--- /dev/null
+Found 19940 haiku...
+
+On line 4:
+ current financial
+ and economic crisis in
+ the United States." In
+
+On line 4:
+ Commission presents to
+ the President, the Congress,
+ and the American
+
+ people the results
+ of its examination
+ and its conclusions
+
+ as to the causes
+ of the crisis. More than two
+ years after the worst
+
+On line 6:
+ financial crisis,
+ our economy, as well as
+ communities and
+
+On line 6:
+ the after-shocks. Millions
+ of Americans have lost their
+ jobs and their homes, and
+
+On line 6:
+ rebound. This report
+ is intended to provide
+ a historical
+
+ accounting of what
+ brought our financial system
+ and economy to
+
+On line 8:
+ better understand
+ how this calamity came to be.
+ The Commission was
+
+On line 8:
+ as part of the Fraud
+ Enforcement and Recovery
+ Act (Public Law 111-21)
+
+On line 10:
+ by Congress and signed
+ by the President in May
+ This independent,
+
+On line 10:
+ panel was composed
+ of private citizens with
+ experience in
+
+On line 10:
+ banking, and consumer
+ protection. Six members of
+ the Commission were
+
+On line 10:
+ by the Democratic
+ leadership of Congress and
+ four members by the
+
+On line 12:
+ specific topics
+ for inquiry and called for the
+ examination
+
+On line 12:
+ collapse of major
+ financial institutions
+ that failed or would have
+
+On line 12:
+ the government. This
+ report fulfills these mandates.
+ In addition, the
+
+On line 12:
+ was instructed to
+ refer to the attorney
+ general of the
+
+On line 12:
+ any appropriate
+ state attorney general
+ any person that the
+
+ Commission found may
+ have violated the laws
+ of the United States
+
+On line 12:
+ relation to the
+ crisis. Where the Commission
+ found such potential
+
+On line 12:
+ The Commission used
+ the authority it was
+ given to issue
+
+On line 12:
+ and the production
+ of documents, but in the
+ vast majority
+
+On line 14:
+ voluntarily
+ cooperated with this
+ inquiry. In the course
+
+On line 14:
+ millions of pages of
+ documents, interviewed more
+ than witnesses, and
+
+On line 14:
+ of public hearings
+ in New York, Washington, D.C.,
+ and communities
+
+On line 14:
+ the country that were
+ hard hit by the crisis. The
+ Commission also
+
+ drew from a large body
+ of existing work about the
+ crisis developed
+
+On line 14:
+ government agencies,
+ academics, journalists, legal
+ investigators,
+
+On line 16:
+ We have tried in this
+ report to explain in clear,
+ understandable terms
+
+On line 16:
+ complex financial
+ system worked, how the pieces fit
+ together, and how
+
+On line 16:
+ occurred. Doing so
+ required research into broad
+ and sometimes arcane
+
+On line 16:
+ risk management. To
+ bring these subjects out of the
+ realm of the abstract,
+
+On line 16:
+ Financial, Fannie
+ Mae, Goldman Sachs, Lehman Brothers,
+ Merrill Lynch, Moody’s, and
+
+ Wachovia. We looked more
+ generally at the roles
+ and actions of scores
+
+On line 18:
+ We also studied
+ relevant policies put in
+ place by successive
+
+On line 18:
+ And importantly,
+ we examined the roles of
+ policy makers
+
+On line 18:
+ Corporation, the
+ Federal Reserve Board, the
+ Federal Reserve
+
+On line 18:
+ Housing and Urban
+ Development, the Office
+ of the Comptroller
+
+ of the Currency,
+ the Office of Federal
+ Housing Enterprise
+
+On line 18:
+ its successor, the
+ Federal Housing Finance
+ Agency), the Office
+
+On line 18:
+ Supervision, the
+ Securities and Exchange
+ Commission, and the
+
+ Treasury Department.
+ Of course, there is much work the
+ Commission did not
+
+On line 20:
+ it to delve into
+ what caused the crisis. In that
+ sense, the Commission
+
+On line 20:
+ other transportation
+ accidents so that knowledge
+ of the probable
+
+On line 20:
+ can help avoid future
+ accidents. Nor were we tasked
+ with evaluating
+
+ the federal law
+ (the Troubled Asset Relief
+ Program, known as TARP)
+
+On line 20:
+ major financial
+ institutions. That duty
+ was assigned to the
+
+On line 22:
+ General for TARP.
+ This report is not the sole
+ repository of
+
+ what the panel found.
+ A website will host a wealth
+ of information
+
+On line 24:
+ contain a stockpile
+ of materials—including
+ documents and emails,
+
+On line 24:
+ Commission’s public
+ hearings, testimony, and
+ supporting research—that
+
+ can be studied for
+ years to come. Much of what is
+ footnoted in this
+
+On line 24:
+ can be found on the
+ website. In addition, more
+ materials that
+
+ cannot be released
+ yet for various reasons
+ will eventually
+
+On line 24:
+ made public through the
+ National Archives and Records
+ Administration.
+
+On line 26:
+ extraordinary
+ commitment and knowledge of
+ the members of the
+
+ Commission who were
+ accorded the honor of
+ this public service.
+
+On line 26:
+ from the perspectives
+ shared with commissioners by
+ thousands of concerned
+
+On line 26:
+ and emails. And we are
+ grateful to the hundreds of
+ individuals
+
+On line 26:
+ personal accounts
+ in extensive interviews,
+ testimony, and
+
+ discussions with the
+ Commission. We want to thank
+ the Commission staff,
+
+On line 30:
+ particular, Wendy
+ Edelberg, our executive
+ director, for the
+
+ professionalism,
+ passion, and long hours they brought
+ to this mission in
+
+On line 30:
+ report would not have
+ been possible without their
+ extraordinary
+
+ dedication. With
+ this report and our website,
+ the Commission’s work
+
+ comes to a close. We
+ present what we have found in the
+ hope that readers can
+
+On line 32:
+ this report to reach
+ their own conclusions, even as
+ the comprehensive
+
+On line 38:
+ record of this crisis
+ continues to be written.
+ CONCLUSIONS OF THE
+
+On line 40:
+ Commission has been
+ called upon to examine
+ the financial and
+
+ economic crisis
+ that has gripped our country and
+ explain its causes
+
+On line 40:
+ American people.
+ We are keenly aware of the
+ significance of
+
+On line 40:
+ economic damage
+ that America has suffered
+ in the wake of the
+
+On line 42:
+ crisis since the Great
+ Depression. Our task was first
+ to determine what
+
+On line 42:
+ and how it happened
+ so that we could understand
+ why it happened. Here
+
+On line 42:
+ our conclusions. We
+ encourage the American
+ people to join us
+
+On line 42:
+ own assessments based
+ on the evidence gathered
+ in our inquiry. If
+
+On line 42:
+ from history, we
+ are unlikely to fully
+ recover from it.
+
+ Some on Wall Street and
+ in Washington with a stake
+ in the status quo
+
+ may be tempted to
+ wipe from memory the events
+ of this crisis, or
+
+On line 42:
+ unravel myths, and
+ help us understand how the
+ crisis could have been
+
+ avoided. It is an
+ attempt to record history,
+ not to rewrite it,
+
+On line 44:
+ allow it to be
+ rewritten. To help our fellow
+ citizens better
+
+On line 44:
+ conclusions at the
+ end of chapters in Parts III,
+ IV, and V of this
+
+ report. The subject
+ of this report is of no
+ small consequence to
+
+On line 46:
+ nation. The profound
+ events of and were neither bumps
+ in the road nor an
+
+ accentuated
+ dip in the financial and
+ business cycles we
+
+On line 46:
+ come to expect in
+ a free market economic
+ system. This was a
+
+On line 46:
+ financial upheaval,
+ if you will—that wreaked havoc in
+ communities and
+
+ neighborhoods across this
+ country. As this report goes
+ to print, there are more
+
+On line 48:
+ million Americans
+ who are out of work, cannot
+ find full-time work,
+
+On line 48:
+ up looking for work.
+ About four million families
+ have lost their homes to
+
+On line 48:
+ their mortgage payments.
+ Nearly trillion in household
+ wealth has vanished, with
+
+On line 48:
+ and life savings swept
+ away. Businesses, large and small,
+ have felt the sting of
+
+On line 48:
+ recession. There is
+ much anger about what has transpired,
+ and justifiably
+
+ so. Many people who
+ abided by all the rules now
+ find themselves out of
+
+On line 48:
+ about their future prospects.
+ The collateral damage
+ of this crisis has
+
+ been real people
+ and real communities.
+ The impacts of this
+
+On line 48:
+ are likely to be
+ felt for a generation.
+ And the nation faces
+
+On line 50:
+ so many Americans,
+ we began our exploration
+ with our own views and
+
+On line 50:
+ how the world’s strongest
+ financial system came to
+ the brink of collapse.
+
+On line 50:
+ our appointment to
+ this independent panel,
+ much had already been
+
+On line 50:
+ said about the crisis.
+ Yet all of us have been deeply
+ affected by what
+
+ we have learned in the
+ course of our inquiry. We have
+ been at various
+
+ times fascinated,
+ surprised, and even shocked by what
+ we saw, heard, and read.
+
+On line 52:
+ revelation. Much
+ attention over the past two
+ years has been focused
+
+On line 52:
+ the decisions by
+ the federal government
+ to provide massive
+
+On line 52:
+ financial system
+ and rescue large financial
+ institutions that
+
+On line 52:
+ important to fail.
+ Those decisions—and the deep
+ emotions surrounding
+
+ them—will be debated
+ long into the future. But
+ our mission was to
+
+ ask and answer this
+ central question: how did it
+ come to pass that in
+
+On line 52:
+ the total collapse
+ of our financial system
+ and economy or
+
+On line 52:
+ and an array of
+ companies, as millions of
+ Americans still lost
+
+ their jobs, their savings,
+ and their homes1 In this report,
+ we detail the events
+
+On line 54:
+ the crisis. But a
+ simple summary, as we
+ see it, is useful
+
+ at the outset. While
+ the vulnerabilities
+ that created the
+
+On line 54:
+ the making, it was
+ the collapse of the housing
+ bubble—fueled by
+
+ low interest rates,
+ easy and available credit, scant
+ regulation, and
+
+ toxic mortgages— that
+ was the spark that ignited
+ a string of events, which
+
+On line 56:
+ fall of Trillions of
+ dollars in risky mortgages had
+ become embedded
+
+On line 56:
+ as mortgage-related
+ securities were packaged,
+ repackaged, and sold to
+
+On line 56:
+ world. When the bubble
+ burst, hundreds of billions of
+ dollars in losses
+
+On line 56:
+ to those mortgages and
+ had borrowed heavily against
+ them. This happened not
+
+On line 56:
+ in the United States
+ but around the world. The losses
+ were magnified by
+
+On line 58:
+ crisis reached seismic
+ proportions in September
+ with the failure of
+
+ Lehman Brothers and the
+ impending collapse of the
+ insurance giant
+
+On line 58:
+ International
+ Group (AIG). Panic fanned by a
+ lack of transparency
+
+On line 58:
+ interconnections
+ among institutions perceived
+ to be "too big to
+
+ fail," caused the credit
+ markets to seize up. Trading
+ ground to a halt. The
+
+On line 58:
+ market plummeted.
+ The economy plunged into
+ a deep recession.
+
+On line 60:
+ financial system
+ we examined bears little
+ resemblance to that
+
+On line 60:
+ generation. The
+ changes in the past three decades alone
+ have been remarkable.
+
+On line 60:
+ markets have become
+ increasingly globalized.
+ Technology has
+
+On line 60:
+ and complexity
+ of financial instruments
+ and transactions. There
+
+On line 60:
+ costs of financing
+ than ever before. And the
+ financial sector
+
+ itself has become
+ a much more dominant force
+ in our economy.
+
+On line 64:
+ the amount of debt held
+ by the financial sector
+ soared from trillion to
+
+On line 66:
+ doubling as a share
+ of gross domestic product.
+ The very nature of
+
+On line 66:
+ to publicly traded
+ corporations taking greater
+ and more diverse kinds
+
+On line 66:
+ risks. By the largest U.S.
+ commercial banks held of the
+ industry’s assets,
+
+On line 66:
+ more than double the
+ level held in On the eve
+ of the crisis in
+
+On line 66:
+ constituted of
+ all corporate profits in
+ the United States, up
+
+On line 66:
+ in Understanding
+ this transformation has been
+ critical to the
+
+On line 68:
+ Now to our major
+ findings and conclusions, which
+ are based on the facts
+
+On line 68:
+ in this report: they
+ are offered with the hope that
+ lessons may be learned to
+
+On line 70:
+ future catastrophe.
+ We conclude this financial
+ crisis was avoidable.
+
+ The crisis was the
+ result of human action
+ and inaction, not
+
+ of Mother Nature
+ or computer models gone
+ haywire. The captains
+
+On line 70:
+ the public stewards
+ of our financial system
+ ignored warnings and
+
+On line 70:
+ evolving risks within
+ a system essential to
+ the well-being of the
+
+On line 72:
+ public. Theirs was a
+ big miss, not a stumble. While
+ the business cycle
+
+On line 72:
+ this magnitude need
+ not have occurred. To paraphrase
+ Shakespeare, the fault lies
+
+ not in the stars, but
+ in us. Despite the expressed
+ view of many on Wall
+
+On line 74:
+ in Washington that
+ the crisis could not have been
+ foreseen or avoided,
+
+On line 74:
+ were warning signs. The
+ tragedy was that they were ignored
+ or discounted. There
+
+On line 74:
+ risky subprime lending
+ and securitization,
+ an unsustainable
+
+On line 74:
+ in household mortgage
+ debt, and exponential growth
+ in financial firms’
+
+On line 74:
+ red flags. Yet there was
+ pervasive permissiveness;
+ little meaningful
+
+On line 76:
+ taken to quell the
+ threats in a timely manner.
+ The prime example
+
+On line 76:
+ failure to stem the
+ flow of toxic mortgages, which
+ it could have done by
+
+On line 78:
+ mortgage-lending standards.
+ The Federal Reserve was
+ the one entity
+
+On line 78:
+ examination
+ is replete with evidence
+ of other failures:
+
+On line 78:
+ bought, and sold mortgage
+ securities they never
+ examined, did not
+
+ care to examine,
+ or knew to be defective;
+ firms depended on
+
+ tens of billions of
+ dollars of borrowing that
+ had to be renewed
+
+ each and every night,
+ secured by subprime mortgage
+ securities; and
+
+On line 78:
+ blindly relied on
+ credit rating agencies as
+ their arbiters of risk.
+
+On line 78:
+ else could one expect
+ on a highway where there were
+ neither speed limits
+
+On line 80:
+ widespread failures in
+ financial regulation
+ and supervision
+
+On line 80:
+ devastating to
+ the stability of the
+ nation’s financial
+
+ markets. The sentries
+ were not at their posts, in no
+ small part due to the
+
+On line 80:
+ self-correcting
+ nature of the markets and
+ the ability of
+
+On line 80:
+ to effectively
+ police themselves. More than years
+ of deregulation
+
+On line 80:
+ former Federal
+ Reserve chairman Alan Greenspan and
+ others, supported
+
+On line 80:
+ by the powerful
+ financial industry at
+ every turn, had stripped
+
+ away key safeguards, which
+ could have helped avoid catastrophe.
+ This approach had opened
+
+ up gaps in oversight
+ of critical areas with
+ trillions of dollars
+
+On line 82:
+ race to the weakest
+ supervisor. Yet we do
+ not accept the view
+
+On line 82:
+ regulators lacked
+ the power to protect the
+ financial system.
+
+On line 84:
+ had ample power
+ in many arenas and they chose
+ not to use it. To
+
+On line 84:
+ three examples: the
+ Securities and Exchange
+ Commission could have
+
+On line 84:
+ more capital and
+ halted risky practices at the
+ big investment banks.
+
+On line 86:
+ Federal Reserve
+ Bank of New York and other
+ regulators could
+
+On line 86:
+ down on Citigroup’s
+ excesses in the run-up to
+ the crisis. They did
+
+On line 86:
+ the runaway mortgage
+ securitization train.
+ They did not. In case
+
+On line 86:
+ the institutions
+ they oversaw as safe and sound
+ even in the face of
+
+On line 86:
+ downgrading them just
+ before their collapse. And where
+ regulators lacked
+
+On line 86:
+ Too often, they lacked
+ the political will—in
+ a political
+
+On line 86:
+ as the fortitude
+ to critically challenge
+ the institutions
+
+On line 88:
+ system occurred in
+ many instances as financial
+ markets evolved. But as
+
+ the report will show,
+ the financial industry
+ itself played a key
+
+ role in weakening
+ regulatory constraints
+ on institutions,
+
+On line 88:
+ and products. It did
+ not surprise the Commission
+ that an industry
+
+On line 88:
+ would exert pressure
+ on policy makers and
+ regulators. From
+
+On line 88:
+ individuals
+ and political action
+ committees in the
+
+On line 88:
+ made more than billion
+ in campaign contributions.
+ What troubled us was
+
+ the extent to which
+ the nation was deprived of
+ the necessary strength
+
+On line 88:
+ independence of
+ the oversight necessary to
+ safeguard financial
+
+On line 90:
+ dramatic failures
+ of corporate governance
+ and risk management
+
+On line 90:
+ institutions were
+ a key cause of this crisis.
+ There was a view that
+
+On line 90:
+ self-preservation
+ inside major financial
+ firms would shield them from
+
+ fatal risk-taking
+ without the need for a steady
+ regulatory
+
+On line 90:
+ argued, would stifle
+ innovation. Too many of
+ these institutions
+
+On line 90:
+ too much risk, with too
+ little capital, and with
+ too much dependence
+
+On line 90:
+ In many respects, this
+ reflected a funda-CONCLUSIONS OF THE
+ FINANCIAL CRISIS
+
+On line 90:
+ these institutions,
+ particularly the large
+ investment banks and
+
+On line 90:
+ lenders and creating,
+ packaging, repackaging, and
+ selling trillions of
+
+On line 92:
+ products. Like Icarus, they
+ never feared flying ever
+ closer to the sun.
+
+On line 94:
+ grew aggressively
+ through poorly executed
+ acquisition and
+
+On line 94:
+ more challenging. The
+ CEO of Citigroup told the
+ Commission that a
+
+On line 94:
+ billion position
+ in highly rated mortgage
+ securities would
+
+ "not in any way have
+ excited my attention,"
+ and the co-head of
+
+On line 94:
+ investment bank said
+ he spent "a small fraction of
+ of his time on those
+
+On line 96:
+ In this instance, too
+ big to fail meant too big to
+ manage. Financial
+
+On line 96:
+ instances. Too often,
+ risk management became risk
+ justification.
+
+On line 98:
+ short-term gain—without
+ proper consideration
+ of long-term consequences.
+
+ Often, those systems
+ encouraged the big bet—where
+ the payoff on the
+
+ upside could be huge
+ and the downside limited.
+ This was the case up
+
+ and down the line—from
+ the corporate boardroom to
+ the mortgage broker
+
+On line 100:
+ examination
+ revealed stunning instances of
+ governance breakdowns
+
+On line 100:
+ read, among other things,
+ about AIG senior management’s
+ ignorance of the
+
+On line 100:
+ company’s billion
+ derivatives exposure
+ to mortgage-related
+
+On line 100:
+ Fannie Mae’s quest for
+ bigger market share, profits,
+ and bonuses, which led
+
+ it to ramp up its
+ exposure to risky loans and
+ securities as
+
+ the housing market
+ was peaking; and the costly
+ surprise when Merrill
+
+On line 100:
+ that the company
+ held billion in "super-senior"
+ and supposedly
+
+On line 102:
+ securities that
+ resulted in billions of
+ dollars in losses.
+
+On line 104:
+ a combination
+ of excessive borrowing,
+ risky investments, and
+
+ lack of transparency
+ put the financial system
+ on a collision
+
+On line 104:
+ with crisis. Clearly,
+ this vulnerability
+ was related to
+
+On line 104:
+ and regulation,
+ but it is significant
+ enough by itself to
+
+On line 106:
+ our attention here.
+ In the years leading up to
+ the crisis, too many
+
+On line 106:
+ as too many households,
+ borrowed to the hilt, leaving
+ them vulnerable
+
+On line 106:
+ financial distress
+ or ruin if the value
+ of their investments
+
+On line 108:
+ even modestly. For
+ example, as of the five
+ major investment
+
+ banks—Bear Stearns, Goldman Sachs,
+ Lehman Brothers, Merrill Lynch, and
+ Morgan Stanley—were
+
+ operating with
+ extraordinarily thin
+ capital. By one
+
+On line 108:
+ measure, their leverage
+ ratios were as high as to
+ meaning for every
+
+On line 108:
+ in assets, there was
+ only in capital to
+ cover losses. Less
+
+On line 108:
+ a drop in asset
+ values could wipe out a firm.
+ To make matters worse,
+
+On line 108:
+ borrowing had to
+ be renewed each and every
+ day. For example,
+
+On line 108:
+ Stearns had billion in
+ equity and billion in
+ liabilities
+
+On line 108:
+ and was borrowing
+ as much as billion in the
+ overnight market. It was
+
+On line 108:
+ a small business with
+ in equity borrowing
+ million, with of that
+
+ due each and every
+ day. One can’t really ask
+ "What were they thinking1"
+
+ when it seems that too
+ many of them were thinking alike.
