Thursday, January 27, 2011

Financial Crisis Inquiry Commission report

by Bill McBride on 1/27/2011 01:05:00 PM

Here is the Financial Crisis Inquiry Commission report

Here are the conclusions.

• We conclude this financial crisis was avoidable. ...

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. ... 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.
This is absolutely correct. In 2005 I was calling regulators and I was told they were very concerned - and several people told me confidentially that the political appointees were blocking all efforts to tighten standards - and one person told me "Greenspan is throwing his body in front of all efforts to tighten standards".

The dissenting views that discount this willful lack of regulation are absurd and an embarrassment for the authors.
• 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 selfcorrecting nature of the markets and the ability of financial institutions to effectively police themselves. ...

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. In case after case after case, regulators continued to rate the institutions they oversaw as safe and sound even in the face of mounting troubles, often downgrading them just before their collapse. And where regulators lacked authority, they could have sought it. Too often, they lacked the political will—in a political and ideological environment that constrained it—as well as the fortitude to critically challenge the institutions and the entire system they were entrusted to oversee.
This is a key finding and absolutely correct.
• We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. ...

• We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis. ...

• We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets. ...

• We conclude there was a systemic breakdown in accountability and ethics. ... For example, our examination found, according to one measure, that the percentage of borrowers who defaulted on their mortgages within just a matter of months after taking a loan nearly doubled from the summer of 2006 to late 2007. This data indicates they likely took out mortgages that they never had the capacity or intention to pay. You will read about mortgage brokers who were paid “yield spread premiums” by lenders to put borrowers into higher-cost loans so they would get bigger fees, often never disclosed to borrowers. The report catalogues the rising incidence of mortgage fraud, which flourished in an environment of collapsing lending standards and lax regulation. ...

• We conclude collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis. ... Many mortgage lenders set the bar so low that lenders simply took eager borrowers’ qualifications on faith, often with a willful disregard for a borrower’s ability to pay. ... These trends were not secret. As irresponsible lending, including predatory and fraudulent practices, became more prevalent, the Federal Reserve and other regulators and authorities heard warnings from many quarters. Yet the Federal Reserve neglected its mission “to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.” ...

• We conclude over-the-counter derivatives contributed significantly to this crisis. ...

• We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly. In some cases, they were obligated to use them, or regulatory capital standards were hinged on them. This crisis could not have happened without the rating agencies.
My view is the keys to the crisis are 1) the willful lack of regulators to do their jobs, combined with 2) the rapid "innovation" in the mortgage market, especially the agency problems associated with the originate-to-distribute model. I'm just starting to read the report, but just based on the conclusions, this report deserves praise.

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