Post-mortem: the official autopsy on the financial market meltdown is now in the hands of a Washington commission. And its work has only just begun.
And so it went, as a panel of appointed non-politicians probed the origins of the 2008 financial market crisis. It was not the sort of grilling you might have seen from members of Congress, feverishly worried about the votes of profoundly irritated constituents who--if they haven't lost their jobs or homes--definitely know people who have.
A few blocks away, the White House wasn't missing the political importance of the event that day. President Obama's press secretary, commenting on the impending testimony from several of the country's top bankers, told reporters that "an apology would be the least we expect" as well as "common sense on how they're paid."
The hearing took place less than a month before a U.S. Senate race in Massachusetts would shake conventional political thinking in Washington. The surprise victory of a Republican for the so-called "Kennedy seat," perceived as an expression of the personal financial agony of a still-Recession-stricken public, precipitated a White House strategy change that threatened to make life a lot tougher for the financial world. And it has brought into sharp focus financial reform efforts sought by the Obama administration and by congressional Democrats.
Last year, with the global economy lying in tatters, Congress did what Congress does best: It appointed a commission to study the problem. Last year, with the global economy lying in tatters, Congress did what Congress does best: It appointed a commission to study the problem. The Financial Crisis Inquiry Commission (FCIC) was charged with examining the causes of the financial meltdown, as well as the collapse of major financial institutions that failed, or would likely have failed, had the American taxpayer not come to the rescue.
The bipartisan commission is led by Phil Angelides, a Democrat from California; and by former House Ways and Means Committee Chairman Bill Thomas, a Republican from California. Other panelists include Brooksley Born, an attorney and former head of the Commodity Futures Trading Commission (CFTC); Byron Georgiou, a former California official and a legal force on behalf of defrauded investors at Enron Corporation, WorldCom, Dynegy Inc., AOL Time Warner Inc. and UnitedHealth Group Inc.; Democrat Robert Graham, former chairman of the Senate Select Committee on Intelligence; Keith Hennessey, former economic adviser to President George W. Bush; Douglas Holtz-Eakin, former director of the Congressional Budget Office; Heather Murren, former managing director of global securities research and economics at Merrill Lynch; John W. Thompson, Symantec Corporation chairman of the board of directors; and Peter Wallison, former White House counsel under President Ronald Reagan and now with the American Enterprise Institute.
As of Jan. 13 of this year, Chairman Angelides noted, "26 million Americans are unemployed or can't find full-time work, or have given up even looking for jobs. Over 2 million families have lost their homes to foreclosure in the last three years. Millions more ... fear they will. Retirement accounts and life saving have been swept away--vanished--like some day-trade gone bad."
The leading financial players who were called to account agreed: Mistakes were made, money was loaned too easily and without traditional safeguards, and there were too many real estate investments--all of which led to a cascade of risks that spiked unemployment and fore-closures, leading ultimately to the worst downturn since the Great Depression.
Raising their hands to swear an oath and testifying for three hours: Lloyd C. Blankfein, chairman of the board and chief executive officer (CEO) of Goldman Sachs Group Inc., New York; James Dimon, chairman of the board and CEO of JPMorgan Chase & Co., New York; John J. Mack, chairman of the board of Morgan Stanley, New York; and Brian T. Moynihan, CEO and president of Bank of America Corporation, Charlotte, North Carolina.
Ordinarily, a hearing room populated with that kind of financial star power would be crackling with the current of lobbyists meeting staffers and lobbyists meeting lobbyists. But on this day, energy was barely perceptible in the standing-room-only main hearing room of the Longworth House Office Building, replete with its neoclassical revival architectural style of high ceilings, decorative stars and eagles, and big chandeliers. Indeed, it was not unusual to catch members of the well-dressed audience with their eyes shut, heads involuntarily jerking forward as sleep stole over them.
And it must be noted that overshadowing this hearing--and most other news of the day--was the massively deadly earthquake that had shaken Haiti the night before.