+ And the leverage was
+
+On line 110:
+ "window dressing" of
+ financial reports available
+ to the investing
+
+ public. The kings of
+ leverage were Fannie Mae and
+ Freddie Mac, the two
+
+On line 112:
+ the end of Fannie’s
+ and Freddie’s combined leverage
+ ratio, including
+
+On line 114:
+ owned and guaranteed,
+ stood at to But financial
+ firms were not alone in
+
+On line 114:
+ the borrowing spree:
+ from to national mortgage
+ debt almost doubled,
+
+On line 114:
+ the amount of mortgage
+ debt per household rose more than
+ from to even while wages
+
+On line 114:
+ the housing downturn
+ hit, heavily indebted
+ financial firms and
+
+On line 116:
+ institutions was
+ exacerbated by the
+ risky assets they were
+
+On line 116:
+ debt. As the mortgage
+ and real estate markets
+ churned out riskier and
+
+On line 116:
+ securities, many
+ financial institutions
+ loaded up on them.
+
+On line 116:
+ the end of Lehman had
+ amassed billion in commercial
+ and residential
+
+On line 116:
+ securities, which
+ was almost twice what it held
+ just two years before,
+
+ and more than four times
+ its total equity. And
+ again, the risk wasn’t
+
+On line 116:
+ taken on just by
+ the big financial firms, but
+ by families, too.
+
+On line 116:
+ mortgage borrowers
+ in and took out "option ARM"
+ loans, which meant they could
+
+On line 118:
+ make payments so low
+ that their mortgage balances rose
+ every month. Within
+
+On line 118:
+ financial system,
+ the dangers of this debt were
+ magnified because
+
+ transparency was not
+ required or desired. Massive,
+ short-term borrowing,
+
+On line 118:
+ obligations unseen
+ by others in the market,
+ heightened the chances the
+
+On line 118:
+ rapidly unravel.
+ In the early part of the
+ 20th century, we
+
+On line 118:
+ protections—the
+ Federal Reserve as a
+ lender of last resort,
+
+On line 118:
+ deposit insurance,
+ ample regulations—to
+ provide a bulwark
+
+On line 118:
+ had regularly
+ plagued America’s banking
+ system in the 19th
+
+On line 118:
+ over the past 30-plus years,
+ we permitted the growth of
+ a shadow banking
+
+On line 118:
+ and laden with short-term
+ debt—that rivaled the size of
+ the traditional
+
+On line 118:
+ of over-the-counter derivatives—were
+ hidden from view, without the
+ protections we had
+
+On line 118:
+ financial meltdowns.
+ We had a 21st-century
+ financial system
+
+ with 19th-century
+ safeguards. When the housing and
+ mortgage markets cratered,
+
+On line 120:
+ lack of transparency,
+ the extraordinary debt
+ loads, the short-term loans,
+
+On line 120:
+ risky assets all came
+ home to roost. What resulted
+ was panic. We had
+
+On line 122:
+ reaped what we had sown.
+ We conclude the government
+ was ill prepared for
+
+On line 122:
+ response added to the
+ uncertainty and panic
+ in the financial
+
+On line 122:
+ As part of our charge,
+ it was appropriate to
+ review government
+
+On line 122:
+ in response to the
+ developing crisis, not
+ just those policies or
+
+On line 122:
+ it, to determine
+ if any of those responses
+ contributed to or
+
+ exacerbated
+ the crisis. As our report
+ shows, key policy
+
+On line 124:
+ Treasury Department,
+ the Federal Reserve Board,
+ and the Federal
+
+On line 124:
+ Bank of New York—who
+ were best positioned to watch
+ over our markets were
+
+On line 126:
+ ill prepared for the
+ events of and Other agencies
+ were also behind
+
+On line 126:
+ were hampered because
+ they did not have a clear grasp
+ of the financial
+
+On line 126:
+ charged with overseeing,
+ particularly as it
+ had evolved in the years
+
+ leading up to the
+ crisis. This was in no small
+ measure due to the
+
+On line 126:
+ of transparency in
+ key markets. They thought risk had
+ been diversified
+
+ when, in fact, it had
+ been concentrated. Time and
+ again, from the spring of
+
+On line 126:
+ an ad hoc basis
+ with specific programs to
+ put fingers in the
+
+On line 126:
+ comprehensive and
+ strategic plan for containment,
+ because they lacked a
+
+On line 126:
+ interconnections
+ in the financial markets.
+ Some regulators
+
+ have conceded this
+ error. We had allowed the
+ system to race ahead
+
+ of our ability
+ to protect it. While there was
+ some awareness of, or
+
+On line 128:
+ least a debate about,
+ the housing bubble, the record
+ reflects that senior
+
+On line 128:
+ officials did not
+ recognize that a bursting
+ of the bubble could
+
+On line 128:
+ threaten the entire
+ financial system. Throughout
+ the summer of both
+
+ Federal Reserve
+ Chairman Ben Bernanke and Treasury
+ Secretary Henry
+
+On line 128:
+ that the turmoil in
+ the subprime mortgage markets
+ would be contained. When
+
+ Bear Stearns’s hedge funds, which
+ were heavily invested
+ in mortgage-related
+
+On line 128:
+ implications of
+ the collapse. Despite the fact
+ that so many other
+
+ funds were exposed to
+ the same risks as those hedge funds,
+ the Bear Stearns funds were
+
+On line 128:
+ be "relatively
+ unique." Days before the collapse
+ of Bear Stearns in March
+
+On line 130:
+ SEC Chairman Christopher
+ Cox expressed "comfort about the
+ capital cushions"
+
+On line 130:
+ big investment banks.
+ It was not until August
+ just weeks before the
+
+On line 130:
+ Mae and Freddie Mac,
+ that the Treasury Department
+ understood the full
+
+On line 130:
+ conditions of those
+ two institutions. And just
+ a month before Lehman’s
+
+On line 130:
+ Bank of New York was
+ still seeking information
+ on the exposures
+
+On line 132:
+ In addition, the
+ government’s inconsistent
+ handling of major
+
+On line 132:
+ rescue Bear Stearns and
+ then to place Fannie Mae and
+ Freddie Mac into
+
+On line 132:
+ Lehman Brothers and then
+ to save AIG—increased uncertainty
+ and panic in the
+
+On line 134:
+ we deeply respect and
+ appreciate the efforts
+ made by Secretary
+
+On line 134:
+ Bernanke, and Timothy
+ Geithner, formerly
+ president of the
+
+On line 134:
+ Bank of New York and
+ now treasury secretary, and
+ so many others who
+
+On line 134:
+ to stabilize our
+ financial system and our
+ economy in the
+
+On line 136:
+ a systemic breakdown
+ in accountability and
+ ethics. The integrity
+
+On line 136:
+ and the public’s trust in
+ those markets are essential
+ to the economic
+
+On line 136:
+ financial system
+ and our economy rely
+ on the notions of
+
+On line 136:
+ In our economy,
+ we expect businesses and
+ individuals
+
+On line 136:
+ pursue profits, at
+ the same time that they produce
+ products and services
+
+On line 138:
+ been the case in past
+ speculative booms and busts—we
+ witnessed an erosion
+
+On line 138:
+ exacerbated
+ the financial crisis. This
+ was not universal,
+
+ but these breaches stretched
+ from the ground level to the
+ corporate suites. They
+
+On line 138:
+ in significant
+ financial consequences but
+ also in damage
+
+On line 138:
+ the trust of investors,
+ businesses, and the public
+ in the financial
+
+On line 140:
+ according to one
+ measure, that the percentage
+ of borrowers who
+
+On line 140:
+ just a matter of
+ months after taking a loan
+ nearly doubled from
+
+On line 140:
+ the summer of to
+ late This data indicates
+ they likely took out
+
+On line 140:
+ 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
+
+On line 140:
+ mortgage fraud grew 20-fold
+ between and and then more than
+ doubled again between
+
+On line 142:
+ and One study places the
+ losses resulting from fraud
+ on mortgage loans made
+
+On line 144:
+ at billion. Lenders made
+ loans that they knew borrowers
+ could not afford and
+
+On line 144:
+ of the loans they were
+ originating could result
+ in "catastrophic
+
+ consequences." Less than
+ a year later, they noted
+ that certain high-risk
+
+On line 144:
+ result not only
+ in foreclosures but also
+ in "financial and
+
+ reputational
+ catastrophe" for the firm. But
+ they did not stop. And
+
+On line 146:
+ sampled loans they were
+ purchasing to package and
+ sell to investors. They
+
+On line 146:
+ a significant
+ percentage of the sampled
+ loans did not meet their
+
+On line 146:
+ of many prospectuses
+ provided to investors found
+ that this critical
+
+ information was
+ not disclosed. THESE CONCLUSIONS
+ must be viewed in the
+
+On line 148:
+ to pin this crisis
+ on mortal flaws like greed and
+ CONCLUSIONS OF THE
+
+On line 148:
+ COMMISSION xxiii
+ hubris would be simplistic. It
+ was the failure to
+
+On line 150:
+ for human weakness
+ that is relevant to this
+ crisis. Second, we
+
+On line 150:
+ believe the crisis
+ was a result of human
+ mistakes, misjudgments,
+
+On line 150:
+ in systemic failures
+ for which our nation has paid
+ dearly. As you read
+
+ this report, you will
+ see that specific firms and
+ individuals
+
+On line 150:
+ Yet a crisis of
+ this magnitude cannot be
+ the work of a few
+
+ bad actors, and such
+ was not the case here. At the
+ same time, the breadth of
+
+On line 150:
+ is at fault"; many firms
+ and individuals did
+ not participate
+
+On line 152:
+ We do place special
+ responsibility with
+ the public leaders
+
+ charged with protecting
+ our financial system, those
+ entrusted to run
+
+On line 152:
+ chief executives
+ of companies whose failures
+ drove us to crisis.
+
+On line 152:
+ of significant
+ responsibility and
+ obligation. Tone at
+
+ the top does matter
+ and, in this instance, we were
+ let down. No one said
+
+On line 152:
+ must also accept
+ responsibility for
+ what we permitted
+
+On line 154:
+ unanimously, we
+ acquiesced to or embraced
+ a system, a set
+
+On line 160:
+ and actions, that gave
+ rise to our present predicament. THIS
+ REPORT DESCRIBES THE
+
+On line 160:
+ and the system that
+ propelled our nation toward
+ crisis. The complex
+
+ machinery of our
+ financial markets has many
+ essential gears—some
+
+On line 160:
+ a critical role
+ as the crisis developed
+ and deepened. Here we
+
+On line 160:
+ our conclusions about
+ specific components of
+ the system that we
+
+ believe contributed
+ significantly to the
+ financial meltdown.
+
+On line 162:
+ pipeline lit and spread
+ the flame of contagion and
+ crisis. When housing
+
+ prices fell and mortgage
+ borrowers defaulted, the
+ lights began to dim
+
+On line 164:
+ toxic mortgages from
+ neighborhoods across America
+ to investors around the
+
+ globe. Many mortgage lenders
+ set the bar so low that lenders
+ simply took eager
+
+On line 166:
+ disregard for a
+ borrower’s ability to
+ pay. Nearly one-quarter
+
+On line 166:
+ made in the first half
+ of were interest-only loans.
+ During the same year,
+
+On line 166:
+ originated by
+ Countrywide and Washington
+ Mutual had low-
+
+On line 168:
+ lending, including
+ predatory and fraudulent
+ practices, became more
+
+On line 168:
+ Federal Reserve
+ and other regulators
+ and authorities
+
+ heard warnings from many
+ quarters. Yet the Federal
+ Reserve neglected
+
+On line 168:
+ mission "to ensure
+ the safety and soundness of
+ the nation’s banking
+
+On line 168:
+ financial system
+ and to protect the credit
+ rights of consumers." It
+
+On line 168:
+ build the retaining
+ wall before it was too late.
+ And the Office of
+
+On line 168:
+ the Office of Thrift
+ Supervision, caught up in
+ turf wars, preempted
+
+ state regulators
+ from reining in abuses. While
+ many of these mortgages
+
+ were kept on banks’ books,
+ the bigger money came from
+ global investors who
+
+On line 170:
+ cash into newly
+ created mortgage-related
+ securities. It
+
+On line 170:
+ regulators alike
+ that risk had been conquered: the
+ investors held highly
+
+On line 170:
+ they thought were sure to
+ perform; the banks thought they had
+ taken the riskiest
+
+On line 170:
+ firms making profits
+ and borrowing costs reduced.
+ But each step in the
+
+On line 170:
+ on the next step to
+ keep demand going. From the
+ speculators who
+
+ flipped houses to the
+ mortgage brokers who scouted
+ the loans, to the lenders
+
+On line 170:
+ firms that created
+ the mortgage-backed securities,
+ collateralized
+
+On line 170:
+ obligations (CDOs), CDOs
+ squared, and synthetic CDOs: no
+ one in this pipeline
+
+ of toxic mortgages
+ had enough skin in the game. They
+ all believed they could
+
+ off-load their risks on
+ a moment’s notice to the
+ next person in line.
+
+On line 170:
+ wrong. When borrowers
+ stopped making mortgage payments,
+ the losses—amplified
+
+On line 170:
+ through the pipeline. As
+ it turned out, these losses were
+ concentrated in
+
+On line 172:
+ millions of mortgages
+ so efficiently has proven
+ to be difficult
+
+On line 172:
+ erected barriers
+ to modifying mortgages
+ so families can
+
+On line 174:
+ housing market and
+ financial institutions.
+ We conclude over-the-counter
+
+On line 174:
+ The enactment of
+ legislation in to ban
+ the regulation
+
+On line 174:
+ the federal and
+ state governments of over-the-counter
+ (OTC) derivatives
+
+ was a key turning
+ point in the march toward the
+ financial crisis.
+
+On line 176:
+ to corporations,
+ to farmers, and to investors,
+ derivatives have
+
+ been used to hedge against,
+ or speculate on, changes in
+ prices, rates, or indices
+
+ or even on events such
+ as the potential defaults
+ on debts. Yet, without
+
+On line 176:
+ rapidly spiraled out
+ of control and out of sight,
+ growing to trillion
+
+On line 176:
+ and collateral
+ requirements; speculation;
+ interconnections
+
+On line 178:
+ in this market. OTC
+ derivatives contributed
+ to the crisis in
+
+On line 178:
+ sold to investors to
+ protect against the default or
+ decline in value
+
+ of mortgage-related
+ securities backed by risky
+ loans. Companies sold
+
+On line 178:
+ tune of billion, in
+ AIG’s case—to investors in these
+ newfangled mortgage
+
+On line 178:
+ to launch and expand
+ the market and, in turn, to
+ further fuel the
+
+On line 180:
+ were essential to
+ the creation of synthetic
+ CDOs. These synthetic
+
+On line 180:
+ on the performance
+ of real mortgage-related
+ securities. They
+
+On line 180:
+ multiple bets on
+ the same securities and
+ helped spread them throughout
+
+On line 182:
+ system. Goldman Sachs
+ alone packaged and sold billion
+ in synthetic CDOs
+
+On line 182:
+ July CONCLUSIONS
+ OF THE FINANCIAL CRISIS
+ INQUIRY COMMISSION
+
+On line 184:
+ to May Synthetic
+ CDOs created by Goldman
+ referenced more than
+
+On line 186:
+ securities, and
+ of them were referenced at
+ least twice. This is apart
+
+On line 188:
+ in synthetic CDOs
+ created by other firms.
+ Finally, when the
+
+On line 188:
+ and crisis followed,
+ derivatives were in the
+ center of the storm.
+
+On line 188:
+ not been required to
+ put aside capital reserves
+ as a cushion for
+
+ the protection it
+ was selling, was bailed out when
+ it could not meet its
+
+On line 188:
+ committed more than
+ billion because of concerns
+ that AIG’s collapse would
+
+ trigger cascading
+ losses throughout the global
+ financial system.
+
+On line 188:
+ the existence of
+ millions of derivatives
+ contracts of all types
+
+On line 188:
+ panic, helping to
+ precipitate government
+ assistance to those
+
+On line 190:
+ conclude the failures
+ of credit rating agencies
+ were essential cogs
+
+On line 190:
+ wheel of financial
+ destruction. The three credit
+ rating agencies were
+
+On line 190:
+ of the financial
+ meltdown. The mortgage-related
+ securities at
+
+On line 190:
+ heart of the crisis
+ could not have been marketed
+ and sold without their
+
+On line 190:
+ regulatory
+ capital standards were hinged
+ on them. This crisis
+
+ could not have happened
+ without the rating agencies.
+ Their ratings helped the
+
+On line 190:
+ market soar and their
+ downgrades through and wreaked havoc
+ across markets and firms.
+
+ In our report, you
+ will read about the breakdowns at
+ Moody’s, examined by
+
+On line 192:
+ This compares with six
+ private-sector companies
+ in the United States
+
+On line 192:
+ early In alone, Moody’s
+ put its triple-A stamp of approval
+ on mortgage-related
+
+On line 192:
+ were disastrous: of
+ the mortgage securities
+ rated triple-A that year
+
+ ultimately were
+ downgraded. You will also
+ read about the forces at
+
+On line 194:
+ behind the breakdowns
+ at Moody’s, including the flawed
+ computer models,
+
+On line 194:
+ from financial firms
+ that paid for the ratings, the
+ relentless drive for
+
+ market share, the lack
+ of resources to do the job
+ despite record profits,
+
+ and the absence of
+ meaningful public oversight.
+ And you will see that
+
+ without the active
+ participation of the
+ rating agencies, the
+
+On line 194:
+ for mortgage-related
+ securities could not have
+ been what it became.
+
+On line 200:
+ ARE MANY COMPETING
+ VIEWS as to the causes of
+ this crisis. In this
+
+On line 200:
+ the Commission has
+ endeavored to address key
+ questions posed to us.
+
+On line 200:
+ availability and
+ excess liquidity, the
+ role of Fannie Mae
+
+ and Freddie Mac (the
+ GSEs), and government housing
+ policy. First, as
+
+On line 200:
+ in our report, we
+ outline monetary policies
+ and capital flows
+
+On line 200:
+ years leading up to
+ the crisis. Low interest
+ rates, widely available
+
+On line 200:
+ international
+ investors seeking to put their
+ money in real
+
+On line 202:
+ a credit bubble.
+ Those conditions created
+ increased risks, which should
+
+ have been recognized
+ by market participants,
+ policy makers,
+
+On line 202:
+ liquidity did
+ not need to cause a crisis.
+ It was the failures
+
+On line 202:
+ in excesses in
+ the mortgage and financial
+ markets—that were the
+
+ principal causes
+ of this crisis. Indeed, the
+ availability of
+
+On line 204:
+ directions. Second,
+ we examined the role of
+ the GSEs, with Fannie
+
+On line 204:
+ government-sponsored
+ enterprises had a deeply
+ flawed business model
+
+On line 204:
+ corporations with
+ the implicit backing of
+ and subsidies from
+
+On line 206:
+ mortgage exposure
+ and market position were
+ significant. In
+
+On line 208:
+ and they decided
+ to ramp up their purchase and
+ guarantee of risky
+
+On line 208:
+ just as the housing
+ market was peaking. They used
+ their political
+
+On line 208:
+ for decades to ward off
+ effective regulation
+ and oversight—spending
+
+On line 210:
+ on lobbying from
+ to They suffered from many of
+ the same failures of
+
+On line 210:
+ management as the
+ Commission discovered in
+ other financial
+
+On line 212:
+ the third quarter of
+ the Treasury Department had
+ provided billion
+
+On line 214:
+ We conclude that these
+ two entities contributed
+ to the crisis, but
+
+On line 214:
+ maintained their value
+ throughout the crisis and did
+ not contribute to
+
+ the significant
+ financial firm losses that
+ were central to the
+
+ financial crisis.
+ The GSEs participated
+ in the expansion
+
+On line 216:
+ subprime and other
+ risky mortgages, but they followed
+ rather than led Wall Street
+
+On line 216:
+ other lenders in the
+ rush for fool’s gold. They purchased
+ the highest rated
+
+On line 216:
+ added helium to
+ the housing balloon, but their
+ purchases never
+
+On line 216:
+ majority of
+ the market. Those purchases
+ represented of
+
+On line 218:
+ non-GSE subprime mortgage-backed
+ securities in with the
+ share rising to in
+
+On line 218:
+ loans and related
+ securities in order
+ to meet stock market
+
+On line 218:
+ regain market share,
+ and to ensure generous
+ compensation for
+
+ their executives
+ and employees—justifying
+ their activities
+
+On line 218:
+ the broad and sustained
+ public policy support
+ for homeownership.
