenue at all costs," said Eric Kolchinsky, a former managing director.
The report says lax regulation had been longstanding. "More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve 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.
Major dissent:
In a Thursday press conference via phone, commission Vice Chairman Bill Thomas, a former congressman and one of the three Republican dissenters, railed at what he called the politically driven "bumper sticker" type explanation for the cause of the crisis stated in the Democrat-dominated majority's report findings. Thomas also said the viewpoints of the commission's Republican members were downplayed in the final report.
The Republican trio argue that the Democrats' conclusion places too great an emphasis on missteps made by U.S. regulators and bankers, and ignores the global nature of the economic crisis.
That group of dissenters, which includes Keith Hennessey and Douglas Holtz-Eakin, two senior economic advisers to former president George W. Bush, places most of the blame on a global credit crisis caused in large part from a glut of savings from China and other countries that found their way to the U.S., resulting in record low interest rates. Those low borrowing costs helped inflate real estate bubbles in the U.S. and Europe. Singling out lax regulations in U.S. markets doesn't tell the whole story, they argue, since Europe suffered similar economic problems despite more stringent regulations than here in the U.S.
"By focusing too narrowly on U.S. regulatory policy and supervision, ignoring international parallels, emphasizing only arguments for greater regulation, failing to prioritize the causes, and failing to distinguish sufficiently between causes and effects, the majority's report is unbalanced and leads to incorrect conclusions about what caused the crisis," the three dissenters concluded in their report.
The second view comes from the other GOP panel member, Peter Wallison of theAmerican Enterprise Institute. He argues that the government policy to increase homeownership in the U.S. resulted in less stringent mortgage underwriting standards and some 27 million risky subprime loans that set the housing market up for a fall once the real estate bubble began to deflate. Had the government not embarked on this policy, "the great financial crisis of 2008 would not have occurred," Wallison argued in his written dissent.
Too little, too late?
Critics of the committee's work say that it uncovered little new ground and offered no policy changes to thwart another meltdown. "The fact that it doesn't cover new ground means its impact will be negligible," says Levitt, now a consultant for the Carlyle Group.
"A lot of good books have dissected these factors and causes," says Robert Pozen, author of The Fund Industry – How Your Money is Managed. "The real question is, what do we do from here." Currently, many aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed last year, have yet to be finalized with regulators. Congress has yet to tackle reform of mortgage giants Freddie Mac and Fannie Mae. "It doesn't take a brilliant scientist to realize that the biggest area not touched is home mortgages," Pozen says.
But the panel was formed to investigate causes of the crisis, not recommend solutions, the majority says in the report. It was also instructed to report evidence of criminal wrongdoing to the appropriate authorities. Chairman Phil Angelides said Thursday that the commission passed along names to the authorities but would not say how many people were cited.