"I think as we conduct these hearings and talk about the problems that were encountered and how close we came to a catastrophe, that right now in Haiti, by one of those acts of God, there is an enormous catastrophe," noted Bill Thomas, who, although retired from politics, as former Ways and Means Committee Chairman seemed to be almost alone in the room in understanding the importance of trying to make this event relevant to the biggest news of the day.
Of the financial executives marshaled for the hearing, the Goldman Sachs CEO faced the sharpest questioning. After all, it was Goldman Sachs that not only escaped the annihilation that took down Bear Stearns and Lehman Brothers, but also was compensated 100 percent on the dollar by American International Group Inc. (AIG) on its mortgage hedge, courtesy of the government's bailout.
Chairman Angelides assured the bankers that they would be called upon more than once for answers as the commission moved toward a consensus. The former treasurer of the state of California from 1999 to 2007, who lost a bid for governor to Arnold Schwarzenegger, Angelides harkened back repeatedly to this question, first posed to Goldman Sachs CEO Blankfein.
"In September 2004," Angelides asked, "the FBI's [Federal Bureau of Investigation's] head of the criminal division warned that mortgage fraud was so rampant in this country that it was a potential 'epidemic,' and that, if unchecked, it would result in a crisis as big as the S&L [savings-and-loan] crisis. Did you take any specific steps in the wake of that 2004 crisis to evaluate the mortgages that you were selling into the marketplace?"
Blankfein told the commission that, although he considered the Goldman Sachs review process "robust," looking back, there probably was too much mortgage-related risk. "Knowing now what happened, whatever we did, whatever the standards of the time were, it didn't work out well," he said.
But, Blankfein went on, risks taken then seemed con textually appropriate: "After 10 benign years, in the context [of] where we were--look, how would you look at the risk of a hurricane?"
As Blankfein pursued his explanation of insurance rates in the context of the unpredictability of hurricanes, an irritated Angelides noted that hurricanes were "acts of God." "These," he chided, referring to the bad loans and miscalculations that brought on financial disaster in 2008, "were acts of men."
With Blankfein sputtering, "I'm just saying ...," Angelides noted solemnly, "These were controllable, is my only observation."
"Clearly, we are much less leveraged now. Consequently, I wish we were much less leveraged then, "Blankfein answered, earlier having told Angelides that "when you look at the leverage of companies, and people are throwing out 30 to 1, or 40 to 1, our high watermark was actually a fraction of that. It was about 20--which was kind of small."
With risky mortgages believed by many to be at the center of the storm, Angelides wanted Blankfein to explain how Goldman Sachs could have sold bundles of these high-risk mortgage-backed securities (MBS) to investors, while at the same time shorting--or betting against--them.
"What we do is risk management," Blankfein explained. "Because we had this risk, because we were accumulating positions--which, by the way, we acquired from clients who want to sell them to us--we have to go out ourselves and provide and source the other side of the transactions so that we can manage our risk. These are all exercises in risk management," he said.
"Well," Angelides shot back, "I'm just going to be blunt with you. It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars. It just--it doesn't seem to me that that's a practice that inspires confidence in the markets."
Bank of America President and CEO Moynihan acknowledged that it may well take a long time to rebuild public confidence. "Over the course of the crisis," he testified, "we, as an industry, caused a lot of damage. Never has it been clearer how the poor business judgments we have made affected Main Street."
Dimon, JPMorgan Chase CEO, agreed that the giants of the banking world wreaked global financial havoc, telling the panel, "No institution, including our own, should be too big to fail. We need a regulatory system that provides for even the largest financial firms to be allowed to fail in a way that did not put taxpayers or the broader economy at risk."