+
+On line 220:
+ of the loans purchased
+ or guaranteed by Fannie
+ and Freddie. While they
+
+On line 220:
+ substantial losses,
+ delinquency rates for GSE loans
+ were substantially
+
+On line 220:
+ securitized by
+ other financial firms. For
+ example, data
+
+On line 220:
+ Commission for a
+ subset of borrowers with
+ similar credit
+
+On line 220:
+ below 660—show that by
+ the end of GSE mortgages were
+ far less likely to
+
+On line 222:
+ non-GSE securitized
+ mortgages: versus We also
+ studied at length how
+
+On line 222:
+ Development’s (HUD’s)
+ affordable housing goals for
+ the GSEs affected
+
+On line 222:
+ CONCLUSIONS OF THE
+ FINANCIAL CRISIS INQUIRY
+ COMMISSION xxvii risky
+
+On line 222:
+ on the evidence
+ and interviews with dozens of
+ individuals
+
+On line 222:
+ this subject area, we
+ determined these goals only
+ contributed marginally
+
+On line 224:
+ Fannie’s and Freddie’s
+ participation in those
+ mortgages. Finally,
+
+On line 224:
+ the matter of whether
+ government housing policies
+ were a primary
+
+On line 224:
+ for decades, government
+ policy has encouraged
+ homeownership through
+
+On line 224:
+ programs, and mandates.
+ These policies were put in place
+ and promoted by
+
+On line 224:
+ and Congresses—indeed,
+ both Presidents Bill Clinton
+ and George W. Bush set
+
+On line 226:
+ homeownership. In
+ conducting our inquiry, we
+ took a careful look
+
+On line 226:
+ noted above, and the
+ Community Reinvestment
+ Act (CRA). The CRA was
+
+On line 226:
+ enacted in to
+ combat "redlining" by banks—the
+ practice of denying
+
+On line 226:
+ individuals
+ and businesses in certain
+ neighborhoods without
+
+On line 226:
+ The CRA requires banks
+ and savings and loans to lend,
+ invest, and provide
+
+On line 228:
+ the CRA was not a
+ significant factor in
+ subprime lending or
+
+On line 228:
+ subprime lenders were not
+ subject to the CRA. Research
+ indicates only
+
+On line 228:
+ of high-cost loans—a
+ proxy for subprime loans—had any
+ connection to the
+
+ law. Loans made by CRA-regulated
+ lenders in the neighborhoods in
+ which they were required
+
+On line 228:
+ were half as likely
+ to default as similar
+ loans made in the same
+
+On line 228:
+ by independent
+ mortgage originators not
+ subject to the law.
+
+On line 230:
+ this respect: As a
+ nation, we set aggressive
+ homeownership goals
+
+On line 230:
+ extend credit to
+ families previously
+ denied access to
+
+On line 230:
+ the philosophy
+ of opportunity was
+ being matched by the
+
+On line 230:
+ ground. Witness again the
+ failure of the Federal
+ Reserve and other
+
+On line 230:
+ irresponsible
+ lending. Homeownership peaked
+ in the spring of and
+
+On line 230:
+ began to decline.
+ From that point on, the talk of
+ opportunity
+
+On line 230:
+ tragically at
+ odds with the reality
+ of a financial
+
+On line 236:
+ disaster in the
+ making. WHEN THIS COMMISSION
+ began its work months
+
+On line 236:
+ some imagined that the
+ events of and their consequences
+ would be well behind
+
+ us by the time we
+ issued this report. Yet more
+ than two years after
+
+On line 236:
+ an unprecedented
+ manner in our financial
+ markets, our country
+
+On line 236:
+ aftereffects of
+ the calamity. Our financial
+ system is, in many
+
+ respects, still unchanged
+ from what existed on the
+ eve of the crisis.
+
+On line 236:
+ in the wake of the
+ crisis, the U.S. financial
+ sector is now more
+
+On line 236:
+ While we have not been
+ charged with making policy
+ recommendations,
+
+ the very purpose of
+ our report has been to take
+ stock of what happened
+
+On line 236:
+ we can plot a new
+ course. In our inquiry, we found
+ dramatic breakdowns
+
+On line 236:
+ profound lapses in
+ regulatory oversight,
+ and near fatal flaws
+
+On line 238:
+ series of choices
+ and actions led us toward
+ a catastrophe for
+
+On line 238:
+ we were ill prepared.
+ These are serious matters
+ that must be addressed
+
+On line 238:
+ to restore faith in
+ our financial markets, to
+ avoid the next crisis,
+
+On line 238:
+ rebuild a system
+ of capital that provides
+ the foundation for
+
+On line 240:
+ shared prosperity.
+ The greatest tragedy would be to
+ accept the refrain
+
+On line 240:
+ no one could have seen
+ this coming and thus nothing
+ could have been done. If
+
+On line 242:
+ this notion, it will
+ happen again. This report should
+ not be viewed as the
+
+ end of the nation’s
+ examination of this
+ crisis. There is still
+
+On line 244:
+ is our collective
+ responsibility. It
+ falls to us to make
+
+On line 261:
+ we want different
+ results. PART I Crisis on
+ the Horizon BEFORE
+
+On line 263:
+ examining the
+ worst financial meltdown since
+ the Great Depression,
+
+On line 263:
+ Financial Crisis
+ Inquiry Commission reviewed
+ millions of pages of
+
+On line 265:
+ people from all walks
+ of life—to find out how and
+ why it happened. In
+
+On line 265:
+ public officials
+ testified that they had been
+ blindsided by the
+
+ crisis, describing
+ it as a dramatic and
+ mystifying turn
+
+ of events. Even among those
+ who worried that the housing
+ bubble might burst, few—if
+
+On line 267:
+ the magnitude of
+ the crisis that would ensue.
+ Charles Prince, the former
+
+On line 267:
+ chief executive
+ officer of Citigroup
+ Inc., called the collapse
+
+On line 267:
+ housing prices "wholly
+ unanticipated."1 Warren
+ Buffett, the chairman
+
+On line 267:
+ of Berkshire Hathaway
+ Inc., which until was the largest
+ single shareholder
+
+On line 267:
+ Moody’s Corporation,
+ told the Commission that "very,
+ very few people could
+
+On line 267:
+ the bubble," which he
+ called a "mass delusion" shared by
+ million Americans."2
+
+On line 267:
+ the chairman and chief
+ executive officer
+ of Goldman Sachs Group,
+
+On line 269:
+ likened the financial
+ crisis to a hurricane.3
+ Regulators echoed
+
+On line 269:
+ similar refrain.
+ Ben Bernanke, the chairman of the
+ Federal Reserve
+
+On line 269:
+ told the Commission
+ a "perfect storm" had occurred
+ that regulators
+
+On line 269:
+ when asked about whether the
+ Fed’s lack of aggressiveness
+ in regulating
+
+On line 269:
+ market during the
+ housing boom was a failure,
+ Bernanke responded, "It
+
+On line 269:
+ indeed. I think it
+ was the most severe failure
+ of the Fed in this
+
+On line 269:
+ episode."4 Alan Greenspan, the Fed
+ chairman during the two decades
+ leading up to the
+
+On line 269:
+ Commission that it
+ was beyond the ability
+ of regulators
+
+On line 271:
+ cannot identify
+ the timing of a crisis,
+ or anticipate
+
+ exactly where it
+ will be located or how
+ large the losses and
+
+ spillovers will be."5 In fact,
+ there were warning signs. In the
+ decade preceding the
+
+On line 273:
+ there were many signs that
+ house prices were inflated, that
+ lending practices had
+
+ spun out of control,
+ that too many homeowners were
+ taking on mortgages
+
+ and debt they could ill
+ afford, and that risks to the
+ financial system
+
+On line 273:
+ were clanging inside
+ financial institutions,
+ regulatory
+
+On line 273:
+ organizations,
+ state law enforcement agencies,
+ and corporations
+
+ throughout America,
+ as well as in neighborhoods
+ across the country. Many
+
+On line 273:
+ to avoid the train wreck.
+ While countless Americans joined
+ in the financial
+
+On line 273:
+ others were shouting
+ to government officials
+ in Washington and
+
+On line 273:
+ to what would become
+ a human disaster, not
+ just an economic
+
+On line 275:
+ "Everybody in the
+ whole world knew that the mortgage
+ bubble was there," said
+
+On line 275:
+ the former chairman
+ of the Securities and
+ Exchange Commission
+
+On line 275:
+ President George H.
+ W. Bush. "I mean, it wasn’t
+ hidden. You cannot
+
+On line 275:
+ at any of this and
+ say that the regulators
+ did their job. This was
+
+On line 275:
+ some hidden problem.
+ It wasn’t out on Mars or
+ Pluto or somewhere.
+
+On line 275:
+ It was right here. You
+ can’t make trillions of dollars’
+ worth of mortgages and
+
+On line 277:
+ notice."6 Paul McCulley, a
+ managing director at
+ PIMCO, one of the
+
+On line 277:
+ money management
+ firms, told the Commission that
+ he and his colleagues
+
+On line 277:
+ to get worried about
+ "serious signs of bubbles"
+ in they therefore sent
+
+On line 279:
+ cities to do what he
+ called "old-fashioned shoe-leather research,"
+ talking to real
+
+On line 279:
+ brokers, and local
+ investors about the housing and
+ mortgage markets. They
+
+On line 279:
+ outright degradation
+ of underwriting standards,"
+ McCulley asserted, and
+
+On line 279:
+ shared what they had learned
+ when they got back home to the
+ company’s Newport
+
+On line 279:
+ when our group came back,
+ they reported what they saw,
+ and we adjusted
+
+On line 281:
+ those who remembered
+ the savings and loan crisis,
+ knew that age-old rules of
+
+On line 281:
+ cast aside. Arnold Cattani,
+ the chairman of Bakersfield,
+ California–based
+
+On line 281:
+ the Commission that
+ he grew uncomfortable with
+ the "pure lunacy"
+
+On line 281:
+ saw in the local
+ home-building market, fueled
+ by "voracious" Wall
+
+On line 281:
+ investment banks; he
+ thus opted out of certain
+ kinds of investments
+
+On line 283:
+ vice chairman and chief
+ executive officer
+ of Service 1st Bank
+
+ of Nevada, told the
+ FCIC that the desire for a
+ "high and quick return"
+
+ blinded people to
+ fiscal realities. "You
+ may recall Tommy
+
+ Lee Jones in Men in
+ Black, where he holds a device
+ in the air, and with
+
+On line 283:
+ bright flash wipes clean the
+ memories of everyone
+ who has witnessed an
+
+On line 285:
+ event," he said.9 Unlike
+ so many other bubbles—tulip bulbs
+ in Holland in the
+
+On line 285:
+ South Sea stocks in the
+ 1700s, Internet stocks in the
+ late 1990s—this one involved
+
+On line 285:
+ the economy: the
+ family home. Homes are the
+ foundation upon
+
+On line 285:
+ economic structures
+ rest. Children usually go
+ to schools linked to their
+
+On line 285:
+ addresses; local
+ governments decide how much
+ money they can spend
+
+ on roads, firehouses,
+ and public safety based on
+ how much property
+
+ tax revenue they have;
+ house prices are tied to consumer
+ spending. Downturns in
+
+On line 289:
+ cause ripple effects
+ almost everywhere. When the
+ Federal Reserve
+
+On line 289:
+ mortgage rates fell, home
+ refinancing surged, climbing
+ from billion in to
+
+On line 289:
+ allowing people
+ to withdraw equity built
+ up over previous
+
+ decades and to consume
+ more, despite stagnant wages. Home
+ sales volume started
+
+On line 289:
+ and average home
+ prices nationwide climbed, rising
+ in eight years by one
+
+On line 289:
+ measure and hitting
+ a national high of in
+ early Home prices in
+
+On line 289:
+ skyrocketed: prices
+ increased nearly two and one-half
+ times in Sacramento,
+
+On line 289:
+ example, in just
+ five years,12 and shot up by about
+ the same percentage
+
+On line 289:
+ Prices about doubled in
+ more than metropolitan
+ areas, including
+
+On line 289:
+ Poughkeepsie, San Diego,
+ and West Palm Beach.13 Housing starts
+ nationwide climbed from
+
+On line 291:
+ reached a record in the
+ spring of although it wouldn’t
+ rise an inch further
+
+On line 291:
+ machine kept churning
+ for another three years. By
+ refinancing their
+
+On line 293:
+ equity between
+ and including billion in
+ alone, more than seven
+
+On line 293:
+ speculators and
+ potential homeowners stood
+ in line outside new
+
+On line 293:
+ for a chance to buy
+ houses before the ground had
+ even been broken. By
+
+On line 293:
+ the first half of more
+ than one out of every ten
+ home sales was to an
+
+On line 293:
+ or someone buying
+ a second home.15 Bigger was
+ better, and even the
+
+On line 293:
+ ballooned in size; the
+ floor area of an average
+ new home grew by to
+
+On line 295:
+ decade from to Money
+ washed through the economy like
+ water rushing through
+
+On line 297:
+ Low interest rates
+ and then foreign capital
+ helped fuel the boom.
+
+On line 297:
+ real estate agents,
+ loan brokers, and appraisers
+ profited on Main
+
+ Street, while investment
+ bankers and traders on Wall Street moved
+ even higher on the
+
+ American earnings
+ pyramid and the share prices of
+ the most aggressive
+
+On line 297:
+ firms reached all-time
+ highs.16 Homeowners pulled cash out
+ of their homes to send
+
+ their kids to college,
+ pay medical bills, install
+ designer kitchens with
+
+On line 297:
+ vacations, or launch
+ new businesses. They also
+ paid off credit cards,
+
+On line 297:
+ as personal debt
+ rose nationally. Survey
+ evidence shows that
+
+On line 297:
+ homeowners pulled out
+ cash to buy a vehicle
+ and over spent the cash
+
+On line 297:
+ tax payments, clothing,
+ gifts, and living expenses.17
+ Renters used new forms of
+
+On line 297:
+ homes and to move to
+ suburban subdivisions,
+ erect-ing swing sets in
+
+On line 299:
+ backyards and enrolling
+ their children in local schools.
+ In an interview
+
+On line 299:
+ the longtime CEO of
+ Countrywide Financial—a lender
+ brought down by its risky
+
+On line 301:
+ rush" mentality
+ overtook the country during
+ these years, and that he
+
+On line 301:
+ swept up in it as
+ well: "Housing prices were rising
+ so rapidly—at a rate
+
+On line 301:
+ that I’d never seen
+ in my years in the business—that
+ people, regular
+
+ people, average
+ people got caught up in the
+ mania of buying
+
+ a house, and flipping
+ it, making money. It was
+ happening. They buy
+
+On line 303:
+ house, make and talk at
+ a cocktail party about it.
+ Housing suddenly
+
+ went from being part
+ of the American dream to
+ house my family
+
+ to settle down—it
+ became a commodity.
+ That was a change in
+
+On line 305:
+ the culture. It was
+ sudden, unexpected."18 On
+ the surface, it looked
+
+On line 305:
+ into investments
+ called securities, which kept
+ cash flowing from Wall
+
+ Street into the U.S.
+ housing market—were tools that had
+ worked well for many years.
+
+On line 307:
+ going wrong. Like a
+ science fiction movie in which
+ ordinary household
+
+On line 307:
+ were being transformed.
+ The time-tested 30-year fixed-rate mortgage,
+ with a down payment,
+
+On line 307:
+ of style. There was a
+ burgeoning global demand
+ for residential
+
+On line 307:
+ securities that
+ offered seemingly solid
+ and secure returns.
+
+On line 307:
+ around the world clamored
+ to purchase securities
+ built on American
+
+On line 309:
+ estate, seemingly
+ one of the safest bets in the
+ world. Wall Street labored
+
+On line 309:
+ demand. Bond salesmen
+ earned multi-million-dollar
+ bonuses packaging
+
+ and selling new kinds
+ of loans, offered by new kinds
+ of lenders, into new
+
+ kinds of investment
+ products that were deemed safe but
+ possessed complex and
+
+On line 309:
+ changes—these financial
+ innovations, they said, had
+ lowered borrowing
+
+On line 309:
+ consumers and moved risks
+ away from the biggest and most
+ systemically
+
+On line 309:
+ in ways that were not
+ understood by either the
+ captains of finance
+
+On line 309:
+ the system’s public
+ stewards. In fact, some of the
+ largest institutions
+
+On line 309:
+ on what would prove to
+ be debilitating risks.
+ Trillions of dollars
+
+ had been wagered on
+ the belief that housing prices
+ would always rise and
+
+ that borrowers would
+ seldom default on mortgages,
+ even as their debt grew.
+
+On line 309:
+ loans had been bundled
+ into investment products
+ in ways that seemed to
+
+On line 309:
+ worlds—high-yield, risk-free—but
+ instead, in many cases, would
+ prove to be high-risk
+
+ and yield-free. All this
+ financial creativity
+ was a lot "like cheap
+
+On line 311:
+ Mayo, a managing
+ director and financial
+ services analyst
+
+On line 311:
+ repackaged to sell at
+ a premium," he told the
+ Commission. "It might
+
+ taste good for a while,
+ but then you get headaches later
+ and you have no idea
+
+On line 313:
+ really inside."19
+ The securitization
+ machine began to
+
+On line 313:
+ these once-rare mortgage
+ products with their strange-sounding
+ names: Alt-A, subprime, I-O
+
+On line 313:
+ low-doc, no-doc, or
+ ninja (no income, no job,
+ no assets) loans; 2–28s
+
+On line 313:
+ piggyback second
+ mortgages; payment-option or
+ pick-a-pay adjustable
+
+On line 313:
+ variants on adjustable-rate
+ mortgages, called "exploding" ARMs,
+ featured low monthly
+
+On line 313:
+ at first, but payments
+ could suddenly double or
+ triple, if borrowers
+
+On line 313:
+ of different kinds
+ of mortgages available on the
+ market, confounding
+
+On line 313:
+ examine the fine
+ print, baffling conscientious
+ borrowers who tried
+
+ to puzzle out their
+ implications, and opening
+ the door for those who
+
+On line 315:
+ in on the action.
+ Many people chose poorly. Some
+ people wanted to
+
+ live beyond their means,
+ and by mid-2005, nearly one-quarter
+ of all borrowers
+
+On line 315:
+ them to defer the
+ payment of principal.20 Some
+ borrowers opted
+
+On line 315:
+ nontraditional
+ mortgages because that was the
+ only way they could
+
+On line 315:
+ foothold in areas such
+ as the sky-high California
+ housing market.21 Some
+
+On line 315:
+ and Georgia became
+ a particular target
+ for investors who used
+
+On line 315:
+ to acquire real
+ estate.22 Some were misled by
+ salespeople who came
+
+On line 315:
+ homes and persuaded
+ them to sign loan documents
+ on their kitchen tables.
+
+On line 315:
+ mortgage brokers who
+ earned more money placing them
+ in risky loans than in
+
+ safe ones.23 With these loans,
+ buyers were able to bid up
+ the prices of houses
+
+On line 315:
+ if they didn’t have
+ enough income to qualify
+ for traditional
+
+On line 317:
+ these exotic loans
+ had existed in the past,
+ used by high-income,
+
+On line 317:
+ secure people as
+ a cash-management tool. Some
+ had been targeted
+
+On line 317:
+ they refinanced. But
+ the instruments began to
+ deluge the larger
+
+On line 317:
+ and The changed occurred
+ "almost overnight," Faith Schwartz, then an
+ executive at
+
+On line 317:
+ lender Option One and
+ later the executive
+ director of Hope
+
+On line 317:
+ "I would suggest most
+ every lender in the country
+ is in it, one way
+
+On line 319:
+ a lot of people
+ really understood the
+ potential hazards
+
+ of these new loans. They
+ were new, they were different,
+ and the consequences
+
+ were uncertain. But
+ it soon became apparent
+ that what had looked like
+
+On line 319:
+ the United States climbed
+ from trillion in to trillion
+ in The mortgage debt
+
+On line 319:
+ American households
+ rose almost as much in the
+ six years from to as
+
+ it had over the course
+ of the country’s more than 200-year
+ history. The amount
+
+On line 319:
+ per household rose from
+ in to in With a simple
+ flourish of a pen
+
+ on paper, millions
+ of Americans traded away
+ decades of equity
+
+ tucked away in their homes.
+ Under the radar, the lending
+ and the financial
+
+On line 321:
+ mutated. In the
+ past, lenders had avoided making
+ unsound loans because
+
+ they would be stuck with
+ them in their loan portfolios.
+ But because of the
+
+On line 321:
+ clear anymore who the
+ lender was. The mortgages would be
+ packaged, sliced, repackaged,
+
+On line 321:
+ securities to
+ an assortment of hungry
+ investors. Now even the
+
+On line 323:
+ find a buyer. More
+ loan sales meant higher profits
+ for everyone in
+
+On line 323:
+ that were expanding
+ mortgage originations. He
+ crisscrossed the nation,
+
+On line 325:
+ originators a
+ year in auditoriums
+ and classrooms. is clients
+
+ included many of
+ the largest lenders—Countrywide, Ameriquest, and Ditech among
+ them. Most of their new
+
+ hires were young, with no
+ mortgage experience, fresh
+ out of school and with
+
+On line 327:
+ "flipping burgers," he
+ told the FCIC. Given the right
+ training, however,
+
+On line 329:
+ could "easily" earn
+ millions.26 "I was a sales and
+ marketing trainer
+
+ in terms of helping
+ people to know how to sell
+ these products to, in
+
+On line 329:
+ and unsuspecting
+ borrowers," he said. He taught
+ them the new playbook:
+
+On line 329:
+ to be concerned about
+ the quality of the loan,
+ whether it was suitable
+
+ for the borrower
+ or whether the loan performed. In
+ fact, you were in a
+
+On line 329:
+ encouraged not to
+ worry about those macro issues."
