Report: Financial Crisis Could Have Been Avoided

While the riots in Egypt dominate the news flow, one of the most important reports on the financial crisis is slipping through the cracks. Earlier this week, the US Financial Crisis Inquiry Commission released their final report, following the review of millions of documents, interviews with more than 700 witnesses, in addition to 19 days of public hearings. However, the conclusions are exactly the same as the Econotwist’s and many others have figured out a long time ago – the point of origin is not to be found amongst greedy bankers, compulsive-gambling-derivative-traders with unpredictable computer systems and faulty risk calculation formulas – because the policy makers and regulators knew all along perfectly well what was going on. Yet, they did nothing.

“The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again.”

Phil Angelides


The report by the Financial Crisis Inquiry Commission was handed over to US president Barack Obama last Monday. “Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done. If we accept this notion, it will happen again”  Chairman of the Commission, Phil Angelides, says in a formal statement.

The Commission’s main concluded is that the global financial crisis could have been avoided, and points out the following reasons to why we now are experiencing one of the worst economic crisis’ ever:

1. Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages.

2. Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk.

3. An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis.

4. Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw.

5. And systemic breaches in accountability and ethics at all levels.

I should, however, also be pointed out that not everyone in the Commission stands by the report.

These statements of dissent have been published along with the report:

Dissent Joined by Keith Hennessey, Douglas Holtz-Eakin, and Bill Thomas

Dissent by Peter J. Wallison

The FCI Commission concludes that the collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.

Over-the-counter derivatives contributed significantly to this crisis, and the failures of credit rating agencies were essential cogs in the wheel of financial destruction.

The Commission have also examined the role of government sponsored enterprises (GSEs), with Fannie Mae serving as the case study.

The Commission have found that the GSEs contributed to the crisis but were not a primary cause.

They had a deeply flawed business model and suffered from many of the same failures of corporate governance and risk management seen in other financial firms but ultimately followed rather than led Wall Street and other lenders in purchasing subprime and other risky mortgages.

According to the Inquiry commission, this is the reasons for the whole bloody mess:

“We conclude this financial crisis was avoidable”

“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. Theirs was a big miss, not a stumble. While the business cycle cannot be repealed, a crisis of this magnitude need not have occurred. To paraphrase Shakespeare, the fault lies not in the stars, but in us.”

“Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The tragedy was that they were ignored or discounted. There was an explosion in risky subprime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red flags. Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner. The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards.”

“The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. What else could one expect on a highway where there were neither speed limits nor neatly painted lines?”

“We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets”

“The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves. 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. This approach had opened up gaps in oversight of critical areas with trillions of dollars at risk, such as the shadow banking system and over-the-counter derivatives markets. In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor.”

“The Securities and Exchange Commission could have required more capital and halted risky practices at the big investment banks. It did not. The Federal Reserve Bank of New York and other regulators could have clamped down on Citigroup’s excesses in the run-up to the crisis. They did not. Policy makers and regulators could have stopped the runaway mortgage securitization train. They did not.”

“Yet we do not accept the view that regulators lacked the power to protect the financial system. They had ample power in many arenas and they chose not to use it. To give just three examples: the Securities and Exchange Commission could have required more capital and halted risky practices at the big investment banks. It did not. The Federal Reserve Bank of New York and other regulators could have clamped down on Citigroup’s excesses in the run-up to the crisis. They did not. Policy makers and regulators could have stopped the runaway mortgage securitization train. They did not.”

“We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis”

“There was a view that instincts for self-preservation inside major financial firms would shield them from fatal risk-taking without the need for a steady regulatory hand, which, the firms argued, would stifle innovation. Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding. In many respects, this reflected a fundamental change in these institutions, particularly the large investment banks and bank holding companies, which focused their activities increasingly on risky trading activities that produced hefty profits. They took on enormous exposures in acquiring and supporting subprime lenders and creating, packaging, repackaging, and selling trillions of dollars in mortgage-related securities, including synthetic financial products. Like Icarus, they never feared flying ever closer to the sun.”

And for the conclusive remarks:

“The Commission’s statutory instructions set out 22 specific topics for inquiry and called for the examination of the collapse of major financial institutions that failed or would have failed if not for exceptional assistance from the government. This report fulfills that mandate. In addition, The Commission was instructed to refer to the attorney general of the United States and any appropriate state attorney general any person that the Commission found may have violated the laws of the United States in relation to the crisis. Where the Commission found such potential violations, it referred those matters to the appropriate authorities.”

 

But don’t think for a second that this is over. The healing process have just begun.

And – as I also have been emphasizing – it could take many years.

Now, back to Europe.

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Copy of the report: “CONCLUSIONS OF THE FINANCIAL CRISIS INQUIRY COMMISSION”

Copy of press release.

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