Addressing public anger
The bankers were asked repeatedly about public "anger," with reporters, at a break in the proceedings, getting a chance to ask Morgan Stanley's Mack about that directly. "There are changes that need to be made," Mack told a gathering swarm of reporters with microcassettes and cameras. "As long as you have unemployment in the 10 percent range and people have lost their homes, people are bound to be angry." (An interesting note here is that, judging by the accents heard during the give-and-take, many of these reporters were from overseas publications, signaling that people around the world are looking for basically the same explanations.)
What about the bonuses, catapulting some on Wall Street into the stratosphere of rock-star earnings? "We have to be more attuned to what's going on in the economy," Mack told reporters, "That's why I didn't take a bonus. But I have a company to run. We've had a record revenue year, and I've got to keep people in place."
At the risk of a public scolding, Moynihan took the corporate jet to Washington, D.C., for the hearings. His office said the BofA executive had been travelling extensively all week and didn't want to take the chance of missing the hearings. Coming in from California on his company's corporate jet was Dimon, whose office cited logistical reasons for the private jet travel. Blankfein and Mack travelled commercially.
Official Washington's response
In the same room the next day, the commission's witnesses put a human--and potentially criminal face--on the excesses of the financial world. Attorney General Eric Holder testified that the Justice Department has more than 2,800 cases of mortgage fraud under investigation, up 400 percent from five years ago, invoking the bank fraud statute in these cases. His department's budget for fiscal year 2010 includes $50 million in program increases to combat white-collar crime, with the addition of 50 new FBI agents and 100 new attorneys.
For Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC), much of the trouble could have been averted, she testified, if the Federal Reserve hadn't taken so long to establish tough rules for subprime mortgage lending.
Financial institutions, she argued, need to be reigned in. "Somebody has to take away the punch bowl," said Bair. "Regulators need to be supported and not pilloried."
Bair says people with responsibility to safeguard the financial system, including Congress and the business sector, relied on what everyone else was doing. "And because everyone was making money," she said, "no one did anything about it."
Bair told the commission there are more than 550 banks on the FDIC's watch list this year, and there will be more bank failures.
"As we learned from the S&L days," she, advised, "it will become more painful." Bank distress in 2010 and going forward, says Bair, will be driven not by regulatory failure, but by the outcome of the financial crisis that results--job losses and the resulting credit distress.
Securities and Exchange Commission (SEC) Chairman Mary Schapiro told the panel that, while she was not in place when the financial world began to unravel, from her current position she sees how the SEC fell down on the job: Underlying all the flaws, an SEC budget so trimmed back that "technological and human resources were never committed" to make the SEC the regulator that was needed. There was reliance on models that proved to be flawed and irrelevant, she said. And behind that, "an expectation that secured funding would always be available. It was not envisioned," said Schapiro, "that secured funding would ever dry up completely."
In the business sector, said Schapiro, ratings agencies failed in their assigned task to provide a reliable risk snapshot to investors and regulators. "Throughout the crisis, credit-rating agencies performed poorly by, among other things, providing high ratings to complex financial products made up of low-quality assets, including subprime mortgages," she told the commission.
The states get a chance to vent
Illinois Attorney General Lisa Madigan reduced it to this: "More than 2 million families have lost their homes to foreclosure since this crisis began in late 2006. Many more have lost their homes in short sales, or handed over their keys to their lenders and walked away. Another 8 [million] to 13 million additional homes are projected to go into foreclosure in the next five years. So far, American taxpayers are on the hook for $500 million in direct payments and guarantees to the financial institutions that created this mess.
It's a lot of bad news, and even if you have suffered the pain of the still-reeling economy--and who hasn't?--the numbers and the failures can become a big blur. That is, until something happens that captures just how deeply the pain has registered. Enter the race for the Kennedy seat in the state of Massachusetts.
Inconceivably to Democratic big wigs, in a special election to fill the U.S. Senate seat left vacant by the recent death of the much-revered Ted Kennedy, Bay State voters decided to put a Republican in a Senate seat held by Democrats for 47 years.