+ He added, "I knew that
+
+ the risk was being
+ shunted off. I knew that we
+ could be writing crap.
+
+On line 329:
+ in the end it was
+ like a game of musical
+ chairs. Volume might go
+
+ down but we were not
+ going to be hurt."27 On Wall
+ Street, where many of these
+
+On line 331:
+ were packaged into
+ securities and sold to
+ investors around the globe,
+
+ a new term was coined:
+ IBGYBG, "I’ll be gone, you’ll
+ be gone."28 It referred
+
+ to deals that brought in
+ big fees up front while risking
+ much larger losses
+
+On line 331:
+ the future. And, for
+ a long time, IBGYBG worked
+ at every level.
+
+On line 333:
+ entered the pipeline
+ soon after borrowers signed
+ the documents and
+
+ picked up their keys. Loans
+ were put into packages and
+ sold off in bulk to
+
+On line 333:
+ banks such as Merrill
+ Lynch, Bear Stearns, and Lehman Brothers,
+ and commercial banks
+
+ and thrifts such as Citibank,
+ Wells Fargo, and Washington
+ Mutual. The firms
+
+On line 333:
+ mostly be stamped with
+ triple-A ratings by the credit
+ rating agencies, and
+
+On line 333:
+ riskier portions of
+ these securities—which would then
+ be sold to other
+
+On line 333:
+ would also receive
+ the coveted triple-A ratings
+ that investors believed
+
+ attested to their
+ quality and safety. Some
+ investors would buy an
+
+ invention from the
+ 1990s called a credit default
+ swap (CDS) to protect
+
+On line 333:
+ For every buyer
+ of a credit default swap,
+ there was a seller:
+
+ as these investors made
+ opposing bets, the layers
+ of entanglement
+
+On line 335:
+ The instruments grew
+ more and more complex; CDOs were
+ constructed out of
+
+On line 335:
+ creating CDOs squared.
+ When firms ran out of real
+ product, they started
+
+On line 335:
+ but just of bets on
+ other mortgage products. Each
+ new permutation
+
+On line 335:
+ to extract more fees
+ and trading profits. And each
+ new layer brought in
+
+On line 335:
+ investors wagering
+ on the mortgage market—even well
+ after the market
+
+ had started to turn.
+ So by the time the process was
+ complete, a mortgage
+
+On line 335:
+ in south Florida
+ might become part of dozens of
+ securities owned
+
+On line 335:
+ Treasury Secretary
+ Timothy Geithner,
+ the president of
+
+On line 335:
+ crisis, described the
+ resulting product as "cooked
+ spaghetti" that became
+
+ hard to "untangle."29
+ Ralph Cioffi spent several
+ years creating CDOs
+
+On line 337:
+ and a couple of
+ more years on the repurchase
+ or "repo" desk, which
+
+On line 337:
+ responsible for
+ borrowing money every
+ night to finance Bear
+
+On line 337:
+ Cioffi created
+ a hedge fund within Bear Stearns
+ with a minimum
+
+On line 337:
+ money—up to borrowed
+ for every from investors—to buy
+ CDOs. Cioffi’s first fund
+
+On line 337:
+ for investors in and
+ in 2005—after the annual
+ management fee and
+
+On line 337:
+ profit for Cioffi
+ and his Bear Stearns team—and grew
+ to almost billion
+
+On line 337:
+ of In the fall of
+ he created another,
+ more aggressive fund.
+
+On line 337:
+ This one would shoot for
+ leverage of up to to By
+ the end of the two
+
+On line 337:
+ in securities
+ issued by CDOs centered on
+ housing. As a CDO
+
+On line 339:
+ mortgage-related CDOs
+ for other investors. Cioffi’s
+ investors and others
+
+On line 341:
+ high-yielding mortgage
+ securities. That, in turn,
+ required high-yielding
+
+On line 341:
+ borrowers, urging
+ them to buy or refinance
+ homes. Direct-mail
+
+On line 341:
+ people’s mailboxes.30
+ Dancing figures, depicting
+ happy homeowners,
+
+On line 341:
+ hook with calls from loan
+ officers offering the
+ latest loan products:
+
+ One percent loan! (But
+ only for the first year.) No
+ money down! (Leaving
+
+On line 341:
+ if home prices fell.) No
+ income documentation
+ needed! (Mortgages soon
+
+On line 341:
+ industry itself.)
+ Borrowers answered the call,
+ many believing that
+
+ with ever-rising prices,
+ housing was the investment
+ that couldn’t lose. In
+
+On line 343:
+ four intermingled
+ issues came into play that
+ made it difficult
+
+ to acknowledge the
+ looming threats. First, efforts to
+ boost homeownership
+
+On line 343:
+ broad political
+ support—from Presidents Bill
+ Clinton and George W.
+
+ Bush and successive
+ Congresses—even though in
+ reality the
+
+On line 343:
+ the spring of Second,
+ the real estate boom was
+ generating a
+
+On line 343:
+ of cash on Wall Street
+ and creating a lot of
+ jobs in the housing
+
+On line 343:
+ believed that even if
+ the housing market tanked, the
+ broader financial
+
+On line 345:
+ would hold up. As the
+ mortgage market began its
+ transformation in
+
+ the late 1990s, consumer
+ advocates and front-line
+ local government
+
+On line 345:
+ among the first to spot
+ the changes: homeowners began
+ streaming into their
+
+ offices to seek help
+ in dealing with mortgages they
+ could not afford to
+
+On line 345:
+ began raising the
+ issue with the Federal
+ Reserve and other
+
+On line 345:
+ general counsel
+ and policy director
+ of the Greenlining
+
+On line 345:
+ California-based
+ nonprofit housing group, told
+ the Commission that
+
+On line 345:
+ he began meeting
+ with Greenspan at least once a year
+ starting in each time
+
+On line 345:
+ to him the growth of
+ predatory lending practices
+ and discussing with him
+
+On line 347:
+ economic problems
+ they were creating.32 One of
+ the first places to see
+
+On line 347:
+ an entire market
+ was Cleveland, Ohio. From to home
+ prices in Cleveland rose
+
+On line 349:
+ median of to
+ while home prices nationally
+ rose about in those same
+
+On line 349:
+ years; at the same time,
+ the city’s unemployment rate,
+ ranging rom in to
+
+On line 351:
+ more or less tracked the
+ broader U.S. pattern. James Rokakis,
+ the longtime county
+
+On line 351:
+ of Cuyahoga County,
+ where Cleveland is located,
+ told the Commission
+
+On line 351:
+ the region’s housing
+ market was juiced by "flipping
+ on mega-steroids," with rings
+
+On line 351:
+ appraisers, and loan
+ originators earning fees
+ on each transaction
+
+On line 353:
+ Street. City officials
+ began to hear reports that
+ these activities
+
+On line 353:
+ propelled by new kinds
+ of nontraditional loans
+ that enabled investors
+
+On line 353:
+ buy properties with
+ little or no money down
+ and gave homeowners
+
+On line 353:
+ to refinance their
+ houses, regardless of whether
+ they could afford to
+
+On line 353:
+ the loans. Foreclosures
+ shot up in Cuyahoga County
+ from a year in to
+
+On line 353:
+ a year in Rokakis and
+ other public officials
+ watched as families
+
+ who had lived for years
+ in modest residences lost
+ their homes. After they
+
+On line 353:
+ were ultimately
+ abandoned, vandalized, and then
+ stripped bare, as scavengers
+
+On line 355:
+ siding to sell for
+ scrap. "Securitization
+ was one of the most
+
+ brilliant financial
+ innovations of the 20th
+ century," Rokakis told
+
+On line 355:
+ Commission. "It freed
+ up a lot of capital.
+ If it had been done
+
+ responsibly, it
+ would have been a wondrous thing
+ because nothing is
+
+On line 357:
+ nothing safer, than the
+ American mortgage market.
+ It worked for years. But
+
+On line 359:
+ scam it."34 Officials
+ in Cleveland and other Ohio
+ cities reached out to the
+
+On line 359:
+ for help. They asked the
+ Federal Reserve, the one
+ entity with the
+
+On line 359:
+ risky lending practices
+ by all mortgage lenders, to use
+ the power it had
+
+On line 359:
+ in under the Home
+ Ownership and Equity
+ Protection Act (HOEPA)
+
+On line 359:
+ new mortgage lending
+ rules. In March Fed Governor
+ Edward Gramlich, an
+
+On line 359:
+ access to credit
+ but only with safeguards in
+ place, attended a
+
+ conference on the
+ topic in Cleveland. He spoke
+ about the Fed’s power
+
+On line 359:
+ HOEPA, declared some of
+ the lending practices to be
+ "clearly illegal,"
+
+On line 363:
+ enforcement measures."35
+ Looking back, Rokakis remarked to
+ the Commission, "I
+
+ naively believed they’d
+ go back and tell Mr. Greenspan and
+ presto, we’d have some new
+
+On line 363:
+ rules. I thought it would
+ result in action being
+ taken. It was kind
+
+On line 365:
+ Cleveland was looking
+ for help from the federal
+ government, other
+
+On line 365:
+ around the country were
+ doing the same. John Taylor,
+ the president of
+
+On line 365:
+ of community
+ leaders from Nevada, Michigan,
+ Maryland, Delaware,
+
+On line 365:
+ New Jersey, and Ohio,
+ went to the Office of Thrift
+ Supervision (OTS),
+
+On line 365:
+ loan institutions,
+ asking the agency to crack
+ down on what they called
+
+On line 367:
+ believed were putting both
+ borrowers and lenders at risk.37
+ The California
+
+On line 367:
+ group based in Northern
+ California, also begged
+ regulators to
+
+On line 367:
+ officials told the
+ Commission. The nonprofit
+ group had reviewed the
+
+On line 367:
+ and discovered that
+ many individuals were
+ being placed into
+
+ high-cost loans when
+ they qualified for better
+ mortgages and that many
+
+ had been misled about
+ the terms of their loans.38 There were
+ government reports,
+
+On line 371:
+ Treasury Department
+ issued a joint report on
+ predatory lending
+
+On line 371:
+ that made a number
+ of recommendations for
+ reducing the risks
+
+On line 371:
+ to borrowers.39 In
+ December the Federal
+ Reserve Board used the
+
+ HOEPA law to amend some
+ regulations; among the changes
+ were new rules aimed at
+
+On line 371:
+ refinancings over
+ a short period of time,
+ if they were not in
+
+ the borrower’s best
+ interest.40 As it would turn
+ out, those rules covered
+
+On line 371:
+ only of subprime
+ loans. FDIC Chairman Sheila C. Bair,
+ then an assistant
+
+ treasury secretary
+ in the administration
+ of President George
+
+On line 371:
+ Bush, characterized
+ the action to the FCIC as
+ addressing only
+
+On line 371:
+ a "narrow range of
+ predatory lending issues."41
+ In Gramlich noted
+
+On line 371:
+ "increasing reports
+ of abusive, unethical
+ and in some cases,
+
+On line 373:
+ lending practices."42 Bair
+ told the Commission that this
+ was when "really
+
+On line 373:
+ on traditional
+ banks to follow suit.43 She said
+ that she and Gramlich
+
+ considered seeking
+ rules to rein in the growth of
+ these kinds of loans, but
+
+ Gramlich told her that
+ he thought the Fed, despite its
+ broad powers in this
+
+ area, would not support
+ the effort. Instead, they sought
+ voluntary rules for
+
+On line 375:
+ but that effort fell
+ by the wayside as well.44 In
+ an environment
+
+On line 375:
+ standards declined. The
+ companies issuing these
+ loans made profits that
+
+On line 377:
+ rose sharply. In the top
+ nonprime lenders originated
+ billion in loans. Their
+
+On line 379:
+ billion in and then
+ billion in California,
+ with its high housing
+
+On line 379:
+ kind of lending. In
+ nearly billion, or of all
+ nontraditional
+
+On line 379:
+ nationwide, were made
+ in that state; California’s
+ share rose to by with
+
+On line 379:
+ growing to billion
+ or by in California
+ in just two years.46 In
+
+On line 379:
+ director of the
+ California Reinvestment
+ Coalition, testified
+
+On line 379:
+ the Commission. "We
+ estimated at that time
+ that the average
+
+On line 379:
+ California was
+ paying over more per month on
+ their mortgage payment
+
+On line 381:
+ result of having
+ received the subprime loan."47 Gail
+ Burks, president and
+
+On line 381:
+ Nevada Fair Housing,
+ Inc., a Las Vegas–based
+ housing clinic, told
+
+On line 381:
+ Commission she and
+ other groups took their concerns
+ directly to Greenspan
+
+On line 383:
+ time, describing to
+ him in person what she called
+ the "metamorphosis"
+
+On line 383:
+ industry. She told
+ him that besides predatory
+ lending practices such
+
+ as flipping loans or
+ misinforming seniors about
+ reverse mortgages, she
+
+On line 385:
+ accounts.48 Lisa Madigan,
+ the attorney general
+ in Illinois, also
+
+On line 385:
+ Consumers complained that
+ they had been deceived into
+ taking out loans with
+
+On line 387:
+ fees. The company
+ was then packaging the loans
+ and selling them as
+
+ securities to
+ Lehman Brothers, Madigan said. The
+ case was settled in
+
+On line 387:
+ received million. First
+ Alliance went out of business.
+ But other firms stepped
+
+On line 389:
+ to investigate
+ another fast-growing lender,
+ California-based
+
+On line 389:
+ nation’s largest subprime
+ lender, originating billion
+ in subprime loans in
+
+ 2003—mostly refinances
+ that let borrowers take cash
+ out of their homes, but
+
+On line 391:
+ hefty fees that ate away
+ at their equity.50 Madigan
+ testified to the
+
+On line 391:
+ Ameriquest revealed that the
+ company engaged in the
+ kinds of fraudulent
+
+On line 391:
+ lenders subsequently
+ emulated on a wide
+ scale: inflating home
+
+On line 391:
+ interest rates on
+ borrowers’ loans or switching
+ their loans from fixed to
+
+ adjustable interest
+ rates at closing; and promising
+ borrowers that they
+
+ could refinance their
+ costly loans into loans with
+ better terms in just
+
+ a few months or a
+ year, even when borrowers had
+ no equity to
+
+ absorb another
+ refinance."51 Ed Parker, the
+ former head of Ameriquest’s
+
+On line 393:
+ the Commission that
+ he detected fraud at the
+ company within
+
+On line 393:
+ month of starting his
+ job there in January but
+ senior management
+
+ did nothing with the
+ reports he sent. He heard that
+ other departments
+
+On line 395:
+ were complaining he
+ "looked too much" into the loans.
+ In November he
+
+On line 399:
+ from "manager" to
+ "supervisor," and was laid
+ off in May In late
+
+On line 399:
+ its loans. He received
+ about boxes of documents.
+ He pulled one file at
+
+ random, and stared at
+ it. He pulled out another
+ and another. He
+
+ noted file after
+ file where the borrowers were
+ described as "an-tiques
+
+On line 399:
+ he recalled in an
+ interview with the FCIC, a
+ disabled borrower
+
+On line 399:
+ his 80s who used a
+ walker was described in the
+ loan application
+
+On line 403:
+ being employed in
+ "light construction."53 "It didn’t
+ take Sherlock Holmes to
+
+On line 403:
+ out this was bogus,"
+ Cox told the Commission. As
+ he tried to figure
+
+On line 403:
+ suggested that he
+ "look upstream." Cox suddenly
+ realized that the
+
+On line 405:
+ product to ship to
+ Wall Street to sell to investors.
+ "I got that it had
+
+On line 407:
+ "The lending pattern
+ had shifted."54 Ultimately,
+ states and the District
+
+ of Columbia joined
+ in the lawsuit against Ameriquest, on
+ behalf of "more than
+
+On line 407:
+ million settlement.
+ But during the years when the
+ investigation
+
+On line 409:
+ way, between and Ameriquest
+ originated another
+ billion in loans,55 which
+
+On line 411:
+ investigation,
+ some federal officials
+ said they had followed
+
+On line 411:
+ Housing and Urban
+ Development, "we began
+ to get rumors" that
+
+On line 411:
+ firms were "running wild,
+ taking applications over
+ the Internet, not
+
+On line 411:
+ peoples’ income or
+ their ability to have a
+ job," recalled Alphonso
+
+On line 413:
+ the HUD secretary
+ from to in an interview
+ with the Commission.
+
+On line 413:
+ great deal of money
+ and there wasn’t a great deal
+ of oversight going
+
+On line 413:
+ he was the nation’s
+ top housing official at
+ the time, he placed much
+
+On line 415:
+ the blame on Congress.56
+ Cox, the former Minnesota
+ prosecutor, and
+
+ Madigan, the Illinois
+ attorney general, told
+ the Commission that
+
+On line 415:
+ the single biggest
+ obstacles to effective
+ state regulation
+
+On line 415:
+ chartered banks—including
+ Bank of America, Citibank, and
+ Wachovia—and the OTS,
+
+On line 415:
+ thrifts. The OCC and OTS
+ issued rules preempting states
+ from enforcing rules
+
+On line 417:
+ national banks and
+ thrifts.57 Cox recalled that in Julie
+ Williams, the chief counsel
+
+On line 419:
+ OCC, had delivered
+ what he called a "lecture" to
+ the states’ attorneys
+
+On line 419:
+ in a meeting in
+ Washington, warning them that
+ the OCC would "quash" them
+
+ if they persisted
+ in attempting to control
+ the consumer practices
+
+On line 421:
+ institutions.58 Two
+ former OCC comptrollers, John
+ Hawke and John Dugan, told
+
+On line 421:
+ Commission that they
+ were defending the agency’s
+ constitutional
+
+On line 421:
+ entities. Because
+ state-chartered lenders had more lending
+ problems, they said, the
+
+On line 421:
+ to involve themselves
+ in federally chartered
+ institutions, an
+
+On line 421:
+ told the Commission
+ that national banks funded
+ of the largest subprime
+
+On line 421:
+ operating with
+ state charters, and that those banks
+ were the end market
+
+On line 421:
+ by the state-chartered firms.
+ She noted that the OCC was
+ "particularly
+
+On line 421:
+ in its efforts to
+ thwart state authority over
+ national lenders, and
+
+ lax in its efforts
+ to protect consumers from the
+ coming crisis."60 Many
+
+On line 423:
+ in enforcing their
+ own lending regulations,
+ as did some cities. In
+
+On line 423:
+ Carolina–based Wachovia
+ Bank told state regulators
+ that it would not abide
+
+ by state laws, because
+ it was a national bank
+ and fell under the
+
+On line 423:
+ Wachovia’s announcement,
+ and Wachovia sued Michigan. The
+ OCC, the American
+
+On line 423:
+ and the Mortgage Bankers
+ Association entered
+ the fray on Wachovia’s
+
+On line 423:
+ and the District of
+ Columbia aligned themselves with
+ Michigan. The legal
+
+On line 423:
+ four years. The Supreme Court
+ ruled in Wachovia’s favor on
+ April leaving the OCC
+
+On line 423:
+ were they negligent,
+ they were aggressive players
+ attempting to stop
+
+On line 425:
+ enforcement action[s].
+ Those guys should have been on our
+ side."61 Nonprime lending
+
+On line 425:
+ surged to billion in
+ and then trillion in and its
+ impact began to
+
+ be felt in more and
+ more places.62 Many of those loans were
+ funneled into the
+
+ pipeline by mortgage
+ brokers—the link between
+ borrowers and the
+
+On line 425:
+ financed the mortgages—who
+ prepared the paperwork for
+ loans and earned fees from
+
+On line 425:
+ lenders for doing it.
+ More than new mortgage brokers
+ egan their jobs during
+
+On line 425:
+ than honorable in
+ their dealings with borrowers.63
+ According to an
+
+On line 425:
+ investigative news
+ report published in between
+ and at least people
+
+On line 425:
+ entered the field in
+ Florida, for example,
+ including who had
+
+On line 425:
+ been convicted of
+ such crimes as fraud, bank robbery,
+ racketeering, and
+
+ extortion.64 J. Thomas
+ Cardwell, the commissioner
+ of the Florida
+
+On line 425:
+ accountability
+ created a condition
+ in which fraud flourished."65
+
+On line 425:
+ Association
+ of Mortgage Brokers, told the
+ Commission that while
+
+ most mortgage brokers
+ looked out for borrowers’ best
+ interests and steered
+
+On line 425:
+ them away from risky loans,
+ about of the newcomers to
+ the field nationwide
+
+On line 425:
+ to do whatever
+ it took to maximize the
+ number of loans they
+
+On line 427:
+ home values grew even
+ faster between and the real
+ estate appraiser
+
+On line 427:
+ initially felt pride
+ that his birthplace, miles north of
+ Los Angeles, "had
+
+On line 427:
+ been discovered" by
+ other Californians.
