Commission: three reasons why the financial crisis happened

The Financial Crisis Inquiry Commission hearings have produced one moment of drama and a few theories from regulators and bankers about why the meltdown happened.

Pablo Martinez Monsivais/AP
Goldman Sachs chairman Lloyd Blankfein (far left) testifes on Capitol Hill in Washington before the Financial Crisis Inquiry Commission.

Through two days of hearings the Financial Crisis Inquiry Commission has not produced much dramatic confrontation.

True, panel chairman Phil Angelides, a Democrat and former California state treasurer, got into it a bit with Goldman Sachs chief Lloyd Blankfein on Wednesday. They tangled over why Goldman sold bundles of bad mortgages, then turned around and bet its own money that the value of those bundles would fall.

But on the whole the 10 member commission, established by Congress, has methodically interviewed bankers and regulators alike, trying to establish a public record as to why the Great Financial Meltdown of fall 2008 occurred.

Given this restraint, the panel may not turn into a rerun of the Pecora Commission. That long-running inquiry, begun in the early 1930s and named for chief investigator Ferdinand Pecora, was really a Senate investigation. It probed the beginnings of the Great Depression at a time when ordinary Americans were suffering and angry.

How the Senate probed the Great Depression

Pecora investigators armed with subpoena powers bore down on Wall Street titans like a gathering storm, reconstructing deals and exposing practices that were shady, or just surprising. Under Pecora’s questioning, J. P. Morgan Jr. admitted that he had paid no income taxes in 1931 and 1932. Pecora discovered that the Morgan bank had a “preferred list” of VIPs who were allowed to buy into stock offerings at deeply discounted prices.

The Pecora panel’s work was followed by the establishment of the Securities and Exchange Commission, the separation of commercial and investment banking via the Glass-Steagall Act, and other New Deal moves to rein in Wall Street power.

In contrast, today’s Financial Crisis Inquiry Commission is beginning its work after the Obama administration has proposed some new financial system regulations.

Establishing an official record of what happened to cause the 2008 meltdown is all well and good, says Paul Light, a professor of public service at New York University and an expert on government practices.

But Light wonders what will happen to the panel’s report when it is written. Will it have a shelf life? Will it become the basis for some new legislative reforms?

“I don’t see it happening,” he says.

Bankers and regulators admit failures

Still, the financial commission’s two days of public hearings have produced a number of interesting admissions from bankers and regulators, and theories as to why what happened, happened.

Among them:

1. Everybody thought gravity had been suspended. Both bankers and regulators touched on the fact that the financial system as a whole did not consider that it was possible housing prices could decline. Banks did not think about this when weighing the risk of housing-related investments, for instance.

“Somehow, we just missed, you know, that home prices don’t go up forever,” said Jamie Dimon, chief executive of J.P. Morgan Chase.

2. The deal was the thing. Regulators Sheila Bair, head of the Federal Deposit Insurance Corporation, and Mary Schapiro, chief of the Securities and Exchange Commission, both testified on Thursday that financial firms had become too used to self-regulation, and that they increasingly saw the generation of financial transactions as their economic role in life.

“The excesses of the last decade represented a costly diversion of resources from other sectors of the economy,” said Bair.

3. Nobody knew anything. The SEC and other regulators have long seen as one of their primary missions the protection of average individual investors from avaricious professionals. But as Wednesday’s exchange between chairman Angelides and Goldman’s Blankfein showed, sometimes even the savvy big guys were clueless about the risks they were taking.

Blankfein defended Goldman’s sale of bundles of sour mortgages by saying that the buyers knew what they were getting into.

“These are professional investors who want this exposure,” said Blankfein.

Given the subsequent collapse in housing prices, and the cratering of the value of those bundled mortgages, perhaps those professional investors should think about other lines of work.


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