A common theme of Brown's was the economy. In an interview with ABC's Barbara Walters on the network's Sunday news show, This Week, Brown said, "[M]ake no mistake--I am a fiscal conservative."
With Brown's election, President Obama's agenda was under siege. The Senate no longer had 60 reliable votes to shut down a health-care reform filibuster. And it seemed that the administration's "cap and trade" climate-change bill had also suffered a mortal blow.
But not only was Brown's election bad news for Democrats, it became bad news for financial institutions. Obama assured Americans he was just as disgusted as they were by the state of the economy and the role that financial industry practices played. He started talking about a financial-risk tax on the banks. And, guided by former Federal Reserve Chairman Paul Volcker, the White House unveiled wide-reaching reform proposals. Banks would be limited in size. And those with deposits backed by the FDIC would be banned from proprietary trading. Those banks would also be banned from owning, investing or sponsoring hedge funds and private-equity funds.
Taking a populist line on banking
At the Thomas A. Roe Institute for Economic Policy Studies, based at the Heritage Foundation in Washington, D.C., Senior Research Fellow in Regulatory Policy James Gattuso believes the White House was bracing to get its clocks cleaned in Massachusetts even before the results were in. "I think the White House made a conscious decision to take a populist line on banking even before the Massachusetts election, in response to sagging approval ratings and also as a way of inoculating the president against possible fallout from news of bonuses and salaries paid at the end of the year," he suggested.
Can the president make that strategy succeed? None of the proposed reforms would be possible without congressional action, and as the Senate Banking Committee began to digest the Volcker plan, Chairman Christopher Dodd (D-Connecticut) sounded worried. Dodd, facing tough voter currents of his own, has decided not to seek re-election this year--although he insists his efforts on financial reform will not be set back as a result.
"It is the job of this Congress to restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them," Dodd has promised. "We must create a sound foundation to grow the economy and create jobs."
What Dodd has in mind
But at hearings on the Volcker plan, Dodd signaled that the White House may be asking for too much. "While I have certainly been familiar with the issue of dealing with proprietary trading and other issues, it does come up late, and the idea that the administration made such a major point a week or so ago seemed to many to be transparently political and not substantive," Dodd said. He said he had no intention of having to be in a position of casting about for a 60th anti-fili-buster vote. The Volcker plan, he warned, was a potential deal-breaker.
Dodd's reform proposals (and others) include the creation of an independent Consumer Financial Protection Agency to guarantee the safety of financial products. He envisions an independent council of regulators to identify risks, enabling the government to prevent a crisis. This council would relegate to banking world history the notion of "too big to fail," enabling regulators to safely shut down large failing financial institutions, ending the practice of emergency Federal Reserve lending to institutions in critical condition.
Replacing the many different government agencies that failed to foresee the global financial crisis, under the Dodd plan: a single federal banking regulator. Credit-ratings agencies would be held accountable for their judgments, and shareholders in publicly owned companies would have a greater voice in how those businesses are run and how their executives are paid.
But absent the Volcker plan, and in the light of President Obama's threat to veto any financial regulatory bill that does not meet his test for "real reform," the Dodd bill--and a congressional bill in general--could be in trouble.
"There really isn't a chance in the world that the bill that will pass in the Senate will meet the president's test," says FCIC Commissioner Wallison. "There's a real question about whether there will be a consumer financial protection agency; there might be one, but it might not be a freestanding agency. And as for many of the controls that he's proposing, such as allowing the Federal Reserve to regulate all large financial companies, that also won't come out of the Senate. So it's very interesting that he would suggest something like this."
Wallison believes that now Senate Republicans will want to make some major changes and think they have the authority.
Overall, Wallison thinks the president's approach to the nation's financial crisis fails to reflect the role played by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, in particular, in the unraveling of the economy. "[Twenty-six] million sub-prime and other high-risk mortgages were put into our financial system, largely by government housing policy. And when those began to fail, that is what caused the failure of so many banks and investment banks. President Obama's proposal suggests that what we have to do now is regulate all those institutions. He doesn't acknowledge at all the role of government housing policy," Wallison says.