+ The city, a farming
+
+On line 427:
+ industry center
+ in the San Joaquin Valley, was
+ drawing national
+
+ attention for the
+ pace of its development.
+ Wide-open farm fields were plowed
+
+On line 429:
+ into thousands of
+ building lots. Home prices jumped in
+ Bakersfield in in
+
+On line 431:
+ more in Crabtree, an
+ appraiser for years, started
+ in and to think that
+
+On line 431:
+ making sense. People
+ were paying inflated prices
+ for their homes, and they
+
+ didn’t seem to have
+ enough income to pay for what
+ they had bought. Within
+
+ a few years, when he
+ passed some of these same houses,
+ he saw that they were
+
+ vacant. "For sale" signs
+ appeared on the front lawns. And
+ when he passed again, the
+
+ yards were untended
+ and the grass was turning brown.
+ Next, the houses went
+
+ into foreclosure,
+ and that’s when he noticed that
+ the empty houses
+
+On line 433:
+ the new suburban
+ subdivisions. The Cleveland
+ phenomenon had
+
+On line 433:
+ Bakersfield, a place
+ far from the Rust Belt. Crabtree
+ watched as foreclosures
+
+On line 433:
+ Houses fell into
+ disrepair and neighborhoods
+ disintegrated.
+
+On line 435:
+ began studying the
+ market. In he ended up
+ identifying what
+
+On line 435:
+ in Bakersfield; some,
+ for instance, were allowing
+ insiders to siphon
+
+On line 435:
+ property transfer.
+ The transactions involved many
+ of the nation’s largest
+
+On line 435:
+ for example, was
+ listed for sale for and was
+ recorded as selling
+
+On line 435:
+ for with financing,
+ though the real estate agent
+ told Crabtree that it
+
+On line 435:
+ actually sold
+ for Crabtree realized that
+ the gap between the
+
+On line 435:
+ sales price and loan amount
+ allowed these insiders to
+ pocket The terms of
+
+On line 435:
+ The house went into
+ foreclosure and was sold in
+ a distress sale for
+
+On line 437:
+ began calling lenders
+ to tell them what he had found;
+ but to his shock, they
+
+On line 437:
+ reached one quality
+ assurance officer at
+ Fremont Investment
+
+On line 437:
+ nation’s eighth-largest subprime
+ lender. "Don’t put your nose where it
+ doesn’t belong," he
+
+On line 439:
+ story to state law
+ enforcement officials and
+ to the Federal
+
+On line 439:
+ Investigation.
+ "I was screaming at the top
+ of my lungs," he said.
+
+On line 439:
+ pace of enforcement
+ and at prosecutors’ lack
+ of response to a
+
+On line 441:
+ wreaking economic
+ havoc in Bakersfield.69 At
+ the Washington, D.C.,
+
+On line 441:
+ the FBI, Chris Swecker,
+ an assistant director,
+ was also trying
+
+On line 441:
+ to pay attention
+ to mortgage fraud. "It has the
+ potential to be
+
+ an epidemic," he
+ said at a news conference
+ in Washington in
+
+On line 441:
+ think we can prevent
+ a problem that could have as
+ much impact as the
+
+On line 443:
+ crisis."70 Swecker called
+ another news conference
+ in December to
+
+On line 443:
+ the same thing, this time
+ adding that mortgage fraud was a
+ "pervasive problem"
+
+ that was "on the rise."
+ He was joined by officials
+ from HUD, the U.S. Postal
+
+On line 443:
+ Internal Revenue
+ Service. The officials told
+ reporters that real
+
+On line 443:
+ executives were
+ not doing enough to root out
+ mortgage fraud and that
+
+On line 445:
+ do more to "police
+ their own organizations."71
+ Meanwhile, the number
+
+On line 447:
+ continued to swell.
+ Suspicious activity
+ reports, also known
+
+On line 447:
+ are reports filed by
+ banks to the Financial Crimes
+ Enforcement Network
+
+On line 447:
+ within the Treasury
+ Department. In November
+ the network published
+
+On line 447:
+ analysis that found
+ a 20-fold increase in mortgage
+ fraud reports between
+
+On line 447:
+ underreporting,
+ because two-thirds of all the loans
+ being created
+
+ were originated
+ by mortgage brokers who were
+ not subject to any
+
+On line 447:
+ addition, many lenders
+ who were required to submit
+ reports did not in
+
+ fact do so.73 "The claim
+ that no one could have foreseen
+ the crisis is false,"
+
+ said William K. Black, an
+ expert on white-collar crime
+ and a former staff
+
+On line 451:
+ Reform, Recovery
+ and Enforcement, created
+ by Congress in as
+
+On line 455:
+ served from February
+ to told the FCIC he could not
+ remember the press
+
+ conferences or news
+ reports about mortgage fraud. Both
+ Gonzales and his
+
+On line 455:
+ Michael Mukasey, who served as
+ attorney general in
+ and told the FCIC that
+
+On line 455:
+ to them as a top
+ priority. "National
+ security was
+
+On line 457:
+ overriding" concern,
+ Mukasey said.75 To community
+ activists and local
+
+On line 457:
+ lending practices were
+ a matter of national
+ economic concern.
+
+On line 457:
+ the Empire Justice
+ Center in Rochester, New York, told
+ Fed Governors Bernanke,
+
+On line 457:
+ Susan Bies, and Roger
+ Ferguson in October
+ that she suspected
+
+On line 457:
+ and Lehman Brothers—were
+ producing such bad loans that
+ the very survival of
+
+ the firms was put in
+ question. "We repeatedly
+ see false appraisals and
+
+On line 457:
+ Fed officials, who
+ were gathered at the public
+ hearing period
+
+On line 457:
+ She urged the Fed to
+ prod the Securities and
+ Exchange Commission
+
+ to examine the
+ uality of the firms’ due
+ diligence; otherwise,
+
+ she said, serious
+ questions could arise about whether they
+ could be forced to buy
+
+ back bad loans that they
+ had made or securitized.76
+ Maker told the board
+
+On line 459:
+ from a confluence
+ of financial events: flat or
+ declining incomes,
+
+On line 461:
+ and fraudulent loans
+ with overstated values.77 In
+ an interview with
+
+On line 461:
+ Fed officials seemed
+ impervious to what the
+ consumer advocates
+
+On line 461:
+ The Fed governors
+ politely listened and said
+ little, she recalled.
+
+On line 461:
+ had their economic
+ models, and their economic
+ models did not see
+
+ this coming," she said.
+ "We kept getting back, ‘This is
+ all anecdotal.’"78 Soon
+
+ nontraditional
+ mortgages were crowding other
+ kinds of products out
+
+ of the market in
+ many parts of the country. More
+ mortgage borrowers
+
+On line 463:
+ out interest-only
+ loans, and the trend was far more
+ pronounced on the West
+
+On line 463:
+ of their easy credit
+ terms, nontraditional loans
+ enabled borrowers
+
+On line 463:
+ buy more expensive
+ homes and ratchet up the prices
+ in bidding wars. The
+
+On line 463:
+ pattern of higher
+ foreclosure rates frequently
+ appeared soon after.
+
+ As home prices shot up
+ in much of the country, many
+ observers began to
+
+On line 465:
+ June the Economist
+ magazine’s cover story
+ posited that the day
+
+ of reckoning was
+ at hand, with the headline "House
+ Prices: After the Fall."
+
+On line 465:
+ depicted a brick
+ plummeting out of the sky.
+ "It is not going
+
+ to be pretty," the
+ article declared. "How the
+ current housing boom
+
+On line 465:
+ decide the course of
+ the entire world economy
+ over the next few years."80
+
+On line 467:
+ month, Fed Chairman Greenspan
+ acknowledged the issue, telling
+ the Joint Economic
+
+On line 467:
+ of the U.S. Congress
+ that "the apparent froth in
+ housing markets may
+
+On line 467:
+ spilled over into the
+ mortgage markets."81 For years, he
+ had warned that Fannie
+
+On line 467:
+ Freddie Mac, bolstered
+ by investors’ belief that these
+ institutions had
+
+On line 467:
+ backing of the U.S.
+ government, were growing so
+ large, with so little
+
+On line 467:
+ for the financial
+ system. Still, he reassured
+ legislators that
+
+ the U.S. economy
+ was on a "reasonably firm
+ footing" and that the
+
+On line 469:
+ be resilient if the
+ housing market turned sour. "The
+ dramatic increase
+
+On line 469:
+ the introduction
+ of other relatively
+ exotic forms of
+
+On line 469:
+ are developments
+ of particular concern,"
+ he testified in
+
+ June. To be sure, these
+ financing vehicles have
+ their appropriate
+
+ uses. But to the
+ extent that some households may
+ be employing these
+
+On line 471:
+ that would otherwise
+ be unaffordable, their use
+ is beginning to
+
+On line 473:
+ to the pressures in
+ the marketplace. Although we
+ certainly cannot
+
+On line 473:
+ local markets, these
+ declines, were they to occur,
+ likely would not have
+
+On line 473:
+ banking and widespread
+ securitization of
+ mortgages makes it less
+
+On line 473:
+ would be impaired than
+ was the case in prior episodes
+ of regional house
+
+On line 475:
+ corrections.82 Indeed,
+ Greenspan would not be the only
+ one confident that
+
+On line 475:
+ downturn would leave the
+ broader financial system
+ largely unscathed. As
+
+On line 475:
+ after housing prices
+ had been declining for a
+ year, Bernanke testified
+
+On line 477:
+ "the problems in the
+ subprime market were likely
+ to be contained"—that is,
+
+On line 479:
+ economy.83 Some were
+ less sanguine. For example,
+ the consumer lawyer Sheila
+
+On line 481:
+ interest-only, a
+ proportion that was more than
+ twice the national
+
+On line 481:
+ "That’s insanity,"
+ she told the Fed governors.
+ "That means we’re facing
+
+ something down the road
+ that we haven’t faced before and
+ we are going to
+
+ be looking at a
+ safety and soundness crisis."84
+ On another front,
+
+ some academics offered
+ pointed analyses as they raised
+ alarms. For example,
+
+On line 485:
+ the Yale professor
+ Robert Shiller, who along with Karl Case
+ developed the Case-Shiller
+
+On line 487:
+ the market appeared
+ in historical terms. Shiller
+ warned that the housing
+
+On line 489:
+ would likely burst.85 In
+ that same month, a conclave of
+ economists gathered
+
+ at Jackson Lake Lodge
+ in Wyoming, in a conference
+ center nestled in
+
+ Grand Teton National
+ Park. It was a "who’s who of
+ central bankers," recalled
+
+On line 491:
+ who was then on leave
+ from the University of
+ Chicago’s business school
+
+On line 491:
+ the chief economist
+ of the International
+ Monetary Fund. Greenspan
+
+ was there, and so was
+ Bernanke. Jean-Claude Trichet, the president
+ of the European
+
+ Central Bank, and Mervyn
+ King, the governor of the
+ Bank of England, were
+
+On line 495:
+ dignitaries.86 Rajan
+ presented a paper with
+ a provocative title:
+
+On line 495:
+ Development Made
+ the World Riskier1" He posited
+ that executives
+
+On line 495:
+ let off the hook for
+ any eventual losses—the
+ IBGYBG syn-drome.
+
+On line 495:
+ investment strategies
+ such as credit default swaps
+ could have disastrous
+
+On line 495:
+ became unstable,
+ and that regulatory
+ institutions might
+
+ be unable to deal
+ with the fallout.87 He recalled
+ to the FCIC that he
+
+ was treated with scorn.
+ Lawrence Summers, a former U.S.
+ treasury secretary
+
+On line 497:
+ then president of
+ Harvard University, called
+ Rajan a "Luddite,"
+
+On line 497:
+ simply opposed to
+ technological change.88 "I
+ felt like an early
+
+On line 497:
+ had wandered into
+ a convention of half-starved
+ lions," Rajan wrote
+
+On line 499:
+ University of
+ Pennsylvania’s Wharton School,
+ prepared a research
+
+On line 499:
+ that the United States
+ could have a real estate
+ crisis similar
+
+On line 501:
+ suffered in Asia in
+ the 1990s. When she discussed her
+ work at another
+
+On line 501:
+ Hole gathering two
+ years later, it received a
+ chilly reception, she
+
+On line 501:
+ Commission. "It was
+ universally panned," she said,
+ and an economist
+
+On line 505:
+ were beginning to
+ highlight indications that
+ the real estate
+
+On line 505:
+ was weakening. Home
+ sales began to drop, and Fitch
+ Ratings reported
+
+On line 505:
+ mortgage delinquencies
+ were rising. That year, the hedge
+ fund manager Mark
+
+On line 505:
+ securities trade
+ group, that investors had become
+ "over optimistic" about
+
+On line 505:
+ market. "I see a
+ lot of irrationality,"
+ he added. He said he
+
+On line 505:
+ different this time"—a
+ rationale commonly heard
+ before previous
+
+On line 507:
+ Some real estate
+ appraisers had also been
+ expressing concerns
+
+On line 509:
+ to a coalition of
+ appraisal organizations
+ circulated and
+
+On line 509:
+ petition; signed by
+ appraisers and including
+ the name and address
+
+On line 509:
+ assigning business
+ only to appraisers who
+ would hit the desired
+
+On line 509:
+ "The powers that be
+ cannot claim ignorance," the
+ appraiser Dennis
+
+On line 511:
+ Black of Port Charlotte,
+ Florida, testified to
+ the Commission.92 The
+
+On line 511:
+ veteran, told the
+ Commission that lenders had opened
+ subsidiaries to perform
+
+On line 511:
+ consumers and making
+ it easier to inflate
+ home values. The steep
+
+On line 511:
+ the un-merited and
+ inflated appraisals she was
+ seeing in Northern
+
+On line 511:
+ was headed for a
+ cataclysmic downturn. In she
+ laid off some of her
+
+On line 511:
+ in order to cut
+ her overhead expenses, in
+ anticipation
+
+On line 511:
+ the coming storm; two
+ years later, she shut down her
+ office and began
+
+ working out of her
+ home.93 Despite all the signs that
+ the housing market
+
+On line 513:
+ slowing, Wall Street just
+ kept going and going—ordering
+ up loans, packaging
+
+On line 513:
+ By the third quarter
+ of home prices were falling and
+ mortgage delinquencies
+
+On line 513:
+ a combination
+ that spelled trouble for mortgage-backed
+ securities. But
+
+On line 513:
+ from the third quarter
+ of on, banks created and
+ sold some trillion in
+
+On line 515:
+ and more than billion
+ in mortgage-related CDOs.94 Not
+ everyone on Wall
+
+On line 515:
+ were urging caution,
+ as corporate governance
+ and risk management
+
+On line 517:
+ down. Reflecting on
+ the causes of the crisis,
+ Jamie Dimon, CEO of
+
+On line 517:
+ testified to the
+ FCIC, "I blame the management
+ teams and no one else."95
+
+On line 519:
+ too many financial
+ firms, management brushed aside the
+ growing risks to their
+
+On line 519:
+ At Lehman Brothers, for
+ example, Michael Gelband, the
+ head of fixed income,
+
+On line 519:
+ his colleague Madelyn
+ Antoncic warned against taking
+ on too much risk in
+
+On line 519:
+ growing pressure to
+ compete aggressively against
+ other investment
+
+On line 519:
+ Antoncic, who was
+ the firm’s chief risk officer
+ from to was shunted
+
+ aside: "At the senior
+ level, they were trying to
+ push so hard that the
+
+ wheels started to come
+ off," she told the Commission.
+ She was reassigned
+
+On line 523:
+ on "philosophical
+ differences."97 At Citigroup,
+ meanwhile, Richard Bowen, a
+
+On line 523:
+ the consumer lending
+ group, received a promotion
+ in early when he
+
+ was named business chief
+ under writer. He would go
+ on to oversee loan
+
+On line 523:
+ quality for over
+ billion a year of mortgages
+ underwritten and
+
+ purchased by CitiFinancial. These
+ mortgages were sold to Fannie
+ Mae, Freddie Mac, and
+
+On line 523:
+ others. In June Bowen
+ discovered that as much as
+ of the loans that Citi
+
+On line 525:
+ meet Citi - group’s loan
+ guidelines and thus endangered
+ the company—if the
+
+On line 525:
+ were to default on
+ their loans, the investors could force
+ Citi to buy them back.
+
+On line 525:
+ the Commission that
+ he tried to alert top managers
+ at the firm by "email,
+
+On line 527:
+ and discussions"; but
+ though they expressed concern, it
+ "never translated
+
+ into any action."
+ Instead, he said, "there was a
+ considerable push
+
+On line 527:
+ to increase market
+ share." Indeed, Bowen recalled, Citi
+ began to loosen its
+
+On line 527:
+ started to purchase
+ stated-income loans. "So we joined
+ the other lemmings
+
+On line 529:
+ for the cliff," he said
+ in an interview with the
+ FCIC.98 He finally
+
+On line 529:
+ his warnings to the
+ highest level he could reach—Robert
+ Rubin, the chairman
+
+On line 529:
+ the Executive
+ Committee of the Board of
+ Directors and a
+
+ former U.S. treasury
+ secretary in the Clinton
+ administration,
+
+ and three other bank
+ officials. He sent Rubin
+ and the others a
+
+On line 531:
+ the words "URGENT—READ
+ IMMEDIATELY" in the
+ subject line. Sharing
+
+ his concerns, he stressed
+ to top managers that Citi faced
+ billions of dollars
+
+On line 531:
+ if investors were to
+ demand that Citi repurchase
+ the defective loans.99
+
+On line 533:
+ told the Commission
+ in a public hearing in
+ April that Citibank handled
+
+On line 533:
+ Bowen matter promptly
+ and effectively. "I do
+ recollect this and
+
+ that either I or
+ somebody else, and I truly
+ do not remember
+
+ who, but either I
+ or somebody else sent it to
+ the appropriate
+
+On line 533:
+ that that was acted
+ on promptly and actions were
+ taken in response
+
+On line 533:
+ the bank undertook
+ an investigation in
+ response to Bowen’s claims
+
+ and the system of
+ underwriting reviews was
+ revised.101 Bowen told the
+
+On line 535:
+ sending emails, he went
+ from supervising0 people
+ to supervising
+
+On line 535:
+ bonus was reduced, and
+ he was downgraded in his
+ performance review.102
+
+On line 539:
+ a former Bear Stearns
+ executive, testified
+ to the FCIC that he
+
+On line 539:
+ to be on a shaky
+ foundation. "Their answer at
+ the time was, and this
+
+On line 539:
+ the thought that was—that was
+ homogeneous throughout Wall
+ Street’s analysts—was home
+
+On line 539:
+ always track income
+ growth and jobs growth. And they showed
+ me income growth on
+
+On line 539:
+ chart and jobs growth on
+ another, and said, ‘We don’t
+ see what you’re talking
+
+ about because incomes
+ are still growing and jobs are
+ still growing.’ And I
+
+On line 539:
+ you obviously
+ don’t realize where the dog
+ is and where the tail
+
+On line 541:
+ what."103 ven those who had
+ profited from the growth of
+ nontraditional
+
+ lending practices said
+ they became disturbed by what
+ was happening. Herb
+
+On line 541:
+ Corporation, which
+ was heavily loaded with
+ option ARM loans, wrote
+
+On line 541:
+ to officials at
+ the Federal Reserve, the
+ FDIC, the OTS, and the
+
+On line 541:
+ regulators were
+ "too dependent" on ratings
+ agencies and "there is
+
+On line 541:
+ high potential for
+ gaming when virtually
+ any asset can be
+
+On line 541:
+ and transformed into
+ a AAA-rated asset, and when a
+ multi-billion
+
+On line 543:
+ all too eager to
+ facilitate this alchemy."104
+ Similarly, Lewis
+
+On line 545:
+ machine in the 1980s,
+ said he didn’t like what he
+ called "the madness" that
+
+On line 545:
+ descended on the
+ real estate market. Ranieri
+ told the Commission,
+
+On line 545:
+ was not the only
+ guy. I’m not telling you I was
+ John the Baptist. There
+
+On line 545:
+ of us, analysts
+ and others, wandering around
+ going ‘look at this
+
+On line 545:
+ it would be hard to
+ miss it."105 Ranieri’s own Houston-based Franklin
+ Bank Corporation
+
+On line 547:
+ under the weight of
+ the financial crisis in
+ November Other
+
+On line 547:
+ inside the business
+ also acknowledged that the
+ rules of the game were
+
+On line 547:
+ the word famously
+ used by Countrywide’s Mozilo
+ to describe one of
+
+ the loan products his
+ firm was originating.106 "In
+ all my years in the
+
+On line 547:
+ have never seen a
+ more toxic [product]," he wrote
+ in an internal
+
+ email.107 Others at the
+ bank argued in response that
+ they were offering
+
+On line 547:
+ of ours."108 Still, Mozilo
+ was nervous. "There was a time
+ when savings and loans
+
+On line 551:
+ doing it," he told
+ the other executives.
+ "They all went broke."109 In
+
+On line 553:
+ to take a look at
+ the changing mortgage market.
