Two years in the making, the report of the government’s Financial Crisis Inquiry Commission—officially known as the Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States—is 631 fact-filled, surprisingly well-written pages long. You should read it, but let’s be honest—you probably won’t. Besides—we read it so you don’t have to. Following are the report’s conclusions about the causes of the financial crisis, and they are worth reading—unless, of course, you want it to happen again.
01. THE FINANCIAL CRISIS DIDN’T HAVE TO HAPPEN.
Fed chair Ben Bernanke told the Commission that a “perfect storm” had occurred that regulators could never have anticipated. Alan Greenspan, the Fed chairman during the two decades leading up to the crash, told the Commission that it was beyond the ability of regulators to foresee such a bursting bubble. “History tells us [that 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.” But the committee concluded that regulators “could have seen this coming,” and plenty of economic prognosticators predicted what Bernanke and Greenspan did not. Why weren’t they listened to?
02. ASLEEP-AT-THE-WHEEL FINANCIAL REGULATORS AND SUPERVISORS THREATENED THE STABILITY OF THE FINANCIAL SYSTEM.
“The sentries were not at their posts,” the report concludes, largely because of widespread confidence that markets self-regulate and financial institutions police themselves. The report blasts “Alan Greenspan and others”—Bernanke and Larry Summers, two advocates of deregulation who happened to work with the Administration at the time of the report’s writing, go unmentioned. To be fair, deregulation was heavily promoted by the financial industry, which spent $2.7 billion on lobbying and $1 billion in campaign contributions during the decade before the fall of 2008.
03. CORPORATE GOVERNANCE AND RISK MANAGEMENT AT FINANCIAL INSTITUTIONS FAILED.
The report takes aim at “stunning instances of governance breakdowns and irresponsibility,” such as when Citigroup CEO Charles Prince told the Commission that a $40 billion stake in mortgage-backed securities “would not in any way have excited my attention.” Other institutions faulted: AIG, Bear Sterns, Fannie Mae, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley. Part of the problem, the report says, came from “poorly executed” mergers and acquisitions that confused management. In other words, firms that advise other companies on M & A—for massive fees—couldn’t keep their own mergers and acquisitions in order.
04. FAILURES IN CORPORATE GOVERNANCE LED TO “EXCESSIVE BORROWING, RISKY INVESTMENTS AND LACK OF TRANSPARENCY.”
The report emphasizes how absurdly leveraged the banks were; at the not-uncommon debt-to-capital ratio of 40:1, “less than a 3-percent drop in asset values could wipe out a firm.” Moreover, the extent of that leverage was hidden in “a shadow banking system,” riddled with complicated financial instruments such as derivatives and off-balance-sheet entities so confusing, the bank heads themselves didn’t always understand them. The worst perpetrators: Fannie Mae and Freddie Mac, whose combined leverage ratio, including loans they owned and guaranteed, stood at 75:1.
05. THE GOVERNMENT WASN’T PREPARED FOR THE CRISIS, AND ITS INITIAL CLUMSY REACTIONS EXACERBATED THE SITUATION.
The Treasury, the Fed and the Federal Reserve Bank of New York—our most vital and powerful financial regulatory bodies—were “ill prepared for the events of 2007 and 2008,” and when the crisis erupted, responded “on an ad hoc basis … to put fingers in the dike.” The government didn’t have a plan to contain what was happening because it didn’t understand what was happening. Specifically, government officials knew that a housing bubble was possible, but never realized how systemic and disastrous the consequences of it bursting would be.
06. A LACK OF ETHICS AND ACCOUNTABILITY IN THE FINANCIAL INDUSTRY HELPED SPARK THE CRISIS.
The structural integrity of the financial system and the American economy depends on a different kind of integrity, the Commission argued—“fair dealing, responsibility and transparency.” But the financial industry had grown rotten. “From the ground level to the corporate suites,” from mortgage brokers to chief executives, “an erosion of standards and responsibility exacerbated the financial crisis.” While it would be simplistic to blame “mortal flaws like greed and hubris,” the financial system failed to factor “human weakness” into its calculations, and the results were catastrophic. The Commission put “special responsibility” on public financial leaders, regulators and financial industry chief executives: “These individuals sought and accepted positions of significant responsibility and obligation. Tone at the top does matter, and, in this instance, we were let down.”
07. PLUNGING MORTGAGELENDING STANDARDS AND THE MORTGAGE SECURITIZATION “PIPELINE” WERE REALLY DUMB IDEAS.
The Commission puts it more delicately—those phenomena “spread the flame of contagion and crisis”—but the point is clear: “Toxic mortgages from neighborhoods across America” were transported “to investors around the globe.” The report describes a pyramid scheme that would have made Bernie Madoff proud: “Each step in the mortgage securitization pipeline depended on the next step to keep demand going.” Speculators, mortgage brokers, lenders, financial firms—“they all believed they could off-load their risks on a moment’s notice to the next person in line.” No one in the whole crazy process “had enough skin in the game.”
08. OVER-THE-COUNTER DERIVATIVES? ALSO REALLY DUMB.
Think acronyms: OTC, CDS, CDO—which led to a crisis at AIG. Both on the page and in the financial system, those acronyms obscure what they stand for, and in the end, “the existence of millions of derivatives contracts of all types between systemically important financial institutions—unseen and unknown in this unregulated market—added to uncertainty and escalated panic.”
09. THANKS BUT NO THANKS, CREDIT RATING AGENCIES.
Moody’s comes in for particular scrutiny from the Commission, but none of the big three credit rating agencies (including Standard & Poor’s and Fitch) did their jobs. Instead, they suffered from “flawed computer models … pressure from financial firms that paid for the ratings … the relentless drive for market share …” and so on. The agencies were complicit in the mortgage madness, and the financial crisis couldn’t have happened without them.
10. IT’S PRETTY MUCH THE FAULT OF BIG GOVERNMENT.
That’s according to the dissenting conclusion from the Commission’s Republicans, who write, “the U.S. government’s housing policies were the major contributor to the financial crisis of 2008. These policies fostered the development of a massive housing bubble between 1997 and 2007 … The losses associated with these [government-supported] weak and high-risk loans caused either the real or apparent weakness of the major financial institutions around the world.”