From 654c0e15965bb48c60a58260c3cd7568977194a3 Mon Sep 17 00:00:00 2001 From: dsc Date: Wed, 21 Dec 2011 19:12:39 -0800 Subject: [PATCH] Haikus. --- data/haikus/haikus-fav.txt | 279 + data/haikus/haikus-longest_chains.txt | 258 + data/haikus/haikus-no_overlap.txt |96309 +++++++++ data/haikus/haikus.txt |349012 +++++++++++++++++++++++++++++++++ data/state.json | 1 - 5 files changed, 445858 insertions(+), 1 deletions(-) create mode 100644 data/haikus/haikus-fav.txt create mode 100644 data/haikus/haikus-longest_chains.txt create mode 100644 data/haikus/haikus-no_overlap.txt create mode 100644 data/haikus/haikus.txt delete mode 100644 data/state.json diff --git a/data/haikus/haikus-fav.txt b/data/haikus/haikus-fav.txt new file mode 100644 index 0000000..19b6d72 --- /dev/null +++ b/data/haikus/haikus-fav.txt @@ -0,0 +1,279 @@ +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 + + can be found on the + website. In addition, more + materials that + + cannot be released + yet for various reasons + will eventually + + 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 40: + American people. + We are keenly aware of the + significance of + + +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 + + million Americans + who are out of work, cannot + find full-time work, + + up looking for work. + About four million families + have lost their homes to + + their mortgage payments. + Nearly trillion in household + wealth has vanished, with + + and life savings swept + away. Businesses, large and small, + have felt the sting of + + 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 + + about their future prospects. + The collateral damage + of this crisis has + + been real people + and real communities. + The impacts of this + + are likely to be + felt for a generation. + And the nation faces + + so many Americans, + we began our exploration + with our own views and + + how the world’s strongest + financial system came to + the brink of collapse. + + + +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: + the total collapse + of our financial system + and economy or + + +On line 20: + what caused the crisis. + In that sense, the Commission + has functioned somewhat + + + +On line 20: + the federal law + (the Troubled Asset Relief + Program, known as TARP) + + + +On line 467: + U.S. Congress that "the + apparent froth in housing + markets may have spilled + + + +On line 467: + Still, he reassured + legislators that the U.S. + economy was on + + + +On line 4799: + you get to the end + of the week, you go out and + you refinance that + + And then you get to + the end of another week + and you refinance + + + +On line 4815: + did not indicate + substantial deficiencies. + He wasn’t looking + + + +On line 4817: + a former senior + managing director at + Bear Stearns, said, "I guess + + + +On line 7855: + Firms and families + are still deleveraging and are + uncertain about both + + + +On line 4053: + the head of credit + trading at AIG Financial + Products, told Alan Frost, + + "every f***ing rating + agency we’ve spoken to [came] + out with more downgrades" + + + +On line 4053: + mark it. It’s, it’s, uh, + we’re [unintelligible] + f***ed basically." + + + +On line 4073: + that "[AIG] would be in + fine shape if Goldman wasn’t + hanging its head out + + + +On line 4073: + f***ing number that’s well + bigger than we ever planned + for." He acknowledged + + + +On line 5235: + referred to it as + "bullsh*t capital." Still, the + GSEs kept buying more + + + +On line 5949: + I think that was sort + of pie in the sky dreaming." + Geithner agreed, + + and told Reich so + bluntly. Reich told the FCIC + about a phone call from + + after the rescue. + "About all I can remember + is the foul language + + + +On line 5951: + Geithner telling + him. "‘You guys have handed me + a bag of sh*t.’ I + + + +On line 5957: + selecting a weak + federal regulator, + the Office of Thrift + + + +On line 4209: + Central Bank infused + billions of Euros into + overnight lending markets. + + + +On line 4243: + known as "breaking the + buck" and generally leads + to a fund’s collapse. + + + +On line 4245: + including large banks + such as Bank of America, + US Bancorp, and SunTrust, + + + +On line 4245: + US Bancorp, and SunTrust, + purchased SIV assets from their + money market funds. + + + +On line 4249: + which may include wealthy + investors who invest million + or more. Enhanced cash + + + diff --git a/data/haikus/haikus-longest_chains.txt b/data/haikus/haikus-longest_chains.txt new file mode 100644 index 0000000..49574eb --- /dev/null +++ b/data/haikus/haikus-longest_chains.txt @@ -0,0 +1,258 @@ +Longest Chains of Haikus + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + loans. Nevertheless, + subprime loans were necessary + for PMBS, because they + + generally bore + higher interest rates and + thus could support the + + yields that investors were + expecting. As subprime loans + were originated, + + Fannie and Freddie + were willing consumers of those + that might meet the AH + + goals; moreover, because + of their lower cost of funds, + they were able to buy + + the "best of the worst," + the highest quality among + the NTMs on off er. + + Th ese factors—the + need for higher yielding loans + and the ability + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + regulation got + out, industry lobbyists + would rush to complain + + to members of the + congressional committee + with jurisdiction + + over the financial + activity at issue. + According to Levitt, + + these members would then + "harass" the SEC with frequent + letters demanding + + answers to complex + questions and appearances of + officials before + + Congress. These requests + consumed much of the agency’s + time and discouraged + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + 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 + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + former senior vice + president, testified to + the FCIC. "When I left + + Moody’s, an analyst’s + worst fear was that he would do + something, or she, that + + would allow him or + her to be singled out for + jeopardizing Moody’s + + market share."123 Clarkson + denied having a "forceful" + management style, and + + his supervisor, + Raymond McDaniel, told the FCIC that + Clarkson was a "good + + manager."124 Former + team managing director + Gary Witt recalled that + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + billion) to billion) + without engendering the + substantial increase + + in delinquencies that + would ordinarily have + alarmed investors and brought + + the bubble to a + halt.46 Indeed, the absence of + delinquencies had the + + opposite eff ect. + As investors around the world saw + housing prices rise in + + the U.S. without any + signifi cant losses even among + subprime and other + + high-yielding loans, they + were encouraged to buy PMBS + that—although rated AAA—still off + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + at the Financial + Services Roundtable in early + "But we also don’t + + want to encourage + the abuses; indeed, we want + to do what we can + + to stop these abuses."49 + Fed General Counsel Scott + Alvarez told the FCIC, + + "There was concern that + if you put out a broad rule, + you would stop things that + + were not unfair and + deceptive because you were + trying to get at + + the bad practices and + you just couldn’t think of all + of the details you + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + an Industrial + Loan Company," November + pp. To approve such + + a proposal, the + Bank Holding Company Act + requires the Fed to + + determine that a + transaction "can reasonably + be expected to + + produce benefits + to the public, such as greater + convenience, increased + + competition, or + gains in efficiency, that + outweigh possible + + adverse effects, such + as undue concentration + of resources, decreased + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + PMBS. Losses of this + magnitude would certainly + be enough—when combined + + with other losses + on securities and loans + not related to + + mortgages—to call into + question the stability + of a large number + + of banks, investment + banks and other fi nancial + institutions in + + the U.S. and around the + world. However, there was one + other factor that + + exacerbated + the adverse eff ect of the + loss of a market + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + were generally + prime mortgages, did not suff er + substantial losses + + at the outset of + the mortgage meltdown, although + as the fi nancial + + crisis turned into + a recession and housing + prices continued to + + fall, losses among prime + mortgages began to approach + the level of prime + + mortgage losses that + had occurred in past housing + crises. However, those + +- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - + + true, in part, because + CRA loans are generally + loans to low income + + individuals; + as such, they are more likely + than loans to middle + + income borrowers + to be subprime and Alt-A loans + and thus sought aft er + + by FHA, Fannie and + Freddie and subprime lenders such + as Countrywide; this + + competition is + another reason why their + rates are likely to + diff --git a/data/haikus/haikus-no_overlap.txt b/data/haikus/haikus-no_overlap.txt new file mode 100644 index 0000000..947f07b --- /dev/null +++ b/data/haikus/haikus-no_overlap.txt @@ -0,0 +1,96309 @@ +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: + and information + technology capable + of handling the job— + +On line 911: + market exploded. + By when the market was years + old, about billion worth + +On line 911: + beyond those done by + Fannie, Freddie, and Ginnie, + were outstanding (see + +On line 911: + billion of credit + card debt; nearly billion worth + of securities + +On line 913: + commercial banks; it + was also a lucrative + new line of business + +On line 913: + Wall Street investment + banks, with which the commercial + banks worked to create + +On line 913: + new securities. + Wall Street firms such as Salomon + Brothers and Morgan + +On line 913: + these complex markets + and relied increasingly + on quantitative + + analysts, called "quants." + As early as the 1970s, Wall + Street executives + +On line 913: + develop models + to predict how markets or + securities might + +On line 913: + importance of this + expertise. Scott Patterson, + author of The Quants, + +On line 915: + the FCIC that using + models dramatically + changed finance. "Wall Street + +On line 917: + Patterson said.23 The + increasing dependence on + mathematics let + + the quants create more + complex products and let their + managers say, and maybe + +On line 917: + that they could better + manage those products’ risk. JP + Morgan developed + +On line 917: + Risk" model (VaR), and + the industry soon adopted + different versions. + +On line 917: + predict with at least + certainty how much a firm + could lose if market + +On line 917: + assumptions based on + limited historical + data; for mortgage-backed + +On line 919: + modeling human + behavior was different + from the problems the + + quants had addressed in + graduate school. "It’s not like + trying to shoot a + +On line 919: + professor who worked + at Goldman Sachs for years, told + the Commission. "The + + way people feel about + gravity on a given + day isn’t going + +On line 921: + the way the rocket + behaves."25 Paul Volcker, Fed + chairman from to told + + the Commission that + regulators were concerned + as early as the + + late 1980s that once banks + began selling instead of + holding the loans they + +On line 921: + making, they would care + less about loan quality. Yet + as these instruments + +On line 921: + relied on the banks + to police their own risks. "It + was all tied up in + +On line 921: + hubris of financial + engineers, but the greater hubris + let markets take care + +On line 921: + said.26 Vincent Reinhart, + a former director of + the Fed’s Division + +On line 923: + in assessing risk.27 + Securitization "was + diversifying + +On line 925: + individual + can diversify your risk. + The system as a + +On line 927: + the risk. And that’s where + the confusion lies."28 THE GROWTH + OF DERIVATIVES: + +On line 929: + MOST SIGNIFICANT + EVENT IN FINANCE DURING THE + PAST DECADE" During the + +On line 929: + and complexity + became closely identified + with one element + +On line 929: + Derivatives are + financial contracts whose prices + are determined by, + +On line 929: + from, the value of + some underlying asset, + rate, index, r event. + + They are not used for + capital formation or + investment, as are + +On line 929: + they are instruments + for hedging business risk or + for speculating + +On line 929: + prices, interest rates, + and the like. Derivatives + come in many forms; the + +On line 929: + are over-the-counter-swaps and + exchange-traded futures and + options.29 They may be + + based on commodities + (including agricultural + products, metals, and + +On line 929: + currency rates, stocks + and indexes, and credit + risk. They can even be + +On line 931: + and commercial firms + use such derivatives. A + firm may hedge its price + + risk by entering + into a derivatives + contract that offsets + +On line 931: + recouped through gains on + the derivatives contract. + Institutional + +On line 931: + are risk-averse sometimes + use interest rate swaps to + reduce the risk to + +On line 931: + for floating payments + with risk-taking entities, + such as hedge funds. Hedge + +On line 931: + swaps for the purpose + of speculating, in hopes + of profiting on + + the rise or fall of + a price or interest rate. + The derivatives + +On line 933: + are organized as + exchanges or as over-the-counter (OTC) + markets, although some + + recent electronic + trading facilities blur + the distinctions. The + +On line 933: + Chicago Board of Trade, + where futures and options are + traded. Such exchanges + + are regulated + by federal law and play + a useful role in + +On line 933: + is, in revealing + the market’s view on prices of + commodities or rates + +On line 933: + investment banks—which act + as derivatives dealers, + buying and selling + +On line 933: + customers. Unlike the + futures and options exchanges, + the OTC market is + + neither centralized + nor regulated. Nor is + it transparent, and + +On line 933: + price discovery is + limited. No matter the + measurement—trading + +On line 933: + represent a very + significant sector of + the U.S. financial + +On line 935: + derivatives on + domestic agricultural + products. In Congress + +On line 935: + act to require that + futures and options contracts + on virtually + +On line 935: + be traded on a + regulated exchange, and + created a new + +On line 935: + the Commodity + Futures Trading Commission + (CFTC), to regulate + +On line 937: + market.30 Outside of + this regulated market, + an over-the-counter market + +On line 937: + The large financial + institutions acting as + OTC derivatives + + dealers worried that + the Commodity Exchange + Act’s requirement that + + trading occur on + a regulated exchange + might be applied to + +On line 937: + the products they were + buying and selling. In the + CFTC sought to address + +On line 939: + prohibitions against + fraud and manipulation.31 + As the OTC market + +On line 939: + the CFTC’s exemption, + a wave of significant + losses and scandals + +On line 939: + hit the market. Among + many examples, in Procter + Gamble, a leading + +On line 939: + products company, + reported a pretax loss + of million, the largest + +On line 939: + nonfinancial firm, + stemming from OTC interest + and foreign exchange + +On line 939: + derivatives sold + to it by Bankers Trust. Procter + Gamble sued Bankers Trust + +On line 939: + settled when Bankers Trust + forgave most of the money + that Procter Gamble + +On line 939: + it. That year, the CFTC + and the Securities and + Exchange Commission + +On line 939: + Bankers Trust million for + misleading Gibson Greeting + Cards on interest + +On line 939: + rate swaps resulting + in a mark-to-market loss + of million, larger + +On line 939: + announced it had lost + billion speculating in + OTC derivatives. + +On line 939: + for bankruptcy—the largest by + a municipality + in U.S. history. + +On line 939: + dealer, Merrill Lynch, + paid million to settle claims.32 + In response, the U.S. + +On line 939: + OTC derivatives + activity among major + dealers, concluding + +On line 939: + sudden failure or + abrupt withdrawal from trading + of any one of these + + large dealers could cause + liquidity problems in + the markets and could + +On line 939: + risks to the others, + including federally + insured banks and the + + financial system + as a whole."33 While Congress then + held hearings on the + +On line 939: + lobbying by the + OTC derivatives dealers + and opposition + +On line 941: + billion on copper + derivatives traded on + a London exchange. + +On line 941: + charged the company + with using derivatives + to manipulate + +On line 941: + to finance the scheme. + Sumitomo settled for + million in penalties + + and restitution. The + CFTC also charged Merrill Lynch + with knowingly and + +On line 943: + prices; it settled for + a fine of million.34 Debate + intensified in + +On line 943: + under Chairperson + Brooksley Born said the agency + would reexamine + +On line 943: + regulated the + OTC derivatives market, + given the market’s + +On line 943: + evolution and the + string of major losses since + The CFTC requested + +On line 945: + got them. Some came from + other regulators, who + took the unusual + +On line 945: + criticizing the + CFTC. On the day that the CFTC + issued a concept + +On line 945: + and SEC Chairman Arthur + Levitt issued a joint statement + denouncing the CFTC’s + +On line 945: + grave concerns about this + action and its possible + consequences. We are + +On line 945: + action may increase + the legal uncertainty + concerning certain + +On line 949: + derivatives. For + months, Rubin, Greenspan, Levitt, and Deputy + Treasury Secretary + +On line 949: + in testimony + to Congress and in other + public pronouncements. + +On line 949: + said: "Aside from safety + and soundness regulation + of derivatives + + dealers under the + banking and securities + laws, regulation + +On line 951: + unnecessary."36 In + September, the Federal + Reserve Bank of New + +On line 951: + of Long-Term Capital + Management (LTCM) by major + OTC erivatives dealers. + +On line 951: + An enormous hedge fund, + LTCM had amassed more than trillion + in notional amount + +On line 951: + of securities + on billion of capital + without the knowledge + +On line 951: + counterparties or + federal regulators.37 + Greenspan testified to + +On line 951: + that in the New York + Fed’s judgment, LTCM’s failure would + potentially have + +On line 951: + effects: a default + by LTCM "would not only have + a significant + +On line 951: + also in the process + could produce large losses, or + worse, for a number + +On line 951: + for other market + participants who were not + directly involved + +On line 955: + moratorium. Greenspan + continued to champion + derivatives and + +On line 955: + market. "By far the + most significant event in + finance during the + +On line 955: + development and + expansion of financial + derivatives," Greenspan + +On line 955: + Association + conference in March "The fact + that the OTC markets + +On line 955: + quite effectively + without the benefits of + [CFTC regulation] + +On line 955: + a strong argument + for development of a + less burdensome regime + +On line 957: + resignation—the + President’s Working Group on + Financial Markets, + +On line 957: + and Commodity + Futures Trading Commission + charged with tracking the + +On line 957: + view. The group issued + a report urging Congress + to deregulate OTC + +On line 959: + well.40 In December + in response, Congress passed and + President Clinton + +On line 959: + the Commodity + Futures Modernization Act + of (CFMA), which in + +On line 959: + deregulated the + OTC derivatives market + and eliminated + +On line 961: + the CFTC and the SEC. + The law also preempted + application of + +On line 961: + The SEC did retain + antifraud authority over + securities-based OTC + +On line 963: + all regulation + or oversight. Subsequently, + other laws enabled + +On line 963: + the expansion of + the market. For example, + under a amendment + +On line 963: + laws, derivatives + counterparties were given + the advantage over + +On line 963: + immediately + terminate their contracts and + seize collateral + +On line 965: + of bankruptcy. The + OTC derivatives market + boomed. At year-end when the + +On line 965: + OTC derivatives + outstanding globally was + trillion, and the gross + +On line 965: + market value was + trillion.41 In the seven and + a half years from then + +On line 965: + peaked, outstanding OTC + derivatives increased more + than sevenfold to + +On line 965: + a notional amount + of trillion; their gross market + value was trillion.42 + + Greenspan testified to + the FCIC that credit default + swaps—a small part of + +On line 967: + problems" during the + financial crisis.43 Rubin + testified that when + +On line 967: + he was "not opposed + to the regulation of + derivatives" and + + had personally + agreed with Born’s views, but that "very + strongly held views in + +On line 967: + to regulation" + were insurmountable.44 Summers + told the FCIC that while + +On line 967: + been foreseen years ago, + "by our regulatory + framework with respect + +On line 967: + was manifestly + inadequate," and that "the + derivatives that + +On line 967: + the most serious, + those associated with + credit default swaps, + +On line 969: + fold between and One + reason for the rapid growth of + the derivatives + +On line 969: + above, financial firms + may use derivatives to + hedge their risks. Such use + +On line 969: + derivatives can + lower a firm’s Value at + Risk as determined + +On line 969: + computer models. + In addition to gaining + this advantage in + + risk management, such + hedges can lower the amount of + capital that banks + +On line 969: + are required to hold, + thanks to a amendment to the + regulatory + +On line 971: + International + Capital Accord, or "Basel + I." Meeting in Basel, + +On line 971: + in the world’s central + banks and bank supervisors + adopted principles + +On line 971: + made adjustments to + implement them. Among the most + important was the + +On line 971: + looser than for all + other assets related + to corporate and + +On line 971: + holdings of Fannie’s + and Freddie’s securities + were less than for all + +On line 973: + assets except those + explicitly backed by the + U.S. government.47 These + +On line 973: + capital standards + accommodated the shift + to increased leverage. + +On line 973: + sought more favorable + capital treatment for their + trading, and the Basel + +On line 973: + adopted the Market + Risk Amendment to Basel I. This + provided that if + +On line 973: + market risks using + derivatives, they could hold + less capital against + +On line 975: + investment banks—increase + their leverage. For example, + entering into + + an equity swap + that mimicked the returns of + someone who owned the + +On line 975: + costs, but the amount of + collateral posted was + much smaller than the + +On line 975: + cost of purchasing + the stock directly. Often + no collateral + + was required at all. + Traders could use derivatives + to receive the same + + gains—or losses—as if + they had bought the actual + security, and + +On line 975: + a buyer’s initial + financial outlay.49 Warren + Buffett, the chairman + +On line 975: + to the FCIC about the + unique characteristics of + the derivatives + +On line 975: + view, the leverage in + the system." He went on to + call derivatives + +On line 975: + to understand—indeed, + he concluded, "I don’t think + I could manage" a + +On line 977: + derivative in + the financial crisis was + the credit default + +On line 977: + seller a little + potential upside at the + relatively small + +On line 977: + a potentially + large downside. The purchaser + of a CDS transferred + +On line 977: + the default risk of + an underlying debt. The + debt security + +On line 977: + be any bond or loan + obligation. The CDS buyer + made periodic + +On line 977: + seller during the + life of the swap. In return, + the seller offered + +On line 977: + "credit events" such as + a partial default. If a + credit event such as + +On line 979: + typically pay + the buyer the face value + of the debt. Credit + +On line 979: + as deregulated + OTC derivatives. This made + CDS very different + +On line 979: + policy. A car + owner can insure only + the car she owns—not + + her neighbor’s. But a + CDS purchaser can use it + to speculate on + + the default of a + loan the purchaser does not + own. These are often + +On line 981: + default swaps" and can + inflate potential losses + and corresponding + +On line 983: + on the default of + a loan or institution. + Before the CFMA + +On line 983: + uncertainty about + whether or not state insurance + regulators had + +On line 983: + authority over + credit default swaps. In June + in response to a + +On line 983: + letter from the law + firm of Skadden, Arps, Slate, Meagher + Flom, LLP, the New York + +On line 983: + determined that "naked" + credit default swaps did not + count as insurance + + and were therefore not + subject to regulation.51 + In addition, when + +On line 985: + sells a policy, + insurance regulators + require that it put + + aside reserves in case + of a loss. In the housing + boom, CDS were sold by + + firms that failed to put + up any reserves or initial + collateral or + +On line 985: + exposure. In the + run-up to the crisis, AIG, the + largest U.S. insurance + +On line 985: + one-half trillion dollar + position in credit risk + through the OTC market + +On line 985: + one dollar’s worth of + initial collateral or + making any other + +On line 985: + alone. The value of + the underlying assets + for CDS outstanding + +On line 987: + grew from trillion at + the end of to a peak of + trillion at the end + +On line 987: + A significant + portion was apparently + speculative or + +On line 989: + default swaps.54 Much of + the risk of CDS and other + derivatives was + + concentrated in + a few of the very largest banks, + investment banks, and + +On line 989: + derivatives. Among + U.S. bank holding companies, + of the notional + +On line 989: + millions of contracts, + were traded by just five large + institutions (in + +On line 989: + JPMorgan Chase, Citigroup, + Bank of America, Wachovia, + and HSBC)—many of the same + +On line 989: + crisis.56 The country’s + five largest investment banks were + also among the world’s + +On line 991: + the FCIC said they do + not track revenues and profits + generated by + + their derivatives + operations, some firms did + provide estimates. + +On line 991: + and of its revenues + from through were generated + by derivatives, + +On line 991: + including to of + the firm’s commodities business, + and half or more of + +On line 991: + its interest rate + and currencies business. From + May through November + +On line 993: + were derivative + transactions.57 When the nation’s + biggest financial + +On line 995: + find themselves straining + to understand an unknown + battlefield shaped by + + unseen exposures + and interconnections as + they fought to keep the + +On line 1005: + CONTENTS Expansion + of banking activities: + "Shatterer of Glass-Steagall" + +On line 1011: + Management: "That’s what + history had proved to them" + Dot-com crash: "Lay on + + more risk"......................................................................59 The wages of + finance: "Well, this one’s doing + it, so how can I + +On line 1023: + OF GLASSSTEAGALL" By the + mid-1990s, the parallel banking + system was booming, + +On line 1023: + largest commercial banks + appeared increasingly like + the large investment + +On line 1023: + telecommunications, + and information services + created economies of + +On line 1023: + more diversified, + innovative, efficient, + and better able to + +On line 1023: + that the largest banks were + not necessarily more + efficient but grew + +On line 1023: + commanding market + positions and creditors’ + perception they were + +On line 1023: + fail. As they grew, the + large banks pressed regulators, + state legislatures, + +On line 1023: + banks in every state, + and removed most restrictions + on opening branches + + in more than one state. + It preempted any state law + that restricted the + +On line 1025: + of out-of-state banks + to compete within the state’s + borders.1 Removing + +On line 1025: + consolidate the + banking industry. Between + and "megamergers" occurred + +On line 1025: + involving banks with + assets of more than billion + each. Meanwhile the largest + +On line 1025: + jumped from owning of + the industry’s assets to + From to the combined + +On line 1025: + the five largest U.S. banks—Bank + of America, Citigroup, + JP Morgan, Wachovia, + +On line 1025: + Wells Fargo—more than + tripled, from trillion to trillion.2 + And investment banks + +On line 1027: + acquired Shearson in + and Salomon Brothers in while + Paine Webber purchased + +On line 1027: + Kidder, Peabody in Two + years later, Morgan Stanley + merged with Dean Witter, + +On line 1027: + Bankers Trust purchased Alex. + Brown Sons. The assets of the + five largest investment + +On line 1027: + Sachs, Morgan Stanley, + Merrill Lynch, Lehman Brothers, and + Bear Stearns—quadrupled, from + +On line 1029: + in to trillion in + In the Economic Growth and + Regulatory + +On line 1029: + required federal + regulators to review + their rules every decade + +On line 1031: + Federal Deposit + Insurance Corporation’s + annual report + +On line 1031: + a photograph of + the vice chairman, John Reich; + the director of + +On line 1031: + using a chainsaw + and pruning shears to cut the + "red tape" binding a + +On line 1033: + Securities and + Exchange Commission chairman + Arthur Levitt told the FCIC + +On line 1033: + regulation got + out, industry lobbyists + would rush to complain + + to members of the + congressional committee + with jurisdiction + + over the financial + activity at issue. + According to Levitt, + + these members would then + "harass" the SEC with frequent + letters demanding + + answers to complex + questions and appearances of + officials before + + Congress. These requests + consumed much of the agency’s + time and discouraged + +On line 1033: + regulations. Levitt + described it as "kind of a + blood sport to make the + +On line 1035: + stupid or inept or + venal."5 However, others + said interference—at + +On line 1035: + the executive + branch—was modest. John Hawke, a + former comptroller + +On line 1035: + he found the Treasury + Department "exceedingly + sensitive" to his + +On line 1037: + its supporters were + also disin-clined to adopt + new regulations + +On line 1039: + with strong incentives + to protect shareholders, would + regulate themselves + +On line 1039: + truly impressive + improvement in methods of + risk measurement and + +On line 1039: + growing adoption of + these technologies by mostly + large banks and other + +On line 1039: + believed that markets + would self-regulate through the + activities of + +On line 1039: + and investors. "It is + critically important + to recognize that + +On line 1039: + market is ever + truly unregulated," + said Fed Chairman Alan + +On line 1039: + "The self-interest + of market participants + generates private + +On line 1039: + regulation. Thus, + the real question is not + whether a market should + +On line 1043: + or weakens private + regulation."8 Richard Spillenkothen, the + Fed’s director of + +On line 1043: + before management + weaknesses were reflected + in poor financial + +On line 1043: + might be viewed as i) + overly-intrusive, burdensome, + and heavy-handed, ii) an + +On line 1043: + availability, or + iii) inconsistent with the + Fed’s public posture."9 + +On line 1045: + and keep any agency + from becoming arbitrary + or inflexible, + +On line 1045: + makers pushed to keep + multiple regulators.10 + In Greenspan testified + +On line 1045: + consolidate bank + regulation: "The current + structure provides banks + +On line 1045: + regulator, an + effective test that provides + a limit on the + +On line 1045: + posture of any one + regulator. The pressure + of a potential + +On line 1045: + institutions has + inhibited excessive + regulation and + +On line 1045: + to the bias of a + regulatory agency + to overregulate."11 + +On line 1045: + the OTS and Office + of the Comptroller of the + Currency (OCC), were + +On line 1045: + the institutions + they regulated. As a + result, the larger + +On line 1045: + of institutions + that chose these regulators, + the greater their budget. + +On line 1047: + success and the tenor + of the times, the largest banks and + their regulators + +On line 1047: + to oppose limits + on banks’ activities or + growth. The barriers + +On line 1047: + banks and investment + banks had been crumbling, little + by little, and now + +On line 1047: + to remove the last + remnants of the restrictions + that separated + +On line 1049: + of after years of + opposing repeal of Glass-Steagall, + the Securities + +On line 1049: + such as Goldman Sachs + and Merrill Lynch—changed course. Because + restrictions on banks + +On line 1049: + the previous decade, + banks already had beachheads in + securities and + +On line 1049: + Despite numerous + lawsuits against the Fed and the + OCC, securities + +On line 1049: + of deregulation + through agency rulings.12 Edward + Yingling, the CEO of + +On line 1049: + organization), + said, "Because we had knocked so + many holes in the walls + +On line 1049: + investment banking + and insurance, we were able + to aggressively + +On line 1049: + their businesses—in some + cases more aggressively + than they could enter + +On line 1049: + industry, then the + insurance companies, and + finally the agents + + came over and said let’s + negotiate a deal and + work together."13 In + +On line 1051: + forced the issue by + seeking a merger with the + insurance giant + +On line 1051: + approved it, citing + a technical exemption + to the Bank Holding + +On line 1051: + Act,14 but Citigroup + would have to divest itself + of many Travelers + + assets within five + years unless the laws were changed. + Congress had to make + +On line 1051: + prepared to break up + the nation’s largest financial + firm1 Was it time to + + repeal the Glass-Steagall Act, + once and for all1 As Congress + began fashioning + +On line 1055: + legislation, the + banks were close at hand. In the + financial sector + +On line 1055: + individuals + and political action + committees (PACs) in + +On line 1055: + election cycle. From + through federal lobbying + by the financial + +On line 1057: + campaign donations + from individuals and + PACs topped billion.15 In + +On line 1057: + President Clinton + signed the Gramm-Leach-Bliley Act (GLBA), which + lifted most of the + +On line 1057: + Glass-Steagall-era restrictions. The + new law embodied many of + the measures Treasury + + had previously + advocated.16 The New York + Times reported that + + Citigroup CEO Sandy + Weill hung in his office "a + hunk of wood—at least + +On line 1059: + wide—etched with his portrait + and the words ‘The Shatterer + of Glass-Steagall.’"17 Now, as long + +On line 1059: + certain safety and + soundness conditions, they could + underwrite and sell + +On line 1059: + were no longer bound by + the Fed’s limit—their primary + regulator, the + +On line 1059: + the legislation + argued that the new holding + companies would be + +On line 1059: + safer (through a broader + diversification of + risks), more useful to + +On line 1059: + of one-stop shopping for + financial services), and more + competitive with + +On line 1059: + opponents warned that + allowing banks to combine + with securities + +On line 1059: + speculation and + could trigger a crisis like + the crash of John Reed, + +On line 1059: + FCIC that, in hindsight, + "the compartmentalization + that was created + +On line 1059: + be a positive + factor," making less likely + a "catastrophic + +On line 1061: + financial system.18 + To win the securities + industry’s support, + + the new law left in + place two exceptions that let + securities firms + +On line 1061: + and industrial + loan companies, a type of + depository + +On line 1061: + with stricter limits on + its activities. Through them, + securities firms + +On line 1061: + FDIC-insured deposits without + supervision by the Fed. + Some securities + +On line 1063: + industrial loan + company grew from less than + billion in assets + +On line 1065: + in to billion in + and to billion in Lehman’s thrift + grew from million in + +On line 1067: + in and its assets + rose as high as billion in + For institutions + +On line 1067: + colloquially + as "Fed-Lite." The Fed supervised + financial holding + +On line 1067: + across the various + subsidiaries owned by the holding + company. To avoid + +On line 1067: + to rely "to the + fullest extent possible" on + examinations + +On line 1067: + securities firms, + and insurance companies. + The expressed intent + +On line 1067: + Fed Chairman Ben Bernanke + told the FCIC that Fed-Lite "made it + difficult for any + +On line 1067: + the whole picture of + activities and risks of + large, complex banking + +On line 1069: + the Fed, would fail to + identify excessive risks + and unsound practices + +On line 1071: + companies such as + Citigroup and Wachovia.22 The + convergence of banks + +On line 1071: + between banking and + securities markets that + Fed Chairman Greenspan had + +On line 1071: + stability. He + compared it to a "spare tire": + if large commercial + +On line 1071: + ran into trouble, + their large customers could borrow + from investment banks + + and others in the + capital markets; if those + markets froze, banks could + +On line 1071: + lending provided + another source of credit + to home buyers and + + other borrowers + that softened a steep decline + in lending by thrifts + +On line 1071: + the crisis in Asian + financial markets in the + late 1990s further proved + + his point, Greenspan said.23 The + new regime encouraged growth and + consolidation + +On line 1073: + securities, and + insurance. The bank-centered + financial holding + + companies such as + Citigroup, JP Morgan, and + Bank of America + +On line 1073: + five" investment banks—Goldman + Sachs, Morgan Stanley, Merrill + Lynch, Lehman Brothers, and + +On line 1073: + loan syndication, + and trading in over-the-counter (OTC) + derivatives. The + +On line 1073: + holding companies + became major players in + investment banking. + + The strategies of the + largest commercial banks and their + holding companies + + came to more closely + resemble the strategies of + investment banks. Each + +On line 1073: + insured deposits, and + the investment banks enjoyed + less regulation. + + Both prospered from the + late 1990s until the outbreak + of the financial + +On line 1073: + that had helped make the + system less vulnerable + would be gone when the + + financial crisis + emerged—all the wheels of the system + would be spinning on + +On line 1079: + MANAGEMENT: "THAT’S WHAT + HISTORY HAD PROVED TO THEM" + In August Russia + +On line 1079: + Russia announced it + would restructure its debt and + postpone some payments. + +On line 1079: + investors dumped higher-risk + securities, including + those having nothing + + to do with Russia, + and fled to the safety of + U.S. Treasury bills and + +On line 1079: + deposits. In response, + the Federal Reserve cut + short-term interest + +On line 1079: + times in seven weeks.24 + With the commercial paper + market in turmoil, + + it was up to the + commercial banks to take up + the slack by lending + +On line 1079: + short-term paper. Banks + loaned billion in September + and October of + +On line 1081: + amount25—and helped prevent + a serious disruption + from becoming much + +On line 1083: + a slump. Not so for + Long-Term Capital Management, + a large U.S. hedge fund. + +On line 1083: + debt securities, + including the junk bonds and + emerging market debt + +On line 1083: + investors were dumping.26 + To buy these securities, + the firm had borrowed + +On line 1083: + investors’ equity;27 + lenders included Merrill Lynch, + JP Morgan, Morgan + +On line 1083: + Lehman Brothers, Goldman + Sachs, and Chase Manhattan. The + previous four years, + +On line 1087: + returns: and while the + S&P yielded an average + But leverage works both + + ways, and in just one + month after Russia’s partial + default, the fund lost + +On line 1087: + more than billion—or more + than of its nearly billion + in capital. Its + +On line 1089: + debt was about billion. + The firm faced insolvency.29 + If it were only + +On line 1089: + a matter of less + than billion, LTCM’s failure might + have been manageable. + +On line 1089: + entering into + derivatives contracts with + more than trillion in + +On line 1089: + derivatives.30 With + very little capital in + reserve, it threatened + +On line 1089: + in the opaque over-the-counter + market, the markets did not + know the size of its + +On line 1089: + that it had posted + very little collateral + against those positions. + +On line 1089: + noted then, if all + the fund’s counterparties had + tried to liquidate + +On line 1089: + would have created + "exaggerated" losses. + This was a classic + +On line 1089: + for a run: losses + were likely, but nobody knew + who would get burned. The + + Fed worried that with + financial markets already + fragile, these losses + +On line 1089: + spill over to investors + with no relationship to + LTCM, and credit and + +On line 1089: + markets might "cease to + function for a period + of one or more days + + and maybe longer."31 To avert + such a disaster, the Fed + called an emergency + + meeting of major + banks and securities firms + with large exposures + +On line 1091: + agreed to organize + a consortium to inject + billion into LTCM + +On line 1091: + in return for of + its stock.33 The firms contributed + between million and + +On line 1093: + securities and + derivatives followed. William + McDonough, then president + + of the New York Fed, + insisted "no Federal + Reserve official + +On line 1093: + were made."35 The rescue + involved no government funds. + Nevertheless, the + + Fed’s orchestration + raised a question: how far would + it go to forestall + +On line 1095: + saw as a systemic + crisis1 The Fed’s aggressive + response had precedents + +On line 1097: + decades. In the Fed had + supported the commercial + paper market; in + +On line 1097: + silver futures; in + the repo market; in the + stock market after + +On line 1097: + fell by percent in + three days. All provided a + template for future + +On line 1097: + interest rates and + encouraged financial firms + in the parallel + +On line 1097: + help ailing markets. + And sometimes it organized + a consortium of + +On line 1099: + several large banks + that they viewed as "too big to + fail" and protected + +On line 1099: + those banks, including + uninsured depositors. Their + rationale was that + +On line 1099: + banks were crucial to + the financial markets and + the economy, and + +On line 1099: + could not allow the + collapse of one arge bank to + trigger a panic + +On line 1101: + was a completely + different proposition to + argue that a hedge + +On line 1101: + big to fail because + its collapse might destabilize + capital markets. + +On line 1101: + rescue indicate + that the Fed was prepared to + protect creditors + +On line 1101: + any type of firm if + its collapse might threaten the + capital markets1 + +On line 1101: + Miller, the bankruptcy + counsel for Lehman Brothers when + it failed in told the + + FCIC that "they [hedge funds] + expected the Fed to save + Lehman, based on the Fed’s + + involvement in LTCM’s + rescue. That’s what history + had proved to them."37 For + + Stanley O’Neal, Merrill’s + CFO during the LTCM rescue, + the experience + + was "indelible." He + told the FCIC, "The lesson I + took away from it though + +On line 1105: + and panic and lack + of liquidity lasted + longer, there would have been + + a lot of firms across + the Street that were irreparably + harmed, and Merrill would + +On line 1107: + have been one of those."38 + Greenspan argued that the events of + had confirmed the spare + +On line 1107: + in a speech that the + successful resolution + of the crisis showed + +On line 1107: + financial sector + provides insurance against a + financial problem + +On line 1107: + Financial Markets + came to a less definite + conclusion. In a + +On line 1107: + its counterparties + had "underestimated + the likelihood that + +On line 1107: + and volatility spreads + would move in a similar + fashion in markets + +On line 1107: + the world at the same + time."40 Many financial firms would + make essentially + +On line 1107: + the Working Group, this + miscalculation raised an + important issue: + +On line 1107: + fostered a major + expansion in the volume + and, in some cases, + +On line 1107: + severe losses. This + shows the need for insuring + that decisions about + +On line 1109: + is explicitly + considered."41 The need for risk + management grew in + + the following decade. + The Working Group was already + concerned that neither + +On line 1109: + and the economy. + Nevertheless, it cautioned + that overreacting + + to threats such as LTCM + would diminish the dynamism + of the financial + +On line 1111: + real economy: + "Policy initiatives that + are aimed at simply + + reducing default + likelihoods to extremely + low levels might be + +On line 1111: + activity and + the intermediation + of risks that support + +On line 1113: + Group’s findings, the SEC + five years later would issue + a rule expanding + + the number of hedge + fund advisors—to include most + advisors—that needed + +On line 1113: + register with the + SEC. The rule would be struck down + in by the United + +On line 1113: + Court of Appeals for + the District of Columbia + after the SEC was + +On line 1115: + were relatively + calm after Glass-Steagall would be deemed + unnecessary, OTC + + derivatives would + be deregulated, and the + stock market and the + +On line 1115: + would continue to + prosper for some time. Like all + the others (with the + + exception of the + Great Depression), this crisis + soon faded into + +On line 1115: + memory. But not + before, in February Time + magazine featured + +On line 1115: + Larry Summers, and + Alan Greenspan on its cover as + "The Committee to + +On line 1115: + the World." Federal + Reserve Chairman Greenspan became + a cult hero—the "Maestro"—who + +On line 1119: + emergency since the + stock market crash.44 DOTCOM CRASH: + "LAY ON MORE RISK" The + + late 1990s was a good + time for investment banking. + Annual public + +On line 1119: + securities in + U.S. markets almost quadrupled, + from billion in to + +On line 1119: + Annual initial + public offerings of stocks + (IPOs) soared from billion + +On line 1119: + in to billion in + as banks and securities + firms sponsored IPOs for + +On line 1119: + telecommunications + companies—the dot-coms + and telecoms.45 A stock + + market boom ensued + comparable to the great + bull market of the + +On line 1119: + value of publicly + traded stocks rose from trillion + in December to + +On line 1119: + trillion in March The + boom was particularly + striking in recent + +On line 1119: + and telecom issues + on the NASDAQ exchange. Over + this period, the + +On line 1121: + skyrocketed from + to In the spring of the tech + bubble burst. The "new + +On line 1121: + telecoms had failed to + match the lofty expectations + of investors, who had + +On line 1121: + bullish—and, as it turned + out, sometimes deceptive—research + reports issued by + +On line 1121: + and securities + firms that had underwritten + the tech companies’ + +On line 1121: + offerings. Between + March and March the NASDAQ fell + by almost two-thirds. This + +On line 1121: + as the nation slipped + into recession. Investors + were further shaken + +On line 1121: + and other scandals + at prominent firms such as + Enron and World-com. + +On line 1121: + leading commercial + and investment banks settled + with regulators + +On line 1121: + improper practices + in the allocation of + IPO shares during the + +On line 1121: + spinning (doling out + shares in "hot" IPOs in return + for reciprocal + +On line 1121: + laddering (doling + out shares to investors who agreed + to buy more later + + at higher prices).47 The + regulators also found + that public research + +On line 1121: + New York’s attorney + general, the National + Association + +On line 1121: + state regulators + settled enforcement actions + against firms for million, + +On line 1123: + certain practices, and + instituted reforms.48 The + sudden collapses + +On line 1123: + of Enron and WorldCom + were shocking; with assets of + billion and billion, + +On line 1125: + Morgan, Merrill Lynch, + and other Wall Street banks paid + billions of dollars—although + +On line 1125: + no wrongdoing—for + helping Enron hide its debt + until just before + + its collapse. Enron + and its bankers had created + entities to do + + complex transactions + generating fictitious + earnings, disguised debt + +On line 1125: + banks had pressured their + analysts to write glowing + valuations of + + Enron. The scandal + cost Citigroup, JP Morgan, + CIBC, Merrill Lynch, and + +On line 1125: + settlements with the + SEC; Citigroup, JP Morgan, + CIBC, Lehman Brothers, and + +On line 1127: + Bank of America + paid another billion to + investors to settle + +On line 1127: + response, the Sarbanes-Oxley Act + of required the personal + certification + +On line 1127: + reports by CEOs and + CFOs; independent audit + committees; longer jail + + sentences and larger + fines for executives who + misstate financial + +On line 1129: + and protections for + whistleblowers. Some firms that lent + to companies that + +On line 1129: + stock market bust were + successfully hedged, having + earlier purchased + + credit default swaps + on these firms. Regulators + seemed to draw comfort + +On line 1131: + banks had succeeded + in transferring losses from + those relationships + +On line 1131: + investors through these and + other hedging transactions. + In November Fed + +On line 1131: + have effectively + spread losses" from defaults by + Enron and other + + large corporations. + Although he conceded the + market was "still too + +On line 1131: + to have been tested" + thoroughly, he observed that + "to date, it appears + +On line 1133: + following year, Fed + Vice Chairman Roger Ferguson + noted that "the most + +On line 1133: + fact regarding the + banking industry during + this period is + +On line 1135: + achieved unprecedented + stability and strong risk + management. The Wall + +On line 1135: + banks’ pivotal role in + the Enron debacle did + not seem to trouble + +On line 1135: + Fed officials. In + a memorandum to the + FCIC, Richard Spillenkothen described + +On line 1135: + Board of Governors + in which some Fed governors + received details of + +On line 1135: + "The message to some + supervisory staff was + neither ambiguous + + nor subtle," Spillenkothen wrote. + Earlier in the decade, he + remembered, senior + +On line 1135: + at the Fed had called + Enron an example of + a derivatives + +On line 1135: + regulated by + market discipline without + government oversight.52 + +On line 1137: + cut interest rates + aggressively in order + to contain damage + +On line 1137: + dot-com and telecom + bust, the terrorist attacks, + and the financial + +On line 1137: + In January the + federal funds rate, the overnight + bank-to-bank lending rate, + +On line 1139: + was By mid-2003, the Fed + had cut that rate to just the + lowest in half a + +On line 1139: + another year. In + addition, to offset the + market disruptions + +On line 1141: + financial markets + with money by purchasing + more than billion in + +On line 1141: + securities and + lending billion to banks. It + also suspended + + restrictions on bank + holding companies so the + banks could make large loans + +On line 1141: + these actions the Fed + prevented a protracted + liquidity crunch + +On line 1141: + in the financial + markets during the fall of + just as it had done + +On line 1143: + the stock market crash + and the Russian crisis. Why + wouldn’t the markets + + assume the central + bank would act again—and again save the + day1 Two weeks before + +On line 1143: + cut short-term rates in + January the Economist + anticipated + +On line 1145: + it: "the ‘Greenspan put’ is + once again the talk of Wall Street. + The idea is that the + + Federal Reserve + can be relied upon in + times of crisis to + +On line 1145: + the rescue, cutting + interest rates and pumping + in liquidity, + +On line 1145: + providing a floor + for equity prices."53 The "Greenspan + put" was analysts’ + + shorthand for investors’ + faith that the Fed would keep the + capital markets + +On line 1145: + no matter what. The + Fed’s policy was clear: to + restrain growth of an + + asset bubble, it + would take only small steps, such + as warning investors + + some asset prices might + fall; but after a bubble + burst, it would use all + +On line 1145: + bursting a bubble + would heavily damage the + economy. "Instead + +On line 1145: + trying to contain + a putative bubble by + drastic actions with + +On line 1145: + in when housing prices + were ballooning, "we chose to + focus on policies + + ‘to mitigate the + fallout when it occurs and, + hopefully, ease the + +On line 1147: + policy—allowing + unrestrained growth, then working + hard to cushion the + +On line 1147: + the question of "moral + hazard": did the policy + encourage investors + +On line 1147: + institutions to + gamble because their upside + was unlimited + +On line 1147: + their downside (at least + against catastrophic losses)1 + Greenspan himself warned about + +On line 1147: + a speech, noting that + higher asset prices were "in + part the indirect + +On line 1147: + investors accepting + lower compensation for + risk" and cautioning + +On line 1147: + liquidity can + readily disappear."55 Yet + the only real + +On line 1147: + would be an upward + march of the federal funds + rate that had begun + +On line 1147: + in the summer of + although, as he pointed out + in the same speech, this + +On line 1149: + And the markets were + undeterred. "We had convinced + ourselves that we were + +On line 1149: + Federal Reserve + governor and National + Economic Council + +On line 1151: + under President + George W. Bush Lawrence Lindsey told + the Commission. "And + +On line 1151: + should any rational + investor respond to a less + risky world1 They should lay + +On line 1155: + more risk."56 THE WAGES OF + FINANCE: "WELL, THIS ONE’S DOING + IT, SO HOW CAN I + +On line 1155: + DO IT1 As figure + demonstrates, for almost half a + century after + + the Great Depression, + pay inside the financial + industry and out + +On line 1155: + financial sector + compensation was more than + greater than in other + +On line 1157: + gap than before the + Great Depression. Until the + New York Stock Exchange, + +On line 1157: + required members to + operate as partnerships.57 + Peter J. Solomon, a + +On line 1157: + Lehman Brothers partner, + testified before the FCIC + that this profoundly + +On line 1157: + bank’s culture. Before + the change, he and the other + partners had sat in + +On line 1157: + room at headquarters, + not to socialize but to + "overhear, interact, + + and monitor" each + other. They were all on the + hook together. "Since + +On line 1157: + seriously," Solomon + said.58 Brian Leach, formerly + an executive + +On line 1157: + before it issued + stock and became a public + corporation: "When + + I first started at + Morgan Stanley, it was a + private company. + + When you’re a private + company, you don’t get paid + until you retire. + +On line 1157: + you get a good, you + know, year-to-year compensation." + But the big payout + + was "when you retire."59 + When the investment banks went + public in the 1980s + +On line 1159: + close relationship + between bankers’ decisions and + their compensation + +On line 1159: + shareholders’ money. + Talented traders and managers + once tethered to their + + firms were now free agents + who could play companies against + each other for more + +On line 1159: + up, commercial banks + did the same. Some included + "clawback" provisions + +On line 1159: + require the return + of compensation under + narrow circumstances, + +On line 1159: + proved too limited + to restrain the behavior + of traders and managers. + +On line 1161: + found that the real + value of executive + pay, adjusted for + +On line 1161: + the years after World + War II, lagging companies’ + increasing size.60 But + +On line 1163: + rate picked up during + the 1970s and rose faster each decade, + reaching a year from + +On line 1163: + to Much of the change + reflected higher earnings + in the financial + +On line 1163: + averaged million + annually, the highest + of any industry. + + Though base salaries differed + relatively little across + sectors, banking and + +On line 1163: + higher bonuses and + awarded more stock. And brokers + and dealers did by + +On line 1165: + more than million in + compensation.62 Both before + and after going + + public, investment + banks typically paid out + half their revenues in + +On line 1165: + compensation. For + example, Goldman Sachs spent + between and a year + +On line 1167: + and Merrill paid out + similar percentages in + and but gave in 2007—a + +On line 1169: + suffered dramatic + losses.63 As the scale, revenue, + and profitability + +On line 1169: + key employees. John + Gutfreund, reported to + be the highest-paid + +On line 1171: + on Wall Street in the + late 1980s, received million in + as CEO of Salomon + +On line 1173: + Stanley O’Neal’s package + was worth more than million in + the last full year he + +On line 1173: + was CEO of Merrill + Lynch.65 In Lloyd Blankfein, CEO at + Goldman Sachs, received + +On line 1173: + Richard Fuld, CEO of Lehman + Brothers, and Jamie Dimon, CEO + of JPMorgan Chase, received + +On line 1173: + million and million, + respectively.67 That year Wall + Street paid workers in + +On line 1173: + York roughly billion + in year-end bonuses alone.68 Total + compensation for + + the major U.S. banks + and securities firms was + estimated at + +On line 1175: + billion.69 Stock options + became a popular form + of compensation, + +On line 1175: + buy the company’s + stock in the future at some + predetermined price, + +On line 1175: + to reap rewards when + the stock price was higher than + that predetermined + +On line 1175: + In fact, the option + would have no value if the + stock price was below + +On line 1175: + price. Encouraging + the awarding of stock options + was legislation + +On line 1175: + while the downside was + simply to receive nothing + if the stock didn’t + +On line 1175: + predetermined price. + The same applied to plans that + tied pay to return + + on equity: they + meant that executives could + win more than they could + +On line 1177: + to increase both risk + and leverage, which could lead to + larger jumps in a + +On line 1179: + price. As these options + motivated financial + firms to take more risk + +On line 1179: + use more leverage, the + evolution of the system + provided the means. + +On line 1179: + commercial banks. OTC + derivatives allowing + for enormous leverage + + proliferated. + And risk management, thought to + be keeping ahead of + +On line 1181: + in the increasing + risks. The dangers of the new + pay structures were clear, + +On line 1181: + were powerless to + change it. Former Citigroup + CEO Sandy Weill told the + + Commission, "I think + if you look at the results + of what happened on + + Wall Street, it became, + Well, this one’s doing it, so + how can I not do + +On line 1181: + if I don’t do it, + then the people are going + to leave my place and + +On line 1181: + of an important + function in a broad base of + companies, I would + +On line 1183: + regulatory + entities, one source of checks + on excessive risk + +On line 1183: + challenges recruiting + financial experts who could + otherwise work in + + the private sector. + Lord Adair Turner, chairman of + the U.K. Financial + +On line 1185: + told the Commission, + "It’s not easy. This is like a + continual process + +On line 1185: + high-skilled people, and + the poachers are better paid + than the game-keepers."71 + +On line 1185: + said the same at an + FCIC hearing: "It’s just simply + never going to + + be the case that the + government can pay what Wall + Street can pay."72 Tying + +On line 1187: + to earnings also, + in some cases, created + the temptation to + +On line 1187: + the numbers. Former + Fannie Mae regulator + Armando Falcon + +On line 1187: + "Fannie began the + last decade with an ambitious + goal—double earnings + +On line 1187: + to [per share]. A large + part of the executives’ + compensation was + +On line 1187: + tied to meeting that + goal." Achieving it brought CEO Franklin + Raines million of his + +On line 1187: + million pay from to + However, Falcon said, the + goal "turned out to be + +On line 1187: + hiding risks. Fannie + and Freddie executives + worked hard to persuade + +On line 1187: + investment, while at + the same time covering up + the volatility and + +On line 1187: + of their own mortgage + portfolios and balance sheets." + Fannie’s estimate + +On line 1187: + of how many mortgage + holders would pay off was off + by million at year-end + +On line 1187: + which meant no bonuses. + So Fannie counted only + half the million on + + its books, enabling Raines + and other executives + to meet the earnings + +On line 1189: + chain, from people who + originated mortgages to + people on Wall Street + +On line 1189: + often the first link + in the process, FDIC Chairman Sheila + Bair told the FCIC that + +On line 1189: + based on the volume + of loans originated rather + than the performance + + and quality of + the loans made." She concluded, + "The crisis has shown + +On line 1189: + Formula-driven + compensation allows high + short-term profits to + +On line 1189: + into generous + bonus payments, without regard + to any longer-term risks."74 SEC + +On line 1189: + success, even if these + same decisions result in + significant long-term + + losses or failure + for investors and taxpayers."75 + FINANCIAL SECTOR + +On line 1193: + "I THINK WE OVERDID + FINANCE VERSUS THE REAL + ECONOMY" For about + +On line 1193: + beginning in the + early 1980s, the financial + sector grew faster than + +On line 1193: + the economy—rising + from about of gross domestic + product (GDP) to about + +On line 1193: + in the early 21st + century. In financial + sector profits were + +On line 1193: + about of corporate + profits. In they hit a high + of but fell back to + +On line 1193: + larger. JP Morgan’s + assets increased from billion + in to trillion in + +On line 1195: + annual growth rate + of Bank of America and + Citigroup grew by + +On line 1197: + respectively, with + Citigroup reaching trillion + in assets in (down + +On line 1197: + from trillion in and + Bank of America trillion. + The investment banks + +On line 1197: + Goldman’s assets grew + from billion in to trillion + by an annual + +On line 1201: + growth rate of At Lehman, + assets rose from billion to + billion, or Fannie + +On line 1201: + Fannie’s assets and + guaranteed mortgages increased + from trillion in to + +On line 1201: + or annually. + At Freddie, they increased from + trillion to trillion, + +On line 1203: + or a year.77 As they + grew, many financial firms added + lots of leverage. That + +On line 1203: + higher returns for + shareholders, and more money + for compensation. + + Increasing leverage + also meant less capital + to absorb losses. + +On line 1205: + and Freddie were the + most leveraged. The law set the + government-sponsored + +On line 1205: + requirement at of + assets plus of the mortgage-backed + securities they + +On line 1207: + So they could borrow + more than for each dollar of + capital used to + +On line 1207: + If they wanted to + own the securities, they + could borrow for each + +On line 1207: + capital. Combined, + Fannie and Freddie owned or + guaranteed trillion + +On line 1209: + at the end of against + just billion of capital, + a ratio of From + +On line 1209: + to in assets for + each dollar of capital, + for leverage ratios + +On line 1209: + between and:1. For some + banks, leverage remained roughly + constant. JP Morgan’s + +On line 1211: + reported leverage + was between and:1. Wells Fargo’s + generally ranged + +On line 1211: + between and Other + banks upped their leverage. Bank of + America’s rose + +On line 1211: + to in Citigroup’s + increased from to:1, then shot up + to by the end of + +On line 1211: + brought off-balance sheet + assets onto the balance + sheet. More than other + + banks, Citigroup held + assets off of its balance + sheet, in part to hold + +On line 1213: + bringing billion worth + of assets on balance sheet, + substantial assets + +On line 1215: + remained off. If those + had been included, leverage + in would have been or + +On line 1215: + Wells Fargo and Bank + of America, including + off-balance-sheet assets + +On line 1219: + have raised the leverage + ratios and respectively.78 + Because investment + +On line 1219: + not subject to the + same capital requirements + as commercial and + +On line 1219: + banks, they were given + greater latitude to rely + on their internal + +On line 1221: + and they reported + higher leverage. At Goldman + Sachs, leverage increased + +On line 1221: + in to in Morgan + Stanley and Lehman increased about + and%, respectively, + +On line 1223: + reached by the end of + Several investment banks + artificially + +On line 1223: + assets right before + the reporting period + and subsequently + + buying them back. As + the investment banks grew, their + business models changed. + +On line 1225: + of the investment + banks’ revenues and earnings was + generated by + +On line 1225: + and derivatives + activities. At Goldman, + revenues from trading + +On line 1227: + investments increased + from of the total in to + in At Merrill Lynch, + +On line 1229: + they generated + of revenue in up from in + At Lehman, similar + +On line 1231: + generated up + to of pretax earnings in + up from in At Bear + +On line 1231: + they accounted for + more than of pretax earnings + in some years after + +On line 1233: + losses in other + businesses.80 Between and debt + held by financial + +On line 1235: + companies grew from + trillion to trillion, more than + doubling from to of + +On line 1235: + told the FCIC that while + the financial sector must + play a "critical" + +On line 1235: + capital to the + most productive uses, it + was reasonable to + +On line 1235: + ask whether over the last + or years it had become too + large. Financial firms + +On line 1235: + companies borrowed + in the credit markets for + every borrowed by + +On line 1235: + were borrowing for + every "We have a lot more + debt than we used to + + have, which means we have + a much bigger financial + sector," said Snow. "I + +On line 1235: + versus the real + economy and got it a + little lopsided + +On line 1247: + so complicated + how is anybody going to + know1" Greater access to + +On line 1249: + business where we can + make some money".............72 Subprime lenders + in turmoil: "Adverse + +On line 1253: + market conditions"..................................74 + The regulators: "Oh, I + see" In the early + + 1980s, subprime lenders such + as Household Finance Corp. and + thrifts such as Long Beach + + Savings and Loan made + home equity loans, often + second mortgages, to + + borrowers who had + yet to establish credit + histories or had + +On line 1253: + and the like. Banks might + have been unwilling to lend + to these borrowers, + +On line 1253: + a subprime lender would + if the borrower paid a + higher interest + +On line 1253: + the extra risk. "No + one can debate the need for + legitimate non-prime + +On line 1253: + president of the + Nevada Fair Housing Center, + Inc., testified to + +On line 1257: + subprime mortgages, with + substantial collateral—the + house— weren’t as high + + as those for car loans, + and were much less than credit + cards. The advantages + +On line 1257: + over other forms of + debt were solidified in + with the Tax Reform + +On line 1257: + consumer loans but kept + the deduction for mortgage + interest payments. + +On line 1259: + the assessment of + risk, mortgage lenders (including + subprime lenders) relied + + on other factors + when underwriting mortgages. + As Tom Putnam, a + + Sacramento-based mortgage + banker, told the Commission, they + traditionally + +On line 1259: + the four C’s: credit + (quantity, quality, and + duration of the + +On line 1259: + income), capital + (sufficient liquid funds to + cover down payments, + +On line 1259: + costs, and reserves), and + collateral (value and + condition of the + +On line 1259: + how strength in one area, + such as collateral, might + offset weaknesses + +On line 1259: + such as credit. They + underwrote borrowers one + at a time, out of + + local offices. In + a few cases, such as CitiFinancial, + subprime lending firms + +On line 1261: + finance companies. + Without access to deposits, + they generally + +On line 1261: + themselves with short-term + lines of credit, or "warehouse + lines," from commercial + + or investment banks. + In many cases, the finance + companies did not + +On line 1261: + Some sold the loans to + the same banks extending the + warehouse lines. The banks + + would securitize + and sell the loans to investors + or keep them on their + +On line 1261: + other cases, the + finance company itself + packaged and sold the + +On line 1261: + partnering with the + banks extending the warehouse + lines. Meanwhile, the S&Ls + +On line 1267: + SO COMPLICATED + HOW IS ANYBODY GOING TO + KNOW1 Debt outstanding + +On line 1267: + markets tripled during + the 1980s, reaching trillion in + was securitized + +On line 1267: + as the single largest + component—a position + they maintained through the + +On line 1269: + In the 1990s mortgage + companies, banks, and Wall Street + securities firms + +On line 1269: + securitizing + mortgages (see figure And more + of them were subprime. + +On line 1271: + and other Wall Street + firms started packaging and + selling "non-agency" + + mortgages—that is, loans that + did not conform to Fannie’s + and Freddie’s standards. + +On line 1271: + handled by Fannie + and Freddie, the question was + not "will you get the + +On line 1271: + "when," former Salomon + Brothers trader and CEO of + PentAlpha Jim Callahan told + +On line 1271: + and that created + an opportunity for + S&P and Moody’s. As Lewis + +On line 1271: + pioneer in the + market, told the Commission, + when he presented + +On line 1271: + they asked, "‘This stuff is + so complicated how is + anybody going to + +On line 1271: + How are the buyers + going to buy1’" Ranieri said, "One + of the solutions + + was, it had to have + a rating. And that put the + rating services in + +On line 1273: + business."5 Non-agency + securitizations were + only a few years + + old when they received + a powerful stimulus + from an unlikely + + source: the federal + government. The savings and + loan crisis had left + +On line 1273: + with billion in loans + and real estate from failed + thrifts and banks. Congress + +On line 1275: + the Resolution + Trust Corporation (RTC) in + to offload mortgages + +On line 1275: + estate, and sometimes + the failed thrifts themselves, now owned + by the government. + +On line 1275: + RTC was able to sell + billion of these mortgages to + Fannie and Freddie, + +On line 1277: + did not meet the GSEs’ + standards. Some were what might be + called subprime today, + +On line 1279: + that later became + popular.6 RTC officials + soon concluded that + + they had neither the + time nor the resources to sell + off the assets in + + their portfolio one + by one and thrift by thrift. They + turned to the private + +On line 1279: + real estate and + financial professionals + to securitize + +On line 1279: + had securitized + billion in residential + mortgages.7 The RTC in + +On line 1279: + familiar with the + securitization of + these assets, mortgage + +On line 1279: + in hand. As figure + shows, subprime originations + increased from billion + +On line 1279: + to billion in The + proportion securitized + in the late 1990s peaked + +On line 1285: + the RTC and by Wall + Street were similar to the + Fannie and Freddie + +On line 1285: + first step was to get + principal and interest + payments from a group + +On line 1285: + securities (that + is, securitizations + not done by Fannie + +On line 1285: + Freddie), the payments + were then "tranched" in a way to + protect some investors + +On line 1287: + of principal and + interest in different + orders. Most of the + +On line 1287: + late 1980s and early + 1990s, used a rudimentary + form of tranching. There + + were typically + two tranches in each deal. The + less risky tranche received + +On line 1287: + guaranteed by an + insurance company. The + more risky tranche received + +On line 1287: + was not guaranteed, + and was usually kept by + the company that + +On line 1289: + mortgages. Within a + decade, securitizations + had become much more + +On line 1289: + they had more tranches, + each with different payment + streams and different + + risks, which were tailored + to meet investors’ demands. The + entire private-label + +On line 1289: + created, sold, and + bought the investments—would become + highly dependent + + on this slice-and-dice process, and + regulators and market + participants alike + +On line 1289: + it efficiently + allocated risk to those + best able and willing + +On line 1291: + that risk. To demonstrate + how this process worked, we’ll describe + a typical deal, + +On line 1291: + mortgage-backed bonds.9 In New + Century Financial, a + California-based + +On line 1291: + lender, originated + and sold subprime mortgages to + Citigroup, which sold + +On line 1291: + separate legal + entity that Citigroup + sponsored that would own + +On line 1291: + mortgages and issue + the tranches. The entity + purchased the loans with + + cash it had raised by + selling the securities + these loans would back. The + +On line 1291: + had been created + as a separate legal + structure so that the + + assets would sit off + Citigroup’s balance sheet, an + arrangement with tax + +On line 1293: + The mortgages carried + the rights to the borrowers’ + monthly payments, which + +On line 1293: + into tranches of + mortgage-backed securities; each + tranche gave investors a + +On line 1293: + priority claim + on the flow of payments from + the borrowers, and + +On line 1293: + repayment schedule. + The credit rating agencies + assigned ratings to + +On line 1295: + heavily on these + ratings. Tranches were assigned + letter ratings by + + the rating agencies + based on their riskiness. In + this report, ratings + +On line 1297: + presented in S&P’s + classification system, + which assigns ratings + +On line 1297: + highest rating for + the safest investments, referred + to here as triple-A), "AA" + +On line 1297: + and "BB," and further + distinguishes ratings with + and Anything rated + +On line 1297: + is considered "junk." + Moody’s uses a similar + system in which "Aaa" + + is highest, followed + by "Aa," "A," "Baa," "Ba," and so + forth. For example, + + an S&P rating of + BBB would correspond to a + Moody’s rating of Baa. + +On line 1301: + this Citigroup deal, + the four senior tranches—the + safest— were rated triple-A + +On line 1303: + the agencies. Below + the senior tranches and next + in line for payments + + were eleven "mezzanine" + tranches—so named because they sat + between the riskiest + +On line 1305: + the safest tranches. These + were riskier than the senior + tranches and, because + +On line 1305: + slowly, carried a + higher risk that an increase + in interest rates + +On line 1305: + the locked-in interest + payments less valuable. As a + result, they paid a + + correspondingly + higher interest rate. Three + of these tranches in + +On line 1305: + Citigroup deal were + rated AA, three were A, three + were BBB (the lowest + + investment-grade + rating), and two were BB, or + junk. The last to be + +On line 1309: + most junior tranche, called + the "equity," "residual," + or "first-loss" tranche, set up + +On line 1309: + whatever cash flow + was left over after all the + other investors had + +On line 1309: + This tranche would suffer + the first losses from any efaults + of the mortgages in + +On line 1309: + Commensurate with + this high risk, it provided + the highest yields (see + +On line 1309: + In the Citigroup + deal, as was common, this piece + of the deal was not + +On line 1309: + at all. Citigroup + and a hedge fund each held half + the equity tranche.10 + + While investors in the + lower-rated tranches received + higher interest + +On line 1311: + because they knew there + was a risk of loss, investors + in the triple-A tranches + +On line 1311: + not expect payments + from the mortgages to stop. This + expectation of + +On line 1311: + the firms structuring + securities focused on + achieving high ratings. + +On line 1311: + In the structure of + this Citigroup deal, which was + typical, million, + +On line 1315: + or was rated triple-A. + GREATER ACCESS TO LENDING: "A + BUSINESS WHERE WE CAN + +On line 1317: + hold, new computer + and modeling technologies + were reshaping the + +On line 1317: + data with loan-level + information on mortgage + performance became + +On line 1317: + widely available. Lenders + underwrote mortgages using + credit scores, such as + +On line 1317: + score, developed by + Fair Isaac Corporation. In + Freddie Mac rolled out + +On line 1317: + system for mortgage + underwriting for use by + lenders, and Fannie Mae + +On line 1317: + later. The days of + labori-ous, slow, and manual + underwriting of + + individual + mortgage applicants were over, + lowering cost and + +On line 1319: + on quantitative + expectations: Given the + borrower, the home, + +On line 1319: + would be on time1 What + was the probability + that borrowers would + +On line 1321: + the Community + Reinvestment Act (CRA). Congress + enacted the CRA + +On line 1321: + banks and thrifts served their + communities, in response + to concerns that banks + +On line 1321: + were refusing to + lend in certain neighborhoods + without regard to + +On line 1321: + creditworthiness + of individuals and + businesses in those + +On line 1323: + (a practice known as + redlining).11 The CRA called on banks + and thrifts to invest, + +On line 1323: + took in deposits, so + long as these activities + didn’t impair their + +On line 1323: + financial safety + and soundness. It directed + regulators to + +On line 1323: + or thrift applied for + regulatory approval + for mergers, to open + + new branches, or to + engage in new businesses.12 + The CRA encouraged + +On line 1325: + borrowers to whom + they may have previously + denied credit. While + +On line 1327: + loans made under the + CRA performed consistently + with the rest of the + +On line 1327: + was not riskier than + the banks’ other lending.13 "There + is little or no + + evidence that banks’ + safety and soundness have been + compromised by such + +On line 1327: + often report sound + business opportunities," + Federal Reserve + +On line 1331: + Alan Greenspan said of CRA + lending in Residential + Mortgage-Backed Securities + +On line 1333: + packaged subprime, Alt-A + and other mortgages into + securities. As + + long as the housing + market continued to boom, + these securities + +On line 1333: + perform. But when the + economy faltered and the + mortgages defaulted, + +On line 1335: + were left worthless. In + President Bill Clinton asked + regulators to + +On line 1335: + while responding to + industry complaints that the + regulatory + +On line 1335: + process for compliance + was too burdensome and too + subjective. In the + + Fed, Office of Thrift + Supervision (OTS), Office + of the Comptroller + +On line 1335: + Deposit Insurance + Corporation (FDIC) issued + regulations that + +On line 1335: + regulatory + focus from the efforts that + banks made to comply + +On line 1337: + observable numbers + that measured banks’ compliance + with the law. Former + + comptroller John Dugan + told FCIC staff that the impact + of the CRA had been + + lasting, because it + encouraged banks to lend to + people who in the + + past might not have had + access to credit. He said, + "There is a tremendous + + amount of investment + that goes on in inner cities + and other places to + +On line 1339: + are quite impressive. + And the bankers conversely say, + ‘This is proven to be + +On line 1339: + business where we can + make some money; not a lot, + but when you factor + +On line 1341: + in plus the good will + that we get from it, it kind + of works.’"15 Lawrence Lindsey, + +On line 1341: + Fed governor who + was responsible for the + Fed’s Division of + +On line 1341: + enforcement, told the + FCIC that improved enforcement + had given the banks + + an incentive to + invest in technology + that would make lending + +On line 1341: + models customized + to the market. Shadow banks + not covered by the + + CRA would use these same + credit scoring models, which + could draw on now more + +On line 1341: + to underwrite loans. + "We basically got a + cycle going which + +On line 1341: + historic data, show + the default rates on this type + of lending were very, + +On line 1341: + low," he said.16 Indeed, + default rates were low during + the prosper-ous 1990s, and + +On line 1341: + bankers, and lenders in the + shadow banking system took + note of this success. + +On line 1347: + Among nonbank mortgage + originators, the late 1990s + were a turning point. + +On line 1347: + disruption caused by + the Russian debt crisis and + the Long-Term Capital + + Management collapse, + the markets saw a "flight to + quality"—that is, a + + steep fall in demand + among investors for risky assets, + including subprime + +On line 1349: + in to in Meanwhile, + subprime originators saw + the interest rate + +On line 1349: + they could borrow in + credit markets skyrocket. + They were caught in a + + squeeze: borrowing costs + increased at the very moment + that their revenue stream + +On line 1349: + up.17 And some were caught + holding tranches of subprime + securities that + +On line 1351: + out to be worth far + less than the value they had + been assigned. Mortgage + +On line 1351: + short-term funding had + immediate problems. For + example, Southern + + Pacific Funding + (SFC), an Oregon-based subprime lender + that securitized + + its loans, reported + relatively positive + second-quarter results + +On line 1351: + in August Then, in + September, SFC notified + investors about "recent + +On line 1351: + conditions" in the + securities markets and + expressed concern about + +On line 1351: + viability + of securitization + in the foreseeable + +On line 1353: + week later, SFC filed + for bankruptcy protection. + Several other + +On line 1353: + financing from the + capital markets also + filed for bankruptcy + +On line 1353: + in and In the two + years following the Russian + default crisis, of + +On line 1355: + declared bankruptcy, + ceased operations, or sold + out to stronger firms.19 When + +On line 1357: + were sold, their buyers + would frequently absorb large + losses. First Union, a + +On line 1357: + bank headquartered in + North Carolina, incurred charges + of almost billion + +On line 1357: + it bought The Money + Store. First Union eventually + shut down or sold off + +On line 1359: + of The Money Store’s + operations. Conseco, a + leading insurance + +On line 1359: + lender. Disruptions in + the securitization + markets, as well as + +On line 1359: + eventually drove + Conseco into bankruptcy + in December At + +On line 1361: + bankruptcy in U.S. + history (after WorldCom and + Enron). Accounting + +On line 1361: + would also bring down + subprime lenders. Keystone, a small + national bank in + + West Virginia that made + and securitized subprime + mortgage loans, failed in + +On line 1361: + in the 1990s—Keystone retained + the riskiest "first-loss" residual + tranches for its own + +On line 1361: + far exceeded the + bank’s capital. But Keystone + assigned them grossly + +On line 1361: + bank in September + after discovering "fraud + committed by the + +On line 1361: + as executives + had overstated the value + of the residual + +On line 1361: + failure occurred at + Superior Bank, one of + the most aggressive + +On line 1361: + lenders. Like Keystone, it + too failed after having kept + and overvalued the + + first-loss tranches on its + balance sheet. Many of the lenders + that survived or were + + bought in the 1990s reemerged + in other forms. Long Beach was + the ancestor of + +On line 1363: + Mortgage (which was in + turn purchased by Washington + Mutual), two of + + the more aggressive + lenders during the first decade of + the new century. + +On line 1363: + to Citigroup, and + Household bought Beneficial + Mortgage before it + +On line 1365: + itself acquired by + HSBC in With the subprime + market disrupted, + +On line 1365: + billion in down from + billion two years earlier.21 + Over the next few years, + +On line 1367: + subprime lending and + securitization would + more than rebound. THE + +On line 1369: + I SEE" During the + 1990s, various federal + agencies had taken + +On line 1369: + regulatory + system was not well equipped to + respond consistently—and + +On line 1369: + protect borrowers. + State regulators, as well + as either the Fed + +On line 1369: + FDIC, supervised the + mortgage practices of state anks. + The OCC supervised + +On line 1369: + national banks. The + OTS or state regulators + were responsible + +On line 1369: + brokers, a growing + portion of the market, but + did not supervise + +On line 1371: + one entity was + unquestionably authorized + by Congress to write + + strong and consistent + rules regulating mortgages + for all types of lenders: + +On line 1371: + the Truth in Lending + Act of In the Fed adopted + Regulation Z + + for the purpose of + implementing the act. But + while Regulation + +On line 1373: + America’s many + financial regulators. + One sticking point was + + the supervision + of nonbank subsidiaries such as + subprime lenders. The Fed + +On line 1373: + enforce the consumer + protections embodied in + the Truth in Lending + +On line 1373: + with respect to these + nonbank lenders. Although the FTC + brought some enforcement + +On line 1373: + mortgage companies, + Henry Cisneros, a former + secretary of the + +On line 1373: + Housing and Urban + Development (HUD), worried + that its budget and + +On line 1373: + commensurate with + its mandate to supervise + these lenders. "We could have + + had the FTC oversee + mortgage contracts," Cisneros told + the Commission. "But + + the FTC is up to + their neck in work today with + what they’ve got. They don’t + +On line 1375: + staff to go out and + search out mortgage problems."23 Glenn + Loney, deputy director + +On line 1375: + of the Fed’s Consumer + and Community Affairs + Division from to + +On line 1377: + the FCIC that ever + since he joined the agency in + Fed officials had + +On line 1377: + whether they—in addition + to the FTC—should enforce rules for + nonbank lenders. But they + +On line 1377: + whether the Fed would be + stepping on congressional + prerogatives by + +On line 1377: + that legislation + had delegated to the + FTC. "A number of + + governors came in + and said, ‘You mean to say we + don’t look at these1’" Loney + + said. "And then we tried + to explain it to them, and + they’d say, ‘Oh, I see.’"24 + +On line 1377: + would not exert its + authority in this area, + nor others that came + +On line 1377: + under its purview in + with any real force until + after the housing + +On line 1379: + that gave the Fed new + responsibilities was + the Home Ownership + +On line 1379: + Protection Act (HOEPA), + passed by Congress and signed by + President Clinton + +On line 1379: + lending practices that + especially affected + low-income borrowers. + +On line 1379: + finance companies + who peddle high-rate, high-fee + home equity loans + + to cash-poor homeowners."25 + For example, a Senate + report highlighted + + the case of a 72-year-old + homeowner, who testified + at a hearing that + +On line 1379: + she paid more than in + upfront finance charges on a + second mortgage. In + +On line 1381: + refinance mortgage + loans, including prepayment + penalties, negative + + amortization, and + balloon payments with a term + of less than five years. + +On line 1381: + the property alone + and "without regard to the + consumers’ repayment + +On line 1383: + a small percentage + of mortgages were initially + subject to the HOEPA + +On line 1383: + interest rate and + fee levels for triggering + HOEPA’s coverage were + +On line 1383: + catch most subprime loans.28 + Even so, HOEPA specifically + directed the Fed + +On line 1383: + act more broadly to + "prohibit acts or practices + in connection with + +On line 1385: + loans] that [the Board] finds + to be unfair, deceptive + or designed to evade + +On line 1387: + provisions of this + [act]."29 In June two years after + HOEPA took effect, the + + Fed held the first set + of public hearings required + under the act. The + +On line 1387: + were Los Angeles, + Atlanta, and Washington, D.C. + Consumer advocates + +On line 1387: + home equity lenders. + A report summarizing + the hearings, jointly + +On line 1387: + Housing and Urban + Development and released + in July said that + +On line 1387: + acknowledged that some + abuses existed, blamed some + of these on mortgage + +On line 1387: + that the increasing + securitization of + subprime mortgages was + + likely to limit + the opportunity for + widespread abuses. The + +On line 1387: + equity loans must + comply with a series of + representations + +On line 1387: + include creditors’ + representations that they + have complied with strict + +On line 1387: + guidelines concerning + the borrower’s ability + to repay the loan."30 + + But in the years to + come, these representations + and warranties would prove + +On line 1391: + Fed continued not + to press its prerogatives. + In January it + +On line 1391: + examinations + of nonbank subsidiaries of bank + holding companies,"31 + +On line 1391: + be criticized by + a November General + Accounting Office + +On line 1391: + for creating a + "lack of regulatory + oversight."32 The July + +On line 1391: + While preparing draft + recommendations for the + report, Fed staff wrote + +On line 1391: + Fed’s Committee on + Consumer and Community + Affairs that "given + +On line 1391: + support substantive + limitations on market + behavior, the draft + + report discusses + various options but does + not advocate any + +On line 1393: + to addressing these + problems."34 In the end, although + the two agencies did + +On line 1393: + both the Fed and HUD + supported legislative bans + on balloon payments + +On line 1393: + lump-sum insurance + premiums, stronger enforcement + of current laws, and + +On line 1393: + as community + outreach efforts and consumer + education and + +On line 1395: + Congress did not act + on these recommendations. + The Fed-Lite provisions + +On line 1395: + the Gramm-Leach-Bliley Act affirmed + the Fed’s hands-off approach to + the regulation + + of mortgage lending. + Even so, the shakeup in the + subprime industry + +On line 1395: + the late 1990s had drawn + regulators’ attention + to at least some of + +On line 1395: + with this lending. For + that reason, the Federal + Reserve, FDIC, OCC, and + +On line 1397: + guidance on March his + guidance applied only to + regulated banks + + and thrifts, and even for + them it would not be binding + but merely laid out + +On line 1397: + in the equity + and asset-backed securities + market has caused some + +On line 1397: + subprime specialists + to exit the market, thus + creating increased + +On line 1397: + enter, or expand + their participation in, + the subprime lending + + business."35 The agencies + then identified key features + of subprime lending + + programs and the need + for increased capital, risk + management, and board + +On line 1399: + accounting issues, + notably the valuation + of any residual + + tranches held by the + securitizing firm. The + guidance went on to + + warn, "Institutions + that originate or purchase + subprime loans must take + +On line 1401: + protection laws and + regulations. Higher fees + and interest rates + +On line 1401: + predatory pricing. + An adequate compliance + management program + +On line 1401: + consumer protection + hazards associated + with subprime lending."36 + +On line 1403: + spring in response to + growing complaints about lending + practices, and at the + + urging of members + of Congress, HUD Secretary + Andrew Cuomo and + +On line 1403: + Summers convened the + joint National Predatory + Lending Task Force. It + + included members + of consumer advocacy + groups; industry trade + +On line 1403: + mortgage lenders, brokers, + and appraisers; local and + state officials; and + + academics. As the Fed + had done three years earlier, + this new entity + +On line 1403: + conducting hearings + in Atlanta, Los Angeles, + New York, Baltimore, + + and Chicago. The task + force found "patterns" of abusive + practices, reporting + +On line 1403: + too-frequent abuses in + the subprime lending market." + Questionable practices + +On line 1403: + of borrowers’ loans + in a short time), high fees and + prepayment penalties + +On line 1403: + borrowers’ losing + the equity in their homes, + and outright fraud and + +On line 1403: + The report cited + testimony regarding + incidents of forged + +On line 1405: + lenders often preyed on + the elderly, minorities, + and borrowers with + +On line 1405: + "limited access + to the mainstream financial + sector"—meaning the banks, + +On line 1405: + unions, which it viewed as + subject to more extensive + government oversight.37 + + Consumer protection + groups took the same message to + public officials. + +On line 1407: + interviews with and + testimony to the FCIC, + representatives + +On line 1407: + National Consumer + Law Center (NCLC), Nevada Fair + Housing Center, Inc., + + and California + Reinvestment Coalition each said + they had contacted + +On line 1407: + multiple times about + their concerns over unfair and + deceptive lending + +On line 1407: + "It was apparent + on the ground as early as + or that the market + +On line 1407: + being flooded with + inappropriate products," + Diane Thompson of + +On line 1409: + the Commission.39 The + HUD-Treasury task force recommended + a set of reforms + +On line 1409: + disclosure, improved + financial literacy, + strengthened enforcement, + +On line 1409: + also recognized + the downside of restricting + the lending practices + +On line 1409: + with less-than-prime credit a + chance at homeownership. It + was a dilemma. Gary + +On line 1409: + the report as a + senior Treasury official + and is currently + +On line 1409: + the Commodity + Futures Trading Commission, + told the FCIC that the + +On line 1409: + on Capitol Hill a + very short time. There wasn’t much + appetite or mood to + +On line 1411: + recommendations."40 + But problems persisted, and + others would take up + +On line 1411: + decade, "the really + poorly underwritten loans, + the payment shock loans" + +On line 1411: + to proliferate + outside the traditional + banking sector, said + +On line 1413: + as the assistant + secretary for financial + institutions from + +On line 1413: + testimony to + the Commission, she observed + that these poor-quality + +On line 1413: + banks and "created + negative competitive + pressure for the banks + +On line 1415: + to start following + suit." She added, [Subprime lending] + was started and the + +On line 1415: + of it occurred in + the nonbank sector, but it + clearly created + +On line 1415: + pressures on banks. I + think nipping this in the bud + in and with some strong + +On line 1415: + that just simply said + you’ve got to document + a customer’s income + +On line 1415: + sure they can repay + the loan, you’ve got to make + sure the income is + +On line 1415: + to pay the loans when + the interest rate resets, + just simple rules like + +On line 1417: + that could have done a + lot to stop this.41 After Bair + was nominated + + to her position + at Treasury, and when she was + making the rounds on + +On line 1417: + Sarbanes, chairman of + the Committee on Banking, + Housing, and Urban + +On line 1417: + told her about lending + problems in Baltimore, where + foreclosures were on + + the rise. He asked Bair + to read the HUD-Treasury report on + predatory lending, + +On line 1417: + the issue. Sarbanes + introduced legislation + to remedy the + +On line 1417: + mortgage industry + and within Congress, Bair told + the Commission. Bair + + decided to try + to get the industry to + adopt a set of "best + +On line 1417: + that would include a + voluntary ban on mortgages + that strip borrowers + +On line 1417: + their equity, and + would offer borrowers the + opportunity + + to avoid prepayment + penalties by agreeing instead + to pay a higher + + interest rate. She + reached out to Edward Gramlich, + a governor at + +On line 1417: + shared her concerns, to + enlist his help in getting + companies to abide + + by these rules. Bair said + that Gramlich didn’t talk out + of school but made it + +On line 1417: + the director of + the Division of Consumer + and Community + +On line 1417: + Fed, said that Gramlich + told the staff that Greenspan was not + interested in + +On line 1419: + regulation.43 When + Bair and Gramlich approached a + number of lenders about + +On line 1419: + voluntary rogram, + Bair said some originators + appeared willing to + +On line 1419: + But the Wall Street firms + that securitized the loans + resisted, saying + +On line 1421: + did not adhere to + the proposed best practices, she + recalled. The effort + + died.44 Of course, even as + these initiatives went nowhere, the + market did not stand + +On line 1425: + Subprime mortgages were + proliferating rapidly, + becoming mainstream + +On line 1427: + Originations were + increasing, and products were + changing. By three of + +On line 1427: + every four subprime + mortgages was a first mortgage, + and of those were used + +On line 1427: + Fifty-nine percent of + those refinancings were cash-outs,45 + helping to fuel + +On line 1438: + spending while whittling + away homeowners’ equity. + PART III The Boom and + +On line 1452: + stabilizing force" + Subprime loans: "Buyers will pay + a high premium" + +On line 1456: + regulatory + scrutiny" Federal rules: + "Intended to curb + +On line 1460: + abusive lending" States: + "Long-standing position"...........................................................................96 + Community-lending + +On line 1462: + pledges: "What we do is + reaffirm our intention" Bank + capital standards: + +On line 1464: + the economy had + grown straight quarters. Federal + Reserve Chairman Alan + +On line 1464: + companies were—or + at least to many observers at + the time, appeared to + +On line 1466: + managing risk. The + housing market was also + strong. Between and prices + +On line 1466: + an annual rate + of over the next five years, the + rate would hit Lower + +On line 1466: + mortgage borrowers + were partly the reason, as + was greater access to + +On line 1466: + left out—including + subprime borrowers. Lower + interest rates and + +On line 1466: + access to credit + were available for other types + of borrowing, too, + +On line 1468: + as credit cards and + auto loans. Increased access + to credit meant a + + more stable, secure + life for those who managed their + finances prudently. + +On line 1468: + meant families could + borrow during temporary + income drops, pay for + +On line 1468: + expenses, or buy + major appliances and cars. + It allowed other + +On line 1468: + to borrow and spend + beyond their means. Most of all, + it meant a shot at + +On line 1468: + benefits; and for + some, an opportunity + to speculate in + +On line 1470: + estate market. As + home prices rose, homeowners with + greater equity felt + + more financially + secure and, partly as a + result, saved less and + + less. Many others went + one step further, borrowing + against the equity. + +On line 1470: + between and mortgage + debt nationally nearly + doubled. Household debt + +On line 1470: + from of disposable + personal income in to + almost by mid-2006. More + + than three-quarters of + this increase was mortgage debt. + Part of the increase + +On line 1472: + new home purchases, + part from new debt on older + homes. Mortgage credit + + became more available + when subprime lending started + to grow again after + +On line 1474: + the major subprime + lenders failed or were purchased in + and Afterward, the + +On line 1474: + billion in assets, + paid billion for Associates + First Capital, the + + second-biggest subprime lender. + Still, subprime lending remained + only a niche, just + +On line 1476: + mortgages in Subprime + lending risks and questionable + practices remained a + +On line 1476: + the Home Ownership + and Equity Protection + Act (HOEPA). Although in + +On line 1476: + rules for a narrow + set of high-cost mortgages.3 + Following losses + +On line 1480: + beginning of the + economy was slowing, even + though unemployment + +On line 1480: + of To stimulate + borrowing and spending, the + Federal Reserve’s + +On line 1480: + Market Committee + lowered short-term interest + rates aggressively. + +On line 1480: + January in a + rare conference call between + scheduled meetings, it + +On line 1480: + benchmark federal + funds rate—at which banks lend to each + other overnight—by a + + half percentage point, + rather than the more typical + quarter point. Later + +On line 1482: + the committee cut + the rate another half point, + and it continued + +On line 1484: + throughout the year—11 times + in all—to the lowest in + years. In the end, the + +On line 1484: + recession of was + relatively mild, lasting + only eight months, from + + March to November, + and gross domestic product, + or GDP—the most common + +On line 1484: + the economy—dropped + by only Some policy + makers concluded + +On line 1484: + the economy had + reached the so-called end of the + business cycle, which + +On line 1484: + economists had been + predicting since before the + tech crash. "Recessions + +On line 1484: + less frequent and less + severe," said Ben Bernanke, then a + Fed governor, in + +On line 1484: + speech early in "Whether + the dominant cause of the + Great Moderation + +On line 1484: + structural change, improved + monetary policy, or + simply good luck is + +On line 1486: + question about which no + consensus has yet formed."4 With + the recession over + + and mortgage rates at + 40-year lows, housing kicked into + high gear—again. The + +On line 1486: + lose more than nonfarm + jobs in but make small gains in + construction. In states + +On line 1486: + with a total of + only more jobs, but with new + construction jobs. In + +On line 1486: + Florida, of net + job growth was in construction. + In builders started more + +On line 1486: + the late 1970s. From to + residential construction + contributed three times + +On line 1488: + to the economy + than it had contributed on + average since But + +On line 1488: + economy remained + sluggish, and employment gains + were frus-tratingly + +On line 1488: + began talking about + a "jobless recovery"—more + production without + +On line 1488: + in employment. For + those with jobs, wages stagnated. + Between and weekly + +On line 1488: + nonsupervisory + wages actually fell by + after adjusting + +On line 1488: + Faced with these challenges, + the Fed shifted perspective, + now considering + +On line 1488: + possibility + that consumer prices could fall, an + event that had worsened + +On line 1488: + quoted speech, Bernanke said + the chances of deflation were + "extremely small" for + +On line 1488: + First, the economy’s + natural resilience: "Despite + the adverse shocks of + +On line 1488: + system remains healthy + and well-regulated, and firm + and household balance + + sheets are for the most + part in good shape." Second, the + Fed would not allow + +On line 1488: + am confident that + the Fed would take whatever + means necessary to + +On line 1488: + in the United States. + [T]he U.S. government has a + technology, called + +On line 1488: + that allows it to + produce as many U.S. dollars + as it wishes at + +On line 1490: + short-term interest + rates low. During the strongest + U.S. companies could + +On line 1490: + commercial paper + market at an average + compared with just three + +On line 1490: + years earlier; rates + on three-month Treasury bills + dropped below in mid-2003 + +On line 1492: + from in Low rates cut + the cost of homeownership: + interest rates for + +On line 1492: + typical 30-year fixed-rate + mortgage traditionally + moved with the overnight fed + +On line 1494: + held (see figure By + creditworthy home buyers + could get fixed-rate mortgages + +On line 1494: + points lower than three + years earlier. The savings + were immediate + +On line 1494: + large. For a home bought + at the median price of + with a down payment, + +On line 1494: + mortgage payment would + be less than in Or to turn + the perspective around—as + +On line 1494: + many people did—for + the same monthly payment of + a homeowner could + +On line 1498: + up from a home to + a one.7 An adjustable-rate mortgage + (ARM) gave buyers even + +On line 1498: + affordable—unless + interest rates rose. In just + of prime borrowers + +On line 1498: + new mortgages chose ARMs; + in did. In the proportion + rose to Among subprime + +On line 1500: + borrowers, already + heavy users of ARMs, it rose from + around to As people + +On line 1500: + the housing market, + prices rose, and in hot markets + they really took + +On line 1500: + then annually + from to In California, + those numbers were even + +On line 1502: + bought for in was worth + nine years later. However, + soaring prices were not + + necessarily + the norm. In Washington State, + prices continued to + +On line 1502: + annually from + to annually from to + In Ohio, the numbers + +On line 1502: + Nationwide, home prices + rose annually from to + 2003—historically + +On line 1504: + steadily, peaking at + of households in Because so + many families were + + benefiting from + higher home values, household + wealth rose to nearly + +On line 1504: + income, up from five + times a few years earlier. + The top of households + +On line 1504: + by net worth, of whom + owned their homes, saw the value + of their primary + +On line 1504: + between and from to + (adjusted for inflation), + an increase of more + +On line 1504: + Median net worth + for all households in the top + after accounting + +On line 1504: + up from to between + and the median value + of their primary + +On line 1506: + residences rose from + to an increase of more than + Median net worth + +On line 1508: + the bottom was in + Historically, every + increase in housing + +On line 1508: + debated whether the + wealth increases would affect + spending more than in + + past years, because so + many homeowners at so many + levels of wealth saw + +On line 1508: + and because it was + easier and cheaper to + tap home equity. + + Higher home prices and + low mortgage rates brought a wave + of refinancing + +On line 1510: + prime mortgage market. + In alone, lenders refinanced over + million mortgages, more + +On line 1510: + four—an unprecedented + level.14 Many homeowners took + out cash while cutting + +On line 1510: + their interest rates. + From through cash-out refinancings + netted these households + +On line 1510: + an estimated + billion; homeowners accessed + another billion + +On line 1510: + home equity loans.15 + Some were typical second + liens; others were a + +On line 1510: + invention, the home + equity line of credit. + These operated + + much like a credit + card, letting the borrower + borrow and repay + + as needed, often + with the convenience of an + actual plastic + +On line 1512: + Survey of Consumer + Finances, of homeowners who + tapped their equity + +On line 1512: + such as medical + bills, taxes, electronics, and + vacations, or to + +On line 1512: + consolidate debt; + another used it for home + improvements; and the + +On line 1514: + A Congressional + Budget Office paper from + reported on the + + recent history: + "As housing prices surged in the + late 1990s and early + +On line 1516: + boosted their spending + faster than their income rose. That + was reflected in + +On line 1516: + Between and increased + consumer spending accounted + for between and of + +On line 1516: + year—rising above in + years when spending growth offset + declines elsewhere in + +On line 1516: + rate dropped from to Some + components of spending grew + remarkably fast: home + +On line 1516: + durables, recreational goods + and vehicles, spending at + restaurants, and health care. + +On line 1516: + consumer spending grew + faster than the economy, and + in some years it grew + +On line 1518: + disposable income. + Nonetheless, the economy + looked stable. By it + +On line 1518: + the brief recession + of and the dot-com bust, which + had caused the largest loss + + of wealth in ecades. With + new financial products like + the home equity + +On line 1518: + against which the Fed had + struck preemptively, did not + materialize. + +On line 1520: + a congressional + hearing in November Greenspan + acknowledged—at least + +On line 1520: + dot-com bubble burst, + the Fed cut interest rates + in part to promote + +On line 1520: + Greenspan argued that the + Fed’s low-interest-rate policy + had stimulated + +On line 1520: + by encouraging + home sales and housing starts with + "mortgage interest + +On line 1520: + that are at lows not + seen in decades." As Greenspan explained, + "Mortgage markets have + +On line 1520: + over the past two years + of economic distress by + facilitating + + the extraction of + some of the equity that + home - owners had + +On line 1522: + up."17 In February + he reiterated his + point, referring to + + "a large extraction + of cash from home equity."18 + SUBPRIME LOANS: "BUYERS + +On line 1526: + A HIGH PREMIUM" + The subprime market roared back + from its shakeout in + +On line 1526: + 1990s. The value of + subprime loans originated + almost doubled from + +On line 1528: + through to billion. In + of these were securitized; + in Low interest + +On line 1528: + spurred this boom, which would + have long-term repercussions, but so + did increasingly + +On line 1530: + borrowers, and the + scale of the firms entering + the market. Subprime + + was dominated + by a narrowing field of + ever-larger firms; the + +On line 1530: + marginal players + from the past decade had merged or + vanished. By the top + +On line 1532: + subprime lenders made of + all subprime loans, up from in + There were now three main + +On line 1532: + commercial banks and + thrifts, Wall Street investment banks, + and independent + +On line 1532: + City Bank, HSBC, and + Washington Mutual—spent + billions on boosting + +On line 1532: + units, acquiring firms, + or offering financing + to other mortgage + +On line 1532: + Almost always, these + operations were sequestered + in nonbank subsidiaries, + +On line 1534: + regulatory + no-man’s-land. When it came + to subprime lending, + + now it was Wall Street + investment banks that worried + about competition + +On line 1534: + commercial banks and + thrifts. Former Lehman president + Bart McDade told the FCIC + +On line 1534: + the banks had gained their + own securitization + skills and didn’t need + + the investment banks + to structure and distribute.21 + So the investment + +On line 1534: + a supply of loans + they could securitize and + sell to the growing + + legions of investors. + For example, Lehman Brothers, + the fourth-largest investment + +On line 1534: + including BNC and + Aurora.22 Bear Stearns, the fifth-largest, + ramped up its subprime + +On line 1534: + originators in + the United States, including + Encore. In Merrill + +On line 1536: + and Morgan Stanley + bought Saxon Capital; in + Goldman Sachs upped its + +On line 1538: + subprime lender. Meanwhile, + several independent + mortgage companies + +On line 1544: + plan concentrated + on "originating loans with + characteristics + +On line 1544: + which whole loan buyers + will pay a high premium."23 + Those "whole loan buyers" + + were the firms on Wall + Street that purchased loans and, most + often, bundled them + +On line 1544: + eager customers. In + New Century sold billion + in whole loans, up from + +On line 1544: + tenth to second place + among subprime originators. + Three-quarters went to + +On line 1544: + Suisse—but New + Century reassured its + investors that there were + +On line 1546: + prospective buyers."25 Ameriquest, + in particular, pursued + volume. According + +On line 1546: + company’s public + statements, it paid its account + executives less + +On line 1546: + competition, but + it encouraged them to make + up the difference + +On line 1546: + loans. "Our people make + more volume per employee + than the rest of the + +On line 1546: + Aseem Mital, CEO of + Ameriquest, said in The company + cut costs elsewhere in + +On line 1546: + The back office for + the firm’s retail division + operated in + +On line 1546: + told a reporter for + American Banker; the work was + divided into + +On line 1548: + and funding. Ameriquest used + its savings to undercut + by as much as what + +On line 1548: + firms, according to + an industry analyst’s + estimate. Between + +On line 1548: + loan origination + rose from an estimated + billion to billion + + annually. That + vaulted the firm from eleventh to + first place among subprime + +On line 1548: + "They are clearly the + aggressor," Countrywide CEO + Angelo Mozilo + +On line 1550: + told his investors in + By Countrywide was third on + the list. The subprime + +On line 1550: + involving them in + every link of the mortgage + chain: originating + +On line 1550: + loans, packaging them + into securities, and + finally selling + +On line 1550: + to investors. Others + concentrated on niches: + New Century, for + + example, mainly + originated mortgages for + immediate sale + + to other firms in + the chain. When originators + made loans to hold through + + maturity—an approach + known as originate-to-hold—they had + a clear incentive + +On line 1552: + mortgages to sell, for + securitization or + otherwise—known as + +On line 1552: + risked losses if the + loan defaulted. As long as + they made accurate + +On line 1552: + the only risk was + to their reputations if + a lot of their loans + + went bad—but during + the boom, loans were not going + bad. In total, this + +On line 1552: + carried more than half + of all mortgages before the + crisis, and a much + +On line 1554: + of subprime mortgages. + For decades, a version of the + originate-to-distribute + + model produced safe + mortgages. Fannie and Freddie + had been buying prime, + + conforming mortgages + since the 1970s, protected by + strict underwriting + +On line 1556: + But some saw that the + model now had problems. "If + you look at how many + + people are playing, + from the real estate agent + all the way through to + +On line 1556: + who is issuing + the security and the + underwriter and + +On line 1556: + underwriting group + and blah, blah, blah, then nobody + in this entire chain + +On line 1556: + an early leader + in securitization, + told the FCIC, ot the + +On line 1556: + other investment + bankers had expected. "None of + us wrote and said, ‘Oh, + + by the way, you have + to be responsible for + your actions,’" Ranieri said. + +On line 1560: + a mortgage broker. + These independent brokers, + with access to a + +On line 1560: + with borrowers to + complete the application + process. Using brokers + +On line 1560: + more rapid expansion, + with no need to build branches; + lowered costs, with no + + need for full-time + salespeople; and extended + geographic reach. + +On line 1562: + came as up-front fees—from + the borrower, from the lender, + or both—so the loan’s + +On line 1562: + These fees were often + paid without the borrower’s + knowledge. Indeed, many + +On line 1562: + brokers acted in + borrowers’ best interest.28 + One common fee paid + +On line 1562: + lender to the broker + was the "yield spread premium": + on higher-interest + +On line 1562: + the lending bank would + pay the broker a higher + premium, giving + + the incentive to + sign the borrower to the + highest possible + + rate. "If the broker + decides he’s going to try + and make more money + +On line 1562: + said Jay Jeffries, a + former sales manager for + Fremont Investment + +On line 1562: + the Commission. "We’ve + got a higher rate loan, we’re + paying the broker + +On line 1564: + yield spread premium."29 + In theory, borrowers + are the first defense + +On line 1564: + lending. By shopping + around, they should realize, for + example, if a + + broker is trying + to sell them a higher-priced loan + or to place them in + + a subprime loan when + they would qualify for a + less-expensive prime + +On line 1564: + But many borrowers + do not understand the most + basic aspects of + +On line 1564: + least of borrowers + with adjustable-rate mortgages did not + understand how much + +On line 1564: + one time, and more than + half underestimated + how high their rates could + +On line 1564: + over the years.30 The same + lack of awareness extended + to other terms of + +On line 1566: + documentation + provided to the lender. "Most + borrowers didn’t + + even realize that + they were getting a no-doc + loan," said Michael Calhoun, + + president of the + Center for Responsible + Lending. "They’d come in + +On line 1566: + their W-2 and end up + with a no-doc loan simply + because the broker + +On line 1566: + getting paid more and + the lender was getting paid more + and there was extra + +On line 1566: + left over for Wall Street + because the loan carried a + higher interest + +On line 1568: + And borrowers with + less access to credit are + particularly + +On line 1568: + equipped to challenge the + more experienced person + across the desk. "While many + +On line 1568: + they are pretty good + at dealing with day-to-day + financial matters, + +On line 1568: + expenses and fees: + overdrawing checking accounts, + making late credit + +On line 1568: + limits on credit + card charges," Annamaria Lusardi, + a professor of + +On line 1570: + Dartmouth College, told + the FCIC. "Comparing terms of + financial contracts + +On line 1570: + around before making + financial decisions are + not at all common + +On line 1572: + Recall our case study + securitization deal + discussed earlier—in which + +On line 1572: + New Century sold + mortgages to Citigroup, which + then sold them to the + +On line 1572: + trust, which then bundled + them into tranches for sale + to investors. Out of + +On line 1574: + those mortgages, brokers + originated on behalf + of New Century. + + For each, the brokers + received an average fee + from the borrowers + +On line 1574: + or of the loan amount. + On top of that, the brokers + also received yield + +On line 1574: + spread premiums from + New Century for of these + loans, averaging + +On line 1576: + brokers received more + than million in fees for the + loans.33 Critics argued + +On line 1576: + with this much money + at stake, mortgage brokers had + every incentive + + to seek "the highest + combination of fees and + mortgage interest + +On line 1576: + the market will bear."34 + Herb Sandler, the founder and CEO + of the thrift Golden + +On line 1576: + Corporation, told + the FCIC that brokers were the + "whores of the world."35 As + +On line 1576: + mortgage market boomed, + so did the brokers. Wholesale + Access, which tracks the + +On line 1576: + from to the number + of brokerage firms rose from + about to In brokers + +On line 1578: + loans; in they peaked at + JP Morgan CEO Jamie Dimon + testified to the + +On line 1578: + loans had more than twice + the losses of the loans that + JP Morgan itself + +On line 1580: + emerged, in subprime and + prime mortgages alike: inflated + appraisals. For the lender, + +On line 1580: + greater losses if a + borrower defaulted. But + for the borrower + + or for the broker + or loan officer who hired + the appraiser, an + +On line 1580: + value could make the + difference between closing + and losing the deal. + +On line 1580: + a home selling for + that an appraiser says is + actually worth + +On line 1582: + In this case, a bank + won’t lend a borrower, say, + to buy the home. The + +On line 1582: + Sure enough, appraisers + began feeling pressure. One + survey found that of + +On line 1582: + appraisers had felt + pressed to inflate the value + of homes; by this had + +On line 1582: + climbed to The pressure + came most frequently from the + mortgage brokers, but + +On line 1582: + from real estate + agents, lenders, and in many cases + borrowers themselves. + +On line 1582: + often, refusal to + raise the appraisal meant losing + the client.38 Dennis J. + + Black, president of + the Florida appraisal and + brokerage services + +On line 1582: + firm D. J. Black Co. + and an appraiser with years’ + experience, held + +On line 1582: + sessions all over the + country for the National + Association + +On line 1582: + Independent Fee + Appraisers. He heard complaints + from the appraisers + +On line 1582: + pressured to ignore + missing kitchens, damaged walls, and + inoperable + +On line 1582: + systems. Black told the + FCIC, "The story I have heard + most often is the + + client saying he could + not use the appraisal because + the value was [not] + + what they needed."39 The + client would hire somebody else. Changes + in regulations + +On line 1584: + appraiser with years’ + experience, explained in + testimony to + +On line 1584: + Federal Reserve, + Office of the Comptroller + of the Currency, + +On line 1584: + Federal Deposit + Insurance Corporation + loosened the appraisal + +On line 1586: + requirements for the + lenders they regulated by + raising from to the + +On line 1586: + home value at which + an appraisal from a licensed + professional was + +On line 1586: + Mann cited the lack + of oversight of appraisers, + noting, "We had a + +On line 1586: + Crabtree told the FCIC + that California’s Office + of Real Estate + +On line 1590: + to strengthen appraisals. + They recommended that an + originator’s loan + +On line 1592: + "appraisal management + company," First American + Corporation, to + +On line 1592: + Nevertheless, in + the New York State attorney + general sued First + +On line 1592: + improperly let + Washington Mutual’s loan + production staff "hand-pick + + appraisers who bring + in appraisal values high enough + to permit WaMu’s loans + +On line 1594: + and improperly + permit[ted] WaMu to pressure + appraisers to change + + appraisal values that + are too low to permit loans + to close."42 CITIGROUP: + +On line 1598: + originations grew, + Citigroup decided to + expand, with troubling + + consequences. Barely + a year after the Gramm-Leach-Bliley Act + validated its + +On line 1598: + Citigroup made its + next big move. In September + it paid billion for + + Associates First, then + the second-largest subprime lender in + the country (after + + Household Finance.). Such + a merger would usually + have required approval + +On line 1598: + bank regulators, + because Associates First owned + three small banks (in Utah, + + Delaware, and South + Dakota). But because these banks + were specialized, a + + provision tucked away + in Gramm-Leach-Bliley kept the Fed out of + the mix. The OCC, FDIC, + +On line 1600: + New York State banking + regulators reviewed the + deal. Consumer groups fought + +On line 1600: + citing a long record + of alleged lending abuses + by Associates First, + +On line 1600: + evaluate the forms. + "It’s simply unacceptable + to have the largest bank + + in America take + over the icon of predatory + lending," said Martin + +On line 1602: + in North Carolina.43 + Advocates for the merger + argued that a large + +On line 1602: + regulator could + reform the company, and + Citigroup promised to + +On line 1602: + suspending mortgage + purchases from close to two-thirds + of the brokers and + +On line 1602: + the banks that had sold + loans to Associates First. "We + were aware that brokers + + were at the heart of + that public discussion and + were at the heart of + +On line 1604: + Trade Commission, which + regulates independent + mortgage companies’ + +On line 1604: + that the company + had pressured borrowers to + refinance into + +On line 1604: + expensive mortgage + insurance. In Citigroup + reached a record million + + civil settlement + with the FTC over Associates’ + "systematic and + +On line 1606: + widespread deceptive + and abusive lending practices."45 + In the New York Fed + + used the occasion + of Citigroup’s next proposed + acquisition—European American Bank + +On line 1606: + New York—to launch its + own investigation of + CitiFinancial, which now contained + +On line 1606: + [Citigroup] approached + that transaction invited + regulatory + + scrutiny," former + Fed Governor Mark Olson + told the FCIC. "They bought + +On line 1606: + passel of problems + for themselves and it was at + least a two-year [issue]."46 + +On line 1608: + loans (usually for + borrowers in financial + trouble) into home + +On line 1608: + repay. Reviewing + lending practices from and the + Fed also accused + +On line 1608: + of selling credit + insurance to borrowers + without checking if + +On line 1608: + would qualify for + a mortgage without it. For + these violations + +On line 1608: + for impeding its + investigation, the Fed + in assessed million + +On line 1608: + said it expected + to pay another million + in restitution to + +On line 1614: + "INTENDED TO CURB + UNFAIR OR ABUSIVE LENDING" + As Citigroup was + +On line 1614: + predatory conduct. + It conducted its second + round of hearings on + +On line 1614: + Protection Act (HOEPA), + and subsequently the staff + offered two reform + + proposals. The first + would have effectively barred + lenders from granting any + +On line 1614: + limited set of + high-cost loans defined by + HOEPA—solely on the value + +On line 1614: + to the borrower’s + ability to repay. For + high-cost loans, the + +On line 1614: + to verify and + document the borrower’s + income and debt; for + +On line 1614: + documentation + standard was weaker, as the + lender could rely on + +On line 1614: + borrower’s payment + history and the like. The + staff memo explained this + +On line 1616: + Despite evidence + of predatory tactics from + their own hearings and + +On line 1616: + recently released + HUD-Treasury report, Fed officials + remained divided + +On line 1616: + strengthen borrower + protections. They grappled with + the same trade-off that the + +On line 1616: + recently noted. + "We want to encourage the + growth in the subprime + +On line 1616: + at the Financial + Services Roundtable in early + "But we also don’t + + want to encourage + the abuses; indeed, we want + to do what we can + + to stop these abuses."49 + Fed General Counsel Scott + Alvarez told the FCIC, + + "There was concern that + if you put out a broad rule, + you would stop things that + + were not unfair and + deceptive because you were + trying to get at + + the bad practices and + you just couldn’t think of all + of the details you + +On line 1616: + need. And if you did + think of all of the details, + you’d end up writing + + a rule that people + could get around very easily."50 + Greenspan, too, later said + +On line 1620: + prohibit certain + products might be harmful. "These + and other kinds of + +On line 1620: + ore broadly available."51 + Instead, at least for certain + violations of + +On line 1620: + laws, he suggested + another approach: "If there + is egregious fraud, if + +On line 1620: + egregious practice, one + doesn’t need supervision + and regulation, + +On line 1620: + law enforcement."52 But + the Federal Reserve would + not use the legal + +On line 1620: + system to rein in + predatory lenders. From to the + end of Greenspan’s tenure + +On line 1620: + Fed referred to the + Justice Department only + three institutions + +On line 1620: + First American Bank, + in Carpentersville, Illinois; Desert + Community Bank, + +On line 1620: + California; and + the New York branch of Société + Générale, a large French + +On line 1622: + After some wrangling, + in December the Fed did + modify HOEPA, but + +On line 1622: + the board highlighted + compromise: "The final rule + is intended to + +On line 1622: + or abusive lending + practices without unduly + interfering with + + the flow of credit, + creating unnecessary + creditor burden, + +On line 1622: + consumers’ options in + legitimate transactions." + The status quo would + +On line 1622: + had estimated + the percentage of subprime + loans covered by HOEPA + +On line 1622: + would increase from to + as much as under the new + regulations.53 But + + lenders changed the terms of + mortgages to avoid the new rules’ + revised interest + +On line 1622: + rate and fee triggers. + By late it was clear that the + new regulations + +On line 1622: + about of subprime loans.54 + Nevertheless, reflecting + on the Federal + +On line 1622: + Greenspan contended in + an FCIC interview that the + Fed had developed + +On line 1624: + rules that have held up + to this day.55 This was a missed + opportunity, + +On line 1624: + Chairman Sheila Bair, who + described the "one bullet" that + might have prevented + +On line 1624: + financial crisis: + "I absolutely would have + been over at the Fed + +On line 1624: + prescribing mortgage + lending standards across the board + for everybody, bank + +On line 1624: + mortgage unless you + have documented income + that the borrower + +On line 1626: + repay the loan."56 The + Fed held back on enforcement + and supervision, + +On line 1626: + too. While discussing HOEPA + rule changes in the staff of the + Fed’s Division of + +On line 1626: + and Community + Affairs also proposed a + pilot program to + +On line 1626: + holding companies’ + nonbank subsidiaries,57 such as CitiFinancial + and HSBC Finance, + +On line 1626: + influence in the + subprime market was growing. + The nonbank subsidiaries + +On line 1626: + by the Federal + Trade Commission, while the banks + and thrifts were overseen + +On line 1626: + holding company + regulator, the Fed had + the authority + +On line 1626: + for "compliance with + the [Bank Holding Company + Act] or any other + +On line 1628: + the Fed enforcement + authority in this area.58 + The Fed resisted + +On line 1628: + these companies, and + despite the support of Fed + Governor Gramlich, + + the initiative stalled. + Sandra Braunstein, then a staff + member in the Fed’s + +On line 1628: + and Community + Affairs Division and now + its director, told + +On line 1628: + other officials + were concerned that routinely + examining the + +On line 1628: + an uneven playing + field because the subsidiaries had + to compete with the + +On line 1628: + supervisory + authority (although the + Fed’s HOEPA rules applied + +On line 1628: + In an interview + with the FCIC, Greenspan went further, + arguing that with + +On line 1628: + Fed lacked sufficient + resources to examine the + nonbank subsidiaries. Worse, + +On line 1628: + misleading message + to the firms and the market; + if you examine + +On line 1628: + organization + incompletely, it tends to + put a sign in their + +On line 1630: + because it creates + a Good Housekeeping stamp.60 But + if resources were the + +On line 1630: + could have argued for + more. The Fed draws income from + interest on the + +On line 1630: + it owns, so it did + not have to ask Congress for + appropriations. + +On line 1632: + it could be subject + to a government audit + of its finances. In + +On line 1632: + same FCIC interview, + Greenspan recalled that he sat in + countless meetings on + + consumer protection, + but that he couldn’t pretend + to have the kind of + +On line 1634: + chaired the Fed’s consumer + subcommittee, favored tighter + supervision of + +On line 1634: + authority to + firms (such as independent + mortgage companies) + + whose lending practices + were not subject to routine + supervision, the + +On line 1634: + antagonize the + states." But without such oversight, + the mortgage business + + was "like a city with + a murder law, but no cops + on the beat."62 In an + +On line 1634: + Street Journal that he + privately urged Greenspan to clamp + down on predatory + + lending. Greenspan demurred + and, lacking support on the + board, Gramlich backed away. + +On line 1634: + told the Journal, "He + was opposed to it, so I + did not really + +On line 1638: + pursue it."63 (Gramlich + died in of leukemia, at age The + Fed’s failure to stop + + predatory practices + infuriated consumer + advocates and some + + members of Congress. + Critics charged that accounts of + abuses were brushed off + +On line 1638: + a law professor + at the University of + Connecticut who served + +On line 1638: + individual + consumers. "That is classic Fed + mindset," said McCoy. "If + + you cannot prove that + it is a broad-based problem + that threatens systemic + +On line 1638: + will be dismissed." It + frustrated Margot Saunders + of the National + +On line 1638: + Center: "I stood up + at a Fed meeting in and + said, ‘How many anecdotes + +On line 1638: + real1 How many tens + [of] thousands of anecdotes will + it take to convince + + you that this is a + trend1’"64 The Fed’s reluctance to + take action trumped the + +On line 1640: + report and reports + issued by the General + Accounting Office + +On line 1640: + subsidiaries until a + pilot program in July + under new chairman + + Ben Bernanke.66 The Fed did + not issue new rules under + HOEPA until July + +On line 1640: + rules banned deceptive + practices in a much broader + category of + +On line 1640: + without regard to + the borrower’s ability + o pay, and required + +On line 1640: + verify income + and assets.67 The rules would not + take effect until + +On line 1642: + October which was + too little, too late. Looking + back, Fed General + + Counsel Alvarez said + his institution succumbed + to the climate of + +On line 1642: + times. He told the FCIC, + "The mind-set was that there should be + no regulation; + +On line 1642: + take care of policing, + unless there already is an + identified problem. + +On line 1642: + in the reactive + mode because that’s what the mind-set + was of the ‘90s and + + the early 2000s." The + strong housing market also + reassured people. + +On line 1642: + the long history + of low mortgage default rates + and the desire to + +On line 1646: + become homeowners.68 + STATES: "LONGSTANDING POSITION" + As the Fed balked, many + + states proceeded on + their own, enacting "mini-HOEPA" laws + and undertaking + +On line 1648: + the OCC and the OTS. + In North Carolina led the + way, establishing + +On line 1648: + a fee trigger of + that is, for the most part any + mortgage with points and + +On line 1648: + more than of the loan + qualified as "high-cost + mortgage" subject to + +On line 1648: + regulations. This + was considerably lower + than the set by the + +On line 1648: + HOEPA regulations. + Other provisions addressed + an even broader class + +On line 1648: + mortgage loans under + and prohibiting repeated + refinancing, known + +On line 1652: + rules did not apply + to federally chartered + thrifts. In the Office + +On line 1652: + position" that its + regulations "occupy + the entire field of + +On line 1652: + from "a hodgepodge of + conflicting and over-lapping state + lending requirements," + +On line 1652: + OTS said, would let thrifts + deliver "low-cost credit + to the public free + +On line 1656: + would protect consumers.70 + Nevertheless, other states + copied North Carolina’s + +On line 1656: + in alone.71 By states and + the District of Columbia + would pass some form of + +On line 1656: + legislation. In + some cases, two or more states + teamed up to produce + +On line 1656: + Massachusetts, and + Minnesota recovered more + than million from First + +On line 1656: + Mortgage Company, + even though the firm had filed for + bankruptcy. Also + +On line 1658: + million in penalties + and restitution to consumers. + In a coalition of + +On line 1658: + states and the District + of Columbia settled with + Ameriquest for million and + +On line 1660: + the company to + follow restrictions on its + lending practices. As + +On line 1660: + see, however, these + efforts would be severely + hindered with respect + +On line 1660: + banks when the OCC in + officially joined the OTS + in constraining states + +On line 1660: + products served as an + implicit endorsement of + their legality," + +On line 1664: + testified to the + Commission.72 COMMUNITYLENDING + PLEDGES: "WHAT WE DO IS + +On line 1666: + more protection against + predatory lenders, they also + lobbied the banks to + + invest in and loan + to low- and moderate-income + communities. The + +On line 1666: + law, including the + Community Reinvestment + Act of in fact, they + +On line 1666: + outside the scope of + the CRA. For example, they + frequently involved + +On line 1666: + individuals + whose incomes exceeded those + covered by the CRA, + +On line 1666: + in geographic + areas not covered by the + CRA, or lending to + + minorities, on which + the CRA is silent. The banks would + either sign agreements + +On line 1666: + community groups + or else unilaterally + pledge to lend to and + +On line 1668: + communities or + populations. Banks often + made these commitments + + when courting public + opinion during the merger + mania at the turn + +On line 1668: + century. One of + the most notable promises was + made by Citigroup + +On line 1668: + billion lending and + investment commitment, some + of which would include + +On line 1670: + with FleetBoston Financial + Corporation in Bank of + America announced + +On line 1670: + its largest commitment + to date: billion over years. Chase + announced commitments + +On line 1670: + respectively, in + its mergers with Chemical + Bank and Bank One. The + +On line 1670: + an advocacy + group, eventually tallied + more than trillion in + +On line 1672: + of them.73 Although banks + touted these commitments in + press releases, the + +On line 1674: + could not verify + this lending happened.74 The FCIC + sent a series of + +On line 1674: + of America, JP + Morgan, Citigroup, and Wells + Fargo, the nation’s + +On line 1674: + largest banks, regarding + their "CRA and community + lending commitments." + +On line 1674: + banks indicated + they had fulfilled most promises. + According to the + +On line 1674: + much smaller than the + larger unilateral pledges + by the banks. Further, + +On line 1674: + categories than did + the CRA, including mortgages + to minority + +On line 1674: + example, only% + of the mortgages made under + JP Morgan’s billion + +On line 1674: + initiative" would have + fallen under the CRA.75 Bank + of America, which + +On line 1674: + and moderate-income + and minority lending + as satisfying + + its pledges, stated that + just over half were likely to + meet CRA requirements. + +On line 1676: + not very risky. This is + not surprising, because such + broad definitions + +On line 1676: + included loans to + borrowers with strong credit + histories—low ncome + +On line 1676: + and weak or subprime + credit are not the same. In + fact, Citigroup’s pledge + +On line 1676: + in mortgage lending + "consisted of entirely + prime loans" to low- and + +On line 1676: + and minority + borrowers. These loans performed + well.76 JP Morgan’s largest + +On line 1676: + a community + group was to the Chicago CRA + Coalition: billion in + +On line 1676: + and fewer than have + been 90-or-more-days delinquent, even + as of late Wachovia + +On line 1676: + mortgage loans between + and under its billion in + unilateral pledges: + +On line 1676: + about were ever more + than days delinquent over the life + of the loan, compared + +On line 1676: + result of Wachovia’s + lending concentration in + the relatively + + stable Southeast, and + partly a reflection of + the credit profile + +On line 1678: + years of the CRA, the + Federal Reserve Board, when + considering whether + +On line 1678: + approve mergers, gave + some weight to commitments made + to regulators. + +On line 1680: + February when the + board denied Continental + Bank’s application + +On line 1680: + not offset its poor + lending record.79 In April the FDIC, + OCC, and Federal + +On line 1680: + OTS) joined the Fed in + announcing that commitments + to regulators + +On line 1682: + documents, and its + public statements, show the Fed + never considered + +On line 1682: + community groups + in evaluating mergers + and acquisitions, + + nor did it enforce + them. As Glenn Loney, a former + Fed official, told + + Commission staff, "At + the very beginning, [we] said + we’re not going to + + be in a posture + where the Fed’s going to be + sort of coercing + +On line 1682: + banks into making + deals with community groups + so that they can get + +On line 1684: + through."81 In fact, the rules + implementing the changes to + the CRA made it clear + +On line 1684: + Federal Reserve + would not consider promises + to third parties or + +On line 1684: + prior agreements with + those parties. The rules state "an + institution’s record + +On line 1684: + these types of agreements + [with third parties] is not an + appropriate CRA + +On line 1684: + criterion."82 Still, + the banks highlighted past acts + and assurances for + +On line 1684: + the future. In for + example, when NationsBank said it + was merging with BankAmerica, + +On line 1684: + it also announced + a 10-year, billion initiative + that included pledges + +On line 1684: + housing, billion for + consumer lending, billion for + small businesses, and + +On line 1686: + respectively. This + merger was perhaps the most + controversial of + + its time because of + the size of the two banks. The + Fed held four public + +On line 1686: + and received more than + comments. Supporters touted + the community + +On line 1686: + opponents decried + its lack of specificity. The + Fed’s internal staff + +On line 1686: + approval repeated + the Fed’s insistence on not + considering these + +On line 1686: + be agreements between + private parties and has not + facilitated, + +On line 1686: + or enforced agreements + or specific portions of + agreements. NationsBank remains + +On line 1686: + the credit needs of + its entire community, + including [low- and + +On line 1688: + its public order + approving the merger, the + Federal Reserve + +On line 1688: + on to state that "an + applicant must demonstrate a + satisfactory + +On line 1688: + performance under + the CRA without reliance on + plans or commitments + +On line 1688: + for future action. + The Board believes that the CRA + plan—whether made as a + +On line 1688: + relevance in this + case without the demonstrated + record of performance + +On line 1690: + companies involved."84 + So were these commitments a + meaningful step, or + +On line 1690: + a gesture1 Lloyd Brown, + a managing director + at Citigroup, told + +On line 1690: + business.85 Speaking of + the merger with Countrywide, + Andrew Plepler, head + +On line 1690: + Corporate Social + Responsibility at + Bank of America, + +On line 1690: + the FCIC: "At a time + of mergers, there is a lot + of concern, sometimes, + + that one plus one will + not equal two in the eyes of + communities where + +On line 1690: + the acquired bank has + been investing. So, what we + do is reaffirm our + +On line 1690: + to continue to + lend and invest so that the + communities where + +On line 1690: + work will continue + to economically thrive." + He explained further + +On line 1690: + pledge amount was arrived + at by working "closely with + our business partners" + +On line 1690: + current levels of + business activity that + qualifies toward + +On line 1690: + lending goals into + the future to assure the + community that + +On line 1692: + investing practices + will continue.86 In essence, banks + promised to keep doing + +On line 1692: + they had been doing, + and community groups had + the assurance that + +On line 1696: + "ARBITRAGE" Although + the Federal Reserve had + decided against stronger + +On line 1696: + it internalized + the lessons of and when the first + generation of + +On line 1696: + at serious risk; + some, such as Keystone Bank and + Superior Bank, + +On line 1696: + when the values of + the subprime securitized + assets they held proved + + to be inflated. + In response, the Federal + Reserve and other + +On line 1698: + thrifts. In October + they introduced the "Recourse + Rule" governing how + +On line 1698: + bank needed to hold + against securitized assets. + If a bank retained + +On line 1698: + tranche of a mortgage + security, as Keystone, + Superior, and + + others had done, it + would have to keep a dollar + in capital for + + every dollar of + residual interest. That + seemed to make sense, since + +On line 1698: + in this instance, would + be the first to take losses + on the loans in the + +On line 1698: + the old rules, banks held + only in capital to + protect against losses + +On line 1698: + and others had been + allowed to seriously + understate their risks + +On line 1698: + not hold sufficient + capital. Ironically, + because the new rule + +On line 1698: + charge on residual + interests it increased banks’ + incentive to sell + +On line 1700: + that they were no longer + the first to lose when the loans + went bad. he Recourse + + Rule also imposed + a new framework for asset-backed + securities. The + +On line 1702: + would be directly + linked to the rating agencies’ + assessment of the + +On line 1702: + holding lower-rated + investments. For example, + invested in AAA + +On line 1702: + holding only in + capital (the same as for + securities backed + +On line 1702: + government-sponsored + enterprises). But the same + amount invested in + +On line 1704: + BB rating required + in capital, or times more. + Banks could reduce the + + capital they were + required to hold for a pool + of mortgages simply + +On line 1704: + securitizing + them, rather than holding them on + their books as whole loans. + +On line 1706: + If a bank kept in + mortgages on its books, it might + have to set aside about + +On line 1706: + against unexpected + losses and in reserves against + expected losses. + +On line 1706: + bank created a + mortgage-backed security, sold + that security + +On line 1708: + "Regulatory + capital arbitrage does + play a role in bank + +On line 1708: + making," said David Jones, + a Fed economist who wrote + an article about + +On line 1708: + the subject in in + an FCIC interview. But "it + is not the only + +On line 1710: + triple-A corporate bond + required in capital—five + times as much as the + +On line 1710: + the corporate bond, + it was ultimately backed + by real estate. + + The new requirements + put the rating agencies in + the driver’s seat. How + + much capital a + bank held depended in part + on the ratings of + + the securities + it held. Tying capital + standards to the views + + of rating agencies + would come in for criticism + after the crisis + +On line 1712: + crutch," former Treasury + Secretary Henry Paulson + testified to the + +On line 1712: + it was better than + the alternative—"to let + the banks rate their own + +On line 1714: + That alternative + "would be terrible," he said, + noting that banks had + +On line 1714: + lower capital + requirements on the grounds that + the rating agencies + +On line 1716: + which were, after all, + supposed to be among the safest + investments. Nor were + +On line 1716: + for ratings downgrades + due to expected losses, + which would require banks + +On line 1716: + post more capital. + And were downgrades to occur + at the moment the + + banks wanted to sell + their securities to raise + capital, there would + +On line 1720: + buyers. All these things + would occur within a few + years. The Commission + +On line 1722: + in significant + ways by major financial + institutions. Some + +On line 1722: + as Citigroup, Lehman + Brothers, and Morgan Stanley, + acquired subprime lenders. + +On line 1722: + addition, major + financial institutions + facilitated + + the growth in subprime + mortgage–lending companies + with lines of credit, + +On line 1724: + other mechanisms. + Regulators failed to rein + in risky home mortgage + +On line 1724: + particular, the + Federal Reserve failed to + meet its statutory + +On line 1730: + lending standards and + to protect against predatory + lending. THE MORTGAGE + +On line 1738: + Mortgages: "A good loan" + Federal regulators: + "Immunity from + +On line 1740: + benefit" Mortgage + securities players: "Wall + Street was very hungry + +On line 1744: + for our product" Moody’s: + "Given a blank check"..........................................................................118 Fannie + Mae and Freddie Mac: + +On line 1746: + in the marketplace"................122 + In commercial banks, thrifts, and + investment banks caught + +On line 1746: + and Freddie Mac in + securitizing home loans. + By they had taken + +On line 1748: + securitizing + prime mortgages below their loan + limits, but the wave + +On line 1748: + refinancing by + prime borrowers spurred by very + low, steady interest + +On line 1748: + out. Meanwhile, Wall Street + focused on the higher-yield loans + that the GSEs could not + +On line 1748: + large, called jumbo loans, + and nonprime loans that didn’t + meet the GSEs’ standards. + + The nonprime loans soon + became the biggest part of + the market—"subprime" + +On line 1748: + for borrowers with + weak credit and "Alt-A" loans, with + characteristics + +On line 1750: + borrowers with strong + credit.1 By and Wall Street was + securitizing + +On line 1750: + more loans than Fannie + and Freddie. In just two years, + private-label mortgage-backed + +On line 1750: + securities had + grown more than reaching trillion + in were subprime or + +On line 1752: + rating agencies—or were + encouraged or restricted + by regulations + +On line 1752: + hungered for Wall Street + mortgage securities backed + by higher-yield mortgages—those + +On line 1752: + borrowers, those with + nontraditional features, + those with limited + +On line 1752: + documentation + ("no-doc loans"), or those that failed + in some other way + +On line 1754: + as a factory + line," former Citigroup CEO + Charles Prince told the FCIC. + + "As more and more and + more of these subprime mortgages + were created as + +On line 1754: + not surprisingly + in hindsight, more and more of + it was of lower + +On line 1760: + at the end of that + process, the raw material + going into it + +On line 1760: + actually bad + quality, it was toxic + quality, and that + + is what ended up + coming out the other end + of the pipeline. Wall + +On line 1762: + origination and + securitization of + these mortgages also + +On line 1762: + access to deposits, + investment banks relied more + on money market + +On line 1762: + and other investors + for cash; commercial paper + and repo loans were + +On line 1762: + the main sources. With house + prices already up from to this + flood of money and + +On line 1762: + apparatus helped + boost home prices another from + the beginning of + +On line 1762: + peak in April 2006—even as + homeownership was falling. + The biggest gains over + +On line 1762: + period were in + the "sand states": places like the Los + Angeles suburbs + +On line 1768: + From June through June the + Federal Reserve kept the + federal funds rate + +On line 1768: + at to stimulate + the economy following + the recession. Over + + the next two years, as + deflation fears waned, the Fed + gradually raised + +On line 1770: + to in quarter-point + increases. In the view of + some, the Fed simply + +On line 1770: + and former under + secretary of treasury for + international + +On line 1770: + primarily on + this action. If the Fed had + followed its usual + +On line 1770: + in mortgages. "The boom + in housing construction starts + would have been much more + + mild, might not even call + it a boom, and the bust as + well would have been mild," + + Taylor said.4 Others + were more blunt: "Greenspan bailed out the + world’s largest equity + +On line 1770: + A. Fleckenstein, the + president of a Seattle-based + money management + +On line 1772: + Ben Bernanke and Alan Greenspan + disagree. Both the current and + former Fed chairman + +On line 1772: + that deciding to + purchase a home depends on + long-term interest rates + + on mortgages, not the + short-term rates controlled by the + Fed, and that short-term + +On line 1772: + long-term rates had become + de-linked. "Between and the fed funds + rate and the mortgage + +On line 1772: + in lock-step," Greenspan said.6 + When the Fed started to raise + rates in officials + + expected mortgage + rates to rise, too, slowing growth. + Instead, mortgage rates + +On line 1772: + for another year. + The construction industry + continued to build + +On line 1774: + rate of million starts + in January 2006—more than a + 30-year high. As Greenspan told + +On line 1774: + and—vulnerable + to financial problems in + the past—encouraged + +On line 1774: + saving. Investors in + these countries placed their savings + in apparently + +On line 1774: + in the United States. + Fed Chairman Bernanke called it a + "global savings glut."8 + + s the United States + ran a large current account + deficit, flows into the + +On line 1776: + unprecedented. Over + six years from to U.S. Treasury + debt held by foreign + +On line 1776: + official public + entities rose from trillion + to trillion; as a + + percentage of U.S. + debt held by the public, these + holdings increased from + +On line 1776: + Foreigners also + bought securities backed by + Fannie and Freddie, + +On line 1776: + with their implicit + government guarantee, seemed + nearly as safe as + +On line 1776: + Treasuries. As the Asian + financial crisis ended + in foreign holdings + +On line 1776: + steady at the level + of almost years earlier, + about billion. By 2000—just + +On line 1778: + of situation + where poor countries like China + were shipping money + +On line 1778: + so weak that they [were] + better off shipping [money] + to countries like the + +On line 1778: + own countries," former + Fed governor Frederic + Mishkin told the FCIC. "The + +On line 1780: + liquidity, which + helped lower long-term interest + rates."9 Foreign investors + +On line 1780: + safe as Treasuries and + GSE securities but with + a slightly higher + +On line 1780: + overseas demand drove + up prices for securitized + debt, it "created + +On line 1782: + the U.S. financial + system: to engineer ‘quasi’ + safe debt instruments + +On line 1782: + riskier assets and + selling the senior tranches," + Pierre-Olivier Gourinchas, an + +On line 1784: + University of + California, Berkeley, told + the FCIC.10 Paul Krugman, + + an economist at + Princeton University, told + the FCIC, "It’s hard to + +On line 1784: + bubble was financed + by large capital inflows. + So were Spanish and + + Irish and Baltic bubbles. + It’s a combination of, + in the narrow sense, + +On line 1786: + international + capital movements."11 It was + an ocean of money. + +On line 1790: + refinancing boom + was over, but originators + still needed mortgages + + to sell to the Street. + They needed new products that, + as prices kept rising, + +On line 1790: + homes more affordable + to still-eager borrowers. + The solution was + +On line 1790: + risks for borrowers. + "Holding a subprime loan has + become something of + +On line 1794: + subprime borrowers + used hybrid adjustable-rate mortgages + (ARMs) such as 2/28s and + +On line 1794: + whose low "teaser" rate + lasts for the first two or three + years, and then adjusts + +On line 1794: + dollar volume of + Alt-A securitization + rose almost from to + +On line 1794: + In general, these + loans made borrowers’ monthly + mortgage payments on + +On line 1794: + homes affordable—at least + initially. Popular Alt-A + products included + +On line 1796: + payment-option ARMs. + Option ARMs let borrowers + pick their payment each + +On line 1796: + amortization. If + the balance got large enough, the + loan would convert to + +On line 1796: + mortgage, increasing + the monthly payment—perhaps + dramatically. + +On line 1798: + first, second, and even + third mortgages—rose. Debt-to-income + ratios climbed, as did + +On line 1798: + for non-owner-occupied + properties. Fannie Mae and + Freddie Mac’s market + +On line 1798: + from of all mortgages + purchased in to in and down + to by Taking their + +On line 1800: + by the GSEs. In this + new market, originators + competed fiercely; + +On line 1800: + It was the biggest + mortgage originator from + until the market + +On line 1800: + failed, buckling under + a mortgage portfolio with + loans that its co-founder + +On line 1800: + "toxic," Mozilo would + describe his 40-year-old company + to the Commission + +On line 1800: + people buy homes and + prevented social unrest + by extending loans + +On line 1800: + discrimination: + "Countrywide was one of the + greatest companies + +On line 1800: + the history of + this country and probably + made more difference + +On line 1800: + to the integrity + of our society, than any + company in the + +On line 1800: + America."19 Lending + to home buyers was only + part of the business. + +On line 1800: + and COO David Sambol + told the Commission, as long + as a loan did not + +On line 1800: + from a financial + or reputation standpoint, + Countrywide was "a + +On line 1802: + The company sold + or securitized of the + trillion in mortgages + +On line 1804: + aggressive goal of + gaining "market dominance" + by capturing of + +On line 1804: + the origination + market.21 His share at the time + was But Countrywide + +On line 1804: + Ameriquest, New Century, + Washington Mutual, and + others all pursued + +On line 1804: + by originating + types of mortgages created + years before as niche + +On line 1804: + now transformed into + riskier, mass-market versions. + "The definition + +On line 1804: + a good loan changed from + ‘one that pays’ to ‘one that could + be sold,’" Patricia + + Lindsay, formerly + a fraud specialist at New + Century, told the + +On line 1808: + 2/28s and 3/27s: "Adjust + for the affordability" + Historically, + +On line 1808: + 3/27s, also known as + hybrid ARMs, let credit-impaired + borrowers repair + + their credit. During + the first two or three years, a + lower interest + +On line 1808: + they could make timely + payments. Eventually the + interest rates would + +On line 1808: + sharply, and payments ould + double or even triple, leaving + borrowers with few + +On line 1808: + had established their + creditworthiness, they could + refinance into + +On line 1808: + mortgage or one with + a better interest rate, + often with the same + + lender;23 if unable to + refinance, the borrower + was unlikely to + + be able to afford + the new higher payments and + would have to sell the + + home and repay the + mortgage. If they could not sell + or make the higher + +On line 1810: + payments, they would have + to default. But as house prices + rose after the 2/28s + +On line 1810: + 3/27s acquired a new + role: helping to get people + into homes or to + + move up to bigger + homes. "As homes got less and less + affordable, you would + +On line 1810: + affordability + in the mortgage because you + couldn’t really + +On line 1810: + the president of + Andrew Davidson Co. and a + veteran of the + +On line 1810: + markets, told the FCIC.24 + Lenders qualified borrowers + at low teaser rates, + +On line 1810: + little thought to what + might happen when rates reset. + Hybrid ARMs became + +On line 1812: + as the Leadership + Conference on Civil Rights + railed against 2/28s and 3/27s, + +On line 1812: + credit nor turned renters + into owners. David Berenbaum + from the National + +On line 1812: + Reinvestment Coalition + testified to Congress in + the summer of "The + +On line 1812: + exotic mortgage + lending such as and ARMs. These + exotic subprime + +On line 1812: + rates shoot up after + an introductory time + period."25 To their + +On line 1812: + simply a way for + lenders to strip equity from + low-income borrowers. + + The loans came with big + fees that got rolled into the + mortgage, increasing + +On line 1812: + the mortgage could be + larger than the home’s value + at the reset date. + + If the borrower + could not refinance, the lender + would foreclose—and then + +On line 1816: + Option ARMs: "Our most + profitable mortgage loan" When they + were originally + +On line 1816: + in the 1980s, option + ARMs were niche products, too, but + by they too became + + loans of choice because + their payments were lower than + more traditional + + mortgages. During the + housing boom, many borrowers + repeatedly made + +On line 1816: + payments required, adding + to the principal balance + of their loan every + +On line 1818: + early seller of + option ARMs was Golden West + Savings, an Oakland, + +On line 1818: + California–based + thrift founded in and acquired + in by Marion + +On line 1818: + and Herbert Sandler. + In the Sandlers merged Golden + West with World Savings; + +On line 1818: + branches under the + name World Savings Bank. The thrift + issued about billion + +On line 1820: + option ARMs between + and Unlike other mortgage + companies, Golden + +On line 1822: + onto them. Sandler + told the FCIC that Golden West’s + option ARMs—marketed as "Pick-a-Pay" + + loans—had the lowest + losses in the industry + for that product. Even + +On line 1822: + almost entirely + in option ARMs, Golden West’s + losses were low by + + industry standards. + Sandler attributed Golden + West’s performance to + +On line 1822: + diligence in running + simulations about what would + happen to its loans + + under various + scenarios—for example, + if interest rates + +On line 1822: + or down or if house + prices dropped even "For a quarter + of a century, + + it worked exactly + as the simulations showed + that it would," Sandler + +On line 1822: + "And we have never + been able to identify a + single loan that was + +On line 1822: + loss or foreclosure."27 + But after Wachovia acquired + Golden West in and + +On line 1822: + housing market soured, + charge-offs on the Pick-a-Pay portfolio + would suddenly jump + +On line 1824: + by September And + foreclosures would climb. Early + in the decade, banks and + +On line 1824: + their origination + of option ARM loans, changing + the product in ways + +On line 1824: + that made payment shocks + more likely. At Golden West, + after years, or if + +On line 1824: + principal balance + grew to of its original + size, the Pick-a-Pay mortgage + +On line 1824: + new fixed-rate mortgage. At + Countrywide and Washington + Mutual, the new + + loans would recast in + as little as five years, or + when the balance hit + +On line 1824: + the original size. + They also offered lower + teaser rates—as low + +On line 1824: + 1%—and loan-to-value + ratios as high as All of + these features raised the + +On line 1824: + that the borrower’s + required payment could rise more + sharply, more quickly, and + +On line 1826: + with less cushion. In + Washington Mutual was + the second-largest mortgage + + originator, just + ahead of Countrywide. It had + offered the option + +On line 1826: + and in as cited + by the Senate Permanent + Subcommittee on + +On line 1826: + conducted a study + "to explore what Washington + Mutual could do + +On line 1826: + sales of Option ARMs, + our most profitable mortgage loan."28 + A focus group made + + clear that few customers + were requesting option ARMs + and that "this is not + + a product that sells + itself."29 The study found "the best + selling point for the + + Option Arm" was to + show consumers "how much lower + their monthly payment + +On line 1826: + be by choosing the + Option Arm versus a fixed-rate + loan."30 The study also + +On line 1828: + many WaMu brokers "felt + these loans were ‘bad’ for customers."31 + One member of the + + focus group remarked, + "A lot of (Loan) Consultants + don’t believe in it + +On line 1828: + and don’t think [it’s] good + for the customer. You’re going + to have to change the + +On line 1830: + Despite these challenges, + option ARM originations + soared at Washington + +On line 1830: + in to billion in + when they were more than half of + WaMu’s originations + +On line 1830: + the thrift’s signature + adjustable-rate home loan product.33 The + average FICO + +On line 1832: + was around well into + the range considered "prime," and + about two-thirds were jumbo + +On line 1834: + Mae and Freddie Mac + were allowed to purchase or + guarantee.34 More than + +On line 1836: + Countrywide’s option + ARM business peaked at billion + in originations + +On line 1836: + quarter of about of + all its loans originated + that quarter.36 But it + +On line 1836: + get there. In July + Countrywide decided it + would lend up to of + +On line 1836: + up from and reduced + the minimum credit score + to as low as In + +On line 1836: + ratio (including + second liens) to he risk in + these loans was growing. + +On line 1836: + rose about the combined + loan-to-value ratio rose + about and debt-to-income + +On line 1836: + ratios had risen from + to borrowers were pledging + more of their income + +On line 1836: + option ARMs had low + documentation in The + percentage of these + +On line 1836: + and speculators—that + is, borrowers with no plans + to use the home as + +On line 1838: + residence—also rose. + These changes worried the lenders even + as they continued + +On line 1838: + loans. In September + and August Mozilo emailed to + senior management + +On line 1838: + reputational + catastrophe."40 Countrywide should + not market them to + +On line 1838: + he insisted. "Pay + option loans being used by + investors is a pure + +On line 1838: + spec[ulation] loan + and not the traditional + home loan that we have + +On line 1838: + managed throughout our + history," Mozilo wrote to + Carlos Garcia, CEO + + of Countrywide Bank. + Speculative investors "should + go to Chase or Wells + +On line 1840: + us. It is also + important for you and your + team to understand + +On line 1840: + of view that there is + nothing intrinsically + wrong with pay options + +On line 1840: + the quality of + borrowers who are being + offered the product + +On line 1840: + and the abuse by third + party originators. [I]f + you are unable to + +On line 1842: + growth of the Bank for + the time being."41 However, + Countrywide’s growth did + +On line 1842: + volume of option + ARMs retained on its balance + sheet, increasing from + +On line 1842: + in to billion in + and peaking in at billion.42 + Finding these loans very + +On line 1842: + billion with the bulk + from California, followed + by Florida.43 But + +On line 1842: + the end, these loans would + cause significant losses + during the crisis. + +On line 1844: + and WaMu as tough, "in + our face" competitors, John Stumpf, + the CEO, chairman, and + +On line 1844: + Wells Fargo, recalled + Wells’s decision not to write + option ARMs, even as + +On line 1846: + originated many + other high-risk mortgages. These + were "hard decisions + + to make at the time," + he said, noting "we did lose + revenue, and we did + +On line 1848: + Across the market, the + volume of option ARMs had + risen nearly fourfold + +On line 1850: + approximately + billion to billion. By then, + WaMu and Countrywide + +On line 1850: + were making only + the minimum payments and + that their mortgages were + +On line 1850: + The percentage of + Countrywide’s option ARMs that + were negatively + +On line 1850: + amortizing grew from + just in to in and then to + more than by At WaMu, + +On line 1850: + was in in and in + Declines in house prices added to + borrowers’ problems: + +On line 1850: + simply be eroded. + Increasingly, borrowers + would owe more on their + +On line 1850: + than their homes were worth + on the market, giving them + an incentive to + +On line 1852: + home and mortgage. Kevin + Stein, from the California + Reinvestment Coalition, + +On line 1854: + option ARMs were sold + inappropriately: "Nowhere + was this dynamic + +On line 1854: + summer of when the + Federal Reserve convened + HOEPA (Home Ownership + +On line 1854: + Act) hearings in San + Francisco. At the hearing, + consumers testified + +On line 1854: + being sold option + ARM loans in their primary + non-English language, only + +On line 1854: + be pressured to sign + English-only documents with + significantly + +On line 1854: + being unable to + make even their initial payments + because they had been + +On line 1856: + to so completely + by their brokers."47 Mona Tawatao, a + regional counsel + +On line 1856: + Services of Northern + California, described the + borrowers she was + +On line 1856: + as "people who got + steered or defrauded into + entering option + +On line 1856: + with teaser rates or + pick-a-pay loans forcing them + to pay into—pay + +On line 1856: + that they could never + pay off. Prevalent among these clients + are seniors, people + +On line 1856: + disabilities, and + limited English speakers + and seniors who are + +On line 1858: + going to have to + hold our nose" Another shift + would have serious + +On line 1858: + consequences. For decades, + the down payment for a prime + mortgage had been (in + +On line 1858: + the loan-to-value + ratio (LTV) had been As prices + continued to rise, + +On line 1858: + finding the cash to + put down became harder, and + from on, lenders began + +On line 1860: + smaller down payments. + There had always been a place + for borrowers with + +On line 1862: + down payments below + Typically, lenders required + such borrower to + +On line 1862: + mortgage insurance + for a monthly fee. If a + mortgage ended in + +On line 1862: + the lender whole. Worried + about defaults, the GSEs would not + buy or guarantee + +On line 1862: + borrower bought the + insurance. Unluckily + for many homeowners, + +On line 1862: + industry, and for + the financial system, lenders + devised a way to + +On line 1862: + rid of these monthly + fees that had added to the cost + of homeownership: + +On line 1864: + down payments that did + not require insurance. Lenders + had latitude in + +On line 1864: + In Congress ordered + federal regulators + to prescribe standards + + for real estate + lending that would apply to + banks and thrifts. The goal + +On line 1864: + reduce risk to the + deposit insurance funds and + enhance the safety + +On line 1864: + LTV standards, but chose + not to, leaving that to the + regulators. In + +On line 1866: + LTV ratios or for + documentation for home + mortgages.50 The agencies + +On line 1866: + a regulation + implementing LTV ratios + would constrict credit, + +On line 1866: + lending costs, reduce + lending flexibility, + impede economic + +On line 1868: + growth, and cause other + undesirable consequences."51 + In regulators + + revisited the + issue, as high LTV lending + was increasing. They + +On line 1868: + and limited a + bank’s total holdings of loans + with LTVs above that lacked + +On line 1868: + other protection; + they also reminded the + banks and thrifts that they + +On line 1870: + internal guidelines + to manage the risk of these + loans.52 High LTV lending + + soon became even more + common, thanks to the so-called + iggyback mortgage. + +On line 1870: + The lender offered a + first mortgage for perhaps of + the home’s value and + +On line 1870: + another or even + Borrowers liked these because + their monthly payments + +On line 1870: + mortgage insurance, + and the interest payments + were tax deductible. Lenders + +On line 1872: + potentially be + sold to the GSEs. At the same + time, the piggybacks + +On line 1872: + risks. A borrower + with a higher combined LTV + had less equity + +On line 1872: + home. In a rising + market, should payments become + unmanageable, the + +On line 1872: + a falling market, + the borrower might owe more + than the home was worth. + +On line 1872: + that many borrowers + would end up with negative + equity if house + +On line 1872: + especially if + the appraisal had overstated + the initial value. + +On line 1874: + lending helped address + a significant challenge + for companies like + +On line 1874: + Century, which were + big players in the market + for mortgages. Meeting + +On line 1874: + required finding new + borrowers, and homebuyers + without down payments + +On line 1874: + Yet among borrowers + with mortgages originated + in by September + +On line 1874: + piggybacks were four + times as likely as other + mortgage holders to + +On line 1874: + or more days delinquent. + When senior management at + New Century heard + + these numbers, the head + of the Secondary Marketing + Department asked for + +On line 1876: + Century increased + mortgages with piggybacks to + of loan production + +On line 1876: + the end of up from + only in They were not alone. + Across securitized + +On line 1876: + subprime mortgages, the + average combined LTV rose + from to between and + +On line 1878: + into mortgages—and + quickly—was to require less + information of + +On line 1880: + years earlier for + people with fluctuating + or hard-to-verify + +On line 1880: + as the self-employed, + or to serve longtime customers + with strong credit. Or + +On line 1880: + looked safe in other + respects. "If I’m making a + loan-to-value, I’m + +On line 1880: + going to get all + of the documentation," + Sandler of Golden + + West told the FCIC. The + process was too cumbersome and + unnecessary. He + +On line 1880: + teachers, accountants, + and engineers made—and if + he didn’t, he could + +On line 1880: + out. All he needed + was to verify that his + borrowers worked where + +On line 1880: + did. If he guessed wrong, + the loan-to-value ratio + still protected his + +On line 1882: + offer borrowers + the convenience of quicker + decisions and not + +On line 1882: + of paperwork. In + return, they charged a higher + interest rate. The + +On line 1882: + to low- and no-doc + loans skyrocketed from less + than to roughly of + +On line 1882: + outstanding loans.56 Among + Alt-A securitizations, + of loans issued in + +On line 1882: + had limited or + no documentation.57 As + William Black, a former + +On line 1882: + before the FCIC, the + mortgage industry’s own fraud + specialists described + +On line 1882: + income loans as "an + open ‘invitation to fraud’ + that justified the + +On line 1884: + industry term ‘liar’s + loans.’"58 Speaking of lending up + to at Citigroup, + +On line 1884: + Bowen, a veteran + banker in the consumer lending + group, told the FCIC, "A + + decision was made + that ‘We’re going to have to + hold our nose and start + +On line 1884: + stated product if + we want to stay in business.’"59 + Jamie Dimon, the CEO + +On line 1884: + told the Commission, + "In mortgage underwriting, + somehow we just missed, + +On line 1884: + know, that home prices don’t + go up forever and that + it’s not sufficient + +On line 1886: + income."60 In the end, + companies in subprime and + Alt-A mortgages had, in + + essence, placed all their chips + on black: they were betting that + home prices would never + +On line 1888: + rising. This was the + only scenario that would keep + the mortgage machine + +On line 1888: + The evidence is + present in our case study mortgage-backed + security, CMLTI + +On line 1890: + 2006-NC2, whose loans have many + of the characteristics + just described. The loans + +On line 1890: + deal were adjustable-rate and + fixed-rate residential mortgages + originated by + +On line 1892: + home price of in The + vast majority had a + 30-year maturity, + +On line 1894: + were originated + in May, June, and July just + after national + +On line 1894: + reportedly for + primary residences, with + for home purchases + +On line 1896: + were from all states and + the District of Columbia, + but more than a fifth + +On line 1898: + and more than a tenth + from Florida.62 About of the + loans were ARMs, and most + +On line 1898: + In a twist, many of + these hybrid ARMs had other + "affordability + +On line 1898: + more than of the ARMs + were interest-only—during + the first two or three + + years, not only would + borrowers pay a lower + fixed rate, they would not + +On line 1898: + pay any principal. + In addition, more than of + the ARMs were hybrid + +On line 1898: + balloon" loans, in which + the principal would amortize + over years—lowering the + +On line 1898: + payments even further, + but as a result leaving + the borrower with + +On line 1900: + end of the 30-year term. + The great majority of + the pool was secured + +On line 1900: + mortgages; of these, had + a piggyback mortgage on + the same property. + +On line 1900: + a result, more than + one-third of the mortgages in this + deal had a combined + +On line 1902: + ratio between and + Raising the risk a bit more, + of the mortgages were + + no-doc loans. The rest + were "full-doc," although their + documentation + +On line 1904: + fuller in some cases + than in others.63 In sum, the + loans bundled in this + +On line 1904: + high LTVs and little + documentation. And even + as many warned of this + +On line 1906: + not on the same page. + FEDERAL REGULATORS: + "IMMUNITY FROM + + MANY STATE LAWS IS A + SIGNIFICANT BENEFIT" + For years, some states had + +On line 1910: + the mortgage business, + especially to clamp down + on the predatory + +On line 1910: + proliferating + in the subprime market. The + national thrifts and + +On line 1910: + Thrift Supervision + (OTS) and the Office of the + Comptroller of the + +On line 1910: + to regulate those + national banks and thrifts. The + companies claimed that + +On line 1910: + one uniform set of + rules, they could not easily + do business across the + +On line 1910: + regulators agreed. + In August as the market + for riskier subprime + + and AltA loans grew, and + as lenders piled on more risk with + smaller down payments, + +On line 1910: + interest-only loans, + and payment-option loans, the + OCC fired a salvo. + +On line 1910: + rules for national + banks, nearly identical to + earlier OTS rules + +On line 1912: + thrifts to disregard + state consumer laws.64 Back in the + OTS had issued rules + +On line 1912: + for federally + regulated thrifts.65 In the + OTS referred to these + + rules in issuing + four opinion letters declaring + that laws in Georgia, + +On line 1912: + New Jersey, and New + Mexico did not apply + to national thrifts. + +On line 1912: + the New Mexico + opinion, the regulator + pronounced invalid New + +On line 1912: + on balloon payments, + negative amortization, + prepayment penalties, + +On line 1914: + to the borrower’s + ability to repay. The + Comptroller of the + +On line 1914: + it regulated, + offering preemption as + an inducement to + +On line 1916: + a national bank + charter. In a speech, before + the final OCC rules + +On line 1918: + many state laws" as "a + significant benefit + of the national + + charter—a benefit + that the OCC has fought hard over + the years to preserve."66 + + In an interview + that year, Hawke explained that the + potential loss of + +On line 1920: + OCC "was a matter + of concern."67 In August the + OCC issued its first + +On line 1920: + preemptive order, + aimed at Georgia’s mini-HOEPA statute, and + in January the + +On line 1920: + adopted a sweeping + preemption rule applying + to all state laws that + +On line 1920: + on national banks’ + ability to lend. Shortly + afterward, three large + +On line 1920: + with combined assets + of more than trillion said they + would convert from state + +On line 1922: + another point of + contention in the preemption + battle. In the OCC + +On line 1922: + regarding state-chartered + operating subsidiaries of + national banks. In + +On line 1922: + into subsidiaries and + asserted that the subsidiaries + were exempt from state + +On line 1924: + lending laws. Four states + challenged the regulation, + but the Supreme Court ruled + +On line 1928: + them in Once OCC and + OTS preemption was in place, + the two federal + +On line 1928: + lending practices by + national banks and thrifts and + their direct subsidiaries. + +On line 1928: + Dugan, who succeeded + Hawke, defended preemption, + noting that of all + + nonprime mortgages were + made by lenders that were subject + to state law. Well over + +On line 1928: + were made by mortgage + lenders that were exclusively + subject to state law."70 + +On line 1928: + of Illinois, flipped the + argument around, noting that + national banks and + +On line 1928: + heavily involved + in subprime lending. Using + different data, + +On line 1928: + and their subsidiaries were + responsible for almost + percent of subprime + +On line 1928: + mortgage loans, percent + of the Alt-A loans, and percent + of the pay-option and + + interest-only ARMs + that were sold." Madigan told the + FCIC: Even as the Fed + + was doing little + to protect consumers and our + financial system + +On line 1930: + lending, the OCC and + OTS were actively engaged + in a campaign to + +On line 1930: + efforts to avert the + coming crisis. In the wake + of the federal + +On line 1930: + push to curtail state + authority, many of the + largest mortgage-lenders shed + +On line 1930: + state licenses and + sought shelter behind the shield + of a national + +On line 1930: + I think that it is + no coincidence that the + era of expanded + +On line 1932: + nation’s history.71 + Comptroller Hawke offered the + FCIC a different + +On line 1932: + suggested that the + OCC’s actions on preemption + have been a grab for + +On line 1932: + to increasingly + aggressive initiatives at + the state level to + +On line 1938: + depended on a + complex supply chain, largely + funded through short-term + +On line 1938: + repo market—which would + become critical as the + financial crisis + +On line 1940: + securities but + by highly rated mortgage + securities backed + +On line 1940: + increasingly risky + loans. Independent mortgage + originators such + +On line 1940: + originate mortgages + from warehouse lines of credit + extended by banks, + +On line 1942: + paper programs, or + from money borrowed in the + repo market. For + +On line 1942: + multibillion-dollar + business. From to Citigroup + made available at any + +On line 1942: + one time as much as + billion in warehouse lines of + credit to mortgage + +On line 1942: + including million + to New Century and more + than billion to Ameriquest.73 + + Citigroup CEO Chuck + Prince told the FCIC he would not + have approved, had he + +On line 1944: + "I found out at the + end of my tenure, I did + not know it before, + +On line 1944: + had some warehouse lines + out to some originators. + And I think getting + +On line 1946: + products—is something + that I wasn’t comfortable + with and that I did + +On line 1946: + consistent with the + prescription I had laid down + for the company + +On line 1948: + to be involved in + originating these products."74 + As early as Moody’s + +On line 1948: + ball game."75 As asset-backed + commercial paper became + a popular method + +On line 1948: + mortgage business, it + grew from about one-quarter to about + one-half of commercial + +On line 1950: + paper sold between + and n only five mortgage + companies borrowed + +On line 1950: + borrowed billion.76 For + instance, Countrywide launched the + commercial paper + +On line 1952: + Park Granada in and + Park Sienna in By May + it was borrowing + +On line 1952: + through Park Granada and + billion through Park Sienna. + These programs would house + + subprime and other + mortgages until they were sold.78 + Commercial banks used + +On line 1956: + arbitrage. When banks + kept mortgages on their balance + sheets, regulators + +On line 1956: + required them to hold + in capital to protect + against loss. When banks put + +On line 1956: + such as commercial + paper programs, there was no + capital charge (in + +On line 1956: + small charge was imposed). + But to make the deals work for + investors, banks had to + +On line 1956: + which they earned a fee. + This liquidity support + meant that the bank would + +On line 1956: + commercial paper + that investors were unwilling + to buy when it came + +On line 1956: + renewal. During + the financial crisis these + promises had to be + + kept, eventually + putting substantial pressure on + banks’ balance sheets. When + +On line 1958: + the private group that + establishes standards for + financial reports, + +On line 1958: + the Enron scandal + by making it harder for + companies to get + +On line 1958: + for these programs, the + favorable capital rules + were in jeopardy. The + +On line 1958: + commercial paper + market stalled. Banks protested that + their programs differed + +On line 1958: + practices at Enron + and should be excluded from + the new standards. In + +On line 1958: + bank regulators + responded by proposing to + let banks remove these + +On line 1958: + introduced for the + first time a capital charge + amounting to at most + +On line 1958: + association, + called that charge "arbitrary," and + State Street Bank complained + +On line 1958: + announced a final + rule setting the charge at up + to or half the amount + +On line 1960: + the first proposal. + Growth in this market resumed. + Regulatory + + changes—in this case, changes + in the bankruptcy laws—also + boosted growth in the + +On line 1960: + transforming the types + of repo collateral. + Prior to repo + +On line 1960: + their collateral + following the borrower’s + bankruptcy only + +On line 1960: + In the Bankruptcy + Abuse Prevention and Consumer + Protection Act of + +On line 1960: + Congress expanded + that provision to include + many other assets, + + including mortgage + loans, mortgage-backed securities, + collateralized + +On line 1960: + reliant on highly + rated non-agency mortgage-backed + securities; but + +On line 1960: + in mid-2007, when banks and + investors became skittish about + the mortgage market, + +On line 1960: + they would prove to be + an unstable funding source + (see figure Once the + +On line 1960: + a greater share of the + tri-party repo market + than most people would + +On line 1960: + Darryll Hendricks, a + UBS executive and chair + of a New York Fed + +On line 1960: + force examining + the repo market after + the crisis, told the + +On line 1962: + worked in practice. Eight + banks and securities firms + provided most of + +On line 1962: + Century needed + to make the mortgages it would + sell to Citigroup. + + Most of the funds came + through repo agreements from a + set of banks—including + +On line 1964: + Barclays Capital, + a division of a U.K.