+ Sabeth Siddique, the
+
+On line 553:
+ for credit risk in
+ the Division of Banking
+ Supervision and
+
+On line 553:
+ Reserve Board, was charged
+ with investigating how
+ broadly loan patterns
+
+On line 553:
+ were changing. He took
+ the questions directly to
+ large banks in and asked
+
+On line 555:
+ of which kinds of loans
+ they were making. Siddique found
+ the information
+
+On line 555:
+ told the Commission.110
+ In fact, nontraditional
+ loans made up percent
+
+On line 555:
+ at National City,
+ at Washington Mutual,
+ at CitiFinancial, and at Bank
+
+On line 555:
+ America. Moreover,
+ the banks expected that their
+ originations of
+
+On line 557:
+ would rise by in to
+ billion. The review also
+ noted the "slowly
+
+On line 557:
+ due to loosening
+ underwriting standards." In
+ addition, it found
+
+On line 557:
+ banks in had been of
+ the stated-income, minimal
+ documentation
+
+On line 557:
+ known as liar loans, which
+ had a particularly
+ great likelihood of
+
+On line 559:
+ sour.111 The reaction
+ to Siddique’s briefing was mixed.
+ Federal Reserve
+
+On line 559:
+ response by the Fed
+ governors and regional
+ board directors as
+
+On line 559:
+ people on the board
+ and regional presidents
+ just wanted to come
+
+ to a different
+ answer. So they did ignore
+ it, or the full thrust
+
+On line 563:
+ the Commission.112 The
+ OCC was also pondering
+ the situation.
+
+On line 563:
+ comptroller of the
+ currency John C. Dugan told
+ the Commission that
+
+On line 563:
+ had come from below,
+ from bank examiners who
+ had become concerned
+
+On line 565:
+ The agency began
+ to consider issuing
+ "guidance," a kind of
+
+On line 565:
+ warning to banks, that
+ nontraditional loans could
+ jeopardize safety
+
+On line 565:
+ bank examiners.
+ Siddique said the OCC led the
+ effort, which became
+
+On line 567:
+ deliberations
+ over the potential guidance
+ also stirred debate
+
+On line 567:
+ critics feared it both
+ would stifle the financial
+ innovation that
+
+On line 567:
+ record profits to Wall
+ Street and the banks and would make
+ homes less affordable.
+
+On line 567:
+ the agencies—the
+ Fed, the OCC, the OTS, the FDIC,
+ and the National
+
+On line 567:
+ work together on
+ it, or it would unfairly
+ block one group of lenders
+
+On line 569:
+ regulatory
+ overreach. "The bankers pushed back," Bies
+ told the Commission.
+
+On line 569:
+ Congress pushed back. Some
+ of our internal people
+ at the Fed pushed back."115
+
+On line 571:
+ represents mortgage
+ insurance companies, weighed
+ in on the other
+
+On line 571:
+ underwritten or
+ unsuitable mortgages and home
+ equity loans," the
+
+On line 571:
+ to regulators
+ in "The most recent market
+ trends show alarming signs
+
+On line 573:
+ risk-taking that puts
+ both lenders and consumers at risk."116
+ In congressional
+
+On line 573:
+ downturns. "We take a
+ conservative position
+ on risk because of
+
+On line 573:
+ first loss position,"
+ Simpson informed the Senate
+ Subcommittee on
+
+On line 573:
+ we also have a
+ historical perspective.
+ We were there when the
+
+On line 573:
+ turned sharply down during
+ the mid-1980s especially in
+ the oil patch and the
+
+On line 575:
+ in California
+ and the Northeast."117 Within the
+ Fed, the debate grew
+
+On line 575:
+ Siddique recalled. "It
+ got very personal," he told
+ the Commission. The
+
+ ideological
+ turf war lasted more than a
+ year, while the number
+
+On line 577:
+ nontraditional
+ loans kept growing and growing.118
+ Consumer advocates
+
+On line 577:
+ up the heat. In a
+ Fed Consumer Advisory
+ Council meeting in
+
+On line 577:
+ March Fed Governors
+ Bernanke, Mark Olson, and Kevin Warsh
+ were specifically
+
+On line 577:
+ warned of dangers that
+ nontraditional loans posed
+ to the economy.
+
+On line 577:
+ director of the
+ North Carolina Fair Housing
+ Center, raised concerns
+
+On line 577:
+ nontraditional
+ lending "may precipitate
+ a downward spiral
+
+ that starts on the coast
+ and then creates panic in
+ the east that could have
+
+On line 579:
+ total economy
+ as well."119 At the next meeting
+ of the Fed’s Consumer
+
+On line 579:
+ June and attended
+ by Bernanke, Bies, Olson, and Warsh,
+ several consumer
+
+On line 579:
+ the Fed governors
+ alarming incidents that were
+ now occurring all
+
+On line 581:
+ and evaluation
+ at the Enterprise Corp. of
+ the Delta, in Jackson,
+
+On line 581:
+ by mortgage brokers
+ that property values were
+ being inflated
+
+On line 581:
+ profit for real
+ estate appraisers and loan
+ originators. Alan
+
+On line 581:
+ in Philadelphia,
+ reported a "huge surge in
+ foreclosures," noting
+
+On line 581:
+ up to half of the
+ borrowers he was seeing
+ with troubled loans had
+
+On line 581:
+ overcharged and given
+ high-interest rate mortgages
+ when their credit had
+
+ qualified them for
+ lower-cost loans. Hattie B.
+ Dorsey, the president
+
+On line 583:
+ Development, said
+ she worried that houses were
+ being flipped back and
+
+ forth so much that the
+ result would be neighborhood
+ "decay." Carolyn Carter
+
+On line 585:
+ authority to
+ "prohibit abuses in the
+ mortgage market."120 The
+
+On line 585:
+ Siddique, before Greenspan
+ left his post as Fed chairman
+ in January he
+
+On line 585:
+ indicated his
+ willingness to accept the
+ guidance. Ferguson
+
+On line 585:
+ the Fed board and the
+ regional Fed presidents
+ to get it done. Bies
+
+ supported it, and
+ Bernanke did as well.121 More than a
+ year after the OCC
+
+ had began discussing
+ the guidance, and after the
+ housing market had
+
+On line 587:
+ September as an
+ interagency warning
+ that affected banks,
+
+On line 587:
+ unions nationwide. Dozens
+ of states followed, directing
+ their versions of the
+
+ guidance to tens of
+ thousands of state-chartered lenders and
+ mortgage brokers. Then,
+
+On line 589:
+ July long after
+ the risky, nontraditional
+ mortgage market had
+
+On line 589:
+ halt, the Federal
+ Reserve finally adopted
+ new rules under HOEPA
+
+On line 589:
+ curb the abuses about
+ which consumer groups had raised red
+ flags for years—including
+
+On line 591:
+ that borrowers have
+ the ability to repay
+ loans made to them. By
+
+ that time, however,
+ the damage had been done. The
+ total value of
+
+On line 591:
+ trillion.122 There was a
+ mountain of problematic
+ securities, debt,
+
+ and derivatives
+ resting on real estate
+ assets that were far
+
+ less secure than they
+ were thought to have been. Just as
+ Bernanke thought the spillovers from
+
+ a housing market
+ crash would be contained, so too
+ policymakers,
+
+ regulators, and
+ financial executives
+ did not understand
+
+On line 593:
+ firms and markets had
+ become to the potential
+ contagion from these
+
+On line 593:
+ instruments. As the
+ housing market began to
+ turn, they scrambled to
+
+On line 593:
+ respond as losses
+ in one part of that system
+ would ricochet to
+
+On line 595:
+ end of most of the
+ subprime lenders had failed or been
+ acquired, including
+
+On line 595:
+ Financial, Ameriquest, and
+ American Home Mortgage. In
+ January Bank of
+
+ America announced
+ it would acquire the ailing
+ lender Countrywide. It
+
+On line 595:
+ became clear that risk—rather
+ than being diversified
+ across the financial
+
+ system, as had been
+ thought—was concentrated at
+ the largest financial
+
+On line 595:
+ risky mortgage assets
+ and dependent on fickle
+ short-term lending, was
+
+ bought by JP Morgan
+ with government assistance
+ in the spring. Before
+
+ the summer was over,
+ Fannie Mae and Freddie Mac
+ would be put into
+
+On line 599:
+ Brothers failed and the
+ remaining investment banks,
+ Merrill Lynch, Goldman
+
+On line 599:
+ confidence. AIG, with
+ its massive credit default
+ swap portfolio and
+
+On line 599:
+ was rescued by the
+ government. Finally, many
+ commercial banks and
+
+ thrifts, which had their own
+ exposures to declining
+ mortgage assets and
+
+ their own exposures
+ to short-term credit markets,
+ teetered. IndyMac had already
+
+ failed over the summer;
+ in September, Washington
+ Mutual became
+
+On line 599:
+ bank failure in U.S.
+ history. In October,
+ Wachovia struck a deal
+
+ to be acquired by
+ Wells Fargo. Citigroup and
+ Bank of America
+
+On line 599:
+ to stay afloat. Before
+ it was over, taxpayers had
+ committed trillions
+
+On line 599:
+ through more than two dozen
+ extraordinary programs
+ to stabilize the
+
+On line 601:
+ crisis that befell
+ the country in had been years
+ in the making. In
+
+On line 601:
+ Commission, former
+ Fed chairman Greenspan defended
+ his record and said most
+
+On line 601:
+ of his judgments had
+ been correct. "I was right of
+ the time but I was
+
+On line 601:
+ wrong of the time," he
+ told the Commission.123 Yet the
+ consequences of what
+
+On line 603:
+ in the run-up to the
+ crisis would be enormous. The
+ economic impact
+
+On line 603:
+ devastating. And
+ the human devasta-tion
+ is continuing.
+
+On line 603:
+ in November but
+ the underemployment rate,
+ which includes those who
+
+On line 603:
+ given up looking
+ for work and part-time workers
+ who would prefer to
+
+On line 603:
+ full-time, was above
+ And the share of unemployed
+ workers who have been
+
+On line 603:
+ of work for more than
+ six months was just above Of large
+ metropolitan
+
+On line 605:
+ were as lethal as many
+ had predicted, and it has
+ been estimated
+
+On line 605:
+ that ultimately
+ as many as million households
+ in the United States
+
+On line 605:
+ foreclosure. As of
+ foreclosure rates were highest
+ in Florida and
+
+On line 605:
+ Florida, nearly
+ of loans were in foreclosure,
+ and Nevada was not
+
+On line 605:
+ American mortgage
+ borrowers owed more on their
+ mortgages than their home
+
+On line 609:
+ was nearly Households
+ have lost trillion in wealth since
+ As Mark Zandi, the
+
+On line 609:
+ economist of Moody’s
+ Economy.com, testified
+ to the Commission,
+
+On line 611:
+ crisis has dealt a
+ very serious blow to the
+ U.S. economy. The
+
+On line 611:
+ the Great Recession:
+ the longest, broadest and most
+ severe downturn since
+
+On line 611:
+ the Great Depression
+ of the 1930s. The longer-term fallout
+ from the economic
+
+On line 611:
+ crisis is also
+ very substantial. It will take
+ years for employment
+
+On line 613:
+ on the years before
+ the crisis, the economist
+ Dean Baker said: "So
+
+On line 613:
+ absolute public
+ knowledge in the sense that we
+ knew the number of
+
+ loans that were being
+ issued with zero down. Now,
+ do we suddenly
+
+On line 613:
+ we have that many more
+ people—who are capable
+ of taking on a
+
+ loan with zero down
+ who we hink are going to
+ be able to pay that
+
+On line 613:
+ off—than was true years ago1
+ I mean, what’s changed in the world1
+ There were a lot of
+
+On line 613:
+ didn’t require any
+ investigation at all;
+ these were totally
+
+On line 615:
+ the data."127 Warren
+ Peterson, a home builder in
+ Bakersfield, felt that
+
+On line 615:
+ world changed to the day.
+ Peterson built homes in an
+ upscale neighborhood,
+
+On line 615:
+ Monday morning, he
+ would arrive at the office
+ to find a bevy of
+
+On line 615:
+ agents, sales contracts in
+ hand, vying to be the ones
+ chosen to purchase
+
+ the new homes he was
+ building. The stream of traffic
+ was constant. On one
+
+On line 615:
+ in November he
+ was at the sales office and
+ noticed that not a
+
+ single purchaser
+ had entered the building. He
+ called a friend, also
+
+On line 617:
+ home-building business,
+ who said he had noticed the
+ same thing, and asked him
+
+On line 628:
+ he thought about it. "It’s
+ over," his friend told Peterson.128
+ PART II Setting the
+
+On line 642:
+ repos: "Unfettered
+ markets"............................................29 The savings and loan
+ crisis: "They put a
+
+On line 646:
+ regulators" The
+ financial crisis of and
+ was not a single
+
+ event but a series
+ of crises that rippled through the
+ financial system
+
+On line 646:
+ Distress in one area
+ of the financial markets
+ led to failures in
+
+On line 646:
+ interconnections
+ and vulnerabilities
+ that bankers, government
+
+On line 646:
+ had missed or dismissed.
+ When subprime and other risky
+ mortgages—issued
+
+ during a housing
+ bubble that many experts failed
+ to identify, and
+
+On line 648:
+ began to default
+ at unexpected rates, a
+ once-obscure market
+
+On line 648:
+ complex investment
+ securities backed by those
+ mortgages abruptly failed.
+
+On line 648:
+ the contagion spread,
+ investors panicked—and the danger
+ inherent in the
+
+On line 648:
+ became manifest.
+ Financial markets teetered on
+ the edge, and brand-name
+
+On line 648:
+ institutions were
+ left bankrupt or dependent
+ on the taxpayers
+
+On line 650:
+ survival. Federal
+ Reserve Chairman Ben Bernanke now
+ acknowledges that he
+
+ missed the systemic risks.
+ "Prospective subprime losses were
+ clearly not large enough
+
+On line 650:
+ their own to account
+ for the magnitude of the
+ crisis," Bernanke told the
+
+On line 654:
+ economy."1 This part
+ of our report explores the
+ origins of risks as
+
+ they developed in
+ the financial system over
+ recent decades. It is
+
+On line 654:
+ complex history
+ that could yield its own report.
+ Instead, we focus
+
+On line 654:
+ developments that
+ helped shape the events that shook our
+ financial markets
+
+On line 654:
+ economy. Detailed
+ books could be written about each
+ of them; we stick to
+
+On line 654:
+ understanding our
+ specific concern, which is
+ the recent crisis.
+
+On line 656:
+ the phenomenal
+ growth of the shadow banking
+ system—the investment
+
+On line 656:
+ most prominently, but
+ also other financial
+ institutions—that
+
+On line 656:
+ regulatory
+ apparatus that had been
+ put in place in the
+
+On line 657:
+ wake of the crash of
+ and the Great Depression. This
+ new system threatened
+
+On line 657:
+ once-dominant
+ traditional commercial
+ banks, and they took their
+
+On line 657:
+ their regulators
+ and to Congress, which slowly
+ but steadily removed
+
+On line 657:
+ and helped banks break out
+ of their traditional mold
+ and join the feverish
+
+ growth. As a result,
+ two parallel financial
+ systems of enormous
+
+On line 657:
+ new competition
+ not only benefited
+ Wall Street but also
+
+On line 657:
+ help all Americans,
+ lowering the costs of their
+ mortgages and boosting
+
+On line 657:
+ returns on their 401(k)s.
+ Shadow banks and commercial
+ banks were codependent
+
+On line 659:
+ new activities
+ were very profitable—and, it turned
+ out, very risky. Second,
+
+On line 659:
+ the evolution of
+ financial regulation.
+ To the Federal
+
+On line 659:
+ granted greater license
+ to market participants
+ appeared to provide
+
+On line 659:
+ and more dynamic
+ alternative to the era
+ of traditional
+
+On line 659:
+ Former Fed chairman
+ Alan Greenspan put it this way: "The
+ market-stabilizing
+
+On line 659:
+ government structures."2
+ In the Fed’s view, if problems
+ emerged in the shadow
+
+On line 659:
+ the large commercial
+ banks—which were believed to be well-run,
+ well-capitalized,
+
+ and well-regulated
+ despite the loosening of
+ their restraints—could provide
+
+On line 659:
+ restore financial
+ stability. It did so
+ again and again in the
+
+On line 659:
+ up to the recent
+ crisis. And, understandably,
+ much of the country
+
+ came to assume that
+ the Fed could always and would
+ always save the day.
+
+ Third, we follow the
+ profound changes in the mortgage
+ industry, from the
+
+On line 661:
+ and servicing 30-year
+ loans to a new era in which
+ the idea was to sell
+
+ the loans off as soon
+ as possible, so that they
+ could be packaged and
+
+ sold to investors around
+ the world. New mortgage products
+ proliferated,
+
+On line 661:
+ market in which the
+ participants—mortgage brokers,
+ lenders, and Wall Street firms—had
+
+ a greater stake in the
+ quantity of mortgages signed
+ up and sold than in
+
+ their quality. We
+ also trace the history
+ of Fannie Mae and
+
+On line 663:
+ dominant forces in
+ providing financing to
+ support the mortgage
+
+On line 665:
+ for investors. Fourth, we
+ introduce some of the most
+ arcane subjects in
+
+On line 665:
+ national vocabu-lary
+ as the financial markets
+ unraveled through and
+
+On line 665:
+ rating agencies whose
+ own motives were conflicted.
+ This entire market
+
+On line 665:
+ to be divorced from
+ reality—and on ever-rising
+ housing prices. When that
+
+On line 665:
+ bubble also burst:
+ the securities almost
+ no one understood,
+
+On line 665:
+ by mortgages no lender
+ would have signed years earlier,
+ were the first dominoes
+
+On line 669:
+ sector. A basic
+ understanding of these four
+ developments will
+
+On line 669:
+ reader up to speed
+ in grasping where matters stood
+ for the financial
+
+On line 669:
+ system in the year
+ at the dawn of a decade of
+ promise and peril.
+
+On line 675:
+ REPOS: "UNFETTERED
+ MARKETS" For most of the 20th
+ century, banks and
+
+On line 675:
+ deposits and loaned that
+ money to home buyers or
+ businesses. Before
+
+On line 675:
+ institutions were
+ vulnerable to runs, when
+ reports or merely
+
+On line 675:
+ that a bank was in
+ trouble spurred depositors
+ to demand their cash.
+
+On line 675:
+ widespread, the bank might
+ not have enough cash on hand to
+ meet depositors’
+
+On line 675:
+ Reserve System in
+ which acted as the lender of
+ last resort to banks.
+
+On line 677:
+ creation of the Fed
+ was not enough to avert bank runs
+ and sharp contrac-tions
+
+On line 677:
+ in the financial
+ markets in the 1920s and 1930s.
+ So in Congress passed
+
+ the Glass-Steagall Act, which, among
+ other changes, established the
+ Federal Deposit
+
+On line 677:
+ bank deposits up to
+ $2,500—an amount that covered the vast
+ majority of
+
+On line 679:
+ deposits at the time;
+ that limit would climb to by
+ where it stayed until
+
+On line 681:
+ was raised to during
+ the crisis in October
+ Depositors no
+
+On line 681:
+ needed to worry
+ about being first in line at
+ a troubled bank’s door.
+
+ And if banks were short
+ of cash, they could now borrow
+ from the Federal
+
+ Reserve, even when they
+ could borrow nowhere else. The Fed,
+ acting as lender of
+
+On line 681:
+ ensure that banks would
+ not fail simply from a lack
+ of liquidity.
+
+ With these backstops in
+ place, Congress restricted banks’
+ activities to
+
+On line 683:
+ move intended to
+ help prevent bank failures, with
+ taxpayer dollars
+
+On line 683:
+ Furthermore, Congress
+ let the Federal Reserve
+ cap interest rates
+
+On line 685:
+ thrifts—also known as
+ savings and loans, or S&Ls— could
+ pay depositors.
+
+On line 685:
+ Regulation Q,
+ was also intended to
+ keep institutions
+
+On line 685:
+ by ensuring that
+ competition for deposits
+ did not get out of
+
+On line 687:
+ was stable as long
+ as interest rates remained
+ relatively steady,
+
+ which they did during
+ the first two decades after World
+ War II. Beginning
+
+On line 687:
+ started to increase,
+ pushing up interest rates.
+ For example, the
+
+On line 687:
+ paid other banks for
+ overnight loans had rarely exceeded
+ in the decades before
+
+On line 687:
+ it reached However,
+ thanks to Regulation Q,
+ banks and thrifts were stuck
+
+On line 687:
+ roughly less than on
+ most deposits. Clearly, this was
+ an untenable bind
+
+On line 687:
+ depository
+ institutions, which could not
+ compete on the most
+
+On line 689:
+ of the interest
+ rate offered on a deposit.
+ Compete with whom1 In
+
+On line 689:
+ others persuaded
+ consumers and businesses to
+ abandon banks and thrifts
+
+On line 691:
+ find new businesses,
+ particularly after
+ the Securities
+
+On line 693:
+ commissions on stock
+ trades in created money
+ market mutual
+
+On line 693:
+ securities such
+ as Treasury bonds and highly
+ rated corporate
+
+On line 693:
+ the funds paid higher
+ interest rates than banks and
+ thrifts were allowed to
+
+On line 695:
+ with a different
+ mechanism: customers bought shares
+ redeemable daily at
+
+On line 695:
+ a stable value.
