Guest Author: Yves Smith is author of the best seller “Econned” and founder of Naked Capitalism.
Note: This is a repost of an Op Ed from January 30, with added Related Articles.
Photo of Phil Angelides, Chairman FCIC
From the very outset, the Financial Crisis Inquiry Commission was set up to fail. Its leadership, particularly its chairman, Phil Angelides, was seen as insufficiently experienced in sophisticated finance.
The timetable was unrealistic for a thorough investigation of a crisis this complex, let alone one international in scope. Its budget and staffing were too small. The investigations were further hampered by the requirement that subpoenas have bi-partisan approval along with Its decision to hold hearings with high profile individuals, including top Wall Street executives, before much in the way of lower-level investigation had been completed. The usual way to get meaningful disclosure from a top executive is to confront him with hard-to-defend material or actions; interrogations under bright lights, while a fun bit of theater, generally yield little in the absence of adequate prep.
So with expectations for the FCIC low, recent reports that the panel urged various prosecutors to launch criminal probes were a hopeful sign that the commission might nevertheless come out with some important findings. But correspondence from insiders in the last few days suggests otherwise. One, for instance, wrote, “I’m still in the process of getting the stink out of my clothes.”
These ideologically-neutral sources close to the investigation depict the commissioners as having pre-conceived narratives and of fitting various tidbits unearthed during the investigation into these frameworks, with the majority focusing more on the problems caused by deregulation and the failure of the authorities to use even the powers they had, while the minority assigns blame to government meddling, particularly housing-friendly policies.
These insiders see both sides as wrong, and want to encourage investigative reporters to challenge both the majority and dissenting accounts. They contend that both versions help perpetuate the myth that Wall Street was as much a victim of the crisis as anyone else.
One of these sources sent this document in an effort to question the notion that any of the reports coming out of the FCIC were the result of a fact-based investigative process, meaning operating in an objective manner, scouring information to see which theories or storylines seemed most consistent with what had been unearthed. As you will see, he makes clear that he regards all of the FCIC narratives as falling well short in explaining the crisis.
Now if we could only get Kurosawa to enter stage left and tell us what really happened…..
From a source close to the investigation:
Recently, I got started talking with a neighbor about ideologues in and around government. He had just read a book called Emerald City. He said it was about how we screwed up in Iraq by letting the ideologues run the post war show. The problem was that they had no “on the street” Iraqi experience. For them it was all theory and little practical experience. They were sure they were right and nothing could be said to change them. When things didn’t go according to plan, they just pretended it did or asserted events would turn their way shortly.
It occurred to me that we should be on the alert for this phenomenon when it comes to the three reports (one report and two dissents) to be released the Financial Crisis Inquiry Commission later this week. True to form, the reports start out with how many documents were reviewed and how many people interviewed. This sets us up to believe that the Commissioners relied on facts garnered from the documents and interviews in coming to their conclusions.
It would do Americans a lot of good to put this to the test. Did the Commissioners really use the facts to arrive at their conclusions or did they arrive at the conclusions first and are simply citing a selection of the facts to support their previously arrived at positions?
In fact, the majority will provide a history of financial crisis anecdotes and then try to fit the facts into its theory that the crisis was avoidable if only the financial sector took fewer risks and government was more competent. The dissents will do the same to support their theory that it was all government’s fault.
The problem is that the financial crisis was a real event. It didn’t happen in a theoretical model. It happened in real life and ruined the retirement savings of millions of Americans. Not only should we be skeptical of both the majority and the dissents, we should put them to the test to explain exactly how their theory explains the losses of hundreds of billions of dollars in the securities markets and trillions more in residential real estate. The question we should always keep in mind is for them to explain how abrupt catastrophic financial systemic failure happened. (Remember Secretary Paulson going to Congress kneeling before Nancy Pelosi and begging for three quarters of a billion [sic] dollars over the weekend.)
In a systemic failure there are always things that people do which in hindsight look imprudent: take on too much leverage, speculate instead of hedge, chase short term goals at the expense of long term security, panic, etc. If these things are offered up by the majority who says the crisis was avoidable, put them to the test. Which of the multitude of anecdotes were critical? If they can’t identify one or two critical factors, ask them specifically (anecdote by anecdote) whether the crisis would have occurred even if the anecdote in question didn’t occur. If they can’t tell you either, then really what they are saying is the crisis was a “perfect storm” of just the right mix of private sector greed and public sector incompetence coming together at the same time. In other words, what happened could not have been predicted and the crisis was not avoidable.
The ideologues in dissent have already started to sell a different theory. Some will try to say that the crisis was all due to affordable housing goals at the GSEs and the Community Reinvestment Act. This theory doesn’t hold true anywhere but in some right wing economist’s model. We should be able to assume that the GSEs did their best to pursue profits for their shareholders. That is, they didn’t intend to underwrite loans they knew would not be paid back. Nothing in the AHGs or CRA required them to underwrite bad mortgages. Indeed, those goals specifically were hedged so that they could be ignored if loans to satisfy them could not be made under terms which were economic.