-based + bank million); Bank of + +On line 1964: + million); and Bear Stearns + million).81 The financing was + provided when New + +On line 1964: + originated these + mortgages; so for about two months, + New Century owed + +On line 1964: + its own commercial + paper program. On August + Citigroup paid New + +On line 1964: + Century million + for the mortgages (and accrued + interest), and New + +On line 1966: + lenders after keeping + a million premium.82 The + investors in the deal + + Investors for mortgage-backed + securities came from all + over the globe; what made + +On line 1970: + were the customized + tranches catering to every + one of them. CMLTI 2006-NC2 + +On line 1970: + tranches, whose investors + are shown in figure Fannie + Mae bought the entire + +On line 1970: + a better return + than super-safe U.S. Treasuries.83 The + other triple-A-rated tranches, + +On line 1970: + worth million, went to + more than institutional + investors around the world, + +On line 1970: + risk globally.84 These + triple-A tranches represented + of the deal. Among the + + buyers were foreign + banks and funds in China, Italy, + France, and Germany; the + + Federal Home Loan + Bank of Chicago; the Kentucky + Retirement Systems; + + a hospital; and + JP Morgan, which purchased part + of the tranche using + +On line 1970: + securities-lending + operation.85 (In other + words, JP Morgan lent + +On line 1970: + its clients to other + financial institutions + in exchange for cash + +On line 1970: + and then put that cash + to work investing in this + deal. Securities + +On line 1972: + market.) The middle, + mezzanine tranches in this + deal constituted + +On line 1972: + the total value + of the security. If + losses rose above to + +On line 1972: + design the threshold + would increase over time), investors + in the residual + +On line 1972: + would be wiped out, and + the mezzanine investors would + start to lose money. + +On line 1972: + collateralized + debt obligations, or CDOs—discussed in + the next chapter—bought + +On line 1972: + of the mezzanine + tranches rated below triple-A + and nearly all those + +On line 1972: + below AA. Only + a few of the highest-rated + mezzanine tranches + +On line 1972: + not put into CDOs. + For example, Cheyne Finance + Limited purchased + +On line 1972: + the top mezzanine + tranche. Cheyne—a structured investment + vehicle (SIV)—would be + +On line 1972: + casualties of + the crisis, sparking panic + during the summer + +On line 1974: + which purchased million + of the second mezzanine + tranche,86 would be one of + + the BNP Paribas funds which + helped ignite the financial + crisis that summer.87 + +On line 1976: + investors seeking high + returns, such as hedge funds, would + buy the equity + + tranches of mortgage-backed + securities; they would be + the first to lose if + +On line 1976: + there were problems. These + investors anticipated + returns of or even + +On line 1976: + Citigroup retained + part of the residual or + "first-loss" tranches, sharing + +On line 1980: + very well" The business + of structuring, selling, and + distributing this deal, + +On line 1980: + the banks. The mortgage + originators profited + when they sold loans for + +On line 1980: + profit flowed down to + employees—particularly + those generating + +On line 1982: + volume. Part of the + million premium received + by New Century + +On line 1982: + analyzed went to + pay the many employees who + participated. + +On line 1982: + salespeople [who] were + the reason our loans came in + were compensated + +On line 1982: + the FCIC. And volume + mattered more than quality. + She noted, "Wall Street + +On line 1982: + very hungry for our + product. We had our loans sold + three months in advance, + + before they were even + made at one point."90 Similar + incentives were at + +On line 1984: + subprime division + of Washington Mutual, + which organized its + +On line 1984: + Incentive Plan by + volume. As WaMu showed in a + plan, "Home Loans Product + +On line 1986: + in higher margin + products (Option ARM, Alt A, + Home Equity, ubprime)," + +On line 1986: + sales force," and "maintain + a compensation structure + that supports the high + +On line 1988: + a security, + an underwriter, often + an investment bank, + +On line 1988: + For a billion deal + like CMLTI 2006-NC2, a fee would earn + Citigroup million. + +On line 1988: + Citigroup instead + kept parts of the residual + tranches. Doing so + +On line 1990: + yield large profits as + long as the deal performed as + expected. Options + +On line 1990: + banks, examined the + mortgage-backed securities sales + and trading desks at + +On line 1990: + from to It found that + associates had average + annual base salaries + +On line 1990: + of to from through but + received bonuses that could well + exceed their salaries. On + +On line 1990: + salaries and bonuses from + to Directors averaged + to At the top was + +On line 1990: + the head of the unit. + For example, in Dow Kim, + the head of Merrill’s + + Global Markets and + Investment Banking segment, + received a base salary + +On line 1992: + plus a million bonus, + a package second only + to Merrill Lynch’s CEO.95 + + MOODY’S: "GIVEN A BLANK + CHECK" The rating agencies were + essential to the + +On line 1996: + Issuers needed them + to approve the structure of + their deals; banks needed + +On line 1996: + markets needed their + ratings to determine loan + terms; some investors could + +On line 1996: + agencies’ judgment was + baked into collateral + agreements and other + + financial contracts. + To examine the rating + process, the Commission + +On line 1996: + Moody’s Investors Service, + the largest and oldest of the + three rating agencies. + +On line 1998: + finance products such + as mortgage-backed securities + made up close to half + +On line 2000: + and From to revenues + from rating such financial + instruments increased + + more than fourfold.97 But + the rating process involved many + conflicts, which would come + +On line 2002: + using models based, + in part, on periods of + relatively strong + +On line 2002: + in underwriting + standards or a dramatic + decline in home prices. + +On line 2002: + even develop a + model specifically to + take into account + +On line 2006: + securities.98 "In + the business forevermore" Credit + ratings have been linked + +On line 2006: + three-quarters of a + century.99 In the Office + of the Comptroller + +On line 2006: + the Currency let + banks report publicly traded + bonds with a rating + + of BBB or better + at book value (that is, the + price they paid for the + + bonds); lower-rated bonds + had to be reported at + current market prices, + +On line 2006: + on lower-rated bonds + held by insurers.100 But the + watershed event in + +On line 2006: + broker-dealers to base + them on credit ratings by + a "nationally + +On line 2006: + organization" + (NRSRO); at the time, that was Moody’s, + S&P, or Fitch. Ratings + +On line 2006: + built into banking + capital regulations + under the Recourse + +On line 2006: + less capital for + higher-rated securities. + For example, BBB + +On line 2006: + Banks in some countries + were subject to similar + requirements under + +On line 2006: + international + capital agreement, signed in + June although U.S. banks + +On line 2008: + also determined + whether investors could buy certain + investments at all. + +On line 2008: + SEC restricts money + market funds to purchasing + "securities that + +On line 2008: + credit ratings from + any two NRSROs in one of the + two highest short-term + +On line 2008: + or comparable + unrated securities."101 + The Department of + +On line 2008: + fund investments to + securities rated A + or higher. Credit + + ratings affect even + private transactions: contracts + may contain triggers + +On line 2008: + or entity be + downgraded. Triggers played an + important role in + +On line 2010: + the mortgage market, + the Secondary Mortgage Market + Enhancement Act of + +On line 2010: + state-chartered financial + institutions to invest + in mortgage-related + + securities if + the securities had high + ratings from at least + + one rating agency. + "Look at the language of the + original bill," Lewis + +On line 2012: + Ranieri told the FCIC. "It + requires a rating. It put + them in the business + + forevermore. It became + one of the biggest, if not + the biggest, business."102 + +On line 2012: + Kolchinsky, a former + Moody’s managing director, + would summarize the + +On line 2014: + "the rating agencies + were given a blank check."103 The + agencies themselves were + +On line 2016: + avoid regulation + for decades. Beginning in the + SEC had to approve + +On line 2016: + application to + become an NRSRO—but if approved, + a company faced + +On line 2018: + later, the SEC got + limited authority + to oversee NRSROs in + +On line 2020: + the Credit Rating + Agency Reform Act of That + law, taking effect + +On line 2020: + in June focused on + mandatory disclosure of + the rating agencies’ + +On line 2022: + or the procedures + and methodologies."104 Many investors, + such as some pension + +On line 2022: + ratings because they + had neither access to the + same data as the + +On line 2022: + analytical + ability to assess the + securities they + +On line 2026: + acknowledged, "Subprime + [residential mortgage–backed + securities] and + +On line 2026: + composition and + characteristics of the + loan collateral. + +On line 2026: + their home-work were + skeptical of these products + despite their ratings. + +On line 2026: + of Mission Bank in + Bakersfield, California, + described deciding + +On line 2028: + the bank’s holdings of + mortgage-backed securities and + CDOs: At one meeting, + +On line 2028: + getting difficult, + maybe in I asked the CFO what + the mechanical + +On line 2028: + securities, if + a borrower in Des Moines, + Iowa, defaulted. I + +On line 2028: + what it is if a + borrower in Bakersfield + defaults, and somebody + +On line 2028: + that mortgage. But as + a package security, + what happens1 And he + + couldn’t answer the + question. And I told him to + sell them, sell all of + + them, then, because we + didn’t understand it, and + I don’t know that we + +On line 2028: + to understand the + financial complexities; + didn’t want any part + +On line 2030: + rating agencies were + not liable for misstatements + in securities + +On line 2030: + ruled that their ratings + were opinions, protected by + the First Amendment. Moody’s + +On line 2030: + standard disclaimer reads + "The ratings are, and must be + construed solely as, + + statements of opinion + and not statements of fact or + recommendations + + to purchase, sell, or + hold any securities." Gary + Witt, a former team + +On line 2030: + director at Moody’s, + told the FCIC, "People expect + too much from ratings + +On line 2032: + always be based on + much more than just a rating."107 + "Everything but the + +On line 2032: + on the table" The + ratings were intended to + provide a means of + + comparing risks across + asset classes and time. In + other words, the risk + +On line 2032: + triple-A rated mortgage + security was supposed + to be similar + + to the risk of a + triple-A rated corporate bond. + Since the mid-1990s, Moody’s has + +On line 2034: + In Moody’s created + a new model, M3 Prime, to + rate prime, jumbo, and + +On line 2034: + Alt-A deals. Only in + the fall of when the housing + market had already + +On line 2034: + it develop its + model for rating subprime + deals, called M3 Subprime.108 + +On line 2036: + and legal factors, + and macroeconomic trends. The + M3 Prime model let + +On line 2036: + automate more of + the process. Although Moody’s did not + sample or review + +On line 2036: + issuer. Relying + on loan-to-value ratios, + borrower credit + +On line 2036: + loan terms and other + information, the model + simulated the + +On line 2038: + loan in scenarios, + including variations in + interest rates and + +On line 2038: + as well as home price + changes. On average, across the + scenarios, home prices + +On line 2038: + little weight on the + possibility prices would + fall sharply nationwide. + +On line 2038: + in developing + the model, told the FCIC, "There + may have been [state-level] + + components of this + real estate drop that the + statistics would have + +On line 2038: + down over this short but + multiple-year period, is + more stressful than the + +On line 2038: + for." Even as housing + prices rose to unprecedented + levels, Moody’s never + +On line 2038: + put greater weight on the + possibility of a + decline. According + +On line 2042: + position was that + there was not a national + housing bubble."110 When + +On line 2042: + on the deal convened + a rating committee of + other analysts + +On line 2042: + it and determine + the overall ratings for the + securities.111 Siegel + +On line 2042: + also integral: + "One common misperception + is that Moody’s credit + +On line 2042: + derived solely from + the application of a + mathematical + +On line 2042: + process or model. This + is not the case. The credit + rating process involves + +On line 2042: + of independent + judgment by members of the + rating committee. + +On line 2042: + majority view + of the committee’s members."112 + As Roger Stein, a Moody’s + +On line 2042: + director, noted, + "Overall, the model has to + contemplate events for + +On line 2044: + there is no data."113 + After rating subprime deals + with the model for + +On line 2046: + subprime mortgage–backed + securities. Like M3 Prime, + the subprime model + +On line 2046: + through scenarios.114 Moody’s + officials told the FCIC they + recognized that stress + +On line 2046: + most stressful scenario, + which reduced the portion of + each deal rated triple-A. + +On line 2046: + was manually + "calibrated" to be more + conservative to + + ensure predicted + losses were consistent with + analysts’ "expert + +On line 2046: + for example, as + one step, analysts took the + "single worst case" from + +On line 2048: + in order to add + deterioration.115 Moody’s + did not, however, + +On line 2048: + of the loans being + securitized. Fons described + this problem to the + + FCIC: "I sat on this + high-level Structured Credit + committee, which you’d + +On line 2048: + would be dealing with + such issues [of declining + mortgage-underwriting + +On line 2048: + and never once was + it raised to this group or put + on our agenda that + +On line 2048: + in quality that + was going into pools, the + impact possibly + +On line 2048: + ratings, other things. + We talked about everything but, + you know, the elephant + +On line 2050: + the table."116 To rate + CMLTI 2006-NC2, our sample deal, Moody’s + first used its model + +On line 2050: + pool. Those estimates, + in turn, determined how big + the junior tranches + +On line 2050: + the deal would have to + be in order to protect + the senior tranches + +On line 2050: + was similar to + another Citigroup deal + of New Century + +On line 2050: + rated earlier + and recommended the same + amount.117 Then the deal was + +On line 2050: + of loans, including + interest-only mortgages.118 For + its efforts, Moody’s was + +On line 2054: + an estimated + (S&P also rated this deal + and received As we + + will describe later, + three tranches of this deal would + be downgraded less + +On line 2054: + Moody’s mass downgrade on + July when housing prices had + declined by only + +On line 2054: + October the M4–M11 + tranches ere downgraded and + by all the tranches + +On line 2054: + been downgraded. Of + all mortgage-backed securities + it had rated triple-A + +On line 2054: + The consequences would + reverberate throughout the + financial system. + +On line 2060: + had violated + accounting rules and now faced + corrections and fines.122 + +On line 2060: + standards, purchasing + and guaranteeing riskier + loans, and increasing + +On line 2060: + their regulator, + the Office of Federal + Housing Enterprise + +On line 2060: + Freddie’s increasing + investments in risky mortgages + and securities. + +On line 2062: + accounting firms. The + company had been using + Arthur Andersen for + +On line 2062: + but when Andersen + got into trouble in the + Enron debacle + + (which put both Enron + and its accountant out of + business), Freddie switched + +On line 2062: + the company had + understated its earnings + by billion from through + +On line 2062: + quarter of in an + effort to smooth reported + earnings and promote + +On line 2062: + as "Steady Freddie," a + company of strong and steady + growth. Bonuses were tied + +On line 2064: + to the accounting + manipulations. Freddie’s + board ousted most top + +On line 2064: + CEO Leland Brendsel, + President and COO David Glenn, + and CFO Vaughn Clarke.124 In + +On line 2064: + risk management. In + January OFHEO directed + Freddie to maintain + +On line 2064: + requirement until + it reduced operational + risk and could produce + +On line 2066: + settle shareholder + lawsuits for million and pay + million in penalties + +On line 2068: + Fannie was next. In + September OFHEO discovered + violations of + +On line 2068: + rules that called into + question previous filings. + In OFHEO reported + +On line 2068: + earnings from through by + billion and that it, too, had + manipulated + +On line 2068: + in ways influenced + by compensation plans.125 OFHEO + made Fannie improve + +On line 2068: + accounting controls, + maintain the same capital + surplus imposed on + + Freddie, and improve + governance and internal + controls. Fannie’s board + +On line 2068: + Raines and others, and + the SEC required Fannie to + restate its results + +On line 2070: + actions for million + in penalties. Donald Bisenius, + an executive + +On line 2070: + at Freddie Mac, told + the FCIC that the accounting + issues distracted + +On line 2070: + the mortgage business, + taking "a tremendous amount of + management’s time and + +On line 2070: + less aggressive or + less competitive in the + marketplace [than] we + +On line 2074: + been."126 As the scandals + unfolded, subprime private + label mortgage–backed + +On line 2074: + securities (PLS) + issued by Wall Street increased + from billion in to + +On line 2078: + the value of Alt-A + mortgage–backed securities + increased from billion + +On line 2078: + billion. Starting in + for Freddie and for Fannie, + the GSEs—particularly Freddie—became + +On line 2078: + market. While private + investors always bought the most, + the GSEs purchased of + +On line 2078: + private-issued subprime + mortgage–backed securities + in The share peaked at + +On line 2078: + then fell back to in + The share for Alt-A mortgage–backed + securities was + + always lower.127 The + GSEs almost always bought the + safest, triple-A-rated tranches. From + +On line 2082: + purchases declined, + both in dollar amount and as + a percentage. These + +On line 2082: + profitable at first, but + as delinquencies increased in + and both GSEs began + +On line 2084: + from their purchases + of Alt-A securities. By + the third quarter of + +On line 2084: + total impairments + on securities totaled + billion at the two + +On line 2086: + to wipe out nearly + of their pre-crisis capital.128 + OFHEO knew about the GSEs’ + +On line 2088: + backed securities. + In its examination, + the regulator + +On line 2088: + Freddie’s purchases + of these securities. It + also noted that + +On line 2090: + mortgages with "higher + risk attributes which exceeded + the Enterprise’s + +On line 2090: + capabilities," + including "No Income/No Asset + loans" that introduced + +On line 2090: + mortgage insurers + were already seeing abuses + with these loans.129 But the + +On line 2090: + that the purchases + of mortgage-backed securities + and riskier mortgages + +On line 2090: + efforts to address + accounting and internal + deficiencies.130 OFHEO + +On line 2090: + nothing in Fannie’s + report about its purchases + of subprime and Alt-A + +On line 2092: + risk management was + deemed satisfactory.131 The + reasons for the GSEs’ + +On line 2092: + of subprime and Alt-A + mortgage–backed securities + have been debated. + +On line 2092: + push to fulfill their + higher goals for affordable + housing. The former + +On line 2092: + a working paper + submitted as part of his + testimony to + +On line 2094: + that when the GSEs were + pressed to "expand ‘affordable + housing commitments,’ + +On line 2094: + multifamily + purchases alone met each of + the goals; in other + +On line 2094: + enterprise would have + met its obligations without + buying subprime or + +On line 2096: + none of Fannie Mae’s + purchases of subprime or + Alt-A securities + +On line 2098: + submitted to HUD + to be counted toward the + goals. Before or less + +On line 2098: + purchases had to + satisfy the affordable + housing goals. In the + +On line 2098: + met the overall goals.133 + Securities purchases + did, in several + +On line 2098: + requiring the GSEs + to purchase or guarantee + loans to purchase homes. + +On line 2098: + Fannie missed one of + these subgoals and would have missed + a second without + +On line 2098: + purchases; in the + securities purchases + helped Fannie meet those + +On line 2100: + the FCIC show that from + through Freddie would have met the + affordable housing + +On line 2100: + of Alt-A or subprime + securities, but used the + securities to + +On line 2102: + Robert Levin, the former + chief business officer of + Fannie Mae, told the + +On line 2102: + was no trade-off [between + making money and hitting + goals], it was a very + + broad-brushed effort" that + could be characterized as + "win-win-win: money, goals, and + +On line 2104: + Winer, the head of + Fannie’s Business, Analysis, + and Decisions Group, + +On line 2104: + of triple-A tranches of + mortgage-backed securities backed + by subprime loans was + +On line 2104: + as an attractive + opportunity with good + returns. He said that + +On line 2104: + satisfied housing + goals, and that the goals became + a factor in the + +On line 2106: + of private label + securities. Overall, while + the mortgages behind + +On line 2106: + were often issued + to borrowers that could help + Fannie and Freddie + +On line 2106: + the mortgages behind + the Alt-A securities were + not. Alt-A mortgages were + + not generally + extended to lower-income + borrowers, and the + +On line 2106: + Alt-A loans—from counting + toward affordability + goals.138 Levin told the FCIC + +On line 2106: + the purchase of Alt-A + securities "did not have + a net positive + + effect on Fannie + Mae’s housing goals."139 Instead, they + had to be offset + +On line 2108: + and moderate-income + borrowers to meet the goals. + Fannie and Freddie + +On line 2108: + from to and also + bought and securitized greater + numbers of riskier + +On line 2110: + their shareholders, and + American taxpayers. The + Commission concludes + +On line 2110: + policy of the + Federal Reserve, along with + capital flows from + +On line 2110: + a housing bubble + could develop. However, + these conditions need + +On line 2110: + Federal Reserve + and other regulators + did not take actions + +On line 2110: + constrain the credit + bubble. In addition, the + Federal Reserve’s + +On line 2110: + encouraged rather than + inhibited the growth of + mortgage debt and the + +On line 2112: + accountability + and responsibility + throughout each level + +On line 2112: + securitizers, + credit rating agencies, and + investors, and ranged from + + corporate boardrooms + to individuals. Loans + were often premised on + + ever-rising home prices + and were made regardless of + ability to pay. + +On line 2114: + process created a + pipeline through which risky mortgages + were conveyed and sold + +On line 2116: + was essential to + the origination of the + burgeoning numbers + +On line 2116: + model undermined + responsibility and + accountability + +On line 2120: + Federal and state + rules required or encouraged + financial firms and + +On line 2120: + institutional + investors to make investments + based on the ratings + +On line 2120: + to undue reliance + on those ratings. However, + the rating agencies + +On line 2120: + regulator to + ensure the quality and + accuracy of + + their ratings. Moody’s, the + Commission’s case study in this + area, relied on flawed + +On line 2120: + issue erroneous + ratings on mortgage-related + securities, failed + +On line 2120: + perform meaningful + due diligence on the assets + underlying the + +On line 2120: + and continued to + rely on those models even + after it became + + obvious that the + models were wrong. Not only + did the federal + +On line 2122: + in risky mortgage-lending + practices, but the Office of + the Comptroller of + +On line 2132: + on this segment of + the mortgage market. THE CDO + MACHINE CONTENTS CDOs: + +On line 2134: + the investor" Bear Stearns’s + hedge funds: "It functioned fine up + until one day it + + just didn’t function".....................................................................................134 + Citigroup’s liquidity + puts: "A potential + +On line 2140: + goose for the entire + Street" Goldman Sachs: "Multiplied + the effects of the + +On line 2144: + collapse in subprime"..................142 + Moody’s: "Achieved through some alchemy" SEC: + "It’s going to be + + an awfully big + mess"..........................................................150 In the first decade of the + 21st century, a + +On line 2146: + financial product + called the collateralized + debt obligation, or + +On line 2146: + transformed the mortgage + market by creating a + new source of demand + +On line 2148: + tranches of mortgage-backed + securities.* Despite their + relatively high + +On line 2148: + be hard to sell. If + borrowers were delinquent or + defaulted, investors + +On line 2148: + these tranches were out + of luck because of where they + sat in the payments + + waterfall. Wall Street + came up with a solution: + in the words of one + + banker, they "created + the investor."1 That is, they built + new securities + +On line 2150: + would buy the tranches + that had become harder to + sell. Bankers would take those + +On line 2150: + BBB or A, from many + mortgage-backed securities and + repackage them into + +On line 2150: + Approximately + of these CDO tranches would be + rated triple-A despite + +On line 2150: + lower-rated tranches + of mortgage-backed securities. + CDO securities + +On line 2150: + be sold with their own + waterfalls, with the risk-averse + investors, again, paid first + +On line 2150: + they did in the case + of mortgage-backed securities, + the rating agencies + +On line 2150: + highest, triple-A ratings + to the securities at + the top (see figure + +On line 2152: + be transformed into + a new security that + is mostly rated + + triple-A. But math made it + so. *Throughout this book, unless + otherwise noted, + +On line 2154: + term "CDOs" to refer + to cash CDOs backed by asset-backed + securities (such + +On line 2156: + also known as ABS + CDOs. The securities firms + argued—and the rating + +On line 2156: + significant—that + if one security went + bad, the second had + + only a very small + chance of going bad at the + same time. And as long + +On line 2156: + limited, only + those investors at the bottom + would lose money. They + + would absorb the blow, + and the other investors would + continue to get + + paid. Relying on + that logic, the CDO machine + gobbled up the BBB + +On line 2158: + lower-rated tranches + of mortgage-backed securities, + growing from a bit + +On line 2158: + Between and as house + prices rose nationally and + trillion in mortgage-backed + +On line 2160: + securities were + created, Wall Street issued + nearly billion in + + CDOs that included + mortgage-backed securities as + collateral.2 With + +On line 2160: + demand loans for their + pools, and hundreds of billions + of dollars flooded + + the mortgage world. In + effect, the CDO became the + engine that powered + +On line 2160: + mortgage supply chain. + "There is a machine going," + Scott Eichel, a senior + +On line 2160: + at Bear Stearns, told a + financial journalist in + May "There is a lot + + of brain power to + keep this going."3 Everyone + involved in keeping + +On line 2162: + machine humming—the CDO + managers and underwriters + who packaged and sold + + the securities, + the rating agencies that gave + most of them sterling + +On line 2162: + protection against their + defaulting—collected fees + based on the dollar + +On line 2162: + of securities + sold. For the bankers who had put + these deals together, + +On line 2162: + the executives + of their companies, volume + equaled fees equaled bonuses. + + And those fees were in + the billions of dollars across + the market. But when + +On line 2164: + market went south, the + models on which CDOs were based + proved tragically + +On line 2164: + would default in large + numbers. This was not how it + was supposed to work. + +On line 2164: + in one region were + supposed to be offset by + successful loans in + + another region. + In the end, CDOs turned out to + be some of the most + +On line 2164: + financial crisis. + The greatest losses would be + experienced by + +On line 2164: + Lynch, and UBS, and by + financial guarantors such + as AIG, Ambac, and + + MBIA. These players had + believed their own models and + retained exposure + +On line 2164: + were understood to + be the least risky tranches of + the CDOs: those rated + +On line 2166: + or even "super-senior," + which were assumed to be safer + than triple-A-rated tranches. "The + +On line 2166: + ABS CDOs had been an + abomination," Patrick Parkinson, + currently the head + +On line 2168: + and regulation + at the Federal Reserve + Board, told the FCIC.4 CDOS: + +On line 2170: + assembled the first + rated collateralized + debt obligation in + +On line 2170: + The strategy made + sense—pooling many bonds reduced + investors’ exposure + +On line 2172: + enabled investors to + pick their preferred level of + risk and return. For + +On line 2172: + who created CDOs, + the key to profitability + of the CDO was the + +On line 2172: + the spread—the difference + between the interest that + the CDO received on + + the bonds or loans that + it held and the interest + that the CDO paid to + +On line 2172: + market bonds and bank + loans. When the liquidity + crisis of drove up + +On line 2172: + Securities saw + an opportunity and + launched a series of + +On line 2172: + "multisector" or + "ABS" securities were backed + by mortgages, mobile + +On line 2172: + leases, mutual + fund fees, and other asset + classes with predictable + +On line 2172: + The diversity + was supposed to provide yet + another layer + +On line 2174: + safety for investors. + Multisector CDOs went through + a tough patch when some + +On line 2174: + securities in + which they invested started + to perform poorly + +On line 2174: + 2002—particularly + those backed by mobile home loans + (after borrowers + +On line 2174: + leases (after and + mutual fund fees (after + the dot-com bust).5 The + +On line 2174: + many investment banks, + investors, and rating agencies + was that the wide range + +On line 2174: + had actually + contributed to the problem; + according to this + +On line 2174: + asset managers who + selected the portfolios + could not be experts + +On line 2176: + as aircraft leases + and mutual funds. So the + CDO industry turned + +On line 2176: + CDO managers believed + they understood, which seemed to + have a record of good + +On line 2176: + was considered a + safe investment. "Everyone + looked at the sector + +On line 2176: + construct works, but we + just need to find more stable + collateral," said + + Wing Chau, who ran two + firms, Maxim Group and Harding + Advisory, that + +On line 2176: + industry looked at + residential mortgage–backed + securities, Alt-A, + +On line 2178: + mortgages, and saw the + relative stability."6 + CDOs quickly became + + ubiquitous in the + mortgage business.7 Investors liked + the combination + +On line 2178: + bankers liked having a + new source of demand for the + lower tranches of + +On line 2178: + created. "We told + you these [BBB-rated securities] + were a great deal, and + +On line 2178: + great spreads, but nobody + stepped up," the Credit Suisse + banker Joe Donovan told + + a Phoenix conference + of securitization + bankers in February + +On line 2180: + we created the + investor."8 By creators of CDOs + were the dominant + +On line 2180: + tranches of mortgage-backed + securities, and their bids + significantly + +On line 2182: + By they were buying + "virtually all" of the + BBB tranches.9 Just as + +On line 2182: + provided the cash + to originate mortgages, now + CDOs would provide the + +On line 2182: + Also by mortgage-backed + securities accounted + for more than half of + +On line 2182: + collateral in + CDOs, up from in Sales of these + CDOs more than doubled + +On line 2184: + hundreds of billions + of dollars of subprime and + Alt-A mortgages. "It was + +On line 2186: + of effort" Five key + types of players were involved + in the construction + +On line 2186: + agencies, investors, and + financial guarantors. Each + took varying degrees + + of risk and, for a + time, profited handsomely. + Securities firms + +On line 2188: + the selection of + collateral, structured the + notes into tranches, + +On line 2188: + were responsible + for selling them to investors. + Three firms—Merrill Lynch, Goldman + +On line 2188: + the securities + arm of Citigroup—accounted + for more than of CDOs + +On line 2190: + were also major + participants.12 "We had sales + representatives + +On line 2190: + were to sell structured + products," Nestor Dominguez, the co-head + of Citigroup’s CDO + + desk, told the FCIC. "We + spent a lot of effort to + have people in place + +On line 2190: + educate, to pitch + structured products. So, it was + a lot of effort, + +On line 2192: + deals that they could sell. + Underwriting did entail + risks, however. The + + securities firm + had to hold the assets, such + as the BBB-rated tranches + +On line 2192: + CDOs. Typically, + during that period, the + securities firm + + took the risk that the + assets might lose value. "Our + business was to make + +On line 2194: + issue fees, [and to] + make sure that if the market + did have a downturn, + + we were somehow hedged," + Michael Lamont, the former + co-head for CDOs at + +On line 2194: + Bank, told the FCIC.14 Chris + Ricciardi, formerly + head of the CDO desk + +On line 2194: + Merrill Lynch, likewise + told the FCIC that he did not + track the performance + +On line 2194: + underwriting them.15 + Moreover, Lamont said it + was not his job to + +On line 2194: + agencies’ models had + the correct underlying + assumptions. That "was + +On line 2194: + brought to the table," + he said.16 In many cases, though, + underwriters helped + + CDO managers select + collateral, leading to + potential conflicts + +On line 2196: + on that later). The + role of the CDO manager + was to select the + + collateral, such + as mortgage-backed securities, + and in some cases + +On line 2196: + such as Chau’s to units + of large asset management + companies such as + +On line 2198: + Blackrock. CDO managers + received periodic fees + based on the dollar + + amount of assets in + the CDO and in some cases + on performance. On + +On line 2198: + percentage basis, + these may have looked small—sometimes + measured in tenths of + +On line 2198: + percentage point—but + the amounts were far from trivial. + For CDOs that focused + +On line 2198: + tended to be in + the range of to a million + dollars per year for + +On line 2198: + billion dollar deal. + For CDOs that focused on the + more junior tranches, + +On line 2200: + were often smaller, + fees would be to million per + year for a million + + deal.17 As managers did + more deals, they generated + more fees without much + +On line 2200: + "You’d hear statements like, + ‘Everybody and his uncle + now wants to be a + +On line 2200: + a structured finance + analyst at Nomura + Securities and + +On line 2200: + credit officer + at S&P, told the FCIC. "That was + an observation + +On line 2200: + several of the + industry conferences around + those times—the enormous + +On line 2202: + proliferation + of CDO managers— because it + was very lucrative."18 + +On line 2204: + industry-wide earned at + least billion in management + fees between and The + +On line 2204: + basic guidelines on + the collateral and the + structure of the CDOs—that + +On line 2204: + the sizes and returns + of the various tranches—in + close consultation + +On line 2204: + the riple-A rating made + those products appropriate + investments. Rating + +On line 2204: + for CDOs.20 For most deals, + at least two rating agencies + would provide ratings + + and receive those fees—although + the views tended to be in + sync. The CDO investors, + +On line 2206: + investors in mortgage-backed + securities, focused on + different tranches + +On line 2206: + for risk and return. + CDO underwriters such as + Citigroup, Merrill + + Lynch, and UBS often + retained the super-senior triple-A + tranches for reasons + +On line 2206: + also sold them to + commercial paper programs + that invested in + +On line 2208: + CDOs became the most + important class of investor + for the mezzanine + +On line 2208: + of the mezzanine + tranches—including those rated + A—and, especially, + +On line 2208: + BBB, the lowest and + riskiest investment-grade + rating—to other + + CDO managers, to be + packaged into other CDOs.22 + It was common for + +On line 2208: + to be structured with + or of their cash invested + in other CDOs; CDOs + +On line 2208: + as to of their cash + invested in other CDOs + were typically + +On line 2208: + notably AIG, played a + central role by issuing + swaps to investors in + +On line 2210: + reimburse them for + any losses on the tranches + in exchange for a + +On line 2210: + of premium-like + payments. This credit default + swap protection made + +On line 2210: + more attractive to + potential investors because + they appeared to be + + virtually risk + free, but it created huge + exposures for the + + credit default swap + issuers if significant + losses did occur. + +On line 2212: + the creation of CDOs, + as is customary on Wall + Street, was reflected + +On line 2212: + products soared during + the liquidity boom at + the beginning of + + the 21st century, + pretax profit for the five + largest investment banks + +On line 2212: + billion to billion; + total compensation at + these investment banks + +On line 2212: + for their employees + across the world rose from billion + to billion.23 A part + +On line 2212: + could be credited + to mortgage-backed securities, + CDOs, and various + +On line 2212: + mortgage and asset-backed + securities salespeople + should especially + +On line 2214: + for investment banks + reported in To see in + more detail how the + +On line 2214: + security, CMLTI + 2006-NC2. Earlier, we described + how most of the below-triple-A + + bonds issued in this + deal went into CDOs. One such + CDO was Kleros Real + + Estate Funding III, + which was underwritten by + UBS, a Swiss bank.25 The + +On line 2218: + Cohen Company; + that investment company + was headed by Chris + + Ricciardi, who + had earlier built Merrill’s + CDO business.26 Kleros III, + +On line 2218: + in purchased and held + million in securities + from the A-rated M5 + +On line 2220: + of other mortgage-backed + securities. In total, + it owned million of + +On line 2220: + of which were rated + BBB or lower, A, and the + rest higher than A. + +On line 2220: + fund those purchases, + Kleros III issued billion of + bonds to investors. As + +On line 2220: + was typical for + this type of CDO at the time, + roughly of the Kleros + + III bonds were triple-A-rated. At + least half of the below-triple-A tranches + issued by Kleros III + +On line 2224: + into other CDOs.27 + "Mother’s milk to the market" + The growth of CDOs had + +On line 2224: + the mortgage market + itself. CDO managers who were + eager to expand + +On line 2224: + assets that they were + managing—on which their income + was based—were willing + +On line 2224: + tranches of mortgage-backed + securities. This "CDO bid" + pushed up market prices + +On line 2226: + securities were + typically protected + from losses by bond + + insurers, who had + analyzed the deals as well. + Beginning in the + +On line 2228: + securities that + were structured with six or more + tranches and other + + features to protect + the triple-A investors became more + common, replacing + +On line 2228: + on bond insurance + to protect investors. By the + earlier forms of + +On line 2228: + had essentially + vanished, leaving the market + increasingly to + +On line 2230: + was a critical + development, given that + the focus of CDO + +On line 2230: + differed from that of + traditional investors. "The + CDO manager and + +On line 2230: + are not the same kind + of folks [as the monoline bond + insurers], who just + +On line 2234: + folks."28 Indeed, Chau, the + CDO manager, portrayed his + job as creating + +On line 2234: + that rating agencies + would approve and investors would + buy, and making sure + +On line 2234: + industry standards." + He said that he relied on + the rating agencies. + + "Unfortunately, + what lulled a lot of investors, + and I’m in that camp + + as well, what lulled us + into that sense of comfort + was that the rating + + stability was + so solid and that it was + so consistent. I + +On line 2234: + making everything + consistent."29 CDO production + was effectively + +On line 2238: + speak lovingly of + ‘the CDO bid.’ It is mother’s + milk to the market," + +On line 2238: + wrote in "Without it, + fewer asset-backed structures could + be built, and those that + + were would have to meet + a much more conservative + standard of design. + + The resulting pangs + of credit withdrawal would + certainly be felt + +On line 2240: + UBS’s Global CDO Group + agreed, noting that CDOs "have now + become bullies in + +On line 2240: + volume and the price + of mortgage-backed securities, + bids from CDOs had "an + +On line 2240: + economy that goes + well beyond the CDO market."31 + Without the demand + +On line 2240: + securities from + CDOs, lenders would have been able to + sell ewer mortgages, + + and thus they would have + had less reason to push so + hard to make the loans + +On line 2244: + inherent in CDOs" + The mortgage pipeline also + introduced leverage + + at every step. Most + financial institutions + thrive on leverage—that + +On line 2244: + investing borrowed + money. Leverage increases + profits in good times, + +On line 2244: + is of the low down + payment, high loan-to-value + ratio variety. + +On line 2244: + and CDOs created + further leverage because they + were financed with debt. + +On line 2244: + the CDOs were often + purchased as collateral + by those creating + +On line 2244: + of debt. Synthetic + CDOs consisting of credit + default swaps, described + + below, amplified + the leverage. The CDO, backed by + securities that + + were themselves backed by + mortgages, created leverage + on leverage, as Dan + +On line 2244: + mortgage department + head at Goldman Sachs, explained + to the FCIC.32 "People + +On line 2244: + either take leverage + individually, as + an institution, + +On line 2246: + take leverage within + the structure," Citigroup’s Dominguez + told the FCIC.33 Even the + +On line 2246: + bought the CDOs could use + leverage. Structured investment + vehicles—a type + +On line 2246: + triple-Arated securities—were + leveraged an average of + just under 14-to-1: in + +On line 2246: + these SIVs would hold in + assets for every dollar + of capital.34 The + +On line 2246: + would be financed with + debt. Hedge funds, which were common + purchasers, were also + +On line 2246: + highly leveraged in + the repo market, as we + will see. But it would + + become clear during + the crisis that some of the + highest leverage was + +On line 2246: + by companies such + as Merrill, Citigroup, and + AIG when they retained + + or purchased the triple-A + and super-senior tranches of + CDOs with little or + +On line 2248: + backing. Thus, in when + the homeownership rate was + peaking, and when new + +On line 2248: + refinancings, by + investors and speculators, + and by second home + +On line 2248: + trillions of dollars + of securities rested + on just two things: the + +On line 2248: + homeowners to make + the payments on their subprime + and Alt-A mortgages and + + the stability + of the market value of + homes whose mortgages were + + the basis of the + securities. Those dangers + were understood all + +On line 2248: + is inherent in + [asset-backed securities] CDOs," + Mark Klipsch, a banker + +On line 2248: + Raton conference + of securitization + bankers in October + +On line 2250: + While it was good for + short-term profits, losses could + be large later on. + +On line 2254: + "We’ll see some problems + down the road."35 BEAR STEARNS’S HEDGE FUNDS: + "IT FUNCTIONED FINE UP + + UNTIL ONE DAY IT + JUST DIDN’ T FUNCTION" Bear Stearns, + the smallest of the + +On line 2256: + started its asset + management business in when + it established Bear + +On line 2260: + Asset Management + (BSAM). Asset management brought + in steady fee income, + +On line 2262: + customers and required + little capital. BSAM played + a prominent role + + in the CDO business + as both a CDO manager + and a hedge fund that + +On line 2262: + and CDOs. At BSAM, by + the end of Ralph Cioffi was + managing CDOs with + +On line 2264: + billion in assets + and hedge funds with billion in + assets.36 Although Bear + +On line 2264: + supervision over + its business.37 The eventual + failure of Cioffi’s + +On line 2264: + mortgage-focused hedge + funds would be an important + event in early in + +On line 2266: + crisis. In Cioffi + launched his first fund at BSAM, the + High-Grade Structured Credit + +On line 2266: + and in he added the + High-Grade Structured Credit Strategies + Enhanced Leverage Fund. + +On line 2266: + funds purchased mostly + mortgage-backed securities or + CDOs, and used leverage + +On line 2268: + returns. The target + was for of assets to be + rated either AAA + +On line 2268: + AA. As Cioffi told + the FCIC, "The thesis behind + the fund was that the + +On line 2268: + markets offered yield + over and above what their ratings + suggested they should + +On line 2268: + Cioffi targeted + a leverage ratio of to + for the first High-Grade fund. + + For Enhanced Leverage, + Cioffi upped the ante, touting + the Enhanced Leverage + +On line 2268: + of the [High Grade] fund" + that targeted leverage of + to At the end of + +On line 2270: + the High-Grade fund contained + billion in assets (using + billion of his hedge + +On line 2270: + investors’ money and + billion in borrowed money). + The Enhanced Leverage + +On line 2274: + money).40 BSAM financed + these asset purchases by + borrowing in the + +On line 2274: + the FCIC identified + at least billion of repo + borrowing as of + +On line 2274: + funds that responded. + The respondents invested + at least billion in + +On line 2274: + or CDOs as of June + The ability to borrow + using the AAA and + + AA tranches of CDOs + as repo collateral + facilitated + +On line 2276: + securities. But + repo borrowing carried + risks: it created + +On line 2276: + leverage and it had + to be renewed frequently. + For example, an + +On line 2276: + stock on margin—meaning + with borrowed money—might have to + put up cents on the + +On line 2278: + other cents loaned by + his or her stockbroker, for + a leverage ratio + +On line 2278: + to A homeowner + buying a house might make a + down payment and take + +On line 2278: + out a mortgage for + the rest, a leverage ratio + of to By contrast, + +On line 2278: + allowed an investor + to buy a security + for much less out of + + pocket—in the case of + a Treasury security, + an investor may have + +On line 2278: + only borrowing + from a securities firm + to In the case of + +On line 2282: + security, an + investor might pay to With this + amount of leverage, a + +On line 2282: + the value of that + mortgage-backed security can + double the investor’s + +On line 2284: + the underlying + collateral could be sold + easily. But when + +On line 2284: + private-label mortgage-backed + securities would prove to + be very different + + from U.S. Treasuries. he + short-term nature of repo + money also makes + +On line 2288: + inherently risky + and unreliable: funding + that is offered at + +On line 2288: + terms today could be + gone tomorrow. Cioffi’s funds, + for example, took + +On line 2290: + that its repo lenders + would decide not to extend, + or "roll," the repo + +On line 2290: + on any given day. + Yet more and more, repo lenders + were loaning money + + to funds like Cioffi’s, + rolling the debt nightly, and not + worrying very much + +On line 2292: + real quality + of the collateral. The + firms loaning money + + to Cioffi’s hedge funds + were often also selling + them mortgage-related + +On line 2292: + and the hedge funds pledged + those same securities to + secure the loans.43 If + + the market value + of the collateral fell, + the repo lenders could + +On line 2292: + hedge fund to back the + repo loan. This dynamic + would play a pivotal + +On line 2292: + of many hedge funds in + 2007—most spectacularly in + the case of Cioffi’s + +On line 2292: + "The repo market, + I mean it functioned fine up + until one day it + + just didn’t function," + Cioffi told the FCIC. Up to + that point, his hedge funds + + could buy billions of + dollars of CDOs on borrowed + money because of + +On line 2292: + the market’s bullishness + about mortgage assets, he said. + "It became a more + +On line 2292: + more repo lenders, more + investors obviously. [It + had a] much broader + +On line 2296: + CDOs were a market + opportunity because + they were complex and + +On line 2296: + in the general + marketplace. In this was a + promising market with + +On line 2298: + risks. Cioffi and his + team not only bought CDOs, they + also created + +On line 2298: + managed other CDOs. + Cioffi would purchase mortgage-backed + securities, CDOs, + +On line 2298: + securities for + his hedge funds. When he had reached + his firm’s internal + +On line 2298: + he would repackage those + securities and sell CDO + securities to + + other customers. With + the proceeds, Cioffi would pay + off his repo lenders, + +On line 2300: + at the same time he + would acquire the equity + tranche of a new CDO.45 + +On line 2302: + created CDOs that + selected collateral + from his own hedge funds,46 + +On line 2302: + positioned on both + sides of the transaction. The + structure created + +On line 2302: + interest between + Cioffi’s obligation to his + hedge fund investors and + + his obligation to + his CDO investors; this was not + unique on Wall Street, and + +On line 2302: + the structure, and the + conflict of interest, to + potential investors.47 + + For example, a + critical question was at + what price the CDO should + + purchase assets from + the hedge fund: if the CDO paid + above-market prices for + +On line 2304: + the hedge fund investors + and disadvantage the CDO + investors. BSAM’s flagship + +On line 2304: + and III—were created + in rapid succession over and + with Citigroup as + +On line 2304: + composed of mortgage- + and asset-backed securities + that BSAM already owned, + + and BSAM retained the + equity position in + all three; all three were + +On line 2304: + asset-backed commercial + paper.48 Typical for the + industry at the + +On line 2304: + managing assets + and holding the equity + tranche, was between and + +On line 2304: + the underlying + collateral.49 Thanks to the + combination of + +On line 2304: + securities, CDOs, + and leverage, Cioffi’s funds earned + healthy returns for a + +On line 2304: + time: the High-Grade fund had + returns of in in and in + after fees.50 Cioffi + +On line 2304: + millions before the + hedge funds collapsed in Cioffi + was rewarded with + +On line 2304: + compensation worth + more than million from to In + the year the two hedge + +On line 2304: + made more than million + in total compensation. + Matt Tannin, his lead + +On line 2304: + compensation of + more than million from to Both + managers invested + +On line 2304: + of their own money + in the funds, and used this as + a selling point when + + pitching the funds to + others.52 But when house prices fell + and investors started + +On line 2306: + question the value + of mortgage-backed securities + in the same short-term + +On line 2306: + amplify losses + and quickly put his two hedge + funds out of business. + +On line 2312: + LIQUIDITY PUTS: + "A POTENTIAL CONFLICT OF + INTEREST" By the + + middle of the decade, + Citigroup was a market + leader in selling + +On line 2312: + types of trouble with + its regulators, and then-CEO + Charles Prince told the FCIC + +On line 2312: + those troubles took up + more than half his time.53 After + paying the million + +On line 2312: + to subprime mortgage + lending, Citigroup again got + into trouble, charged + +On line 2312: + company filed for + bankruptcy in 2001—use structured + finance transactions + +On line 2312: + to manipulate + its financial statements. In + July Citigroup + +On line 2314: + allegations and + also agreed, under formal + enforcement actions + + by the Federal + Reserve and Office of the + Comptroller of the + +On line 2316: + to overhaul its risk + management practices.54 By March + the Fed had seen enough: + +On line 2316: + legal compliance. + According to Prince, he had + already decided + +On line 2318: + growth."55 Robert Rubin, a + former treasury secretary + and former Goldman + +On line 2318: + time chairman of the + Executive Committee + of Citigroup’s board + +On line 2318: + recommended that + Citigroup increase its risk + taking—assuming, he told + +On line 2320: + was a natural + area for growth after the Fed + and then Congress had + +On line 2320: + commercial banks. One + opportunity among many + was the CDO business, + +On line 2322: + was just then taking + off amid the booming mortgage + market. In Citi’s CDO + +On line 2322: + was a tiny unit in + the company’s investment + banking arm, "eight guys + +On line 2322: + a Bloomberg" terminal, + in the words of Nestor Dominguez, then + co-head of the desk.57 + + Nevertheless, this + tiny operation under + the command of homas + + Maheras, co-CEO of the + investment bank, had become + a leader in the + +On line 2324: + for CDOs, creating + more than billion in and 2004—close + to one-fifth of the + + market in those years. + The eight guys had picked up on + a novel structure + +On line 2326: + by Goldman Sachs and + WestLB, a German bank. Instead + of issuing the + +On line 2326: + of the CDOs as long-term + debt, Citigroup structured them + as short-term asset-backed + + commercial paper.58 + Of course, using commercial + paper introduced + +On line 2326: + risk (not present when the + tranches were sold as long-term debt), + because the CDO would + +On line 2326: + days or weeks—for the + life of the CDO. But asset-backed + commercial paper + + was a cheap form of + funding at the time, and it + had a large base of + +On line 2326: + funds. To mitigate + the liquidity risk and + to ensure that the + +On line 2326: + their top ratings, Citibank + (Citigroup’s national bank + subsidiary) provided + +On line 2326: + puts. In selling the + liquidity put, for an + ongoing fee the + + bank would be on the + hook to step in and buy the + commercial paper + +On line 2326: + there were no buyers + when it matured or if the + cost of funding rose + +On line 2328: + predetermined amount.59 + The CDO team at Citigroup + had jumped into the + +On line 2328: + in July with a + billion CDO named Grenadier Funding + that included a + +On line 2328: + billion tranche backed by + a liquidity put from + Citibank.60 Over the next three + +On line 2328: + liquidity puts + on billion of commercial + paper issued by + +On line 2328: + more than any other + company. BSAM’s three Klio CDOs, + which Citigroup had + +On line 2328: + accounted for just + over billion of this total,62 + a large number that + + would not bode well for + the bank. But initially, this + "strategic initiative," + +On line 2330: + Dominguez called it, was very + profitable for Citigroup. The + CDO desk earned roughly + +On line 2330: + in structuring fees + for Citigroup’s investment + banking arm, or about + +On line 2330: + for a billion deal. + In addition, Citigroup + would generally + +On line 2330: + annually for + the liquidity puts.63 In + other words, for a + +On line 2330: + Citibank would receive to + million annually on + the liquidity + +On line 2330: + alone—practically free + money, it seemed, because the + trading desk believed + +On line 2332: + these puts would never + be triggered.64 In effect, the + liquidity put + +On line 2332: + another highly + leveraged bet: a contingent + liability + +On line 2332: + that would be triggered + in some circumstances. Prior + to the change in the + +On line 2332: + (discussed earlier), + Citigroup did not have to + hold any capital + +On line 2332: + contingencies. Rather, + it was permitted to use + its own risk models + + to determine the + appropriate capital + charge. But Citigroup’s + +On line 2332: + only a remote + possibility that the + puts would be triggered. + +On line 2332: + Following the rule + change, Citibank was required to hold + in capital against + +On line 2332: + amount of commercial + paper supported by the + liquidity put, + +On line 2332: + fee for the put, the + annual return on that + capital could still + +On line 2332: + Dominguez told the FCIC, the + triple-A or similar ratings, + the multiple fees, + +On line 2332: + requirements made the + liquidity puts "a much + better trade" for Citi’s + +On line 2334: + sheet.65 The events of would + reveal the fallacy of + those assumptions and + +On line 2334: + commercial paper + straight onto the bank’s balance + sheet, requiring it + +On line 2334: + with billion in cash + as well as more capital + to satisfy bank + +On line 2336: + liquidity puts + were approved by Citigroup’s + Capital Markets + + Approval Committee, + which was charged with reviewing + all new financial + +On line 2336: + Deeming them to be + low risk, the company based + its opinions on the + +On line 2336: + failed to consider + the liquidity risk posed + by a general + + market disruption.67 + The OCC, the supervisor + of Citigroup’s largest + +On line 2338: + bank sub - sidiary, was + aware that the bank had issued + the liquidity + +On line 2338: + terms of the OCC’s post-Enron + enforcement action focused + only on whether Citibank + + had a process in place + to review the product, and + not on the risks of + +On line 2340: + few large financial + institutions, such as AIG + Financial Products, + + BNP, WestLB of Germany, + and Société Générale of France, + wrote significant + +On line 2340: + of liquidity + puts on commercial paper + issued by CDOs.70 Bank + + of America, the + biggest commercial bank in + the United States, wrote + +On line 2342: + small deals through but did + billion worth in just before + the market crashed.71 When + +On line 2342: + participants were + not writing liquidity + puts, Dominguez stated that + + Société Générale and + BNP were big players in that + market. "You needed + + to be a bank with + a strong balance sheet, access + to collateral, + +On line 2346: + relationships with + collateral managers," he + said.72 The CDO desk stopped + +On line 2346: + liquidity puts + in early when it reached its + internal limits. + +On line 2346: + Citibank’s treasury function + had set a billion cap on + liquidity puts;74 + +On line 2346: + bringing the total + to billion.75 Risk management + had also set a + +On line 2346: + which included the + liquidity puts. Later, + in an October + +On line 2346: + Group criticized the + firm’s pricing of the puts, which + failed to consider + + the risk that investors + would not buy the commercial + paper protected + +On line 2346: + it came due, thereby + creating a billion cash + demand on Citibank.76 An + +On line 2346: + (believed to have been + drafted in also questioned + one of the practices + +On line 2346: + investment bank, which + paid traders on its CDO desk for + generating the + +On line 2348: + without regard to + later losses: "There is a + potential conflict + + of interest in + pricing the liquidity + put cheep [sic] so that + +On line 2348: + and more structuring + fee to be generated."77 + The result would be + +On line 2348: + severe that they would + help bring the huge financial + conglomerate to + + the brink of failure, + as we will see. AIG: "GOLDEN + GOOSE FOR THE ENTIRE + +On line 2352: + STREET" In American + International Group was + the largest insurance + +On line 2352: + as measured by stock + market value: a massive + conglomerate with + +On line 2354: + billion in assets, + employees in countries, and3 + subsidiaries. But to Wall + +On line 2354: + most valuable asset + was its credit rating: that + it was awarded the + +On line 2354: + possible rating—Aaa by + Moody’s since AAA by S&P since 983—was + crucial, because these + +On line 2354: + cheaply and deploy + the money in lucrative + investments. Only + +On line 2356: + in early carried + those ratings.78 Starting in AIG + Financial Products, + + a Connecticut-based unit + with major operations + in London, figured + + out a new way to + make money from those ratings. + Relying on the + + guarantee of its + parent, AIG, AIG Financial + Products became a + +On line 2356: + in notional amount. + Among other derivatives + activities, the + + unit issued credit + default swaps guaranteeing + debt obligations held + +On line 2356: + agreed to reimburse + the investor in such a debt + obligation in the + + event of any default. + The credit default swap (CDS) + is often compared + +On line 2356: + insurance, but when + an insurance company + sells a policy, + +On line 2356: + set aside a reserve + in case of a loss. Because + credit default swaps + +On line 2356: + such requirement was + applicable. In this case, + the unit predicted + +On line 2356: + with confidence that + there would be no realized + economic loss on + +On line 2356: + CDOs on which they wrote + CDS protection, and failed to + make any provisions + +On line 2358: + losses—a decision + that would prove fatal to AIG + in AIG Financial + +On line 2358: + huge business selling + CDS to European banks on + a variety of + +On line 2358: + assets, including + bonds, mortgage-backed securities, + CDOs, and other debt + +On line 2358: + For AIG, the fee for + selling protection via the + swap appeared well worth + + the risk. For the banks + purchasing protection, the + swap enabled them to + +On line 2358: + and thereby hold less + capital against its assets. + Purchasing credit + +On line 2358: + AIG could reduce the + amount of regulatory + capital that the + +On line 2360: + needed to hold against + an asset from to By AIG + had written billion + +On line 2360: + regulatory + capital benefits; most + were with European + +On line 2360: + for a variety + of asset types. That total + would rise to billion + +On line 2362: + The same advantages + could be enjoyed by banks in + the United States, where + +On line 2362: + capital standards + for banks’ holdings of mortgage-backed + securities and + +On line 2362: + investments under + the Recourse Rule in So a + credit default swap + +On line 2364: + could also lower + American banks’ capital + requirements. In and + +On line 2366: + AIG sold protection + on super-senior CDO tranches + valued at billion, + +On line 2368: + billion in In an + interview with the FCIC, one + AIG executive + +On line 2370: + Financial Products’ + principal swap salesman, Alan + Frost, as "the golden + +On line 2372: + for the entire Street."83 + AIG’s biggest customer in this + business was always + +On line 2372: + billions of dollars + of protection for Merrill + Lynch, Société Générale, + +On line 2372: + other firms. AIG "looked + like the perfect customer for + this," Craig Broderick, + +On line 2372: + chief risk officer, + told the FCIC. "They really + ticked all the boxes. + +On line 2372: + among the highest-rated + [corporations] around. They had + what appeared to be + +On line 2376: + this space, backed by a + long history of trading + in it."84 AIG also + +On line 2376: + imprimatur of its + pristine credit rating on + commercial paper + +On line 2376: + liquidity puts, + similar to the ones that + Citigroup’s bank wrote + +On line 2376: + many of its own deals, + guaranteeing it would buy + commercial paper + +On line 2376: + one else wanted it. + It entered this business in + by it had written + +On line 2378: + of liquidity + puts on commercial paper + issued by CDOs. AIG + +On line 2378: + also wrote more than + billion in CDS to protect + Société Générale against + +On line 2378: + on liquidity + puts that the French bank itself + wrote on commercial + +On line 2378: + issued by CDOs.85 "What + we would always try to do + is to structure a + +On line 2378: + where the transaction + was virtually riskless, + and get paid a small + +On line 2378: + director at AIG + Financial Products, told the + FCIC. "And we’re one of + + the few guys who can + do that. Because if you think + about it, no one wants + + to buy disaster + protection from someone who + is not going to + +On line 2380: + be around. That was AIGFP’s + sales pitch to the Street or to + banks."86 AIG’s business of + + offering credit + protection on assets of + many sorts, including + +On line 2380: + grew from billion in + to billion in and billion + in This business was + +On line 2380: + small part of the AIG + Financial Services business + unit, which included + +On line 2382: + billion in or of + AIG’s total. AIG did not post + any collateral + +On line 2382: + but unlike monoline + insurers, AIG Financial + Products agreed to post + +On line 2382: + the underlying + securities dropped, or if + the rating agencies + +On line 2382: + guarantors—insurance + companies such as MBIA and + Ambac that focused + +On line 2384: + paying out until + actual losses occurred. + The collateral + + posting terms in AIG’s + credit default swap contracts + would have an enormous + +On line 2386: + on the crisis about + to unfold. But during the + boom, these terms didn’t + +On line 2386: + The investors got their + triple-Arated protection, AIG got its + fees for providing + +On line 2386: + that insurance—about + of the notional amount of + the swap per year88—and the + +On line 2386: + In the case of the + London subsidiary that ran the + operation, the + +On line 2386: + bonus pool was of new + earnings.89 Financial Products + CEO Joseph J. Cassano + +On line 2386: + at the end of the + year.90 Between and the least amount + Cassano paid himself + +On line 2386: + the later years, his + compensation was sometimes + double that of the + +On line 2388: + By November the + company had reduced its + reported earnings + +On line 2388: + the five-year period + by billion.92 The board forced out + Maurice "Hank" Greenberg, + +On line 2388: + been CEO for years. New + York Attorney General + Eliot Spitzer prepared to + + bring fraud charges against him. + Greenberg told the FCIC, "When the + AAA credit rating + +On line 2392: + in spring it would have + been logical for AIG to + have exited or + + reduced its business + of writing credit default + swaps."93 But that didn’t + +On line 2392: + Financial Products + wrote another billion in + credit default swaps + +On line 2394: + tranches of DOs in + The company wouldn’t make + the decision to + +On line 2400: + THE EFFECTS OF THE + COLLAPSE IN SUBPRIME" Henry + Paulson, the CEO of + +On line 2400: + until he became + secretary of the Treasury + in testified to + + the FCIC that by the + time he became secretary + many bad loans already + + had been issued—"most + of the toothpaste was out of + the tube"— and that "there + +On line 2402: + Paulson provided + examples: "Subprime mortgages + went from accounting + +On line 2402: + originators from + the risk of the products they + originated." The + +On line 2402: + housing bubble that + eventually burst in far + more spectacular + +On line 2404: + bubbles."97 Under Paulson’s + leadership, Goldman Sachs had + played a central role + +On line 2404: + creation and sale of + mortgage securities. From + through the company + +On line 2404: + billions of dollars + in loans to mortgage lenders; most + went to the subprime + +On line 2404: + Long Beach, Fremont, New + Century, and Countrywide + through warehouse lines of + + credit, often in + the form of repos.98 During + the same period, + +On line 2404: + billion of loans from + these and other subprime loan + originators, which + +On line 2406: + totaling billion + (about a quarter were subprime), + and CDOs totaling + +On line 2406: + issued synthetic + or hybrid CDOs with a face + value of billion + +On line 2408: + Synthetic CDOs were + complex paper transactions + involving credit + +On line 2410: + cash CDO, synthetic + CDOs contained no actual + tranches of mortgage-backed + + securities, or + even tranches of other CDOs. + Instead, they simply + +On line 2410: + and thus were bets on + whether borrowers would pay their + mortgages. In the place + +On line 2410: + default swaps and did + not finance a single home + purchase. Investors in + +On line 2410: + included "funded" + long investors, who paid cash to + purchase actual + +On line 2410: + issued by the CDO; + "unfunded" long investors, who + entered into swaps + +On line 2410: + if the reference + securities performed; and + "short" investors, who bought + +On line 2410: + default swaps on the + reference securities, + making money if + +On line 2410: + securities failed. + While funded investors received + interest if the + +On line 2412: + if the reference + securities defaulted. + Unfunded investors, + +On line 2412: + waterfall, received + premium-like payments from + the CDO as long as + +On line 2412: + beyond a certain + point and if the CDO did not + have sufficient funds + +On line 2412: + the short investors. Short + investors, often hedge funds, bought + the credit default + +On line 2412: + the CDOs and paid those + premiums. Hybrid CDOs were + a combination + +On line 2414: + CDOs. Firms like Goldman + found synthetic CDOs cheaper + and easier to + +On line 2414: + than traditional + CDOs at the same time as the + supply of mortgages + + was beginning to + dry up. Because there were no + mortgage assets to + + collect and finance, + creating synthetic CDOs + took a fraction of + +On line 2418: + time. They also were + easier to customize, + because CDO managers + + and underwriters + could reference any mortgage-backed + security—they were + +On line 2418: + limited to the + universe of securities + available for them to + +On line 2420: + Figure provides an + example of how such a + deal worked. In Goldman + +On line 2420: + launched its first major + synthetic CDO, Abacus 2004-1—a + deal worth billion. About + +On line 2420: + the rest, commercial + mortgage–backed securities + (made up of bundled + +On line 2422: + real estate loans) + and other securities. + Goldman was the short + +On line 2422: + entire billion deal: + it purchased credit default + swap protection on + +On line 2422: + securities from + the CDO. The funded investors—IKB (a + German bank), the TCW + +On line 2424: + Wachovia—put up + a total of million to + purchase mezzanine + +On line 2426: + assets performed. If + the referenced assets did + not perform, Goldman, + +On line 2426: + as the short investor, + would receive the million.102 In + this sense, IKB, TCW, and + +On line 2426: + "long" investors, betting + that the referenced assets + would perform well, and + + Goldman was a "short" + investor, betting that they would + fail. The unfunded + + investors—TCW and GSC Partners + (asset management firms that + managed both hedge funds + +On line 2430: + up any money up + front; they received annual + premiums from the + +On line 2430: + pay the CDO if the + reference securities + failed and the CDO did + +On line 2432: + have enough funds to pay + the short investors.103 Goldman was + the largest unfunded + +On line 2432: + Goldman’s billion short + position more than offset + that exposure; about + +On line 2432: + long position by + buying credit protection + from AIG, in return + +On line 2432: + for an annual + payment of million.104 As a + result, by AIG was + +On line 2432: + unfunded investor + in the super-senior tranches + of the Abacus deal. + +On line 2434: + told, long investors in + Abacus 2004-1 stood to receive + millions of dollars + + if the reference + securities performed (just + as a bond investor + + makes money when a + bond performs). On the other + hand, Goldman stood to + +On line 2436: + gain nearly billion + if the assets failed. In the + end, Goldman, the short + +On line 2436: + in the Abacus 2004-1 + CDO, has received about million + while the long investors + +On line 2438: + lost just about all of + their investments. In April GSC + paid Goldman million + + as a result of + CDS protection sold by GSC + to Goldman on the + +On line 2440: + received million from + AIG Financial Products as + a result of the + +On line 2440: + protection it had + purchased against the super-senior + tranche. The same month it + +On line 2440: + received million from + TCW as a result of the + CDS purchased against the + +On line 2440: + junior mezzanine + tranches, and million from IKB + because of the CDS + +On line 2440: + purchased against the C + tranche. In April IKB paid Goldman + another million + +On line 2442: + as a result of + the CDS against the B tranche. Through + May Goldman received + +On line 2442: + from IKB, Wachovia, and + TCW as a result of the + credit default swaps + +On line 2442: + the A tranche. As was + common, some of the tranches + of Abacus 2004-1 found + +On line 2442: + way into other + funds and CDOs; for example, + TCW put tranches of + +On line 2444: + of its own CDOs. In + total, between July and + May Goldman packaged + +On line 2444: + and sold synthetic + CDOs, with an aggregate face + value of billion.105 + +On line 2444: + underwriting fee + was to of the deal totals, + Dan Sparks, the former + +On line 2444: + Goldman’s mortgage desk, + told the FCIC.106 Goldman would earn + profits from shorting + + many of these deals; on + others, it would profit by + facilitating + +On line 2444: + transaction between + the buyer and the seller + of credit default + +On line 2446: + protection. As we + will see, these new instruments + would yield substantial + + profits for investors + that held a short position + in the synthetic + +On line 2446: + is, investors betting + that the housing boom was a + bubble about to burst. + +On line 2446: + losses when housing + prices collapsed. When borrowers + defaulted on their + +On line 2446: + expecting cash from + the mortgage payments lost. And + investors betting on + +On line 2446: + securities via + synthetic CDOs also lost + (while those betting against + +On line 2446: + mortgages would gain).107 As + a result, the losses from + the housing collapse + +On line 2448: + Citigroup mortgage-backed + securities deal, CMLTI 2006-NC2. + Credit default swaps + +On line 2448: + it possible for + new market participants + to bet for or against + +On line 2448: + significantly + increased the demand for such + bets. For example, + +On line 2448: + about million worth of + bonds in the M9 (BBB-rated) tranche—one + of the mezzanine + +On line 2448: + Auriga, Volans, and + Neptune CDO IV all contained + credit default swaps + + in which the M9 tranche + was referenced. As long as + the M9 bonds performed, + + investors betting that + the tranche would fail (short investors) + would make regular + +On line 2448: + into the CDO, which + would be paid out to other + investors banking on + +On line 2448: + succeed (long investors). + If the M9 bonds defaulted, + then the long investors + + would make large payments + to the short investors. That is + the bet—and there were + +On line 2450: + more than million in + such bets in early on the + M9 tranche of this deal. + +On line 2450: + the basis of the + performance of million in + bonds, more than million + + could potentially + change hands. Goldman’s Sparks put it + succinctly to the + +On line 2450: + if there’s a problem + with a product, syn thetics + increase the impact.108 + +On line 2452: + amplification + of the M9 tranche was not unique. + A million tranche of + +On line 2452: + Glacier Funding CDO 2006-4A, + rated A, was referenced + in million worth of + +On line 2452: + synthetic CDOs. A + million tranche of the Soundview + Home Equity Loan + +On line 2454: + also rated A, + was referenced in million + worth of synthetic + +On line 2456: + A million tranche of + the Soundview Home Equity + Loan Trust 2006-EQ1, rated + +On line 2458: + worth of synthetic + CDOs.109 In total, synthetic + CDOs created by + +On line 2458: + Goldman referenced + mortgage securities, some + of them multiple + +On line 2458: + were referenced twice. + Indeed, one single mortgage-backed + security was + +On line 2460: + DOs created by + Goldman Sachs.110 Because of such + deals, when the housing + +On line 2462: + they also maintained + that their creation had "social + utility" because + +On line 2462: + enabled investors to + customize the exposures + they wanted in their + +On line 2462: + President and Chief + Operating Officer + Gary Cohn argued: "This + + is no different + than the tens of thousands of + swaps written every + +On line 2462: + U.S. dollar versus + another currency. Or, + more importantly, + +On line 2464: + U.S. Treasuries This is + the way that the financial + markets work."112 Others, + +On line 2464: + these deals. Patrick Parkinson, + the current director of + the Division of + +On line 2464: + Federal Reserve + Board, noted that synthetic + CDOs "multiplied the + +On line 2466: + of the collapse in + subprime."113 Other observers were + even harsher in their + + assessment. "I don’t + think they have social value," + Michael Greenberger, a + +On line 2466: + the University + of Maryland School of Law and + former director + + of the Division + of Trading and Markets at + the Commodity + +On line 2466: + Commission, told the + FCIC. He characterized the + credit default swap + +On line 2466: + a "casino." And he + testified that "the concept + of lawful betting + +On line 2466: + the question of whether + a homeowner would default + on a mortgage that + +On line 2466: + by either party, + has had a profound effect + on the American + +On line 2470: + taxpayers."114 MOODY’S: "ACHIEVED + THROUGH SOME ALCHEMY" The machine + churning out CDOs would + + not have worked without + the stamp of approval given + to these deals by the + +On line 2470: + often relied on + the rating agencies’ views rather + than conduct their own + + credit analysis. + Moody’s was paid according to + the size of each deal, + +On line 2470: + set at a half-million + dollars for a "standard" CDO + in and and as much + +On line 2474: + for a "complex" CDO.115 + In rating both synthetic + and cash CDOs, Moody’s faced + +On line 2474: + by the CDO (or its + synthetic equivalent) and, + second, gauging the + +On line 2474: + is, the likelihood + that the securities would + default at the same + + time.116 Imagine flipping + a coin to see how many times + it comes up heads. Each + +On line 2474: + others; that is, the + flips are uncorrelated. + Now, imagine a loaf + +On line 2474: + sliced bread. When there is + one moldy slice, there are likely + other moldy slices. The + +On line 2474: + each slice is highly + correlated with that of + the other slices. As + +On line 2474: + now understand, the + mortgage-backed securities in + CDOs were less like coins + +On line 2476: + bread. To estimate + the probability of + default, Moody’s relied + +On line 2476: + its own ratings of + the mortgage-backed securities + purchased by the CDOs.117 + +On line 2476: + did the agencies "look + through" the securities to + the underlying + +On line 2478: + been assigned by the + [mortgage-backed securities] group," + Gary Witt, formerly + +On line 2478: + for the CDO unit, told + the FCIC. This approach would lead + to problems for Moody’s—and + +On line 2478: + disintegrated + below us and we didn’t + react and we should + +On line 2478: + have. We had to be + looking for a problem. And + we weren’t looking."118 + + To determine the + likelihood that any given + security in + + the CDO would default, + Moody’s plugged in assumptions based + on those original + + ratings. This was no + simple task. Meanwhile, if the + initial ratings turned + +On line 2480: + poor underwriting, + fraud, or any other cause—to + poorly reflect the + +On line 2480: + blindly compounded + when mortgage-backed securities + were packaged into + +On line 2482: + securities in + the portfolio—always tricky, but + particularly + +On line 2482: + of CDOs consisting + of subprime and Alt-A mortgage-backed + securities that + +On line 2482: + history. So the + firm explicitly relied + on the judgment of + + its analysts. "In + the absence of meaningful + default data, it + +On line 2482: + based on actual + observations of defaults," + Moody’s acknowledged in + +On line 2484: + explanation of + its process.119 In plainer English, + Witt said, Moody’s didn’t + +On line 2484: + them up." He recalled, + "They went to the analyst + in each of the groups + +On line 2484: + they said, ‘Well, you know, + how related do you think + these types of [mortgage-backed + + securities] are1’"120 + This problem would become more + serious with the + +On line 2486: + CDOs in the middle + of the decade. Witt felt strongly + that Moody’s needed to + +On line 2488: + CDOs.121 He undertook + two initiatives to address + this issue. First, in + +On line 2488: + incorporated + correlation into the + model. However, + +On line 2488: + not applied to CDO + ratings for another year.122 + Second, he proposed + +On line 2490: + research initiative + in early to "look through" a + few CDO deals at the + +On line 2490: + securities and + to see if "the assumptions + that we’re making for + +On line 2490: + consistent with the + correlation assumptions + that we’re making for + +On line 2490: + received approval from + his superiors for this + investigation, + +On line 2492: + buying the software + he needed to conduct the + look-through analysis.123 In + +On line 2492: + based the new model + on trends from the previous + years, a period + +On line 2492: + prices were rising and + mortgage delinquencies were very + low—and a period + +On line 2492: + nontraditional + mortgage products had been a + very small niche. Then, Moody’s + +On line 2492: + adjustments based on + factors such as region, year + of origination, + +On line 2492: + For example, if + two mortgage-backed securities + were issued in the + +On line 2494: + region—say, Southern + California— Moody’s boosted + the correlation; + +On line 2494: + they shared a common + mortgage servicer, Moody’s boosted + it further. But at + +On line 2494: + the estimated + correlation of default, + which would improve the + +On line 2494: + estimated that + two mortgage-backed securities + would be less closely + +On line 2496: + card or auto loans.124 + The other major rating + agencies followed a + +On line 2496: + be dangerous. "The + complexity of structured + finance transactions + +On line 2496: + to situations + where investors tend to rely + more heavily on + +On line 2496: + than for other types + of rated securities. + On this basis, the + +On line 2496: + number of questions + with important potential + implications. One + +On line 2496: + question is whether tranched + instruments might result in + unanticipated + +On line 2498: + sponsored by the world’s + regulators and central + banks, warned in June CDO + +On line 2498: + and underwriters + relied on the ratings to + promote the bonds. For + +On line 2498: + CDO, they created + marketing material, + including a pitch + + book that investors used + to decide whether to subscribe + to a new CDO. Each + +On line 2498: + described the types of + assets that would make up the + portfolio without + + providing details.127 + Without exception, every + pitch book examined + +On line 2500: + the historical + "stability" of these new + products’ ratings with + +On line 2500: + of corporate bonds. + Statistics that made this case + included the fact + +On line 2500: + of these new products + did not experience any + rating changes over a + +On line 2500: + of corporate bonds + maintained their ratings. Over a + longer time period, + +On line 2500: + however, structured + finance ratings were not so + stable. Between and + +On line 2500: + triple-A-rated structured finance + securities retained their + original rating + +On line 2502: + sell CDOs using these + statistics in their pitch books + during and after + + mortgage defaults had + started to rise but before + the rating agencies + +On line 2502: + numbers of mortgage-backed + securities. Of course, each + pitch book did include + +On line 2502: + that "past performance + is not a guarantee of + future performance" + +On line 2504: + testified before + the House Financial Services + Committee, CDOs that + +On line 2504: + lower-rated tranches + of mortgage-backed securities + "are arcane structured + + finance products that + were designed specifically + to make dangerous, + +On line 2504: + through some alchemy and + some negligence in adapting + unrealistic + +On line 2506: + on behalf of the + ratings agencies. They convinced + investors that of a + +On line 2506: + subprime tranches were + the ratings equivalent of + U.S. Government bonds."129 + +On line 2508: + to fall nationwide + and defaults increased, it turned + out that the mortgage-backed + +On line 2508: + were in fact much more + highly correlated than + the rating agencies + + had estimated—that + is, they stopped performing at + roughly the same time. + +On line 2510: + of the CDOs. In of + U.S. CDO securities would + be downgraded. In + +On line 2514: + In late Moody’s would throw + out its key CDO assumptions + and replace them with + +On line 2516: + to three times higher + than used before the crisis.131 + In retrospect, it + +On line 2518: + that the agencies’ CDO + models made two key mistakes. + First, they assumed that + +On line 2518: + these securities + weren’t that different to + begin with. "There were + +On line 2520: + [the credit rating + agencies] did wrong," Federal + Reserve Chairman Ben + + Bernanke told the FCIC. "They + did not take into account + the appropriate + +On line 2522: + the categories of + mortgages."132 Second, the agencies + based their CDO ratings + +On line 2522: + the underlying + collateral. "The danger + with CDOs is when they + + are based on structured + finance ratings," Ann Rutledge, + a structured finance + + expert, told the FCIC. + "Ratings are not predictive + of future defaults; + +On line 2522: + only describe a + ratings management process, and + a mean and static + + expectation of + security loss."133 Of course, + rating CDOs was a + +On line 2524: + the rating agencies. + Including all types of CDOs—not + just those that were mortgage-related—Moody’s + +On line 2526: + deals in in in and + in the value of those deals + rose from billion in + +On line 2526: + in and billion in + The reported revenues of + Moody’s Investors Service + +On line 2528: + products—which included + mortgage-backed securities and + CDOs—grew from million in + +On line 2530: + corporate revenue. + The rating of asset-backed CDOs + alone contributed more + +On line 2530: + of the revenue from + structured finance.135 The boom years + of structured finance + +On line 2530: + company-wide surge in + revenue and profits. From to + the corporation’s + +On line 2534: + to billion and its + profit margin climbed from to + Yet the increase in + +On line 2534: + CDO group’s workload and + revenue was not paralleled + by a staffing increase. + +On line 2534: + were always playing + catch-up," Witt said.136 Moody’s "penny-pinching" + and "stingy" management + +On line 2534: + was insoluble. + Investment banks often hired + away our best people. + + As far as I can + remember, we were never + allocated funds + + to make counter offers," + Witt said. "We had almost no + ability to do + +On line 2534: + Kolchinsky, a former + team managing director + at Moody’s, told the FCIC + +On line 2534: + in the number of + deals rated was "huge but our + personnel did not + +On line 2534: + up accordingly." + By Kolchinsky recalled, "My role + as a team leader + +On line 2534: + crisis management. + Each deal was a crisis."138 When + personnel worked to + +On line 2534: + new methodology, + Witt said, "We had to kind of + do it in our spare + +On line 2536: + agencies worked closely + with CDO underwriters and + managers as each new + +On line 2536: + was devised. And the + rating agencies now relied + for a substantial + +On line 2536: + number of players. + Citigroup and Merrill alone + accounted for more + +On line 2538: + The ratings agencies’ + correlation assumptions + had a direct and + +On line 2538: + ow CDOs were structured: + assumptions of a lower + correlation made + +On line 2538: + easy-to-sell triple-A tranches + and smaller harder-to-sell BBB + tranches. Thus, as is + +On line 2538: + because issuers could + choose which rating agencies to + do business with, and + +On line 2538: + on the issuers for + their revenues, rating agencies + felt pressured to give + +On line 2540: + that they might remain + competitive. The pressure + on rating agency + +On line 2540: + was also intense + as a result of the high + turnover—a revolving door + + that often left raters + dealing with their old colleagues, + this time as clients. In + +On line 2540: + Yoshizawa, a Moody’s team + managing director for + U.S. derivatives + +On line 2540: + in was presented + with an organization + chart from July She + +On line 2542: + identified out of + analysts—about of the staff— who + had left Moody’s to work + +On line 2544: + or commercial banks.141 + Brian Clarkson, who oversaw + the structured finance + +On line 2544: + always a challenge, + for the simple reason that + the banks paid more. As + +On line 2544: + Moody’s employees were + prohibited from rating + deals by a bank or + +On line 2544: + institution, but + the responsibility + for notifying + + management of the + interview rested on the + employee. After + +On line 2544: + former employees + were barred from interacting + with Moody’s on the same + +On line 2544: + they had rated while + in its employ, but there were + no bans against working + + on other deals with + Moody’s.142 SEC: "IT’S GOING TO BE + AN AWFULLY BIG + +On line 2548: + The five major U.S. + investment banks expanded + their involvement in + +On line 2548: + mortgage and mortgage + securities industries + in the early 21st + +On line 2548: + formal government + regulation beyond their + broker-dealer subsidiaries. + +On line 2548: + In the European + Union told U.S. financial firms + that to continue + +On line 2548: + in Europe, they would + need a "consolidated" + supervisor by + +On line 2548: + company. The U.S. + commercial banks already met + that criterion— + +On line 2550: + supervisor was + the Federal Reserve—and + the Office of Thrift + +On line 2550: + oversight of AIG would + later also satisfy + the Europeans. The + + five investment banks, + however, did not meet the + standard: the SEC was + + supervising their + securities arms, but no + one supervisor + +On line 2550: + of these companies + on a consolidated + basis. Thus all five + + faced an important + decision: what agency would + they prefer as their + +On line 2552: + combined assets at + the five firms totaled trillion, + more than half of the + +On line 2552: + trillion of assets + held by the five largest U.S. bank + holding companies. + +On line 2552: + In the next three years + the investment banks’ assets + would grow to trillion. + +On line 2554: + the largest, followed by + Morgan Stanley and Merrill, + then Lehman and Bear. These + +On line 2554: + international + firms had transformed their business + models over the years. + +On line 2554: + activities on + top of their traditional + investment banking + +On line 2554: + Recall that at Bear + Stearns, trading and investments + accounted for more + +On line 2556: + some years after The + investment banks also owned + depository + +On line 2556: + they could provide FDIC-insured + accounts to their brokerage + customers; the deposits + +On line 2556: + limited funding. + These depositories took + the form of a thrift + +On line 2556: + an industrial + loan company (supervised + by the Federal + +On line 2556: + and Lehman, which had among + the largest of these subsidiaries, used + them to finance their + +On line 2558: + subsidiaries suggested + two obvious choices when + they found themselves in + +On line 2558: + If a firm chartered + its depository as + a commercial bank, + +On line 2558: + would be its holding + company supervisor; + if as a thrift, the + +On line 2558: + would do the job. But + the investment banks came up + with a third option. + + They lobbied the SEC + to devise a system of + regulation that + +On line 2560: + Consolidated + Supervised Entity (CSE) + program to oversee + +On line 2560: + holding companies + of investment banks and all + their subsidiaries. The CSE + +On line 2560: + large U.S. broker-dealer + subsidiaries already subject to + SEC regulation. + + However, this was + the SEC’s first foray into + supervising firms + +On line 2560: + soundness. The SEC did + not have express legislative + authority to + +On line 2560: + it proposed that the + CSE program be voluntary; + the SEC crafted the + +On line 2560: + program out of its + authority to make rules + for the broker-dealer + +On line 2560: + banks. The program would + apply to broker-dealers that + volunteered to be + +On line 2560: + consolidated + supervision under the + CSE program, or those + +On line 2560: + already were subject + to supervision by the + Fed at the holding + +On line 2560: + as JP Morgan and + Citigroup. The CSE program + would introduce a + +On line 2560: + of supervision + by SEC examiners. CSE + firms were allowed to + +On line 2560: + were holding against their + securities portfolios—a + methodology based + +On line 2560: + the "alternative + net capital rule," would be + similar to the + +On line 2562: + on the Market Risk + Amendment to the Basel rules—that large + commercial banks and + +On line 2564: + The traditional + net capital rule that had + governed broker-dealers + +On line 2564: + asset classes and + credit ratings, a bright-line + approach that gave firms + +On line 2564: + rules would allow the + investment banks to create + their own proprietary + + Value at Risk (VaR) + models to calculate their + regulatory + + capital—that is, the + capital each firm would have + to hold to protect + +On line 2564: + customers’ assets should + it experience losses + on its ecurities + +On line 2564: + SEC estimated + that the proposed new reliance + on proprietary VaR + +On line 2564: + reduce average + capital charges by The firms + would be required to + +On line 2564: + SEC an early-warning + notice if their tentative + net capital (net + +On line 2566: + capital minus + hard-to-sell assets) fell below + billion at any time. + +On line 2568: + securities firms + and argued that it therefore + was the natural + + supervisor of + their holding companies. In + a letter to the + +On line 2568: + the OTS was harshly + critical of the agency’s + proposal, which it + +On line 2570: + over savings and loan + holding companies that would + also be CSEs. The + + OTS argued that the + SEC was interfering with + the intentions of + +On line 2570: + Act, "carefully kept + the responsibility + for supervision + +On line 2570: + holding company + itself with the OTS or the + Federal Reserve + +On line 2570: + depending upon + whether the holding company + was a [thrift holding + + company] or a + bank holding company. This + was in recognition + + of the expertise + developed over the years by + these regulators + +On line 2570: + and the federal + deposit insurance funds by + depository + +On line 2570: + their affiliates." + The OTS declared: "We believe + that the SEC’s proposed + +On line 2570: + holding companies] + is unfounded and could pose + significant risks + +On line 2572: + and the federal + deposit insurance funds."144 In + contrast, the response + + from the financial + services industry to the + SEC proposal was + +On line 2572: + computation. Lehman + Brothers, for example, wrote + that it "applauds and + +On line 2572: + the Commission." JP + Morgan was supportive of + what it saw as an + +On line 2572: + rule that still governed + securities subsidiaries of + the commercial banks: + +On line 2572: + overstates the amount of + capital a broker-dealer + needs," the company + + wrote. Deutsche Bank found it + to be "a great stride towards + consistency with + +On line 2572: + executives at + the investment banks stated + that the firms preferred + +On line 2574: + familiar with their + core securities-related + businesses. In an + +On line 2574: + adopt the CSE program + and the new net capital + calculations that + +On line 2574: + banks volunteered for + this supervision, although + Merrill’s and Lehman’s thrifts + +On line 2574: + to be supervised + by the OTS. Several firms + delayed entry to + +On line 2576: + price movements. Harvey + Goldschmid, SEC commissioner + from to told FCIC staff + +On line 2576: + the CSE program was + created, SEC staff members + were concerned about how + +On line 2576: + had over the Wall Street + firms, including their hedge funds + and overseas subsidiaries. + + Once the CSE program + was in place, the SEC had "the + authority to + + look at everything."146 + SEC commissioners discussed + at the time the risks + + they were taking by + allowing firms to reduce + their capital. "If + +On line 2576: + goes wrong it’s going + to be an awfully big + mess," Goldschmid said at + +On line 2576: + we feel secure if + these drops in capital and + other things [occur] + + we really will + have investor protection1" In + response, Annette Nazareth, + + the SEC official + who would be in charge of the + program, assured the + + commissioners that + her division was up to + the challenge.147 The new + +On line 2578: + the SEC’s Office of + Prudential Supervision + and Risk Analysis, + +On line 2578: + staff of to within + the Division