+ In Merrill Lynch introduced
+ something even more like
+
+ a bank account: "cash
+ management accounts" allowed
+ customers to write checks.
+
+On line 697:
+ market mutual
+ funds quickly followed.5 These funds
+ differed from bank and
+
+ thrift deposits in one
+ important respect: they were
+ not protected by
+
+On line 697:
+ higher interest
+ rates, and the stature of the funds’
+ sponsors reassured
+
+On line 697:
+ promised to maintain the
+ full net asset value of
+ a share. The funds would
+
+On line 697:
+ buck," in Wall Street terms.
+ Even without FDIC insurance,
+ then, depositors
+
+ considered these funds
+ almost as safe as deposits
+ in a bank or thrift.
+
+ Business boomed, and so
+ was born a key player in
+ the shadow banking
+
+On line 697:
+ growing up beside
+ the traditional banking
+ system. Assets in
+
+On line 699:
+ market mutual
+ funds jumped from billion in to
+ more than billion in
+
+On line 701:
+ To maintain their edge
+ over the insured banks and thrifts,
+ the money market
+
+On line 701:
+ in, and they quickly
+ developed an appetite for
+ two booming markets:
+
+On line 703:
+ "commercial paper"
+ and "repo" markets. Through these
+ instruments, Merrill
+
+On line 703:
+ Morgan Stanley, and
+ other Wall Street investment
+ banks could broker and
+
+On line 703:
+ Commercial paper
+ was unsecured corporate
+ debt—meaning that it
+
+On line 705:
+ the corporation’s
+ promise to pay. These loans were
+ cheaper because they
+
+On line 705:
+ sometimes as short as
+ two weeks and, eventually,
+ as short as one day;
+
+On line 705:
+ "rolled them over" when the
+ loan came due, and then again and
+ again. Because only
+
+On line 705:
+ were able to issue
+ commercial paper, it was
+ considered a very
+
+On line 705:
+ companies such as
+ General Electric and IBM,
+ investors believed, would
+
+ always be good for
+ the money. Corporations
+ had been issuing
+
+On line 705:
+ since the beginning
+ of the century, but the
+ practice grew much more
+
+On line 707:
+ the 1960s. This market,
+ though, underwent a crisis
+ that demonstrated that
+
+ capital markets,
+ too, were vulnerable to
+ runs. Yet that crisis
+
+On line 707:
+ in the U.S., filed for
+ bankruptcy with million in
+ commercial paper
+
+On line 707:
+ railroad’s default caused
+ investors to worry about the
+ broader commercial
+
+On line 707:
+ market; holders of
+ that paper—the lenders—refused to
+ roll over their loans to
+
+On line 707:
+ commercial paper
+ market virtually shut
+ down. In response, the
+
+On line 707:
+ with almost million
+ in emergency loans and with
+ interest rate cuts.7
+
+On line 707:
+ Fed’s actions enabled
+ the banks, in turn, to lend to
+ corporations so
+
+On line 707:
+ commercial paper—the
+ borrowers—typically
+ set up standby lines
+
+On line 707:
+ credit with major
+ banks to enable them to pay
+ off their debts should there
+
+On line 707:
+ another shock. These
+ moves reassured investors that
+ commercial paper
+
+On line 709:
+ a safe investment.
+ In the 1960s, the commercial
+ paper market jumped
+
+On line 709:
+ than sevenfold. Then
+ in the 1970s, it grew almost
+ fourfold. Among the largest
+
+On line 709:
+ market mutual
+ funds. It seemed a win-win-win deal: the
+ mutual funds could
+
+On line 709:
+ stable companies
+ could borrow more cheaply, and
+ Wall Street firms could earn
+
+On line 709:
+ fees for putting the deals
+ together. By commercial
+ paper had risen to
+
+On line 711:
+ less than billion in
+ The second major shadow
+ banking market that
+
+On line 711:
+ market for repos,
+ or repurchase agreements. Like
+ commercial paper,
+
+On line 711:
+ a long history,
+ but they proliferated
+ quickly in the 1970s.
+
+On line 711:
+ often sold Treasury
+ bonds with their relatively
+ low returns to banks
+
+On line 711:
+ while then investing
+ the cash proceeds of these sales
+ in securities
+
+On line 711:
+ The dealers agreed to
+ repurchase the Treasuries—often
+ within a day—at
+
+On line 711:
+ for which they sold them.
+ This repo transaction—in
+ essence a loan—made it
+
+ inexpensive and
+ convenient for Wall Street firms
+ to borrow. Because
+
+On line 711:
+ the securities
+ dealers borrowed nearly the
+ full value of the
+
+On line 711:
+ a small "haircut." Like
+ commercial paper, repos
+ were renewed, or "rolled
+
+On line 711:
+ could be considered
+ "hot money"—because lenders could
+ quickly move in and
+
+On line 711:
+ these investments in
+ search of the highest returns,
+ they could be a risky
+
+On line 713:
+ repo market, too,
+ had vulnerabilities,
+ but it, too, had emerged
+
+On line 713:
+ stronger than ever. In
+ two major borrowers, the
+ securities firms
+
+On line 713:
+ losses for lenders. In
+ the ensuing fallout, the
+ Federal Reserve
+
+On line 713:
+ resort to support
+ a shadow banking market.
+ The Fed loosened the
+
+ terms on which it lent
+ Treasuries to securities
+ firms, leading to a
+
+On line 715:
+ to a tri-party
+ arrangement in which a large
+ clearing bank acted
+
+On line 715:
+ borrower and lender,
+ essentially protecting
+ the collateral
+
+On line 715:
+ them in escrow.9 This
+ mechanism would have severe
+ consequences in and
+
+On line 715:
+ 1980s, however, these
+ new procedures stabilized
+ the repo market.
+
+ The new parallel
+ banking system—with commercial
+ paper and repo
+
+On line 717:
+ a crucial catch: its
+ popularity came at
+ the expense of the
+
+On line 719:
+ this development
+ with growing alarm. According
+ to Alan Blinder, the
+
+On line 721:
+ vice chairman of the
+ Federal Reserve from to
+ "We were concerned as
+
+On line 721:
+ regulators with
+ the eroding competitive
+ position of banks,
+
+On line 721:
+ of course would threaten
+ ultimately their safety
+ and soundness, due to
+
+On line 721:
+ they were getting from
+ a variety of nonbanks—and
+ these were mainly Wall
+
+On line 721:
+ were taking deposits
+ from them, and getting into
+ the loan business to
+
+ some extent. So, yeah,
+ it was a concern; you could
+ see a downward trend
+
+On line 725:
+ financial assets."10
+ raditional and Shadow
+ Banking Systems The
+
+ funding available through
+ the shadow banking system
+ grew sharply in the 2000s,
+
+On line 725:
+ the traditional
+ banking system in the years
+ before the crisis.
+
+On line 727:
+ that during the 1990s
+ the shadow banking system
+ steadily gained ground on
+
+On line 729:
+ sector for a brief
+ time after Banks argued that
+ their problems stemmed from
+
+On line 729:
+ Glass-Steagall Act. Glass-Steagall strictly
+ limited commercial banks’
+ participation
+
+On line 729:
+ the securities
+ markets, in part to end the
+ practices of the 1920s,
+
+On line 729:
+ securities to
+ depositors. In Congress
+ also imposed new
+
+ regulatory
+ requirements on banks owned by
+ holding companies,
+
+On line 729:
+ order to prevent
+ a holding company from
+ endangering any
+
+On line 731:
+ Bank supervisors
+ monitored banks’ leverage—their
+ assets relative
+
+On line 733:
+ by nearly every
+ financial institution,
+ amplifies returns.
+
+On line 733:
+ example, if an
+ investor uses of his own
+ money to purchase
+
+On line 733:
+ security that
+ increases in value by
+ he earns However,
+
+On line 733:
+ invests times as much
+ the same increase in value
+ yields a profit of
+
+On line 733:
+ investment. If the
+ investment sours, though, leverage
+ magnifies the loss
+
+On line 733:
+ much. A decline of
+ costs the unleveraged investor
+ leaving him with but
+
+On line 733:
+ wipes out the leveraged
+ investor’s An investor buying
+ assets worth times his
+
+On line 733:
+ of with the numbers
+ representing the total
+ money invested
+
+On line 735:
+ committed to the
+ deal. In bank supervisors
+ established the first
+
+On line 735:
+ liabilities—should
+ be at least of assets for
+ most banks. Capital,
+
+On line 735:
+ general, reflects
+ the value of shareholders’
+ investment in the
+
+On line 737:
+ which bears the first risk
+ of any potential losses.
+ By comparison,
+
+On line 737:
+ leverage, unhindered
+ by oversight of their safety
+ and soundness or by
+
+On line 737:
+ requirements outside
+ of their broker-dealer subsidiaries,
+ which were subject to
+
+ a net capital
+ rule. The main shadow banking
+ participants—the
+
+ money market funds
+ and the investment banks that
+ sponsored many of them—were
+
+ not subject to the
+ same supervision as banks
+ and thrifts. The money
+
+On line 739:
+ from federally
+ insured depositors but
+ principally from
+
+ investors (in the case
+ of money market funds) or
+ commercial paper
+
+On line 741:
+ repo markets (in
+ the case of investment banks).
+ Both money market
+
+On line 741:
+ and securities
+ firms were regulated by
+ the Securities
+
+On line 741:
+ SEC, created in
+ was supposed to supervise
+ the securities
+
+On line 741:
+ investors. It was charged
+ with ensuring that issuers
+ of securities
+
+ disclosed sufficient
+ information for investors,
+ and it required firms
+
+On line 741:
+ securities to
+ comply with procedural
+ restrictions such as
+
+On line 741:
+ separate accounts.
+ Historically, the SEC
+ did not focus on
+
+On line 741:
+ impose capital
+ requirements on broker-dealers
+ designed to protect
+
+On line 743:
+ Meanwhile, since deposit
+ insurance did not cover
+ such instruments as
+
+On line 743:
+ market mutual
+ funds, the government was not
+ on the hook. There was
+
+On line 743:
+ concern about a run.
+ In theory, the investors
+ had knowingly risked
+
+ their money. If an
+ investment lost value, it
+ lost value. If a
+
+On line 743:
+ failed, it failed. As a
+ result, money market funds
+ had no capital
+
+ or leverage standards.
+ "There was no regulation,"
+ former Fed chairman
+
+On line 743:
+ Volcker told the
+ Financial Crisis Inquiry
+ Commission. "It was
+
+On line 743:
+ restricting the type
+ of securities in which
+ they could invest, the
+
+On line 743:
+ securities, and
+ the diversification
+ of their portfolios.
+
+On line 743:
+ ensure that investors’
+ shares would not diminish in
+ value and would be
+
+On line 743:
+ against losses was the
+ implicit guarantee of
+ sponsors like Merrill
+
+On line 745:
+ with reputations
+ to protect. Increasingly,
+ the traditional
+
+ world of banks and thrifts
+ was ill-equipped to keep up
+ with the parallel
+
+On line 745:
+ of the Wall Street firms.
+ The new shadow banks had few
+ constraints on raising
+
+On line 745:
+ investing money.
+ Commercial banks were at a
+ disadvantage and
+
+On line 745:
+ danger of losing
+ their dominant position.
+ Their bind was labeled
+
+On line 745:
+ system concluded
+ that policy makers, all
+ the way back to the
+
+On line 745:
+ only by capping
+ the interest rates they could
+ pay depositors
+
+On line 745:
+ critics argued, the
+ regulatory constraints
+ on industries across
+
+On line 745:
+ competition and
+ restricted innovation,
+ and the financial
+
+On line 747:
+ example of such
+ a hampered industry. Years
+ later, Fed Chairman
+
+On line 749:
+ the argument for
+ deregulation: "Those of us
+ who support market
+
+On line 749:
+ competitive forms
+ might argue that unfettered
+ markets create a
+
+ degree of wealth that
+ fosters a more civilized
+ existence. I have
+
+On line 753:
+ that insight compelling."12
+ THE SAVINGS AND LOAN CRISIS:
+ "THEY PUT A LOT OF
+
+On line 755:
+ continued to chafe
+ against the regulations still
+ in place. The playing
+
+ field wasn’t level,
+ which "put a lot of pressure
+ on institutions
+
+On line 755:
+ higher-rate performing
+ assets," former SEC Chairman
+ Richard Breeden told the
+
+On line 757:
+ of pressure on their
+ regulators to allow
+ this to happen."13 The
+
+On line 757:
+ banks and the S&Ls went
+ to Congress for help. In the
+ Depository
+
+On line 757:
+ Monetary Control
+ Act repealed the limits on
+ the interest rates
+
+On line 757:
+ a significant
+ regulatory constraint
+ on banks and thrifts, it
+
+On line 757:
+ their competitive
+ advantage. Depositors
+ wanted a higher
+
+On line 757:
+ of return, which banks
+ and thrifts were now free to pay.
+ But the interest
+
+ banks and thrifts could earn
+ off of mortgages and other
+ long-term loans was largely
+
+ fixed and could not match
+ their new costs. While their deposit
+ base increased, they now
+
+On line 757:
+ faced an interest
+ rate squeeze. In the difference
+ in interest earned
+
+ on the banks’ and thrifts’
+ safest investments (one-year Treasury
+ notes) over interest
+
+On line 757:
+ deposits was almost
+ percentage points; by it was
+ only percentage
+
+On line 757:
+ The institutions
+ lost almost percentage points
+ of the advantage
+
+On line 757:
+ enjoyed when the rates
+ were capped.14 The legislation
+ had not done enough to
+
+On line 759:
+ facing the banks and
+ thrifts. That legislation was
+ followed in by the
+
+ Garn-St. Germain Act, which
+ significantly broadened
+ the types of loans and
+
+ investments that thrifts
+ could make. The act also gave
+ banks and thrifts broader
+
+ scope in the mortgage
+ market. Traditionally,
+ they had relied on
+
+On line 759:
+ fixed-rate mortgages. But the
+ interest on fixed-rate mortgages
+ on their books fell short
+
+ as inflation surged
+ in the mid-1970s and early 1980s
+ and banks and thrifts found
+
+ it increasingly
+ difficult to cover the
+ rising costs of their
+
+ short-term deposits. In
+ the Garn-St. Germain Act, Congress
+ sought to relieve this
+
+On line 759:
+ and adjustable-rate mortgages
+ (ARMs), even in states where state laws
+ forbade these loans. For
+
+On line 759:
+ term. Borrowers with
+ ARMs enjoyed lower mortgage
+ rates when interest
+
+ rates decreased, but their
+ rates would rise when interest
+ rates rose. For banks and
+
+ thrifts, ARMs offered an
+ interest rate that floated
+ in relationship
+
+ to the rates they were
+ paying to attract money
+ from depositors.
+
+ The floating mortgage
+ rate protected banks and S&Ls
+ from the interest
+
+On line 759:
+ by inflation, but
+ it effectively transferred
+ the risk of rising
+
+On line 761:
+ interest rates to
+ borrowers. Then, beginning
+ in the Federal
+
+On line 761:
+ banks to undertake
+ activities forbidden
+ under Glass-Steagall and its
+
+On line 761:
+ in "bank-ineligible"
+ activities, including
+ selling or holding
+
+On line 761:
+ of securities
+ that were not permissible
+ for national banks
+
+ to invest in or
+ underwrite. At first, the Fed
+ strictly limited
+
+On line 761:
+ activities to
+ no more than of the assets
+ or revenue of any
+
+On line 761:
+ time, however, the
+ Fed relaxed these restrictions.
+ By bank-ineligible
+
+On line 761:
+ represent up to
+ of assets or revenues of
+ a securities
+
+On line 763:
+ Meanwhile, the OCC, the
+ regulator of banks with
+ national charters,
+
+On line 763:
+ equivalent to, or
+ a logical outgrowth of,
+ a recognized bank
+
+On line 763:
+ new activities
+ were underwriting as well
+ as trading bets and
+
+On line 763:
+ derivatives, on
+ the prices of certain assets.
+ Between and the OCC
+
+On line 763:
+ derivatives in
+ which banks might deal to include
+ those related to
+
+On line 765:
+ metals such as gold
+ and silver and equity
+ stocks Fed Chairman Greenspan
+
+On line 765:
+ regulators and
+ legislators supported
+ and encouraged this
+
+On line 765:
+ financial markets.
+ They argued that financial
+ institutions had
+
+On line 765:
+ regulate themselves
+ through improved risk management.
+ Likewise, financial
+
+On line 765:
+ would exert strong and
+ effective discipline through
+ analysts, credit
+
+ rating agencies, and
+ investors. Greenspan argued that the
+ urgent question about
+
+On line 767:
+ the issue this way:
+ financial "modern-ization" was
+ needed to "remove
+
+On line 767:
+ limit choices and
+ options for the consumer of
+ financial services."
+
+On line 767:
+ more effectively
+ in their natural markets.
+ The result would be
+
+On line 769:
+ better services to
+ the public."17 During the 1980s
+ and early 1990s, banks
+
+On line 769:
+ higher interest
+ payments. They made loans to oil
+ and gas producers,
+
+On line 769:
+ leveraged buyouts of
+ corporations, and funded
+ developers of
+
+ residential and
+ commercial real estate.
+ The largest commercial
+
+On line 769:
+ advanced money to
+ companies and governments
+ in "emerging markets,"
+
+On line 769:
+ riskier than the banks’
+ traditional lending. The
+ consequences appeared
+
+On line 769:
+ the real estate
+ markets, with a bubble and
+ massive overbuilding
+
+ in residential
+ and commercial sectors in
+ certain regions. For
+
+On line 769:
+ example, house prices
+ rose per year in Texas from to
+ In California,
+
+On line 769:
+ rose annually
+ from to The bubble burst first
+ in Texas in and but
+
+On line 769:
+ trouble rapidly spread
+ across the Southeast to the mid-Atlantic
+ states and New England,
+
+ then swept back across the
+ country to California
+ and Arizona. Before
+
+On line 769:
+ nationally by
+ from July to February
+ 199220—the first such fall since
+
+On line 771:
+ Depression—driven
+ by steep drops in regional
+ markets.21 In the 1980s,
+
+On line 771:
+ considerably less
+ than current interest rates,
+ spiraling defaults
+
+On line 771:
+ residential and
+ commercial real estate
+ loans, and losses on
+
+ energy-related,
+ leveraged-buyout, and overseas loans,
+ the industry was
+
+On line 773:
+ commercial banks and
+ thrifts failed in what became known
+ as the S&L crisis
+
+On line 773:
+ 1980s and early 1990s.
+ By comparison, only
+ banks had failed between
+
+On line 773:
+ of federally
+ insured depository
+ institutions had
+
+On line 773:
+ required financial
+ assistance, affecting of
+ the banking system’s
+
+On line 773:
+ assets.23 More than bank
+ and S&L executives were
+ convicted of felonies.24
+
+On line 773:
+ the government cleanup
+ was complete, the ultimate
+ cost of the crisis
+
+On line 775:
+ was billion.25 Despite
+ new laws passed by Congress in
+ and in response to
+
+On line 777:
+ deregulatory
+ movement focused in part on
+ continuing to
+
+On line 777:
+ study calling for the
+ elimination of the old
+ regulatory
+
+On line 777:
+ all geographic
+ restrictions on banking and
+ repeal of the Glass-Steagall
+
+On line 777:
+ The study urged Congress
+ to abolish these restrictions
+ in the belief that
+
+On line 777:
+ banks closely tied to
+ the capital markets would
+ be more profitable and
+
+On line 777:
+ competitive with
+ the largest banks from the United
+ Kingdom, Europe, and
+
+On line 777:
+ proposals would let
+ banks embrace innovation
+ and produce a "stronger,
+
+ more diversified
+ financial system that will
+ provide important
+
+On line 779:
+ to the consumer and
+ important protections to
+ the taxpayer."26 The
+
+On line 779:
+ were insurance agents,
+ real estate brokers, and
+ smaller banks, who felt
+
+On line 779:
+ possibility
+ that the largest banks and their huge
+ pools of deposits would
+
+On line 779:
+ unleashed to compete
+ without restraint. The House of
+ Representatives
+
+On line 779:
+ proposal in but
+ similar proposals were
+ adopted by Congress
+
+ later in the 1990s.
+ In dealing with the banking
+ and thrift crisis of
+
+On line 781:
+ early 1990s, Congress
+ was greatly concerned by a
+ spate of high-profile
+
+On line 781:
+ the nation’s 7th-largest bank;
+ in First Republic, number
+ in MCorp, number in
+
+On line 781:
+ England, number These
+ banks had relied heavily
+ on uninsured short-term
+
+On line 781:
+ vulnerable to
+ abrupt withdrawals once confidence
+ in their solvency
+
+On line 783:
+ covered by the FDIC
+ were protected from loss, but
+ regulators felt
+
+ obliged to protect the
+ uninsured depositors—those whose
+ balances exceeded
+
+On line 783:
+ prevent potential
+ runs on even larger banks that
+ reportedly may
+
+ have lacked sufficient
+ assets to satisfy their
+ obligations, such as
+
+On line 785:
+ Bank of America,
+ and Manufacturers Hanover.27
+ During a hearing
+
+On line 785:
+ of Continental
+ Illinois, Comptroller of the
+ Currency C. Todd
+
+On line 787:
+ regulators would
+ not allow the largest "money
+ center banks" to fail.28
+
+On line 787:
+ it had a catchy name.
