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Tuesday, February 1, 2011

Financial Crisis Commission Points to Various Causes: But Have We Learned Anything?

In January, 2011, the Financial Crisis Commission announced its findings. The usual suspects are not much of a surprise; what is particularly notable is how little had changed on Wall Street since the crisis in September of 2008. According to the New York Times, "The report examined the risky mortgage loans that helped build the housing bubble; the packaging of those loans into exotic securities that were sold to investors; and the heedless placement of giant bets on those investments." In spite of the Financial Reform Act of 2010 and the panel's report, the New York Times reports that "little on Wall Street has changed." One commissioner, Byron S. Georgiou, a Nevada lawyer, said the financial system was “not really very different” today from before the crisis. “In fact, the concentration of financial assets in the largest commercial and investment banks is really significantly higher today than it was in the run-up to the crisis, as a result of the evisceration of some of the institutions, and the consolidation and merger of others into larger institutions,” he said. Richard Baker, the president of the Managed Funds Association, told the Financial Times, "The most recent financial crisis was caused by institutions that didn't know how to adequately manage risk and were over-leveraged. And I worry that if there is another crisis, it will be because the same institutions have failed to learn from the mistakes of the past." From the testimonies of managers of some of those institutions, one might surmise that the lack of learning has been due to a refusal to admit to even a partial role in the 2008 crisis.  In other words, there appears to be a crisis of mentality, which is not easily fixed.

To comprehend the danger in the continuance of the status quo, it is helpful to digest the panel's findings. The crisis commission found "a bias toward deregulation by government officials, and mismanagement by financiers who failed to perceive the risks." This ought to raise a red flag when we hear politicians urge more deregulation.  "Don't they get it?" one might reasonably conclude. Lest it be thought that the panel proffered a pro-government verdict, however, the commission also concluded that "Fannie and Freddie had loosened underwriting standards, bought and guaranteed riskier loans and increased their purchases of mortgage-backed securities because they were fearful of losing more market share to Wall Street competitors." These two organizations were not really market participants, however, as they were guaranteed by the U.S. Government. That government-backed corporations would act so much like private competitive firms undercuts the assumed civic mission that premises government-underwriting. In other words, the government-backed entities were neither civic as from government nor effective as private companies. In other words, government-established "firms" can behave like the private companies they were intended to check, yet this does not mean that more de-regulation is the solution.
Lehman was a particularly inept player leading up to the crisis.     Zambio

In terms of the private sector, The New York Times reports that the panel "offered new evidence that officials at Citigroup and Merrill Lynch had portrayed mortgage-related investments to investors as being safer than they really were. It noted — Goldman’s denials to the contrary — that 'Goldman has been criticized — and sued — for selling its subprime mortgage securities to clients while simultaneously betting against those securities.'”  The bank's proprietary net short position can not be justified by simply market-making as a counter-party to its clients, Blankfein's congressional testimony notwithstanding. Relatedly, the panel also pointed to problems in executive compensation at the banks. For example, Stanley O’Neal, chief executive of Merrill Lynch, a bank which failed in the crisis, told the commission about a “dawning awareness” through September 2007 that mortgage securities had been causing disastrous losses at the firm; in spite of his incompetence, he walked away weeks later with a severance package worth $161.5 million. The panel might have gone on to point to the historically relatively huge difference between CEO and lower-level manager compensation and questioned the relative merit, but such a conclusion would go beyond the commission's mission to explain the financial crisis.

In terms of the government, The New York Times reports that the panel "showed that the Fed and the Treasury Department had been plunged into uncertainty and hesitation after Bear Stearns was sold to JPMorgan Chase in March 2008, which contributed to a series of “inconsistent” bailout-related decisions later that year." The Federal Reserve was clearly the steward of lending standards in this country,” said one commissioner, John W. Thompson, a technology executive. “They chose not to act.” Furthermore, Sabeth Siddique, a top Fed regulator, described how his 2005 warnings about the surge in “irresponsible loans” had prompted an “ideological turf war” within the Fed — and resistance from bankers who had accused him of “denying the American dream” to potential home borrowers. That is to say, the Federal Reserve, a corporation wholly owned by the U.S. Government, is too beholden to bankers instead of the common good. So we are back to the issue of a government-guaranteed corporation acting like or on behalf of private companies (and badly at that).


Sam Jones, "Hedge Funds Rebuke Goldman," Financial Times, January 28, 2011, p. 18.