of Market + Regulation.148 In + +On line 2578: + CSE program had grown + to Still, only "monitors" + were responsible + +On line 2578: + the five investment + banks; monitors were assigned + to each firm, with some + +On line 2580: + CSE program was based + on the bank supervision + model, but the SEC + +On line 2580: + to do exactly + what bank examiners did.151 + For one thing, unlike + +On line 2580: + SEC never assigned + on-site examiners under + the CSE program; by + +On line 2582: + alone assigned more than + examiners full-time + at Citibank. According + + to Erik Sirri, the + SEC’s former director of + trading and markets, + +On line 2584: + a securities + firm traditionally had + no access to a + +On line 2584: + resort.152 (Of course, that + would change during the crisis.) + The investment banks + +On line 2584: + examinations, + during which staff reviewed the + firms’ systems and records + + and verified that + the firms had instituted + control processes. + +On line 2586: + from the start. The SEC + conducted an exam for + each investment bank + + when it entered the + program. The result of Bear + Stearns’s entrance exam, + +On line 2586: + deficiencies. For + example, examiners + were concerned that there + +On line 2586: + VaR limits and that + contingency funding plans + relied on overly + +On line 2586: + was aware of the firm’s + concentration of mortgage + securities and + +On line 2586: + SEC did not ask Bear + to change its asset balance, + decrease its leverage, + +On line 2588: + to SEC officials.154 + Then, because the CSE program + was preoccupied + +On line 2588: + its next annual + exam, during which the SEC + was supposed to be + +On line 2590: + did meet monthly with + all CSE firms, including Bear,155 + and it did conduct + +On line 2592: + worried that Bear was + too reliant on unsecured + commercial paper + +On line 2592: + and Bear reduced its + exposure to unsecured + commercial paper + +On line 2592: + increased its reliance + on secured repo lending.156 + Unfortunately, + +On line 2592: + billions of dollars + of that repo lending was + overnight funding that could + + disappear with no + warning. Ironically, in + the second week of + +On line 2594: + firm went into its + four-day death spiral, the SEC + was on-site conducting + +On line 2594: + first CSE exam since + Bear’s entrance exam more than + two years earlier.157 + +On line 2596: + at the investment + banks increased from to growth that + some critics have blamed + +On line 2596: + the SEC’s change in the + net capital rules. Goldschmid + told the FCIC that the + +On line 2598: + had been higher at + the five investment banks in + the late 1990s, then dropped + +On line 2598: + over the life of the + CSE program—a history + hat suggests that the + +On line 2598: + responsible for + the changes.159 In Sirri noted + that under the CSE + +On line 2598: + and, in some cases, + increased significantly" + over the program.160 Still, + +On line 2598: + Goldschmid, who left the + SEC in argued that the SEC + had the power to + +On line 2598: + in the investment + banks. He insisted, "There was + much more than enough moral + +On line 2600: + suasion and kind of + practical power that was + involved. The SEC has + +On line 2602: + ability to do + a lot if it uses its + power."161 Overall, the + +On line 2602: + was widely viewed as + a failure. From until the + financial crisis, + +On line 2602: + their spectacular + growth, relying heavily + on short-term funding. + +On line 2602: + "fundamentally + flawed from the beginning."162 Mary + Schapiro, the current SEC + +On line 2602: + "was not successful + in providing prudential + supervision."163 And, + +On line 2602: + chapters ahead, the SEC’s + inspector general would + be quite critical, + +On line 2602: + all five of the largest + independent investment + banks had either closed + + down (Lehman Brothers), merged + into other entities + (Bear Stearns and Merrill + + Lynch), or converted + to bank holding companies + to be supervised + +On line 2604: + Reserve (Goldman Sachs + and Morgan Stanley). For the + Fed, there would be a + +On line 2604: + shrinking over the course + of the decade, as JP Morgan + switched the charter of + + its banking subsidiary + to the OCC164 and as the OTS + and SEC promoted + +On line 2604: + "The OTS and SEC were + very aggressive in trying + to promote themselves + +On line 2604: + a regulator + in that environment and + wanted to be the + +On line 2604: + a Fed governor + from to "There was a lot of + competitiveness + +On line 2604: + January Fed staff + had prepared an internal + study to find out why + +On line 2604: + the investment banks + had chosen the Fed as its + consolidated + +On line 2604: + interviewed five firms + that already were supervised + by the Fed and four + +On line 2604: + had chosen the SEC. + According to the report, + the biggest reason + +On line 2608: + riskier portions (or + tranches) of mortgage-related + securities led + +On line 2608: + an enormous volume + of collateralized debt + obligations (CDOs). These + +On line 2608: + for nonprime mortgage + securitization and + contributed to the + +On line 2608: + important role in + doing so, including CDOs + squared, credit default + +On line 2608: + that invested in + mortgage-backed securities and + CDOs. Many of these risky + +On line 2608: + systemically + important institutions + and contributed to + +On line 2610: + near failure in the + financial crisis. Credit + default swaps, sold to + + provide protection + against default to purchasers of + the top-rated tranches + +On line 2610: + facilitated + the sale of those tranches by + convincing investors + +On line 2610: + low risk, but greatly + increased the exposure of + the sellers of the + +On line 2612: + swap protection to + the housing bubble’s collapse. + Synthetic CDOs, which + +On line 2612: + to continue and + expand even as the mortgage + market dried up and + +On line 2612: + speculators with + a means of betting on the + housing market. By + +On line 2612: + spread and amplified + exposure to losses when + the housing market + +On line 2614: + the continuing + securitization of + nonprime mortgages. There + + was a clear failure + of corporate governance + at Moody’s, which did not + +On line 2614: + of its ratings on + tens of thousands of mortgage-backed + securities and + +On line 2616: + The Securities + and Exchange Commission’s poor + oversight of the five + +On line 2616: + banks failed to restrict + their risky activities and + did not require them + +On line 2616: + failure or need for + government bailouts of all five + of the supervised + +On line 2626: + financial crisis. + ALL IN CONTENTS The bubble: + "A credit-induced boom".................................................................157 + +On line 2630: + and due diligence: "A + quality control issue + in the factory" + +On line 2636: + loans and commercial + real estate: "You’ve got + to get up and dance" + +On line 2642: + "moving" to "storage" + Fannie Mae and Freddie Mac: + "Two stark choices"............................................178 In + +On line 2642: + Warren Peterson + was paying as little as + for a 10,000-square-foot lot, + + about the size of three + tennis courts. The next year the + cost more than tripled to + +On line 2642: + had built between and + custom and semi-custom homes + a year. For a while, + +On line 2644: + was building as many + as And then came the crash. "I + have built exactly + +On line 2646: + new home since late he + told the FCIC five years later.1 + In the average + +On line 2646: + of California’s + agricultural center, the + San Joaquin Valley. That + +On line 2646: + jumped to almost by + June "By money seemed to be + coming in very fast + +On line 2646: + everywhere," said Lloyd + Plank, a Bakersfield real + estate broker. "They + + would purchase a house + in Bakersfield, keep it for + a short period + +On line 2646: + resell it. Sometimes + they would flip the house while it + was still in escrow, + +On line 2648: + and would still make to + Nationally, housing prices + jumped between and their + +On line 2650: + in more than in any + decade since at least It would be + catastrophically + +On line 2650: + machine kept churning + well into apparently + indifferent to + + the fact that housing + prices were starting to fall and + lending standards to + +On line 2650: + Newspaper stories + highlighted the weakness in + the housing market— + + even suggesting this + was a bubble that could burst + anytime. Checks were in + +On line 2658: + their own due diligence + on what they were buying. The + Federal Reserve + +On line 2658: + easier access + to credit were common in + other markets, too. + +On line 2658: + was flowing into + commercial real estate + and corporate loans. + + How to react to + what increasingly appeared + to be a credit + +On line 2660: + enterprises, such + as Lehman Brothers and Fannie + Mae, pushed deeper. All + + along the assembly + line, from the origination + of the mortgages to + +On line 2660: + marketing of the + mortgage-backed securities and + collateralized + +On line 2660: + (CDOs), many understood + and the regulators at + least suspected that + +On line 2662: + which would not perform + as advertised. THE BUBBLE: + "A CREDITINDUCED BOOM" + +On line 2664: + own loan quality + was deteriorating + and stripped power from + +On line 2664: + June presentation, + the Quality Assurance + staff reported they + +On line 2664: + errors, including + evidence of predatory + lending, legal and + +On line 2664: + violations, and + credit issues, in of the + loans they audited + +On line 2666: + December In Chief + Operating Officer + and later CEO Brad + +On line 2666: + recommended these + results be removed from the + statistical tools + +On line 2666: + performance, and in + the department was dissolved + and its personnel + +On line 2666: + deficiencies in + loan files; out of nine reviews + it conducted in + +On line 2666: + cut the department’s + budget, saying in a memo + that the "group was out + + of control and tries + to dictate business practices + instead of audit."6 + +On line 2668: + company struggled + with increasing requests that + it buy back soured loans + +On line 2668: + almost of its loans + were going into default + within the first three + +On line 2668: + with increasing loan + originations, without due + regard to the risks + +On line 2670: + securitizers, + and investors met at the ABS + East conference in + +On line 2670: + Raton, Florida, + to play golf, do deals, and talk + about the market. The + +On line 2670: + was still good, but even + the most optimistic could read + the signs. Panelists had + +On line 2672: + by "fundamentals" + such as increased demand1 Would + rising interest + + rates halt the arket1 + And was the CDO, because of + its ratings-driven + +On line 2674: + mortgage market18 The + numbers were stark. Nationwide, + house prices had never + +On line 2676: + national indices + masked important variations. + House prices in the four + +On line 2676: + California, had + dramatically larger + spikes—and subsequent + +On line 2676: + did the nation. If + there was a bubble, perhaps, + as Fed Chairman Alan + +On line 2676: + said, it was only + in certain regions. He told + a congressional + +On line 2676: + committee in June + that growth in nonprime mortgages + was helping to push + +On line 2676: + prices in some markets + to unsustainable levels, + "although a ‘bubble’ + +On line 2678: + prices for the nation + as a whole does not appear + likely."9 Globally, + +On line 2678: + jumped in many countries + around the world during the 2000s. + As Christopher Mayer, + +On line 2678: + to the Commission, + "What really sticks out is + how unremarkable + +On line 2678: + is relative to + our European peers."10 From to + price increases in + + the United Kingdom + and Spain were above those in the + United States, while price + +On line 2678: + France were just below. + In an International + Monetary Fund study + +On line 2678: + from more than one half + of the developed countries + analyzed had greater + +On line 2678: + appreciation + than the United States from late + through the third quarter + +On line 2678: + and yet some of these + countries did not suffer sharp + price declines.11 Notably, + +On line 2678: + home price increases + followed by a modest and + temporary decline + +On line 2678: + in Researchers at the + Federal Reserve Bank of + Cleveland attributed + + Canada’s experience + to tighter lending standards than + in the United States + +On line 2680: + structural differences + in the financial system.12 + Other countries, such + +On line 2682: + steep house price declines. + American economists and + policy makers + +On line 2682: + to explain the house + price increases. The good news + was the economy + +On line 2684: + and unemployment + was low. But, a Federal + Reserve study in May + +On line 2684: + cost of owning rather + than renting was much higher + than had been the case + +On line 2684: + historically: + home prices had risen from times the + annual cost of + +On line 2684: + times.13 In some cities, the + change was particularly + dramatic. From to + +On line 2684: + prices to rents rose in + Los Angeles, Miami, + and New York City by + +On line 2684: + index—which measures whether + a typical family + could qualify for + + a mortgage on a + typical home— had reached a + record low.15 But that was + +On line 2686: + based on the cost of + a traditional mortgage + with a down payment,16 + +On line 2686: + was no longer required. + Perhaps such measures were no + longer relevant, when + +On line 2686: + could make lower down + payments and obtain loans such + as payment-option + +On line 2686: + and interest-only + mortgages, with reduced initial + mortgage payments. Or + +On line 2688: + given homeowners’ + expectations of further + price gains. During a + +On line 2688: + Market Committee + (FOMC), composed of Federal + Reserve governors, + +On line 2688: + presidents, and the + Federal Reserve Bank of + New York president, + +On line 2688: + presentations on + mortgage risks and the housing + market. Members and + +On line 2688: + developing a + consensus on whether housing + prices were overvalued + +On line 2688: + and "it was hard for + many FOMC participants to + ascribe substantial + +On line 2688: + to the proposition + that overvaluation in + the housing market + +On line 2688: + the major systemic + risks that we now know it did," + according to a + +On line 2688: + Fed Chairman Ben Bernanke + to the FCIC. "The national + mortgage system might + +On line 2690: + not break," and "neither + borrowers nor lenders appeared + particularly + +On line 2690: + according to the + letter. In discussions about + nontraditional + +On line 2690: + mortgages are not an + especially sinister + development," and + +On line 2690: + cushioned by large down + payments." The presentation + also noted that + +On line 2690: + were rising on a + portion of interest-only + loans, the ratios for + +On line 2690: + that housing market + activity could be the + result of "solid + + fundamentals." Yet + another presentation + concluded that the + + impact of changes in + household wealth on spending would + be "perhaps only + + half as large as that + of the 1990s stock bubble." Most + FOMC participants + +On line 2692: + were "agnostics" on + housing, unwilling to risk + their reputations + +On line 2692: + finding support in + economic theory.18 Fed + Vice Chairman Donald + +On line 2694: + "Identification + [of a bubble] is a tricky + proposition because + +On line 2694: + driving asset prices + are directly observable," + Kohn said in a speech, + + citing research by + the European Central Bank. + "For this reason, any + +On line 2694: + by a central bank + that stocks or homes are overpriced + is inherently + +On line 2696: + to sound a louder + alarm. "The situation is + beginning to look + + like a credit-induced + boom in housing that could very + well result in a + +On line 2696: + Federal Deposit + Insurance Corporation + Chief Economist Richard + +On line 2698: + Brown wrote in a March + report. "During the past five + years, the average + +On line 2700: + U.S. home has risen in + value by while homes in the + fastest-growing markets + +On line 2700: + approximately + doubled in value." While this + increase might have been + +On line 2700: + fundamentals, "the + dramatic broadening of + the housing boom in + +On line 2700: + the influence of + systemic factors, including + the low cost and wide + + availability of + mortgage credit."20 A couple + of months later, Fed + +On line 2702: + that housing prices were + overvalued, but downplayed the + potential impacts + + of a downturn. Even + in the face of a large price + decline, they argued, + +On line 2702: + would not be widespread, + given the large equity + that many borrowers + +On line 2702: + in their homes. Structural + changes in the mortgage market + made a crisis less + +On line 2702: + financial system + seemed well capitalized. "Even + historically + +On line 2702: + declines in house prices + would be small relative to + the recent decline + +On line 2702: + wealth owing to the + stock market," the economists + concluded. "From a + +On line 2710: + only company + that ignored concerns about poor + loan quality. Across + +On line 2710: + mortgage industry, + with the bubble at its peak, + standards had declined, + +On line 2710: + no longer verified, + and warnings from internal + audit departments + +On line 2710: + patterns during the + savings and loan crisis, told + the Commission that + +On line 2710: + by one estimate, + in the mid-2000s, at least million + loans annually + + contained "some sort of + fraud," in part because of the + large percentage of + +On line 2712: + housing can entail + a borrower’s lying or + intentionally + +On line 2712: + deception to gain + financially from the sale + of a house. Illinois + +On line 2714: + mortgage products to + borrowers."24 In of cases, + according to the + +On line 2714: + involves industry + insiders.25 For example, + property flipping + +On line 2714: + real estate agents, + appraisers, and complicit + closing agents. In a + +On line 2714: + second," the buyer, + with the collusion of a + loan officer and + +On line 2714: + the knowledge of the + first mortgage lender, disguises + the existence of + + a second mortgage + to hide the fact that no down + payment has been made. + + "Straw buyers" allow + their names and credit scores to + be used, for a fee, + + by buyers who want + to conceal their ownership.26 + In one instance, two + +On line 2716: + South Florida were + indicted in for placing + ads between and in + +On line 2716: + were accused of then + stealing the identities of + hundreds of people + + who came for help and + using the information + to buy properties, + +On line 2716: + A. Ferrer told the + Commission it was "one of + the cruelest schemes" he + + had seen.27 Estimates + vary on the extent of fraud, + as it is seldom + +On line 2720: + business relations + at Inter - thinx, a fraud + detection service, + +On line 2720: + the FCIC that her firm + analyzed a large sample + of all loans from to + +On line 2720: + and found contained lies + or omissions significant + enough to rescind the + +On line 2720: + worth of fraudulent + loans from to resulted in + foreclosures, leading + +On line 2720: + losses of billion + for the holders. According + to Fulmer, experts + +On line 2720: + the percentage of + transactions involving less + significant forms + +On line 2724: + the radar, because many + borrowers made payments on + time. Ed Parker, the + + head of mortgage fraud + investigation at Ameriquest, + the largest subprime lender + +On line 2724: + FCIC that fraudulent + loans were very common at the + company. "No one + +On line 2724: + watching. The volume + was up and now you see the + fallout behind the + +On line 2724: + Markets at Fannie + Mae, told the Commission that + in one package of + +On line 2724: + his analysts found + one purchaser who had bought + properties, falsely + +On line 2724: + time as the owner + of only one property, + while another had + + bought five properties.30 + Fannie Mae’s detection of + fraud increased steadily + +On line 2724: + the housing bubble + and accelerated in + late according to + +On line 2724: + current director + of the company’s mortgage + fraud program. He said + +On line 2724: + seeing evidence + of fraud, Fannie demanded + that lenders such as Bank + +On line 2724: + Citigroup, and JP + Morgan Chase repurchase about + million in mortgages + +On line 2724: + million in "Lax or + practically non-existent + government oversight + +On line 2724: + thrive," said Henry N. + Pontell, a professor of + criminology + +On line 2724: + the University + of California, Irvine, in + testimony to + + the Commission.32 The + responsibility to + investigate and + +On line 2726: + to local, state and + federal law enforcement + officials. On the + + federal level, + the Federal Bureau of + Investigation + +On line 2726: + prosecution to + U.S. Attorneys, who are part + of the Department + + of Justice. Cases + may also involve other + agencies, including + +On line 2726: + U.S. Postal Inspection + Service, the Department of + Housing and Urban + +On line 2726: + The FBI, which has the + broadest jurisdiction of + any federal law + +On line 2726: + Chris Swecker began + noticing a rise in mortgage + fraud while he was the + +On line 2726: + charge of the Charlotte, + North Carolina, office from + to In that office + +On line 2726: + Mortgage for selling + fraudulent loans to Fannie + Mae, leading to the + +On line 2726: + prosecution of + the company’s owner, James + Edward McLean Jr., and + +On line 2728: + but then—without any + interference from Fannie—resold + them to Ginnie Mae.34 + +On line 2730: + Ginnie, Fannie paid + million of restitution to + the government. McLean + +On line 2730: + to the attention + of the FBI after buying + a luxury yacht + +On line 2730: + after Swecker was + promoted to assistant + FBI director for + +On line 2730: + turned a spotlight on + mortgage fraud. "The potential + impact of mortgage + +On line 2730: + clear," Swecker told a + congressional committee + in "If fraudulent + +On line 2730: + fraud is allowed to + become unrestrained, it will + ultimately place + +On line 2730: + institutions at + risk and have adverse effects + on the stock market."36 + +On line 2732: + Swecker pointed out + the inadequacies of + data regarding + +On line 2732: + that Congress mandate + a reporting system and + other remedies and + +On line 2732: + not. For example, + suspicious activity + reports, also known + +On line 2732: + reports filed by FDIC-insured + banks and their affiliates + to the Financial + +On line 2732: + Enforcement Network + FinCEN), a bureau within the + Treasury Department + +On line 2734: + and works closely with + law enforcement to combat + financial crimes. SARs + +On line 2734: + in a financial + transaction. But many mortgage + originators, such + +On line 2734: + New Century, and + Option One, were outside FinCEN’s + jurisdiction—and + +On line 2734: + investment banks, were + not subject to FinCEN review. + William Black testified + +On line 2734: + to the Commission + that an estimated of + nonprime mortgage loans + +On line 2734: + SARs. And as for those + institutions required to + do so, he believed + + he saw evidence + of underreporting in + that, he said, only + +On line 2734: + filed even a single + criminal referral for + alleged mortgage fraud + +On line 2736: + in the first half of + Countrywide, the nation’s largest + mortgage lender at the + +On line 2738: + activity in + its mortgage business in in + and in according + + to Francisco San + Pedro, the former senior + vice president of + +On line 2740: + investigations + at the company.38 But it + filed only SARs in + +On line 2742: + in Similarly, + in examining Bank of + America in its + +On line 2742: + regulator, the + Office of the Comptroller + of the Currency + +On line 2742: + activity for + which no report had been filed + with FinCEN. All met the + +On line 2742: + required management + to refine its processes + to ensure that SARs + +On line 2744: + and fraud analyst + at Wells Fargo, the second + largest mortgage lender from + +On line 2744: + the largest in told the + Commission that "hundreds and + hundreds and hundreds + +On line 2744: + identified within + Wells Fargo’s home equity + loan division were + + not reported to + FinCEN. And, she added, at least half + the loans she flagged for + +On line 2746: + objections.41 Despite + the underreporting, the + jump in mortgage fraud + +On line 2748: + drew attention. FinCEN + in November reported + a 20-fold increase in + +On line 2748: + SARs related to + mortgage fraud between and It + noted that two-thirds of + +On line 2748: + were originated + by mortgage brokers who were + not subject to any + +On line 2748: + standard or oversight.42 + Swecker unsuccessfully + asked legislators + + to compel all lenders + to forward information + about criminal fraud + + to regulators + and law enforcement agencies.43 + Swecker attempted + +On line 2750: + gain more funding to + combat mortgage fraud but was + resisted. Swecker + +On line 2750: + cut at either the + director level at the + FBI, at the Justice + + Department, or at + the Office of Management + and Budget. He called + +On line 2752: + his struggle for more + resources an "uphill slog."44 In + SARs related to + +On line 2754: + mortgage fraud were filed; + in there were The number kept + climbing, to in in + +On line 2756: + At the same time, top + FBI officials, focusing + on terrorist threats, + +On line 2758: + to white-collar crime + from in the fiscal year to + fewer than by That + +On line 2758: + mortgage fraud program + had only agents at any one + time to review more + +On line 2758: + than SARs filed with FinCEN. + In response to inquiries from + the FCIC, the FBI said + + that to compensate + for a lack of manpower, + it had developed + +On line 2758: + methods to detect + and combat mortgage fraud," such + as a computer + +On line 2760: + property flipping.46 + Robert Mueller, the FBI’s director + since said mortgage fraud + +On line 2760: + priorities," such + as terrorism. He told the + Commission that he + + hired additional + resources to fight fraud, but that + "we didn’t get what + + we had requested" + during the budget process. He + also said that the + + FBI allocated + additional resources to + reflect the growth in + +On line 2760: + fraud, but acknowledged + that those resources may have been + insufficient. "I + +On line 2760: + not going to tell + you that that is adequate + for what is out there," + + he said. In the wake + of the crisis, the FBI is + continuing to + + investigate fraud, + and Mueller suggested that some + prosecutions may + +On line 2762: + nation’s attorney + general from February + to September told + +On line 2762: + that while he might have + done more on mortgage fraud, in + hindsight he believed + +On line 2762: + more pressing: "I don’t + think anyone can credibly + argue that [mortgage + +On line 2762: + more important than + the war on terror. Mortgage + fraud doesn’t involve + + taking loss of life + so it doesn’t rank above the + priority of + +On line 2764: + Housing Enterprise + Oversight, the regulator + of the GSEs, released + + a report showing + a "significant rise in + the incidence of + +On line 2764: + in mortgage lending + in and the first half of OFHEO + stated it had been + + working closely with + law enforcement and was an + active member of + + the Department of + Justice Mortgage Fraud Working + Group.49 "The concern about + +On line 2764: + issue," Richard Spillenkothen, head + of banking supervision + and regulation + +On line 2764: + Fed from to told the + FCIC. "And we understood there + was an increasing + +On line 2766: + B. Mukasey, who served as + U.S. attorney general + from November to + +On line 2766: + the end of told the + Commission that he recalled + "receiving reports + +On line 2766: + mortgage failures and + of there being fraudulent + activity in + +On line 2766: + with flipping houses, + overvaluation, and the + like. I have a dim + + recollection of + outside people commenting + that additional + +On line 2766: + be devoted, and + there being speculation + about whether resources that + +On line 2766: + investigations + were somehow impeding fraud + investigations, + + which I thought was a + bogus issue." He said that + the department had + +On line 2768: + as terrorism, gang + violence, and southwestern + border issues.51 In + + letters to the FCIC, + the Department of Justice + outlined actions it + + undertook along with + the FBI to combat mortgage + fraud. For example, + +On line 2768: + Continued Action, + targeting a variety + of financial crimes, + +On line 2768: + the agency started + to publish an annual + mortgage fraud report. + +On line 2768: + following year, the + FBI and other federal + agencies announced a + +On line 2768: + produced indictments, + arrests, and convictions for + mortgage fraud. In the + +On line 2768: + cases and increased + personnel dedicated + to those efforts. And + +On line 2768: + Mortgage resulted + in mortgage fraud cases in + which defendants were + +On line 2770: + Attorneys offices + throughout the country.52 William Black + told the Commission + +On line 2770: + issue and allowed + it to worsen. "The FBI did + have severe limits," + +On line 2770: + and the problem was + compounded by the lack of + cooperation: + + "The terrible thing + that happened was that the FBI + got virtually + +On line 2770: + assistance from the + regulators, the banking + regulators and + +On line 2772: + FBI official, told + the Commission he had no + contact with banking + +On line 2774: + As mortgage fraud grew, + state agencies took action. In + Florida, Ellen Wilcox, + + a special agent with + the state Department of Law + Enforcement, teamed with + +On line 2774: + Agency to bring down + a criminal ring scamming + homeowners in the + +On line 2774: + Its key member was + Orson Benn, a New York–based + vice president of + +On line 2774: + of Ameriquest. Beginning + in investigators and + two prosecutors + +On line 2774: + repair contractors, + title companies, notaries, + and a convicted + +On line 2776: + case that involved some + loans.55 According to charging + documents in the + +On line 2776: + neighborhoods, looking + for elderly homeowners + they thought were likely + + to have substantial + equity in their homes. They + would suggest repairs + + or improvements to + the homes. The homeowners would + fill out paperwork, + + and insiders would + use the information to + apply for loans in + +On line 2776: + the ring would prepare + fraudulent loan documents, + including false W-2 + +On line 2776: + with information + about invented employment + and falsified salaries, + +On line 2776: + out home equity + loans in the homeowners’ names. + Each person involved + + in the transaction + would receive a fee for his + or her role; Benn, at + +On line 2776: + Argent, received a + kickback for each loan he helped + secure. When the loan + +On line 2776: + out to the bogus + home construction company + that had proposed the + +On line 2776: + would then disappear + with the proceeds. Some of the + homeowners never + + received a penny + from the refinancing on + their homes. Hillsborough + +On line 2776: + to say that scheduled + repairs had never been made + to their homes, and then + +On line 2776: + of equity as + well. Sixteen of defendants, + including Benn, have + +On line 2778: + or have pled guilty.56 Wilcox + told the Commission that the + "cost and length of these + + investigations + make them less attractive to + most investigative + +On line 2778: + their budgets based on + investigative statistics."57 + She said it has been + +On line 2778: + to follow up on + other cases because so + many of the subprime + +On line 2778: + of business, making + it difficult to track down + perpetrators and + +On line 2778: + Ameriquest, for example, + collapsed in although Argent, + and the company’s + + loan-servicing arm, were + bought by Citigroup that same + year. DISCLOSURE AND + +On line 2786: + QUALITY CONTROL + ISSUE IN THE FACTORY" + In addition to + +On line 2786: + the final years of + the bubble. After growing + for years, Alt-A lending + +On line 2786: + another from to + In particular, option + ARMs grew during that + +On line 2788: + for borrowers with + fixed-rate mortgages) grew Overall, by + no-doc or low-doc + +On line 2790: + loans made up of all + mortgages originated. Many + of these products would + + perform only if + prices continued to rise and + the borrower could + +On line 2792: + participant along + the securitization + pipeline should have had + +On line 2792: + in the quality + of every underlying + mortgage. In practice, + + their interests were + often not aligned. Two New York + Fed economists have + +On line 2792: + frictions" in mortgage + securitization—places + along the pipeline where + + one party knew more + than the other, creating + opportunities + + to take advantage.59 + For example, the lender who + originated the + +On line 2792: + for sale, earning a + commission, knew a great deal + about the loan and the + +On line 2792: + but had no long-term stake + in whether the mortgage was paid, + beyond the lender’s own + +On line 2794: + process. They described their + role as being "an umpire + in the market."60 But + +On line 2794: + security, nor + did they check to see that the + mortgages were what the + +On line 2796: + said they were. So the + integrity of the market + depended on two + +On line 2796: + First, firms purchasing + and securitizing the + mortgages would conduct + + due diligence reviews + of the mortgage pools, either + using third-party + +On line 2796: + rules, parties in the + securitization process + were expected to + + disclose what they were + selling to investors. Neither + of these checks performed + +On line 2800: + securitizers + undertook due diligence on + their own or through third + +On line 2800: + The originator + and the securitizer + negotiated + +On line 2800: + extent of the due + diligence investigation. + While the percentage + +On line 2802: + the pool examined + could be as high as it was + often much lower; + + according to some + observers, as the market grew + and originators + +On line 2802: + bargaining power + over the mortgage purchasers, and + samples were sometimes + +On line 2802: + requested that the + due diligence firm analyze + a random sample + +On line 2802: + mortgages from the pool; + others asked for a sampling + of those most likely + + to be deficient + in some way, in an effort + to efficiently + + detect more of the + problem loans. layton Holdings, + a Connecticut-based firm, + +On line 2804: + was a major provider + of third-party due diligence + services. As Clayton + +On line 2804: + Vicki Beal explained + to the FCIC, firms like hers were + "not retained by [their] + + clients to provide an + opinion as to whether a loan + is a good loan or + + a bad loan." Rather, they + were hired to identify, among + other things, whether the + +On line 2806: + to enable clients to + negotiate better prices + on pools of loans.63 The + +On line 2806: + the originator’s + standards, sometimes with overlays + or additional + +On line 2806: + provided by the + financial institutions + purchasing the loans)1 + +On line 2806: + values accurate164 + And, critically: to the + degree that a loan + + was deficient, did + it have any "compensating + factors" that offset + +On line 2806: + loan had a higher + loan-to-value ratio than + guidelines called for, did + +On line 2806: + as the borrower’s + higher income mitigate + that weakness1 The due + +On line 2806: + firm would then grade the + loan sample and forward the + data to its client. + +On line 2806: + securitizer + would negotiate a price + for the pool and could + +On line 2808: + loans that did not meet + the stated guidelines. Because + of the volume of + + loans examined by + Clayton during the housing + boom, the firm had a + + unique inside view of + the underwriting standards + that originators + +On line 2808: + willing to accept. + Loans were classified into + three groups: loans that met + +On line 2808: + (a Grade Event), those that + failed to meet guidelines but were + approved because of + +On line 2810: + (a Grade Event), and those + that failed to meet guidelines and + were not approved (a + +On line 2814: + Event). Overall, for the + months that ended June Clayton + rated of the loans + +On line 2814: + it analyzed as + Grade and another as Grade + 2—for a total of + +On line 2814: + guidelines outright or + with compensating factors. + The remaining of + +On line 2814: + the loans were Grade In + theory, the banks could have + refused to buy a + + loan pool, or, indeed, + they could have used the findings + of the due diligence + +On line 2814: + firm to probe the loans’ + quality more deeply. Over the + 18-month period, of + +On line 2814: + the loans that Clayton + found to be deficient—Grade 3—were "waived in" + by the banks. Thus of + + the loans sampled by + Clayton were accepted even + though the company + +On line 2816: + found a basis for + rejecting them (see figure + Referring to the + +On line 2816: + Keith Johnson, the + president of Clayton from + May to May told the + +On line 2816: + me says there [was] a + quality control issue + in the factory" + +On line 2816: + Johnson concluded + that his clients often waived in + loans to preserve their + +On line 2816: + of rejections might + lead the originator to + sell the loans to a + +On line 2816: + a sellers’ market. + "Probably the seller had + more power than the + +On line 2818: + FCIC.67 The high rate of + waivers following rejections + may not itself be + +On line 2818: + Beal testified. She + said that as originators’ + lending guidelines were + +On line 2818: + credit Rejected + Loans Waived in by Selected + Banks guidelines. "As you + + know, there was stated + income, they were telling us look + for reasonableness + +On line 2818: + one would expect more + rejections, and, after the + securitizer + +On line 2818: + at the rejected + loans, possibly more waivers. As + Moody’s Investors Service + +On line 2818: + a letter to the + FCIC, "A high rate of waivers from + an institution + + with extremely tight + underwriting standards could + result in a pool + + that is less risky than + a pool with no waivers from an + institution with + +On line 2818: + indicated that + the loans in the pools either + met guidelines outright + +On line 2818: + had compensating + factors, even though Clayton’s records + show that only a + + portion of the loans + were sampled, and that of those + that were sampled, a + +On line 2820: + percentage of Grade + Event loans were waived in. Johnson + said he approached the + +On line 2820: + agencies in and to + gauge their interest in the + exception-tracking + + product that Clayton + was developing. He said + he shared some of their + +On line 2820: + the agencies that the + data would benefit the + ratings process. "We went + +On line 2822: + and said, ‘Wouldn’t this + information be great for + you to have as you + + assign tranche levels + of isk1’" Johnson recalled. The + agencies thought the due + + diligence firm’s data + were "great," but they did not want + the information, + + Johnson said, because + it would presumably produce + lower ratings for + +On line 2828: + market was winding + down.70 When securitizers + did kick loans out of + +On line 2828: + some originators + simply put them into new + pools, presumably in + +On line 2828: + the next pool’s sampling. + The examiner’s report + for New Century + +On line 2828: + Investment Loan had + a policy of putting loans + into subsequent + +On line 2828: + they were kicked out three + times, the company’s former + regulatory + + compliance and risk + manager, Roger Ehrnman, told + the FCIC. As Johnson + + described the practice + to the FCIC, this was the "three + strikes, you’re out rule."72 Some + +On line 2830: + their own due diligence, + but seemed to devote only + limited resources + +On line 2830: + At Morgan Stanley, + the head of due diligence was + based not in New York + + but rather in Boca + Raton, Florida. He had, + at any one time, two + +On line 2830: + him directly—and they were + actually employees + of a personnel + + consultant, Equinox.73 Deutsche + Bank and JP Morgan likewise + also had only + +On line 2832: + diligence teams.74 Banks did + not necessarily have + better processes + + for monitoring + the mortgages that they purchased. + At an FCIC hearing + +On line 2832: + the mortgage business, + Richard Bowen, a whistleblower who + had been a senior + +On line 2832: + testified that his + team conducted quality + assurance checks on + +On line 2832: + Citigroup from a + network of lenders, including + both subprime mortgages + +On line 2832: + hold and prime mortgages + that it intended to sell + to Fannie Mae and + +On line 2834: + purchases, Bowen’s team + would review the physical + credit file of the + +On line 2834: + they were purchasing. + "During and I witnessed many + changes to the way the + +On line 2834: + evaluated for + these pools during the purchase + processes," Bowen said. + +On line 2834: + example, he said, + the chief risk officer in + Citigroup’s Consumer + +On line 2836: + business reversed large + numbers of underwriting + decisions from "turn + +On line 2838: + part of Bowen’s charge was + to supervise the purchase + of roughly billion + +On line 2838: + in prime loan pools, a + high percentage of which were + sold to Fannie Mae + + and Freddie Mac for + securitization. The + sampling provided + +On line 2838: + quality control + was supposed to include at + least of the loan pool + +On line 2838: + usually ignored." + Samples of were more likely, + and the loan samples + +On line 2838: + group did examine + showed extremely high rates of + noncompliance. "At + +On line 2838: + time that I became + involved, which was early to + mid-2006, we identified + +On line 2838: + to percent of the + files either had a ‘disagree’ + decision, or they + +On line 2840: + supervisor and + company executives + about the quality + + and underwriting + of mortgages that CitiMortgage purchased + and then sold to the + + GSEs. As discussed in + a later chapter, the GSEs + would later require + +On line 2840: + Citigroup to buy + back billion in loans as of + November finding + +On line 2842: + the loans Citigroup + had sold them did not conform + to GSE standards. SEC: + +On line 2846: + the room is that we + didn’t review the prospectus + supplements" By the + +On line 2846: + time the financial + crisis hit, investors held more + than trillion of non-GSE + +On line 2848: + billion of CDOs that + held mortgage-backed securities.77 + These securities + +On line 2850: + with practically + no SEC oversight. And only + a minority + +On line 2850: + ongoing public + reporting requirements. The + SEC’s mandate is to + +On line 2850: + disclosures so that + investors can make up their own + minds. In the case of + +On line 2850: + offerings of a + company’s shares, the work has + historically + +On line 2852: + other "offering + materials" prior to + sale.78 However, with + +On line 2852: + "shelf registration," + a method of registering + securities on + +On line 2852: + became much quicker + for mortgage-backed securities + ranked in the highest + +On line 2852: + the rating agencies. + The process allowed issuers to + file a base prospectus + +On line 2852: + issuer intended + to offer securities + in the future. The + +On line 2852: + offering’s terms. "The + elephant in the room is that + we didn’t review + +On line 2852: + in corporation + finance, Shelley Parratt, told + the FCIC.79 To improve + +On line 2852: + Regulation AB + in late The regulation + required that every + +On line 2852: + credit-granting or + underwriting criteria + used to originate + + or purchase the pool + assets, including, to the + extent known, any changes + +On line 2852: + criteria and the + extent to which such policies + and criteria are + +On line 2854: + be overridden."80 With + essentially no review + or oversight, how good + +On line 2854: + included disclaimers + to the effect that not all + mortgages would comply + +On line 2854: + the lending policies + of the originator: "On + a case-by-case basis + +On line 2854: + may determine that, + based upon compensating + factors, a prospective + + mortgage not strictly + qualifying under the + underwriting risk + +On line 2856: + an underwriting + exception."81 The disclosure + typically had + +On line 2858: + number" or perhaps + "a substantial portion of + the Mortgage Loans will + +On line 2858: + Bowen criticized the + extent of information + provided on loan + +On line 2858: + no disclosure made + to the investors with regard + to the quality + + of the files they were + purchasing."83 Such disclosures + were insufficient + +On line 2860: + know what criteria + the mortgages they were buying + actually did + +On line 2862: + meet. Only a small + portion—as little as to 3%—of + the loans in any deal + +On line 2862: + from Clayton shows that + a significant number + did not meet stated + +On line 2862: + have compensating + factors.84 On he loans in the + remainder of the + +On line 2864: + that were not sampled + (as much as Clayton and the + securitizers + +On line 2864: + information, but + one could reasonably expect + them to have many of + +On line 2864: + at the same rate, as + the sampled loans. Prospectuses + for the ultimate + +On line 2864: + this information, + or information on how + few loans were reviewed, + + raising the question + of whether the disclosures were + materially + +On line 2866: + violation of + the securities laws. CDOs + were issued under + +On line 2866: + framework from the one + that applied to many mortgage-backed + securities, and + +On line 2866: + rules. Underwriters + typically issued CDOs + under the SEC’s Rule + +On line 2868: + so-called qualified + institutional buyers + (QIBs); these included + + investors as diverse + as insurance companies + like MetLife, pension funds + +On line 2868: + California State + Teachers’ Retirement System, + and investment banks + +On line 2870: + U.S. investment banks + more competitive with their + foreign counterparts; + +On line 2870: + participants viewed + U.S. disclosure requirements + as more onerous than + +On line 2870: + significantly + expanded the market for + these securities + +On line 2870: + distributions which + complied with the rule would no + longer be considered + +On line 2870: + exemption with the + National Securities + Markets Improvements + +On line 2870: + that Denise Voigt Crawford, + a commissioner on the + Texas Securities + +On line 2870: + prohibit[ing] the states + from taking preventative + actions in areas + +On line 2870: + the current crisis."86 + Under this legislation, + state securities + + regulators were + preempted from overseeing + private placements such + +On line 2870: + In the absence of + registration requirements, + a new debt market + +On line 2870: + Rule 144A. This market + was liquid, since qualified + investors could freely trade + +On line 2872: + securities. But + debt securities when Rule + 144A was enacted + +On line 2872: + corporate bonds, very + different from the CDOs that + dominated the + +On line 2874: + been adequate, filed + numerous lawsuits under + federal and state + +On line 2878: + new mortgage products + had been on regulators’ + radar screens in the years + +On line 2880: + banks’ own internal + risk management systems.88 "As + internal systems + +On line 2880: + the basic thrust of + the examination process + should shift from largely + +On line 2880: + feedback that the bank + can use to enhance further + the quality of + +On line 2880: + its risk-management + systems," Chairman Greenspan had said + in Across agencies, there + +On line 2880: + approach, that a lighter + hand at regulation was + the appropriate + + way to regulate," + Eugene Ludwig, comptroller + of the currency + +On line 2880: + from to told the FCIC, + referring to the Gramm-Leach-Bliley Act + in The New York Fed, + +On line 2882: + "lessons-learned" analysis + after the crisis, pointed + to the mistaken + + belief that "markets + will always self-correct." + "A deference to + +On line 2882: + supervisors from + imposing prescriptive views + on banks," the report + +On line 2886: + capital standards. + Banks had complained for years that + the original Basel + +On line 2886: + did not allow them + sufficient latitude to + base their capital + +On line 2886: + with strong support from + the Fed, introduced the Basel + II capital regime + +On line 2886: + which would allow banks + to lower their capital + charges if they could show + +On line 2886: + sophisticated + approaches that it allowed, + Basel II reflected + + and reinforced the + supervisors’ risk-focused + approach. Spillenkothen said that + +On line 2886: + "acceptance of Basel + II premises," which he described + as displaying "an + +On line 2886: + accuracy of + complex quantitative risk + measurement techniques, + +On line 2886: + willingness (at least + in the early days of Basel + II) to tolerate + +On line 2886: + regulatory + capital in return for + the prospect of better + +On line 2888: + Regulators had + been taking notice of the + mortgage market for + +On line 2888: + mortgage products and + borrowers had changed during + and following the + + refinancing boom + of the previous year, and + they began work on + +On line 2888: + guidance to banks and + thrifts. But too little was done, + and too late, because + +On line 2888: + interagency + discord, industry pushback, + and a widely held + +On line 2890: + participants had + the situation well in + hand. "Within the board, + +On line 2890: + many of these loan types + had gotten to an extreme," + Susan Bies, then a + +On line 2890: + governor and chair + of the Federal Reserve + Board’s subcommittees + + on both safety and + soundness supervision and + consumer protection + + supervision, told + the FCIC. "So the main debate + within the board was + + how tightly [should we] + rein in the abuses that we + were seeing. So it + +On line 2894: + was more of ‘to a + degree.’"93 Indeed, in the same + June Federal Open + +On line 2894: + Committee meeting + described earlier, one FOMC + member noted that + +On line 2894: + and untested credit + default instruments had caused + some market turmoil." + +On line 2894: + participant was + concerned "that subprime lending + was an accident + +On line 2894: + third participant + noted the risks in mortgage + securities, the + +On line 2894: + information on + borrowers," adding, however, + that record profits and + +On line 2894: + capital levels + allayed those concerns. A fourth + participant said + +On line 2894: + "we could be seeing + the final gasps of house price + appreciation." + + The participant + expressed concern about "creative + financing" and was + +On line 2894: + of default ould be + higher than suggested by + the securities + +On line 2894: + backed, "could be making + the books of GSEs look better + than they really + + were." Fed staff replied that + the GSEs were not large purchasers + of private label + +On line 2896: + securities.94 In + the spring of the FOMC would again + discuss risks in the + +On line 2896: + markets and express + nervousness about the growing + "ingenuity" of + +On line 2896: + amortization loans + had the per-nicious effect of + stripping equity + +On line 2896: + and raised concerns about + nontraditional lending + practices that seemed based + + on the presumption + of continued increases + in home prices. John Snow, + +On line 2900: + treasury secretary, + told the FCIC that he called a + meeting in late or + +On line 2900: + proliferation + of poor lending practices. He + said he was struck that + +On line 2900: + to see a problem + at their own institutions. + "Nobody had a full + +On line 2900: + regulators was, + ‘Well, there may be a problem. + But it’s not in my + +On line 2900: + view,’" Snow told the FCIC. + Regulators responded + to Snow’s questions by + +On line 2900: + rates are very low. Our + institutions are very well + capitalized. Our + + institutions [have] + very low delinquencies. So we + don’t see any real + +On line 2904: + problem."95 In May the + banking agencies did issue + guidance on the risks + +On line 2904: + and home equity + loans. It cautioned financial + institutions about + +On line 2904: + loan-to-value and + debt-to-income ratios, lower + credit scores, greater use + +On line 2904: + and the increase in + transactions generated + through a loan broker + +On line 2904: + third party. While this + guidance identified many of + the problematic + +On line 2904: + engaged in by bank + lenders, it was limited to + home equity loans. + +On line 2906: + to first mortgages.96 In + examiners from the Fed + and other agencies + +On line 2908: + confidential "peer + group" study of mortgage practices + at six companies + +On line 2908: + that together had + originated trillion in + mortgages in almost + +On line 2908: + national total. + In the group were five banks whose + holding companies + +On line 2908: + and Wells Fargo—as well + as the largest thrift, Washington + Mutual.97 The study + +On line 2908: + in the volume of + these irresponsible loans, + very risky loans," Sabeth + +On line 2908: + head of credit risk + at the Federal Reserve + Board’s Division of + +On line 2908: + Supervision and + Regulation, told the FCIC.98 + A large percentage + +On line 2908: + their loans issued were + subprime and Alt-A mortgages, and + the underwriting + +On line 2910: + for these products had + deteriorated.99 Once + the Fed and other + +On line 2910: + had identified the + mortgage problems, they agreed to + express those concerns + + to the industry + in the form of nonbinding + guidance. "There was among + +On line 2912: + Board of Governors + folks, you know, some who felt that + if we just put out + + guidance, the banks would + get the message," Bies said.100 The + federal agencies + +On line 2914: + drafted guidance on + nontraditional mortgages + such as option ARMs, + +On line 2914: + comment in late The + draft guidance directed lenders + to consider a + +On line 2914: + the loan payment when + rates adjusted, rather than just + the lower starting + +On line 2916: + loans should be "used with + caution."101 Immediately, + the industry was + +On line 2916: + The American Bankers + Association said the + guidance "overstate[d] + +On line 2916: + the guidance required + them to assume "a worst case + scenario," that is, the + +On line 2916: + which borrowers would + have to make the full payment + when rates adjusted.103 + +On line 2916: + that "almost any form + of documentation can + be appropriate."104 + +On line 2918: + denied that better + disclosures were required to + protect borrowers + +On line 2918: + nontraditional + mortgages, arguing that they + were "not aware of any + +On line 2920: + supports the need for + further consumer protection + standards."105 The need for + +On line 2920: + was controversial + within the agencies, too. "We + got tremendous pushback + +On line 2920: + industry as well + as Congress as well as, you + know, internally," + +On line 2920: + the FCIC. "Because it + was stifling innovation, + potentially, and + +On line 2922: + American dream to + many people."106 The pressures to + weaken and delay + +On line 2922: + were strong and came from + many sources. Opposition by + the Office of Thrift + + Supervision helped + delay the mortgage guidance + for almost a year.107 + + Bies said, "There was some + real concern about if the + Fed tightened down on + +On line 2922: + regulated], whether + that would create an un-level + playing field [for] stand-alone + +On line 2922: + the mortgage market + was Congress. She recalled an + occasion when she + + testified about a + proposed rule and "members of + Congress [said] that we + +On line 2922: + going to deny + the dream of homeownership + to Americans if + + we put this new stronger + standard in place."108 When guidance + was put in place in + +On line 2926: + institutions switched + regulators in search of + more lenient treatment. + +On line 2926: + Countrywide applied + to switch regulators from + the Fed and OCC to + +On line 2926: + OTS. Countrywide’s move + came after several months + of evaluation + +On line 2926: + the benefits of + OTS regulation, many of + which were promoted + +On line 2926: + OTS itself over the + course of an "outreach effort" + initiated in + +On line 2928: + John Reich became + director of the agency. + Publicly, Countrywide + +On line 2928: + the decision to + switch to the OTS was driven + by the desire to + +On line 2930: + holding company.109 + However, other factors + came into play as + +On line 2930: + OCC’s top Countrywide + examiner told the FCIC + that Countrywide CEO + + Angelo Mozilo + and President and COO David + Sambol thought the OCC’s + +On line 2932: + property appraisals + would be "killing the business."110 An + internal July + +On line 2934: + OTS regulation + of holding companies is + not as intrusive + +On line 2934: + of the Federal + Reserve. In particular, + the OTS rarely conducts + + extensive onsite + examinations and when + they do conduct an + +On line 2934: + regulator than + the Federal Reserve."111 In + August Mozilo wrote + +On line 2934: + his executive + team, "It appears that the Fed + is now troubled by + +On line 2934: + the OTS is not. Since + pay options are a major + component of both + +On line 2934: + and profitability + the Fed may force us into + a decision faster + +On line 2934: + would like." Countrywide + Chief Risk Officer John McMurray + responded that "based + +On line 2934: + with the FRB and OTS, + the OTS appears to be both + more familiar and + +On line 2936: + ARMs."112 The OTS approved + Countrywide’s application + for a thrift charter + +On line 2942: + March LEVERAGED LOANS AND + COMMERCIAL REAL ESTATE: + "YOU’VE GOT TO GET + +On line 2944: + AND DANCE" The credit + bubble was not confined to + the residential + +On line 2944: + (typically loans + to below-investment-grade + companies to aid + +On line 2944: + dynamics, although + the effects were not as large + and damaging as + +On line 2944: + in residential + real estate. From to these + other two markets + +On line 2944: + by structured finance + products—commercial mortgage–backed + securities and + +On line 2944: + loan obligations (CLOs), + respectively—which were in + many ways similar + + to residential + mortgage-backed securities and + CDOs. And just as in + +On line 2944: + standards loosened, even + as the cost of borrowing + decreased,113 and trading + +On line 2946: + Historically, + leveraged loans had been made by + commercial banks; but + +On line 2946: + institutional + investors developed and grew + in the mid- to late + + 1990s.115 An "agent" bank would + originate a package of + loans to only one + + company and then + sell or syndicate the loans + in the package to + +On line 2946: + large nonbank investors. + The package generally + included loans with + +On line 2946: + lines of credit, which + would be syndicated to + banks; the rest were longer-term + +On line 2946: + syndicated to + nonbank, institutional + investors. Leveraged loan + +On line 2946: + doubled from to but + the rapid growth was in the longer-term + institutional + +On line 2946: + rather than in short-term + lending. By the longer-term leveraged + loans rose to billion, + +On line 2948: + up from billion in + Starting in the longer-term leveraged + loans were packaged in + + CLOs, which were rated + according to methodologies + similar to those + +On line 2948: + for CDOs. Like CDOs, CLOs + had tranches, underwriters, + and collateral + +On line 2948: + The market was less + than billion annually + from to but then it + +On line 2950: + Annual issuance + exceeded billion in and + peaked above billion in + +On line 2950: + through the third quarter + of more than of leveraged loans + were packaged into + + CLOs.117 As the market + for leveraged loans grew, credit + became looser and + +On line 2952: + became larger and + costs of borrowing declined. + Loans that in had paid + +On line 2952: + of percentage points + over an interbank lending + rate were refinanced + +On line 2952: + in early into + loans paying just percentage + points over that same rate. + + During the peak of + the recent leveraged buyout + boom, leveraged loans were + +On line 2954: + to defer paying + interest by issuing + new debt to cover + +On line 2954: + interest. Covenant-lite + loans exempted borrowers + from standard loan covenants + +On line 2954: + usually require + corporate firms to limit + their other debts and + +On line 2954: + those that specialized + in investing directly + in companies, found + +On line 2954: + cheaper to finance + their leveraged buyouts. Just as + home prices rose, so too + + did the prices of the + target companies. One of + the largest deals ever + +On line 2956: + on April by KKR, a + private equity firm. KKR + said it intended + +On line 2956: + Corporation, a + processor of electronic + data including + +On line 2956: + debit card payments, + for about billion. As part of + this transaction, KKR + +On line 2956: + in junk bonds and take + out another billion in + leveraged loans from a + +On line 2956: + Deutsche Bank, Goldman Sachs, + HSBC Securities, Lehman + Brothers, and Merrill + +On line 2958: + As late as July + Citigroup and others were + still increasing their + + leveraged loan business.120 + Citigroup CEO Charles Prince then + said of the business, + +On line 2958: + music stops, in terms + of liquidity, things will + be complicated. + + But as long as the + music is playing, you’ve + got to get up and + + dance. We’re still dancing." + Prince later explained to the + FCIC, "At that point in + +On line 2958: + interest rates had + been so low for so long, the + private equity + + firms were driving very + hard bargains with the banks. And + at that point in time + +On line 2958: + participating + in this lending business. It + was not credible + +On line 2958: + one institution + to unilaterally back + away from this leveraged + + lending business. It + was in that context that I + suggested that all + +On line 2960: + up lending standards + in the leveraged lending area."121 + The CLO market would + +On line 2960: + up in the summer + of during the financial + crisis, just as the + +On line 2960: + roughly billion in + outstanding commitments for + new loans; as demand + +On line 2960: + the secondary market + dried up, these loans ended up + on the banks’ balance + +On line 2962: + and industrial + properties—went through a bubble + similar to that + +On line 2962: + the housing market. + Investment banks created + commercial mortgage– + +On line 2964: + securities and + even CDOs out of commercial + real estate loans, + +On line 2964: + with residential + mortgages. And, just as houses + appreciated + +On line 2964: + from on, so too did + commercial real estate + values. Office prices + +On line 2966: + between and in the + central business districts of + the markets for which + +On line 2968: + available. The increase + was in Phoenix, in Tampa, in + Manhattan, and in + +On line 2970: + Angeles.123 Issuance + of commercial mortgage–backed + securities rose + +On line 2970: + reaching billion in + When securitization + markets contracted, + +On line 2970: + issued billion of + commercial mortgage CDOs, a + number that again dropped + +On line 2974: + came together on + July when the Blackstone Group + announced its plan to + +On line 2974: + buy Hilton—a hotel chain + with properties—for billion, + a premium over + + the share price. A year + later, one author described + this deal as "the apogee + +On line 2974: + private equity + firms to buy out companies + at often absurd + + overvaluations, + saddle them with massive debt, + and then pay themselves + +On line 2974: + fees for the trouble."125 + Twenty billion dollars in + financing came from + +On line 2974: + investment banks and + large commercial banks such as + Bank of America + + and Deutsche Bank.126 Bear Stearns + was increasingly active + in these markets. While + +On line 2976: + in residential + securitizations, it + ranked in the bottom + + half in commercial + securitizations.127 But + it was racing to + +On line 2978: + established Bear Stearns + as a global presence in + commercial real + +On line 2980: + originations more + than doubled between and And + then the market came + +On line 2980: + a halt. Although the + commercial real estate + mortgage market was + +On line 2980: + market—in commercial + real estate debt was less + than trillion, compared + +On line 2980: + for residential + mortgages129—it declined even + more steeply. From its peak, + +On line 2980: + real estate fell + roughly in value, and prices + have remained close to + + their lows. Losses on + commercial real estate + would be an issue + +On line 2980: + And potentially + for the taxpayer. When the + Federal Reserve + +On line 2980: + assume billion of + Bear’s illiquid assets in that + would include roughly + +On line 2980: + unsold portion of + the Hilton financing package.130 + And the commercial + +On line 2980: + estate market would + continue to decline long + after the housing + +On line 2984: + to stabilize. LEHMAN: + FROM "MOVING" TO "STORAGE" Even + as the market was + +On line 2986: + its peak, Lehman took on + more risk. On October when + commercial real + +On line 2986: + of its assets, Lehman + Brothers acquired a major + stake in Archstone Smith, + +On line 2988: + investment trust, for + billion. Archstone owned more than + apartments, including + +On line 2988: + under construction, + in over communities in + the United States. It + +On line 2990: + would generate more + than billion in profits over + years—projections based + +On line 2990: + assumptions, given + the state of the market at + that point. Both Lehman and + + Archstone were highly + leveraged: Archstone had little + cushion if its rent + + receipts should go down, + and Lehman had little cushion + if investments such + +On line 2990: + lose value.132 Although + the firm had proclaimed that "Risk + Management is at + +On line 2990: + core of Lehman’s business + model," the Executive + Committee simply + +On line 2990: + its risk officer, + Madelyn Antoncic, out of + the loop when it made + + this investment.133 Since + the late 1990s, Lehman had also + built a large mortgage + +On line 2992: + and a powerful + underwriting division + as well. Then, in its + +On line 2992: + Richard Fuld and other + executives explained to + their colleagues a new + +On line 2992: + an aggressive growth + strategy, including greater + risk and more leverage. + +On line 2994: + a "storage" business, + in which Lehman would make and hold + longer-term investments.134 By + +On line 2994: + firm’s risk policies and + limits—and warnings from risk + managers—and pursued + + its "countercyclical + growth strategy." It had worked + well during prior + +On line 2994: + dislocations, and + Lehman’s management assumed that + it would work again.135 Lehman’s + +On line 2994: + unit continued to + originate Alt-A loans after + the housing market + +On line 2994: + also continued + to securitize mortgage + assets for sale but + + was now holding more + of them as investments. Across + both the commercial + +On line 2994: + estate sectors, the + mortgage-related assets on + Lehman’s books increased from + +On line 2994: + in to billion in + This increase would be part of + Lehman’s undoing a + +On line 2996: + rapid growth. The SEC, Lehman’s + main regulator, knew of + the firm’s disregard + +On line 2996: + management. The SEC + knew that Lehman continued to + increase its holding + +On line 2996: + SEC reports obtained + by the FCIC.137 Nonetheless, Erik + Sirri, who led the + + SEC’s supervision + program, told the FCIC that it + would not have mattered + + if the agency had + fully recognized the risks + associated + +On line 2996: + To avoid serious + losses, Sirri maintained, Lehman + would have had to start + +On line 2996: + assets in Instead, + it kept buying, well into + the first quarter of + +On line 2998: + according to the + bankruptcy examiner, + Lehman understated + +On line 2998: + balance sheet before + each reporting period. + Martin Kelly, Lehman’s + +On line 2998: + balance sheet." Other + Lehman executives described + Repo transactions + +On line 2998: + of managing the + balance sheet as opposed to + legitimately + +On line 2998: + quarter-end." Bart McDade, who + became Lehman’s president and + chief operating + +On line 3000: + an email called Repo + transactions "another drug + we R on."139 Ernst Young + +On line 3000: + Lehman’s auditor, was + aware of the Repo practice + but did not question + +On line 3000: + failure to publicly + disclose it, despite being + informed in May by + +On line 3000: + improper. The Lehman + bankruptcy examiner + concluded that E&Y + +On line 3000: + investigate the + Repo allegations, took + no steps to question + +On line 3000: + non-disclosure by Lehman," + and that "colorable claims exist + that E&Y did not meet + +On line 3000: + investigating + Lee’s allegations and in + connection with its + + audit and review + of Lehman’s financial statements."140 + New York Attorney + +On line 3000: + accusing the firm + of facilitating a + "massive accounting + +On line 3002: + about its financial + condition.141 The Office of + Thrift Supervision + +On line 3002: + regulated Lehman + since through its jurisdiction + over Lehman’s thrift subsidiary. + +On line 3002: + regulator," the + OTS examiner told the + FCIC, "we in no way + + just assumed that [the + SEC] would do the right thing, so + we regulated + + and supervised the + holding company."142 Still, not + until July 2008—just + + a few months before + Lehman failed— would the OTS issue + a report warning + +On line 3004: + had made an "outsized + bet" on commercial real + estate—larger than + +On line 3004: + its peer firms, despite + Lehman’s smaller size; that Lehman was + "materially + + overexposed" to the + commercial real estate + sector; and that Lehman + +On line 3006: + failings in its risk + management process."143 FANNIE MAE + AND FREDDIE MAC: "TWO + +On line 3008: + STARK CHOICES" In while + Countrywide, Citigroup, Lehman, + and many others in + +On line 3008: + and CDO businesses + were going into overdrive, + executives at + +On line 3008: + two behemoth GSEs, + Fannie and Freddie, worried + they were being left + +On line 3008: + Fannie would not buy + the new mortgages, Countrywide + President and COO + +On line 3008: + the FCIC.144 Typical + of the market as a whole, + Countrywide sold of + +On line 3012: + in and in "The risk + in the environment has + accelerated + +On line 3012: + Lund, Fannie’s head of + single-family lending, + told fellow senior + +On line 3012: + planning meeting on + June In a bulleted list, + he ticked off changes in + +On line 3014: + concern about housing + bubbles, growing concerns about + borrowers taking + + on increased risks and + higher debt, [and] aggressive + risk layering."146 "We + +On line 3016: + two stark choices: stay + the course [or] meet the market + where the market is," + +On line 3016: + If Fannie Mae stayed + the course, it would maintain its + credit discipline, + +On line 3016: + the quality of + its book, preserve capital, + and intensify + +On line 3016: + company’s public + voice on concerns. However, + it would also face + +On line 3016: + declines in market + share, lower earnings, and a + weakening of key + +On line 3016: + relationships.147 It + was simply a matter of + relevance, former + + CEO Dan Mudd told the + FCIC: "If you’re not relevant, + you’re unprofitable, and + + you’re not serving the + mission. And there was danger + to profitability. + +On line 3018: + speaking more long term + than in any given quarter + or any given year. + +On line 3020: + saw significant + obstacles to meeting the + market. He noted + +On line 3020: + offered by Wall Street, + its unfamiliarity + with the new credit + + risks, worries that the + price of the mortgages wouldn’t + be worth the risk, and + + regulatory + concerns surrounding certain + products.149 At this and + + other meetings, Lund + recommended studying whether + the current market + +On line 3020: + were cyclical or more + permanent, but he also + recommended that + +On line 3020: + capabilities + to compete in any mortgage + environment."150 Citibank + +On line 3020: + a presentation + to Fannie’s board in July + warning that Fannie + + was increasingly + at risk of being marginalized, + and that "stay the course" + +On line 3020: + the second-largest seller + of mortgages to Fannie, Citibank + would benefit from + + such a move. Over the + next two years, Citibank would increase + its sales to Fannie + +On line 3020: + more than a quarter, + to billion in the fiscal + year, while more than tripling + +On line 3024: + of interest-only + mortgages, to billion.152 Lund told + the FCIC that in the + +On line 3024: + recommendation: + for the time being, Fannie + would "stay the course," while + +On line 3024: + capabilities + to compete with Wall Street in + nonprime mortgages.153 In + +On line 3024: + reports show that by + September the company + had already begun + +On line 3024: + its acquisitions + of riskier loans. By the end + of its Alt-A loans were + +On line 3028: + from billion in and + its interest-only mortgages + were billion in up + +On line 3028: + billion in (Note that + these categories can overlap. + For example, Alt-A + + loans may also lack + full documentation.) To + cover potential + +On line 3028: + had a total of + billion in capital at + the end of "Plans to + +On line 3028: + market share targets + resulted in strategies to + increase purchases + +On line 3028: + prudent credit risk + management and corporate + business objectives," + +On line 3028: + (the successor to + the Office of Federal + Housing Enterprise + +On line 3028: + Oversight) would write in + September on the eve of + the government takeover + +On line 3030: + Mae. "Since Fannie Mae + has grown its Alt-A portfolio + and other higher + +On line 3032: + adequate controls + in place."154 In its financial + statements, Fannie Mae’s + + disclosures about key + loan characteristics changed + over time, making it + +On line 3032: + of a "subprime" loan + was one originated by + a company or + +On line 3032: + Fannie Mae stated + that subprime loans accounted + for less than of its + +On line 3032: + during those years even + while it reported that of + its conventional, + +On line 3036: + portfolios quickly + with limited capital.156 + In CEO Richard Syron + +On line 3036: + Andrukonis, Freddie’s + longtime chief risk officer. + Syron said one of + +On line 3036: + the FCIC, "I had a + legitimate difference + of opinion on how + +On line 3036: + dangerous it was. + Now, as t turns out he was + able to foresee the + +On line 3036: + better than a lot + of the rest of us could."157 The + new risk officer, + +On line 3036: + to the FCIC staff that + he repeatedly made the + case for increasing + +On line 3036: + vice president for + single-family housing, + told FCIC staff that he + + did not recall such + discussions.159 Syron never + made Saksena part + +On line 3038: + of riskier loans and + securities in every + examination + +On line 3040: + never told the GSEs + to stop. Rather, year after year, + the regulator + +On line 3040: + both companies had + adequate capital, strong + asset quality, + +On line 3042: + active officers + and directors. In May at + the same time as it + +On line 3042: + penalty related + to deficiencies in its + accounting practices, + +On line 3042: + mortgage portfolio + to billion, the level on + December Two months + +On line 3042: + later, Freddie agreed + to limit the growth of its + portfolio to per + +On line 3042: + examination + reports for the year issued + to both companies + +On line 3042: + noted the growth in + purchases of risky loans and + non-GSE securities + +On line 3044: + examination + of Fannie was limited + in scope—focusing + + primarily on + the company’s efforts to + fix accounting and + +On line 3044: + of the extensive + resources needed to complete + a three-year special + +On line 3048: + report on Fannie + Mae detailed the "arrogant + and unethical + + corporate culture + where Fannie Mae employees + manipulated + +On line 3050: + trigger bonuses for + senior executives from + to OFHEO Director + + James Lockhart (who had + assumed that position the + month the report was + +On line 3050: + during the special + examination an email + from Mudd, then Fannie’s + +On line 3052: + to CEO Franklin Raines. Mudd + wrote, "The old political + reality [at + +On line 3054: + was that we always + won, we took no prisoners + we used to be able + +On line 3056: + or have written rules + that worked for us."165 Soon after + his arrival, Lockhart + +On line 3056: + for legislation + was obvious as OFHEO was + regulating two + +On line 3056: + institutions," he + told the FCIC.166 But no reform + legislation would + +On line 3058: + July and by then + it would be too late. "Increase + our penetration + +On line 3060: + After several + years during which Fannie Mae + purchased riskier loans + + and securities, + then-Chief Financial Officer + Robert Levin proposed a + +On line 3060: + subprime" at Fannie’s + January board meeting.167 In + the next month the board + +On line 3060: + and more aggressive + in its purchases. During + a summer retreat + + for Fannie’s senior + officers, as Stephen Ashley, + the chairman of the + +On line 3060: + Enrico Dallavecchia, + he declared that the new CRO + would not stand in the + +On line 3060: + of risk taking: "We + have to think differently + and creatively about + +On line 3060: + compliance, and about + controls. Historically + these have not been strong + +On line 3062: + suits of Fannie Mae. + Today’s thinking requires that + these areas become + + active partners with + the business units and be viewed + as tools that enable + +On line 3062: + and address market + needs. Enrico Dallavecchia was + not brought on-board to be + +On line 3066: + acquired billion of + loans; of those (including some + overlap), billion, or + +On line 3068: + and billion of Alt-A + non-GSE mortgage-backed securities.171 + The total amount of + +On line 3070: + larger multiples + of capital than before. + At least initially, + + while house prices were still + increasing, the strategic plan + to increase risk and + +On line 3070: + successful. Fannie + reported net income of + billion in and then + +On line 3070: + in In those two years, + CEO Mudd’s compensation + totaled million and + +On line 3072: + interim CFO and + then chief business officer, + received million.172 In + +On line 3072: + risk, "expand[ing] the + purchase and guarantee of + higher-risk mortgages to + +On line 3072: + competitive, and + be responsive to sellers’ + needs."173 It lowered its + +On line 3072: + products, offered to + a broader range of customers + than ever before, + +On line 3072: + for about of that year’s + purchases. Freddie Mac’s plan + also seemed to be + +On line 3072: + for and billion.174 CEO + Richard Syron’s compensation + totaled million for + +On line 3072: + and combined,175 while Chief + Operating Officer + Eugene McQuade received + +On line 3074: + Again, OFHEO was aware of + these developments. Its March + report noted that + +On line 3074: + to purchase higher-risk + products included a plan + to capture of the + +On line 3074: + OFHEO reported that + credit risk increased "slightly" + because of growth in + + subprime and other + nontraditional products. + But overall asset + + quality in its + single-family business + was found to be "strong," + + and the board members + were "qualified and active." + And, of course, Fannie + +On line 3078: + Similarly, OFHEO + told Freddie in that it had + weaknesses that raised + +On line 3078: + strength and financial + capacity made failure + unlikely.178 Freddie + +On line 3078: + a "significant + supervisory concern,"179 + and OFHEO noted the + +On line 3078: + higher-risk mortgages.180 But + again, as in previous years, + the regulator + +On line 3080: + asset quality + and credit risk management + were "strong."181 The GSEs charged + +On line 3080: + for guaranteeing + payments on GSE mortgage–backed + securities, and + +On line 3080: + Fannie’s practice of + charging less to guarantee + securities than + +On line 3080: + indicated was + appropriate. Mark Winer, + the head of Fannie’s + +On line 3080: + Group since May and the + person responsible for + odeling pricing fees, + +On line 3080: + Fannie Mae was not + charging fees for Alt-A mortgages + that adequately + + compensated for + the risk. Winer recalled that + Levin was critical + +On line 3080: + models, asking, "Can + you show me why you think you’re + right and everyone + +On line 3080: + to Todd Hempstead, the + senior vice president at + Fannie in charge of + +On line 3080: + western region.183 Mudd + acknowledged the difference + between the model + +On line 3080: + fee actually + charged and also told the FCIC + that the scarcity of + +On line 3082: + data for many loans + caused the model fee to be + unreliable.184 In + +On line 3082: + that would recommend + that Fannie be placed into + conservatorship, + + OFHEO would expressly + cite this practice as unsafe + and unsound: "During + +On line 3082: + and modeled loan fees + were higher than actual + fees charged, due to an + +On line 3082: + on growing market + share and competing with Wall + Street and the other + +On line 3086: + GSE."185 "Moving deeper + into the credit pool" By + the time housing prices + +On line 3086: + the second quarter + of delinquencies had started + to rise. During the + +On line 3086: + held in April Lund said + that dislocation in the + housing market was + +On line 3086: + Fannie to reclaim + market share. At the same time, + Fannie would support + +On line 3086: + Fannie’s market share + could increase to from about in + Indeed, in Fannie + +On line 3086: + ahead, purchasing more + high-risk loans.188 Fannie also + purchased billion of + +On line 3088: + non-GSE securities, + and billion of Alt-A.189 In June, + Fannie prepared its + +On line 3088: + strategic plan, titled + "Deepen Segments—Develop Breadth." The plan, which + mentioned Fannie’s "tough + +On line 3088: + debt market"—included + taking and managing "more + mortgage credit risk, + +On line 3088: + deeper into the + credit pool to serve a large + and growing part of + + the mortgage market." + Overall, revenues and earnings + were projected to + +On line 3090: + of the following + five years.190 Management told the + board that Fannie’s risk + + management function + had all the necessary means + and budget to act + + on the plan. Chief Risk + Officer Dallavecchia did not + agree, especially + +On line 3090: + in light of a planned + cut in his budget. In a + July email to CEO + + Mudd, Dallavecchia wrote that + he was very upset that he + had to hear at the + +On line 3090: + meeting that Fannie + had the "will and the money + to change our culture + + and support taking + more credit risk," given the + proposed budget cut + +On line 3092: + for his department + in after a reduction + in headcount in In + +On line 3092: + had written to Chief + Operating Officer + Michael Williams that Fannie + +On line 3092: + "one of the weakest + control processes" that he + "ever witnessed in + +On line 3092: + [his] career, was not + even close to having proper + control processes + + for credit, market + and operational risk," and + was "already back to + +On line 3092: + These deficiencies + indicated that "people + don’t care about the [risk] + + function or they don’t + get it."192 Mudd responded, "My + experience is + +On line 3096: + a very good venue for + conversation, venting or + negotiating." + + If Dallavecchia felt that + he had been dealt with in bad + faith, he should "address + +On line 3096: + to man," unless he + wanted Mudd "to be the one + to carry messages + + for you to your peers." + Mudd concluded, "Please come and + see me today face + + to face."193 Dallavecchia told + the FCIC that when he wrote this + email he was tired and + +On line 3096: + and that the view it + expressed was more extreme than + what he thought at the + +On line 3096: + guarantee higher-risk + mortgages in would report a + billion net loss for + +On line 3096: + by credit losses. + In Mudd’s compensation + totaled million and + +On line 3100: + also persisted + in increasing purchases + of riskier loans. A + + strategic plan from March + highlighted "pressure on the + franchise" and the "risk + + of falling below + our return aspirations."195 + The company would + +On line 3100: + to improve earnings + by entering adjacent + markets: "Freddie Mac + +On line 3100: + non-GSE participants + in nonprime," the strategy + document explained. + +On line 3100: + opportunity + to expand into markets + we have missed—Subprime and Alt-A."196 + +On line 3100: + OFHEO would note in its + examination report, + Freddie purchased and + +On line 3100: + characteristics, + including interest-only + loans, loans with FICO + +On line 3100: + than loans with higher + loan-to-value ratios, loans + with high debt-to-income + +On line 3100: + documentation. + Financial results in were + poor: a billion net + +On line 3100: + driven by credit + losses. The value of the + billion subprime and + +On line 3100: + securities book + suffered a billion decline + in market value.197 + +On line 3102: + housing goals: "GSEs cried + bloody murder forever" As + discussed earlier, + +On line 3102: + set goals for the GSEs + related to increasing + homeownership among + +On line 3102: + and borrowers in + underserved areas. Until + these goals were based on + +On line 3102: + were intended to + be only a modest reach + beyond the mortgages + +On line 3104: + normally purchase.198 + From to of GSE purchases + were required to meet + +On line 3104: + low-and moderate-income + borrowers. In the goal was + raised to Mudd said that + + as long as the goals + remained below half of the + GSEs’ lending, loans made + + in the normal course + of business would satisfy + the goals: "What comes in + +On line 3104: + through the natural + course of business will tend to + match the market, and + + therefore will tend to + meet the goals."200 Levin told the FCIC + that "there was a great + + deal of business that + came through normal channels that + met goals" and that most + +On line 3106: + that satisfied the + goals "would have been made anyway."201 + In HUD announced that + +On line 3106: + starting in of the + GSEs’ purchases would need to + satisfy the low- + +On line 3108: + and moderate-income + goals. The targets would reach in + and in Given the + + dramatic growth in + the number of riskier loans + riginated in + + the market, the new + goals were closer to where the + market really + +On line 3110: + But, as Mudd noted, + "When became ultimately, + then you have to work + +On line 3110: + more attention, and + create a preference for + those loans."203 Targeted + +On line 3110: + specifically to + meet the targets), while always + a small share of the + +On line 3112: + rose in importance. + Mudd testified that by when + the housing market + +On line 3112: + Fannie Mae could no + longer balance its obligations + to shareholders with + +On line 3112: + demands: "There may have + been no way to satisfy + of the myriad + + demands for Fannie + Mae to support all manner + of projects [or] housing + + goals which were set above + the origination levels + in the marketplace."204 + +On line 3116: + combined size of the + GSEs rose steadily from trillion + in to trillion in + +On line 3116: + GSEs needed to serve + in order to fulfill the + affordable housing + +On line 3116: + were stretching to meet + the higher goals, according + to a number of + + GSE executives, + OFHEO officials, and market + observers. Yet all but + + two of the dozens of + current and former Fannie + Mae employees and + +On line 3118: + the subject told the + FCIC that reaching the goals was + not the primary + +On line 3118: + the GSEs’ purchases + of riskier mortgages and of + subprime and Alt-A non-GSE + +On line 3118: + to originators’ + demands, and responding to + shareholder demands + +On line 3118: + increase market share + and profits, in addition + to fulfilling the + +On line 3118: + meeting affordable + housing goals and providing + liquidity to + +On line 3120: + For example, Levin + told the FCIC that while Fannie, + to meet its housing + + goals, did purchase some + subprime mortgages and mortgage-backed + securities it + + would otherwise have + passed up, Fannie was driven + to "meet the market" + +On line 3120: + reverse declining + market share. On the other + hand, he said that most + +On line 3120: + would not have counted + toward the goals, so those were + purchased solely to + +On line 3120: + Similarly, Lund + told the FCIC that the desire + for market share was + +On line 3120: + Fannie’s strategy + in Housing goals had been a + factor, but not the + + primary one.207 And + Dallavecchia likewise told the FCIC + that Fannie increased + +On line 3120: + purchases of Alt-A + loans to regain relevance + in the market and + +On line 3122: + customer needs.208 Hempstead, + Fannie’s principal contact + with Countrywide, told + +On line 3122: + that while housing goals + were one reason for Fannie’s + strategy, the main + +On line 3122: + Fannie entered the + riskier mortgage market was + that those were the types + +On line 3122: + originated in + the primary market.209 If + Fannie wanted to + +On line 3122: + large quantities of + loans, the company would need + to buy riskier loans. + +On line 3122: + vice president of + multifamily lending, + said much the same thing, + +On line 3122: + also wanted to + see market share and returns + rise.210 Former Fannie + +On line 3124: + chairman Stephen Ashley + told the FCIC that the change in + strategy in and + +On line 3124: + was owed to a "mix + of reasons," including the + desire to regain + + market share and the + need to respond to pressures + from originators + +On line 3124: + as to pressures from + real estate industry + advocates to be + + more engaged in the + marketplace.211 To ensure an + adequate supply + +On line 3128: + in case the goals were + not met in the normal course + of business, Fannie + +On line 3128: + for originators + and brokers.212 In addition, + as explained by Mike + +On line 3128: + responsible for + the goals, Fannie set lower + fees on loans that met + +On line 3128: + it would not purchase + mortgages that fell outside its + predetermined risk + +On line 3128: + that Fannie did not + shift eligibility + or underwriting + +On line 3128: + instead directed + its resources to marketing + and promotional + +On line 3128: + partnership offices. + "The effort was really + in the outreach as + + opposed to reduced + or diminished or loosened + standards," Ashley told + +On line 3130: + testified that the + GSEs invested in subprime + and Alt-A mortgages in + +On line 3130: + to increase profits + and regain market share and + that any impact on + +On line 3130: + attributed the GSEs’ + change in strategy to their + drive for profit and + + market share, as well + as the need to meet housing + goals. Noting that the + +On line 3130: + housing goals increased + markedly in he said in an + FCIC interview that + + the "goals were just one + reason, certainly not the + exclusive reason" + + for the change.217 These views + were corroborated by + numerous other + +On line 3132: + from the agency.218 The + former HUD official Mike + Price told the FCIC that + + while the "GSEs cried bloody + murder forever" when it + came to the goals, they + +On line 3132: + contribution to + increasing homeownership. + In addition, Price + +On line 3134: + HUD officials told + the FCIC that the GSEs never + claimed that meeting the + +On line 3136: + in an unsafe or + unsound condition.219 Indeed, + the law allowed both + +On line 3136: + Mac to fall short of + meeting housing goals that were + "infeasible" or + +On line 3136: + companies’ safety + and soundness.220 And while the GSEs + often exceeded + +On line 3136: + goals, in some cases + those targets were adjusted + downward by HUD or, + +On line 3136: + were simply missed by + the GSEs.221 For example, on + December Mudd wrote + +On line 3136: + Mae believes that the + low- and moderate-income and + special affordable + +On line 3136: + anticipated + such a communication, + stating, "In the event + + we reach a viewpoint + that achieving the goals this year + is ‘infeasible,’ + +On line 3138: + how best to address + the matter with HUD and will + continue to keep + +On line 3138: + accordingly."223 In + fact, both Fannie and Freddie + appealed to HUD to + +On line 3140: + complied and allowed + the GSEs to fall short without + any consequences.224 The + + impact of the goals + At least until HUD set new + affordable housing + +On line 3142: + for the GSEs only + supplemented their routine + purchases with a + +On line 3142: + and non-GSE mortgage–backed + securities needed to + meet their requirements. + + The GSEs knew that they + might not earn as much on these + targeted goal loans + +On line 3142: + non-goal-qualifying + loans purchased in the usual + course of business; on + +On line 3142: + administrative + and other costs related + to the housing goals. + +On line 3144: + In June Freddie Mac + staff made a presentation + to the Business and + + Risk Committee of + the Board of Directors on + the costs of meeting + +On line 3146: + goals. From to the cost + of the targeted goal loans + was effectively + +On line 3146: + more challenging and + cost Freddie money in the + multifamily + +On line 3146: + after did meeting + the multifamily and + single-family + +On line 3146: + cost the GSE money. + Still, only about of all loans + purchased by Freddie + +On line 3146: + between and were bought + "specifically because they + contribute to the + +On line 3146: + loans did have higher + than average expected + default rates, although + +On line 3146: + fee to guarantee + them. From through Freddie’s costs of + complying with the + +On line 3146: + averaged million + annually. The costs of + complying with these + +On line 3146: + took into account + three components: expected + revenues, expected + +On line 3146: + and foregone revenues + (based on an assumption of + what they might have earned + + elsewhere). These costs were + only computed on the + narrow set of loans + +On line 3146: + to achieve the goals, as + opposed to goal-qualifying + loans purchased in the + +On line 3148: + earnings averaged + just under billion per year + from to In Fannie + +On line 3148: + McKinsey and Citigroup + to determine whether it would + be worthwhile to give + +On line 3148: + and put constraints on + business practices, including + its mission goals. The + + final report to + Fannie Mae’s top management, + called Project Phineas, found that + +On line 3148: + the explicit cost + of