+ Representative Stewart
+ McKinney of Connecticut
+
+ responded, "We have
+ a new kind of bank. It is
+ called ‘too big to fail’—TBTF—and
+
+On line 789:
+ is a wonderful
+ bank."29 In during this era of
+ federal rescues
+
+On line 789:
+ banks, Drexel Burnham
+ Lambert—once the country’s fifth-largest
+ investment bank—failed.
+
+ Crippled by legal
+ troubles and losses in its
+ junk bond portfolio,
+
+On line 789:
+ bankruptcy in the
+ securities industry
+ to date when lenders shunned
+
+On line 789:
+ and repo markets.
+ While creditors, including
+ other investment
+
+On line 789:
+ rattled and absorbed
+ heavy losses, the government
+ did not step in, and
+
+On line 789:
+ failure did not cause
+ a crisis. So far, it seemed
+ that among financial
+
+On line 791:
+ only commercial
+ banks were deemed too big to fail.
+ In Congress tried to
+
+On line 791:
+ Deposit Insurance
+ Corporation Improvement
+ Act (FDICIA), which sought
+
+On line 791:
+ early when a bank
+ or thrift got into trouble.
+ In addition, if
+
+On line 791:
+ had to resolve the
+ failed institution in a
+ manner that produced
+
+On line 791:
+ to the FDIC’s deposit
+ insurance fund. However,
+ the legislation
+
+On line 791:
+ exempted the FDIC
+ from the least-cost constraints
+ if it, the Treasury,
+
+On line 791:
+ institution posed
+ a "systemic risk" to markets.
+ The other loophole
+
+On line 791:
+ raised by some Wall Street
+ investment banks, Goldman Sachs
+ in particular:
+
+On line 791:
+ of commercial banks
+ to help securities firms
+ during previous
+
+On line 791:
+ for an amendment to
+ FDICIA to authorize the
+ Fed to act as lender
+
+On line 791:
+ banks by extending
+ loans collateralized by
+ the investment banks’
+
+On line 795:
+ legislation sent
+ financial institutions
+ a mixed message: you
+
+ are not too big to
+ fail—until and unless you are
+ too big to fail. So
+
+On line 795:
+ and shadow banking
+ industries—remained an open
+ question until the
+
+On line 807:
+ Mae and Freddie Mac:
+ "The whole army of lobbyists".............................38
+ Structured finance: "It
+
+On line 809:
+ the risk"...................................................42 The growth of
+ derivatives: "By far the
+ most significant
+
+On line 813:
+ in finance during
+ the past decade" FANNIE MAE AND
+ FREDDIE MAC: "THE WHOLE
+
+On line 815:
+ crisis in the thrift
+ industry created an
+ opening for Fannie
+
+On line 815:
+ Freddie Mac, the two
+ massive government-sponsored
+ enterprises (GSEs)
+
+On line 817:
+ Congress to support
+ the mortgage market. Fannie
+ Mae (officially,
+
+On line 817:
+ the Great Depression
+ in to buy mortgages insured
+ by the Federal
+
+On line 817:
+ The new government
+ agency was authorized to
+ purchase mortgages that
+
+On line 817:
+ guaranteeing the
+ supply of mortgage credit
+ that banks and thrifts could
+
+On line 817:
+ homebuyers. Fannie
+ Mae either held the mortgages
+ in its portfolio
+
+On line 817:
+ often, resold them to
+ thrifts, insurance companies,
+ or other investors.
+
+On line 817:
+ War II, Fannie Mae
+ got authority to buy
+ home loans guaranteed
+
+ by the Veterans
+ Administration (VA) as
+ well. This system worked
+
+On line 819:
+ weakness: Fannie Mae
+ bought mortgages by borrowing.
+ By Fannie’s mortgage
+
+On line 819:
+ portfolio had grown
+ to billion and its debt weighed
+ on the federal
+
+On line 819:
+ administration
+ and Congress reorganized
+ it as a publicly
+
+On line 819:
+ to take over Fannie’s
+ subsidized mortgage programs
+ and loan portfolio.
+
+On line 819:
+ insured mortgages, but
+ it was now a hybrid, a
+ "government-sponsored
+
+On line 819:
+ years later, in the
+ thrifts persuaded Congress to
+ charter a second
+
+On line 819:
+ (officially, the
+ Federal Home Loan Mortgage
+ Corporation), to
+
+On line 825:
+ help the thrifts sell their
+ mortgages. The legislation
+ also authorized
+
+ Fannie and Freddie
+ to buy "conventional" fixed-rate
+ mortgages, which were not
+
+On line 829:
+ the FHA or the VA.
+ Conventional mortgages were
+ stiff competition
+
+On line 829:
+ because borrowers
+ could get them more quickly and
+ with lower fees. Still,
+
+ the conventional
+ mortgages did have to conform
+ to the GSEs’ loan size
+
+On line 829:
+ and underwriting
+ guidelines, such as debt-to-income
+ and loan-to-value
+
+On line 833:
+ Mae generally
+ held the mortgages it purchased,
+ profiting from the
+
+On line 833:
+ spread—between its cost
+ of funds and the interest
+ paid on these mortgages.
+
+On line 833:
+ mortgages, in A lender
+ would assemble a pool of
+ mortgages and issue
+
+On line 833:
+ backed by the mortgage
+ pool. Those securities would
+ be sold to investors,
+
+On line 833:
+ timely payment of
+ principal and interest.
+ Ginnie charged a fee
+
+On line 835:
+ to issuers for this
+ guarantee. In Freddie got
+ into the business
+
+On line 835:
+ timely payment of
+ principal and interest.
+ In after a spike
+
+On line 837:
+ Fannie’s portfolio
+ of mortgages, Fannie followed.
+ During the 1980s and
+
+On line 837:
+ market expanded,
+ the GSEs grew in importance,
+ and the market share
+
+ of the FHA and VA
+ declined. Fannie and Freddie
+ had dual missions,
+
+On line 839:
+ the mortgage market
+ and maximize returns for
+ shareholders. They did
+
+On line 839:
+ mortgages; they purchased
+ them—from banks, thrifts, and mortgage
+ companies—and either
+
+On line 839:
+ them. Congress granted
+ both enterprises special
+ privileges, such as
+
+On line 839:
+ from state and local
+ taxes and a billion line
+ of credit each from
+
+On line 839:
+ Federal Reserve
+ provided services such as
+ electronically
+
+On line 839:
+ payments for GSE debt
+ and securities as if
+ they were Treasury bonds.
+
+On line 839:
+ almost as low as
+ the Treasury paid. Federal
+ laws allowed banks, thrifts,
+
+On line 839:
+ and regulations
+ strictly limited the amount
+ of loans banks could make
+
+On line 839:
+ investments in the
+ debt obligations of other
+ firms. In addition,
+
+On line 839:
+ were required to hold
+ very little capital to
+ protect against losses:
+
+On line 839:
+ their guarantees of
+ mortgage-backed securities and
+ to back the mortgages
+
+On line 839:
+ of mortgages assets
+ under capital standards.
+ Such privileges led
+
+On line 839:
+ to believe that the
+ government implicitly
+ guaranteed the GSEs’
+
+On line 839:
+ and debt and that GSE
+ securities were therefore
+ almost as safe as
+
+ Treasury bills. As a
+ result, investors accepted
+ very low returns on
+
+On line 841:
+ funded by short-term
+ borrowings. For example,
+ thrifts generally
+
+On line 841:
+ their mortgages. Fannie
+ ought its mortgage portfolio
+ by borrowing short-
+
+On line 841:
+ interest rates to
+ quell inflation, Fannie, like
+ the thrifts, found that its
+
+ cost of funding rose
+ while income from mortgages did
+ not. By the 1980s, the
+
+On line 841:
+ Development (HUD)
+ estimated Fannie had
+ a negative net
+
+On line 841:
+ primary business
+ was guaranteeing mortgage-backed
+ securities, not
+
+On line 841:
+ Freddie Mac avoided
+ taking the interest rate
+ risk that hit Fannie’s
+
+On line 843:
+ Congress provided
+ tax relief and HUD relaxed
+ Fannie’s capital
+
+On line 843:
+ a vibrant market
+ for home mortgages served the best
+ interests of the
+
+On line 843:
+ but the moves also
+ reinforced the impression
+ that the government
+
+ would never abandon
+ Fannie and Freddie. Fannie
+ and Freddie would soon
+
+On line 843:
+ and either hold or
+ securitize mortgages worth
+ hundreds of billions,
+
+On line 843:
+ trillions, of dollars.
+ Among the investors were U.S. banks,
+ thrifts, investment funds,
+
+On line 845:
+ as well as central
+ banks and investment funds around
+ the world. Fannie and
+
+On line 847:
+ too big to fail. While
+ the government continued
+ to favor Fannie
+
+On line 847:
+ thrifts following the
+ savings and loan crisis. Thrifts
+ had previously
+
+On line 847:
+ the mortgage business
+ as large holders of mortgages.
+ In the Financial
+
+On line 847:
+ and Enforcement Act
+ of (FIRREA), Congress imposed
+ tougher, bank-style capital
+
+On line 847:
+ and regulations
+ on thrifts. By contrast, in the
+ Federal Housing
+
+On line 847:
+ Safety and Soundness
+ Act of Congress created
+ a supervisor
+
+On line 847:
+ Enterprise Oversight
+ (OFHEO), without legal powers
+ comparable to
+
+On line 847:
+ thrift supervisors
+ in enforcement, capital
+ requirements, funding,
+
+On line 847:
+ Crack-ing down on thrifts
+ while not on the GSEs was no
+ accident. The GSEs
+
+On line 847:
+ power during the
+ drafting of the law.3 "OFHEO was
+ structurally weak and
+
+On line 847:
+ designed to fail," said
+ Armando Falcon Jr., a
+ former director
+
+On line 849:
+ to the FCIC.4 All this
+ added up to a generous
+ federal subsidy.
+
+On line 849:
+ the value of that
+ subsidy at billion or more
+ and estimated
+
+ that more than half of
+ these benefits accrued to
+ shareholders, not to
+
+On line 851:
+ worked as it always
+ does: the markets shifted to
+ the lowest-cost,
+
+On line 851:
+ requirements on thrifts,
+ it became increasingly
+ profitable for them to
+
+ securitize with
+ or sell loans to Fannie and
+ Freddie rather than hold
+
+On line 853:
+ the loans. The stampede
+ was on. Fannie’s and Freddie’s
+ debt obligations and
+
+On line 855:
+ securities grew
+ from billion in to trillion
+ in and trillion in
+
+On line 857:
+ legislation that
+ transformed Fannie in also
+ authorized HUD to
+
+On line 857:
+ affordable housing
+ goals for Fannie: to "require
+ that a reasonable
+
+On line 857:
+ the national goal
+ of providing adequate
+ housing for low and
+
+On line 857:
+ but with reasonable
+ economic return to the
+ corporation."7 In
+
+On line 857:
+ to implement the
+ law and, after a barrage
+ of criticism from
+
+On line 857:
+ Federal Housing
+ Enterprises Financial
+ Safety and Soundness
+
+On line 857:
+ Congress extended
+ HUD’s authority to set
+ affordable housing
+
+ goals for Fannie and
+ Freddie. Congress also changed
+ the language to say
+
+On line 857:
+ affordable housing,
+ "a reasonable economic
+ return may be less
+
+ than the return earned
+ on other activities."
+ The law required HUD
+
+On line 859:
+ to maintain the sound
+ financial condition of
+ the enterprises."
+
+ The act now ordered
+ HUD to set goals for Fannie
+ and Freddie to buy
+
+On line 859:
+ and moderate-income
+ housing, special affordable
+ housing, and housing
+
+On line 859:
+ rural areas, and
+ other underserved areas.
+ Congress instructed
+
+On line 859:
+ category as
+ a percentage of the GSEs’
+ mortgage purchases.
+
+On line 861:
+ an initiative to
+ boost homeownership from to
+ of families by
+
+On line 861:
+ one component raised
+ the affordable housing goals
+ at the GSEs. Between
+
+On line 861:
+ and almost million
+ households entered the ranks of
+ homeowners, nearly
+
+ twice as many as in
+ the previous two years. "But
+ we have to do a
+
+ lot better," Clinton
+ said. "This is the new way home
+ for the American
+
+ middle class. We have
+ got to raise incomes in this
+ country. We have got
+
+On line 863:
+ security for
+ people who are doing the
+ right thing, and we have
+
+On line 863:
+ people believe that
+ they can have some permanence
+ and stability
+
+ in their lives even as
+ they deal with all the changing
+ forces that are out there
+
+On line 863:
+ economy."9 The push
+ to expand homeownership
+ continued under
+
+On line 863:
+ George W. Bush, who, for
+ example, introduced a
+ "Zero Down Payment
+
+On line 863:
+ that under certain
+ circumstances could remove the
+ down payment rule for
+
+On line 865:
+ Housing and Urban
+ Development from to and
+ now governor of
+
+On line 865:
+ means many things. There were
+ moderate income loans. These
+ were teachers, these were
+
+ firefighters, these were
+ municipal employees,
+ these were people with
+
+On line 867:
+ who paid mortgages. These
+ were not subprime, predatory
+ loans at all."11 Fannie
+
+On line 869:
+ were problematic.
+ Former Fannie CEO Daniel Mudd
+ told the FCIC that "the
+
+On line 871:
+ structure required the
+ companies to maintain a
+ fine balance between
+
+On line 871:
+ financial goals and
+ what we call the mission goals
+ the root cause of the
+
+On line 871:
+ lies with their business
+ model."12 Former Freddie CEO
+ Richard Syron concurred:
+
+On line 873:
+ it’s a good business
+ model."13 Fannie and Freddie
+ accumulated
+
+On line 873:
+ and an implicit
+ government guarantee, and
+ because they had to
+
+On line 873:
+ with regulators,
+ affordable housing goals, and
+ capital standards
+
+On line 873:
+ the two reported
+ spending more than million on
+ lobbying, and their
+
+On line 873:
+ campaigns.14 The "Fannie
+ and Freddie political
+ machine resisted
+
+On line 873:
+ tactics," Falcon, who
+ regulated them from to
+ testified. "OFHEO was
+
+On line 873:
+ the director of
+ OFHEO and its successor, the
+ Federal Housing
+
+On line 875:
+ from through testified
+ that he argued for reform
+ from the moment he
+
+On line 875:
+ became director
+ and that the companies were
+ "allowed to be so
+
+On line 875:
+ they resisted the
+ very legislation that might
+ have saved them."16 Former
+
+On line 875:
+ a bipartisan
+ fashion through my offices. It’s
+ pretty amazing the
+
+On line 877:
+ number of people
+ that were in their employ."17 In
+ that army helped secure
+
+On line 877:
+ GSEs to count toward
+ their affordable housing goals
+ not just their whole loans
+
+ but mortgage-related
+ securities issued by
+ other companies,
+
+ which the GSEs wanted
+ to purchase as investments.
+ Still, Congressional
+
+On line 879:
+ Director June O’Neill
+ declared in that "the goals are
+ not difficult to
+
+On line 879:
+ and it is not clear
+ how much they have affected
+ the enterprises’
+
+On line 879:
+ as the Federal
+ Housing Administration
+ devote a larger
+
+On line 879:
+ their mortgage lending
+ to targeted borrowers
+ and areas than do
+
+ the enterprises."18
+ Something else was clear: Fannie
+ and Freddie, with their
+
+On line 881:
+ and lax capital
+ requirements, were immensely
+ profitable throughout the
+
+On line 881:
+ 1990s. In Fannie had
+ a return on equity
+ of Freddie, That year,
+
+On line 881:
+ Fannie and Freddie
+ held or guaranteed more than
+ trillion of mortgages,
+
+On line 885:
+ by only billion
+ of shareholder equity.19
+ STRUCTURED FINANCE: "IT
+
+On line 887:
+ T REDUCING THE
+ RISK" While Fannie and Freddie
+ enjoyed a near-monopoly
+
+On line 887:
+ securitizing
+ fixed-rate mortgages that were within
+ their permitted loan
+
+On line 887:
+ the 1980s the markets
+ began to securitize
+ many other types of
+
+On line 887:
+ other mortgages the
+ GSEs were not eligible
+ or willing to buy.
+
+ The mechanism worked
+ the same: an investment bank,
+ such as Lehman Brothers
+
+On line 887:
+ a securities
+ affiliate of a bank),
+ bundled loans from a
+
+ bank or other lender
+ into securities and
+ sold them to investors,
+
+On line 887:
+ by the principal
+ and interest payments from
+ the loans. Investors held
+
+On line 887:
+ more complicated
+ than the GSEs’ basic mortgage-backed
+ securities; the
+
+On line 887:
+ were not just mortgages
+ but equipment leases, credit
+ card debt, auto loans,
+
+ and manufactured
+ housing loans. Over time, banks and
+ securities firms
+
+On line 887:
+ to mimic banking
+ activities outside the
+ regulatory
+
+On line 887:
+ For example, where
+ banks traditionally took
+ money from deposits
+
+ to make loans and held
+ them until maturity,
+ banks now used money
+
+ from the capital
+ markets—often from money
+ market mutual
+
+On line 887:
+ make loans, packaging
+ them into securities
+ to sell to investors.
+
+ For commercial banks,
+ the benefits were large. By
+ moving loans off their
+
+ books, the banks reduced
+ the amount of capital they
+ were required to hold
+
+On line 891:
+ generated cash
+ that could be used to make loans.
+ Banks could also keep
+
+On line 891:
+ securities on
+ their books as collateral
+ for borrowing, and
+
+On line 893:
+ an important source
+ of revenues. Lawrence Lindsey, a
+ former Federal
+
+On line 893:
+ of the National
+ Economic Council under
+ President George W.
+
+ Bush, told the FCIC that
+ previous housing downturns
+ made regulators
+
+On line 893:
+ banks’ holding whole loans
+ on their books. "If you had a
+ regional real
+
+On line 893:
+ took down the banks in
+ that region along with it, which
+ exacerbated
+
+ the downturn," Lindsey
+ said. "So we said to ourselves,
+ ‘How on earth do we
+
+On line 897:
+ key benefits to
+ investors: pooling and tranching.
+ If many loans were pooled
+
+On line 897:
+ securities could
+ also be sliced up and sold
+ in portions—known as
+
+On line 897:
+ buyers customize
+ their payments. Risk-averse investors
+ would buy tranches that
+
+On line 897:
+ off first in the event
+ of default, but had lower
+ yields. Return-oriented
+
+ investors bought riskier
+ tranches with higher yields. Bankers
+ often compared it
+
+ to a waterfall;
+ the holders of the senior
+ tranches—at the top of
+
+On line 899:
+ junior tranches. And
+ if payments came in below
+ expectations, those
+
+On line 903:
+ lenders, investment bankers,
+ and investors. Lenders earned fees for
+ originating and
+
+On line 903:
+ Investment banks earned
+ fees for issuing mortgage-backed
+ securities. These
+
+ securities fetched
+ a higher price than if the
+ underlying loans
+
+On line 903:
+ investors’ needs, were more
+ diversified, and could be
+ easily traded.
+
+On line 903:
+ safer tranches got a
+ higher rate of return than
+ ultra-safe Treasury
+
+On line 903:
+ made them harder to
+ understand and to price than
+ individual
+
+ loans. To determine
+ likely returns, investors had
+ to calculate the
+
+On line 903:
+ probabilities
+ that certain kinds of mortgages
+ might default, and to
+
+On line 903:
+ revenues that would be
+ lost because of those defaults.
+ Then investors had to
+
+On line 903:
+ the effect of the
+ losses on the payments to
+ different tranches.
+
+On line 905:
+ three leading credit
+ rating agencies—Moody’s, Standard Poor’s (S&P),
+ and Fitch—into key
+
+On line 905:
+ positioned between
+ the issuers and the investors
+ of securities.
+
+On line 905:
+ became common, the
+ credit rating agencies had
+ mainly helped investors
+
+On line 907:
+ that they needed to
+ secure favorable credit
+ ratings in order
+
+On line 907:
+ sell structured products
+ to investors. Investment banks
+ therefore paid handsome
+
+On line 907:
+ rating agencies to
+ obtain the desired ratings.
+ "The rating agencies
+
+ were important tools
+ to do that because you know
+ the people that we
+
+ were selling these bonds
+ to had never really
+ had any history
+
+On line 907:
+ They were looking for
+ an independent party
+ to develop an
+
+ opinion," Jim Callahan
+ told the FCIC; Callahan is CEO
+ of PentAlpha, which services
+
+On line 909:
+ of the earliest
+ securitizations.21 With
+ these pieces in place—banks
+
+On line 909:
+ to shed assets and
+ transfer risk, investors ready to
+ put their money to
+
+On line 909:
+ &n
projects / crisishaiku.git / commitdiff