The ideologues may say that underwriting bad mortgages by the GSEs resulted in an unsustainable increase in housing prices that all of a sudden collapsed (causing the financial crisis). But this would not (could not) have happened so widely and so quickly without other factors intervening. For example, how did the AHGs and CRA cause the rapid collapse of AIG, various monoline insurers, various investment banks, numerous money market funds or billions of dollars of losses in a huge number of mutual funds and pension funds none of which were subject either to the goals or CRA?
Catastrophic financial system collapse is not the result of largely unrelated anecdotes. There are too many firewalls in the system to allow it to happen. It has to be the result of one or more firewalls failing or something really big in the system going bad. What was there about the system that was big enough to cause systemic failure so quickly? What connects the two: the failure of the housing and securities markets?
Based on further discussions with individuals familiar with how the report was developed, the following shortcomings are evident:
The Commission was able to do comparatively little in the way of forensic work; the bulk of its effort was devoted to the hearings, which delivered relatively little in the way of new insight
As indicated above, the FCIC report is guilty of “drunk under the streetlight” behavior, of trying to fit its story to already known or easily found information. Even though the report makes extensive use of salacious extracts from e-mails, the insiders content that none of these information in these e-mails illuminates information critical to the crisis trajectory.
As a result, the report underplays or completely misses the real drivers of the crisis. Specifically, it gives short shrift to the obvious epicenters:
– How a previously benign securitization process allowed for the creation and sale of bad mortgages on a widespread basis
– How inadequate disclosure as alleged in a number of recently filed big lawsuits allowed mortgage backed bonds that contained many loans that fell below the underwriters’ promised standards to be sold to investors
– How a shadow banking system ballooned with products increasingly based on dubious financial instruments
– How CDOs that were devised by subprime shorts, most importantly the hedge fund Magnetar, drove the demand for the worst sort of subprime loans, extended the toxic phase of the subprime bubble well past its sell-by date
– How the dealer banks knowingly created toxic products, and via flawed risk management processes, allowed traders to retain significant portions of them via strategies that amounted to gaming of the banks’ bonus systems
Merely reading news releases of the last few weeks will show the shortcomings of the FCIC report. For instance, it skips over the role of the failure of the securitization industry to adhere to its own agreements, even though the FCIC was presented with this information last summer. It also is silent on the sort of abuses coming to light, such as the fact that Bear Stearns was allegedly double-dipping on its own deals, demanding that originators make extra cash payments on bad mortgages they had sold into pools that Bear was selling to investors, while failing to pass those payments on to investors (knowing that they instead would seek to have the bond insurers be the ones who would make investors whole).
Similarly, on the eve of the release of the FCIC report, the SEC, which astonishingly had declared disclosure on mortgage-backed securities to be “robust”, has done a quiet about face and has issued a new rule requiring issuers of asset backed securities to conduct a quality review and disclose to investors what that review consisted of. Note that this closing of a gaping loophole in disclosure has gone largely unnoticed.
The sad thing isn’t that the FCIC did not do its job. As we indicated earlier, that failure was by design. No one in the officialdom wants the mechanisms of the crisis to be exposed in full. It would compromise too many influential people and restoke well warranted public ire about the bailout of a miscreant financial services industry and its ongoing extractive behavior. Ironically, this core element of the dissent’s criticism is spot on, even if their own narrative suffers from precisely the same flaws. As FCIC commissioner Peter Walliston observes:
Like Congress and the Obama administration, the Commission’s majority erred in assuming that it knew the causes of the financial crisis…The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority’s report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority’s report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis…..
From the beginning, the Commission’s investigation was limited to validating the standard narrative about the financial crisis—that it was caused by deregulation or lack of regulation, weak risk management, predatory lending, unregulated derivatives, and greed on Wall Street. Other hypotheses were either never considered or were treated only superficially. In criticizing the Commission, this statement is not intended to criticize the staff, who worked diligently and effectively under difficult circumstances and did extraordinarily fine work in the limited areas they were directed to cover. The Commission’s failures were failures of management.
By having the FCIC validate widely accepted, superficial, and ultimately inadequate explanations of the crisis, the Obama administration continues in its policy of looking forward rather than back, when looking back is the foundation of any serious scientific, investigative, or prosecutorial process. The odds are high that the media and the public at large will mistake the extensive use of anecdote in the FCIC report for accuracy and completeness. As with so many accounts of the crisis, the artful use of detail will yet again have the effect of diverting attention from the true drivers of the crisis and thus leave Wall Street free to devise new ways to wreck the economy for fun and profit.
Wallison Revises History and His Own Positions by William K. Black
The Great Debate©: Wallison vs. Black on the FCIC by William K. Black
How Can the Architects of Crisis Investigate It? by William K. Black
Ian Fraser: Is the House of Lords’ Crisis Inquiry Putting the FCIC to Shame? by Yves Smith (at Naked Capitalism)
The FCIC, in Lockset with Officialdom, Refuses to Use the ‘C’ Word by Yves Smith (at Naked Capitalism)
FCIC Insider: I Can’t Believe They Suborned Brooksley Born by Yves Smith (at Naked Capitalism)