The odds for reform
So where does that put financial regulatory reform? Steve O'Connor, senior vice president of government affairs for the Mortgage Bankers Association (MBA), says the next couple of months "are going to be absolutely critical to whether financial reform gets any traction, or whether it becomes a next-year deal," referring to the post-midterm-elections Congress.
Is Chairman Dodd weakened by his announced intention to retire? There are lots of opinions about that, says O'Connor. No doubt, he says, Dodd is an effective legislator and commands the respect of his peers on the committee in both parties. "The question is," he asks, "can different points of view be reconciled?"
In general, MBA's O'Connor isn't sure that White House tough talk aimed at the financial sector can be productive. "Clearly," he says, "the administration believes that this is a helpful way to proceed to score political points. At the end of the day, there are two kinds of forces. There are political forces, which are very real; [and] there's a certain amount of populist dissatisfaction with the financial services industry at large. But at the same time, people realize they need a functioning and efficient financial system."
Global financial analyst David Smick, chairman and CEO of Johnson Smick International, Washington, D.C., agrees. "President Obama would be wise to keep his eye on the ball. Whether the Massachusetts Senate seat debacle is repeated in the midterm elections will likely depend on whether the unemployment rate has dropped significantly," he says.
"For a dramatic increase in job creation (over and above the modest government-stimulated jobs from the stimulus plan), the economy needs to see more investment by companies as well as new business startups. But that requires greater bank lending." Smick warns that "going 'populist' against the banks will come at a cost. Our banking sector has been lending at a meager pace. The danger is that the banks respond to the administration's political maneuvering by shrinking bank lending further. In the end, the danger is that job losses trump populist politics."
At the Robert H. Smith School of Business at the University of Maryland, College Park, Professor Peter Morici says, for all of the tough talk, there hasn't yet been an effort to go after Wall Street's supersize bonuses--a major flaw in the Obama administration's approach. "The bank tax does not claw back the bonuses, and it is not good long-term policy. It is likely to cause banks, U.S. and foreign, to move assets and balance sheets abroad," says Morici.
Morici isn't impressed by the Financial Crisis Inquiry Commission, calling it "Another volume on the shelf, dust collected and not much meaningful done." Morici calls on the president "to stop playing the crowd and start playing the game. Come up with comprehendible approaches and reach across the aisle."
Smick says it will take a lot more than a commission to get the economy back on its feet. "Instead," he says, "a blue-ribbon panel should deal with the issue of global public and private debt. According to the Congressional Budget Office's most recent estimates, the U.S. government will face financial Armageddon because of its budget deficit within a decade. The European situation is even worse from the standpoint of debt. Japan is a walking public-debt zombie, its deficit alone measuring 230 percent of GDP [gross domestic product]. The financial crisis was a result of a series of financial bubbles. If the world is not careful, we could see the bursting of a global public-sector debt bubble with devastating economic consequences."
FCIC Chairman Angelides has heard it all. In the wake of the president's State of the Union address, the independent and populist outcries that swept Massachusetts Republican Scott Brown into the Senate, and the confirmation of Federal Reserve Chairman Ben Bernanke that almost wasn't, Angelides and his team remain committed to their charge. "We hope to tell, in the end, the big story of what happened," he told a meeting of reporters and policy wonks gathered at the offices of progressive think tank New Democrat Network (NDN) in Washington. "What's happened here is of enormous consequence to our country," he said. "People have talked about this crisis as if it was, when it still is."
The report is due in December. MB
Louise L. Schiavone is a journalist based in Washington, D.C. She can be reached at firstname.lastname@example.org.
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|Comment:||Post-mortem: the official autopsy on the financial market meltdown is now in the hands of a Washington commission.|
|Author:||Schiavone, Louise L.|
|Date:||Mar 1, 2010|
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