compliance with the goals + from to was close to + +On line 3148: + hard to discern a + fundamental marginal + cost to meeting the + + housing goals on the + single family business + side."227 The report came + +On line 3150: + greater difficulty + of meeting the goals in the + refinancing boom: + + the large numbers of + homeowners refinancing, + in particular + +On line 3150: + and upper income, + necessarily reduced + the percentage of + +On line 3152: + qualify for the + goals. In calculating these + costs, the consultants + +On line 3152: + difference between + fees charged on goal-qualifying + loans and the higher + + fees suggested by + Fannie’s own models. But this + cost was not unique to + +On line 3152: + qualifying loans. + Across its portfolio, Fannie + charged lower fees than + +On line 3152: + models computed + for goals loans as well as for + non-goals loans. As a + +On line 3152: + Fannie’s discount was + actually smaller for + many goal-qualifying + +On line 3154: + for the others from + to Facing more aggressive + goals in and Fannie + +On line 3154: + loans. These included + mortgages acquired under the + My Community + +On line 3154: + looser standards, and + manufactured housing loans. + For these loans, Fannie + +On line 3154: + opportunity + cost (foregone revenues based on + an assumption of + + what they might have earned + elsewhere) along with the so-called + cash flow cost, or the + + difference between + their expected losses and + expected revenue + +On line 3154: + these loans. For as the + market was peaking, Fannie + Mae estimated + +On line 3154: + cash flow cost of the + loans to be million and the + opportunity + +On line 3154: + of the targeted + goals loans million, compared to + net income that year + +On line 3154: + of billion—a figure + that includes returns on the + goal-qualifying loans + +On line 3154: + course of business.228 The + targeted goals loans amounted + to billion, or of + +On line 3154: + single-family + mortgage purchases in As + the markets tightened + +On line 3154: + the middle of the + opportunity cost for + that year was forecast + +On line 3156: + Looking back at how + the targeted affordable + portfolio performed + +On line 3156: + at Freddie Mac took + the analysis of the goals’ + costs one step further. + +On line 3156: + While the outstanding + billion of these targeted + affordable loans was + +On line 3156: + portfolio, these were + relatively high-risk loans + and were expected + +On line 3156: + to account for of + total projected losses. + In fact, as of late + +On line 3156: + had accounted for + only of losses—meaning + that they had performed + +On line 3156: + whole portfolio. The + company’s major losses + came from loans acquired + +On line 3156: + the normal course of + business. The presentation + noted that many of + +On line 3158: + perform adequate + due diligence on the mortgages + they purchased and at + +On line 3158: + Potential investors + were not fully informed or + were misled about the + +On line 3158: + some mortgage-related + securities. These problems + appear to have been + + significant. The + Securities and Exchange + Commission failed to + +On line 3158: + securities from + its review, and preempted + states from applying + +On line 3158: + law to them, thereby + failing in its core mission + to protect investors. + +On line 3160: + to recognize the + cataclysmic danger posed by + the housing bubble + + to the financial + system and refused to take + timely action to + +On line 3160: + believing that it + could contain the damage from + the bubble’s collapse. + +On line 3162: + standards and practices + created conditions that + were ripe for mortgage + +On line 3172: + THE MADNESS CONTENTS + CDO managers: "We are not a + rent-a-manager" + +On line 3176: + Credit default swaps: + "Dumb question"..............................................................190 Citigroup: "I + do not believe we + +On line 3180: + powerless"..................................................195 AIG: "I’m + not getting paid enough to stand + on these tracks" Merrill: + +On line 3182: + "Whatever it takes" + Regulators: "Are undue + concentrations of + +On line 3186: + developing1" Moody’s: + "It was all about revenue"....................................................................206 The + collateralized + +On line 3186: + could have sputtered to + a natural end by the + spring of Housing prices + +On line 3186: + started to slow down + its business of insuring + subprime-mortgage CDOs. + +On line 3186: + that Wall Street didn’t + need its golden goose any more. + Securities firms + + were starting to take + on a significant share + of the risks from their + +On line 3186: + deals, without AIG as + the ultimate bearer of + the risk of losses + +On line 3186: + "That just seemed kind of + odd, given everything we + had seen and what we + +On line 3186: + Gary Gorton, a Yale + finance professor who had + designed AIG’s model + + for analyzing + its CDO positions, told the + FCIC.1 The CDO machine + +On line 3190: + promoters of CDOs, + Citigroup, Merrill Lynch, and + UBS— apparently + + did not accept or + perhaps even understand the + risks inherent in + + the products they were + creating. More and more, the + senior tranches were + +On line 3190: + securities firms, + the mezzanine tranches were + bought by other CDOs, + +On line 3190: + equity tranches + were bought by hedge funds that were + often engaged in + +On line 3190: + made money when the + CDOs performed, but could also + make money if the + +On line 3190: + These factors helped keep + the mortgage market going + long after house prices + +On line 3192: + ultimately bring + many of them to the brink of + failure. The subprime + +On line 3192: + pioneer Lewis Ranieri + called the willing suspension + of prudent standards + +On line 3198: + madness." He told the + FCIC, "You had the breakdown of + the standards, because + +On line 3200: + the checks and balances + that normally would have stopped + them."2 Synthetic CDOs + +On line 3200: + opportunities + for bullish and bearish investors + to bet for and against + +On line 3200: + that depended on + it. Synthetic CDOs also + made it easier + + for investment banks + and CDO managers to create + CDOs more quickly. But + +On line 3202: + sets of customers, each + with different interests. + And managers sometimes + +On line 3202: + in selecting the + collateral—including + those who were betting + +On line 3202: + collateral, as + a high-profile case launched by + the Securities + +On line 3204: + would eventually + illustrate.3 Regulators + reacted weakly. + +On line 3204: + recognized that CDOs + and credit default swaps (CDS) + could actually + + concentrate rather than + diversify risk, but they + concluded that Wall + +On line 3204: + issued guidance in + late warning banks of the risks + of complex structured + +On line 3204: + securities and + CDOs, because they saw the risks + of those products as + +On line 3208: + straightforward and well + understood.4 Disaster was + fast approaching. CDO + +On line 3210: + During the "madness," + when everyone wanted a + piece of the action, + +On line 3210: + declined, as demand + for mortgage-backed securities + drove up prices, squeezing + +On line 3210: + they made on CDOs. At + the same time, new CDO managers + were entering the + +On line 3210: + CDO manager who + frequently worked with Merrill + Lynch, said the fees fell + +On line 3210: + compensation could + be maintained by creating + and managing more + + new product. More than + had been the case three or four + years earlier, in + +On line 3212: + were influenced by + the underwriters—the + securities firms + +On line 3212: + and marketed the + deals. An FCIC survey of CDO + managers confirmed this + + point.6 Sometimes managers + were given a portfolio + constructed by the + + securities firm; + the managers would then choose the + mortgage assets from + +On line 3214: + in the first place—also + influenced the selection + of assets in many + +On line 3216: + rent-a-manager, + we actually select + our collateral," + +On line 3216: + securities firms + often had particular + CDO managers with whom + +On line 3216: + CDOs underwritten + by Merrill frequently bought + tranches of other + +On line 3218: + CDOs. According to + market participants, CDOs + stimulated greater + +On line 3218: + the greater demand in + turn affected the standards + for originating + +On line 3220: + underlying those + securities.8 As standards + fell, at least one firm + + opted out: PIMCO, + one of the largest investment + unds in the country, + +On line 3222: + whose CDO management + unit was one of the nation’s + largest in Early in + +On line 3222: + it announced that it + would not manage any new deals, + in part because of + +On line 3222: + credit quality + of mortgage-backed securities. + "There is an awful + +On line 3222: + sector," Scott Simon, + a managing director + at PIMCO, told the + +On line 3222: + audience at an + industry conference in + "You either take the + +On line 3222: + don’t—we’re not going + to hurt accounts or damage + our reputation + +On line 3222: + were being applied + to new types of subprime and + AltA loans with little + +On line 3222: + performance data.9 + Not everyone agreed with this + viewpoint. "Managers who + + are sticking in this + business are doing it right," + Armand Pastine, the + + chief operating + officer at Maxim Group, + responded at that + +On line 3222: + "To suggest that CDO + managers would pull out of an + economically + + viable deal for moral + reasons—that’s a cop-out."10 As was + typical for the + +On line 3222: + during the crisis, + two of Maxim’s eight mortgage-backed + CDOs, Maxim High Grade + +On line 3222: + I and Maxim High + Grade CDO II, would default on + interest payments + + to investors—including + investors holding bonds that had + originally been + +On line 3222: + triple-A—and the other six + would be downgraded to junk + status, including + +On line 3224: + also changed the CDOs: + in and CDO managers were less + likely to put their + + own money into + their deals. Early in the decade, + investors had taken + +On line 3224: + managers’ investment + in the equity tranche of + their own CDOs to be + + an assurance of + quality, believing that + if the managers were + +On line 3224: + the risk of loss, they + would have an incentive to + pick collateral + +On line 3224: + lost force as the amount + of managers’ investment per + transaction declined + +On line 3224: + Capital, provides + a good illustration of + this trend. ACA held of + +On line 3226: + the equity in + the CDOs it originated + in and and of two + +On line 3226: + it originated + in between and of deals in + and between and of + +On line 3228: + And synthetic CDOs, + as we will see, had no fail-safe + at all with regard + +On line 3228: + managers’ incentives. + By the very nature of the + credit default swaps + + bundled into these + synthetics, customers on the + short side of the deal + +On line 3232: + credit default swap, + a complex instrument that + mimicked the timing + +On line 3232: + which these new swaps were + bundled were much easier + to issue and sell. + +On line 3234: + a second major + development, introduced + in January the + +On line 3234: + credit default swaps + on mortgage-backed securities. + Known as the ABX.HE, + + it was really + a series of indices, meant + to act as a sort + +On line 3234: + Jones Industrial + Average for the nonprime + mortgage market, and + +On line 3234: + popular way to + bet on the performance of + the market. Every + +On line 3234: + securities in + each of five ratings-based tranches: + AAA, AA, A, BBB, and + +On line 3236: + Investors who believed + that the bonds in any given + category would + + fall behind in their + payments could buy protection + through credit default + + swaps. As demand for + protection rose, the index + would fall. The index + +On line 3238: + the confidence of + the market. Synthetic CDOs + proliferated, + +On line 3238: + it was much quicker + and easier for managers + to assemble a + +On line 3238: + CDO out of mortgage-backed + securities. "The beauty + in a way of the + + synthetic deals is + you can look at the entire + universe, you don’t have + + to go and buy the + cash bonds," said Laura Schwartz of + ACA Capital.14 There + +On line 3238: + no warehousing costs + or associated risks. + And they tended to + +On line 3238: + estimated that + the equity tranche on a + synthetic CDO could + +On line 3238: + typically yield + about while the equity tranche + of a typical + +On line 3240: + cash CDO could pay An + important driver in the + growth of synthetic + +On line 3240: + credit default swaps + on mortgage-backed securities. + Greg Lippmann, a Deutsche + +On line 3242: + trader, told the FCIC + that he often brokered these + deals, matching the "shorts" + +On line 3242: + minimizing any + risk for his own bank. Lippmann + said that between and + +On line 3244: + he brokered deals for + at least and maybe as many as + hedge funds that wanted + +On line 3244: + mezzanine tranches + of mortgage-backed securities. + Meanwhile, on the long + +On line 3244: + our CDS purchases + were from UBS, Merrill, and Citibank, + because they were the + +On line 3244: + [synthetic] CDOs."16 In + many cases, they were buying + those positions from + + Lippmann to put them + into synthetic CDOs; as + it would turn out, the + +On line 3244: + would retain much of + the risk of those synthetic + CDOs by keeping the + + super-senior and triple-A + tranches, selling below-triple-A tranches + largely to other + +On line 3246: + selling equity + tranches to hedge funds. Issuance + of synthetic CDOs + +On line 3246: + from billion in to + billion just one year later. + (We include all CDOs + +On line 3246: + or more synthetic + collateral; again, unless + otherwise noted, + +On line 3246: + to CDOs that include + mortgage-backed securities.) Even + CDOs that were labeled + +On line 3246: + of billion in CDOs + were issued in including + those labeled as cash, + +On line 3246: + or synthetic; the + FCIC estimates that of the + collateral was + +On line 3248: + with in and in The + advent of synthetic CDOs + changed the incentives + +On line 3248: + CDO managers and hedge + fund investors. Once short investors + were involved, the CDO + +On line 3248: + types of investors with + opposing interests: those + who would benefit + +On line 3248: + who would benefit + if the mortgage borrowers + stopped making payments + +On line 3250: + to perform. Even the + incentives of long investors + became conflicted. + +On line 3250: + sophisticated + investors to place bets against the + housing market or + +On line 3250: + more complex trading + strategies. Investors, usually + hedge funds, often used + +On line 3250: + default swaps to take + offsetting positions in + different tranches + +On line 3250: + security; that + way, hey could make some money + as long as the CDOs + + performed, but they stood + to make more money if the + entire market crashed. + +On line 3250: + survey of more than + hedge funds encompassing over + trillion in assets + +On line 3250: + early found this to + be a common strategy + among medium-size hedge + +On line 3250: + funds: of all the CDOs + issued in the second half + of more than half of + +On line 3250: + was being used in + the mortgage-backed securities + market as well. The + +On line 3252: + the largest hedge funds held + billion in equity and + other lower-rated + +On line 3254: + more than offset by + billion in short positions.19 + These types of trades changed + +On line 3254: + traditionally + had the greatest incentive + to monitor the + + credit risk of an + underlying portfolio. + With the advent of + +On line 3256: + default swaps, it was + no longer clear who—if anyone—had + that incentive. For + +On line 3258: + Merrill Lynch’s billion + Norma CDO, issued in The + equity investor, + +On line 3258: + Capital, a hedge + fund, was executing a + common strategy + +On line 3258: + the correlation + trade—it bought the equity tranche + while shorting other + + tranches in Norma + and other CDOs. According + to court documents, + +On line 3258: + was also involved + in selecting assets for + Norma.20 Magnetar + +On line 3258: + this transaction and + NIR Capital Management, + the CDO manager, + +On line 3258: + additional fees.21 + Magnetar’s counsel told the + FCIC that the million + +On line 3258: + discount in the form + of a rebate on the price + of the equity + +On line 3258: + positions purchased + by Magnetar and not a + payment received in + +On line 3258: + for good or services.22 + Court documents indicate + that Magnetar was + +On line 3258: + collateral, and + that NIR abdicated its + asset selection + +On line 3258: + had executed + approximately million + in trades for Norma + +On line 3260: + colleagues, "Dumb question. + Is Magnetar allowed to + trade for NIR1"23 Merrill + +On line 3260: + failed to disclose that + Magnetar was paid million + or that Magnetar + +On line 3262: + position that would + benefit from losses.24 The + counsel for Merrill’s + + new owner, Bank of + America, explained to the + FCIC that it was a + + common industry + practice for "the equity + investor in a CDO, + +On line 3264: + input during the + collateral selection + process[;] however, the + +On line 3264: + The letter did not + specifically mention the + Norma CDO. Bank of + +On line 3264: + produce documents + related to this issue + requested by the + +On line 3266: + instruments inside + synthetic CDOs. In April the + SEC charged Goldman Sachs + +On line 3266: + Management, had picked + the underlying assets + in a CDO when in + +On line 3266: + a short investor, the + Paulson Co. hedge fund, had played + a "significant + +On line 3266: + Goldman’s marketing + materials for Abacus + 2007-AC1, one of Goldman’s + +On line 3270: + deals.26 Ira Wagner, + the head of Bear Stearns’s CDO Group + in told the FCIC that + + he rejected the + deal when approached by Paulson + representatives. + + When asked about Goldman’s + contention that Paulson’s picking the + collateral was + +On line 3270: + collateral was + disclosed and because Paulson + was not well-known at + +On line 3270: + time, Wagner called + the argument "ridiculous." He + said that the structure + + encouraged Paulson + to pick the worst assets. While + acknowledging the + +On line 3270: + every synthetic + deal necessarily had + long and short investors, + +On line 3270: + investors select the + referenced collateral + as a serious + +On line 3272: + and for that reason + declined to participate.27 + ACA executives + +On line 3272: + the FCIC they were not + initially aware that the short + investor was involved + +On line 3272: + the collateral. + CEO Alan Roseman said that he + first heard of Paulson’s role + + when he reviewed the + SEC’s complaint.28 Laura Schwartz, who + was responsible + +On line 3272: + the deal at ACA, said + she believed that Paulson’s firm was + the investor taking + +On line 3272: + tranche and would therefore + have an interest in the + deal performing well. + + She said she would not + have been surprised that Paulson + would also have had + + a short position, + because the correlation + trade was common in + +On line 3274: + added, "To be honest, + [at that time,] until the SEC + testimony I + +On line 3274: + Paulson was only + short."29 Paulson told the FCIC that + any synthetic CDO + +On line 3274: + in "a pool that both + a buyer and seller of + protection could agree + +On line 3274: + [synthetic] CDO has + a buyer and seller of + protection. So for + +On line 3274: + that they didn’t want + to structure a CDO because + someone was buying + +On line 3276: + then you wouldn’t do + any CDOs."30 In July Goldman + Sachs settled the case, + +On line 3278: + "acknowledge[d] that the + marketing materials + for the ABACUS 2007-AC1 + + transaction contained + incomplete information. + In particular, + + it was a mistake + for the Goldman marketing + materials to + +On line 3282: + that the reference + portfolio was ‘selected + by’ ACA Management + +On line 3282: + without disclosing + the role of Paulson Co. Inc. + in the portfolio + +On line 3286: + that Paulson’s economic + interests were adverse to + CDO investors."31 The new + +On line 3286: + opportunity + for bearish investors to bet + against the housing boom. + + Home prices in the hottest + markets in California + and Florida had + +On line 3286: + was hard for skeptics + to believe that their upward + trajectory could + + continue. And if + it did not, the landing would + not be a soft one. + + Some spoke out publicly. + Others bet the bubble would + burst. Betting against CDOs + +On line 3288: + in some cases, a + bet against the rating agencies + and their models. Jamie + +On line 3288: + Hockett, principals + at the small investment firm + Cornwall Capital, + +On line 3288: + FCIC that they had warned + the SEC in that the agencies + were dangerously + + overoptimistic in their + assessment of mortgage-backed CDOs. + Mai and Hockett saw + +On line 3288: + rating agencies as + "the root of the mess," because + their ratings removed + + the need for buyers + to study prices and perform due + diligence, even as "there + +On line 3290: + of gaming going + on."32 Shorting CDOs was "pretty + attractive" because + +On line 3290: + of Paulson Co. told + the FCIC. Paulson established + a fund in June that + +On line 3290: + focused only on + shorting BBB-rated tranches. By the + end of Paulson Co.’s + +On line 3290: + Opportunities + fund, set up less han a year + earlier to bet + +On line 3292: + exclusively against + the subprime housing market, + was up "Each MBS tranche + +On line 3292: + California, in + Florida, in New York, and + when you aggregate + +On line 3292: + same geographic + diversification. To + us, there was not much + +On line 3292: + research convinced him + that if home prices were to stop + appreciating, + +On line 3292: + securities would + be at risk for downgrades. Should + prices drop CDO losses + +On line 3294: + small number of the + underlying loans were to + go into fore - + + closure, the losses + would render virtually + all of the riskier + + BBB-rated tranches worthless. + "The whole system worked fine as + long as everyone + + could refinance," Steve + Eisman, the founder of a fund + within FrontPoint Partners, + +On line 3296: + told the FCIC. The minute + refinancing stopped, "losses + would explode. By about + +On line 3296: + low-doc. You were at + max underwriting weakness + at max housing prices. + + And so the system + imploded. Everyone was + so levered there was + +On line 3296: + no ability to + take any pain."34 On October + James Grant wrote in his + +On line 3298: + processes" in which + "Wall Street transforms BBB-minus-rated mortgages + into AAA-rated tranches + +On line 3298: + by creating CDOs. + He estimated that even + the triple-A tranches of + +On line 3298: + would experience + some losses if national + home prices were to fall + +On line 3298: + or less within two + years; and if prices were to fall + investors of tranches + +On line 3300: + AA- or below would + be completely wiped out.35 In + Eisman and others + + were already looking + for the best way to bet on + this disaster by + +On line 3300: + efficient. Eisman + realized that he could pick + what he considered + +On line 3300: + most vulnerable + tranches of the mortgage-backed bonds + and bet millions of + +On line 3302: + that’s what he did. By + the end of Eisman had put + millions of dollars + +On line 3302: + short positions on + credit default swaps. It was, + he was sure, just a + +On line 3302: + of time. "Everyone + really did believe that + things were going to + + be okay," Eisman said. + "[I] thought they were certifi-able + lunatics."36 Michael Burry, + + another short who + became well-known after the + crisis hit, was a + +On line 3304: + fund, Scion Capital, + in Northern California’s + Silicon Valley, + +On line 3304: + heart, because he had + invested in homebuilder stocks + in But the closer + + he looked, the more he + wondered about the financing + that supported this + +On line 3304: + Burry decided + that some of the newfangled + adjustable rate mortgages + + were "the most toxic + mortgages" created. He told + the FCIC, "I watched those + +On line 3304: + as they migrated + down the credit spectrum to + the subprime market. + +On line 3304: + had increased on the + back of virtually no + accompanying + +On line 3304: + in wages and incomes, + I came to the judgment that + in two years there will + +On line 3304: + on housing when those + two-year [adjustable rate mortgages] seek + refinancing."37 By + +On line 3304: + bonds of financial + companies in the housing + market, including + + Fannie Mae, Freddie + Mac, and AIG. Eisman, Cornwall, + Paulson, and Burry + +On line 3306: + not alone in shorting + the housing market. In fact, + on one side of tens + +On line 3306: + billions of dollars + worth of synthetic CDOs were + investors taking short + +On line 3306: + of credit default + swaps illustrate the impact + of derivatives + + in introducing + new risks and leverage into + the system. Although + +On line 3306: + investors profited + spectacularly from the + housing crisis, they + +On line 3306: + a single subprime + loan or bought an actual + mortgage. In other + +On line 3306: + they owned. Instead, they + merely made side bets on the + risks undertaken + + by others. Paulson + told the FCIC that his research + indicated that + + if home prices remained + flat, losses would wipe out the + BBB-rated tranches; meanwhile, + +On line 3308: + time he could purchase + default swap protection on + them very cheaply.38 On + +On line 3308: + eventually be + battered. Burry acknowledged + to the FCIC, "There is + +On line 3308: + argument to be + made that you shouldn’t allow + what I did." But the + + problem, he said, was + not the short positions he + was taking; it was + + the risks that others + were accepting. "When I did + the shorts, the whole time + +On line 3310: + I was putting on the + positions there were people + on the other side + +On line 3310: + just eating them up. + I think it’s a catastrophe + and I think it was + +On line 3312: + default swaps greased the + CDO machine in several + ways. First, they allowed + +On line 3312: + managers to create + synthetic and hybrid CDOs + more quickly than they + +On line 3312: + they enabled investors + in the CDOs (including the + originating banks, + + such as Citigroup + and Merrill) to transfer the + risk of default to + +On line 3312: + default swap (such as + AIG and other insurance + companies). Third, they + + made correlation + trading possible. As the + FCIC survey revealed, + +On line 3312: + hedge fund purchases + of equity and other + junior tranches of + +On line 3312: + were done as part of + complex trading strategies.40 As + a result, credit + +On line 3312: + swaps were critical + to facilitate demand + from hedge funds for the + +On line 3312: + junior tranches of + mortgage-backed securities and + CDOs. Finally, they + +On line 3314: + make bets for or against + the housing market without + putting up much cash. On + + the other hand, it + can be argued that credit + default swaps helped end + +On line 3314: + could more easily + buy mortgage exposure for + their CDOs through credit + +On line 3314: + actual mortgage-backed + securities, demand for + credit default swaps + +On line 3314: + reduced the need to + originate high-yield mortgages. + In addition, some + +On line 3314: + participants have + contended that without the + ability to short + +On line 3314: + market via credit + default swaps, the bubble would + have lasted longer. As + +On line 3314: + will see, the declines + in the ABX index in late + would be one of the + + first harbingers of + market turmoil. "Once [pessimists] + can, in effect, sell + + short via the CDS, prices + must reflect their views and not + just the views of the + +On line 3316: + John Geanakoplos, a + Yale economics professor + and a partner in + + the hedge fund Ellington + Capital Management, which + both invested in + + and managed CDOs, told + the FCIC.41 CITIGROUP: "I DO + NOT BELIEVE WE WERE + + POWERLESS" While the + hedge funds were betting against the + housing market in + +On line 3320: + and Citigroup’s CDO + desk was pushing more money + to the center of + +On line 3322: + paper issued by + Citigroup’s CDOs—the bank’s treasury + department had put + +On line 3322: + the practice. To keep + doing deals, the CDO desk had + to find another + +On line 3322: + for the super-senior + tranches of the CDOs it was + underwriting—or it + +On line 3322: + find a way to get + the company to support + the CDO production + +On line 3322: + another billion + in super-senior exposures, + most between early + +On line 3322: + and August which it + otherwise would have been able + to sell into the + +On line 3322: + loss.42 It was also + increasingly financing + securities that + +On line 3322: + its CDO warehouse—that + is, securities that were + waiting to be put + +On line 3324: + securities was + not what securities firms + did. The adage "We are + +On line 3326: + securities, not + buying or retaining them. + However, as the + +On line 3326: + banks competed in + the securities business + in the late 1990s and + +On line 3326: + new century, they + often touted the "balance + sheet" that they could make + +On line 3326: + support the sale of + new securities. In this + regard, Citigroup + +On line 3326: + trillion commercial + bank whose deposits were insured + by the FDIC. While its + +On line 3326: + did the same, few did + so as aggressively or, + ultimately, with + +On line 3328: + the super-senior and + triple-A tranches of most of the + CDOs it created. + +On line 3328: + credit protection + from a monoline insurance + company such as + + Ambac. Because these + hedges were in place, Citigroup + presumed that the risk + +On line 3330: + had been neutralized. + Citigroup reported these + tranches at values + + for which they could not + be sold, raising questions about + their accuracy + +On line 3332: + the accuracy + of reported earnings. "As + everybody in any + +On line 3332: + growing, that means you’re + not pricing it correctly," + Richard Bookstaber, who had + +On line 3332: + of risk management + at Citigroup in the late + 1990s, told the FCIC. But + +On line 3332: + on the books at these + prices improved the finances for + creating the deal. + +On line 3332: + of the CDO business + by mispricing," Bookstaber said.43 + The company would + +On line 3332: + begin writing the + securities down toward + the market’s real + +On line 3334: + treatment. As we saw + in an earlier chapter, + under the Recourse + +On line 3334: + of the attractions + of triple-A-rated securities was + that banks were required + +On line 3336: + than against lower-rated + securities. And if the + bank held those assets + +On line 3336: + trading account (as + opposed to holding them as + a long-term investment), + +On line 3338: + better capital + treatment under the Market + Risk Amendment. That rule + +On line 3338: + banks to use their own + models to determine how + much capital to + +On line 3338: + varied according + to how much market prices moved. + Citigroup judged that + +On line 3338: + for the super-senior + tranches of synthetic CDOs + it held for trading + +On line 3338: + zero, because the + prices didn’t move much. As a + result, Citigroup + +On line 3340: + some synthetic CDOs; + that is, it sold protection + to the CDO. If the + +On line 3340: + underperformed, the + short investors would begin to + get paid. Money to + + pay them would come first + from wiping out long investors + who had bought tranches + + that were below triple-A. + Then, if the short investors were + still owed money, Citibank + +On line 3342: + pay. For taking on + this risk, Citi typically + received about to in + +On line 3342: + a billion-dollar + transaction, it would earn an + annual fee of + +On line 3344: + securities that + went into CDOs during the + ramp-up period, + + which could be as long + as six or nine months, before + it packaged and sold + +On line 3344: + CDO. Typically, + Citigroup’s securities + unit would set up a + +On line 3344: + funding line for the + CDO manager. During the + ramp-up period, + +On line 3344: + securities would + pay interest; depending + on the terms of the + +On line 3344: + that interest would + either go exclusively + to Citigroup or + +On line 3344: + the manager. For + the CDO desk, this frequently + represented a + +On line 3348: + facility had + relatively attractive + yields—often to more + + than the typical + bank borrowing rate—and it + was not uncommon + +On line 3350: + earn to million in + interest on a single + transaction.44 Traders on + +On line 3350: + desk would get credit + for those revenues at bonus time. + But Citigroup would + + also be on the + hook for any losses incurred + on assets stuck in + + the warehouse. When the + financial crisis deepened, + many CDO transactions + +On line 3352: + investment banks were + forced to write down the value + of securities + +On line 3352: + their warehouses. The + result would be substantial + losses across Wall Street. + +On line 3352: + cases, to offload + assets underwriters placed + collateral from + +On line 3356: + warehouses into + other CDOs. A factor that + made firm-wide hedging + +On line 3356: + Citigroup could have + various and offsetting + exposures to the + +On line 3356: + was possible, even + likely, that the CDO desk would + structure a given + +On line 3356: + ran into trouble, + the CDO immediately + would have to pay the + +On line 3356: + the underlying + collateral; if the CDO + ran out of money + +On line 3356: + pay, it would have to + draw on the division that + bought the unfunded + +On line 3356: + November after + Citigroup had reported + substantial losses + +On line 3356: + its CDO portfolio, + regulators would note that + the company did + +On line 3356: + good understanding + of its firmwide CDO exposures: + "The nature, origin, + +On line 3356: + of CDO exposure + were surprising to many in + senior management + +On line 3356: + liquidity put + exposure was not well known. + In particular, + +On line 3358: + risk inherent in + CDO positions."45 Citigroup’s + willingness to use + + its balance sheet to + support the CDO business had + the desired effect. + +On line 3358: + included mortgage- + acked securities in their + collateral in + +On line 3358: + CDO underwriters, + including all types of CDOs, + Citigroup rose from + +On line 3360: + fourteenth place in to + second place in according + to FCIC analysis + +On line 3362: + good for Citigroup’s + investment bank was also + lucrative for its + +On line 3362: + bankers. Thomas Maheras, the + co-CEO of the investment bank + who said he spent less + +On line 3364: + than million in salary + and bonus compensation in + Co-head of Global + +On line 3364: + Randolph Barker made + about million in that same year. + Citigroup’s chief risk + +On line 3364: + made million.47 Others + were also well rewarded. + The co-heads of the + +On line 3364: + global CDO business, + Nestor Dominguez and Janice Warne, each + made about million in + +On line 3366: + despite Citigroup’s + eventual large losses, no + compensation was + +On line 3366: + clawed back under this + policy. The Corporate + Library, which rates firms’ + +On line 3366: + Citigroup a C. + In early the Corporate + Library would downgrade + +On line 3366: + D, "reflecting a + high degree of governance + risk." Among the issues + +On line 3368: + that were poorly aligned + with shareholder interests.49 + Where were Citigroup’s + +On line 3368: + while the company + piled up tens of billions of + dollars of risk in + +On line 3368: + business1 Citigroup + had a complex corporate + structure and, as a + +On line 3368: + directed, relied + on others to monitor + the most important + +On line 3368: + Comptroller of the + Currency (OCC) supervised + the largest bank subsidiary, + +On line 3368: + securities firm, + Citigroup Global Markets. + Moreover, Citigroup + +On line 3368: + on the CDO desk on + an intricate transaction + could interact with + +On line 3370: + specific concerns. + Unlike the Fed and OCC, which + had risk management + +On line 3370: + these exams to look + for general weaknesses + in risk management. + + Unlike safety and + soundness regulators, who + concentrated on + +On line 3370: + from failing, the SEC + always kept its focus on + protecting investors. + +On line 3370: + recent review of + Citigroup’s securities + arm preceding the + +On line 3370: + the examiners + completed their report in + June In that exam, + + they told the FCIC, they + saw nothing "earth shattering," + but they did note key + +On line 3370: + internal pricing + and valuation controls, + for example, and + + a willingness to + allow traders to exceed their + risk limits.50 Unlike + +On line 3374: + the Fed and OCC did + maintain a continuous + on-site presence. During + +On line 3374: + CDOs boomed, the OCC team + regularly criticized + the company for + + its weaknesses in + risk management, including + specific problems + +On line 3378: + CDO business. "Earnings + and profitability growth have + taken precedence over + + risk management and + internal control," the OCC + told the company + +On line 3378: + stated, "The findings + of this examination + are disappointing, + +On line 3378: + far in excess of + management’s underlying + infrastructure and + +On line 3378: + peers at the other + Federal Reserve banks was + critical of the + +On line 3378: + of Citigroup. The + review concluded that the + Fed’s on-site Citigroup + +On line 3378: + supervisory + issues that detract from the + team’s continuous + +On line 3378: + the level of the + staffing within the Citi team has + not kept pace with the + +On line 3378: + the institution + has realized."53 That the Fed’s + examination + + of Citigroup did + not raise the concerns expressed + that same year by the + + OCC may illustrate + these problems. Four years later, + the next peer review + +On line 3380: + in the New York Fed’s + oversight of Citigroup.54 In + April the Fed raised the + + holding company’s + supervisory rating + from the previous + +On line 3380: + "satisfactory."55 + It lifted the ban on new + mergers imposed the + + previous year in + response to Citigroup’s many + regulatory + + problems.56 The Fed and + OCC examiners concurred + that the company + +On line 3380: + made "substantial progress" + in implementing CEO Charles + Prince’s plan to overhaul + +On line 3380: + Reserve enforcement + actions related to the + execution of + +On line 3380: + structured transactions + and controls."57 The following + year, Citigroup’s board + +On line 3382: + in justifying + his compensation increase.58 + The OCC noted in + +On line 3382: + that the lifting of + supervisory constraints + in had been a key + + turning point. "After + regulatory restraints + against significant + + acquisitions were + lifted, Citigroup embarked + on an aggressive + +On line 3384: + wrote to Vikram Pandit, + Prince’s replacement, in early + "Additionally, + +On line 3384: + removal of formal + and informal agreements, the + previous focus + +On line 3384: + and compliance gave + way to business expansion + and profits." Meanwhile, + + risk managers granted + exceptions to limits, and + increased exposure + + limits, instead of + keeping business units in check + as they had told the + + regulators.59 Well + after Citigroup sustained + large losses on its + +On line 3384: + criticize the firm + for using its commercial + bank to support its + +On line 3384: + "Senior management + allowed business lines largely + un-challenged access to + +On line 3384: + to pursue revenue + growth," the Fed wrote in an April + letter to Pandit. + +On line 3384: + share across numerous + products, including leveraged + finance and structured + +On line 3384: + balance sheet for its + ‘originate to distribute’ + strategy. Senior + +On line 3384: + potential balance + sheet implications of this + strategy in the + +On line 3384: + negative impact + of earnings volatility of + these businesses on + + the firm’s capital + position."60 eithner + told the Commission + + that he and others + in leadership positions + could have done more to + +On line 3388: + "I do not believe + we were powerless."61 AIG: "I’M + NOT GETTING PAID ENOUGH + +On line 3392: + TRACKS" Unlike their peers + at Citigroup, some senior + executives at + +On line 3392: + Financial Products + subsidiary had figured out that + the company was + + taking on too much + risk. Nonetheless, they did not + do enough about it. Doubts + +On line 3392: + default swaps that they + were originating emerged in + among AIG Financial + +On line 3392: + including Andrew + Forster and Gene Park. Park told the + FCIC that he witnessed + + Financial Products + CEO Joseph Cassano berating + a salesman over the + +On line 3392: + volume of credit + default swaps being written + by AIG Financial + +On line 3392: + there was already some + high-level uneasiness with + these deals. Told by a + +On line 3392: + the "multisector" + CDOs on which AIG was selling + credit default swaps + +On line 3392: + consisted mainly + of mortgage-backed securities + with less than subprime + + and Alt-A mortgages, Park + asked Adam Budnick, another + AIG employee, for + +On line 3392: + checked and returned to + say, according to Park, "‘I + can’t believe it. You + +On line 3392: + or Reviewing the + portfolio—and thinking about a + friend who had received + +On line 3392: + his new home after + losing his job—Park said, "This is + horrendous business. + +On line 3394: + We should get out of + it."62 In July Park’s colleague + Andrew Forster sent an + +On line 3394: + both to Alan Frost, the + AIG salesman primarily + responsible for + +On line 3394: + company’s booming + credit default swap business, + and to Gorton, who + + had engineered the + formula to determine + how much risk AIG was + + taking on each CDS + it wrote. "We are taking on + a huge amount of sub + +On line 3394: + mortgage exposure + here," Forster wrote. "Everyone we + have talked to says they + +On line 3394: + worried about deals with + huge amounts [of high-risk mortgage] + exposure yet I + +On line 3394: + with [high-risk mortgage] + concentrations currently. + Are these really + +On line 3396: + same risk as other + deals1"63 Park and others studied + the issue for weeks, + +On line 3396: + whether it made sense for + AIG to continue to write + protection on the + +On line 3396: + mortgage markets. The + general view of others + was that some of the + +On line 3396: + "were structured to fail, + [but] that all the borrowers + would basically + +On line 3398: + bailed out as long as + real estate prices went up."64 + The AIG consultant + + Gorton recalled a + meeting that he and others + from AIG had with one + +On line 3398: + analyst was so + optimistic about the housing + market that they thought + + he was "out of his + mind" and "must be on drugs or + something."65 Speaking of + +On line 3398: + potential decline + in the housing market, Park + related to the + +On line 3398: + the risks as he and + some of his colleagues saw them, + saying, "We weren’t + +On line 3398: + paid enough money to + take that risk. I’m not going + to opine on whether there’s + +On line 3398: + train on its way. I + just know that I’m not getting + paid enough to stand on + +On line 3400: + tracks."66 By February + Park and others persuaded + Cassano and Frost to + +On line 3404: + an email to Cassano + on February Park wrote: Joe, + Below summarizes + +On line 3404: + message we plan on + delivering to dealers + later this week with + +On line 3404: + ABS super senior + business going forward. We + feel that the CDO of + +On line 3404: + has increasingly + become less diverse over the + last year or so and + + is currently at + a state where deals are almost + totally reliant + +On line 3404: + and the potential + for higher rates we are no + longer as comfortable + +On line 3404: + on we would like to + see significant change in + the composition + +On line 3408: + of our ongoing + due diligence we are not as + comfortable with the + +On line 3408: + layers (namely BBB + and single A tranches) of + this asset class. We + + realize that this + is likely to take us out + of the CDO of ABS + +On line 3408: + in developing + the CDO of ABS market to + hopefully become + +On line 3408: + a collateral + perspective. With that in mind, + we will be open to + +On line 3408: + asset classes to + these structures or increasing + allocations to + +On line 3412: + with indifference. + "The day that you [AIG] drop out, + we’re going to have + +On line 3412: + other people who + are going to replace you," + Park says he was told + +On line 3412: + an investment banker + at another firm.68 In any + event, counterparties + +On line 3412: + Products continued + to write the credit default + swaps. While the bearish + +On line 3412: + the issue from the + summer of onward, the team + continued to work + +On line 3412: + in the pipeline, even + after February Overall, + they completed deals + +On line 3414: + July 2006—one of them + on a CDO backed by subprime + assets.69 By June AIG + +On line 3414: + swaps on billion in + multisector CDOs, five times + the billion held at + +On line 3414: + Park asserted that + neither he nor most others + at AIG knew at the + +On line 3414: + of the referenced + securities declined.71 Park + said their concern was + + simply that AIG would + be on the hook if subprime + and Alt-A borrowers + + defaulted in large + numbers. Cassano, however, + told the FCIC that he + +On line 3414: + about the possible + alls,72 but AIG’s SEC filings to + investors for mentioned + +On line 3416: + only if AIG were + downgraded. Still, AIG never + hedged more than million + +On line 3418: + subprime exposure.73 + Some of AIG’s counterparties + not only used AIG’s + + swaps to hedge other + positions but also hedged + AIG’s ability to + +On line 3418: + its contracts. As we + will see later, Goldman Sachs + hedged aggressively + +On line 3418: + CDS protection on + AIG and by shorting other + securities and + +On line 3418: + to counterbalance + the risk that AIG would fail to + pay up on its swaps + +On line 3420: + pull down the value + of mortgage-backed securities. + MERRILL: "WHATEVER + +On line 3422: + When Dow Kim became + co-president of Merrill Lynch’s + Global Markets and + +On line 3422: + in July he was + instructed to boost revenue, + especially in + +On line 3422: + in which Merrill lagged + behind its competitors.74 Kim + focused on the CDO + +On line 3424: + an integral part + of their trading strategy, + CEO Stanley O’Neal told + +On line 3424: + from Credit Suisse, + where Ricciardi’s group had sold + more CDOs than anyone + + else.76 Ricciardi + came through, lifting Merrill’s CDO + business from fifteenth + +On line 3428: + in to second place + behind only Citigroup + in and Goldman in + +On line 3428: + February he left + the bank to become CEO of + Cohen Company, + +On line 3428: + asset management + business; at Cohen he would + manage several + +On line 3430: + left, Kim instructed + the rest of the team to do + "whatever it takes" + + not just to maintain + market share but also to + take over the number + +On line 3430: + former employees + said in a complaint filed against + Merrill Lynch.78 Kim told + +On line 3430: + conversations but + that after Ricciardi + left, Merrill was still + +On line 3430: + globally and that + he, Kim, wanted people to + know that Merrill was + +On line 3432: + commit its people, + resources, and balance sheet to + achieve that goal.79 It was + +On line 3432: + Despite the loss of + its rainmaker, Merrill swamped + the competition, + +On line 3432: + a total billion + in mortgage-related CDOs in + while the second-ranked firm, + +On line 3432: + Morgan Stanley, did + only billion, and earning + another first-place + +On line 3432: + on the strength of the + CDO machine Ricciardi + had built—a machine + +On line 3436: + more than billion in + fees between and To keep its + CDO business going, + + Merrill pursued three + strategies, all of which involved + repackaging riskier + +On line 3436: + more attractively + or buying its own products + when no one else would. + +On line 3436: + Citigroup, Merrill + increasingly retained for + its own portfolio + +On line 3436: + creating, mainly + the super-senior tranches, and + it increasingly + +On line 3436: + the hard-to-sell BBB-rated and + other low-rated tranches of + its CDOs into its + +On line 3436: + used the cash sitting + in its synthetic CDOs to + purchase other CDO + + tranches. It had long + been standard practice for CDO + underwriters to + +On line 3440: + mezzanine tranches + to other CDO managers. Even + in the early days + +On line 3440: + mezzanine tranches + of other CDOs; the rating + agencies signed off on + +On line 3440: + practice when rating + each deal. But reliance on them + became heavier as + +On line 3440: + from traditional + investors waned, as it had for + the riskier tranches + +On line 3440: + The market came to + call traditional investors + the "real money," + +On line 3440: + distinguish them from + CDO managers who were buying + tranches just to put + +On line 3442: + their CDOs. Between and + the typical amount a CDO + could include of the + +On line 3444: + of other CDOs and + still maintain its ratings grew + from to according + +On line 3444: + CDO manager Wing + Chau.82 According to data + compiled by the FCIC, + +On line 3444: + tranches from CDOs rose + from an average of of + the collateral + +On line 3444: + mortgage-backed CDOs in to + by CDO-squared deals—those engineered + primarily from + +On line 3446: + of other CDOs—grew from + marketwide in to in and in + Merrill created + +On line 3448: + them.83 Still, there are clear + signs that few "real money" + investors remained in + +On line 3450: + CDO market by late + Consider Merrill: for the + ABS CDOs that Merrill + +On line 3450: + created and sold + from the fourth quarter of through + August nearly of + +On line 3450: + tranches were purchased + by CDO managers.84 The pattern + was similar for + +On line 3452: + determined that of + the mezzanine tranches sold + by the CDOs managed + +On line 3452: + purchased tranches in + Merrill’s Norma CDO. In the + most extreme case found + +On line 3454: + CDO managers were the + only purchasers of Merrill’s + Neo CDO.86 Marketwide, in + +On line 3454: + CDOs took in about of + the A tranches, of the Aa + tranches, and of the + + Baa tranches issued + by other CDOs, as rated + by Moody’s. (Moody’s rating + +On line 3456: + Aaa is equivalent + to S&P’s AAA, Aa to AA, Baa + to BBB, and Ba to + +On line 3456: + those numbers were and + respectively.87 Merrill and + other investment + +On line 3458: + buy the harder-to-sell + portions of the old ones. As + SEC attorneys told + +On line 3458: + FCIC, heading into + there was a Streetwide gentle-man’s + agreement: you buy my + +On line 3460: + I’ll buy yours.88 Merrill + and its CDO managers were the + biggest buyers of + +On line 3462: + own products. Merrill + created and sold CDOs from + to All but of these—134 + + CDOs—sold at least one tranche + into another Merrill + CDO. In Merrill’s deals, + +On line 3464: + average, of the + collateral packed into + the CDOs consisted + +On line 3464: + tranches of other + CDOs that Merrill itself had + created and sold. + +On line 3464: + but not the highest: + for Citigroup, another + big player in this + +On line 3468: + Managers defended + the practice. Chau, who managed + CDOs created and + +On line 3468: + and later Harding + Advisory and had worked + with Ricciardi + +On line 3468: + the early days of + multisector CDOs, told the + FCIC that plain mortgage-backed + +On line 3468: + relation to their + returns, even as the real + estate market sagged. + +On line 3468: + securities, they + were in demand, and that is + why CDO managers packed + + their securities + with other CDOs.90 And Merrill + continued to push + +On line 3470: + CDO business despite + signals that the market was + weakening. As late + +On line 3470: + as the spring of when + AIG stopped insuring even the + very safest, super-senior + +On line 3470: + Merrill and others, + it did not reconsider + its strategy. Cut + +On line 3472: + off from AIG, which had + already insured billion of + its CDO bonds91—Merrill was AIG’s + +On line 3472: + switched to the monoline + insurance companies for + protection. In the + +On line 3472: + Merrill management + noticed that Citigroup, its + biggest competitor + +On line 3472: + of CDOs onto its + own balance sheet at razor-thin + margins, and thus in + +On line 3472: + returns for investors + in the BBB-rated and equity + tranches. In response, + +On line 3472: + continued to ramp + up its CDO warehouses and + inventory; and + + in an effort to + compete and get deals done, it + increasingly took + +On line 3474: + positions without + insurance from AIG or the + monolines.92 This would not + +On line 3476: + of Merrill’s all-in + wager on the mortgage and + CDO businesses. Even + +On line 3476: + the first-place trophy + in the mortgage-related CDO + business in it had + +On line 3476: + that Lehman Brothers and + Bear Stearns had pioneered, which + required having a + +On line 3476: + step of the mortgage + business—originating + mortgages, bundling these loans + +On line 3476: + securities, and + selling all of them on Wall + Street. In September + +On line 3476: + bubble had started + to deflate and delinquencies + had begun to rise, + + Merrill announced it + would acquire a subprime lender, + First Franklin Financial + +On line 3476: + analysts because + the market for subprime loans + was souring in a + +On line 3476: + Mortgage Solutions + Inc., for which it provided + a warehouse line of + +On line 3476: + provided a line + of credit to Mortgage Lenders + Network.94 Both of those + + companies would cease + operations soon after + the First Franklin purchase.95 + +On line 3478: + did Merrill cut back + in September when one of + its own analysts + +On line 3478: + report warning that + this subprime exposure could + lead to a sudden + +On line 3478: + assets could dry up + quickly.96 That assessment was + not in line with the + +On line 3478: + Merrill did nothing. + Finally, at the end of + Kim instructed his + + people to reduce + credit risk across the board.97 As + it would turn out, they + +On line 3482: + pipeline was too large. + REGULATORS: "ARE UNDUE + CONCENTRATIONS OF + +On line 3484: + DEVELOPING1 As + had happened when they faced the + question of guidance + +On line 3484: + the rapidly changing + structured finance market the + regulators failed + +On line 3484: + action. They missed a + crucial opportunity. + On January one + +On line 3484: + collapse of Enron, + the U.S. Senate Permanent + Subcommittee on + +On line 3484: + immediately + initiate a one-time, joint + review of banks and + +On line 3484: + U.S. company’s use + of deceptive accounting + in its financial + +On line 3484: + The subcommittee + recommended the agencies + issue joint guidance + +On line 3484: + products, transactions + and practices" by June Four years + later, the banking + +On line 3484: + Risk Complex Structured + Finance Activities," a + document that was + +On line 3486: + all of nine pages long.99 + In the intervening years, + from to the banking + +On line 3486: + SEC issued two draft + statements for public comment. + The draft, issued the + +On line 3486: + the OCC, Fed, and SEC + had brought enforcement actions + against Citigroup and + +On line 3486: + manipulate its + financial statements, focused + on the policies and + +On line 3486: + have for managing + the structured finance business.100 + The aim was to avoid + +On line 3486: + institutions to + look out for customers that, like + Enron, were trying + +On line 3486: + regulatory + or financial reporting + requirements, evade tax + +On line 3488: + guidance as too broad, + prescriptive, and burdensome. + Several said it + +On line 3488: + cover many structured + finance products that did not + pose significant + +On line 3488: + Another said that + it "would disrupt the market + for legitimate + +On line 3488: + market for [complex + structured finance transactions] + in the United States + +On line 3490: + Two years later, in + May the agencies issued an + abbreviated + + draft that reflected + a more "principles-based" approach, + and again requested + +On line 3490: + of the requirements + were very similar to those + that the OCC and Fed + +On line 3492: + and JP Morgan in + the enforcement actions.102 When + the regulators + +On line 3492: + issued the final + guidance in January the + industry was more + +On line 3494: + to participants + in the financial markets, + have well-established track records, + +On line 3494: + considered [complex + structured finance transactions] + for purposes of + +On line 3494: + had been added after + the regulators received + comments on the draft. + +On line 3496: + did take note of the + potential risks of CDOs and + credit default swaps. + +On line 3498: + Basel Committee on + Banking Supervision’s Joint + Forum, which includes + +On line 3498: + around the world, issued + a comprehensive report + on these products. The + +On line 3498: + focused on whether banks + and other firms involved in + the CDO and credit + + default swap business + understood the credit isk + they were taking. It + +On line 3498: + to make sure that they + understood the nature of + the rating agencies’ + +On line 3498: + especially for + CDOs. And it further advised + them to make sure that + +On line 3498: + and the financial + guarantors—would be good for + that protection if + + it was needed.104 The + regulators also said + they had researched in + +On line 3500: + depth, for the CDO and + derivatives market, the + question "Are undue + +On line 3500: + risk developing1" + Their answer: probably not. + The credit risk was + +On line 3500: + monoline financial + guarantors appeared to know + what they were doing.105 + +On line 3504: + [Joint Forum’s Working + Group on Risk Assessment and + Capital] has not + + found evidence of + ‘hidden concentrations’ of + credit risk. There are + +On line 3504: + model focuses + on taking on credit risk. + Most important among + +On line 3504: + monoline financial + guarantors. Other market + participants seem + + to be fully aware + of the nature of these firms. + In the case of the + +On line 3504: + been a primary + business activity and + they have invested + +On line 3504: + in obtaining the + relevant expertise. While + obviously this + +On line 3504: + to experience + unanticipated problems + or to misjudge the + +On line 3504: + the catastrophic + or macroeconomic level. + It is also clear + +On line 3504: + are subjected to + regulatory, rating + agency, and market + +On line 3506: + learned from earlier + flare-ups in the CDO sector: "The + Working Group believes + +On line 3506: + it is important + for investors in CDOs to seek + to develop a + + sound understanding + of the credit risks involved + and not to rely + + solely on rating + agency assessments. In many + respects, the losses + +On line 3506: + CDOs have probably + been salutary in highlighting + the potential risks + +On line 3510: + MOODY’S: "IT WAS ALL ABOUT + REVENUE" Like other market + participants, Moody’s + +On line 3510: + the three dominant + rating agencies, was swept up + in the frenzy of + +On line 3510: + products market. The + tranching structure of mortgage-backed + securities and + +On line 3510: + guidelines set by the + agencies; without their models + and their generous + +On line 3510: + of triple-A ratings, there + would have been little investor + interest and few + +On line 3510: + the dollar value + of that business increased from + million to million; + +On line 3510: + of staff rating these + deals doubled. But over the same + period, while the + +On line 3510: + increased sevenfold, + staffing increased only From to + annual revenue + +On line 3512: + tied to CDOs grew from + million to million.108 When Moody’s + Corporation went + +On line 3512: + the investor Warren + Buffett’s Berkshire Hathaway held + of the company. + +On line 3512: + repurchases by + Moody’s Corporation, Berkshire + Hathaway’s holdings of + +On line 3514: + increased to over by + As of Berkshire Hathaway and + three other investors + +On line 3514: + combined of Moody’s. When + asked whether he was satisfied + with the internal + +On line 3514: + responded to the + FCIC that he knew nothing about + the management of + + Moody’s. "I had no idea. + I’d never been at Moody’s, I + don’t know where they are + +On line 3514: + that he invested + in the company because + the rating agency + +On line 3516: + and "the single-most + important decision in + evaluating a + +On line 3518: + pricing power."110 Many + former employees said that + after the public + +On line 3518: + culture changed—it went + "from [a culture] resembling + a university + +On line 3518: + department to one + which values revenues at all + costs," according to + +On line 3518: + also identified + a new focus on market + share directed by + +On line 3518: + Moody’s Investors Service + Brian Clarkson. Clarkson had + joined Moody’s in as a + +On line 3518: + co-chief operating + officer of the rating + agency in and then + +On line 3518: + Clarkson: "My kind of + working hypothesis was + that [former chairman + +On line 3518: + CEO] John Rutherford was + thinking, ‘I want to remake + the culture of this + +On line 3518: + to make that happen, + and he was successful in + that regard. And that + +On line 3518: + why Brian Clarkson’s + rise was so meteoric: he + was the enforcer who + +On line 3518: + culture to have more + focus on market share."113 The + former managing + +On line 3518: + responsible for + assembling an internal + history of Moody’s, + +On line 3518: + main problem was that + the firm became so focused, + particularly + + the structured area, on + revenues, on market share, and + the ambitions of + +On line 3518: + they willingly looked + the other way, traded the + firm’s reputation + + for short-term profits."114 + Moody’s Corporation Chairman + and CEO Raymond McDaniel + + did not agree with this + assessment, telling the FCIC that + he didn’t see "any + +On line 3520: + spin-off.115 Clarkson also + disputed this version of + events, explaining that + +On line 3520: + share was important + to Moody’s well before it was + an independent + +On line 3520: + company. "[The idea + that before Moody’s] was spun off + from Dun Bradstreet, it + +On line 3520: + of sleepy, academic + kind of company that was + in an ivory tower + +On line 3520: + explained. "I think [the + ivory tower] was really + a misnomer. I think + +On line 3522: + business."116 Clarkson and + McDaniel also adamantly disagreed + with the perception + +On line 3522: + concerns about market + share trumped ratings quality. + Clarkson told the FCIC + + that it was fine for + Moody’s to lose transactions if + it was for the "right + +On line 3522: + reason or it was + a credit reason, there’s not + a lot you can do + +On line 3522: + deal because you’re not + communicating, you’re not + being transparent, + +On line 3522: + the phone, that could be + problematic."117 McDaniel cited + unforeseen market + + conditions as the + reason that the models did + not accurately + +On line 3522: + credit uality.118 + He testified to the FCIC, + "We believed that our + + ratings were our best + opinion at the time that we + assigned them. As we + +On line 3522: + new information + and were able to update our + judgments based on the + +On line 3522: + information and + the trends we were seeing in + the housing market, + +On line 3524: + made what I think are + appropriate changes to our + ratings."119 Nonetheless, + +On line 3524: + did not seem to have + the same enthusiasm for + compliance as he + + did for market share + and profit, according to + those who worked with him. + + Scott McCleskey, a former + chief compliance officer + at Moody’s, recounted + + a story to the + FCIC about an evening when he and + Clarkson were dining + +On line 3524: + board of directors + after the company had + announced strong earnings, + +On line 3524: + of rating mortgage-backed + securities and CDOs. "So + Brian Clarkson comes + +On line 3524: + front of everybody + at the table, including + board members, and says + + literally, ‘How + much revenue did Compliance + bring in this quarter1 + +On line 3526: + Nothing. Nothing.’ For + him to say that in front of + the board, that’s just so + +On line 3526: + telling of how he felt + that he was bulletproof. For + him, it was all about + +On line 3526: + Clarkson told the FCIC + that he didn’t remember + this conversation + +On line 3528: + employees, Clarkson’s + management style left little + room for discussion + +On line 3528: + referred to Clarkson + as the "dictator" of Moody’s + and said that if he + +On line 3528: + employee to do + something, "either you comply + with his request or + +On line 3528: + for another job."122 + "When I joined Moody’s in late an + analyst’s worst fear + +On line 3528: + we would contribute + to the assignment of a + rating that was wrong," + +On line 3528: + former senior vice + president, testified to + the FCIC. "When I left + + Moody’s, an analyst’s + worst fear was that he would do + something, or she, that + + would allow him or + her to be singled out for + jeopardizing Moody’s + + market share."123 Clarkson + denied having a "forceful" + management style, and + + his supervisor, + Raymond McDaniel, told the FCIC that + Clarkson was a "good + + manager."124 Former + team managing director + Gary Witt recalled that + +On line 3530: + received a monthly + email from Clarkson "that outlined + basically my + +On line 3530: + market share in the + areas that I was in charge + of. I believe it + +On line 3530: + the deals that we did, + and then it would list the deals + like S&P and/or Fitch + + did that we didn’t + do that was in my area. And + at times, I would have + +On line 3530: + a written report + about—you know, look into what + was it about that deal, + + why did we not rate + it. So, you know, it was clear + that market share was + + important to him." + Witt acknowledged the pressures + that he felt as a + + manager: "When I + was an analyst, I just + thought about getting the + +On line 3530: + deals right. Once I [was + promoted to managing + director and] had + +On line 3530: + to meet, I had salaries + to pay, I started thinking + bigger picture. I + +On line 3530: + realizing, yes, + we do have shareholders and, + yes, they deserved to + +On line 3530: + money. We need to + get the ratings right first, that’s + the most important + +On line 3532: + thing; but you do have + to think about market share."125 Even + as far back as a + +On line 3532: + share was evident + in employee performance + evaluations. In + +On line 3532: + subordinates that + listed analysts and the + number and dollar + + volume of deals each + had "rated" or "NOT rated." + Clarkson’s instructions: + +On line 3532: + using this in PE’s + [performance evaluations] + and to give people + + a heads up on where + they stand relative to their + peers."126 Team managing + +On line 3532: + deals, received a base + salary, cash bonus, and stock options. + Their performance goals + + generally fell + into the categories of + market coverage, + +On line 3532: + and development + of analytical tools, + only one of which + + was impossible + to measure in real time + as compensation + + was being awarded: + ratings quality. It might + take years for the poor + + quality of a + rating to become clear as + the rated asset + +On line 3534: + failed to perform as + expected. In January + a derivatives + +On line 3534: + manager listed + his most important achievements + in a performance + +On line 3534: + the list: "Protected + our market share in the CDO + corporate cash flow + +On line 3536: + we missed only one + CLO [collateralized loan + obligation] from BofA + +On line 3538: + because of it’s [sic] + bizarre structure."127 More evidence + of Moody’s emphasis + + on market share was + provided by an email that + circulated in + +On line 3538: + of in the midst of + significant downgrades in + the structured finance + +On line 3538: + Yoshizawa asked her team’s + managing directors to + explain a market + +On line 3540: + from to Despite this + apparent emphasis on + market share, Clarkson + +On line 3540: + McDaniel, the chairman and + CEO of Moody’s Corporation, + elaborated: "I + + disagree that there was + a drive for market share. We + pay attention to + +On line 3540: + in the market. But + ratings quality, getting + the ratings to the + +On line 3542: + status, is paramount."130 + Whatever McDaniel’s or Clarkson’s + intended message, + +On line 3542: + market share. Former + team managing director + Witt recalled that the + + "smoking gun" moment + of his employment at Moody’s + occurred during a + +On line 3542: + "town hall" meeting in + the third quarter of with Moody’s + management and its + +On line 3542: + a presentation + about Moody’s financial outlook + for the year ahead, one + +On line 3542: + responded: "I was + interested, Ray, to hear + your belief that the + +On line 3542: + thing in the minds of + people in this room is the + financial outlook + +On line 3542: + the remainder of + the year. [M]y thinking is there’s + a much greater concern + +On line 3542: + franchise." He added, "I + think that the greater anxiety + being felt by the + +On line 3542: + people in this room + and by the analysts is + what’s going on with + +On line 3542: + ratings and what the + outlook is[,] specifically + the severe ratings + +On line 3542: + we’re dealing with and + uncertainty about what’s ahead + on that, the ratings + +On line 3542: + reputation was + just being absolutely + lacer-ated; and that + +On line 3542: + are standing here, and + they’re not even addressing—they’re + acting like it’s not + +On line 3542: + even happening, even + now that it’s already happened. + [T]hat just made it so + +On line 3542: + clear to me that the + balance was far too much on + the side of short-term + +On line 3544: + memorandum from + October sent to McDaniel, in + a section titled + +On line 3544: + Interest: Market + Share," Chief Credit Officer + Andrew Kimball xplained + + that "Moody’s has erected + safeguards to keep teams from too + easily solving + +On line 3544: + market share problem + by lowering standards." But + he observed that these + + protections were far + from fail-safe, as he detailed in + two area. First, "Ratings + +On line 3544: + are susceptible + to market share objectives)." + Second, "Methodologies + +On line 3546: + latitude within + those boundaries to register + market influence.)"134 + + Moreover, the pressure + for market share, combined with + complacency, may + +On line 3548: + Moody’s from creating + new models or updating + its assumptions, as + +On line 3548: + their competence and + the adequacy of their + procedures rather than + +On line 3548: + a run of good luck. + [O]ur years of success rating + RMBS [residential + +On line 3548: + merely fine-tune the + existing system—to make + it more efficient, + +On line 3550: + in fact, it often + makes success less certain."135 If + an issuer didn’t + +On line 3550: + a Moody’s rating on + a particular deal, it + might get a better + +On line 3550: + ratings agency. The + agencies were compensated + only for rated + +On line 3550: + effect, only for + the deals for which their ratings + were accepted by + +On line 3552: + from two directions: + in-house insistence on + increasing market + +On line 3552: + from the issuers and + investment bankers, who pushed for + better ratings with + +On line 3554: + Michalek, a former Moody’s + vice president and senior + credit officer, + +On line 3554: + to the FCIC, "The threat + of losing business to a + competitor, even if + +On line 3554: + the balance away from + an independent arbiter + of risk towards a + +On line 3554: + transfer."137 Witt agreed. When + asked if the investment banks + frequently threatened + +On line 3554: + they didn’t get their + desired rating, Witt replied, "Oh + God, are you kidding1 + + All the time. I mean, + that’s routine. I mean, they would + threaten you all of + +On line 3554: + the time. It’s like, ‘Well, + next time, we’re just going to + go with Fitch and S&P.’"138 + + Clarkson affirmed that + "it wouldn’t surprise me to + hear people say that" + +On line 3556: + employees.139 Former + managing director Fons + suggested that Moody’s + +On line 3556: + complaisant when it should + have been principled: "[Moody’s] knew + that they were being + + bullied into cav-ing + in to bank pressure from the + investment banks and + +On line 3558: + originators of + these things. Moody’s allow[ed] itself + to be bullied. And, + +On line 3558: + they willingly played + the game. They could have stood up + and said, ‘I’m sorry, + +On line 3558: + not—we’re not going to + sign off on this. We’re going + to protect investors. + +On line 3558: + to stop—you know, we’re + going to try to protect + our reputation. + + We’re not going to + rate these CDOs, we’re not going + to rate these subprime + +On line 3560: + in his October + memorandum: Ideally, + competition would + + be primarily + on the basis of ratings + quality, with a + +On line 3564: + three competitive + factors, rating quality + is proving the least + +On line 3564: + given the long tail + in measuring performance. + The real problem + +On line 3564: + not that the market + does underweights [sic] ratings + quality but rather + +On line 3564: + by awarding rating + mandates based on the lowest + credit enhancement + +On line 3564: + the highest rating. + Unchecked, competition on this + basis can place the + +On line 3564: + at risk. It turns out + that ratings quality has + surprisingly few + +On line 3564: + high ratings; investors + don’t want rating downgrades; and + bankers game the rating + +On line 3566: + few extra basis + points on execution.141 Moody’s + employees told the + + FCIC that one tactic + used by the investment bankers + to apply subtle + +On line 3566: + was to submit a + deal for a rating within + a very tight time frame. + +On line 3566: + who oversaw ratings + on CDOs, recalled the case of + a particular + +On line 3566: + the trouble on this + deal was, and this is crucial + about the market share, + + was that the banker gave + us hardly any notice and + any documents and + +On line 3566: + time to analyze + this deal. Because bankers knew that + we could not say no + + to a deal, could not + walk away from the deal because + of a market share, + + they took advantage + of that."142 For this CDO deal, the + bankers allowed only + + three or four days for + review and final judgment. + Kolchinsky emailed Yoshizawa + +On line 3568: + "egregiously pushed our + time limits (and analysts)."143 + Before the frothy days + + of the peak of the + housing boom, an agency took + six weeks or even two + +On line 3570: + a CDO.144 By Kolchinsky + described a very different + environment in + + the CDO group: "Bankers were + pushing more aggressively, + so that it became + +On line 3572: + quiet little group + to more of a machine."145 In + Moody’s gave triple-A ratings + +On line 3574: + securities each + and every working day.146 Such + pressure can be seen + +On line 3574: + email to Yoshizawa from + a managing director + in synthetic CDO + +On line 3574: + "I’m going to have + a major political + problem if we can’t + + make this [deal rating] + short and sweet because, even though + I always explain + +On line 3574: + investors that closing + is subject to Moody’s timelines, + they often choose not + +On line 3578: + ‘pitched’ by bankers, issuers, + investors—all with reasonable + arguments—whose views can + +On line 3578: + sometimes improving + it, other times degrading + it (we ‘drink the kool-aid’). + +On line 3578: + with strong internal + emphasis on market share + margin focus, this + +On line 3582: + ratings quality."148 + The SEC investigated + the rating agencies’ + +On line 3582: + in reporting its + findings to Moody’s in July + The SEC criticized + + Moody’s for, among other + things, failing to verify + the accuracy + +On line 3582: + leaving that work to + due diligence firms and other + parties; failing to + +On line 3582: + documentation + about how most deals were rated; + allowing ratings + +On line 3582: + to be compromised + by the complexity of + CDO deals; not hiring + +On line 3584: + pushing ratings out + the door with insufficient + review; failing to + +On line 3584: + its rating process for + mortgage-backed securities and + CDOs; and allowing + +On line 3586: + of interest to + affect rating decisions.149 + So matters stood in + +On line 3586: + the machine that had + been humming so smoothly and + so lucratively + +On line 3588: + seized up entirely. + The Commission concludes that + the credit rating + + agencies abysmally failed + in their central mission to + provide quality + +On line 3588: + securities for + the benefit of investors. + They did not heed many + +On line 3588: + housing and mortgage + sector. Moody’s, the Commission’s + case study in this area, + +On line 3588: + The business model + under which firms issuing + securities paid + +On line 3588: + the quality and + integrity of those ratings; + the rating agencies + + placed market share and + profit considerations + above the quality + +On line 3590: + the leveling off + and subsequent decline of + the housing market + +On line 3590: + collateralized + debt obligations (CDOs), CDOs squared, + and synthetic CDOs + +On line 3590: + unabated, greatly + expanding the exposure + to losses when the + +On line 3590: + exacerbating + the impact of the collapse + on the financial + +On line 3592: + fueled the market + for synthetic CDOs to bet + on the future of + +On line 3592: + synthetic products + had potential conflicts in + trying to serve the + +On line 3592: + of customers who were + betting mortgage borrowers + would continue to + + make their payments and + of customers who were betting + the housing market + + would collapse. There were + also potential conflicts + for underwriters + +On line 3594: + securities to + the extent they shorted the + products for their own + +On line 3604: + outside of their roles + as market makers. THE BUST + CONTENTS Delinquencies: + +On line 3610: + before"....................................................................221 CDOs: "Climbing + the wall of subprime worry"..................................................223 + Legal remedies: "On + + the basis of the + information"..............................................224 Losses: "Who + owns residential + +On line 3614: + What happens when a + bubble bursts1 In early it + became obvious + +On line 3614: + falling in regions + that had once boomed, that mortgage + originators were + +On line 3614: + and that more and more + families, especially + those with subprime and + +On line 3616: + unable to make their + mortgage payments. What was not + immediately + +On line 3616: + the housing crisis + would affect the financial + system that had helped + +On line 3616: + bubble. Were all those + mortgage-backed securities and + collateralized + +On line 3616: + on the balance sheets + of the world’s largest financial + institutions1 "The + +On line 3616: + concerns were just that + if people couldn’t value + the assets, then that + +On line 3616: + created questions + about the solvency of the + firms," William C. Dudley, + + now president of + the Federal Reserve Bank + of New York, told the + +On line 3618: + banking system were + supposed to distribute risk + efficiently among + +On line 3620: + would prove to be wrong. + Much of the risk from mortgage-backed + securities had + + actually been + taken by a small group of + systemically + +On line 3620: + with outsized holdings + of, or exposure to, the + super-senior and triple-A + +On line 3620: + CDOs. These companies + would ultimately bear great + losses, even though those + +On line 3624: + agencies to downgrade + first mortgage-backed securities, + then CDOs. Alarmed investors + + sent prices plummeting. + Hedge funds faced with margin calls + from their repo lenders + +On line 3624: + to sell at distressed + prices; many would shut down. Banks wrote + down the value of + +On line 3626: + their holdings by tens + of billions of dollars. The + summer of also + + saw a near halt in + many securitization + markets, including + +On line 3626: + the second quarter + of (already down from prior + quarters). That figure + +On line 3626: + to billion in the + third quarter and to only + billion in the fourth + +On line 3626: + issuance topped billion + in the second quarter, but + fell to billion in + +On line 3626: + of Once-booming + markets were now gone—only + billion in subprime + +On line 3628: + in the first half of + and almost none after that.2 + CDOs followed suit. From + +On line 3630: + a high of more than + billion in the first quarter + of worldwide issuance + +On line 3630: + securities as + collateral plummeted + to billion in the + +On line 3630: + third quarter of and + only billion in the fourth + quarter. And as the + +On line 3630: + a halt, investors no + longer trusted other structured + products.3 Over billion + +On line 3630: + loan obligations (CLOs), + or securitized leveraged + loans, were issued in + +On line 3630: + only billion were + issued in The issuance of + commercial real + +On line 3630: + estate mortgage–backed + securities plummeted + from billion in to + +On line 3632: + held up during the + turmoil in eventually + suffered in as the + +On line 3632: + small business loans, and + equipment leases all nearly + ceased in the third and + +On line 3636: + THE HOUSING MARKET" + Home prices rose nationally + in their third year of + +On line 3636: + double-digit growth. But + by the spring of as the sales + pace slowed, the number + + of months it would take + to sell off all the homes on + the market rose to + +On line 3638: + its highest level + in years. Nationwide, home prices + peaked in April Members + +On line 3638: + Reserve’s Federal + Open Market Committee (FOMC) + discussed housing prices + +On line 3638: + Chairman Ben Bernanke and + other members predicted + a decline in home + +On line 3638: + but were uncertain + whether the decline would be slow + or fast. Bernanke believed + + some correction in + the housing market would be + healthy and that the goal + +On line 3638: + the FOMC should be to + ensure the correction did + not overly affect + +On line 3640: + Economy.com, a + business unit separate from + Moody’s Investors Service, + + issued a report + authored by Chief Economist + Mark Zandi titled + +On line 3640: + The Outlook for the + U.S. Residential Real + Estate Market." He + +On line 3642: + to the following + conclusion: Nearly of the + nation’s metro areas + +On line 3642: + crash in house prices; a + double-digit peak-to-trough decline + in house prices. These sharp + +On line 3642: + expected along the + Southwest coast of Florida, + in the metro areas + +On line 3642: + and Nevada, in a + number of California + areas, throughout the + + broad Washington, D.C. + area, and in and around Detroit. + Many more metro areas + +On line 3642: + to experience + only house-price corrections + in which peak-to-trough price + +On line 3642: + declines remain in + the single digits. It is + important to note + +On line 3644: + various markets + are expected to extend + into and even With + +On line 3644: + nation’s housing stock + experiencing or about + to experience + +On line 3644: + declines, national + house prices are also set to + decline. Indeed, odds + +On line 3646: + Association + of Realtors announced that + the number of sales + +On line 3646: + of existing homes + had experienced the sharpest + fall in years. That year, + +On line 3648: + prices declined In they + would drop a stunning Overall, + by the end of prices + +On line 3648: + peak in Some cities saw + a particularly large + drop: in Las Vegas, + +On line 3648: + as of August home + prices were down from their peak. And + areas that never + +On line 3648: + have experienced + losses as well: home prices in + Denver have fallen + +On line 3650: + since their peak. In some + areas, home prices started to + fall as early as + +On line 3650: + late For example, + in Ocean City, New Jersey, where + many properties are + +On line 3650: + vacation homes, home + prices had risen since they topped out + in December and + +On line 3650: + in the first half of + By mid-2010, they would be% below + their peak. Prices topped out + +On line 3650: + in Sacramento in + October and are today + down nearly In most + +On line 3650: + for a bit longer. For + instance, in Tucson, Arizona, + prices kept increasing + +On line 3650: + much of climbing from + to their high point in August + and then fell only + +On line 3652: + by the end of the + year.8 One of the first signs of + the housing crash was + +On line 3652: + borrowers’ being + or more days delinquent within + the first year. Figures + +On line 3652: + provided to the + FCIC show that by the summer + of of loans less than + +On line 3652: + a year old were in + default. The figure would peak + in late at well above + +On line 3654: + out by borrowers + who never made a single + payment— went above of + +On line 3654: + early Responding + to questions about that data, + CoreLogic Chief Economist + +On line 3654: + payment default rate + "certainly correlates with + the increase in the + +On line 3654: + shares and the turn of + the housing market and the + sensitivity + +On line 3656: + loan products."10 Mortgages + in serious delinquency, + defined as those or + +On line 3656: + days past due or in + foreclosure, had hovered around + during the early + +On line 3658: + part of the decade, jumped + in and kept climbing. By the + end of of mortgage + +On line 3658: + By comparison, + serious delinquencies peaked + at in following + +On line 3660: + the country that had + experienced the biggest + housing booms. In the + +On line 3660: + Arizona, Nevada, and + Florida—serious delinquency + rose to in mid-2007 and + +On line 3660: + late double the rate + in other areas of the + country (see figure + +On line 3662: + (see figure Subprime + adjustable-rate mortgages began to + show increases in + +On line 3662: + in early even as + house prices were peaking; the rate + rose rapidly to in + +On line 3662: + late the delinquency + rate for subprime ARMs was Prime + ARMs did not weaken + +On line 3662: + at about the same time + as subprime fixed-rate mortgages. Prime + fixed-rate mortgages, which have + +On line 3662: + showed a slow increase + in serious delinquency + that coincided + +On line 3664: + of the recession + and of unemployment in + The FCIC undertook + +On line 3664: + of mortgages purchased + or guaranteed by the GSEs, + those securitized + +On line 3664: + of each year from through + The data contained mortgages + in four groups—loans that + +On line 3664: + subprime by issuers + (labeled SUB), loans sold into + private label Alt-A + +On line 3664: + either purchased or + guaranteed by the GSEs (GSE), + and loans guaranteed + +On line 3664: + group, in addition + to the more traditional + conforming GSE loans, + +On line 3664: + mortgages that the GSEs + identified as subprime and + Alt-A loans owing to + +On line 3666: + characteristics, + as discussed in earlier + chapters. Within each + +On line 3666: + the four groups, the FCIC + created subgroups based on + characteristics + + that could affect loan + performance: FICO credit + scores, loan-to-value + +On line 3666: + (LTVs), and mortgage size. + For example, one subgroup + would be GSE loans with + +On line 3666: + a balance below + (conforming to GSE loan size + limits), a FICO + +On line 3666: + and (a borrower + with below-average credit + history), and LTV + +On line 3666: + and Another group + would be Alt-A loans with the same + characteristics. + +On line 3666: + each year, the loans were + broken into different + subgroups—144 each for GSE, + +On line 3668: + demonstrates the results + of the examination. + The various bars + +On line 3668: + range of average + delinquencies for each of the + four groups examined, + +On line 3668: + the distribution + of delinquency rates within + the subgroups for each + +On line 3668: + black portion of each + bar represents the middle + on either side of + +On line 3668: + including both dark + and light shading, represents + the middle of the + + distribution of + average delinquency rates. + The bars exclude the + +On line 3668: + the extremes of each + end of the distribution. + For example, at + +On line 3668: + black portion of the + GSE bar spans a average + delinquency rate on + +On line 3668: + the low end and a + average delinquency rate + on the high end. The + +On line 3668: + full bar for the GSEs + spans average delinquency + rates from to That means + +On line 3668: + were in subgroups with + average delinquency rates + above In sharp contrast, + +On line 3670: + (SUB) spans average + delinquency rates between on + the low end and on + +On line 3670: + end, and the full bar + spans average delinquency + rates between and That + +On line 3672: + The worst-performing of + GSE loans are in subgroups with + rates of serious + +On line 3674: + to the best-performing + of SUB loans.16 By the end of + performance within + +On line 3676: + market had weakened. + The median delinquency + rate—the midpoints of the + +On line 3678: + black bars—rose from in to + for GSE loans, from to for SUB + loans, from to for Alt-A + +On line 3680: + at roughly for FHA + loans. The data illustrate + that in and GSE loans + +On line 3680: + or non-GSE, subprime and + Alt-A loans. That holds true even when + comparing loans in + +On line 3680: + that share the same key + characteristics with the + loans in privately + +On line 3680: + such as low FICO + scores. For example, among loans + to borrowers with + +On line 3684: + times as likely to + be seriously delinquent + as a GSE. In the + +On line 3684: + delinquency rates for + the non-GSE and GSE loans were and + These patterns are most + +On line 3686: + by some differences + not captured in these mortgages.17 + For instance, in the + +On line 3686: + borrowers tended + to make bigger down payments. + The FCIC’s data show + +On line 3686: + indicating that + the borrower made a down + payment of at least + +On line 3686: + relatively large + down payment would help offset + the effect of the + +On line 3686: + under The data + illustrate that non-agency + securitized loans + +On line 3686: + more likely to have + more than one risk factor and + thereby exhibit + +On line 3686: + risk layering, such + as low FICO scores on top + of small down payments. + +On line 3688: + Alt-A securities. + For example, in among loans + with an LTV above the + +On line 3688: + an average rate + of serious delinquency + of versus a rate + +On line 3688: + loans in private Alt-A + securities.18 These results + are also, in large + +On line 3690: + by differences in + risk layering. Others frame + the situation + +On line 3690: + to Ed Pinto, a + mortgage finance industry + consultant who was + +On line 3690: + credit officer + at Fannie Mae in the 1980s, + GSEs dominated + +On line 3690: + market for risky loans. + In written analyses reviewed + by the FCIC staff and + +On line 3690: + Commissioners as + well as in a number of + interviews, Pinto + +On line 3690: + has argued that the + GSE loans that had FICO scores + below a combined + +On line 3690: + as interest-only + payments were essentially + equivalent to those + +On line 3692: + labeled subprime and + Alt-A by issuers. Using strict + cutoffs on FICO + +On line 3692: + partly related + to mortgage performance (as + well as relying + + on a number of + other assumptions), Pinto + estimates that as + +On line 3692: + June of all mortgages + in the country—26.7 million of + them—were risky mortgages that + +On line 3692: + defines as subprime + or Alt-A. Of these, Pinto counts + million, or that were + +On line 3694: + GSEs.19 In contrast, the + GSEs categorize fewer + than million of their + + loans as subprime or + Alt-A.20 Importantly, as the + FCIC review shows, the + +On line 3696: + loans classified as + subprime or Alt-A in Pinto’s + analysis did not + +On line 3696: + as poorly as loans + in non-agency subprime or + Alt-A securities. + +On line 3696: + suggest that grouping + all of these loans together + is misleading. In + +On line 3696: + characteristics + such as high loan-to-value + ratios are not at + +On line 3696: + performance data + assembled and analyzed + by the FCIC show that + +On line 3696: + securitized loans + experienced much higher + rates of delinquency + +On line 3698: + In addition to + examining loans owned and + guaranteed by the + + GSEs, Pinto also + commented on the role of + the Community + +On line 3698: + Act (CRA) in causing + the crisis, declaring, "The pain + and hardship that CRA + +On line 3700: + to this view, two Fed + economists determined that + lenders actually + + made few subprime loans + to meet their CRA requirements. + Analyzing a + +On line 3702: + of nearly million + loans originated in they + found that only a + +On line 3702: + percentage of all + higher-cost loans as defined + by the Home Mortgage + + Disclosure Act had + any connection to the CRA. + These higher-cost loans + +On line 3702: + rough proxy for subprime + mortgages. Specifically, the + study found that only + +On line 3702: + or moderate-income + neighborhoods by banks and thrifts + (and their subsidiaries and + +On line 3704: + covered by the CRA. + The other of higher-cost + loans either were made + +On line 3704: + institutions that + did not receive CRA credit + for these loans or were + +On line 3704: + not covered by the + CRA. Using other data + sources, these economists + +On line 3704: + that CRA-related subprime loans + appeared to perform better + than other subprime + +On line 3704: + "Taken together, + the available evidence seems + to run counter to the + +On line 3704: + the CRA contributed + in any substantive way to + the current crisis," + +On line 3706: + come to similar + conclusions. For example, + two economists at + + the San Francisco + Fed, using a different + methodology and + +On line 3706: + of loans made by CRA-covered + lenders were located in low- + and moderate-income + +On line 3706: + not covered by the + CRA. Further, fewer than of + the loans made by CRA + +On line 3706: + communities were + higher priced, even at the peak + of the market. In + +On line 3706: + loans originated + by independent mortgage + companies in these + +On line 3706: + of the loans and the + borrowers, such as income + and credit score, the + +On line 3706: + loans made by CRA-covered lenders + in the low-and moderate-income + areas they serve were + +On line 3706: + similar loans made + by independent mortgage + companies, which are + +On line 3706: + are subject to less + regulatory oversight + in general. "While + +On line 3706: + this suggests that the + CRA, and particularly + its emphasis on + +On line 3706: + assessment area, helped + to ensure responsible + lending, even during + +On line 3708: + overall declines in + underwriting standards," they + concluded.23 Overall, + +On line 3708: + and CRA-covered banks and thrifts + accounted for at least of + all mortgage lending + +On line 3708: + mortgage companies + originated less than one-third + of all mortgages but + +On line 3708: + These affiliates + accounted for another + roughly of mortgage + +On line 3710: + but about of high-price + lending. Bank of America + provided the FCIC + +On line 3710: + its CRA-qualifying portfolio, + which represented only + of the bank’s mortgage + +On line 3710: + portfolio.25 In the + end of the first quarter of + of the bank’s billion + +On line 3710: + of residential + mortgages was nonperforming: + of the billion CRA-qualifying + +On line 3712: + nonperforming at + that date. John Reed, a former + CEO of Citigroup, + + when asked whether he thought + government policies such as + the CRA played a role + +On line 3714: + the crisis, said that + he didn’t believe THE BUST1 + banks would originate + +On line 3714: + policy allowed + it" unless the bank could sell + off the mortgage to + + Fannie or Freddie, + which had their own obligations + in this arena. He + + said, "It’s hard for me + to answer. If the reason + the regulators + +On line 3714: + jump up and down and + yell at the low-doc, no-doc + subprime mortgage was + + because they felt that + they, Congress had sort of pushed + in that direction, + + then I would say yes."26 + "You know, CRA could be a pain + in the neck," the banker + +On line 3716: + Ranieri told the FCIC. "But + you know what1 It always, in + my view, it always + + did much more good than + it did anything. You know, we + did a lot. CRA made + +On line 3716: + a difference." But + lenders including Countrywide + used pro-homeownership + +On line 3716: + "smokescreen" to do away + with underwriting standards + such as requiring + + down payments, he said. + "The danger is that it gives + air cover to all + +On line 3718: + kind of madness that + had nothing to do with the + housing goal."27 RATING + +On line 3720: + to the ratings of + mortgage-backed securities at + Moody’s were monitored + +On line 3720: + the same analysts + who had rated them in the + first place. In Nicolas + +On line 3720: + officer and team + managing director, was + charged with creating + +On line 3722: + team to monitor + previously rated deals.28 + In November the + +On line 3722: + team began to see + a rise in early payment + defaults in mortgages + +On line 3722: + Loan,29 and downgraded + several securities + with underlying + +On line 3722: + or put them on watch + for future downgrades. "This was + a very unusual + + situation as + never before had we put + on watch deals rated + +On line 3722: + same calendar year," + Weill later wrote to Raymond + McDaniel, the chairman and + +On line 3724: + Brian Clarkson, the + president of Moody’s Investors + Service.30 In early + +On line 3724: + report, overseen by + Weill, about the sharp increases + in early payment + +On line 3724: + were concentrated + in subprime mortgage pools. In + addition, more than + +On line 3724: + securitized in + the second quarter of were + days delinquent within + +On line 3724: + months, more than double + the rate a year earlier + The exact cause of + +On line 3724: + agency, though. "Moody’s is + currently assessing whether + this represents an + +On line 3726: + overall expected + loss."31 For the next few months, the + company published + +On line 3726: + the subprime mortgage + market. Over the next three months, + Moody’s took negative + +On line 3726: + Then, on July in + an unprecedented move, Moody’s + downgraded subprime + +On line 3726: + securities that + had been issued in and put + an additional + +On line 3726: + securities that + were affected, all rated + Baa and lower, made + +On line 3726: + securities that + Moody’s rated Baa in For the + time eing, there were no + +On line 3726: + with prolonged, slowing + home price appreciation" + and noted that about + +On line 3726: + contained mortgages from + one of four originators: + Fremont Investment + +On line 3728: + Corporation, and + WMC Mortgage Corp.32 Weill later + told the FCIC staff that + +On line 3728: + a mass announcement, + rather than downgrading a few + securities at + +On line 3728: + to avoid creating + confusion in the market.33 + A few days later, + +On line 3728: + tranches. These initial + downgrades were remarkable not + only because of + +On line 3728: + of securities + involved but also because + of the sharp rating + +On line 3728: + of four notches per + security, when one or + two notches was more + +On line 3728: + a single notch would + be a downgrade from AA to + AA-). Among the tranches + +On line 3730: + M10, and M11) of the + Citigroup deal that we have + been examining, + +On line 3732: + CMLTI 2006-NC2. By that point, + nearly of the original + loan pool had prepaid + +On line 3734: + but another were + or more days past due or in + foreclosure.34 Investors + +On line 3734: + were assessing their + own exposure, and guessing + at that of others, + +On line 3734: + to these assets. A + report from Bear Stearns Asset + Management detailed + +On line 3734: + exposure. One of + its CDOs, Tall Ships, had direct + exposure to our + +On line 3734: + sample deal, owning + million of the M7 and M8 + tranches. BSAM’s High-Grade hedge + +On line 3734: + had exposure through + a million credit default + swap position with + + Lehman referencing + the M8 tranche. And BSAM’s Enhanced + Leverage hedge fund owned + +On line 3734: + of the equity + in Independence CDO, which + in turn owned the M9 + + tranche of our sample + deal. In addition, these funds + had exposure through + +On line 3736: + holdings of other + CDOs that in turn owned tranches + of the Citigroup + +On line 3738: + Then, on October + Moody’s downgraded another + tranches billion) of + +On line 3738: + tranches billion) on + watch for potential downgrade. + Now the total of + +On line 3738: + Moody’s had rated. Of + the securities placed on + watch in October, + +On line 3740: + tranches billion) were + originally Aaa-rated and + billion) were Aa-rated. + +On line 3740: + the first months of of + the mortgage-backed security + deals issued in had + +On line 3742: + one tranche downgraded + or put on watch.36 By this point + in October, of + +On line 3744: + our case study deal CMLTI + 2006- NC2 were seriously + delinquent and some homes + +On line 3744: + M4 through M8 tranches + were downgraded as part of + the second wave of + +On line 3744: + Five additional + tranches would eventually + be downgraded in + +On line 3748: + downgrade of all the + Aaa mortgage-backed securities + tranches and all of + + the Baa tranches. For + those securities issued + in the second half + +On line 3750: + and Baa tranches were + downgraded. Of all THE BUST3 + tranches initially + +On line 3750: + investment grade—that + is, rated Baa3 or higher—76% + of those issued in + +On line 3752: + were downgraded to + junk, as were of those from CDOS: + "CLIMBING THE WALL OF + +On line 3754: + WORRY" In March Moody’s + reported that CDOs with high + concentrations of + + subprime mortgage–backed + securities could incur + "severe" downgrades.39 In + +On line 3754: + sent five days after + the report, Group Managing + Director of U.S. + +On line 3754: + Yuri Yoshizawa explained + to Moody’s Chairman McDaniel and to + Executive Vice + +On line 3754: + banks like Merrill, Citi, + and UBS still furiously + doing transactions + +On line 3754: + He believes that they + are creating and pricing + the CDOs in order + +On line 3754: + remove the assets + from the warehouses, but that + they are holding on + +On line 3756: + the CDOs in hopes that + they will be able to sell them + later."40 Several + + months later, in a + review of the CDO market + titled "Climbing the + +On line 3758: + noted, "Some of the + first quarter’s activity + [in was the result + +On line 3758: + feverishly working + to clear inventory and + reduce their balance + +On line 3758: + to the subprime class."41 + Even though Moody’s was aware that the + investment banks were + +On line 3758: + of the warehouses + and into CDOs—possibly regardless + of quality—the firm + + continued to rate + new CDOs using existing + assumptions. Former + + Moody’s executive + Richard Michalek testified to the + FCIC, "It was a case + + of, with respect to + why didn’t we stop and change + our methodology, + +On line 3760: + at Moody’s, at least while + I was there, that suggested + that the only thing + +On line 3760: + quickly getting a + new methodology in place + is quickly getting + +On line 3760: + methodology in + place and having to unwind + that and to fail to + +On line 3762: + July, McDaniel gave a + presentation to the board + on the company’s + +On line 3762: + plan. His slides had such + bleak titles as "Spotlight on + Mortgages: Quality + +On line 3762: + Continues to Erode," + "House Prices Are Falling "Mortgage + Payment Resets Are + +On line 3762: + the quality of + the underlying mortgages + was declining, Moody’s + +On line 3762: + ratings assumptions + until late September.44 Out + of billion in CDOs + +On line 3764: + subprime mortgage–backed + securities on July + were rated Aaa.45 Moody’s + +On line 3764: + borrowers might stay + current. However, in mid-September, + Eric Kolchinsky, a + +On line 3764: + learned that a survey + of servicers indicated + that very few troubled + +On line 3764: + being modified.46 + Worried that continuing + to rate CDOs without + + adjusting for known + deterioration in + the underlying + +On line 3764: + could expose Moody’s to + liability, Kolchinsky + advised Yoshizawa that + +On line 3768: + the FCIC that Yoshizawa + "admonished" him for making + the suggestion.47 y + +On line 3768: + the end of more than + of all tranches of CDOs had + been downgraded. Moody’s + +On line 3770: + downgraded nearly + all of the Aaa and all of + the Baa CDO tranches. + +On line 3772: + And, again, the downgrades + were large—more than of Aaa CDO + bonds and more than of + +On line 3776: + THE BASIS OF THE + INFORMATION" The housing + bust exposed the flaws + +On line 3776: + the mortgages that had + been made and securitized. + After the crisis + +On line 3776: + mortgage insurance + firms—closely examined the + representations + +On line 3776: + assure investors and + insurers that the mortgages + met stated guidelines. + +On line 3776: + securitizers’ + due diligence on the mortgage + pools underlying + +On line 3776: + their disclosure about + the characteristics of + those deals. As private + + mortgage insurance + companies found similar + deficiencies in + +On line 3778: + have denied claims to + an unprecedented extent. + Fannie and Freddie + +On line 3778: + warranties—that the loans + meet specified criteria. + They then checked samples + +On line 3778: + the loans to ensure + that these representations + and warranties were not + +On line 3778: + was a breach and the + loans were "ineligible" + for purchase, the GSE + +On line 3780: + the right to require + the seller to buy back the + loan—assuming, of course, + +On line 3782: + seller had not gone + bankrupt. As a result of + such sampling, during + +On line 3782: + the three years and eight + months ending August Freddie + and Fannie required + +On line 3782: + to repurchase loans + totaling billion. So far, + Freddie has received + +On line 3782: + sellers, and Fannie + has received billion—a total + of billion.49 The amount + +On line 3782: + is notable in that + it represents of billion + in credit-related + +On line 3784: + beginning of through + September In testing to + ensure compliance + +On line 3784: + its standards, Freddie + reviews a small percentage + of performing loans + +On line 3784: + a high percentage + of foreclosed loans (including + well over of all loans + +On line 3784: + default in the first + two years). In total, Freddie + reviewed billion of + +On line 3784: + (out of trillion in + loans acquired or guaranteed) + and found billion to + +On line 3786: + time an increasing + percentage were found to be + ineligible, + +On line 3788: + put back very few of + these performing loans to the + originators. Among + +On line 3788: + that of the delinquent + loans were ineligible, + as were of the loans + +On line 3788: + Most of these were put + back to originators—again, + in cases in which + +On line 3790: + if the reasons for + ineligibility + were sufficiently + + minor, the loans were + not put back. Overall, of the + delinquent loans and loans + +On line 3792: + foreclosure sampled + by Freddie, were put back. In + and Freddie put back + +On line 3792: + loan volumes to the + following lenders: Countrywide, + billion; Wells Fargo, + +On line 3792: + Chase Home Financial, + billion; Bank of America, + million; and Ally + +On line 3794: + Financial, million.53 + Using a method similar + to Freddie’s to test + +On line 3794: + and of the mortgages + originated since 2005—sampling + at the higher rates + +On line 3794: + for delinquent loans. From + through Fannie put back loans to + the following large + +On line 3794: + Morgan Chase, billion; + Citigroup, billion; SunTrust Bank, + million; and Ally + +On line 3794: + Financial, million.54 + In early January Bank + of America reached + + a deal with Fannie + and Freddie, settling the GSEs’ + claims with a payment + +On line 3796: + more than billion. Like + Fannie and Freddie, private + mortgage insurance + + (PMI) companies have + been finding significant + deficiencies in + +On line 3796: + They are refusing + to pay claims on some insured + mortgages that have gone + +On line 3796: + insurance protects + the holder of the mortgage + if a homeowner + +On line 3796: + on a loan, even though + the responsibility + for the premiums + +On line 3796: + homeowner. By the + end of PMI companies had + insured a total + +On line 3798: + mortgage losses.56 As + defaults and losses on the + insured mortgages have + + been increasing, the + PMI companies have seen a + spike in claims. As of + +On line 3798: + largest PMI companies, + which share of the market, had + rejected about of + +On line 3800: + claims (or billion of + billion) brought to them, because + of violations + +On line 3802: + Separate from their + purchase and guarantee of + mortgages, over the course + +On line 3802: + housing boom the GSEs + purchased billion of subprime + and Alt-A private-label + +On line 3802: + have recorded billion + in charges on securities + from January to + +On line 3802: + Frustrated with the + lack of information from + the securities’ + +On line 3802: + in many cases large + banks, on July the GSEs through + their regulator, + +On line 3802: + to various trustees + and servicers in transactions + in which the GSEs lost + +On line 3802: + violations, the + GSEs intend to demand that + the trustees recognize + + their rights (including + any rights to put loans back to + the originator + + or wholesaler).61 While this + strategy being followed + by the GSEs is based + +On line 3804: + contract law, other + investors are relying on + securities law + +On line 3804: + by inaccurate + or incomplete prospectuses; + and, in a number + +On line 3806: + they are winning. As + of mid-2010, court actions embroiled + almost all major + +On line 3806: + loan originators + and underwriters—there + were more than lawsuits + +On line 3806: + and warranties, by one + estimate.62 These lawsuits filed + in the wake of the + +On line 3806: + crisis include those + alleging "untrue statements + of material + +On line 3806: + or "material + isrepresentations" in + the registration + +On line 3806: + They generally + allege violations of + the Securities + +On line 3808: + Act of Both private + and government entities + have gone to court. For + +On line 3808: + sued units of Bank of + America, Wells Fargo, and + UBS Securities.63 + +On line 3808: + of inadequate + disclosure relating to + their sales of mortgage-backed + +On line 3810: + Stanley agreed to pay + million and Goldman Sachs agreed + to pay million.64 To + +On line 3810: + Bank of Chicago has + sued several defendants, + including Bank of + +On line 3810: + sued units of Morgan + Stanley, Citigroup, HSBC, + Goldman Sachs, Barclays, + +On line 3810: + of America, among + others, "on the basis of + the information + +On line 3814: + downgraded mortgage-backed + securities and CDOs, and + investors began to + +On line 3814: + market prices for these + securities plunged. Both the + direct losses as + + well as the marketwide + contagion and panic that + ensued would lead to + +On line 3814: + or near failure of + many large financial firms across + the system. The drop + +On line 3814: + the underlying + mortgages would actually + default (meaning that + + less cash would flow to + the investors) as well as the + more generalized + +On line 3814: + because they wanted + the assurance that they could + sell securities + + quickly to raise cash + if necessary. Potential + investors worried they + +On line 3814: + get stuck holding these + securities as market + participants looked + +On line 3816: + exposure to the + collapsing mortgage market. + As market prices dropped, + +On line 3816: + required firms to write + down their holdings to reflect + the lower market + +On line 3818: + first quarter of the + largest banks and investment banks + began complying + +On line 3818: + accounting rule and + for the first time reported + their assets in one + +On line 3818: + three valuation + categories: "Level assets," + which had observable + +On line 3818: + market prices, like stocks + on the stock exchange; "Level + assets," which were not + +On line 3818: + priced because they were + not actively traded; and + "Level assets," which + + were illiquid and had + no discernible market prices or + other inputs. To + +On line 3818: + value of Level + and in some cases Level + assets where market + + prices were unavailable, + firms used models that relied + on assumptions. Many + +On line 3818: + Level assets that + substantially exceeded + their capital. For + +On line 3820: + for the first quarter + of Bear Stearns reported about + billion in Level + +On line 3822: + capital; Morgan + Stanley re-THE BUST7 ported about + billion in Level + +On line 3824: + were required on many + securities even if there + were no actual + +On line 3824: + losses and in some + cases even if the firms did + not intend to sell + +On line 3824: + in part, on credit + rating agencies’ and investors’ + expectations that + +On line 3824: + default. But only + when those defaults came to pass + would holders of the + +On line 3824: + market value of + securities that did not + trade was difficult, + + was subjective, and + became a contentious issue + during the crisis. + +On line 3826: + and capital, and + triggered collateral calls. + These mark-to-market + +On line 3826: + received a good deal + of criticism in recent + years, as firms argued + +On line 3826: + the lower market + prices did not reflect market + values but rather fire-sale + + prices driven by forced + sales. Joseph Grundfest, when he was + a member of the + + SEC’s Committee on + Improvements to Financial + Reporting, noted + +On line 3826: + market prices "creates + situations where you have + to go out and raise + +On line 3826: + never really + there."66 But not valuing assets + based on market prices + + could mean that firms were + not recording losses required + by the accounting + +On line 3828: + capital. As the + mortgage market was crashing, + some economists and + +On line 3828: + estimated that + actual losses, also + known as realized + +On line 3828: + losses, on subprime + and Alt-A mortgages would total + to billion;67 so far, + +On line 3828: + by the figure has + turned out not to be much more + than that. As of year-end + +On line 3828: + total about billion.68 + Securities are impaired + when they have suffered + +On line 3828: + are expected to + suffer realized losses + imminently. While + +On line 3830: + numbers are small in + relation to the trillion + U.S. economy, the + +On line 3830: + mortgages themselves are + a pretty small asset class," + Fed Chairman Ben Bernanke + +On line 3830: + explaining how in + he and Treasury Secretary + Henry Paulson had + +On line 3830: + repercussions of the + emerging housing crisis. "You + know, the stock market + +On line 3830: + down every day more + than the entire value of + the subprime mortgages + +On line 3830: + the country. But what + created the contagion, + or one of the things + +On line 3830: + the contagion, was + that the subprime mortgages were + entangled in these + + huge securitized + pools."69 The large drop in market + prices of the mortgage + +On line 3832: + had large spillover effects + to the financial sector, + for a number of + +On line 3832: + discussed, when the prices + of mortgage-backed securities + and CDOs fell, many of + +On line 3832: + those securities + marked down the value of their + holdings—before they + + had experienced + any actual losses. In + addition, rather than + +On line 3834: + had concentrated + them. "Who owns residential + credit risk1" two Lehman + +On line 3834: + analysts asked in + a September report. The + answer: three-quarters + +On line 3834: + investment-grade + securities and has been + almost entirely + +On line 3834: + (CDO) holders."70 A set + of large, systemically + important firms with + +On line 3834: + or exposure to + these securities would be + found to be holding + +On line 3834: + little capital + to protect against potential + losses. And most of + +On line 3834: + companies would turn + out to be considered by + the authorities + +On line 3836: + fail in the midst of + a financial crisis. The + International + +On line 3836: + examined where the + declining assets were held + and estimated + +On line 3836: + write-downs would be. All + told, the IMF calculated + that roughly trillion + +On line 3836: + these, trillion were GSE + mortgage–backed securities; + the IMF expected + +On line 3836: + billion, but investors + holding these securities + would lose no money, + +On line 3836: + mortgage assets were + estimated to be prime + and nonprime mortgages + +On line 3836: + by the banks and the + GSEs. These were expected to + suffer as much as + +On line 3836: + estimated to + be mortgage-backed securities + and CDOs. Write-downs on + +On line 3836: + expected to be + billion. And, even more troubling, + more than one-half of these + +On line 3836: + were expected to + be borne by the investment + banks, commercial banks, + +On line 3836: + rest of the write-downs + from non-agency mortgage–backed + securities were + +On line 3836: + institutions such + as insurance companies, + pension funds, the GSEs, + +On line 3836: + funds. The October + report also expected + another billion + +On line 3836: + securities, CLOs, + leveraged loans, and other loans + and securities—with + + more than half coming + from commercial mortgage–backed + securities. Again, + + the commercial banks + and thrifts and investment banks + were expected to + +On line 3838: + (suggested by the + sizable revi-sions in the + IMF estimates) and + +On line 3838: + promote contagion. + Investors would realize they + did not know as much + + as they wanted to + know about the mortgage assets + that banks, investment + +On line 3838: + and other firms held + or to which they were exposed. + To an extent not + +On line 3838: + before the crisis, + financial institutions + had leveraged themselves + +On line 3838: + commercial paper, + with derivatives, and in + the short-term repo + +On line 3840: + by using mortgage-backed + securities and CDOs as + collateral. Lenders + +On line 3840: + of the assets that + those companies had posted + as collateral + +On line 3840: + the same time that they + were questioning the value + of those companies’ + +On line 3844: + highest-rated tranches + of mortgage-backed securities + were downgraded, and + +On line 3844: + balance sheets based on + declines in market value. + However, although + +On line 3844: + this could not be known + in at the end of most of + the triple-A tranches of + +On line 3844: + securities have + avoided actual losses + in cash flow through and + +On line 3846: + avoid significant + realized losses going + forward. Overall, for + +On line 3846: + mass downgrades, only + about of Alt-A and of subprime + securities had + +On line 3846: + "materially + impaired"—meaning that losses + were imminent or + +On line 3846: + (see figure For the + lower-rated Baa tranches, of + Alt-A and of subprime + +On line 3846: + securities were + impaired. In all, by the end + of billion worth of + +On line 3846: + outcome would be far + worse for CDO investors, whose fate + largely depended + +On line 3848: + lower-rated mortgage-backed + securities. More than of + Baa CDO bonds and of + +On line 3850: + were ultimately + impaired.72 The housing bust would + not be the end of + +On line 3850: + to the FCIC: "What I + did not recognize was the + extent to which the + +On line 3850: + it that were going + to amplify the initial + shock from subprime and + +On line 3852: + much bigger crisis."73 + The Commission concludes that + the collapse of the + +On line 3852: + bubble began the + chain of events that led to the + financial crisis. + +On line 3856: + vulnerable to + the downturn in the market + in The investment + +On line 3856: + had leverage ratios, + by one measure, of up to + to This means that for + +On line 3856: + they held only of + capital. Fannie Mae and + Freddie Mac (the GSEs) + +On line 3858: + many institutions + was even greater than reported + when one takes into + +On line 3858: + of Citigroup, and + derivatives positions + such as those of AIG. + +On line 3860: + contributed to, but + were not a primary cause + of, the financial + +On line 3862: + mortgage exposure + and market position were + significant, and + +On line 3862: + dramatic failures. + They participated in + the expansion of + +On line 3862: + mortgage lending and + declining mortgage standards, + adding significant + + demand for less-than-prime loans. + However, they followed, rather + than led, the Wall Street + +On line 3862: + The delinquency rates + on the loans that they purchased + or guaranteed were + + significantly + lower than those purchased and + securitized by + +On line 3864: + The Community + Reinvestment Act (CRA)—which requires + regulated banks + +On line 3864: + services consistent + with safety and soundness to + the areas where they + +On line 3864: + in subprime lending. + However, community + lending commitments + +On line 3864: + required by the CRA + were clearly used by lending + institutions for + +On line 3889: + CONTENTS Goldman: "Let’s + be aggressive distributing + things"..............................................235 Bear Stearns’s hedge funds: + +On line 3891: + pretty damn ugly"........................................238 + Rating agencies: "It can’t be + all of a sudden"..................................................242 + +On line 3895: + AIG: "Well bigger than + we ever planned for" Over the + course of the collapse + +On line 3895: + bubble and the abrupt + shutdown of subprime lending + led to losses for + +On line 3895: + institutions, runs + on money market funds, tighter + credit, and higher + +On line 3895: + steady, hovering just + below until the end of + the year, and oil prices + +On line 3895: + dramatically. + By the middle of home prices + had declined almost + +On line 3895: + their peak in Early + evidence of the coming + storm was the drop in + +On line 3897: + the ABX Index—a Dow + Jones–like index for credit + default swaps on BBB-tranches + +On line 3899: + issued in the first + half of That drop came after + Moody’s and S&P put on + +On line 3899: + backed by mortgages from + one originator: Fremont + Investment Loan.2 In + +On line 3899: + Sebring Capital + ceased operations. Senior + risk officers of + +On line 3899: + largest investment banks + told the Securities and + Exchange Commission + +On line 3899: + that they expected + to see further subprime lender + failures in "There is + + a broad recognition + that, with the refinancing + and real estate + +On line 3899: + business model of + many of the smaller subprime + originators is + + no longer viable," SEC + analysts told Director + Erik Sirri in a + +On line 3901: + became more and more + evident. In January, + Mortgage Lenders Network + +On line 3901: + funding mortgages and + accepting applications. + In February, New + +On line 3901: + credit losses and + HSBC, the largest subprime lender + in the United States, + +On line 3901: + billion increase in + its quarterly provision + for losses. In March, + +On line 3901: + after receiving + a cease and desist order + from the Federal + + Deposit Insurance + Corporation. In April, New + Century filed for + +On line 3903: + their operating + cash on short-term funding through + commercial paper + +On line 3903: + paper buyers and + banks became unwilling to + continue funding + + them, and repo lenders + became less and less willing + to accept subprime + + and Alt-A mortgages or + mortgage-backed securities as + collateral. They + +On line 3903: + gave them the option + of withholding funding on + short notice if they + + lost confidence in + the borrower. Another + sign of problems in + +On line 3905: + companies began + to report more detail about + their assets under + +On line 3905: + securities that + were becoming illiquid and + hard to value. The + +On line 3905: + sum of more illiquid + Level and assets at these + firms was "eye-popping + +On line 3905: + the amount of leverage + the banks and investment banks + had," according to + +On line 3905: + Chanos, a New York hedge + fund manager. Chanos said that + the new disclosures + +On line 3905: + large exposures from + securitizations. "You + clearly didn’t get + + the magnitude, and + the market didn’t grasp the + magnitude until + +On line 3905: + of when the figures + began to be published, and + then it was as if + +On line 3905: + bell, because almost + immediately upon + the publication + +On line 3905: + journalists began + writing about it, and hedge funds + began talking about + +On line 3907: + began speaking about + it in the marketplace."4 In + late and early some + + banks moved to reduce + their subprime exposures by + selling assets and + + buying protection + through credit default swaps. Some, + such as Citigroup + +On line 3907: + Merrill Lynch, reduced + mortgage exposure in some + areas of the firm + + but increased it in + others. Banks that had been busy + for nearly four years + +On line 3907: + collateralized + debt obligations (CDOs) scrambled + in about that many months + +On line 3907: + hedge whatever they + could. They now dumped these products + into some of the + +On line 3907: + Merrill Lynch, and UBS, + particularly, were forced + to retain larger + +On line 3907: + larger quantities + of the "super-senior" tranches + of these CDOs. The bankers + +On line 3909: + always hope— and many + apparently even believed—that + all would turn out well + +On line 3911: + these super seniors, + which were, in theory, the + safest of all. With such + +On line 3911: + market value of + mortgage assets, trades became + scarce and setting prices + +On line 3913: + subprime markets, they + misjudged the risks posed to the + financial system. + +On line 3913: + that investment banks + had credit exposure to + struggling subprime lenders + +On line 3913: + these exposures are + material."5 The Treasury + and Fed insisted + +On line 3913: + the spring and early + summer that the damage would + be limited. "The + +On line 3913: + broader economy + and financial markets of + the problems in the + +On line 3913: + market seems likely + to be contained,"6 Fed Chairman + Ben Bernanke testified + +On line 3913: + Congress on March That + same day, Treasury Secretary + Henry Paulson told + +On line 3915: + "From the standpoint of + the overall economy, my + bottom line is we’re + +On line 3919: + but it appears to + be contained."7 EARLY GOLDMAN: + "LET’S BE AGGRESSIVE + +On line 3919: + DISTRIBUTING THINGS" In + December following the + initial decline in + +On line 3919: + ABX BBB indices and + after consecutive days + of trading losses + + on its mortgage desk, + executives at Goldman + Sachs decided to + +On line 3919: + the value of its + mortgage-related products to + reflect the lower + + ABX prices, and began + posting daily losses for + this inventory.8 + +On line 3921: + internal report + on December regarding + "the major risk in + +On line 3921: + Mortgage business" to + Chief Financial Officer + David Viniar and Chief Risk + +On line 3921: + get "closer to home," + meaning that they wanted to + reduce their mortgage + + exposure: sell what + could be sold as is, repackage + and sell everything + + else.10 Kevin Gasvoda, the + managing director for + Goldman’s Fixed Income, + +On line 3921: + the sales team to sell + asset-backed security and + CDO positions, even + +On line 3921: + loss: "Pls refo-cus + on retained new issue bond + positions and move + + them out. There will be + big opportunities the + next several months + +On line 3921: + want to be hamstrung + based on old inventory. + Refocus efforts + +On line 3923: + move stuff out even if + you have to take a small loss."11 + In a December + +On line 3923: + ABX, the position + is reasonably sensible + but is just too big. + +On line 3925: + spend a little to + size it appropriately. + On everything else + +On line 3925: + message was let’s be + aggressive distributing things + because there will be + +On line 3925: + opportunities + as the market goes into + what is likely to + +On line 3925: + greater distress and we + want to be in position + to take advantage + +On line 3927: + the "everything else" + meant mortgage-related assets. + On December in + +On line 3927: + Goldman’s Stacy Bash-Polley, + a partner and the co-head + of fixed income sales, + + noted that the firm, + unlike others, had been able + to find buyers for + + the super-senior and + equity tranches of CDOs, + but the mezzanine + + tranches remained a + challenge. The "best target," she + said, would be to put + +On line 3927: + other CDOs: "We have + been thinking collectively + as a group about how + + to help move some of + the risk. While we have made great + progress moving the tail + +On line 3927: + and equity—we + think it is critical to + focus on the mezz + +On line 3927: + that has been built up + over the past few months. Given + some of the feedback + +On line 3927: + have received so far + [from investors,] it seems that cdo’s + maybe the best target + +On line 3927: + some of this risk but + clearly in limited size + (and timing right now + +On line 3929: + It was becoming + harder to find buyers for + these securities. + + Back in October, + Goldman Sachs traders had complained + that they were being + + asked to "distribute + junk that nobody was dumb enough + to take first time around."14 + + Despite the first of + Goldman’s business principles—that + "our clients’ interests + +On line 3929: + in its efforts to + reduce subprime exposure. + In a December + +On line 3929: + discussing a list of + customers to target for the + year, Goldman’s Fabrice + +On line 3929: + trading desk, said to + "focus efforts" on "buy and + hold rating-based buyers" + +On line 3929: + "sophisticated + hedge funds" that "will be on the + same side of the trade + +On line 3929: + we will."15 The "same of + side of the trade" as Goldman + was the selling or + +On line 3929: + the mortgage market + to continue to decline. + In January, Daniel + +On line 3929: + the head of Goldman’s + mortgage department, extolled + Goldman’s success in + +On line 3929: + the team had "structured + like mad and traveled the world, + and worked their tails off + +On line 3929: + some lemonade from some + big old lemons."16 Tourre acknowledged + that there was "more and + +On line 3929: + himself in the third + person—said he was "standing + in middle of all + + these complex, highly + levered, exotic trades he + created without + +On line 3931: + of those monstrosities."17 + On February Goldman CEO + Lloyd Blankfein questioned + +On line 3933: + million in losses + on residual positions + from old deals, asking, + + "Could/should we have cleaned + up these books before and are + we doing enough right + +On line 3935: + to sell off cats and + dogs in other books throughout + the division1"18 The + + numbers suggest that + the answer was yes, they had + cleaned up pretty well, + +On line 3935: + billions of dollars + of subprime exposure still + retained. In the first + +On line 3935: + its mortgage business + earned a record million, driven + primarily by + +On line 3935: + position on the + bellwether ABX BBB index, whose + drop the previous + + November had been + the red flag that got Goldman’s + attention. In the + +On line 3937: + products to its clients. + From December through August + it created and + +On line 3939: + of CDOs— including + billion of synthetic CDOs. + The firm used the cash + +On line 3939: + its own remaining + inventory of other + CDO securities + +On line 3941: + criticized—and sued—for + selling its subprime mortgage + securities to + +On line 3941: + finance expert at + R&R Consulting in New York, + reportedly called + +On line 3941: + most cynical use + of credit information + that I have ever + + seen," and compared it + to "buying fire insurance + on someone else’s house + +On line 3943: + arson."20 During a + FCIC hearing, Goldman CEO Lloyd + Blankfein was asked if + +On line 3943: + a proper, legal, + or ethical practice for + Goldman to sell clients + +On line 3945: + believed would default, + while simultaneously + shorting them. Blankfein + + responded, "I do + think that the behavior is + improper and we + +On line 3945: + have lost money"21 The + next day, Goldman issued a + press release declaring + +On line 3945: + improper. Blankfein + was responding to a lengthy + series of statements + +On line 3945: + by a question that + was predicated on the + assumption that a + +On line 3945: + selling a product + that it thought was going to + default. Mr. Blankfein + +On line 3945: + true, the practice would + be improper. Mr. Blankfein + does not believe, nor + +On line 3949: + say, that Goldman Sachs + had behaved improperly + in any way."22 EARLY + +On line 3949: + President and Chief + Operating Officer + Gary Cohn testified: + +On line 3951: + the two years of the + financial crisis, Goldman + Sachs lost billion in + +On line 3951: + its residential + mortgage–related business. We + did not bet against our + +On line 3953: + numbers underscore + that fact."23 Indeed, Goldman’s short + position was not + + the whole story. The + daily mortgage "Value at + Risk" measure, or VaR, + + which tracked potential + losses if the market moved + unexpectedly, + +On line 3955: + in the three months through + February. By February, + Goldman’s company-wide + +On line 3955: + bet on the mortgage + market’s continuing to + decline. Preferring + +On line 3955: + between March and May, + the mortgage securities + desk reduced its short + +On line 3955: + Index;24 between June + and August, it again reversed + course, increasing its + +On line 3957: + assets. The Basis + Yield Alpha Fund, a hedge fund + and Goldman client that + +On line 3957: + invested million + in Goldman’s Timberwolf CDO, + sued Goldman for fraud + +On line 3959: + The Timberwolf deal + was heavily criticized + by Senator Carl + +On line 3959: + Subcommittee on + Investigations during + an April hearing. The + +On line 3959: + that Goldman designed + Timberwolf to quickly fail + so that Goldman could + +On line 3959: + low-quality assets + and profit from betting against + the CDO. Within two + +On line 3959: + investment, Goldman + began making margin calls + on the deal. By the + +On line 3959: + of July it had + demanded more than million.25 + According to the + +On line 3959: + fund, Goldman’s demands + forced it into bankruptcy + in August 2007—Goldman + +On line 3961: + the liquidation. + Goldman denies Basis Yield + Alpha Fund’s claims, and + +On line 3961: + Blankfein dismissed the + notion that Goldman misled + investors. "I will tell + + you, we only dealt + with people who knew what they + were buying. And of + +On line 3961: + when you look after + the fact, someone’s going to + come along and say they + +On line 3963: + didn’t know," he told + the FCIC.26 In addition to + selling its subprime + +On line 3963: + to customers, the firm + took short positions using + credit default swaps; + +On line 3963: + short positions on + the ABX indices and on some + of the financial + +On line 3963: + its securities + after considering both + actual market + + trades and surveys of + how other institutions + valued the assets. + +On line 3963: + crisis unfolded, + Goldman marked mortgage-related + securities at + +On line 3963: + significantly + lower than those of other + companies. Goldman + +On line 3963: + similar assets. + In addition, Goldman’s marks + would get picked up by + +On line 3963: + in dealer surveys. + As a result, Goldman’s marks + could contribute to + +On line 3963: + companies recording + "mark-to-market" losses: that + is, the reported + +On line 3965: + their assets could fall + and their earnings would decline. + The markdowns of these + +On line 3965: + could also require + that companies reduce their + repo borrowings + +On line 3965: + sold credit default + swap protection. In a May + email, Craig Broderick, + +On line 3965: + was responsible + for tracking how much of the + company’s money + + was at risk,27 noted + to colleagues that the mortgage + group was "in the process + +On line 3965: + marks on their mortgage + portfolio [especially] + CDOs and CDO squared. This + + will potentially + have a big [profit and loss] + impact on us, but + +On line 3965: + derivatives, and + other products. We need to + survey our clients and + +On line 3965: + determining the + most vulnerable clients, knock + on implications, + + etc. This is getting + lots of 30th floor attention + right now."28 Broderick + +On line 3967: + right about the impact + of Goldman’s marks on clients and + counterparties. The + +On line 3967: + first significant + dispute about these marks began + in May it concerned + + the two high-flying, + mortgage-focused hedge funds run + by Bear Stearns Asset + +On line 3973: + (BSAM). BEAR STEARNS’S HEDGE FUNDS: + "LOOKS PRETTY DAMN UGLY" In + Ralph Cioffi and Matthew + +On line 3973: + structured CDOs at Bear + Stearns, were busy managing BSAM’s + High-Grade Structured Credit + +On line 3975: + Strategies Fund. When they + added the higher-leveraged, higher-risk + Enhanced Fund in they + +On line 3977: + By April internal + BSAM risk exposure reports + showed about of the High-Grade + + fund’s collateral + to be subprime mortgage–backed + CDOs, assets that were + +On line 3977: + a diary kept in + his personal email account + because he "didn’t + +On line 3979: + to use [his] work email + anymore," Tannin recounted + that in "a wave of + +On line 3979: + set over [him]" when he + realized that the Enhanced + Fund "was going to + + subject investors to + ‘blow up risk’" and "we could not + run the leverage as + +On line 3981: + as I had thought we + could."30 This "blow up risk," coupled + with bad timing, proved + +On line 3983: + Fund. Shortly after + the fund opened, the ABX BBB- + index started to + +On line 3983: + falling in the last + three months of then another + in January and + +On line 3983: + ABX. Investors began + to bail out of both Enhanced + and High-Grade. Cioffi and + +On line 3983: + Tannin stepped up their + marketing. On March Tannin + said in an email to + +On line 3983: + prudent opportunity—I am putting + in additional capital—I think + you should as well."31 On + +On line 3983: + March conference call, + Tannin and Cioffi assured + investors that both funds + +On line 3983: + of liquidity," + and they continued to use + the investment of + +On line 3983: + evidence of their + confidence.32 Tannin even said + he was increasing + +On line 3985: + investment, although, + according to the SEC, he + never did.33 Despite + +On line 3985: + avowals of confidence, + Cioffi and Tannin were in + full red-alert mode. In April, + +On line 3985: + redeemed million of + his own million investment + in Enhanced Leverage + +On line 3985: + transferred the funds to + a third hedge fund he managed.34 + They tried to sell the + +On line 3985: + by the hedge funds. They + had little success selling + them directly on + +On line 3987: + market,35 but there was + another way. In late May, + BSAM put together + +On line 3987: + a CDO-squared deal that would + take billion of CDO assets + off the hedge funds’ books. + +On line 3987: + billion, EARLY were + sold as commercial paper + to short-term investors + +On line 3991: + commercial paper + investors would refuse to roll over + this particular + +On line 3995: + more than billion on + this arrangement.37 is doomsday" + Nearly all hedge funds + + provide their investors + with market value reports, + at least monthly, based + +On line 3995: + readily traded + assets, such as stocks, at the + current trading price, + +On line 3995: + very slow markets were + marked by surveying price quotes + from other dealers, + +On line 3995: + and then arriving + at a final net asset + value. For mortgage-backed + +On line 3995: + marking assets was + an extremely important + exercise, because + + the market values + were used to inform investors + and to calculate + +On line 3995: + for internal risk + management purposes, and + because these assets + +On line 3995: + as collateral + for repo and other lenders. + Crucially, if the + +On line 3995: + hedge fund’s portfolio + declined, repo and other + lenders might require more + + collateral. In + April, JP Morgan told Alan Schwartz, + Bear Stearns’s co-president, + + that the bank would be + asking the BSAM hedge funds to + post additional + +On line 3997: + support its repo + borrowing.38 Dealer marks were + slow to keep up with + +On line 3997: + the ABX indices. Even + as the ABX BBB- index + recovered some in + +On line 3997: + March, rebounding marks + by broker-dealers finally + started to reflect + +On line 3997: + the lower values. + On April Goldman sent BSAM marks + ranging from cents to + +On line 3997: + on the dollar—meaning + that some securities were + worth as little as + +On line 3997: + initial value.39 On + Thursday, April in preparation + for an investor call + +On line 3997: + following week, BSAM + analysts informed Cioffi + and Tannin that in + +On line 3997: + value of the funds’ + portfolios had declined sharply.40 + On Sunday, Tannin + +On line 3997: + Cioffi’s personal + account arguing that both + hedge funds should be closed + +On line 3999: + and liquidated: + "Looks pretty damn ugly. If + we believe the runs + + [the analyst] has + been doing are ANYWHERE CLOSE + to accurate, I + +On line 3999: + should close the Funds now. + If [the runs] are correct then + the entire sub-prime + + market is toast."41 But + by the following Wednesday, + Cioffi and Tannin + +On line 3999: + on the same upbeat + page. At the beginning of + the conference call, + + Tannin told investors, + "The key sort of big picture + point for us at this + +On line 3999: + confidence that the + structured credit market and + the sub-prime market + +On line 3999: + in particular, + has not systemically + broken down; we’re very + +On line 3999: + exactly where we + are." Cioffi also assured + investors that the funds + +On line 3999: + likely finish the + year with positive returns.42 + On May the two hedge + +On line 3999: + funds had attracted + more than million in new funds, + but more than million + +On line 4001: + redeemed by investors.43 + That same day, Goldman sent BSAM + marks ranging from cents + +On line 4001: + cents on the dollar.44 + Cioffi disputed Goldman’s + marks as well as marks + +On line 4001: + from Lehman, Citigroup, + nd JP Morgan.45 On May in + a preliminary + +On line 4001: + told investors that the + net asset value of the + Enhanced Leverage Fund + +On line 4001: + In computing the + final numbers later that + month, he requested + +On line 4001: + Committee instead + use fair value marks based on + his team’s modeling, + +On line 4003: + were to million less + than losses using Goldman’s + marks.47 On June although + +On line 4003: + marks rather than to use + fair value. The committee + also noted that + +On line 4003: + the decline in net + asset value would be greater + than the estimate, + + because "many of the + positions that were marked down + received dealer marks + +On line 4005: + after release of + the estimate."48 The decline + was revised from to + +On line 4005: + Cioffi, a number + of factors contributed to + the April revision, + +On line 4005: + marks were one factor.49 + After these meetings, Cioffi + emailed one committee + +On line 4005: + is no market its + [sic] all academic anyway—19% + [value] is doomsday."50 + +On line 4007: + On June BSAM announced + the drop and froze redemptions. + "Canary in the mine + + shaft" When JP Morgan + contacted Bear’s co-president + Alan Schwartz in April about + +On line 4009: + call, Schwartz convened an + executive committee + meeting to discuss + + how repo lenders were + marking down positions and + making margin calls + +On line 4009: + the basis of those + new marks.51 In early June, Bear + met with BSAM’s repo + +On line 4009: + explain that BSAM lacked + cash to meet margin calls and + to negotiate + + a 60-day reprieve. Some + of these very same firms had sold + Enhanced and High-Grade some + + of the same CDOs and + other securities that + were turning out to + +On line 4009: + bad assets.52 Now all + refused Schwartz’s appeal; instead, + they made margin calls.53 + +On line 4009: + result, the two funds + had to sell collateral + at distressed prices to + + raise cash.54 Selling the + bonds led to a complete loss + of confidence by + +On line 4011: + Shortly after BSAM + froze redemptions, Merrill Lynch + seized more than million + +On line 4011: + posted by Bear for + its outstanding repo loans. + Merrill was able to + +On line 4011: + sell just million of + the seized collateral at + auction by July + +On line 4011: + at discounts to its + face value.55 Other repo + lenders were increasing + + their collateral + requirements or refusing + to roll over their loans.56 + +On line 4011: + run on both hedge funds + left both BSAM and Bear Stearns with + limited options. + +On line 4011: + management business, + Bear’s equity positions + in the two BSAM hedge + +On line 4011: + April Bear’s co-president + Warren Spector approved a + million investment + + into the Enhanced + Leverage Fund.57 Bear Stearns had no + legal obligation + + to rescue either + the funds or their repo lenders. + However, those lenders + +On line 4011: + investment banks that + Bear Stearns dealt with every day.58 + Moreover, any failure + +On line 4011: + related to Bear + Stearns could raise investors’ concerns + about the firm itself. + + Thomas Marano, the head + of the mortgage trading desk, + told FCIC staff that the + + constant barrage of + margin calls had created + chaos at Bear. In late + +On line 4013: + Stearns dispatched him to + engineer a solution + with Richard Marin, BSAM’s CEO. + + Marano now worked to + understand the portfolio, + including what it + +On line 4013: + a worst-EARLY case scenario + in which significant amounts + of assets had to + +On line 4013: + Stearns’s conclusion: High-Grade + still had positive value, + but Enhanced Leverage + +On line 4015: + not. On the basis + of that analysis, Bear Stearns + committed up to + +On line 4015: + ultimately loaned + billion—to take out the High-Grade + Fund repo lenders and + +On line 4017: + sole repo lender to + the fund; Enhanced Leverage was + on its own. During + + a June Federal + Open Market Committee (FOMC) + meeting, members were + +On line 4017: + the subprime market + and the BSAM hedge funds. The staff + reported that the + +On line 4017: + housing market." The + liquidation of subprime + securities at + +On line 4019: + two BSAM hedge funds was + compared to the troubles faced + by Long-Term Capital + +On line 4019: + Chairman Bernanke noted + that the problems the hedge funds + experienced were + + a good example + of how leverage can increase + liquidity risk, + +On line 4019: + in situations + in which counterparties were + not willing to give + +On line 4019: + time to liquidate + and possibly realize + whatever value + +On line 4019: + in the positions. + But it was also noted + that the BSAM hedge funds + +On line 4019: + be "relatively + unique" among sponsored funds in their + concentration in + + subprime mortgages.60 Some + members were concerned about the + lack of transparency + +On line 4021: + funds, the consequent + lack of market discipline + on valuations + +On line 4021: + funds because they were + outside its jurisdiction. + These facts caused members + +On line 4023: + be concerned about whether + they understood the scope of + the problem. During + +On line 4023: + size of the credit + derivatives market, its + lack of transparency + +On line 4025: + cloud in the background + of policy. Meanwhile, Bear + Stearns executives + +On line 4025: + supported the High-Grade + bailout did not expect to lose + money. However, + +On line 4025: + Cayne and Earl Hedin, the + former senior managing + director of Bear + +On line 4025: + and BSAM, were opposed, + because they did not want to + increase shareholders’ + + potential losses.61 + Their fears proved accurate. By + July, the two hedge + +On line 4027: + almost nothing: High-Grade + Fund was down Enhanced Leverage + Fund, On July both + + filed for bankruptcy. + Cioffi and Tannin would be + criminally charged + +On line 4027: + investors, but they were + acquitted of all charges in + November Civil + + charges brought by the SEC + were still pending as of the + date of this report. + +On line 4029: + back, Marano told the + FCIC, "We caught a lot of flak + for allowing the + +On line 4029: + we had no option."63 + In an internal email in + June, Bill Jamison of + +On line 4029: + Investors, one of the + largest of all mutual fund + companies, referred + +On line 4029: + the Bear Stearns hedge funds + as the "canary in the mine + shaft" and predicted + +On line 4029: + turmoil.64 As the two + funds were collapsing, repo + lending tightened across + + the board. Many repo + lenders sharpened their focus on + the valuation + +On line 4031: + margins on loans to + institutions that appeared + to be exposed to + + the mortgage market; + they often required Treasury + securities as + + collateral; in + many cases, they demanded + shorter lending terms.65 + +On line 4031: + securities and + CDOs were not considered the + "super-safe" investments + +On line 4033: + dealers—had only + recently believed. Cayne called + Spector into the + +On line 4035: + resign. On Sunday, + August Spector submitted + his resignation + +On line 4037: + to the board. RATING + AGENCIES: "IT CAN’ T BE ALL + OF A SUDDEN" While + + BSAM was wrestling with its + two ailing flagship hedge funds, + the major credit + +On line 4037: + downgrades and credit + watch warnings on an array + of residential + +On line 4037: + securities. These + announcements foreshadowed the + actual losses + +On line 4039: + placed tranches backed by + U.S. subprime collateral, + or some billion in + + securities, on + negative watch. S&P promised to + review every deal + +On line 4039: + downgraded mortgage-backed + securities issued in + backed by U.S. subprime + +On line 4039: + watch. These Moody’s downgrades + affected about billion in + securities. The + +On line 4039: + placed tranches of CDOs, + with original face value + of about billion, on + +On line 4039: + Two days after its + original announcement, S&P + downgraded of the + +On line 4041: + placed on negative + watch. Fitch Ratings, the smallest + of the three major + +On line 4043: + While the specific + securities downgraded + were only a small + +On line 4043: + the universe (less than + of mortgage-backed securities + issued in investors + +On line 4043: + downgrades might come. Many + investors were critical of + the rating agencies, + +On line 4043: + for their belated + reactions. By July by + one measure, housing + +On line 4043: + had already fallen + about nationally from their + peak at the spring of + +On line 4045: + conference call with + S&P, the hedge fund manager + Steve Eisman questioned + +On line 4045: + director of S&P’s + residential mortgage–backed + securities group. + + Eisman asked, "I’d like + to know why now. I mean, the + news has been out on + + subprime now for many, + many months. The delinquencies have + been a disaster + +On line 4045: + for many, many months. (Your) + ratings have been called into + question now for many, + + many months. I’d like to + understand why you’re making + this move today when + +On line 4045: + you—and why didn’t you + do this many, many months ago. I + mean, it can’t be that + + all of a sudden, + the performance has reached a + level where you’ve + +On line 4045: + S&P "took action as + soon as possible given + the information + + at hand."68 The ratings + agencies’ downgrades, in tandem + with the problems at + + Bear Stearns’s hedge funds, had + a further chilling effect + on the markets. The + +On line 4047: + July, confirming + and guaranteeing even more + problems for holders + +On line 4047: + Enacting the same + inexorable dynamic that + had taken down the + + Bear Stearns funds, repo + lenders increasingly required + other borrowers + +On line 4047: + as collateral + to put up more, because their + value was unclear + + or depressed. Many of + these borrowers sold assets + to meet these margin + +On line 4047: + calls, EARLY and each + sale had the potential to + further depress prices. + +On line 4047: + other assets in + more liquid markets, for which + prices were readily + + available, pushing prices + downward in those markets, too. + AIG: "WELL BIGGER THAN + + WE EVER PLANNED FOR" + Of all the possible losers + in the looming rout, + +On line 4051: + have been among the most + concerned. After several + years of aggressive + +On line 4051: + growth, AIG’s Financial + Products subsidiary had written + billion in over-the-counter + +On line 4051: + swap (CDS) protection + on super-senior tranches of + multisector CDOs + +On line 4053: + by subprime mortgages. + In a phone call made July + the day after the + + downgrades, Andrew Forster, + the head of credit trading + at AIG Financial + +On line 4053: + executive vice + president of Financial + Product’s Marketing + +On line 4053: + had to analyze + exposures because "every + f***ing rating agency + +On line 4053: + spoken to [came] out + with more downgrades" and that he + was increasingly + +On line 4053: + "About a month ago I + was like, you know, suicidal. + The problem that we’re + + going to face is + that we’re going to have just + enormous downgrades on + +On line 4053: + the stuff that we’ve got. + Everyone tells me that it’s + trading and it’s two + + points lower and all + the rest of it and how come + you can’t mark your book. + +On line 4053: + it’s definitely + going to give it renewed + focus. I mean we + +On line 4053: + mark it. It’s, it’s, uh, + we’re [unintelligible] + f***ed basically."69 + +On line 4055: + likely worried that + most of AIG’s credit default + swap contracts required + +On line 4055: + collateral be + posted to the purchasers, should + the market value + + of the referenced + securities decline by + a certain amount, or + + should rating agencies + downgrade AIG’s long-term debt. That is, + collateral calls + + could be triggered even + if there were no actual + cash losses in, for + +On line 4055: + CDOs upon which the + protection had been written. + Remarkably, top AIG + +On line 4055: + Officer Robert Lewis, + Chief Credit Officer Kevin + McGinn, and Financial + +On line 4055: + Division CFO Elias + Habayeb—told FCIC investigators + that they did not even + +On line 4055: + these terms of the swaps + until the collateral + calls started rolling in + +On line 4055: + who supervised AIG + on a consolidated + basis didn’t know + +On line 4055: + Frost, who was the chief + credit default swap salesman + at AIG Financial + +On line 4055: + did know about the terms, + and he said he believed they + were standard for the + +On line 4057: + the division’s CEO, + also knew about the terms.73 And + the counterparties + +On line 4057: + knew, of course. On the + evening of July Goldman Sachs, + which held billion of + +On line 4057: + super-senior credit + default swaps,74 sent news of the + first collateral + + call in the form of + an email from Goldman’s salesman + Andrew Davilman to + +On line 4059: + DAVILMAN: Sorry to + bother you on vacation. + Margin call coming + +On line 4063: + Want to give you a + heads up. FROST, minutes later: + On what1 DAVILMAN, one + +On line 4065: + later: 20bb billion] + of supersenior.75 he next + day, Goldman made the + +On line 4065: + purchased million of + five-year protection—in the form + of credit default + +On line 4069: + on its obligations.77 + Frost never responded to + Davilman’s email. And when + +On line 4069: + from vacation, he + was instructed to not have + any involvement in + +On line 4069: + wanted Forster to take + the lead on resolving the + dispute.78 AIG’s models + + showed there would be no + defaults on any of the bond + payments that AIG’s swaps + +On line 4071: + if market value + declined, irrespective of + any long-term cash losses.79 + +On line 4071: + estimated that + the average decline in + the market value + +On line 4073: + of the bonds was So, + first Bear Stearns’s hedge funds and now + AIG was getting hit + +On line 4073: + securities. Like + Cioffi and his colleagues at + Bear Stearns, Frost and his + +On line 4073: + disputed Goldman’s + marks. On July Forster was told + by another AIG + + trader that "[AIG] would + be in fine shape if Goldman + wasn’t hanging its + +On line 4073: + out there." The margin + call was "something that hit out + of the blue and it’s + +On line 4073: + f***ing number that’s well + bigger than we ever planned + for." He acknowledged + +On line 4073: + that dealers might say + the marks "could be anything from + to sort of, you know, + +On line 4075: + because of the lack + of trading but said Goldman’s + marks were "ridiculous."81 In + +On line 4075: + FCIC, Viniar said Goldman + had stood ready to sell mortgage-backed + securities to + + AIG at Goldman’s own + marks.82 AIG’s Forster stated that he + would not buy the bonds + +On line 4075: + to value its own + portfolio of similar + assets at the same + + price. Forster said, "In the + current environment I + still wouldn’t buy them + +On line 4075: + they could probably + go low we can’t mark any of + our positions, and + +On line 4075: + what saves us having + this enormous mark to market. + If we start buying + + the physical bonds + back then any accountant is + going to turn around + +On line 4075: + and say, well, John, you + know you traded at you must + be able to mark your + +On line 4077: + "was not budging" on + its collateral demands, + according to Tom + +On line 4077: + a conference call + with Goldman executives + on August "I played + +On line 4077: + had, legal wording, + market practice, intent of + the language, meaning + +On line 4077: + and also stressed the + potential damage to the + relationship and + + GS said that this has + gone to the ‘highest levels’ + at GS and they feel + +On line 4081: + ‘test case.’"84 Goldman Sachs + and AIG would continue to + argue about Goldman’s + +On line 4081: + would continue to + post collateral that would + fall short of Goldman’s + + demands and Goldman + would continue to purchase + CDS contracts against the + +On line 4081: + possibility + of AIG’s default. Over the next + months, more such disputes + + would cost AIG tens of + billions of dollars and help + lead to one of the + +On line 4085: + history. EARLY + The Commission concludes that + entities such as + + Bear Stearns’s hedge funds and + AIG Financial Products that + had significant + +On line 4085: + parent companies. + The commercial paper and + repo markets—two + +On line 4085: + in collateral + asset values and concern + about financial firms’ + +On line 4099: + FUNDING CONTENTS IKB + of Germany: "Real money + investors" Countrywide: + +On line 4105: + BNP Paribas: "The ringing + of the bell"...............................................................250 SIVs: "An oasis + of calm"......................................................................................252 Money funds + +On line 4107: + and other investors: + "Drink[ing] from a fire hose.........................253 In + the summer of as + +On line 4107: + securities crashed + and Bear’s hedge funds imploded, + broader repercussions + + from the declining + housing market were still not + clear. "I don’t think [the + +On line 4107: + mess] poses any threat + to the overall economy," + Treasury Secretary + +On line 4107: + were looking under + every rock for any sign of + hidden or latent + + subprime exposure. + In late July, they found it + in the market for + +On line 4107: + commercial paper + (ABCP), a crucial, usually + boring backwater + +On line 4109: + financing allowed + companies to raise money + by borrowing against + +On line 4109: + short-term assets. By + mid-2007, hundreds of billions out + of the trillion U.S. + + ABCP market were backed + by mortgage-related assets, + including some with + +On line 4111: + noted, the rating + agencies had given all of + these ABCP programs their + +On line 4111: + investment-grade + ratings, often because of + liquidity puts + +On line 4113: + commercial banks. When + the mortgage securities + market dried up and + +On line 4113: + market mutual + funds became skittish about broad + categories of ABCP, + +On line 4113: + banks would be required + under these liquidity + puts to stand behind + +On line 4113: + the assets onto + their balance sheets, transferring + losses back into + +On line 4113: + would support programs + they had sponsored even when they + had made no prior + + commitment to do + so. IKB OF GERMANY: "REAL + MONEY INVESTORS" The + +On line 4123: + the run on asset-backed + commercial paper was a + German SUMMER bank, + +On line 4123: + IKB Deutsche Industriebank + AG. Since its foundation in + IKB had focused on + +On line 4123: + but in the past decade, + management diversified. + In IKB created + +On line 4123: + commercial paper + program, called Rhineland, to purchase + a portfolio of + +On line 4123: + securities backed + by credit card receivables, + business loans, auto + + loans, and mortgages. It + made money by using less + expensive short-term + + commercial paper + to purchase higher-yielding long-term + securities, a + + strategy known as + "securities arbitrage." + By the end of June, + +On line 4123: + of which were CDOs and + CLOs (collateralized loan + obligations—that is, + +On line 4123: + leveraged loans). And at + least billion billion) of that + was protected by + +On line 4125: + through liquidity + puts.3 Importantly, German + regulators at + +On line 4125: + did not require IKB + to hold any capital to + offset potential + +On line 4127: + losses.4 As late as + June when so many were bailing + out of the structured + +On line 4127: + planning to expand + its off-balance-sheet holdings and + was willing to take + +On line 4129: + such as synthetic + CDOs.5 This attitude made IKB + a favorite of the + + investment banks and + hedge funds that were desperate + to take the short side + +On line 4131: + the deal. In early + when Goldman was looking for + buyers for Abacus + +On line 4131: + in part III, it looked + to IKB. An employee of + Paulson Co., the hedge + +On line 4131: + was taking the short + side of the deal, bluntly said + that "real money" + +On line 4131: + scenario," the Paulson + employee wrote in an email. + "In my opinion this + + situation is + due to the fact that rating + agencies, CDO managers + + and underwriters + have all the incentives to + keep the game going, + +On line 4135: + IKB subsequently + purchased million of the A1 + and A2 tranches of + +On line 4135: + the Abacus CDO and + placed them in Rhineland.7 It would lose + of that investment. + + In mid-2007, Rhineland’s asset-backed + commercial paper was held + by a number of + + American investors, + including the Montana Board + of Investments, the + +On line 4137: + the Robbinsdale Area + School District in suburban + Minneapolis. + +On line 4139: + that ratings downgrades + of mortgage-backed securities + would have only a + + limited impact + on its business.8 However, + within days, Goldman + +On line 4139: + which regularly + helped Rhineland raise money in the + commercial paper + + market, told IKB that + it would not sell any more Rhineland + paper to its clients. + +On line 4141: + On Friday, July + Deutsche Bank, recognizing that + the ABCP markets would + + soon abandon Rhineland and + that IKB would have to provide + substantial support + +On line 4141: + program, decided + that doing business with IKB + was too risky and cut + +On line 4141: + its credit lines. These + were necessary for IKB to + continue running + + its business. Deutsche Bank + also alerted the German + bank regulator + + to IKB’s critical + state. With the regulator’s + encouragement, IKB’s + +On line 4141: + largest shareholder, KfW + Bankengruppe, announced on July + that it would bail out + +On line 4143: + its liquidity + puts with KB. Rhineland’s commercial + paper investors were + + able to get rid of + the paper, and KfW took the + hit instead—with its + +On line 4145: + losses expected + to eventually reach The + IKB episode served notice + +On line 4145: + mortgage assets were + lurk-ing in the portfolios of + even risk-averse investors. + +On line 4145: + the short-term funding + markets—even those that were + not exposed to risky + +On line 4145: + was a recognition, + I’d say an acute recognition, + that potentially + + some of the asset-backed + commercial paper conduits + could have exposure + +On line 4145: + a result, investors + in general—without even + looking into the + +On line 4145: + assets—decided + ‘I don’t want to be in any + asset-backed commercial + +On line 4145: + don’t want to invest + in a fund that may have those + positions,’" Steven Meier, + +On line 4147: + at State Street Global + Advisors, testified to + the FCIC.10 From its peak + +On line 4147: + asset-backed commercial + paper market would decline + by almost billion + +On line 4151: + three days after the + IKB rescue, Countrywide CEO + Angelo Mozilo + + realized that his + company was unable to + roll its commercial + + paper or borrow + on the repo market. "When + we talk about [August + +On line 4151: + at Countrywide, that’s + our he said. "We worked seven + days a week trying + +On line 4151: + figure this thing out + and trying to work with the + banks. Our repurchase + +On line 4153: + billions and billions + of dollars."11 Mozilo emailed Lyle + Gramley, a former + +On line 4153: + credit markets is + now tending towards panic. + There is little to + + no liquidity + in the mortgage market with + the exception of + +On line 4155: + is not deemed to be + conforming either cannot + be sold into the + +On line 4157: + Eric Sieracki + told investors that Countrywide + had "significant + +On line 4157: + sources of our bank. It + is important to note that + the company has + +On line 4157: + commercial paper."13 + Moody’s reaffirmed its A3 ratings + and stable outlook + + on the company. + The ratings agencies and the + company itself + +On line 4161: + would quickly reverse + their positions. On August + Mozilo reported + +On line 4161: + the board during a + specially convened meeting + that, as the meeting + +On line 4161: + (both prime and non-prime) had + unexpectedly and with + almost no warning + +On line 4161: + and COO David Sambol + told the board, "Management can + only plan on a + +On line 4161: + week basis due to + the tenuous nature of + the situation." + + Mozilo reported + that although he continued + to negotiate + +On line 4161: + for alternative + sources of liquidity, the + "unprecedented and + +On line 4161: + secondary market could + force the company to draw + down on its backup + +On line 4163: + lines.14 Shortly after + the Countrywide board meeting, + the Fed’s Federal + +On line 4163: + Open Market SUMMER + Committee members discussed + the "considerable + +On line 4163: + market and that some + firms, including Countrywide, + were showing some strain. + + They noted that the + data did not indicate + a collapse of the + +On line 4163: + was imminent and + that, if the more optimistic + scenarios proved to + + be accurate, they + might look back and be surprised + that the financial + + events did not have a + stronger impact on the real + economy. But the + +On line 4163: + effects of subprime + developments could spread to + other sectors and + +On line 4163: + and duration of + the deterioration + of these markets. One + +On line 4163: + in a paraphrase of + a quote he attributed to + Winston Churchill, said that + +On line 4163: + of history would + exonerate those present if + they did not prepare + +On line 4165: + staff presentations.15 + Several days later, on + August Countrywide + +On line 4165: + that foreclosures and + delinquencies were up and that + loan production had + +On line 4165: + preceding month. A + company spokesman said layoffs + would be considered. + +On line 4165: + same day, Fed staff, who + had supervised Countrywide’s + holding company + +On line 4167: + the bank switched to a + thrift charter in March sent a + confidential memo + +On line 4169: + The company is + heavily reliant on an + originate-to-distribute + + model, and, given + current market conditions, + the firm is unable + +On line 4169: + its non-conforming + mortgages. Countrywide’s short-term + funding strategy + + relied heavily + on commercial paper (CP) + and, especially, + +On line 4169: + market conditions, + the viability of + that strategy is + +On line 4171: + ability of the + company to use [mortgage] + securities as + +On line 4171: + Those liquidity + pressures conceivably could lead + eventually to + +On line 4173: + provide assistance, + perhaps by waiving a Fed + rule and allowing + +On line 4173: + subsidiary to support + its holding company by + raising money from + +On line 4173: + through discount-window + lending, which would require the + Fed to accept risky + +On line 4173: + securities as + collateral, something it + never had done and + +On line 4173: + before the Board could + authorize lending to the + holding company + +On line 4173: + mortgage subsidiary," staff + wrote. "The Federal Reserve + had not lent to a + +On line 4175: + current circumstances + seemed highly improbable."17 + The following day, + +On line 4175: + recommended to + his board that the company + notify lenders of + +On line 4175: + intention to draw + down billion on backup lines + of credit.18 Mozilo + + and his team knew that + the decision could lead to + ratings owngrades. "The + + only option we + had was to pull down those lines," + he told the FCIC. "We + +On line 4175: + a pipeline of loans + and we either had to say + to the borrowers, + + the customers, ‘we’re out + of business, we’re not going + to fund’—and there’s great + +On line 4175: + that, litigation + risk, we had committed to + fund. When it’s between + +On line 4177: + your image, you hold + on to your ass."19 On the same + day that Countrywide’s + +On line 4177: + drawdown—but before + the company announced it + publicly, the Merrill + +On line 4177: + Kenneth Bruce, who had + reissued his "buy" rating on + the company’s stock + +On line 4177: + days earlier, switched + to "sell" with a "negative" + outlook because of + + Countrywide’s funding + pressures, adding, "if the market + loses confidence + + in its ability + to function properly, then + the model can break. + +On line 4177: + in a weak market, + then it is possible for + [Countrywide] to go + +On line 4179: + The next day, as news + of Bruce’s call spread, Countrywide + informed markets about + +On line 4179: + senior unsecured + debt rating to the lowest + tier of investment + +On line 4179: + grade. Countrywide shares + fell closing at for the year, + the company’s stock + +On line 4179: + was down The bad news + led to an old-fashioned bank + run. Mozilo singled + +On line 4179: + Los Angeles Times + article covering Bruce’s + report, which, he said, + +On line 4179: + "caused a run on our + bank of billion on Monday." + The article spurred + +On line 4179: + their funds by noting + specific addresses of + Countrywide branches + +On line 4179: + Mozilo told the FCIC. + A reporter "came out with a + photographer and, + + you know, interviewed + the people in line, and he + created— it was + +On line 4183: + horrible for us. + Totally unnecessary," + Mozilo said.21 Six days + +On line 4183: + on August, Bank of + America announced it would + invest billion for + +On line 4183: + nation’s biggest bank + would soon acquire the mortgage + lender. Mozilo told the + +On line 4183: + "There was never a + question about our survival"; he + said the investment + +On line 4185: + net loss of billion, + its first quarterly loss in + years. As charge-offs on its + +On line 4185: + raised provisions for + loan losses to million from + only million one + +On line 4185: + January Bank of + America issued a press + release announcing + +On line 4185: + approximately + billion. It said the combined + entity would stop + +On line 4187: + would expand programs + to help distressed borrowers. + BNP PARIBAS: "THE RINGING + + OF THE BELL" Meanwhile, + problems in U.S. financial + markets hit the largest + +On line 4189: + On August BNP Paribas + SA suspended redemptions + from three investment + +On line 4189: + had plunged in less than + two weeks. Total assets in + those funds were billion, + +On line 4189: + that amount in subprime + securities rated AA + or higher.23 The bank + + said it would also + stop calculating a fair + market value for + + the funds because "the + complete evaporation of + liquidity in + +On line 4189: + it impossible + to value certain assets + fairly regardless + +On line 4191: + "was the ringing of + the bell" for short-term funding + markets, Paul McCulley, a + +On line 4193: + the FCIC. "The buyers + went on a buyer strike and + simply weren’t rolling."25 + +On line 4193: + is, they stopped rolling over + their commercial paper and + instead demanded + +On line 4193: + payment on their loans. + On August the interest + rates for overnight lending + +On line 4195: + It would continue + rising unevenly, hitting + in August Figure + +On line 4199: + in response, lending + declined. In August alone, the + asset-backed commercial + +On line 4199: + On August subprime + lender American Home Mortgage’s + asset-backed commercial + +On line 4199: + program invoked its + privilege of postponing + repayment, trapping + +On line 4199: + Lenders quickly withdrew + from programs with similar + provisions, which shrank + +On line 4201: + market from billion + to billion between May and + August.26 The paper + +On line 4203: + as frequently as + possible. The average + maturity of + +On line 4203: + asset-backed commercial + paper in the United States + fell from bout days in + +On line 4203: + July to about days + by mid-September, though the overwhelming + majority was + +On line 4205: + issued for just to + days.27 Disruptions quickly spread + to other parts of + +On line 4205: + flight to quality, + investors dumped their repo and + commercial paper + + holdings and increased + their holdings in seemingly + safer money market + +On line 4205: + other’s potential + subprime exposures, scrambled + to amass funds for their + + own liquidity. + Banks became less willing to + lend to each other. + +On line 4205: + indicator of + interbank lending rates, called + the one-month LIBOR-OIS + +On line 4207: + that banks were concerned + about the credit risk involved + in lending to each + +On line 4207: + three-to fourfold + over historical values, + and by September + +On line 4209: + climbed by another + In it would peak much higher. + The panic in the + +On line 4209: + interbank markets + was met by immediate + government action. + +On line 4209: + On August the day + after BNP Paribas suspended + redemptions, the Fed + +On line 4209: + facilitate the + orderly functioning of + financial markets,"28 + + and the European + Central Bank infused billions + of Euros into + +On line 4209: + markets. On August + the Fed cut the discount rate + by basis points—from + +On line 4209: + be the first of many + such cuts aimed at increasing + liquidity. The + +On line 4209: + also extended + the term of discount-window + lending to days (from + + the usual overnight or + very short-term period) to + offer banks a more + + stable source of funds. + On the same day, the Fed’s FOMC + released a statement + +On line 4209: + continued market + deterioration and + promising that it was + + "prepared to act as + needed to mitigate the + adverse effects on + +On line 4213: + "AN OASIS OF CALM" + In August, the turmoil in + asset-backed commercial + +On line 4213: + market for structured + investment vehicles, or + SIVs, even though most of + +On line 4213: + programs had little + subprime mortgage exposure. + SIVs had a stable + +On line 4215: + in These investments + had weathered a number of + credit crises—even + +On line 4215: + through early summer + of as noted in a Moody’s + report issued on + +On line 4219: + "SIVs: An Oasis of + Calm in the Sub-prime Maelstrom."30 + Unlike typical + +On line 4219: + paper programs, SIVs + were funded primarily + through medium-term notes—bonds + +On line 4219: + in one to five years. + SIVs held significant amounts + of highly liquid + +On line 4219: + and marked those assets + to market prices daily or + weekly, which allowed + +On line 4221: + without explicit + liquidity support from + their sponsors. The SIV + +On line 4221: + and On the eve of + the crisis, there were SIVs with + almost billion in + +On line 4221: + was invested in + mortgage-backed securities or + in CDOs, but only + +On line 4227: + first SIVs to fail were + concentrated in subprime + mortgage– SUMMER backed + +On line 4227: + mortgage-related CDOs, + or both. These included Cheyne + Finance (managed by + +On line 4227: + structured by Barclays + Capital). Between August + and October, each + +On line 4229: + these four was forced to + restructure or liquidate. + Investors soon ran from + + even the safer SIVs. "The + media was quite happy to + sen-sationalize + + the collapse of the + next ‘leaking SIV’ or the next + ‘SIV-positive’ institution," + +On line 4229: + Henry Tabe told the + FCIC.32 The situation was + complicated by + +On line 4229: + of transparency. "In + a context of opacity + about where risk resides, + +On line 4229: + general distrust + has contaminated many + asset classes. What + +On line 4229: + been liquid is now + illiquid. Good collateral + cannot be sold or + +On line 4231: + wrote on September + Even high-quality assets + that had nothing to + + do with the mortgage + market were declining in + value. One SIV marked + +On line 4231: + a CDO to seven + cents on the dollar while it + was still rated triple-A.34 + +On line 4231: + managers sold assets. + But selling high-quality + assets into a + +On line 4231: + prices of these unimpaired + securities and pushed down + the market values + +On line 4233: + portfolios. By the + end of November, SIVs still + in operation + +On line 4233: + their portfolios, on + average.35 Sponsors rescued + some SIVs. Other SIVs + +On line 4233: + liquidated; some + investors had to wait a year + or more to receive + + payments and, even then, + recouped only some of their + money. In the case + +On line 4233: + Rhinebridge, investors lost + and only gradually + received their payments + +On line 4233: + the next year.36 Investors + in one SIV, Sigma, lost more + than As of fall not + +On line 4235: + single SIV remained + in its original form. The + subprime crisis had + +On line 4235: + resilient market in + which losses due to subprime + mortgage defaults had + +On line 4237: + if anything, modest + and localized. MONEY FUNDS + AND OTHER INVESTORS: + + "DRINKING FROM A FIRE + HOSE" The next dominoes were the + money market funds + +On line 4241: + Fidelity, Vanguard, + and Federated. Under + SEC regulations, + +On line 4241: + market funds that serve + retail investors must keep two + sets of accounting + +On line 4241: + reflecting the price + they paid for securities + and the other the + +On line 4241: + (the "shadow price," in + market parlance). However, + funds do not have to + +On line 4241: + shadow price unless + the fund’s net asset value + (NAV) has fallen by + +On line 4243: + below (to per share. + Such a decline in market + value is known as + + "breaking the buck" and + generally leads to a + fund’s collapse. It can + +On line 4243: + example, if just + of a fund’s portfolio is + in an investment + +On line 4245: + of its value. So + a fund manager cannot + afford big risks. But + +On line 4245: + were considered very + safe investments—they always + had been—and were widely + +On line 4245: + market funds. In fall + dozens of money market funds + faced losses on SIVs + +On line 4245: + asset-backed commercial + paper. To prevent their funds + from breaking the buck, + +On line 4245: + including large banks + such s Bank of America, + US Bancorp, and SunTrust, + + purchased SIV assets + from their money market funds.38 + Similar dramas + +On line 4247: + the money market + sector known as enhanced cash + funds. These funds serve not + +On line 4249: + but rather "qualified + purchasers," which may include wealthy + investors who invest + +On line 4249: + SEC regulations + and disclosure requirements. + Because they have much + + higher investment + thresholds than retail funds, and + because they face less + +On line 4249: + and higher returns. + Nonetheless, these funds also + aim to maintain a + +On line 4251: + net asset value. + As the market turned, some of + these funds did break the + +On line 4251: + of others stepped in + to support their value. The + billion GE Asset + +On line 4251: + fund that managed GE’s + own pension and employee + benefit assets, + +On line 4251: + the summer; it had + of its assets in mortgage-backed + securities. When + +On line 4251: + million and closed in + November investors redeemed + their interests at + +On line 4253: + largest enhanced cash fund, + with billion in assets at + its peak—after one of that + +On line 4257: + largest investors withdrew + billion in November An + interesting case + +On line 4257: + the Credit Suisse + Institutional Money + Market Prime Fund. The + +On line 4257: + "portals," which supplied + an estimated billion + to money market + + funds and other funds. + Investors used these portals to + quickly move their cash + +On line 4257: + higher return could + attract significant funds: + one money market + +On line 4257: + manager later + compared the use of portal + money to "drink[ing] + +On line 4257: + a fire hose."41 But the + money could vanish just as + quickly. The Credit + + Suisse fund posted + the highest returns in the + industry during + +On line 4257: + the months before the + liquidity crisis, and + increased its assets + +On line 4259: + summer of to more + than billion in the summer + of To deliver + +On line 4259: + focused on structured + finance products, including + CDOs and SIVs such as + +On line 4259: + When investors became + concerned about such assets, they + yanked about billion out + +On line 4261: + the fund in August + alone. Credit Suisse, the Swiss + bank that sponsored the + +On line 4261: + was forced to bail it + out, purchasing billion of + assets in August.42 + + The episode highlights the + risks of money market funds’ + relying on "hot + +On line 4261: + institutional + investors who move quickly in + and out of funds in + +On line 4263: + The losses on SIVs + and other mortgage-tainted + investments also + +On line 4263: + investment pools across + the country, some of which held + billions of dollars + +On line 4263: + districts, and other + government agencies with economies + of scale, investment + +On line 4265: + participation + is mandatory. With billion + in assets, Florida’s + + local government + investment pool was the largest + in the country, and + +On line 4265: + a highly liquid, + low-risk money market fund, with + securities like + +On line 4265: + state legislature + noted.43 But by November + because of ratings + +On line 4265: + the fund held at least + billion in securities + that no longer met the + +On line 4265: + state’s requirements. It + had more than billion in SIVs + and other distressed + +On line 4265: + securities, of + which about million had already + defaulted. And it + +On line 4265: + maturities that + stretched out as far as June In + early November, + +On line 4265: + of news reports, the + fund suffered a run. Local + governments withdrew + +On line 4265: + two weeks. Orange and + Pinellas counties pulled out their + entire investments. + +On line 4267: + withdrawals. Florida’s was + the hardest hit, but other + state investment pools + +On line 4269: + on SIVs and other + mortgage-related holdings. The + Commission concludes + +On line 4269: + the shadow banking + system was permitted to + grow to rival the + + commercial banking + system with inadequate + supervision and + +On line 4269: + That system was very + fragile due to high leverage, + short-term funding, risky + +On line 4269: + the mortgage market + collapsed and financial firms + began to abandon + +On line 4269: + commercial paper + and repo lending markets, + some institutions + +On line 4269: + operations failed + or, later in the crisis, + had to be rescued. + +On line 4269: + interconnections + created contagion, as + the crisis spread even + +On line 4269: + markets and firms that + had little or no direct + exposure to the + + mortgage market. In + addition, regulation + and supervision + +On line 4271: + thrifts to operate + with fewer constraints and to + engage in a wider + + range of financial + activities, including + activities in + +On line 4273: + banking system. The + financial sector, which grew + enormously in the + +On line 4273: + leading up to the + financial crisis, wielded + great political + +On line 4273: + institutional + supervision and market + regulation of + +On line 4273: + vulnerable to + the financial crisis and + exacerbated + +On line 4285: + TO EARLY BILLIONS + IN SUBPRIME LOSSES CONTENTS + Merrill Lynch: "Dawning + + awareness over the course + of the summer".................257 Citigroup: + "That would not in any + + way have excited + my attention"...................260 AIG’s dispute + with Goldman: "There could + +On line 4295: + never expected + losses"...................................................276 While a handful of + banks were bailing out + + their money market + funds and commercial paper + programs in the fall + +On line 4295: + loans, securities, + and derivatives, with no + end in sight. Among U.S. + + firms, Citigroup and + Merrill Lynch reported the + most spectacular + +On line 4295: + debt obligation (CDO) + businesses, writing down a + total of billion + +On line 4295: + respectively, by + the end of the year. Billions + more in losses were + +On line 4297: + America billion), + Morgan Stanley billion), JP + Morgan billion), and + +On line 4297: + hedge funds, and other + financial institutions + collectively had + +On line 4299: + discriminating + between firms perceived to be + relatively healthy + + and others about which + they were not so sure. Bear Stearns + and Lehman Brothers were + +On line 4299: + at the top of the + "suspect" list; by year-end the cost + of five-year protection + + against default on their + obligations in the credit + default swap market + +On line 4299: + respectively, and + annually for every + million, while the cost + +On line 4301: + relatively stronger + Goldman Sachs stood at Meanwhile, + the economy was + +On line 4301: + financial markets, + declining home prices, and oil + prices above a barrel, + +On line 4301: + Reserve lowered the + overnight bank borrowing rate from + earlier in the + +On line 4309: + to in September, + in October, and then in + December. LATE TO + +On line 4313: + EARLY MERRILL LYNCH: + "DAWNING AWARENESS OVER THE COURSE + OF THE SUMMER" On + +On line 4313: + when it announced that + third-quarter earnings would include + a billion loss on + +On line 4313: + CDOs and billion on + subprime mortgages—$7.9 billion in + total, the largest Wall + +On line 4313: + that point, and nearly + twice the billion loss that the + company had warned + +On line 4313: + expect just three weeks + earlier. Six days later, + the embattled CEO + + Stanley O’Neal, a 21-year + Merrill veteran, resigned. + Much of this write-down + +On line 4317: + from the firm’s holdings + of the super-senior tranches + of mortgage-related + + CDOs that Merrill had + previously thought to be + extremely safe. As + +On line 4319: + its management had + been "bullish on growth" and "bullish on + [the subprime] asset + +On line 4319: + the signs of trouble + were becoming difficult + even for Merrill to + + ignore. Two mortgage + originators to which the + firm had extended + +On line 4319: + lines failed: Ownit, in + which Merrill also had a + small equity stake, + +On line 4319: + Network. Merrill seized + the collateral backing + those loans: billion from + +On line 4321: + Mortgage Lenders, billion + from Ownit. Merrill, like many + of its competitors, + + started to ramp up + its sales efforts, packaging + its inventory + + of mortgage loans and + securities into CDOs + with new vigor. Its + +On line 4321: + was to reduce the + firm’s risk by getting those loans + and securities + + off its balance sheet. + Yet it found that it could not + sell the super-senior + +On line 4323: + CDOs at acceptable + prices; it therefore had to "take + down senior tranches + +On line 4323: + of tens of billions + of dollars of those tranches + on Merrill’s books. Dow + +On line 4323: + the co-president of + Merrill’s investment banking + segment, told FCIC staff + +On line 4323: + buildup of the retained + super-senior tranches in the + CDO positions was + +On line 4323: + actually part + of a strategy begun + in late to reduce + +On line 4323: + firm’s inventory + of subprime and Alt-A mortgages. + Sell the lower-rated + +On line 4323: + tranches, retain the + super-senior tranches: those had + been his instructions + +On line 4323: + managers at the end + of Kim recalled. He believed + that this strategy + + would reduce overall + credit risk. After all, the + super-senior tranches + +On line 4323: + of those investments.6 + To some degree, however, + the strategy was + +On line 4323: + were having trouble + selling these investments, and + some were even sold at + + a loss.7 Initially, + the strategy seemed to work. + By May, the amount of + +On line 4325: + securities to + be packaged into CDOs had + declined to billion + +On line 4325: + net amount in retained + super-senior CDO tranches had + increased from billion + +On line 4325: + in September to + billion by March and billion + by May.9 But as the + + mortgage market came + under increasing pressure + and as the market + +On line 4325: + super-senior tranches + crumbled, the strategy would + come back to haunt the + +On line 4327: + for 2007—net revenues of + billion—were its second-highest + quarterly results + +On line 4327: + for the Fixed Income, + Currencies and Commodities + business, which housed the + +On line 4327: + CDO positions. These + esults were announced during a + conference call with + +On line 4327: + event that investors and + analysts rely on to + obtain important + +On line 4327: + about the company + and that, like other public + statements, is subject + +On line 4329: + securities laws. + Merrill’s then-CFO Jeffrey Edwards + indicated that + +On line 4329: + dislocation in + the subprime market, because + "revenues from subprime + +On line 4329: + of our net revenues" + over the past five quarters, and + because Merrill’s "risk + +On line 4329: + better than ever, + and crucial to our success + in navigating + +On line 4329: + Providing further + assurances, he stated, "We + believe the issues + +On line 4331: + not negatively + impacted other sectors."10 + However, Edwards + +On line 4331: + increase in retained + super-senior CDO tranches or + the difficulty + +On line 4331: + those tranches, even at + a loss—though specific questions + on the subject were + +On line 4333: + first-quarter report with + another for the second + quarter that "enabled + +On line 4333: + company to achieve + record net revenues, net earnings + and net earnings per + +On line 4333: + share for the first half + of During the conference + call announcing the + +On line 4333: + analyst Glenn Schorr + of UBS, a large Swiss bank, asked + the CFO to provide + + some "color around myth + versus reality" on + Merrill’s exposure + +On line 4333: + CDO positions. As + he had three months earlier, + Edwards stressed Merrill’s + + risk management and + the fact that the CDO business + was a small part of + +On line 4333: + said that there had been + significant reductions + in Merrill’s retained + +On line 4333: + lower-rated segments + of the market, although he + did not disclose that + +On line 4335: + of Merrill’s retained + CDOs had reached billion by June. + Edwards declined to + + provide details about + the company’s exposure + to subprime mortgage + +On line 4335: + inventory of + mortgage-backed securities to + be packaged into + +On line 4335: + "We don’t disclose our + capital allocations + against any specific + +On line 4337: + broader group," Edwards + said.12 On July, after the + super-senior tranches + +On line 4337: + executives first + officially informed its + board about the buildup. At + +On line 4337: + presentation to + the board’s Finance Committee, + Dale Lattanzio, co-head + +On line 4337: + of the Fixed Income, + Currencies and Commodities + business, reported + +On line 4339: + a "net" exposure + of billion in CDO-related assets, + essentially all + +On line 4339: + with exposure to + the lower-rated asset class + significantly + +On line 4339: + was the amount of CDO + positions left after the + subtraction of the + +On line 4341: + guarantees in one + form or another—that Merrill + had purchased to pass + +On line 4341: + third parties willing + to provide that protection + and take that risk for + +On line 4343: + fee. AIG and the small + club of monoline insurers + were significant + + suppliers of these + guarantees, commonly done + as credit default + +On line 4343: + July Merrill had + begun to increase the amount + of CDS protection + +On line 4345: + told the committee, + "[Management] decided in + the beginning of + +On line 4345: + reduce exposure + to lower-rated assets in + the sub-prime asset + +On line 4345: + senior and super + senior tranches."14 Edwards did + not see any problems. + + As Kim insisted, + "Everyone at the firm and + most people in the + +On line 4349: + that super-senior was + super safe."15 LATE TO EARLY + Former CEO O’Neal told + +On line 4349: + the company was + retaining the super-senior + tranches of the CDOs + +On line 4349: + Finance Committee. + He was startled, if only + because he had been + +On line 4349: + the impression that + Merrill’s mortgage-backed-assets business + had been driven by + +On line 4349: + he had assumed that + if there were no new customers, + there would be no new + +On line 4349: + CDOs, why would Merrill + have to retain CDO tranches + on the balance sheet1 + +On line 4349: + said he was surprised + about the retained positions + but stated that the + +On line 4349: + and estimation + of potential losses were + not sufficient to + +On line 4349: + retained positions + had experienced only + million in losses.17 + + Over the next three months, + the market value of the + super-senior tranches + +On line 4351: + and losses ballooned; + O’Neal told the FCIC: "It was a + dawning awareness over + +On line 4351: + course of the summer + and through September as the + size of the losses + +On line 4353: + October Merrill + executives gave its board + a detailed account + +On line 4353: + of how the firm found + itself with what was by that + time billion in net + + exposure to the + super-senior tranches—down from + a peak in July + +On line 4353: + of billion because + the firm had increasingly + hedged, written off, and + +On line 4353: + its exposure. On + October Merrill announced + its third-quarter earnings: + +On line 4353: + of billion. Merrill + also reported—for the + first time—its billion net + +On line 4353: + CDO positions. Still, + in their conference call with + analysts, O’Neal and + + Edwards refused to + disclose the gross exposures, + excluding the hedges + + from the monolines and + AIG. "I just don’t want to get + into the details + + behind that," Edwards + said. "Let me just say that what + we have provided + +On line 4353: + the Securities + and Exchange Commission, by + September Merrill + +On line 4353: + accumulated + billion of "gross" retained CDO + positions, almost + +On line 4355: + reported during + the October conference + call.20 On October + +On line 4357: + O’Neal resigned, he left + with a severance package + worth million21—on top of + +On line 4359: + million in total + compensation he earned in + when his company + +On line 4359: + operations. Kim, + who oversaw the strategy + that left Merrill with + +On line 4359: + in losses, had left + in May after being paid + million for his work + +On line 4361: + a firm.22 By late the + viability of the + monoline insurers + +On line 4361: + from which Merrill had + purchased almost billion in + hedges had come into + +On line 4361: + rating agencies were + downgrading them, as we will + see in more detail + +On line 4361: + had told Merrill that + it would impose a punitive + capital charge on + +On line 4361: + might not be good for + all the protection purchased, + Merrill began to + +On line 4363: + allowances, starting with + billion on January By + the end of Merrill + +On line 4363: + total of billion + related to monolines and + had recorded total + +On line 4365: + billion of other + mortgage-related exposures. + ITIGROUP: "THAT WOULD + + NOT IN ANY WAY HAVE + EXCITED MY ATTENTION" + Five days after O’Neal’s + +On line 4369: + its total subprime + exposure was billion, which + was billion more than + +On line 4369: + told investors just three + weeks earlier. Citigroup + also announced it + +On line 4369: + to billion loss on + its subprime mortgage–related + holdings and that Chuck + +On line 4369: + resigning as its + CEO. Like O’Neal, Prince had learned late + of his company’s + +On line 4369: + CDO exposures. Prince + and Robert Rubin, chairman of + the Executive + +On line 4369: + Committee of the + board, told the FCIC that before + September they had + +On line 4369: + investment banking + division had sold some CDOs + with liquidity + +On line 4371: + super-senior tranches + of others.23 Prince told the FCIC + that even in hindsight + +On line 4371: + was difficult for + him to criticize any of + his team’s decisions. + +On line 4373: + had elevated + to my level that we were + putting on a trillion + +On line 4373: + balance sheet, billion + of triple-A-rated, zero-risk paper, that + would not in any way + +On line 4373: + attention," Prince said. + "It wouldn’t have been useful + for someone to come + +On line 4373: + and say, ‘Now, we have + got trillion on the balance + sheet of assets. I + + want to point out to + you there is a one in a + billion chance that this + +On line 4373: + billion could go south.’ + That would not have been useful + information. There + + is nothing I can + do with that, because there is + that level of chance + + on everything."24 In + fact, the odds were much higher + than that. Even before + +On line 4373: + the mass downgrades of + CDOs in late a triple-A tranche of + a CDO had a in + +On line 4375: + original rating.25 + Certainly, Citigroup was + a large and complex + +On line 4375: + organization. + That trillion balance sheet—and + trillion off-balance + +On line 4377: + sheet—was spread among more + than operating subsidiaries + in Prince insisted + +On line 4377: + to manage."26 But it + was an organization + in which one unit would + + decide to reduce + mortgage risk while another + unit increased it. And + +On line 4377: + management would not + be notified of billion + in concentrated + +On line 4379: + exposure— of the + company’s balance sheet and + more than a third of + +On line 4381: + Financial Control + Group had argued in that the + liquidity puts + + that Citigroup had + written on its CDOs had been + priced for investors too + +On line 4381: + in light of the risks.28 + Also, in early Susan + Mills, a managing + +On line 4381: + mortgages from other + companies and bundled them + for sale to investors—took + +On line 4381: + subprime market and + created a surveillance + group to track loans that + +On line 4381: + By mid-2006, her group saw + a deterioration + in loan quality + + and an increase in + early payment defaults—that + is, more borrowers + +On line 4381: + within a few months + of getting a loan. From to + Mills recalled before + +On line 4381: + the FCIC, the early + payment default rates nearly + tripled from to or In + +On line 4381: + diligence on what it + bought. However, neither Mills + nor other members + + of the unit shared any + of this information with + other divisions + +On line 4381: + in Citi-LATE TO EARLY + group, including the CDO desk.31 + Around March or April in + +On line 4383: + observed. "Management + acknowledged that, in looking + back, it should have made + +On line 4383: + throughout the firm. The + Global Consumer Group saw signs + of sub-prime issues + +On line 4383: + as did mortgage backed + securities traders, but CDO + structures business did + +On line 4387: + was] no dialogue + across businesses."33 Co-head of + the CDO desk Janice + + Warne told the FCIC that + she first saw weaknesses in + the underlying + +On line 4387: + In February, when + the ABX.HE.BBB- 06-2 fell to + below par, the CDO + +On line 4387: + on the financing + of mortgage securities + for inventory + +On line 4389: + produce CDOs.34 Shortly + thereafter, however, the same + ABX index started + +On line 4389: + rising to below + par in March and holding around + that level through May. + +On line 4389: + the CDO desk reversed + course and accelerated + its purchases of + + inventory in + April, according to Nestor Dominguez, + Warne’s co-head on the + +On line 4391: + Dominguez said he didn’t + see the market weakening + until the summer, + +On line 4393: + the index fell to + less than below par.36 Murray + Barnes, the Citigroup + +On line 4393: + officer assigned + to the CDO business, approved + the CDO desk’s request + +On line 4395: + collateral. Barnes + observed, in hindsight, that rather + than looking at the + +On line 4395: + opportunity, + Citigroup should have reassessed + its assumptions and + + examined whether the + decline in the ABX was a + sign of strain in the + +On line 4397: + manage its risk.37 The + risk management division + also increased the + +On line 4397: + CDO desk’s limits for + retaining the most senior + tranches from billion + +On line 4397: + to billion in the + first half of As at Merrill, + traders and risk managers + +On line 4397: + Citigroup believed + that the super-senior tranches + carried little risk.38 + +On line 4397: + Super Senior AAA + CDO exposure was perhaps + Citigroup’s ‘biggest + +On line 4397: + As management felt + comfortable with the credit + risk of these tranches, + +On line 4397: + positions on the + balance sheet. As the sub-prime + market began to + +On line 4397: + total about billion, + nearly half of Citigroup’s + capital at the + +On line 4397: + end of About billion + of that loss related to + protection purchased + +On line 4399: + insurers.40 Barnes’s + decision to increase the + CDO risk limits was + +On line 4399: + superior, Ellen + Duke. Barnes and Duke reported + to David Bushnell, the + + chief risk officer. + Bushnell—whom Prince called "the best + risk manager on + +On line 4399: + did not remember + specifically approving + the increase but that, + + in general, the + risk management function did + approve higher risk + +On line 4399: + when a business line + was growing.41 He described a + "firm-wide initiative" + +On line 4401: + Citigroup’s structured + products business.42 Perhaps what + is most remarkable + +On line 4401: + strategies employed by + the ecuritization and + CDO desks is that their + +On line 4401: + independent risk + meetings. Duke reflected that + she was not overly + +On line 4401: + when the issue came + up, saying she and her risk + team were "seduced by + +On line 4401: + the underlying + collateral."43 According + to Barnes, the CDO desk + +On line 4401: + CDOs’ underlying + collateral because it + lacked the "ability" + +On line 4401: + see loan performance + data, such as delinquencies + and early payment + +On line 4401: + unit in Citigroup’s + securitization desk + might have been able to + +On line 4401: + some insights based on + its own data.45 Barnes told the + FCIC that Citigroup’s + +On line 4401: + management tended + to be managed along business + lines, noting that he + +On line 4401: + what was happening + to the underlying loans. + He regretted not + +On line 4403: + to the consumer bank + to "get the pulse" of mortgage + origination.46 "That + + has never happened + since the Depression" Prince and + Rubin appeared to + +On line 4405: + up until the fall + of that any downside risk in + the CDO business was + +On line 4407: + "I don’t think anybody + focused on the CDOs. This was + one business in a + +On line 4407: + wasn’t one that had + any particular profile," + Rubin—in Prince’s words, a + +On line 4407: + important member + of [the] board"47—told the FCIC. "You + know, Tom Maheras was + + in charge of trading. + Tom was an extremely well + regarded trading + +On line 4407: + figure on the street. + And this is what traders do, they + handle these kinds of + +On line 4407: + Maheras, the co-head + of Citigroup’s investment + bank, told the FCIC that + +On line 4407: + spent "a small fraction + of of his time thinking about + or dealing with the + +On line 4409: + management function + was simply not very concerned + about housing market + + risks. According to + Prince, Bushnell and others told + him, in effect, "‘Gosh, + +On line 4409: + housing prices would have + to go down nationwide for + us to have, not a + + problem with [mortgage-backed + securities] CDOs, but for + us to have problems,’ + + and that has never + happened since the Depression."50 + Housing prices would be + +On line 4409: + down much less than when + Citigroup began having + problems because of + +On line 4411: + the liquidity + puts it had written. By June + national house prices + +On line 4411: + and about of subprime + adjustable-rate mortgages were delinquent. + Yet Citigroup still + + did not expect that + the liquidity puts could + be triggered, and it + +On line 4411: + On June Citigroup + made a presentation to + the SEC about subprime + +On line 4411: + in its CDO business. + The presentation noted + that Citigroup did + +On line 4411: + the liquidity + puts were not a concern: "The + risk of default is + +On line 4413: + [and] certain market + events must also occur for + us to be required + + to fund. Therefore, we + view these positions to be + even less risky than the + +On line 4415: + Super Senior Book."51 + Just a few weeks later, the + July failure of + + the two Bear Stearns hedge + funds spelled trouble. Commercial + paper written against + +On line 4415: + CDOs for which Bear Stearns + Asset Management was the + asset manager + +On line 4415: + on LATE TO EARLY + which Citigroup had issued + liquidity puts + +On line 4415: + puts would be triggered + if interest rates on the + asset-backed commercial + + paper rose above a + certain level. The Office + of the Comptroller + +On line 4417: + regulator of + Citigroup’s national bank + subsidiary, had expressed + +On line 4419: + apprehensions about + the liquidity puts in + But by the summer + +On line 4419: + of OCC Examiner-in-Charge John Lyons + told the FCIC, the OCC became + concerned. Buying the + +On line 4419: + drain billion of the + company’s cash and expose + it to possible + +On line 4419: + distress. But given + the rising rates, Lyons also + said Citigroup did + + not have the option + to wait. Over the next six months, + Citigroup purchased + +On line 4421: + been subject to its + liquidity puts.52 On a + July conference + +On line 4421: + CFO Gary Crittenden + told analysts and investors + that the company’s + +On line 4421: + fallen from billion + at the end of to billion + on June But he made + + no mention of the + super-senior exposures and + liquidity puts. + +On line 4421: + risk team did a nice + job of anticipating + that this was going + +On line 4421: + be a difficult + environment, and so set + about in a pretty + +On line 4421: + effort to reduce + our exposure over the last + six months,"53 he said. A + +On line 4421: + reiterated + that subprime exposure had + been cut: "So I think + +On line 4423: + anticipating + some market dislocation + here."54 By August, as + +On line 4423: + Citigroup’s CDO desk + was revaluing its super-senior + tranches, though it had + +On line 4423: + assigning value. + However, as the market + congealed, then froze, the + +On line 4423: + prices for these tranches + demanded a model. The + New York Fed later + +On line 4423: + for Super Senior + CDOs, based on fundamental + economic factors, + +On line 4423: + Citigroup’s current + validation methodologies + yet it was relied + +On line 4425: + exposures."55 Barnes, the + CDO risk officer, told the + FCIC that sometime that + +On line 4425: + CDO desk to express + his concerns about possible + losses on both the + +On line 4425: + CDO inventory + and the retained super-senior + tranches. The message + +On line 4425: + through. Nestor Dominguez told the + FCIC, "We began extensive + discussions about the + +On line 4425: + implications of + the dramatic decline of + the underlying + +On line 4425: + that would feed into + the super-senior positions."56 + Also at this time— + +On line 4427: + first time—such concerns + reached Maheras. He justified + his lack of prior + +On line 4427: + in inventory + and super-senior tranches by + pointing out "that the + +On line 4427: + competent managers + and by an independent + risk group and that I + +On line 4427: + properly apprised + of the general nature + of our work in this + +On line 4429: + attendant risks."57 The + exact dates are not certain, + but according to + +On line 4429: + he remembers a + discussion at a "Business + Heads" meeting about the + +On line 4429: + volatility on those + super-senior tranches in late + August or early + +On line 4429: + paper backing the + super-senior tranches of the + CDOs that BSAM managed.58 + + This was also when + Chairman and CEO Prince first heard + about the possible + +On line 4429: + "open positions" on + the super-senior CDO tranches + that Citigroup held: + +On line 4429: + wasn’t presented + at the time in a startling + fashion [but] hen it + +On line 4429: + bigger and bigger + and bigger, obviously, + over the next days."59 In + +On line 4429: + might range from million + to billion. This number was + recalculated + +On line 4431: + as to million in + mid-September, as the valuation + methodology was + +On line 4437: + ahead, those numbers would + skyrocket. "DEFCON calls" + To get a handle + +On line 4437: + liquidity puts, + starting on September Prince + convened a series + +On line 4439: + senior management + team; they included Rubin, + Maheras, Crittenden, + +On line 4439: + as well as Lou Kaden, + the chief administrative + officer.61 Rubin + +On line 4441: + in Korea during + the first meeting but Kaden kept + him informed.62 Rubin + +On line 4441: + emailed Prince: "According + to Lou, Tom [Maheras] never + did provide a clear + + and direct answer + on the super seniors. If + that is so, and the + + meeting did not bring + that to a head, isn’t that + deeply troubling not as + +On line 4441: + what happened—that is a + different question that is + also troubling—but + + as to providing + full and clear information + and analysis now." + +On line 4441: + disagreed, writing, "I + thought, for first mtg, it was good. + We weren’t trying + + to get to final + answers."63 A second meeting + was held September + +On line 4445: + Rubin was back in + the country. This meeting marked + the first time Rubin + +On line 4445: + and liquidity + put exposure. He later + commented, "As far + + as I was concerned + they were all one thing, because + if there was a put + +On line 4445: + circumstance might be, + you hadn’t fully disposed + of the risk."64 And, of + +On line 4445: + the circumstance was + not remote, since billions of + dollars in subprime + +On line 4447: + assets had already + come back onto Citigroup’s + books. Prince told the FCIC + +On line 4447: + Maheras had assured + him throughout the meetings and + the DEFCON calls + +On line 4447: + the super seniors + posed no risk to Citigroup, + even as the market + +On line 4447: + added that he became + increasingly uneasy with + Maheras’s assessment. + +On line 4447: + and said till his last + day at work [October ‘We + are never going + + to lose a penny + on these super seniors. We + are never going + +On line 4447: + to lose a penny + on these super seniors. And + as we went along and + +On line 4447: + really began + to have some very serious + concerns about what was + +On line 4449: + happen."65 Despite Prince’s + concerns, Citigroup remained + publicly silent about the + +On line 4449: + exposure from the + super-senior positions and + liquidity puts, + +On line 4451: + third-quarter earnings on + October On October + the rating agencies + +On line 4451: + first in a series + of downgrades on thousands of + securities. In + +On line 4451: + view, these downgrades were + "the precipitating event + in the financial + +On line 4451: + On the same day, Prince + restructured the investment + bank, a move that led + +On line 4453: + the resignation + of Maheras. Four days later, + the question of the + +On line 4453: + specifically raised + at the board of directors’ + Corporate Audit + +On line 4453: + and Risk Management + LATE TO EARLY Committee + meeting and brought up + + to the full board. A + presentation concluded + that "total sub-prime + + exposure in [the + investment bank] was $13bn with + an additional + +On line 4457: + Super Senior and + $27bn in Liquidity and + Par Puts."67 Citigroup’s + +On line 4457: + subprime exposure + was billion, nearly half of + its capital. The + +On line 4457: + of the super-senior- + and liquidity-put-related + exposure as he + +On line 4457: + told participants + that Citigroup had under + billion in subprime + +On line 4459: + A week later, on + Saturday, October Prince + learned from Crittenden + +On line 4459: + the board. He later + reflected, "When I drove home + and Gary called me and + +On line 4459: + it wasn’t going + to be two or million but + it was going to + +On line 4459: + never forget that + call. I continued driving, + and I got home, I + + walked in the door, I + told my wife, I said here’s what + I just heard and if + +On line 4461: + to be true, I am + resigning."69 On November + Citigroup revealed + +On line 4461: + accurate subprime + exposure—now estimated + at billion—and it + +On line 4461: + Though Prince had resigned, + he remained on Citigroup’s + payroll until the + + end of the year, and + the board of directors gave + him a generous + +On line 4461: + in cash and million + in stock, bringing his total + compensation to + +On line 4463: + sued Citigroup for + its delayed disclosures. To + resolve the charges, the + +On line 4465: + extensive level + of subprime exposure posed + by Super Senior + +On line 4465: + management, as well + as the independent Risk + Management function + +On line 4467: + and analyze these + risks in a timely fashion."71 + Prince’s replacements as + +On line 4467: + Pandit—were announced in + December. Rubin would stay + until January + +On line 4467: + having been paid more + than million from to during + his tenure at the + +On line 4467: + as chairman of the + Executive Committee, + a position that + +On line 4467: + the FCIC. "My agreement + with Citi provided that I’d + have no management + +On line 4469: + John Reed, former co-CEO + of Citigroup, attributed + the firm’s failures in + +On line 4469: + to a culture change + that occurred when the bank took + on Salomon Brothers + +On line 4471: + of the Travelers + merger. He said that Salomon + executives "were + +On line 4471: + used to taking big + risks" and "had a history + [of] making a lot + +On line 4473: + of money but then + getting into trouble."74 AIG’S + DISPUTE WITH GOLDMAN: + +On line 4477: + NEVER BE LOSSES" + Beginning on July when + Goldman’s Davilman sent + +On line 4477: + that disrupted the + vacation of AIG’s Alan Frost, + the dispute between + +On line 4477: + and AIG over the need + for collateral to back + credit default swaps + +On line 4477: + the attention of + the senior management of + both companies. For + +On line 4477: + day. It would pursue + AIG relentlessly with emands + for collateral + + based on marks that were + initially well below those + of other firms—while + +On line 4479: + burgeoning crisis. + The initial collateral + call was a shock to + +On line 4479: + executives, most + of whom had not even known that + the credit default + +On line 4481: + They had known there were + enormous exposures—$79 billion, + backed in large part by + +On line 4481: + subprime and Alt-A loans, + in compared with the parent + company’s total + +On line 4481: + said they had never + been concerned. "The mantra at [AIG + Financial Products] + +On line 4481: + always been (in my + experience) that there could + never be losses," + + Vice President of + Accounting Policy Joseph + St. Denis said.76 Then + +On line 4485: + first collateral + call. St. Denis told FCIC staff + that he was so "stunned" + +On line 4485: + news that he "had to + sit down."77 The collateral + provisions surprised + +On line 4487: + who had insisted + months earlier that AIG stop + writing the swaps. He + +On line 4487: + FCIC that "rule Number + at AIG FP" was to never + post collateral. + +On line 4487: + particularly + important in the credit + default swap business, + +On line 4489: + said, because it was + the only unhedged business + that AIG ran.78 But Jake + + Sun, the general + counsel of the Financial + Products subsidiary, who + +On line 4489: + executed, told + the FCIC that the provisions + were standard both at + +On line 4489: + the industry.79 Frost, + who was the first to learn of + the collateral + +On line 4489: + and said that other + financial institutions + also commonly + +On line 4489: + Micottis, the Paris-based + head of the AIG Financial + Products’ Enterprise + +On line 4491: + were indeed common + in derivatives contracts— + but surprising in + +On line 4491: + CDS contracts, which were + considered safe.81 Insurance + supervisors did + +On line 4491: + like MBIA and Ambac + to pay out except when the + insured entity + +On line 4491: + an actual loss, + and therefore those companies + were forbidden to + +On line 4491: + decline in market + value or unrealized + losses. Because AIG + +On line 4491: + regulated as + an insurance company, + it was not subject + +On line 4493: + prohibition. As + disturbing as the senior + AIG executives’ + +On line 4493: + inability to + assess the validity + of Goldman’s numbers. + +On line 4493: + Financial Products + did not have its own model + or otherwise try + +On line 4493: + CDO portfolio that + it guaranteed through credit + default swaps, nor did + +On line 4493: + exposure. Gene Park + explained that hedging was seen + as unnecessary + + in part because of + the mistaken belief that + AIG would have to pay + +On line 4493: + only if holders + of the super-senior tranches + incurred actual + + losses. He also + said that purchasing a hedge + from UBS, the Swiss bank, + + was considered, but + that Andrew Forster, the head of + credit trading at + +On line 4493: + Financial Products, + rejected the idea because + it would cost more than + +On line 4493: + Financial Products + was receiving to write the + CDS protection. "We’re + +On line 4495: + to pay a dime for + this," Forster told Park.82 Therefore, AIG + Financial Products + +On line 4495: + did not provide a + tool for monitoring the + CDOs’ market value. + +On line 4495: + by LATE TO EARLY + Gary Gorton, then a finance + professor at the + + University of + Pennsylvania’s Wharton School, + who began working + +On line 4495: + as a consultant + to AIG Financial Products + in and was close to + +On line 4495: + Cassano. The Gorton + model had determined with + confidence that the + +On line 4497: + of the super-senior + tranches of the CDOs insured + by AIG Financial + + Products would never + suffer real economic + losses, even in an + +On line 4497: + the worst post–World War II + recession. The company’s + auditors, PricewaterhouseCoopers (PwC), + +On line 4497: + the collateral + requirements, concluded that + "the risk of default + +On line 4497: + [AIG’s] portfolio has + been effectively removed + and as a result + +On line 4497: + the fair value of + the liability stream + on these positions + +On line 4497: + a risk management + perspective could reasonably + be considered to + +On line 4499: + zero."83 In speaking + with the FCIC, Cassano was adamant + that the "CDS book" was + + effectively hedged. + He said that AIG could never + suffer losses on + +On line 4499: + swaps, because the CDS + contracts were written only + on the super-senior + +On line 4499: + securities with + high "attachment points"—that is, many + securities in + +On line 4499: + would have to default + in order for losses to + reach the super-senior + + tranches—and because the + bulk of the exposure came + from loans made before + +On line 4499: + deteriorate.84 + Indeed, according to Gene + Park, Cassano put a + +On line 4499: + halt to a million + hedge, in which AIG had taken + a short position + + in the ABX index. + As Park explained, "Joe stopped that + because after we + +On line 4499: + put on the first the + market moved against us we were + losing money on + +On line 4501: + the million. Joe said, + ‘You know, I don’t think the world + is going to blow + +On line 4503: + don’t want to spend that + money. Stop it.’"85 Despite the + limited market + +On line 4503: + transparency in the + summer of Goldman used what + information there + +On line 4503: + information from + ABX and other indices, to + estimate what it + +On line 4503: + be realistic + prices. Goldman also spoke with + other companies + +On line 4503: + they assigned to the + securities. Finally, + Goldman looked to its + +On line 4503: + experience: in + most cases, when the bank bought + credit protection + + on an investment, + it turned around and sold credit + protection on the + + same investment to + other counterparties. These + deals yielded more price + +On line 4505: + Until the dispute + with Goldman, AIG relied on + the Gorton model, + +On line 4507: + So Goldman’s marks caught + AIG by surprise. When AIG pushed + back, Goldman almost + +On line 4509: + reduced its July + collateral demand from + billion to billion, + +On line 4509: + that underscored the + difficulty of finding + reliable market + +On line 4509: + new demand was still + too high, in AIG’s view, which was + corroborated + +On line 4509: + Goldman valued the + CDOs between and cents on the + dollar, while Merrill + +On line 4511: + same securities + between and cents.87 On August + Cassano told PwC that + + there was "little or + no price transparency" and that + it was "difficult + +On line 4511: + were indicative of + true market levels moving."88 + AIG managers did call + +On line 4511: + bonds to check their marks + in order to help its case + with Goldman, but those + +On line 4511: + the dealers would not + actually execute + transactions at the + +On line 4511: + above estimated + values do not represent + actual bids or + +On line 4511: + by Merrill Lynch" was + the disclaimer in a listing + of estimated + +On line 4511: + values provided + by Merrill to AIG.89 Goldman + Sachs disputed the + +On line 4515: + of such estimates. + "Without being flippant" On + August for the first + +On line 4515: + AIG executives + publicly disclosed the billion + in credit default + +On line 4515: + second-quarter earnings + call. They acknowledged that the + great majority + +On line 4515: + underlying bonds + thus insured—$64 billion—were backed + by subprime mortgages. + +On line 4515: + BBB-rated collateral. + On the call, Cassano maintained + that the exposures + +On line 4515: + no problem: "It is + hard for us, without being + flippant, to even see + +On line 4515: + scenario within any + kind of realm or reason that + would see us losing + +On line 4515: + concluded: "We see + no issues at all emerging. + We see no dollar + +On line 4515: + of [the CDO] business. + Any reasonable scenario that + anyone can draw, and + +On line 4515: + say reasonable, I + mean a severe recession + scenario that you can + +On line 4515: + out for the life of + the securities." Senior + Vice President and + +On line 4515: + that reassurance: + "We believe that it would take + declines in housing + +On line 4515: + to reach depression + proportions, along with default + frequencies never + +On line 4517: + AA investments would + be impaired."90 These assurances + focused on the risk + +On line 4517: + actual mortgage + defaults would create real + economic losses + +On line 4517: + company’s credit + default swap positions.91 But + more important at + +On line 4517: + the other tremendous + risks that AIG executives + had already discussed + +On line 4517: + demand for billion + in collateral; the clear + possibility + +On line 4517: + calls could jeopardize + AIG’s liquidity; or the + risk that AIG would be + +On line 4519: + to take an "enormous + mark" on its existing book, + the concern Forster had + +On line 4521: + The day after the + conference call, AIG posted + million in cash to + +On line 4521: + posting since Goldman + had requested the billion. + As Frost wrote to Forster + +On line 4521: + an August email, the + idea was "to get everyone + to chill out."92 For one + +On line 4521: + including Cassano, + had late-summer vacations + planned. Cassano signed off + +On line 4521: + on the million "good + faith deposit" before leaving + for a cycling trip + +On line 4521: + executed a + side letter making clear that + both disputed the + +On line 4523: + that had been doing + business together for decades + agreed to disagree. On + +On line 4523: + August Frost went to + Goldman’s offices to "start the + dialog," which had + + stalled while Cassano and + other key executives + were on vacation. + + Two days later, Frost + wrote to Forster: "Trust me. This is + not the last margin + +On line 4525: + call we are going + to debate."94 He was right. By + September Société + +On line 4525: + more commonly as + SocGen—had demanded million in + collateral on + + CDS it had purchased + from AIG Financial Products, + UBS had demanded + +On line 4525: + and Goldman had upped + its demand by million. The + SocGen demand was based + +On line 4525: + price provided by + Goldman, which AIG disputed. + Tom Athan, managing + +On line 4525: + AIG Fi-LATE TO EARLY + nancial Products, told Forster that + SocGen "received marks from + +On line 4525: + that would result in + big collateral calls but + SG disputed them + + with GS."95 Several + weeks later, Cassano told AIG + Financial Services + +On line 4525: + Habayeb that he believed + the SocGen margin call had been + "spurred by Goldman," and + +On line 4525: + "disputed the call + and [had] not heard from SocGen again + on that specific + +On line 4525: + of additional + downgrades affecting tens of + billions of dollars + +On line 4525: + subprime mortgage–backed + securities and CDOs. By + November Goldman’s + +On line 4525: + had almost doubled, + to billion. On November + Bensinger, the CFO, informed + +On line 4525: + Audit Committee + that Financial Products had + received margin calls + +On line 4527: + five counterparties + and was disputing every + single one.97 This stance + + was rooted in the + company’s continuing + belief that Goldman + +On line 4527: + low. AIG’s position + was corroborated, at + least in part, by the + +On line 4527: + point, Merrill Lynch and + Goldman made collateral + demands on the very + +On line 4527: + same CDS positions, + but Goldman’s marks were almost + lower than Merrill’s.98 + +On line 4529: + had executed, + market activity we + observed, price changes in + +On line 4529: + the current prices of + relevant liquid indices."99 + Trading in the ABX + +On line 4529: + from over trades per week + through the end of September + to less than per week + +On line 4529: + TABX, which focuses + on lower-rated tranches, dropped + from roughly trades per + +On line 4531: + through mid-July to almost + zero by mid-August.100 But Cassano + believed that the quick + +On line 4531: + the million deposit + confirmed that Goldman was not + as certain of its + + marks as it later + insisted. According to + Cassano, Michael Sherwood, + + co-CEO of Goldman Sachs + International, told him + that Goldman "didn’t + +On line 4531: + in glory during + this period" but that "the + market’s starting to + +On line 4531: + took those comments as + an implicit admission + that Goldman’s initial + +On line 4535: + had been aggressive.101 + "More love notes" In mid-August, Forster told + Frost in an email that + +On line 4535: + of aggressively + marking down assets to "cause + maximum pain to + + their competitors."102 PricewaterhouseCoopers, + which served as auditor for + both AIG and Goldman + +On line 4535: + that AIG had never + before marked these positions + to market. In the + +On line 4535: + demands piling up, + PwC prompted AIG to begin + developing a + +On line 4535: + of its own. Prior + to the Goldman margin call, + PwC had concluded + + that "compensating + controls" made up for AIG’s not + having a model. + +On line 4535: + from counterparties + that collateral was due.103 + In other words, one + +On line 4535: + management tools was + to learn of its own problems + from counterparties + +On line 4535: + have the ability + to mark their own positions + to market prices and + +On line 4537: + to develop a + valuation model was + not unanimous. In + + mid-September, Cassano and Forster + met with Habayeb and others to + discuss marking the + +On line 4539: + in AIG’s financial + statements. Cassano still thought the + valuation process + +On line 4539: + possibility + of defaults was "remote."104 He + sent Forster and others + +On line 4539: + requests from Habayeb as + "more love notes [asking us to + go through] the same drill + +On line 4539: + with PwC, AIG started + to evaluate the pricing + model for subprime + +On line 4539: + used by Moody’s. Cassano + considered the Moody’s model + only a "gut check" + +On line 4539: + coupled this model + with generic CDO tranche data + sold by JP Morgan + +On line 4539: + be relatively + representative of the + market. Of course, by + +On line 4539: + that this was not a + perfect solution, but AIG + and its auditors + + thought it could serve as + an interim step. The makeshift + model was up and + + running in the third + quarter. "Confident in our + marks" On November + +On line 4543: + AIG reported its + third-quarter earnings, it disclosed + that it was taking + +On line 4543: + through October of + approximately million + before tax [on that] + +On line 4545: + conference call, CEO + Sullivan assured investors + that the insurance + +On line 4545: + strong risk management." + He said, "AIG continues to + believe that it is + +On line 4547: + will be required to + make payments with respect to + these derivatives." + +On line 4547: + that AIG had "more than + enough resources to meet any of + the collateral + + calls that might come in."107 + While the company remained + adamant that there would be + +On line 4547: + economic losses + from the credit default swaps, + it used the newly + +On line 4547: + the relevance of + the model: it hadn’t been + validated in + +On line 4547: + earnings release, it + didn’t take into account + important structural + +On line 4547: + about the swap contracts, + and there were questions about the + quality of the + + data.108 AIG didn’t + mention those caveats on the call. + Two weeks later, on + +On line 4549: + Goldman demanded + an additional billion + in cash. AIG protested, + +On line 4551: + memo from Forster listing + the pertinent marks for the + securities from + +On line 4551: + Lynch, Calyon, Bank + of Montreal, and SocGen.110 The + marks varied widely, + +On line 4551: + as little as of + the bonds’ original value + to virtually + + full value. Goldman’s + estimated values were + much lower than those + +On line 4551: + other dealers. For + example, Goldman valued + one CDO, the Dunhill + +On line 4551: + at of par, whereas + Merrill valued it at of + par; the Orient Point + +On line 4553: + CDO was valued at + of par by Goldman but at + of par by Merrill. + +On line 4553: + marks validated + AIG’s long-standing contention + that "there is no one + +On line 4553: + more knowledge than the + others or with a better + deal flow of trades and + +On line 4553: + admit to LATE TO + EARLY ‘guesstimating’ pricing."111 + Cassano agreed. "No one + +On line 4553: + know how to discern + a market valuation + price from the current + +On line 4553: + Cassano wrote to a + colleague. "This information + is limited due + +On line 4555: + give indications + on these obligations."112 One week + later, Cassano called + +On line 4555: + London office and + demanded reimbursement + of billion. He told + +On line 4555: + executives that + independent third-party + pricing for of the + +On line 4555: + the CDOs on which AIG + FP had written CDS and AIG’s + own valuation + +On line 4557: + return the money.113 + Goldman refused, and instead + demanded more.114 By + +On line 4557: + there was relative + agreement within AIG and with + its auditor that + +On line 4557: + was inadequate + for valuing the super-senior + book.115 But there was no + +On line 4557: + on how that book should + be valued. Inputting generic + CDO collateral + +On line 4557: + would result in a + billion valuation loss; + using Goldman’s marks + +On line 4559: + would result in a + billion valuation loss, + which would wipe out the + +On line 4561: + On November PwC + auditors met with senior + executives from + +On line 4561: + to discuss the whole + situation. According + to PwC meeting notes, + +On line 4561: + that disagreements with + Goldman continued, and AIG + did not have data + +On line 4561: + marks. Forster recalled that + Sullivan said that he was + going to have a + + heart attack when he + learned that using Goldman’s marks + would eliminate the + +On line 4561: + profits.117 Sullivan + told FCIC staff that he did not + remember this part + + of the meeting.118 AIG + adjusted the number, and + in doing so it + +On line 4565: + president in charge + of models, came up with a + solution. Convinced + +On line 4565: + between the value + of the underlying bonds + and the value of + +On line 4567: + "negative basis + adjustment," which would reduce + the unrealized + +On line 4567: + loss estimate from + billion (Goldman’s figure) to + about billion. With their + +On line 4569: + to go. Several + documents given to the + FCIC by PwC, AIG, and + +On line 4569: + discussions during + and after the November + meeting. During a + +On line 4569: + (Financial Products + executives, including + Cassano and Forster, did + +On line 4569: + the valuation + of the credit default swap + portfolio, as well + +On line 4571: + collateral. AIG + Financial Products had paid + out billion without + +On line 4571: + Risk Management group. + Another issue was "the + way in which AIGFP [had] + +On line 4571: + PwC will not get any + more information until + after the investor + +On line 4573: + auditors laid out + their concerns about conflicting + strategies pursued by + +On line 4575: + subsidiaries. Notably, the + securities-lending subsidiary + had been purchasing + +On line 4575: + using cash raised by + lending securities that + AIG held on ehalf of + +On line 4575: + of through September + its holdings rose from billion + to billion. Meanwhile, + +On line 4575: + acting on its own + analysis, had decided + in to begin pulling + +On line 4575: + on writing credit + default swaps on CDOs. In PwC’s + view, in allowing + +On line 4575: + subsidiary to increase + exposure to subprime while + another subsidiary + +On line 4575: + market entirely, + the parent company’s risk + management failed. PwC + +On line 4575: + second quarter of + financial disclosures would + have been changed if the + +On line 4575: + "these items together + raised control concerns around risk + management which could + +On line 4575: + weakness."120 Kevin McGinn, AIG’s + chief credit officer, shared + these concerns about the + +On line 4577: + a November email, + McGinn wrote: "All units were apprised + regularly of + +On line 4577: + the housing market. + Some listened and responded; + others simply chose + +On line 4577: + then, to add insult + to injury, not to spot the + manifest signs." He + + concluded that this + was akin to "Nero playing the + fiddle while Rome burns."121 + + On the opposite + side, Sullivan insisted + to the FCIC that the + + conflicting strategies + in the securities-lending + business and at AIG + +On line 4577: + revealed that the two + subsidiaries adopted different + business models, and + +On line 4579: + did not constitute + a risk management failure.122 + On December six + +On line 4579: + conference call about + AIG’s risk management systems + and the company’s + +On line 4579: + risk we have taken + in the U.S. residential + housing sector is + +On line 4581: + structure. we believe + the probability that + it will sustain an + +On line 4581: + to zero. We are + confident in our marks and + the reasonableness + +On line 4581: + methods." Charlie Gates, + an analyst at Credit + Suisse, a Swiss bank, + +On line 4581: + about valuation + and collateral disputes + with counterparties + +On line 4581: + AIG had alluded + in its third-quarter financial + results. Cassano replied, + + "We have from time to + time gotten collateral + calls from people and + +On line 4581: + we say to them, well + we don’t agree with your numbers. + And they go, oh, and + + they go away. And you + say well what was that1 It’s like + a drive-by in a + +On line 4581: + And the other times + they sat down with us, and none + of this is hostile + + or anything, it’s all + very cordial, and we sit down + and we try and find + + the middle ground and + compare where we are."123 Cassano + did not reveal the + +On line 4583: + dollars posted to + other counterparties, and + the daily demands + + from Goldman and the + others for additional + cash. The analysts + + and investors on the + call were not informed about the + "negative basis + +On line 4583: + did not know that AIG’s + earnings were overstated by + billion—and they would + +On line 4587: + until February + "Material weakness" By + January AIG still + +On line 4587: + market price of the + securities on which it + had written credit + +On line 4587: + Nevertheless, on + January LATE TO EARLY + Cassano sent an email + +On line 4587: + and CFO David Viniar at + Goldman demanding that they + return billion of + +On line 4587: + billion posted.124 He + attached a spreadsheet showing + that AIG valued many + +On line 4587: + as if there had been + no decline in their value. + That was simply not + + credible, Goldman + executives told the FCIC.125 + Meanwhile, Goldman had + +On line 4587: + built up billion in + protection by purchasing + credit default swaps + +On line 4587: + AIG to cover the + difference between the amount + of collateral + +On line 4589: + they had demanded + and the amount that AIG had paid.126 + On February PwC + +On line 4589: + Willumstad, the chairman + of AIG’s board of directors. + They informed him that + +On line 4589: + "negative basis + adjustment" used to reach the + billion estimate + +On line 4589: + December investor + call had been improper and + unsupported, and + +On line 4589: + deficiency was + a material weakness + as of December + +On line 4589: + words, PwC would have to + announce that the numbers AIG + had already publicly + + reported were wrong. + Why the auditors waited + so long to make this + +On line 4591: + particularly + given that PwC had known about + the adjustment in + +On line 4593: + In the meeting with + Willumstad, the auditors were + broadly critical + +On line 4593: + they deemed unable to + compensate for Sullivan’s + weaknesses; and Lewis, + +On line 4593: + complex matters" had + contributed to the problems.128 + Despite PwC’s findings, + +On line 4593: + received million over + four years in compensation + from AIG, including + +On line 4593: + severance package + of million. When asked about these + figures at a FCIC + +On line 4593: + recollection of + those numbers whatsoever, + sir. I certainly + + don’t recall earning + that amount of money, sir."129 The + following day, PwC + +On line 4595: + auditors said they + could complete AIG’s audit, but + only if Cassano + +On line 4597: + not interfere in + the process." Retaining Cassano + was a "management + +On line 4597: + culture needed to + change at FP."130 On February + AIG disclosed in an + + SEC filing that its + auditor had identified + the material + +On line 4597: + it had reduced its + December valuation + loss estimates by + +On line 4597: + is, the difference + between the estimates of + billion and billion— + +On line 4601: + agencies responded + immediately. Moody’s and + S&P announced downgrades, + +On line 4601: + AIG on "Ratings Watch + Negative," suggesting that + a future downgrade + +On line 4603: + possible. AIG’s stock + declined for the day, closing + at At the end of + +On line 4603: + was demanding an + additional billion, and + had upped to billion + +On line 4603: + protection against an + AIG failure. On February + AIG disappointed + +On line 4603: + fourth-quarter and fiscal + year earnings. The company + reported a net + +On line 4603: + CDO credit default + swap exposure and more than + illion in losses + + relating to the + securities-lending business’s + mortgage-backed purchases. + + Along with the losses, + Sullivan announced Cassano’s + retirement, but the + + news wasn’t all bad + for the former Financial + Products chief: He made + +On line 4603: + Financial Products + in January of until + his retirement in + +On line 4605: + consulting agreement + after his retirement.131 In + March, the Office of + +On line 4605: + AIG and its subsidiaries, + downgraded the company’s + composite rating + +On line 4607: + still judged the threat to + overall viability + as remote.132 It did + +On line 4607: + of the company’s + financial condition for + another six months. + + By then, it would be + too late. FEDERAL RESERVE: + "THE DISCOUNT WINDOW + +On line 4615: + course of the fall, the + announcements by Citigroup, + Merrill, and others + +On line 4615: + clear that financial + institutions were going + to take serious + +On line 4615: + from their exposures + to the mortgage market. Stocks + of financial firms + +On line 4615: + end of November, + the S&P Financials Index + had lost more than for + +On line 4615: + November, asset-backed + commercial paper declined + about which meant that those + + assets had to be + sold or funded by other + means. Investment banks + +On line 4615: + tighter funding markets + and increasing cash pressures. + As a result, the + +On line 4615: + Reserve decided + that its interest rate cuts + and other measures + + since August had not + been sufficient to provide + liquidity and + +On line 4615: + Fed’s discount window + hadn’t attracted much bank + borrowing because + +On line 4615: + the stigma attached + to it. "The problem with the + discount window is + + that people don’t like + to use it because they view + it as a risk that + +On line 4615: + will be viewed as weak," + William Dudley, then head of the + capital markets + +On line 4617: + the New York Fed and + currently its president, + told the FCIC.133 Banks and + +On line 4617: + of liquidity; + in particular, during + the second half of + +On line 4617: + Federal Home Loan + Banks—which are government-sponsored + entities that lend + +On line 4619: + of March and the end + of December Washington + Mutual, the largest + +On line 4619: + borrowing from the + Federal Home Loan Banks from + billion to billion; + +On line 4619: + Countrywide increased + its borrowing from billion + to billion; Bank of + +On line 4619: + billion to billion. + The Federal Home Loan Banks + could thus be seen as + + the lender of next to + last resort for commercial + banks and thrifts—the + +On line 4621: + addition, the loss + of liquidity in the + financial sector + +On line 4621: + TO EARLY cult for + businesses and consumers to + get credit, raising + + the Fed’s concerns. From + July to October, the + percentage of loan + +On line 4621: + tightening standards + on prime mortgages increased from + to about Over that time, + + the percentage of + loan officers reporting + tightening standards + +On line 4621: + on loans to large and + midsize companies increased + from to its highest + +On line 4623: + wasn’t working as + hoped," Frederic Mishkin, a Fed + governor from to + +On line 4623: + they were extremely + controversial."136 The first of + these measures, announced + +On line 4623: + December was the + creation of the Term Auction + Facility (TAF). + +On line 4623: + was to reduce the + discount window stigma by + making the money + + available to all banks + at once through a regular + auction. The program + +On line 4623: + had some success, with + banks borrowing billion by + the end of the year. + + Over time, the Fed would + continue to tweak the TAF + auctions, offering + + more credit and longer + maturities. Another + Fed concern was that + +On line 4625: + and others who did + have cash would hoard it. Hoarding + meant foreign banks had + +On line 4625: + Those sales and fears of + more sales to come weighed on the + market prices of U.S. + + securities. In + response, the Fed and other + central banks around the + +On line 4625: + on December new + "currency swap lines" to help + foreign banks borrow + + dollars. Under this + mechanism, foreign central + banks swapped currencies + + with the Federal + Reserve—local currency + for U.S. dollars—and lent + +On line 4625: + foreign banks. "During + the crisis, the U.S. banks were + very reluctant to + +On line 4625: + liquidity to + European banks," Dudley said.137 + Central banks had used + +On line 4625: + the aftermath of + the attacks to bolster the + global financial + +On line 4627: + In late the swap lines + totaled billion. During the + financial crisis + +On line 4629: + seven years later, + they would reach billion. The Fed + hoped the TAF and the + +On line 4629: + lines would reduce strains + in short-term money markets, + easing some of the + +On line 4629: + pressure on other + struggling participants such + as investment banks. + + Importantly, it + wasn’t just the commercial + banks and thrifts but the + +On line 4629: + "Historically, + the Federal Reserve has + always tended to + +On line 4629: + that liquidity + provided to the banking + system can be [lent + +On line 4629: + institutions in + the nonbank sector. What we + saw in this crisis + +On line 4629: + that didn’t always + take place to the extent that + it had in the past. + +On line 4629: + think people going + in really had a full + understanding of + +On line 4631: + complexity of + the shadow banking system, + the role of [structured + +On line 4633: + explicitly or + implicitly."138 Burdened with + capital losses + +On line 4633: + to cover their own + funding commitments, the banks + were not stable enough + +On line 4633: + the void, even after + the Fed lowered interest + rates and began the + +On line 4635: + In January the + Fed cut rates again— and then again, + twice within two weeks, + +On line 4637: + highly unusual + move that brought the federal + funds rate from to he + +On line 4637: + also started plans + for a new program that would + use its emergency + + authority, the + Term Securities Lending + Facility, though + +On line 4639: + launched until March. "The + TLSF was more a view that the + liquidity that + + we were providing + to the banks through the TAF was + not leading to a + +On line 4639: + diminishment of + financing pressures elsewhere," + Dudley told the FCIC. + + "So maybe we should think + about bypassing the banking + system and [try] to + +On line 4641: + to the primary + dealer community more + directly."139 On March + +On line 4641: + the Fed increased the + total available in each of + the biweekly TAF + +On line 4641: + auctions from billion + to billion, and guaranteed + at least that amount for + +On line 4641: + months. The Fed also + liberalized its standard + for collateral. + +On line 4645: + backed securities, + as collateral. The Fed + expected to have + +On line 4647: + billion in such loans + outstanding at any given + time. Also at this + +On line 4647: + central bank began + contemplating a step that + was revo-lutionary: + +On line 4647: + over which the Fed had + no supervisory or + regulatory + +On line 4649: + similar to those + available to commercial banks. + MONOLINE INSURERS: + +On line 4651: + NEVER EXPECTED + LOSSES" Meanwhile, the rating + agencies continued + +On line 4651: + to downgrade mortgage-backed + securities and CDOs through + By January as + + a result of the + stress in the mortgage market, + S&P had downgraded + +On line 4651: + of residential + mortgage–backed securities + and tranches from CDOs. + + MBIA and Ambac, the + two largest monoline insurers, + had taken on a + +On line 4651: + products. Downgrades on + the products that they insured + brought the financial + +On line 4651: + companies into + question. After conducting + stress analysis, S&P + +On line 4651: + estimated in + February that Ambac would + need up to million + + in capital to + cover potential losses + on structured products.140 + +On line 4651: + charges would affect the + monolines’ own credit ratings, + which in turn could lead + +On line 4653: + of the products they + had guaranteed. Like many of + the monolines, ACA, the + +On line 4655: + smallest of them, kept + razor-thin capital— less than + million—against its + +On line 4655: + billion in credit + default swaps on CDOs. In late + ACA reported a + +On line 4655: + net loss of billion, + almost entirely due to + credit default swaps. + +On line 4657: + they and various + stakeholders—the rating + agencies, investors, and + +On line 4657: + the monolines never + would have to take a loss. As + Alan Roseman, CEO of + +On line 4659: + ACA, told FCIC staff: "We + never expected losses. + We were providing + +On line 4659: + we believed, to take + the volatility because we + didn’t have to post + +On line 4659: + market value to + our counterparty, number + one. Number two, we + +On line 4659: + told by the rating + agencies that LATE TO EARLY + rated us that that + +On line 4659: + variation was not + important to our rating, + from a financial + +On line 4661: + point of view at the + insurance company."141 In + early November, + +On line 4661: + use of the monolines + for hedging "a concern that + we also share."142 The + +On line 4661: + to minimize their + exposure to the monolines, + particularly + +On line 4661: + ACA. On December + S&P downgraded ACA to junk + status, rating the + +On line 4661: + CCC, which was fatal + for a company whose CEO + said that its "rating + +On line 4661: + like Merrill Lynch would + get virtually nothing + for the guarantees + + they had purchased from + ACA. Despite the stresses in + the market, the SEC + +On line 4663: + confined to ACA. A + January internal SEC + document said, "While + +On line 4663: + a clear sentiment + that capital raising will + need to continue, + +On line 4663: + that the guarantors + (with the exception of ACA) + are relatively + +On line 4663: + provides hope that event[s] + in this sector will unfold + in a manageable + +On line 4665: + the rating agencies + told the monolines that if they + wanted to retain + +On line 4665: + they would have to raise + capital. MBIA and Ambac + ultimately did + +On line 4667: + billion and billion, + respectively. Nonetheless, + S&P downgraded both + +On line 4667: + to AA in June As + the crisis unfolded, most + of the monolines stopped + +On line 4669: + is easy to follow: + in anticipation of + the monoline downgrades, + +On line 4669: + that had nothing to + do with the mortgage-backed markets, + including a set + +On line 4669: + investments known as + auction rate securities, + or ARS. An ARS is + +On line 4669: + interest rate is + reset at regularly + scheduled auctions held + +On line 4669: + one to seven weeks.145 + Existing investors can choose + to rebid for the + +On line 4669: + new investors can come + in. The debt is frequently + municipal bonds. + +On line 4671: + As of December + state and local governments + had issued billion + +On line 4671: + ARS, accounting for + half of the billion market. + The other half were + +On line 4671: + bundles of student + loans and debt of nonprofits + such as museums + +On line 4673: + hospitals. The key + point: these entities wanted + to borrow long-term but + + get the benefit + of lower short-term rates, and + investors wanted to + +On line 4673: + without tying up + their money for a long time. + Unlike commercial + +On line 4673: + this market had no + explicit liquidity + backstop from a bank, + +On line 4673: + was an implicit + backstop: often, if there were + not enough new buyers + +On line 4673: + the dealers running + these auctions, including firms + like UBS, Citigroup, + +On line 4673: + would step in and pick + up the shortfall. Because of + these interventions, + +On line 4675: + were only failures + between and early in more + than auctions. Dealers + +On line 4675: + to convince clients that + ARS were very liquid, short-term + instruments, even in + +On line 4677: + auction did fail, the + previous ARS investors would + be obligated + +On line 4677: + compensation, the + interest rates on the debt + would reset, often + +On line 4677: + but investors’ funds would + be trapped until new investors + or the ealer stepped + +On line 4677: + or the borrower + paid off the loan. ARS investors + were typically + +On line 4677: + risk averse and valued + liquidity, and so they + were willing to pay + +On line 4677: + the monolines’ growing + problems in the latter half + of affected the + + ARS market. Fearing + that the monolines would not be + able to perform on + +On line 4679: + were all that kept the + market going, but the stress + became too great. With + + their own problems to + contend with, the dealers were + unable to step in + +On line 4679: + ensure successful + auctions. In February, en + masse, they pulled up stakes. + +On line 4679: + The market collapsed + almost instantaneously. + On February in + +On line 4679: + dislocations of + the financial crisis, of + the ARS auctions failed; + +On line 4681: + the following week, + failed. Hundreds of billions of + dollars were trapped by + +On line 4683: + small businesses, and + charities—constituted + more than billion of + +On line 4683: + who chose to remain + in the market demanded + a premium to + +On line 4683: + and interest rate + resets, countless governments, + infrastructure projects, + +On line 4685: + on tight budgets were + slammed with interest rates of + or higher. Problems + +On line 4685: + the ARS market cost + Georgetown University, a + borrower, million.148 + +On line 4687: + New York State was stuck + with interest rates that soared + from about to more than + +On line 4687: + on billion of its + debt. The Port Authority + of New York and New + +On line 4687: + saw the interest + rate on its debt jump from to + in a single week + +On line 4689: + SEC received more than + investor complaints regarding + the failed ARS auctions. + +On line 4689: + led them to believe + that ARS were safe and liquid, + essentially the + +On line 4689: + accounts but with the + potential for a slightly + higher interest + +On line 4689: + also reported + that the frozen market blocked their + access to money + + for short-term needs such + as medical expenses, + college tuition, and, + +On line 4691: + some small businesses + and charities, payroll. By + the SEC had settled + +On line 4693: + including Bank of + America, RBC Capital + Markets, and Deutsche Bank + + to resolve charges that + the firms misled investors. As + a result, these and + +On line 4693: + other banks made more + than billion available to pay + off tens of thousands + +On line 4697: + of ARS investors.150 LATE + TO EARLY The Commission + concludes that some large + +On line 4697: + holding companies, + and insurance companies, + including Merrill + + Lynch, Citigroup, and + AIG, experienced massive + losses related + +On line 4701: + regulators—the + Securities and Exchange + Commission for the + +On line 4701: + investment banks and + the banking supervisors + for the bank holding + +On line 4701: + to adequately + supervise their safety and + soundness, allowing + +On line 4701: + take inordinate + risk in activities such + as nonprime mortgage + +On line 4701: + dealing and to hold + inadequate capital + and liquidity. + +On line 4715: + MARCH THE FALL OF BEAR + STEARNS CONTENTS "I requested + some forbearance" "We + +On line 4719: + suitably skeptical"...............................................................................282 + "Turn into a death spiral" + "Duty to protect + +On line 4723: + government would not + permit a higher number" + "It was heading to + +On line 4725: + black hole"..........................................................................290 After its + hedge funds failed in July Bear + Stearns faced more challenges + + in the second half + of the year. Taking out the + repo lenders to the + +On line 4725: + brought nearly billion + in subprime assets onto + Bear’s books, contributing + +On line 4725: + a billion write-down + on mortgage-related assets + in November. That + +On line 4725: + to scrutinize Bear + Stearns’s finances. Over the fall, Bear’s + repo lenders—mostly + +On line 4725: + required Bear to post + more collateral and pay + higher interest + +On line 4725: + rates. Then, in just one + week in March a run by these + lenders, hedge fund customers, + +On line 4727: + the biggest piece of + Bear Stearns’s most-profitable division, + its fixed-income business, + +On line 4729: + which generated + of the firm’s total revenues. + Growing fast was the + + Global Client Services + division, which included + Bear’s prime brokerage + +On line 4729: + Stearns was the second-biggest + prime broker in the country, + with a market share + +On line 4731: + origination through + securitization and + sale. It both acquired + +On line 4731: + created its own + captive originators to + generate mortgages + + that Bear bundled, turned + into securities, and + sold to investors.2 The + +On line 4733: + top-three underwriter + of private-label mortgage– backed + securities from + +On line 4733: + underwrote billion + in collateralized debt + obligations of all + +On line 4739: + more than double its + figure of billion. MARCH The + total included + +On line 4739: + CDOs that included + mortgage-backed securities, putting + it in the top in + + that business.4 As was + typical on Wall Street, the + company’s view was + +On line 4739: + the moving business, + not the storage business—that is, + it sought to provide + +On line 4741: + to clients rather than take + on long-term exposures of its + own.5 Bear expanded + +On line 4741: + that the market was + beginning to falter, as + did other firms such + +On line 4741: + as Citigroup and + Merrill. As early as May + Bear had lost million + +On line 4741: + defaults6 on mortgages + which occurred within days of + origination, which + +On line 4741: + rare in the decade. But + Bear persisted, assuming + the setback would be + +On line 4741: + February Bear even + acquired Encore Credit, its + third captive mortgage + + originator in + the United States, doubling its + capacity. The + +On line 4743: + markets and waiting + for them to turn around.7 Only + a month after the + +On line 4743: + the Securities + and Exchange Commission wrote + in an internal + +On line 4743: + market risk losses" + on its Alt-A mortgage assets.8 + The losses were small, + +On line 4743: + the SEC reported + that "risk managers note[d] that + these events reflect a + +On line 4745: + anticipated + in ex ante models of stress + events."9 "I REQUESTED + +On line 4747: + Vacationing on + Nantucket Island when the + two Bear-sponsored hedge funds + +On line 4747: + on July former + Bear treasurer Robert Upton + anticipated + +On line 4747: + the rating agencies + would downgrade the company, + raising borrowing + +On line 4747: + its operations + borrowing short-term in the + repo market; it + +On line 4747: + borrowed between and + billion overnight.10 Even a threat of + a downgrade by a + +On line 4749: + would make financing + more expensive, starting the + next morning. Investors, + +On line 4749: + scrutinized leverage + ratios, available at the end + of each quarter. By + +On line 4749: + Bear’s leverage ratio + had reached nearly to By the + end of Bear’s Level + +On line 4749: + assets difficult + to value and to sell—were + of its tangible + +On line 4749: + common equity; + thus, writing down these illiquid + assets by would wipe + +On line 4751: + tangible common + equity. At the end of + each quarter, Bear would + + lower its leverage + ratio by selling assets, + only to buy them + +On line 4751: + at the beginning + of the next quarter. Bear and + other firms booked these + +On line 4751: + as sales—even though + the assets didn’t stay off + the balance sheet for + +On line 4751: + order to reduce + the amount of the company’s + assets and lower + +On line 4751: + leverage ratio. Bear’s + former treasurer Upton + called the move "window + + dressing" and said it + ensured that creditors and + rating agencies were + +On line 4751: + the balance sheet was + approximately lower + than the average + + month-end balance over + the previous twelve months.12 To + forestall a downgrade, + +On line 4753: + Upton spoke with the + three main rating agencies, Moody’s, + Standard Poor’s, and Fitch, + +On line 4753: + August.13 Several + times in ncluding April and June—S&P + had confirmed Bear’s strong + +On line 4753: + in April that "Bear’s risk + profile is relatively + conservative" and + +On line 4753: + senior management + oversight and a strong culture + throughout the firm are + + the foundation of + Bear’s risk management process." On + June, Moody’s had also + +On line 4755: + management had learned + its lesson about governance + and risk management + +On line 4755: + the failure of the + two hedge funds and was going + to rely less on + +On line 4755: + not foresee that Bear’s + own repo lenders might refuse to + lend against risky mortgage + +On line 4757: + even against Treasuries. "I + requested some forbearance" + from S&P, Upton told + +On line 4757: + the FCIC.14 He did not + get it. On August just three + days after the two + +On line 4759: + base as it placed Bear + on a "negative outlook."15 + Asked how he felt about + +On line 4759: + Jimmy Cayne, Bear’s CEO + until said, "A negative + outlook can touch a + +On line 4761: + businesses. It was + like having a beautiful + child and they have a + + disease of some sort + that you never expect to + happen and it did. + + How did I feel1 Lousy."16 + To reassure investors that + no more shoes would drop, + + Bear invited them + on a conference call that + same day. The call did + +On line 4763: + By the end of the + day, Bear’s stock slid to below + its all-time high + +On line 4767: + reached earlier in + "WE WERE SUITABLY SKEPTICAL" + On Sunday, August + +On line 4767: + Bear had another + opportunity to make + its case: this time, with + +On line 4767: + supervisors who + visited the company + that Sunday were Michael + +On line 4769: + of the division + of market regulation. + The regulators + +On line 4769: + the mortgage market, + including the billion in + adjustable-rate mortgages on + +On line 4769: + books that were waiting + to be securitized. Bear + executives gave + +On line 4769: + that inventory + would shrink once investors returned + in September from + +On line 4769: + regulators are + not supposed to listen to + happy talk and go + +On line 4771: + smiling," Eichner + told the FCIC. "Thirteen billion + in ARMs is no joke." + +On line 4771: + not believe the Bear + executives were being + disingenuous. He + +On line 4773: + the upside.17 Alan Schwartz, + the co-president who later + succeeded Jimmy + +On line 4773: + Thomas Marano, head of + Global Mortgages and Asset + Backed Securities, + + seemed unconcerned. But + other executives were + leery. Wendy de Monchaux, + +On line 4773: + urged Marano to trim + the mortgage portfolio, as + did Steven Meyer, the + + co-head of stock sales + and trading.18 According to + Chief Risk Officer + + Michael Alix, former + chairman Alan Greenberg would say, + "the best hedge is a + +On line 4773: + sale."19 Bear finally + reduced the portfolio from + billion in the third + +On line 4773: + of to billion in + the fourth quarter, but it was + too little too late. + +On line 4777: + MARCH That summer, the + SEC felt Bear’s liquidity + was adequate for + +On line 4777: + insisted. After + the August meeting, the SEC + required that Bear Stearns + +On line 4777: + agency had grossly + underestimated the + possibility + +On line 4779: + updated the SEC + on Bear’s billion balance sheet, + with specifics on repo + +On line 4779: + commercial paper. + On September Bear Stearns raised + approximately + +On line 4779: + reports slowed to once + a week.21 The SEC’s inspector + general later + +On line 4779: + that they did not push + Bear to reduce leverage or + "make any efforts to + +On line 4779: + mortgages at Bear Stearns + had numerous shortcomings, + including lack of + +On line 4779: + backed securities" + and "persistent understaffing; + a proximity + + of risk managers to + traders suggesting a lack of + independence; turnover + + of key personnel + during times of crisis; and + the inability + +On line 4779: + unwillingness to + update models to reflect + changing circumstances."22 + + Michael Halloran, a + senior adviser to SEC + Chairman Christopher Cox, + + told the FCIC the SEC + had ample information + and authority + +On line 4781: + other financial + institutions were doing. + Halloran said that + +On line 4781: + as early as the + first quarter of he had asked + Erik Sirri, in charge + +On line 4781: + Entities program, + about Bear Stearns (and Lehman Brothers), + "Why can’t we make them + +On line 4781: + risk1" According to + Halloran, Sirri said the + SEC’s job was not to + + tell the banks how to + run their companies but to + protect their customers’ + + assets.23 "TURN INTO + A DEATH SPIRAL" In August, + after the rating + +On line 4785: + revised their outlook + on Bear, Cayne tried to obtain + lines of credit from + + Citigroup and JP + Morgan. Both banks acknowledged + Bear had always been + +On line 4785: + customer and maintained + they were interested in + helping.24 "We wanted + +On line 4785: + be belts-and-suspenders," + said CFO Samuel Molinaro, as Bear + attempted both to + +On line 4785: + money market funds. + But, Cayne told the FCIC, nothing + happened. "Why the [large] + +On line 4785: + to participate + and provide lines during that + period of time, + +On line 4787: + traditionally + seen as a riskier lifeline + than repo. Throughout + +On line 4787: + commercial paper + (from billion at the end of + to only billion + +On line 4787: + and replaced it with + secured repo borrowing + (which rose from billion + +On line 4787: + billion). But Bear Stearns’s + growing dependence on overnight + repo would create + + a different set + of problems. The tri-party + repo market used + +On line 4791: + escrow; and then lend + their own cash to borrowers + during the day. This + +On line 4791: + to as "unwinding" + the repo transaction; it + allows borrowers + +On line 4791: + the assets posted + as collateral every + day. The transaction + + is then "rewound" at + the end of the day, when the + lenders post cash to the + +On line 4793: + banks in return for + the new collateral. The + little-regulated + +On line 4793: + grown from billion in + average daily volume + in to trillion in + +On line 4793: + in and trillion by + early It had become a + very deep and liquid + +On line 4793: + most borrowers rolled + repo overnight, it was also + considered a very + +On line 4793: + because transactions + were overcollateralized + (loans were made for less + +On line 4793: + the general view + before the onset of the + financial crisis. + +On line 4795: + tri-party repo + borrowing, it became more + dependent on JP + + Morgan, the clearing + bank. A risk that was little + appreciated + +On line 4797: + before was that JP + Morgan and BNY Mellon could + face large losses if + +On line 4797: + defaulted during + the day. Essentially, JP + Morgan served as Bear’s + + daytime repo lender. + Even long-term repo loans have to + be unwound every + +On line 4799: + clearing bank, if not + by the lender. Seth Carpenter, + an officer at + +On line 4799: + Reserve Board, compared + it to a mortgage that has + to be refinanced + + every week: "Imagine + that your mortgage is only + a week. Instead of + +On line 4799: + got a one-week mortgage. + If everything’s going fine, + you get to the end + + of the week, you go + out and you refinance that + mortgage because you + +On line 4799: + have enough cash on hand + to pay off the whole mortgage. + And then you get to + +On line 4801: + end of another + week and you refinance that + mortgage. And that’s, for + +On line 4803: + fall, Federated + Investors, which had taken Bear + Stearns off its list of + +On line 4803: + commercial paper + counterparties, continued + to provide secured + +On line 4803: + another major + lender, limited its overall + exposure to Bear, + +On line 4803: + maturities.30 In + October, State Street Global + Advisors refused + +On line 4807: + were mortgage-related + securities and of these, + billion—more than Bear’s + +On line 4809: + Level assets. In + the fourth quarter of Bear Stearns + reported its first + +On line 4813: + The SEC concluded, + "Bear Stearns’ liquidity pool + remains stable."32 In + +On line 4813: + board had commissioned + the consultant Oliver Wyman + to review the firm’s + +On line 4813: + Case for Economic + Capital Development," + was presented on + +On line 4813: + February to the + management committee. Among + its conclusions: risk + +On line 4813: + not effectively + positioned to challenge front + office decisions," + +On line 4813: + and considered a + "low priority." Schwartz told + the FCIC the findings + + did not indicate + substantial deficiencies. + He wasn’t looking + +On line 4815: + positive feedback + from the consultants, because + the Wyman re-MARCH port was + +On line 4815: + to provide a road + map of what "the gold standard" + in risk management + +On line 4817: + January before + the report was completed, + Cayne resigned as CEO, + +On line 4817: + after receiving + million in compensation + from through He remained + +On line 4817: + chairman of the board. + Some senior executives + sharply criticized him + +On line 4817: + the board. Thomas Marano + told the FCIC that Cayne played a + lot of golf and bridge.35 + +On line 4817: + board, Paul Friedman, a + former senior managing + director at Bear + +On line 4817: + said, "I guess because + I’d never worked at a firm + with a real board, + + it never dawned on + me that at some point somebody + would have or should have + +On line 4817: + the board involved in + all of this," although he told + the FCIC that he made + + these comments in anger + and frustration in the wake + of Bear’s failure.36 In + +On line 4817: + final report on + Bear, the Corporate Library, + which researches and + +On line 4817: + company a "D," + reflecting "a high degree + of governance risk" + +On line 4817: + levels of concern + related to the board and + compensation."37 When + + asked if he had made + mistakes while at Bear Stearns, Cayne + told the FCIC, "I take + +On line 4819: + to walk away from the + responsibility."38 At + Bear, compensation + + was based largely on + the return on equity + in a given year. + +On line 4821: + executives, about + half of each bonus was paid in + cash, and about half in + + restricted stock that + vested over three years and had + to be held for five.39 + +On line 4821: + for the size of each + year’s compensation pool was + determined by a + +On line 4821: + plan and capital + accumulation plan for + senior managing + +On line 4821: + told the FCIC he set + his own compensation and + the compensation + +On line 4821: + five members of the + Executive Committee. + According to Cayne, + +On line 4823: + including the board, + questioned his decisions.40 For + even with its losses, + +On line 4823: + Bear Stearns paid out of + revenues in compensation. + Alix, who sat on + + the Compensation + Committee, told FCIC staff the + firm typically + +On line 4823: + that the percentage + increased in because revenues + fell—if management + +On line 4823: + proportionately, + he said, many employees might + have quit.41 Base salaries for + +On line 4823: + senior managers were + capped at with the remainder + of compensation + +On line 4825: + a discretionary mix + of cash, restricted stock, and + options.42 From through the + +On line 4827: + at Bear Stearns took home + over million in cash and over + billion from stock sales, + +On line 4829: + than a total of + billion. This exceeded the + annual budget + + for the SEC.43 Alan Schwartz, + who took over as CEO after + Cayne and had been a + +On line 4829: + of investing in + the mortgage sector, earned more + than million from to + +On line 4829: + Warren Spector, the + co-president responsible + for overseeing the + +On line 4829: + had failed, received more + than million during the same + period. Although + +On line 4829: + asked to resign, Bear + never asked him to return + any money. In Cayne, + +On line 4829: + Schwartz, and Spector each + earned more than times as much as + Alix, the chief risk + + officer.44 Cayne was + out, Schwartz was in, and Bear Stearns + continued hanging + +On line 4833: + in early Bear was + still able to fund its balance + sheet through repo loans, + + though the interest + rates the firm had to pay had + increased.45 Marano said + +On line 4833: + this increased cost would + signal to the market that + Bear was distressed, which + + could "make our problems + turn into a death spiral."46 + DUTY TO PROTECT + +On line 4835: + Treasurer Upton + reported an internal + accounting error + +On line 4835: + have less than billion + in liquidity—triggering + a report to the + +On line 4835: + the error, the SEC + reinstituted daily + reporting by the + +On line 4837: + its liquidity.47 + Lenders and customers were more and + more reluctant to + +On line 4837: + do business with the + company. On February + Bear Stearns had billion + + in mortgages, mortgage-backed + securities, and asset-backed + securities on + +On line 4837: + almost billion from + November. Nearly billion + were subprime or Alt-A + +On line 4839: + that were clients of Bear’s + prime brokerage services were + particularly + +On line 4839: + unable to return + their cash and securities. + Lou Lebedin, the head + +On line 4839: + Bear’s prime brokerage, + told the FCIC that hedge fund clients + occasionally + + inquired about the bank’s + financial condition in + the latter half of + +On line 4839: + that such inquiries picked + up at the beginning of + particularly + +On line 4839: + the cost increased of + purchasing credit default + swap protection on + +On line 4839: + started taking their + business elsewhere. "They felt there + were too many concerns + +On line 4839: + us and felt that this + was a short-term move," Lebedin + said. "Often they would + +On line 4839: + they’d be happy to + bring the business back, but that + they had the duty + +On line 4839: + protect their investors." + Renaissance Technologies, one + of Bear’s biggest prime + +On line 4839: + of its business. By + April, Lebedin’s prime brokerage + operation would + +On line 4839: + billion in assets + under management, down more + than from billion in + +On line 4841: + during the week of + March when SEC staff inspected + Bear’s liquidity + +On line 4843: + liquidity pool + ranged from billion to billion.49 + Bear opened for business + +On line 4843: + on Monday, March with + approximately billion + in cash reserves. The + +On line 4843: + downgraded mortgage-backed + securities issued by + Bear Stearns Alt-A Trust, a + +On line 4843: + the downgrades carried + abbreviated headlines + stating, "Moody’s Downgrades + +On line 4843: + said.50 Rumors flew and + counterparties panicked.51 Bear’s + liquidity pool + + began to dry up, + and the SEC was now concerned + that Bear was being + +On line 4843: + all directions.52 While + "everything rolled" during the + day—that is, Bear’s repo + + lenders renewed their commitments—SEC + officials worried that this + would "probably not + +On line 4847: + Fed announced it would + lend to investment banks and + other "primary + +On line 4847: + Term Securities + Lending Facility (TSLF) + would make available up + +On line 4847: + billion in Treasury + securities, accepting + as collateral + +On line 4849: + and non-GSE mortgage–backed + securities rated triple-A. + The hope was that lenders + +On line 4849: + lend to investment + banks if the collateral + was Treasuries rather than + +On line 4849: + securities. The + Fed also announced it would + extend loans from overnight + +On line 4851: + the relentless need + to unwind repos every + morning. With the TSLF, + +On line 4851: + would be setting a + new precedent by extending + emergency credit + +On line 4851: + under section of + the Federal Reserve Act + to determine that + +On line 4851: + were "unusual and + exigent circumstances." The + Fed had not invoked + +On line 4853: + authority since + the Great Depression; it was + the Fed’s first use of + + the authority + since Congress had expanded + the language of the + +On line 4853: + to allow the Fed + to lend to investment banks.54 + The Fed was taking + +On line 4853: + unusual step of + declaring its willingness to + soon open its checkbook + +On line 4855: + and whose financial + condition it had never + examined. But the + +On line 4855: + Fed would not launch the + TSLF until March more than two + weeks later—and it was + + not clear that Bear could + last that long. The following + day, Jim Embersit + +On line 4855: + Reserve Board checked on + Bear’s liquidity with the + SEC. The SEC said Bear + +On line 4855: + billion in cash—down + from about billion at the start + of the week—and was able + +On line 4855: + "The SEC indicates + that no notable losses have + been sustained and that + +On line 4857: + position of the + firm is ‘fine.’"55 Derivatives + counterparties were + +On line 4857: + be exposed to Bear. + In some cases they unwound + trades in which they faced + +On line 4857: + in others they made + margin or collateral + calls.56 In Bear’s last few + +On line 4857: + had substantially + increased its exposure to + derivatives. At + +On line 4857: + year Bear had trillion + in notional exposure + on derivatives + +On line 4857: + contracts, compared with + trillion at fiscal year-end and + trillion at the end + +On line 4859: + of Derivatives + counterparties who worried + about Bear’s ability + +On line 4859: + their payments could get + out of their derivative + positions with Bear + +On line 4859: + Assignments allow + counterparties to assign + their positions to + + someone else: if firm + X has a derivatives + contract with firm Y, + +On line 4859: + firm X can assign + its position to firm Z, + so that Z now is + +On line 4861: + counterparties to + get out of their exposure + to each other, but + + by bringing in a + third party: instead of X + facing Y, X faces + +On line 4861: + Y. Both assignments + and novations are routine + transactions on Wall + +On line 4861: + on Tuesday, Brian + Peters of the New York Fed + advised Eichner + + at the SEC that the + New York Fed was "seeing some + HFs [hedge funds] wishing + +On line 4863: + assign trades the clients + had done with Bear to other + CPs [counterparties] + + so that Bear ‘steps out.’"57 + Counterparties did not want + to have Bear Stearns as + +On line 4865: + more. Bear Stearns also + encountered difficulties + stepping into trades. + + Hayman Capital + Partners, a hedge fund in Texas + wanting to decrease + +On line 4865: + to subprime mortgages, + had decided to close out + a relatively + +On line 4865: + small million subprime + derivative position + with Goldman Sachs. Bear + +On line 4865: + best bid, so Hayman + expected to assign its + position to Bear, + + which would then become + Goldman’s counterparty in + the derivative. + +On line 4865: + Hayman notified + Goldman by a routine email + on Tuesday, March at + +On line 4867: + The reply minutes + later was unexpected: + "GS does not consent + +On line 4869: + this trade."58 hat startled + Kyle Bass, Hayman’s managing + partner. He told the + +On line 4869: + next morning offered + no details: "Our trading desk + would prefer to stay + +On line 4869: + not want to face Bear."60 + Adding to the mystery, minutes + later Goldman agreed + +On line 4869: + accept Bear Sterns as + the counterparty after + all.61 But the damage + +On line 4869: + The news hit the street + that Goldman had refused a + routine transaction + +On line 4869: + one of the other + big five investment banks. The + message: don’t rely + +On line 4871: + CEO Alan Schwartz hoped an + appearance on CNBC would + reassure markets. + +On line 4873: + about this incident, + Schwartz said he had no knowledge + of such a refusal + +On line 4873: + Cox told reporters his + agency was monitoring + capital levels + +On line 4875: + Bear Stearns and other + securities firms "on a + constant basis" and + + has "a good deal of + comfort about the capital + cushions at these firms + +On line 4877: + moment."63 Still, the run + on Bear accelerated. + Many investors believed + + the Fed’s announcement + about its new loan program was + directed at Bear + + Stearns, and they worried + about the facility’s not + being available for + +On line 4877: + weeks. On Wednesday, March + the SEC noted that Bear paid + another billion + +On line 4879: + Repo lenders who had + already tightened the terms for + their contracts over the + +On line 4879: + or five months shortened + the leash again, demanding more + collateral from + +On line 4881: + evening, Bear’s ability + to borrow in the repo + market was drying + +On line 4881: + important money + funds, including Fidelity + and Mellon, had told + + Bear after the close + of business Wednesday they "might + be hesitant to + +On line 4881: + The SEC said that though + they believed the amounts were "very + manageable (between + +On line 4881: + the withdrawals would not + send a helpful signal to + the market.67 But the + +On line 4881: + moot. Schwartz called New York + Fed President Timothy + Geithner that + +On line 4883: + event that some repo + lenders did pull away.68 Upton, the + treasurer, said that + + before that week, he + had never worried about the + disappearance of + +On line 4883: + lending. By Thursday, + he believed the end was near.69 + Bear executives + + informed the board that + the rumors were dissuading + counterparties from + +On line 4883: + calls, that billion in + repo was not going to + roll over, and that "there + + was a reasonable + chance that there would not be enough + cash to meet [Bear’s] needs."70 + + Some repo lenders were + already so averse to Bear that + they stopped lending to + +On line 4883: + FCIC.71 Derivatives + counterparties continued + to run from Bear. By + +On line 4885: + liquidity had + dwindled to a mere billion + (see figure Bear had + +On line 4885: + Executives and + regulators continued + to believe the firm + +On line 4885: + however. Former + SEC Chairman Cox testified + before the FCIC, "At + +On line 4885: + all times during the + week of March to up to and + including the time + +On line 4885: + to be acquired by + JP Morgan, Bear Stearns had a + capital cushion + +On line 4887: + what is required."72 "THE + GOVERNMENT WOULD NOT PERMIT + A HIGHER NUMBER" + +On line 4889: + On Thursday evening, March + Bear Stearns informed the SEC that + it would be "unable + +On line 4889: + on Friday."73 CEO Alan + Schwartz called JP Morgan CEO Jamie + Dimon to request + +On line 4889: + billion credit line. + Dimon turned him down,74 citing, + according to Schwartz, + +On line 4889: + own significant + exposure to the mortgage + market. Because Bear + +On line 4889: + of mortgage assets, + JP Morgan would not render + assistance without + + government support. + Schwartz spoke with Geithner + again. Schwartz insisted + +On line 4889: + liquidity, not + insufficient capital. + A series of calls + + between Schwartz, Dimon, + Geithner, and Treasury + Secretary Henry + + Paulson followed.75 To + address Bear’s liquidity + needs, the New York Fed + +On line 4889: + made a billion loan + to Bear Stearns through JP Morgan + on the morning of + +On line 4891: + Friday, March Standard + Poor’s lowered Bear’s rating three + levels to BBB. Moody’s + +On line 4891: + also downgraded + the company. By the end + of the day, Bear was + +On line 4893: + Its stock plummeted + closing below The markets + evidently viewed + +On line 4893: + sign of terminal + weakness. After markets closed + on Friday, Paulson + +On line 4893: + CEO Schwartz that the Fed + loan to JP Morgan would not + be available after + + the weekend. Without + that loan, Bear could not conduct + business. In fact, Bear + +On line 4893: + to find a buyer + before the Asian markets opened + Sunday night or the + + game would be over.76 Schwartz, + olinaro, Alix, and others + spent the weekend in + + due diligence meetings + with JP Morgan and other + potential buyers, + +On line 4897: + JP Morgan was the + only candidate with the + size and stature to make + +On line 4899: + within hours.77 As Bear + Stearns’s clearing bank for repo + trades, JP Morgan held + +On line 4899: + of Bear Stearns’s assets + as collateral and had + been assessing their + +On line 4901: + let JP Morgan move + more quickly. On Sunday, March + JP Morgan informed + +On line 4901: + Fed and the Treasury + that it was interested + in a deal if it + +On line 4901: + finding "unusual + and exigent circumstances" + as required under + +On line 4901: + Federal Reserve + Act, agreed to purchase billion + of Bear’s assets to + + get them off the firm’s + books through a new entity + called Maiden Lane LLC + +On line 4903: + other assets, and + hedges from Bear’s mortgage trading + desk—would be under New + + York Fed management. + To finance the purchases, + JP Morgan made a + +On line 4903: + subordinated + loan and the New York Fed lent + billion. Because of + +On line 4903: + loan, JP Morgan bore + the risk of the first billion + of losses; the Fed + +On line 4903: + any further losses + up to billion.80 The Fed’s loan + would be repaid as + + Maiden Lane sold the + collateral. On Sunday + night, with Maiden Lane + +On line 4905: + in place, JP Morgan + publicly announced a deal to + buy Bear Stearns for a + +On line 4905: + of Bear’s board meeting + indicate that JP Morgan + had considered but + +On line 4905: + it to "because the + government would not permit + a higher number. + +On line 4905: + Fed and the Treasury + Department would not support + a transaction where + +On line 4905: + equity holders + received any significant + consideration + + because of the ‘moral + hazard’ of the federal + government using + + taxpayer money + to ‘bail out’ the investment + bank’s stockholders."81 Eight + +On line 4907: + days later, on March + Bear Stearns and JP Morgan agreed + to increase the price + +On line 4907: + of the financial + institutions mergers and + acquisitions group + +On line 4907: + JP Morgan, told the + FCIC they increased the price to + make Bear shareholders’ + +On line 4907: + more likely.82 Bear CEO + Schwartz told the FCIC the increase + let Bear preserve the + +On line 4907: + extent possible + under the circumstances for + our shareholders, our + +On line 4911: + employees, and our + creditors."83 "IT WAS HEADING + TO A BLACK HOLE" The + +On line 4911: + and Eichner were + as stunned as everyone else + by the speed of Bear’s + +On line 4911: + Macchiaroli had had doubts + as far back as August, he + told the FCIC, but he + +On line 4911: + expected Bear would + be able to fund itself through + the repo market, + + albeit at higher + margins.84 Fed Chairman Ben Bernanke + later called the Bear + +On line 4913: + Stearns decision the + toughest of the financial + crisis. The trillion + +On line 4913: + repo market had + "really [begun] to break + down," Bernanke said. "As the + + fear increased," short-term + lenders began demanding more + collateral, "which + + was making it more + and more difficult for the + financial firms to + +On line 4913: + creating more and + more liquidity pressure + on MARCH them. And, it + + was heading sort of + to a black hole." He saw the + collapse of Bear Stearns + + as threatening to + freeze the tri-party repo + market, leaving the + +On line 4913: + with collateral + they would try to "dump on the + market. You would have + +On line 4915: + big crunch in asset + prices."85 "Bear Stearns, which is not that + big a firm, our view + +On line 4915: + important to save + it—you may disagree—but our + view was that because + +On line 4915: + so essentially + involved in this critical + repo financing + +On line 4915: + failure would have brought + down that market, which would have + had implications + + for other firms," Bernanke + told the FCIC.86 Geithner + explained the need for + +On line 4919: + acquisition by + JP Morgan as follows: "The + sudden discovery + +On line 4919: + to protect themselves + from financial risk were no + longer operative + +On line 4919: + triggered substantial + further dislocation in + markets. This would have + +On line 4919: + to liquidate the + collateral they held against + those positions and + +On line 4919: + attempt to replicate + those positions in already + very fragile markets."87 + +On line 4921: + FCIC that Bear had both + a liquidity problem + and a capital + + problem. "Could you just + imagine the mess we would have + had1 If Bear had gone + + there were hundreds, maybe + thousands of counterparties + that all would have grabbed + +On line 4921: + collateral, would + have started trying to sell + their collateral, + +On line 4921: + was huge fear about the + investment banking model + at that time." Paulson + +On line 4921: + if Bear had filed for + bankruptcy, "you would have had + Lehman going almost + + immediately + if Bear had gone, and just the + whole process would have just + + started earlier."88 + The Commission concludes the + failure of Bear Stearns + +On line 4923: + by its exposure + to risky mortgage assets, its + reliance on short-term + + funding, and its high + leverage. These were a result + of weak corporate + +On line 4923: + largely on return + on equity, creating + incentives to use + +On line 4925: + on short-term gains such + as annual growth goals. Bear + experienced runs + +On line 4925: + repo lenders, hedge fund + customers, and derivatives + counterparties and + +On line 4925: + considered it too + interconnected to fail. + Bear’s failure was in + +On line 4925: + the Securities + and Exchange Commission, which + did not restrict its + +On line 4925: + activities and + which allowed undue leverage + and insufficient + +On line 4939: + RISK CONCERNS CONTENTS + The Federal Reserve: "When + people got scared".................................................293 JP + +On line 4945: + stages of assessing + the potential systemic risk" + Banks: "The markets were + +On line 4947: + catastrophe—for the + time being. The Federal + Reserve had found new + + ways to lend cash to + the financial system, and + some investors and lenders + +On line 4947: + extraordinary + government intervention. + Investors began to + +On line 4947: + recession and more + about inflation, as the price + of oil continued + +On line 4949: + rise (hitting almost + per barrel in July). At + the beginning of + +On line 4951: + the stock market had + fallen almost from its peak + in the fall of Then, + +On line 4953: + in May the Dow Jones + climbed to within of the record + set in October + +On line 4953: + the prices of credit + default swaps—declined from the + highs of March and April. + +On line 4953: + hindsight, the markets + were surprisingly stable + and almost seemed to + +On line 4953: + a month after Bear + Stearns, leading all the way up + to September," said + +On line 4953: + Stanley’s treasurer.1 + Taking advantage of the + brief respite in investor + +On line 4953: + top ten American + banks and the four remaining + big investment banks, + +On line 4953: + just under billion + and billion, respectively, + in new equity + + by the end of June. + Despite this good news, bankers and + their regulators + + were haunted by the + speed of Bear Stearns’s demise. And they + knew that the other + +On line 4957: + in illiquid mortgage + securities and other + troubled assets. In + +On line 4957: + on Bear had exposed + the dangers of tri-party + repo agreements and + + the counterparty + risk caused by derivatives + contracts. And the word + +On line 4965: + on the street—despite + the assurances of Lehman CEO + Dick Fuld at MARCH TO + +On line 4965: + shareholder meeting + that "the worst is behind us"2—was + that Bear would not be + + the only failure. + THE FEDERAL RESERVE: "WHEN + PEOPLE GOT SCARED" The + +On line 4971: + potential failure + of the repo market—a + market that "grew very, + +On line 4971: + purview of it," former + Treasury Secretary Henry + Paulson would tell the + +On line 4971: + safe and durable source of + collateralized short-term + financing. It was + +On line 4971: + that Bear had shifted + approximately billion + of its unsecured + +On line 4971: + now it was clear that + repo funding could be just + as vulnerable + +On line 4973: + runs as were other + forms of short-term financing. + The repo runs of + +On line 4973: + devastated hedge + funds such as the two Bear Stearns + Asset Management + +On line 4973: + originators such + as Countrywide, had seized the + attention of the + +On line 4973: + participants and + regulators now better + appreciated + + how the quality + of repo collateral + had shifted over time + +On line 4975: + and Freddie Mac to + highly rated non-GSE mortgage– + backed securities + +On line 4975: + before the crisis, + this riskier collateral + accounted for as + +On line 4975: + April the Bankruptcy + Abuse Prevention and Consumer + Protection Act of + +On line 4975: + dramatically + expanded protections for + repo lenders holding + +On line 4975: + securities, that + was riskier than government + or highly rated + +On line 4975: + These protections gave + lenders confidence that they had + clear, immediate + +On line 4975: + declare bankruptcy. + Nonetheless, Jamie Dimon, the + CEO of JP Morgan, + +On line 4975: + the FCIC, "When people + got scared, they wouldn’t finance + the nonstandard stuff + +On line 4977: + ensure access to + the repo market. Repo + lenders cared just as much + + about the financial + health of the borrower as + about the quality + +On line 4977: + borrowers.7 Despite + the bankruptcy provisions + in the act, lenders were + +On line 4977: + risk the hassle of + seizing collateral, even + good collateral, + +On line 4979: + borrower. Steven Meier + of State Street testified to + the FCIC: "I would say + + the counterparties + are a first line of defense, + and we don’t want to + +On line 4979: + uncomfortable process + of having to liquidate + collateral."8 William + + Dudley of the New + York Fed told the FCIC, "At the + first sign of trouble, + +On line 4981: + tri-party repo + tend to run rather than take the + collateral that + +On line 4981: + So high-quality + collateral itself is + not sufficient when + +On line 4983: + an institution + gets in trouble."9 Moreover, if + a borrower in + +On line 4983: + funds—frequent lenders in + this market—may have to seize + collateral that + +On line 4983: + cannot legally own. + For example, a money + market fund cannot + +On line 4983: + Typically, if + a fund takes possession of + such collateral, + +On line 4983: + the securities + immediately, even—as + was the case during + +On line 4983: + crisis—into a + declining market. As a + result, funds simply + +On line 4983: + securities. In + the crisis, investors didn’t + consider secured + +On line 4983: + to be much better + than unsecured, according + to Darryll Hendricks, + +On line 4983: + and global head of + risk methodology at UBS, + as well as the head + +On line 4983: + private-sector task + force on the repo market + organized by the + +On line 4985: + noted, the Fed had + announced a new program, the + Term Securities + +On line 4985: + Facility (TSLF), + on the Tuesday before Bear’s + collapse, but it would + +On line 4985: + available until March + The TSLF would lend a total + of up to billion + +On line 4985: + affiliates of + the large commercial banks and + investment banks that + +On line 4985: + with the New York Fed, + such as Citigroup, Morgan + Stanley, or Merrill + +On line 4985: + return for Treasuries. + The primary dealers could + then use those Treasuries + +On line 4985: + collateral to + borrow cash in the repo + market. Like the Term + +On line 4985: + earlier, the TSLF + would run as a regular + auction to reduce + +On line 4985: + However, after + Bear’s collapse, Fed officials + recognized that the + + situation called + for a program that could be + up and running right + +On line 4987: + And they concluded + that the TSLF alone would not be + enough. So, the Fed would + + create another + program first. On the Sunday + of Bear’s collapse, the + +On line 4987: + cash, not Treasuries, to + investment banks and other + primary dealers + +On line 4987: + institutions—banks + and thrifts—received through the Fed’s + discount window. The + +On line 4987: + came "just about minutes" + too late for Bear, Jimmy Cayne, + its former CEO, told + +On line 4989: + the FCIC.11 Unlike the + TSLF, which would offer Treasuries + for days, the PDCF + +On line 4989: + loans in exchange for + collateral. In effect, + this program could serve + +On line 4989: + alternative to + the overnight tri-party repo + lenders, potentially + + providing hundreds + of billions of dollars of + credit. "So the idea + +On line 4989: + then was anything that + the dealer couldn’t finance—the + securities that + +On line 4989: + the discount window—if + they couldn’t get financing + in the market, they + + could get financing + from the Federal Reserve," + said Seth Carpenter, + +On line 4989: + the Division of + Monetary Affairs at the + Federal Reserve + +On line 4989: + way, you don’t have to + worry. And by providing + that support, other + +On line 4991: + that they’re going to + be able to get their money + back the next day."12 By + +On line 4991: + Reserve’s discount rate + and adding additional fees + for regular use, + +On line 4991: + Federal Reserve + encouraged dealers to use + the PDCF only + +On line 4991: + In its first week of + operation, this program + immediately + +On line 4991: + in cash to Bear Stearns + (as bridge financing until + the JP Morgan deal + +On line 4993: + of Citigroup, among + others. However, as the + immediate post-Bear + +On line 4993: + TO AUGUST after + April and ceased completely by + late July.13 Because + + the dealers feared that + markets would see reliance on + the PDCF as an + +On line 4993: + severe distress, the + facility carried a + stigma similar + + to the Fed’s discount + window. "Paradoxically, + while the PDCF was + +On line 4993: + loss of confidence + in an investment bank, use + of the PDCF was + +On line 4993: + both within Lehman, and + possibly by the broader + market, as an event + + that could trigger a + loss of confidence," noted + the Lehman bankruptcy + +On line 4995: + examiner.14 On + May the Fed broadened the kinds + of collateral + +On line 4995: + to include other + triple-A-rated asset-backed securities, + such as auto and + + credit card loans. In + June, the Fed’s Dudley urged in + an internal email + +On line 4997: + at least through the end + of the year. "PDCF remains + critical to the + +On line 4997: + of the [investment + banks]," he wrote. "Amounts don’t matter + here, it is the fact + +On line 4999: + Fed extended both + programs through January JP + MORGAN: "REFUSING + +On line 5003: + TO UNWIND WOULD BE + UNFORGIVABLE" The repo + run on Bear also + +On line 5003: + repo clearing banks—JP + Morgan, the main clearing bank + for Lehman and Merrill + + Lynch, as it had been + for Bear Stearns, and BNY Mellon, + the main clearing bank + +On line 5005: + Stanley—to the risks + they were taking. Before Bear’s + collapse, the market + +On line 5005: + colossal exposures + that the tri-party repo + market created + +On line 5005: + explained earlier, + the "unwind/rewind" mechanism + could leave JP Morgan + +On line 5005: + enormous "intraday" + exposure—an interim + exposure, but no + + less real for its + brevity. In an interview + with the FCIC, Dimon + + said that he had not + become fully aware of the + risks stemming from his + +On line 5005: + tri-party repo + clearing business until the + Bear crisis in A + +On line 5005: + bank had two concerns: + First, if repo lenders abandoned + an investment bank, + + it could be pressured + into taking over the role + of the lenders. Second, + +On line 5005: + bank defaulted, it + could be stuck with unwanted + securities. "If + +On line 5005: + intraday, we own + the securities and we + have to liquidate + + them. That’s a huge risk + to us," Dimon explained.17 To + address those risks in + +On line 5007: + for the first time both + JP Morgan and BNY Mellon + started to demand + +On line 5009: + investment banks—be + overcollateralized. The + Fed increasingly + +On line 5009: + systemic risk posed by + the two repo clearing banks. + In the chain-reaction + +On line 5011: + that it envisioned, + if either JP Morgan or + BNY Mellon chose not + + to unwind its trades + one morning, the money funds + and other repo + +On line 5011: + billions of dollars + in repo collateral. + Those lenders would then be + + in the difficult + position of having to + sell off large amounts of + + collateral in + order to meet their own cash + needs, an action that + + in turn might lead to + widespread fire sales of repo + collateral and + +On line 5013: + by lenders.18 The PDCF + provided overnight funding, in + case money market + + funds and other epo + lenders refused to lend as they + had in the case of + +On line 5013: + it did not protect + against clearing banks’ refusing + exposure to an + +On line 5015: + bank during the day. + On July Fed officials + circulated a + +On line 5015: + the two clearing banks + would become unwilling or + unable to unwind + + its trades.19 The plan would + allow the Fed to provide + troubled investment + +On line 5015: + such as Lehman Brothers, + with billion in tri-party + repo financing + +On line 5015: + covering for JP + Morgan or BNY Mellon if + the two clearing banks + +On line 5015: + or could not provide + that level of financing.20 + Fed officials made + +On line 5015: + for the proposal + in an internal memo: "Should + a dealer lose the + + confidence of its + investors or clearing bank, their + efforts to pull away + +On line 5015: + providing credit + could be disastrous for the + firm and also cast + + widespread doubt about the + instrument as a nearly + risk free, liquid overnight + + investment."21 But the + New York Fed’s new plan shouldn’t + be necessary as + +On line 5017: + as the PDCF was + there to back up the overnight lenders, + argued Patrick Parkinson, + + then deputy director + of the Federal Reserve + Board’s Division of + +On line 5019: + and Statistics. "We + should tell [JP Morgan] that with + the PDCF in place + +On line 5019: + is unnecessary + and would be unforgiveable," + he emailed Dudley and + +On line 5021: + A week later, on + July Parkinson wrote to Fed + Governor Kevin Warsh + + and Fed General + Counsel Scott Alvarez that JP + Morgan, because of + + its clearing role, was + "likely to be the first to + realize that the + +On line 5023: + investors that provide + tri-party financing to + [Lehman Brothers] are pulling + +On line 5023: + in which a clearing + bank’s refusal to unwind would + lead to a widespread + +On line 5025: + facilitated + Bear’s acquisition by JPMC," + he said.23 Still, it was + +On line 5025: + dissuade JP Morgan + from refusing to unwind + Lehman’s repos, Parkinson + +On line 5025: + Lehman’s collateral + was ineligible to + be funded by the + + PDCF, and because + Lehman could fail during the day + (before the repos + +On line 5025: + settled), JP Morgan + still faced significant risks. + Parkinson noted that + +On line 5025: + even if the Fed lent + as much as billion to Lehman, + the sum might not be + + enough to ensure the + firm’s survival in the absence + of an acquirer: + +On line 5025: + counterparties to + stop providing funding to + Lehman, the company + + would fail.24 THE FED AND + THE SEC: "WEAK LIQUIDITY + POSITION" Among the + +On line 5029: + one key measure of + liquidity risk was the + portion of total + +On line 5029: + liabilities + that the firms funded through the + repo market: to + +On line 5031: + for Lehman and Merrill + Lynch, to for Morgan Stanley, + and about for Goldman + +On line 5031: + the reliance on overnight + repo (which mature in one + day) or open repo + +On line 5031: + be terminated + at any time). Despite efforts + among the investment + +On line 5031: + reduce the portion + of their repo financing + that was overnight or open, + +On line 5031: + open repo funding + to total repo funding + still exceeded for + + all but Goldman Sachs. + Comparing the period + between March and May + + to the period + between July and August, + Lehman’s percentage fell + +On line 5031: + MARCH TO AUGUST from + to Merrill Lynch’s fell from to + Morgan Stanley’s fell + +On line 5033: + and Goldman’s fell from + to Another measure of + risk was the haircuts + +On line 5033: + loans—that is, the amount of + excess collateral that + lenders demanded for + + a given loan. Fed + officials kept tabs on the + haircuts demanded + + of investment banks, + hedge funds, and other repo + borrowers. As Fed + +On line 5035: + later noted, "With + lenders worrying that they could + lose money on the + +On line 5035: + as collateral, + haircuts increased—doubling for + some agency mortgage + +On line 5035: + significantly + even for borrowers with high + credit ratings and + +On line 5037: + collateral such + as Treasury securities."27 + On the day of Bear’s + +On line 5037: + an effort to get + a better understanding + of the investment + + banks, the New York Fed + and the SEC sent teams to work + on-site at Lehman Brothers, + +On line 5037: + and Morgan Stanley. + According to Erik Sirri, + director of the + +On line 5039: + assets, funding, and + capital.28 Fed Chairman Ben + Bernanke would testify + +On line 5039: + a House committee + that the Fed’s primary role + at the investment + +On line 5039: + banks in was not as + a regulator but as + a lender through the new + +On line 5039: + analyses: First, was each + investment bank liquid—did + it have access to + + the cash needed to + meet its commitments1 Second, + was it solvent—was + +On line 5041: + U.S. Treasury also + dispatched so-called SWAT teams to + the investment banks + +On line 5041: + in the spring of The + arrival of officials from + the Treasury and the + +On line 5041: + SEC had never had. + Historically, the SEC’s + primary concern + + with the investment + banks had been liquidity + risk, because these firms + +On line 5041: + the credit markets + for funding.31 The SEC already + required these firms to + +On line 5041: + designed to ensure + that they had sufficient cash + available to sustain + + themselves on a stand-alone + basis for a minimum + of one year without + +On line 5041: + unsecured funding + and without having to sell + a substantial amount + +On line 5041: + the run on Bear in + the repo market, the SEC’s + liquidity stress + +On line 5041: + known as stress tests—had + not taken account of the + possibility + + that a firm would lose + access to secured funding. + According to the + +On line 5041: + SEC never thought that + a situation would arise + where an investment + +On line 5041: + by high-quality + collateral including + Treasuries. He told the + +On line 5041: + financial crisis + worsened, the SEC began to + see liquidity + + and funding risks as + the most critical for the + investment banks, and + +On line 5041: + commercial paper + and an extension of the + maturities of + +On line 5043: + loans.32 The Fed and the + SEC collaborated in + developing two + +On line 5043: + the investment banks’ + ability to withstand a + potential run or + +On line 5043: + systemwide disruption + in the repo market. The + stress scenarios, called + + "Bear Stearns" and "Bear Stearns + Light," were developed jointly + with the remaining + +On line 5043: + investment banks. In + May, Lehman, for example, would + be billion short of + +On line 5043: + in the more stringent + Bear Stearns scenario and billion + short under Bear Stearns + +On line 5045: + The Fed conducted + another liquidity + stress analysis in + + June. While each firm ran + ifferent scenarios that + matched its risk profile, + +On line 5045: + between the tests. The + tests assumed that each firm would + lose of unsecured + +On line 5045: + and a fraction of + repo funding that would vary + with the quality + +On line 5045: + Morgan Stanley were + relatively sound. Merrill + Lynch and Lehman Brothers + +On line 5045: + the two banks came out + billion and billion short of + cash, respectively; + +On line 5045: + each had only of + the liquidity it would + need under the stress + +On line 5047: + assets" and noted + that "Merrill’s liquidity + pool is low, a fact + +On line 5049: + does not acknowledge." + As for Lehman Brothers, the Fed + concluded that "Lehman’s + + weak liquidity + position is driven by + its relatively + +On line 5049: + exposure to overnight + [commercial paper], combined + with significant + +On line 5051: + "less liquid assets" + included mortgage-related + securities—now + + devalued. Meanwhile, + Lehman ran stress tests of its own + and passed with billions + +On line 5053: + Although the SEC and + the Fed worked together on + the liquidity + +On line 5053: + tests, with equal access + to the data, each agency + has said that for months + +On line 5053: + told the bankruptcy + examiner that the SEC + had declined to share + +On line 5053: + reviews of the banks’ + liquidity positions + and exposures to + + commercial real + estate. The SEC’s response was + that the documents + +On line 5053: + "draft" form and had not + been reviewed or finalized. + Adding to the tension, + +On line 5053: + or expertise to + adequately evaluate + the data.37 This lack + +On line 5053: + remedied only by + a formal memorandum + of understanding + +On line 5055: + former SEC Chairman + Christopher Cox, "One reason the + MOU was needed was + +On line 5055: + Fed was reluctant + to share supervisory + information with + +On line 5055: + SEC, out of concern + that the investment banks would + not be forthcoming + +On line 5057: + if they thought they would + be referred to the SEC for + enforcement."38 The MOU + +On line 5059: + the collapse of Bear + Stearns. DERIVATIVES: "EARLY + STAGES OF ASSESSING + +On line 5063: + Fed’s Parkinson advised + colleagues in an internal + August email that the + + systemic risks of the + repo and derivatives + markets demanded + + attention: "We have + given considerable thought + to what might be done + +On line 5063: + under existing + authority are not very + attractive—lots of risk + + to Fed/taxpayer, + lots of moral hazard.) We still + are at the early + +On line 5063: + risk from close-out of OTC + derivatives transactions + by an investment + +On line 5065: + and identifying + potential mitigants."39 The + repo market was + +On line 5065: + but as discussed in + earlier chapters, it was + dwarfed by the global + +On line 5065: + notional amount of + the over-the-counter derivatives + market was trillion + +On line 5067: + trillion (see figure + Adequate information + about the risks in this + +On line 5067: + participants or + government regulators + like the Federal + +On line 5067: + were not subject to + reporting or disclosure + requirements and no + +On line 5067: + agency had oversight + responsibility. While + the Office of the + +On line 5067: + of the Currency + did report information + on derivatives + +On line 5067: + from commercial banks + and bank holding companies, + it did not collect + +On line 5067: + investment banks and + insurance companies like + AIG, which were also + +On line 5067: + crisis the lack of + such basic information + created heightened + +On line 5069: + relationships that + derivatives created + among the small number + +On line 5069: + large financial firms + that act as dealers in the + OTC derivatives + +On line 5069: + parties, such that one + party may have to make large + and unexpected + +On line 5071: + to the other based + on sudden price or rate changes + or loan defaults. If + +On line 5071: + is unable to make + those payments when they become + due, that failure may + +On line 5071: + may have offsetting + obligations to third parties + and depend on prompt + + payment. Indeed, most + OTC derivatives dealers + hedge their contracts with + + offsetting contracts; + thus, if they are owed payments + on one contract, they + +On line 5071: + offsetting contract, + creating the potential + for a series of + +On line 5071: + these contracts numbered + in the millions and allowed + a party to have + +On line 5071: + of sudden large and + devastating losses in + this market could pose + +On line 5073: + The Counterparty + Risk Management Policy + Group, led by former + +On line 5073: + York Fed President + E. Gerald Corrigan + and consisting of + +On line 5073: + warned that a backlog + in paperwork confirming + derivatives trades + +On line 5073: + corporate defaults + occur.40 With urging from New + York Fed President + +On line 5073: + Geithner, by + September major market + participants had + + significantly + reduced the backlog and had + ended the practice + + of assigning trades + to third parties without the + prior consent of + +On line 5075: + counterparties.41 Large + derivatives positions, + and the resulting + +On line 5075: + and operational + risks, were concentrated in + a very few firms. Among + +On line 5075: + institutions held + enormous OTC derivatives + positions as of + +On line 5077: + in notional amount + for JP Morgan, trillion for + Bank of America, + +On line 5077: + Citigroup, trillion + for Wachovia, and trillion for + HSBC. Goldman Sachs + +On line 5077: + companies in held + and trillion, respectively, + in notional amount + +On line 5079: + of In the current + and potential exposure + to derivatives + + at the top five U.S. + bank holding companies was + on average three + +On line 5081: + was even higher at + the investment banks. Goldman + Sachs, just after it + +On line 5081: + concentrations of + positions in the hands of + the largest bank holding + +On line 5081: + and investment banks + posed risks for the financial + system because of + +On line 5083: + By the summer of + outstanding amounts of some types + of derivatives + +On line 5083: + begun to decline + sharply. As we will see, over the + course of the second + +On line 5085: + problems for hedging + and price discovery. The Fed + was uneasy in part + +On line 5085: + counterparties had + played an important role in + the run on Bear Stearns. + +On line 5085: + by derivatives + counterparties to assign + their positions away + +On line 5085: + rumored refusal by + Goldman to accept Bear as + a derivatives + + counterparty—were + still a fresh memory across + Wall Street. Chris Mewbourne, + +On line 5085: + told the FCIC that the + ability to novate ceased + to exist and this + + was a key event in + the demise of Bear Stearns.43 Credit + derivatives in + +On line 5087: + were a serious + source of worry. Of greatest + interest were the + +On line 5087: + of credit default + swaps: the monoline insurers + and AIG, which back-MARCH TO + +On line 5087: + everyone, because + they guaranteed hundreds of + billions of dollars + +On line 5087: + products. As we have + seen, when their credit ratings + were downgraded, the + +On line 5087: + of all the assets + they guaranteed, including + municipal bonds + +On line 5087: + the conservative + institutional investors + in those markets. In + + the vernacular + of Wall Street, this outcome is + the knock-on effect; + +On line 5087: + the domino effect; + in the vernacular of + the Fed, systemic risk. + +On line 5091: + BANKS: "THE MARKETS WERE + REALLY, REALLY DICEY" + By the fall of signs + +On line 5091: + were beginning to + emerge among the commercial banks. + In the fourth quarter + +On line 5093: + of commercial banks’ + earnings declined to a 16- + year low, driven by + + write-downs on mortgage-backed + securities and CDOs and + by record provisions + +On line 5093: + as borrowers had + increasing difficulty + meeting their mortgage + +On line 5093: + greater difficulty + was anticipated. The + net charge-off rate—the ratio + +On line 5095: + to total loans—rose + to its highest level since + when the economy + +On line 5095: + recession. Earnings + continued to decline in + 2008—at first, more for big + +On line 5095: + securities, CDOs, + and collateralized loan + obligations. Declines + +On line 5095: + values required banks + to write down the value of + their holdings of these + +On line 5095: + As previously + noted, several of the + largest banks had also + +On line 5095: + activities, such + as money market funds and + commercial paper + +On line 5097: + assets onto their + balance sheets— assets that were + losing value fast. + +On line 5097: + begun to downgrade + the ratings of many smaller + banks in response to + + their high exposures + in residential real + estate construction, + +On line 5097: + went out of business + as financing dried up in + mid-2007. By the end of + +On line 5099: + on its "problem list"; + their combined assets totaled + billion.44 (When large banks + +On line 5099: + to be downgraded, + in early they stayed off the + FDIC’s problem list, as + + supervisors rarely + give the largest institutions + the lowest ratings.)45 + +On line 5101: + mortgages that did not + meet Fannie Mae’s or Freddie + Mac’s underwriting + +On line 5101: + mortgage size guidelines) + had also vanished in the + fourth quarter of Not + +On line 5101: + these nonconforming + loans prove harder to sell, but + they also proved less + +On line 5101: + to keep on balance + sheet, as house price forecasts looked + increasingly grim. + +On line 5101: + house prices had fallen + about for the year, depending + on the measure. In + +On line 5101: + the first quarter of + real estate loans in the + banking sector showed + +On line 5101: + smallest quarterly + increase since IndyMac reported + a decline in loan + +On line 5101: + for that quarter from + a year earlier, because + it had stopped making + +On line 5101: + thrift, discontinued + all remaining lending through + its subprime mortgage + +On line 5103: + channel in April But + those actions could not reduce + the subprime and Alt-A + + exposure that these + arge banks and thrifts already had. + And on these assets, + +On line 5105: + the banks to raise new + capital. In January + Citigroup secured + +On line 5105: + in capital from + Kuwait, Sin-gapore, Saudi Prince + Alwaleed bin Talal, + +On line 5105: + In April, Washington + Mutual raised billion from + an investor group led + +On line 5105: + Capital. Wachovia + raised billion in capital + at the turn of the + +On line 5105: + an additional + billion in April Despite the + capital raises, + +On line 5107: + significant part + of this period, starting + with August Roger Cole, + +On line 5107: + of the Division + of Banking Supervision + and Regulation + + at the Federal + Reserve Board, told the FCIC.47 The + same was true for the + +On line 5107: + director in risk + management manager in + the Office of Thrift + +On line 5107: + particularly + small, midsized thrifts—to keep up + with [how quickly the + +On line 5107: + occurred during the + crisis] and change their business + models and not get + +On line 5107: + without the chair when + the music stopped They got caught. + The rating downgrades + + started and by the + time the thrift was able to do + something about it, it + +On line 5109: + was too late Business + models can’t keep up with what + we saw in As the + +On line 5109: + commercial banks’ health + worsened in examiners + downgraded even large + +On line 5109: + These ratings downgrades + and enforcement actions came + late in the day—often + +On line 5109: + investigated, + regulators either did + not identify the + + problems early enough + or did not act forcefully + enough to compel the + +On line 5113: + to come up with a + new playbook" For Citigroup, + supervisors at + + the New York Fed, who + examined the bank holding + company, and at + +On line 5113: + the Comptroller of + the Currency, who oversaw + the national bank + + subsidiary, finally + downgraded the company + and its main bank to + +On line 5113: + satisfactory" + in April 2008—five months after the + firm’s announcement in + +On line 5113: + billions of dollars + in write-downs related to + its mortgage-related + +On line 5113: + supervisors put + the company under new + enforcement actions + +On line 5113: + May and June. Only + a year earlier, both the + Fed and the OCC had + +On line 5113: + after lifting all + remaining restrictions and + enforcement actions + +On line 5113: + transactions that it + had structured for Enron and + to the actions of + +On line 5113: + subsidiary CitiFinancial, discussed + in an earlier chapter. + "The risk management + +On line 5113: + assessment for is + reflective of a control + environment where + +On line 5113: + in its annual + inspection report on April + had noted. "During + +On line 5113: + were lifted. Board and + senior management remain + actively engaged + +On line 5115: + supervisors. In + November MARCH TO AUGUST + the New York Fed led + +On line 5115: + international + supervisors, the Senior + Supervisors Group, + +On line 5115: + largest firms to assess + lessons learned from the financial + crisis up to that + +On line 5117: + the toughest language + was reserved for Citigroup. + "The firm did not have + +On line 5117: + management. "Stress tests + were not designed for this type + of extreme market + +On line 5117: + that CDOs and leveraged + loans would be syndicated, + and that the credit + +On line 5119: + was negligible."50 + In retrospect, Citigroup + had two key problems: + +On line 5119: + risks and a lack of + proper infrastructure and + internal controls + +On line 5119: + to the creation of + CDOs. The OCC appears to have + identified some of + +On line 5119: + as early as but + did not effectively act + to rectify them. + +On line 5121: + OCC assessed both the + liquidity puts and the + super-senior tranches + +On line 5121: + part of its reviews + of the bank’s compliance with + the post-Enron enforcement + + action, but it did + not examine the risks of + these exposures. As + +On line 5121: + it did spot, the OCC + failed to take forceful steps to + require mandatory + +On line 5121: + assurances in that + the executives would strive + to meet the OCC’s goals + +On line 5123: + risk management. In + contrast, documents obtained + by the FCIC from the + +On line 5123: + examination + staff had any independent + knowledge of those two + +On line 5123: + Fed’s supervision + of Citigroup, conducted + by examiners + +On line 5123: + Banks (the December + Operations Review of + the New York Fed, which + +On line 5123: + four years), concluded: + The supervision program + for Citigroup has + +On line 5123: + less than effective. + Although the dedicated + supervisory + +On line 5123: + sound knowledge of the + organization, there have + been significant + +On line 5123: + the execution + of the supervisory + program. The team has + +On line 5123: + firm, as evidenced + by the double downgrades in + the firm’s financial + +On line 5123: + subcomponents at + year-end Additionally, the + supervisory + + program has lacked the + appropriate level of + focus on the firm’s + +On line 5123: + a result, there is + currently significant + work to be done in + +On line 5123: + areas. Moreover, the + team has lacked a disciplined + and proactive approach + +On line 5125: + issues.51 Timothy + Geithner, secretary + of the Treasury and + +On line 5125: + president of the + Federal Reserve Bank of + New York, reflected + +On line 5125: + of Citigroup, telling + the Commission, "I do not + think we did enough as + + an institution + with the authority we + had to help contain + +On line 5127: + that ultimately + emerged in that institution."52 + In January an + + OCC review of the + breakdown in the CDO business + noted that the risk + +On line 5127: + in the unit had grown + rapidly since after the OCC’s + and Fed’s ifting of + +On line 5127: + various control + problems at Citigroup. In + April the Fed and OCC + +On line 5127: + their overall ratings + of the company and its + largest bank subsidiary from + +On line 5127: + satisfactory), + reflecting weaknesses in + risk management that + +On line 5129: + now apparent to + the supervisors. Both Fed + and OCC officials + +On line 5129: + cited the Gramm-Leach-Bliley Act + of as an obstacle that + prevented each from + +On line 5129: + of the risks assumed + by large financial firms such + as Citigroup. The + +On line 5131: + it more difficult— + though not impossible—for + regulators to + +On line 5131: + direct purview into + other areas of a large + firm. Citigroup, for + +On line 5133: + from the Fed, OCC, SEC, + OTS, and state agencies. In May + and June Citigroup + +On line 5133: + memoranda of + understanding with both the + New York Fed and OCC + +On line 5133: + to resolve the risk + management weaknesses that + the events of had laid + +On line 5133: + the ensuing months, + Fed and OCC officials said, + they were satisfied + +On line 5133: + compliance with their + recommendations. Indeed, + in speaking to the + +On line 5133: + Manzari, the senior + relationship manager + for Citigroup at + +On line 5133: + York Fed from April to + September complimented + Citigroup on its + +On line 5133: + management, raising + capital from investors in + late and putting in place + + a number of much + needed "internal fixes." + However, Manzari + +On line 5133: + on, "Citi was trapped in + what was a pretty vicious + systemic event," and for + + regulators "it + was time to come up with a + new playbook."53 Wachovia: + +On line 5135: + West acquisition + was a mistake" At Wachovia, + which was supervised + +On line 5135: + as well as the OTS + and the Federal Reserve, + a end-of-year report showed + + that credit losses + in its subsidiary Golden West’s + portfolio of "Pick-a-Pay" + +On line 5135: + adjustable-rate mortgages, or + option ARMs, were expected + to rise to about of + +On line 5135: + portfolio for in + losses in this portfolio + had been less than It + +On line 5137: + would soon become clear + that the higher estimate + for was not high enough. + + The company would + hike its estimate of the + eventual losses + +On line 5139: + to by June and to% + by September. Facing these + and other growing + + concerns, Wachovia raised + additional capital. + Then, in April, Wachovia + +On line 5141: + a loss of million + for the first three months of the + year. Depositors + +On line 5141: + terms, increasing rates, + and reducing loan amounts.54 By + June, according to + +On line 5141: + management had launched + a liquidity crisis + management plan in + +On line 5141: + more adverse market + reaction to second-quarter + losses that would be + +On line 5143: + in July.55 On June + Wachovia’s board ousted CEO Ken + Thompson after he + +On line 5143: + had spent years at the + bank, of them at its helm.56 At + the end of the month, + +On line 5143: + announced that it would + stop originating Golden + West’s Pick-a-Pay products and + +On line 5143: + TO AUGUST waive all + fees and prepayment penalties + associated + +On line 5143: + Wachovia reported + an billion second-quarter loss. + The new CEO, Robert Steel, + + most recently an + undersecretary of the + treasury, announced a + + plan to improve the + bank’s financial condition: + raise capital, cut + +On line 5145: + the stock dividend, + and lay off to of the staff. + The rating agencies + + and supervisors + ignored those reassurances. + On the same day as + + the announcement, S&P + downgraded the bank, and the + Fed, after years of + +On line 5145: + showed losses that could + wipe out the recently raised + capital: losses + +On line 5145: + exceed billion, an + amount that could cause a further + ratings downgrade.57 The + +On line 5145: + directed Wachovia + to reevaluate and update + its capital plans + +On line 5145: + up to the summer + meltdown, the Fed now declared + that many of Wachovia’s + + problems were "long-term in + nature and result[ed] from + delayed investment + +On line 5147: + and a desire to + have business lines operate + autonomously."58 The Fed + +On line 5147: + criticized the board + and senior management for + "an environment + +On line 5147: + of all risk-taking + activities, including + deficiencies in + +On line 5147: + management had not + completely understood the + level of risk across + +On line 5147: + in certain nonbank + investments, and management + had delayed fixing + +On line 5147: + questioned investment + decisions.59 Nonetheless, the + Fed concluded that + +On line 5147: + market disruption, + management had minimized + exposure to overnight + +On line 5149: + markets. On August + the OCC downgraded Wachovia + Bank and assessed its + + overall risk profile + as "high." The OCC noted many + of the same issues + +On line 5149: + strong remarks about the + acquisition of Golden + West, identifying + +On line 5149: + foreclosures as the + heart of Wachovia’s problem. The + OCC noted that the + +On line 5151: + "acknowledged that the + Golden West acquisition + was a mistake."60 The + +On line 5151: + that the market was + focused on the company’s + weakened condition + + and that some large fund + providers had already limited + their exposure to + +On line 5151: + the Fed, however, + the OCC concluded that the + bank’s liquidity + +On line 5151: + undermined market + confidence.61 And, like the Fed, + the OCC approved of + +On line 5151: + new management and + a new, more hands-on oversight + role for the board of + +On line 5153: + Yet Wachovia’s problems + would continue, and in the + fall regulators + +On line 5155: + persistent lack of + progress" Washington Mutual, + often called WaMu, was + +On line 5155: + the largest thrift in the + country, with over billion in + assets at the end + +On line 5155: + the time, billion of + the home loans on its balance + sheet were option ARMs, + +On line 5155: + in California. + The reason WaMu liked option + ARMs was simple: in + +On line 5155: + as subprime loans, they + had generated returns + up to times those on + +On line 5155: + securities.62 But + that was then. WaMu was forced to + write off billion for + +On line 5155: + the fourth quarter of + and another billion in + the first quarter of + +On line 5157: + related to its + portfolio of option ARMs. + In response to these + +On line 5157: + Supervision, WaMu’s + regulator, requested + that the thrift address + +On line 5159: + asset quality, + earnings, and liquidity— + issues that the OTS + +On line 5159: + in the past but that + had not been reflected in + supervisory + + ratings. "It has been + hard for us to justify + doing much more than + +On line 5159: + have not really + been adversely impacted + in terms of losses,"63 + +On line 5159: + a email. Indeed, the + nontraditional mortgage + portfolio had been + +On line 5161: + very well through and But + with WaMu now taking losses, + the OTS determined + +On line 5161: + that its condition + required a downgrade in its + rating from a to + +On line 5163: + March, the OTS advised + that WaMu undertake "strategic + initiatives"— that is, + +On line 5163: + a buyer or raise + new capital. In April, WaMu + secured a billion + + investment from a + consortium led by the Texas + Pacific Group, a + + private equity + firm.65 But bad news continued + for thrifts. On July + +On line 5167: + largest-ever thrift to fail. + On July, WaMu reported + a billion loss in + +On line 5167: + the second quarter. + WaMu’s depositors withdrew + billion over the next + +On line 5167: + Home Loan Bank of San + Francisco—which, as noted, had + historically + +On line 5167: + served with the other + Federal Home Loan Banks as + an important source + +On line 5167: + and others—began + to limit WaMu’s borrowing + capacity. The + +On line 5169: + while maintaining the + overall rating at As the + insurer of many + +On line 5169: + deposits, the FDIC had + a stake in WaMu’s condition, + and it was not as + + generous as the + OTS in its assessment. It + had already dropped WaMu’s + +On line 5171: + March indicating + a "high level of concern."67 + The FDIC expressly + +On line 5171: + OTS’s decision to + maintain the overall rating, + recommending a + +On line 5171: + Ordinarily, + would have triggered a formal + enforcement action, + +On line 5171: + was forthcoming. In + an August interview, William + Isaac, who was chairman + +On line 5171: + that the OTS and FDIC + had competing interests. + OTS, as primary + + regulator, "tends + to want to see if they can + rehabilitate + +On line 5171: + bank and doesn’t want + to act precipitously + as a rule." On the + +On line 5171: + hand, "The FDIC’s job is + to handle the failures, and + it—generally + +On line 5173: + on the theory + that the sooner the problems + are resolved, the less + +On line 5175: + the cleanup will be."69 FDIC + Chairman Sheila Bair underscored + this tension, telling the + +On line 5175: + the underwriting + quality of WaMu’s mortgage + portfolio, and we + +On line 5175: + the OTS in terms of + going in and letting our + [FDIC] examiners + +On line 5179: + AUGUST The Treasury’s + inspector general would + later criticize + + OTS’s supervision + of Washington Mutual: + "We concluded that + +On line 5179: + sooner to force WaMu’s + management to correct the + problems identified + +On line 5179: + progress in correcting + OTS-identified weaknesses, we believe + OTS should have followed + +On line 5179: + policies and taken + formal enforcement action + rather than informal + + enforcement action."71 + Regulators: "A lot of + that pushback" In these + +On line 5183: + late to identify + the mistakes and problems of + commercial banks and + +On line 5183: + not react strongly + enough when they were identified. + In part, this failure + + reflects the nature + of bank examinations + conducted during + +On line 5183: + when institutions + were reporting profits. In + addition to their + +On line 5183: + working with banks to + assess the adequacy + of their systems. This + + function was, to a + degree, a reflection of + the supervisors’ + +On line 5183: + do not attempt to + restrict risk-taking but rather + determine whether banks + +On line 5183: + the risks they assume."72 + As the crisis developed, + bank regulators + +On line 5185: + to shift gears. Senior + supervisors told the FCIC + it was difficult + +On line 5185: + express their concerns + forcefully when financial + institutions were + +On line 5185: + record-level profits. The + Fed’s Roger Cole told the FCIC that + supervisors did + + discuss issues such + as whether banks were growing too + fast and taking too + +On line 5185: + risk, but ran into + pushback. "Frankly a lot of that + pushback was given + +On line 5185: + the firms by the fact + that—like a Citigroup was + earning to billion + + a quarter. And that + is really hard for a + supervisor to + +On line 5185: + money is flowing + out quarter after quarter + after quarter, and + +On line 5187: + very hard to challenge."73 + Supervisors also told + the FCIC that they feared + + aggravating a + bank’s already-existing problems. + For the large banks, the + +On line 5187: + a formal, public + supervisory action + taken under the + +On line 5187: + banking statutes marked a + severe regulatory + assessment of the + + bank’s risk practices, and + it was rarely employed for banks + that were determined + +On line 5189: + Richard Spillenkothen, the Fed’s head + of supervision until + early attributed + +On line 5189: + "a belief that the + traditional, nonpublic + (behind-the-scenes) approach to + + supervision was + less confrontational and more + likely to induce + + bank management to + cooperate; a desire + not to inject an + +On line 5189: + into what was felt + to be a constructive or + equable relationship + +On line 5189: + management; and a + fear that financial markets + would overreact to + +On line 5189: + actions, possibly + causing a run." Spillenkothen argued + that these concerns were + +On line 5189: + needed corrective + action. One of the lessons of + this crisis is that + +On line 5189: + working presumption + should be earlier and stronger + supervisory + + follow up."74 ouglas + Roeder, the OCC’s senior deputy + comptroller for Large + +On line 5191: + from to said that the + regulators were hampered + by inadequate + + information from + the banks but acknowledged that + regulators did + + not do a good job + of intervening at key + points in the run-up to + + the crisis. He said + that regulators, market + participants, and + +On line 5191: + markets work, noting, + "We underestimated + what systemic risk would + +On line 5193: + in the marketplace."75 + Regulators also blame + the complexity + +On line 5193: + supervisory + system in the United States. + The patchwork quilt of + +On line 5193: + banks to shop for the + most lenient regulator, + and the presence of + +On line 5193: + one supervisor + at an organization. + For example, a + +On line 5193: + supervising the + bank holding company, the + OCC supervising + +On line 5195: + supervising the + securities firm, and the + OTS supervising + +On line 5195: + thrift subsidiary—creating + the potential for both gaps + in coverage and + +On line 5195: + leaders have proposed + consolidation of the + supervisors to + +On line 5195: + system over the years. + Notably, Secretary Henry + Paulson released the + +On line 5197: + Structure" on March two + weeks after the Bear rescue, + in which he proposed + + getting rid of the + thrift charter, creating a + federal charter + +On line 5197: + only by the states), + and merging the SEC and CFTC. + The proposals did + +On line 5199: + banks and thrifts or their + poor corporate governance + and risk management, + + often maintaining + satisfactory ratings + on institutions + + until just before + their collapse. This failure was + caused by many factors, + +On line 5199: + were capable of + self-regulation, and that + regulators should + +On line 5201: + with activities + reported as profitable. Large + commercial banks and + +On line 5201: + such as Wachovia and + IndyMac, that had significant + exposure to risky + +On line 5203: + assets were subject + to runs by creditors and + depositors. The + +On line 5203: + too late the systemic + danger inherent in the + interconnections + +On line 5203: + unregulated + over-the-counter (OTC) derivatives + market and did not + +On line 5211: + the information + needed to act. SEPTEMBER + THE TAKEOVER OF FANNIE + + MAE AND FREDDIE MAC + CONTENTS "A good time to buy"...........................................................................................310 + "The only game in + +On line 5223: + game be cool"...............................................................................312 "The idea + strikes me as perverse" "It will + increase confidence"................................................................................315 + +On line 5227: + "Critical unsafe + and unsound practices" "They went + from zero to three + +On line 5231: + in between" "The worst-run + financial institution".................................................................321 + "Wasn’t done at my + +On line 5233: + pay grade"...........................................................................322 From the fall + of until Fannie Mae and + Freddie Mac were placed + +On line 5233: + conservatorship + on September government + officials struggled + +On line 5233: + enterprises and + their mission to support the + mortgage market. The + +On line 5233: + the mortgage market + was quickly weakening—home prices + were declining, loan + +On line 5233: + result, the values + of mortgage securities + were plummeting. Lenders + +On line 5233: + borrowers into + affordable mortgages if these + government-sponsored + + enterprises (GSEs) + would purchase the new loans. If + the GSEs bought more loans, + +On line 5233: + would stabilize the + market, but it would also + leave the GSEs with more + +On line 5235: + balance sheets. The GSEs + were highly leveraged—owning + and guaranteeing + +On line 5235: + trillion of mortgages + with capital of less than + When interviewed by + +On line 5235: + Treasury Secretary + Henry Paulson acknowledged + that after he was + +On line 5235: + on the GSEs upon + taking office in June he + believed that they were + +On line 5235: + happen" and that one + key problem was the legal + definition of + +On line 5235: + their regulator + lacked discretion to adjust; + indeed, he said that + +On line 5235: + referred to it as + "bullsh*t capital."1 Still, the + GSEs kept buying more + +On line 5235: + riskier mortgage loans + and securities, which by + fall constituted + +On line 5235: + The GSEs reported + billions of dollars of net + losses on these loans + +On line 5237: + beginning in the + third quarter of But many in + Treasury believed the + +On line 5237: + needed the GSEs to + provide liquidity to + the mortgage market + +On line 5237: + and guaranteeing + loans and securities at + a time when no one + +On line 5237: + would. Paulson told the + FCIC that after the housing + market dried up in + +On line 5237: + summer of the key + to getting through the crisis + was to limit the + +On line 5237: + ensure continued + mortgage funding, all of which + required that the GSEs + +On line 5237: + viable.2 However, + there were constraints on how many + loans the GSEs could fund; + +On line 5237: + agreed to portfolio + caps—limits on the loans and + securities they + +On line 5241: + surplus requirement. + So, even as each company + reported billions + +On line 5241: + their regulator, + the Office of Federal + Housing Enterprise + +On line 5241: + "From the fall of to + the conservatorships, it + was a tightrope with no + + safety net," former + OFHEO Director James Lockhart + testified to the + +On line 5241: + the balancing act + ultimately failed and both + companies were placed + +On line 5243: + conservatorship, + costing the U.S. taxpayers + billion—so far. "A + +On line 5245: + TIME TO BUY" In an + August letter to Lockhart, + Fannie Mae CEO Daniel + +On line 5245: + sought immediate + relief from the portfolio + caps required by the + +On line 5245: + have witnessed growing + evidence of turmoil in + virtually all + +On line 5245: + finance market," Mudd + wrote, and "the immediate + crisis in subprime + +On line 5245: + indicative of a + serious liquidity + event impacting the + +On line 5245: + credit market, not + just subprime."4 As demand for + purchasing loans dried + +On line 5245: + lenders like Countrywide + kept loans that they normally + securitized, and + +On line 5245: + under. A number + of firms told Fannie that they + would stop making loans + + if Fannie would not + buy them. Mudd argued that a + relaxed cap would let + +On line 5247: + liquidity. "A + moderate, percent increase + in the Fannie Mae + +On line 5247: + cap would provide us + with flexibility and + send a strong signal + + to the market that + the GSEs are able to address + liquidity events + +On line 5247: + crises." He maintained that + the consent agreement allowed + OFHEO to lift the cap + +On line 5249: + deficiencies— the + primary condition for + removing the cap. + + Finally, he stressed + that the GSEs’ charter required + Fannie to provide + +On line 5249: + stability to + the market. "Ultimately," + Mudd concluded, "this + +On line 5249: + market confidence + that the GSEs can fulfill their + stabilizing role + +On line 5251: + money. Because there + was less competition, the + GSEs could charge higher + +On line 5251: + pay less for loans and + securities they wanted + to own, enabling them + + (in theory) to + increase returns.6 Tom Lund, a + longtime Fannie Mae + +On line 5251: + FCIC that the market + moved in Fannie Mae’s favor + af-SEPTEMBER ter August as + +On line 5253: + dropped out and prices of + loans and securities fell. + Lund told FCIC staff that + +On line 5253: + liquidity shock, + Fannie had "more comfort that + the relationship + +On line 5253: + and price was correct."7 + Robert Levin, the company’s chief + business officer, + +On line 5255: + was a good time to + buy."8 On August OFHEO’s Lockhart + notified Fannie + +On line 5255: + the portfolio cap + would be "premature" but the + regulator would + +On line 5255: + the request under + "active consideration." + Lockhart wrote that he + + would not authorize + changes, because Fannie could still + guarantee mortgages + +On line 5255: + it couldn’t buy them + and because Fannie remained + a "significant + +On line 5255: + addition, Lockhart + noted that Fannie could not + prudently address + +On line 5255: + in the subprime and + Alt-A mortgage market, and the + company’s charter + + did not permit it + to address problems in the + market for jumbo + +On line 5255: + (mortgages larger than + the GSEs’ loan limit).9 Although + there had been progress in + +On line 5255: + work remained. Fannie + still had not filed financial + statements for or "a + +On line 5257: + unsettled markets."10 + As Lockhart testified to + the FCIC, "It became + +On line 5257: + clear by August that + the turmoil was too big for + the Enterprises + +On line 5257: + GSEs] to solve in a + safe and sound manner." He was + worried that fewer + + controls would mean more + losses. "They were fulfilling + their mission," Lockhart + + told the FCIC, "but they + had no power to do more + in a safe and sound + +On line 5257: + their mission is to + provide stability and + lessen market turmoil, + + there was nothing in + their capital structure" that + would allow them to + + do so.11 Lockhart had + worried about the financial + stability of + +On line 5259: + two GSEs and about OFHEO’s + ability to regulate + the behemoths from + +On line 5261: + the day he became + director in May and he + advocated for + +On line 5263: + his largely toothless + agency. Lockhart pushed for the + power to increase + +On line 5263: + and to limit growth, + and he sought authority + over mission goals set + +On line 5263: + of the Department + of Justice. His shopping list + also included + + the authority + to put Fannie and Freddie + into receivership, + + a power held by + bank regulators over banks, + and to liquidate + +On line 5263: + effect, to force a + government takeover—but because + it lacked funding to + +On line 5263: + deteriorate + even further before Lockhart + secured the powers + +On line 5267: + "THE ONLY GAME IN + TOWN" But Fannie and Freddie + were "the only game + +On line 5267: + the housing market + dried up in the summer of + Paulson told the FCIC. + +On line 5267: + by the spring of "[the + GSEs,] more than anyone, were the + engine we needed + +On line 5269: + Few doubted Fannie + and Freddie were needed to + support the struggling + + housing market. The + question was how to do so + safely.14 Purchasing + +On line 5269: + guaranteeing risky + mortgage-backed securities helped + make money available + + for borrowers, but + it could also result in + further losses for + +On line 5269: + two huge companies + later on. "There’s a real + trade-off," Lockhart said in + +On line 5269: + 2007—a trade-off made all the + more difficult by the state + of he GSEs’ balance + +On line 5269: + and securities + was swamping their reported + capital. By the + +On line 5269: + end of guaranteed + and portfolio mortgages with + FICO scores less than + +On line 5269: + Fannie Mae by more + than seven to one; Alt-A loans + and securities, + + by more than six to + one. Loans for which borrowers + did not provide full + +On line 5271: + to more than ten times + reported capital.16 In + mid-September, OFHEO relented + +On line 5271: + marginally loosened the + GSEs’ portfolio cap, from about + billion to billion. + +On line 5271: + Fannie to increase + the amount of mortgage loans and + securities it + +On line 5271: + per year—a power that + Freddie already had under + its agreement with OFHEO. + +On line 5271: + increases "because + the remediation process + is not yet finished, + +On line 5271: + safety and soundness + issues are not yet resolved, + and the criteria + +On line 5271: + Mae consent agreement + and Freddie Mac’s voluntary + agreement have not been + +On line 5273: + important to the + mortgage market. By the fourth + quarter of they were + +On line 5273: + new mortgages, nearly + twice the level. With trillion + in mortgages resting + +On line 5273: + "a withdrawal by + Freddie Mac and Fannie Mae + or even a drop in + +On line 5275: + have created a + self-fulfilling credit + crisis."18 In early + +On line 5275: + to temporarily + lift portfolio limits on + the GSEs by percent, + +On line 5275: + approximately + billion, most of which would be + designated for + +On line 5277: + "ill advised," were not + enacted.19 In November, + Fannie and Freddie + +On line 5279: + that it had billion + of capital to absorb + potential losses + +On line 5279: + assets and trillion + of guarantees on mortgage-backed + securities; if + +On line 5279: + exceeded it would + be insolvent. Freddie would + be insolvent if + +On line 5281: + validity of + their "reported" capital. + "IT’S A TIME GAME BE + +On line 5283: + first quarter, real + gross domestic product fell + at an annual + +On line 5283: + decline in consumer + spending since the early 1990s. + The unemployment + +On line 5283: + rate averaged in + the first three months of up from + a low of in spring + +On line 5283: + passed the Economic + Stimulus Act, which raised the + limits on the size + +On line 5285: + mortgages that Fannie + and Freddie could purchase, among + other measures. The + + push to get OFHEO to + loosen requirements on the GSEs + also continued. + +On line 5287: + capital surcharge; + such a stringent requirement, + he wrote Lockhart on + +On line 5291: + days later, Fannie + CEO Mudd reported losses + in the fourth quarter + +On line 5291: + of acknowledging + that Fannie was "working through + the toughest housing + +On line 5291: + a generation."21 + The company had issued + billion of preferred + +On line 5291: + had completed all + requirements of the consent + agreement with OFHEO, and + +On line 5291: + surplus requirement. + The next day, Freddie also + reported losses + +On line 5293: + the company had + raised billion of preferred stock. + As both companies + +On line 5293: + time, fulfilling a + condition of lifting the + restrictions imposed + +On line 5293: + announced that OFHEO would + remove the portfolio caps + on March He also + +On line 5293: + requirement, because + both companies had made progress + in satisfying + +On line 5293: + and had recently + raised capital through preferred + stock offerings. Mudd + +On line 5293: + the FCIC that he sought + relief from the capital + surplus requirement + +On line 5295: + Fannie fell short of + required capital levels.22 + On February the + +On line 5295: + growth limits, a New + York Fed analyst noted + to Treasury that the + +On line 5297: + market.23 Calls to ease + the surcharge also came from + the marketplace. Mike + +On line 5297: + Steel that a crisis + loomed in the credit markets + that only the GSEs + +On line 5297: + "We believe that we + are nearing a tipping point; + lack of transparency + +On line 5297: + asset class" and "a + dearth of buyers" foreshadowed + worse news, Farrell wrote. + +On line 5297: + capital surcharge + and passing legislation + to overhaul the GSEs + +On line 5297: + for them to provide + more stability, he said. + Farrell recognized + +On line 5297: + GSEs might believe their + return on capital would + be insufficient, + +On line 5297: + have to get past that + and focus on fulfilling + their charters," because + +On line 5297: + big picture is that + right now whatever is best + for the economy + +On line 5297: + the ROI [return on + investment] for Fannie and + Freddie shareholders."24 + +On line 5299: + Bear Stearns collapsed, Steel + reported to Mudd that he + had "encouraging" + + conversations with + Senator Richard Shelby, the + ranking member of + +On line 5299: + and Urban Affairs, + and Representative Frank, + chairman of the House + +On line 5301: + legislation and + capital relief for the + GSEs. He intended + +On line 5301: + with Senate Banking + Committee Chairman Christopher + Dodd. Confident that + +On line 5303: + GSEs to back up the + mortgage market, Mudd proposed + an "easier trade." + + If regulators + would eliminate the surcharge, + Fannie Mae would agree + +On line 5303: + new capital.25 In + a March email to Fannie chief + business officer + +On line 5303: + Levin, Mudd suggested + that the capital surplus + requirement might be + +On line 5303: + reduced without any + trade: "It’s a time game whether they + need us more or if + +On line 5305: + hit the capital + wall first. Be cool."26 n the next + day, March Treasury and + +On line 5305: + email enclosing an + alarming analysis: it claimed + that in reporting + +On line 5307: + which resembled one + offered in a March Barron’s + article, stated: + +On line 5309: + show the company + is currently insolvent. + Accounting fraud has + +On line 5309: + asset categories + (non-agency securities, + deferred tax assets, + +On line 5309: + understated. These + accounting shenanigans add up + to tens of billions + +On line 5311: + worth. Yet, the impact + of a tsunami of mortgage + defaults has yet to + +On line 5313: + income statement and + further annihilate its + capital. Such grim + +On line 5313: + to serve the housing + market while maximizing + shareholder returns. + + In trying to do + both, Fannie has done neither + well. With shareholder + +On line 5315: + government seizure of + the company is inevitable.27 + Given the turmoil + +On line 5315: + the Bear Stearns crisis, + Paulson said he wanted to + increase confidence + +On line 5315: + mortgage market by + having Fannie and Freddie + raise capital. Steel + +On line 5315: + him that Treasury, OFHEO, + and the Fed were preparing + plans to relax the + +On line 5317: + capital surcharges + in exchange for assurances + that the companies + +On line 5319: + capital. On March + Steel also reported to + his Treasury colleagues + +On line 5319: + then executive + vice president of the New + York Fed, wanted to + +On line 5321: + Freddie and Fannie. + Steel wrote that Dudley "leaned on + me hard" to make the + +On line 5321: + in conjunction with + dialing back the surcharge + and attempting to + +On line 5321: + worried about how this + might affect the federal + government’s balance + +On line 5321: + "I do not like that + and it has not been part of + my conversation + +On line 5321: + else. I view that as + a very significant move, + way above my pay grade + + to double the size + of the U.S. debt in one fell + swoop."28 "THE IDEA STRIKES ME + +On line 5325: + the Treasury huddled + with GSE executives to + discuss lowering + +On line 5325: + requirements if the + GSEs would raise more capital. + "The entire mortgage + +On line 5325: + was at risk," Lockhart + told the FCIC.29 The pushing and + tugging continued. + + Paulson told the FCIC + that personal commitments + from Mudd and Freddie + +On line 5325: + CEO Richard Syron to + raise capital cinched the deal.30 + Just days earlier, + +On line 5325: + on March Syron had + announced in a quarterly + call to investors that + +On line 5325: + capital. Fannie + and Freddie executives + prepared a draft press + + release before a + discussion with Lockhart and + Steel. It announced a + +On line 5325: + reduction in the + capital surcharge from to + Lockhart was not pleased; + +On line 5325: + com-SEPTEMBER mitment to raise + additional capital, + stating instead that + + the GSEs planned to raise + it "over time as needed."31 It + looked as if the GSEs + + were making the deal + with their fingers crossed. In an + email to Steel and the + +On line 5327: + of both entities, + Lockhart wrote: "The idea strikes me + as perverse, and I + + assume it would seem + perverse to the markets that + a regulator + +On line 5327: + agree to allow a + regulatee to increase + its very high mortgage + + credit risk leverage + (not to mention increasing + interest rate risk) + +On line 5327: + new capital." The + initial negotiations + had the GSEs raising + +On line 5327: + of capital for + each of reduction in the + surplus. Lockhart wrote + +On line 5327: + in frustration, "We + seem to have gone from to right + through to to now to + +On line 5329: + the deal, unaltered + in any material way, + on March OFHEO agreed to + +On line 5331: + capital restraint + from to Fannie and Freddie + pledged to "begin the + +On line 5331: + giving no concrete + commitment.33 Paulson told the + FCIC that the agreement, + + which included a + promise to raise capital, + was "a no-brainer," and + +On line 5333: + had no memory + of Lockhart ever having + called it "perverse."34 The + + market analyst + Joshua Rosner panned the deal. "We + view any reduction + + [in capital] as + a comment not only on + the GSEs but on the + + burgeoning panic + in Washington," he wrote. "If + this action results + +On line 5335: + the destabilizing + of the GSEs, OFHEO will go from + being the only + +On line 5335: + into trouble, to + a textbook example of + why regulators + +On line 5337: + pressure."35 Fannie would + keep its promise by raising + billion in preferred + +On line 5337: + Executive Vice + President Donald Bisenius + offered two reasons + +On line 5337: + hindsight, Fannie Mae + did not raise additional + capital. First was + +On line 5337: + shareholders. "I’m sure + [Fannie’s] investors are not very + happy," Bisenius told + +On line 5339: + downturn in house prices, + you wouldn’t raise capital."36 + Similarly, CEO + +On line 5341: + spoke of the downside + of raising capital on + August "Raising a + + lot more capital + at these kinds of prices could be + quite dilutive to + +On line 5341: + interest of our + shareholders."37 But Lockhart saw + it differently; + +On line 5341: + put "a good face on + Freddie’s inability to + raise capital." He + +On line 5341: + "[Syron] was getting + advice from his attorneys + about the high risk of + +On line 5341: + before releasing + [quarterly earnings] and our + lawyers could not disagree + +On line 5343: + accounting issues," + Lockhart told the FCIC.38 "IT WILL + INCREASE CONFIDENCE" + +On line 5345: + the two companies + announced further losses in + the first quarter. Even + +On line 5345: + the situation + deteriorated, on + June OFHEO rewarded + +On line 5345: + in new capital + by further lowering the + capital surcharge, + +On line 5345: + fell Freddie’s, The price + of protection on million + in Fannie’s debt through + +On line 5345: + credit default swaps + jumped to in June, up from in + May; between and it + +On line 5345: + In August, they both + reported more losses for + the second quarter. + +On line 5347: + after both Fannie + and Freddie became public + companies owned by + + shareholders, they had + continued to possess an + asset that is hard + +On line 5347: + full faith and credit + of the U.S. government. The + government worried + +On line 5347: + that it could not let + the trillion GSEs fail, because + they were the only + +On line 5347: + of liquidity + in the mortgage market and + because their failure + + would cause losses to + owners of their debt and their + guaranteed mortgage + +On line 5347: + GSEs before. It bailed + out Fannie when double-digit + inflation wrecked its + +On line 5349: + sheet in the early + 1980s, and it came through in the + mid-1980s for another + +On line 5351: + Corporation, was + given a helping hand. As + the market grappled + +On line 5351: + the fundamental + question of whether Fannie and + Freddie would be backed + + by the government, + the yield on the GSEs’ long-term bonds + rose. The difference + +On line 5351: + the rate that the GSEs + paid on their debt and rates on + Treasuries—a premium + +On line 5351: + that reflects investors’ + assessment of risk—widened in to + one-half a percentage + +On line 5351: + compared with the same + figure for other publicly + traded companies, + +On line 5351: + for the ultra-safe + GSEs. By June the spread had risen + over the level; by + +On line 5351: + the spread had nearly + doubled from its level to + just under making + +On line 5351: + more difficult and + costly for the GSEs to fund + their operations. + +On line 5351: + increased slightly over + this time period, while the + prices of private-label + +On line 5351: + dramatically + declined. For example, the + price of the FNCI7 + +On line 5351: + index of Fannie + mortgage–backed securities + with an average + +On line 5351: + price of the FNCI5 + index—Fannie securities with an + average coupon of + +On line 5353: + to during the same + time period. In July + and August Fannie + +On line 5353: + a liquidity + squeeze, because it was unable + to borrow against its + + own securities + to raise sufficient cash in + the repo market. + +On line 5355: + Its stock price dove to + less than a share. Fannie asked + the Fed for help.39 A + + senior adviser + in the Federal Reserve + Board’s Division of + +On line 5355: + Supervision and + Regulation gave the FCIC + a bleak account of + + the situation + at the two GSEs and noted + that "liquidity + +On line 5357: + so essential, so + the Federal Reserve agreed + to help provide it."40 + +On line 5359: + York Fed to extend + emergency loans to the GSEs + "should such lending prove + +On line 5361: + availability of + home mortgage credit during + a period of + + stress in financial + markets."41 Fannie and Freddie + would never tap the + +On line 5363: + Treasury laid out a + three-part legislative plan + to strengthen the GSEs + +On line 5363: + lines of credit with + the Treasury, authorizing + Treasury to inject + +On line 5363: + into the GSEs, and + replacing OFHEO with the new + Federal Housing + +On line 5363: + Agency (FHFA), with + the power to place the GSEs + into receivership. + +On line 5367: + needed "a bazooka" at + their disposal. SEPTEMBER + "You are not likely + +On line 5367: + take it out," Paulson + told legislators. "I just + say that by having + +On line 5367: + is unspecified, + it will increase confidence. + And by increasing + +On line 5367: + greatly reduce the + likelihood it will ever + be used."43 Fannie’s Mudd + + and Freddie’s Syron + praised the plan.44 At the end of + July, Congress passed + +On line 5369: + Act (HERA) of giving + Paulson his bazooka—the ability + to extend secured + +On line 5369: + of credit to the + GSEs, to purchase their mortgage + securities, and + +On line 5371: + inject capital. + The 261-page bill also strengthened + regulation of + +On line 5371: + GSEs by creating + FHFA, an independent + federal agency, + +On line 5371: + and compensation. + In addition, the bill raised + the federal debt + +On line 5371: + ceiling by billion + to trillion, providing funds + to operate the + +On line 5373: + Federal Reserve + Board consented in mid-July to + furnish emergency + +On line 5373: + of the Comptroller + of the Currency (OCC), along + with Morgan Stanley, + +On line 5373: + as an adviser + to Treasury, initiated + a review of the + +On line 5373: + Timothy Clark, who + oversaw the weeklong review + for the Fed, told the + +On line 5373: + that it was the first + time they ever had access + to information + +On line 5373: + the GSEs. He said that + previously, "The GSEs [saw] + the Fed as public + +On line 5373: + number one. There was + a battle between us and + them." Clark added, "We would + + deal with OFHEO, which was + also very guarded. So we + did not have access + + to info until + they wanted funding from us."45 + Although Fed and OCC + + personnel were at + the GSEs and conferring with + executives, Mudd + + told the FCIC that he + did not know of the agencies’ + involvement until + +On line 5377: + enterprises were + both in conservatorship.46 + The Fed and the OCC + +On line 5377: + that the problems were + worse than their suspicions and + reports from FHFA + +On line 5377: + led them to believe. + According to Clark, the Fed + found that the GSEs were + +On line 5377: + "underreserved," with + huge potential losses, and + their operations + +On line 5377: + and unsound."47 The OCC + rejected the forecasting + methodologies on which + +On line 5377: + and Freddie relied. + Using its own metrics, it + found insufficient + +On line 5377: + future losses and + identified significant + problems in credit + +On line 5377: + loss forecasting was + problematic, and that its + loan losses therefore + +On line 5377: + He added that Fannie + had overvalued its deferred + tax assets—because + +On line 5379: + had no value.48 Loss + projections calculated + by Morgan Stanley + +On line 5379: + Stanley concluded + that Fannie’s loss projection + methodology was + +On line 5381: + Fannie’s projections + did not. All told, the litany of + understatements and + +On line 5381: + OCC’s Bailey to a + firm conclusion. If the GSEs + were not insolvent + +On line 5381: + there," he told the FCIC.49 + Regulators also learned + that Fannie was not + +On line 5381: + off loans until they + were delinquent for two years, a + head-in-the-sand approach. Banks + +On line 5381: + charge off loans once they + are days delinquent. For these and + numerous other + +On line 5381: + Fannie and Freddie + earned rebukes. "Given he role + of the GSEs and their + +On line 5381: + Instead they appear + to significantly lag + the industry in + +On line 5385: + respects."50 "CRITICAL + UNSAFE AND UNSOUND PRACTICES" + Paulson told the FCIC + +On line 5385: + that although he learned + of the Fed and OCC findings + by August it took + +On line 5385: + three weeks to convince + Lockhart and FHFA that there + was a capital + + shortfall, that the GSEs + were not viable, and that they + should be placed under + + government control.51 + On August, FHFA informed + both Mudd and Syron + +On line 5385: + were "adequately + capitalized" under the + regulations, a + +On line 5385: + that was "certified + and represented as true + and correct by [GSE] + +On line 5385: + current level of + Fannie Mae’s capital" if + the housing market + +On line 5387: + grew gloomier. Fannie + informed Treasury on August + 25—and repeatedly + +On line 5387: + raising capital + was infeasible and that + the company was + +On line 5387: + Even Fannie’s "base-case + earnings forecast" pointed to + substantial pressure + +On line 5389: + September Lockhart + and FHFA agreed with Treasury + that the GSEs needed + +On line 5389: + That day, Syron and + Mudd received blistering midyear + reviews from FHFA. + +On line 5389: + opening paragraph of + each letter informed the CEOs + that their companies + + had been downgraded + to "critical concerns," and + that "the critical + +On line 5389: + unsound practices and + conditions that gave rise to + the Enterprise’s + +On line 5391: + bad situation + was expected to worsen. + The 21-page report sent + +On line 5391: + Fannie identified + sweeping concerns, including + failures by the board + +On line 5391: + senior management, + a significant drop in + the quality of + +On line 5391: + and securities + owned or guaranteed by the + GSE, insufficient + +On line 5391: + exclusive reliance + on short-term funding, and the + inability to + +On line 5391: + for their "imprudent + decisions" to "purchase or + guarantee higher + +On line 5391: + mortgage products." The + letter faulted Fannie for + purchasing high-risk + +On line 5391: + and for attempting + to increase market share by + competing with Wall + +On line 5391: + prudent credit risk + management and corporate + business objectives," + +On line 5391: + Using models that + underestimated this + risk, the GSE then charged + +On line 5391: + models suggested + were appropriate. FHFA + determined that these + +On line 5391: + fees were charged because + "focus was improperly + placed on market share + +On line 5397: + Wall Street and [Freddie + Mac]."55 SEPTEMBER Even after + internal reports + + pointed to market + problems, Fannie kept buying + and guaranteeing + + riskier loan products, + FHFA said. "Despite signs in + the latter half of + +On line 5399: + problems, management + continued activity + in risky programs, and + +On line 5399: + for Alt-A loans without + establishing limits."56 The + company also + +On line 5399: + by Alt-A and subprime + loans.57 Losses were likely to + be higher than the + +On line 5401: + had estimated, + FHFA found. FHFA also + noted "increasing + +On line 5401: + models it used to + forecast losses had not been + independently + + validated or + updated for several + years. FHFA judged that + +On line 5401: + would likely show a + "material increase." In + addition, Fannie + +On line 5401: + performance, FHFA + found this benefit to be + significantly + +On line 5403: + of that GSE’s safety + and soundness, but more severe + criticisms of its + +On line 5403: + the report noted + a significant lack of + market confidence, + +On line 5403: + ability to raise + capital." FHFA, for its + part, "lost confidence + +On line 5403: + other serious + misjudgments." According to + the regulator, + +On line 5403: + could not be relied + on, particularly in + light of their widespread + +On line 5403: + address criticisms. + In addition, FHFA said + that Freddie’s failure + +On line 5403: + capital despite + its assurances "invite[d]" + the conclusion that + +On line 5405: + about the capital + surcharge reduction.59 As in + its assessment of + +On line 5405: + and guarantee of + higher-risk loan products in and + in a declining + +On line 5405: + after being told + by the regulator in + that its purchases + +On line 5405: + subprime private-label + securities had outpaced + its risk management + +On line 5405: + Freddie bought billion + of subprime securities + in each subsequent + +On line 5407: + FHFA also found + that "aggressive" accounting + cast doubt on Freddie’s + + reported earnings + and capital. Despite "clear + signals" that losses + +On line 5407: + mortgage assets were + likely, Freddie waited to + record write-downs until + + the regulator + threatened to issue a cease + and desist order. + + Even then, one write-down + was reversed "just prior to + the issuance of the + +On line 5407: + credit losses would + "result in a substantial + dissipation of + +On line 5411: + capital."60 "THEY WENT + FROM ZERO TO THREE WITH NO + WARNING IN BETWEEN" + +On line 5413: + kind of criticisms + leveled in the September + letter. He said the + +On line 5413: + situation" then + was "inconsistent with what + you would consider + +On line 5413: + practice to be—like, + first warning: fix it; second + warning: fix it; third + +On line 5413: + ut of here. Instead, + they went from zero to three + with no warning in + + between."61 A review + of the examination + reports and other + +On line 5413: + FHFA to the FCIC + largely supports Mudd’s view + on this specific + +On line 5413: + examination + reports noted concerns about + increasing credit + +On line 5413: + remediation + of deficiencies required + by the May consent + +On line 5413: + do not include the + sweeping criticisms contained + in the September + +On line 5415: + were designated + "critical concerns," Mudd at + Fannie and Syron + +On line 5415: + government takeover. On + September FHFA Acting + Deputy Director Chris + +On line 5417: + was not a foregone + conclusion. Paulson, Lockhart, + and Bernanke met with Mudd, + +On line 5417: + persuade them to cede + control.63 Essentially the + GSEs faced a Hobson’s + +On line 5417: + take the horse offered + or none at all. "They had to + voluntarily + + agree to a consent + agreement," Lockhart told the FCIC. + The alternative, + + a hostile action, + invited trouble and "nasty + lawsuits," he noted. + +On line 5419: + made a very strong case + so the board of directors + did not have a choice."64 + +On line 5419: + the GSEs that he had + authority to inject + capital, but he + +On line 5421: + so unless they were + in conservatorship.65 Mudd + was "stunned and angry," + +On line 5421: + business, told the FCIC + that conservatorship came + as a surprise to + + everyone.67 Levin told + the FCIC that he never saw + a government seizure + +On line 5421: + that Fannie Mae was + or might become insolvent.68 + Interviewed in Mudd + +On line 5421: + the FCIC: "I did not + think in any way it was fair + for the government + + to have been in a + position of being in + the chorus for the + +On line 5421: + to add capital, + and then to inject itself + in the capital + +On line 5421: + reiterated + all the damning evidence + presented in the + +On line 5421: + earlier. Losses + at Fannie Mae for the year + were estimated + +On line 5421: + billion and billion.70 + Freddie Mac’s memorandum + differed only in + +On line 5421: + details. Its losses, + recorded at billion in the + first six months of were + +On line 5421: + projected to end + up between and billion by + the end of the year.71 + +On line 5423: + the boards had a choice, + the only realistic + option was assent. + +On line 5423: + agree to go in a + conservatorship anyway," + Syron told the FCIC. + +On line 5423: + "There was a very clear + message that the [September + letter was there as + + a mechanism to + bring about a result."72 Mudd agreed, + observing that "the + +On line 5423: + really to force + conservatorship."73 The boards + of both companies + + voted to accept + conservatorship. Both CEOs + were ousted, but the + +On line 5425: + persisted. As promised, + the Treasury was prepared to + take two direct steps + +On line 5425: + solvency. First, it + would buy up to billion of + senior preferred stock + +On line 5425: + the GSEs and extend + them short-term secured loans. In + addition, it pledged + +On line 5425: + from Wall Street firms and + others until the end of + Up front, Treasury bought + +On line 5427: + preferred stock with a + dividend. Each GSE also + gave Treasury warrants + +On line 5427: + representing of + shares outstanding. Existing + common and preferred + +On line 5427: + effectively wiped + out. The decline in value + of the preferred stock + +On line 5427: + held SEPTEMBER these + securities, contributing + to the failure of + +On line 5429: + capitalized" by + their regulators.74 Paulson + told the FCIC that he + +On line 5429: + "naive" enough to believe + that the action would halt the + crisis because it + +On line 5429: + a floor under the + housing market decline, and + provide confidence + + to the market." He + realized he was wrong on + the next day, when, as + +On line 5429: + "Lehman started to go."75 + Former Treasury Assistant + Secretary Neel Kashkari + +On line 5429: + "We thought that after + we stabilized Fannie and + Freddie that we bought + +On line 5429: + three months. But they were + such profound interventions, + stabilizing such + + a huge part of the + financial markets, that would + buy us some time. We + + were surprised that Lehman + then happened a week later, + that Lehman had to be + + taken over or it + would go into bankruptcy."76 + The firms’ failure was + +On line 5431: + event and increased the + magnitude of the crisis, + according to Fed + + Governor Kevin Warsh + and New York Fed General + Counsel Tom Baxter.77 + + Warsh also told the + FCIC that the events surrounding + the GSE takeover led to + +On line 5431: + underreported, + underappreciated + jolt to the system." + +On line 5431: + according to Warsh, + when the market grasped that it + had misunderstood + +On line 5431: + that the government + could have conceivably let them + fail, it "caused investors + + to panic about the + value of every asset, + to reassess every + + portfolio."78 FHFA + Director Lockhart described + the decision to + +On line 5433: + failure. Given that + the investment bank’s balance + sheet was about one-fifth + + the size of Fannie + Mae’s, he felt that the fallout + from Lehman’s bankruptcy + +On line 5435: + in comparison + to a GSE failure. He said, + "What happened after + +On line 5435: + GSE securities + included the Chinese and + Russian central banks, + +On line 5435: + them, owned more than half + a trillion dollars of these + securities, and + +On line 5435: + financial firms and + investment funds had even more + extensive holdings. + +On line 5435: + that U.S. banks owned more + than trillion in GSE debt and + securities—more + +On line 5437: + capital and of + their total assets at the + time.80 Testifying + +On line 5439: + the FCIC, Mudd claimed that + failure was all but inevitable. + "In the companies + +On line 5439: + from the twin shocks of + a housing crisis followed + by a financial + + crisis," he said. "A + monoline GSE structure asked to + perform multiple + +On line 5439: + cannot withstand a + multiyear home price decline + on a national + + scale, even without the + accompanying global + financial turmoil. + + The model allowed + a balance of business and + mission when home prices + +On line 5439: + prices crashed far beyond + the realm of historical + experience, it + +On line 5441: + and the Pendulum,’ + a choice between horrible + alternatives."81 "THE + +On line 5443: + When interviewed by + the FCIC, FHFA officials + were very critical + +On line 5443: + John Kerr, the FHFA + examiner (and an OCC + veteran) in charge + +On line 5443: + no words. He labeled + Fannie "the worst-run financial + institution" he + +On line 5443: + had seen in his years + as a bank regulator. + Scott Smith, who became + +On line 5443: + FHFA after that + agency replaced OFHEO, concurred; + in his view, Fannie’s + +On line 5443: + capabilities + were not particularly + well thought out, and lacked + +On line 5443: + variety of stress + scenarios. Both officials + noted Fannie’s weak + +On line 5443: + included hundreds + of market simulations + but scarcely any that + +On line 5443: + prices. To Austin Kelly, + an OFHEO examination + specialist, there was + + no relying on + Fannie’s numbers, because their + "processes were a + +On line 5443: + of spaghetti." Kerr and + a colleague said that that they + were struck that Fannie + +On line 5445: + was less tech-savvy than the + average community + bank.82 Nonetheless, OFHEO’s + +On line 5445: + criticisms. FHFA + officials conceded that + they had made mistakes + + in their oversight of + Fannie and Freddie. They paid + too much attention + +On line 5447: + did not react to + Fannie’s increasing credit + risk. Lockhart told the + +On line 5447: + that more resources should + have been dedicated to + assessing credit + +On line 5447: + mortgage assets and + guarantees.83 Current FHFA + Acting Director + + Edward DeMarco told the + FCIC that it would not pass the + "reasonable person + +On line 5447: + deny that OFHEO took + its eye off the ball by not + paying sufficient + +On line 5447: + on operational + risk, accounting and lack of + audited results.84 + +On line 5449: + Mudd and others, OFHEO’s + mistakes were not surprising. + Mudd told the FCIC that + +On line 5449: + "developing but + below average."85 Henry + Cisneros, a former + +On line 5449: + a similar view. + "OFHEO," Cisneros told the FCIC, "was + puny compared to what + +On line 5449: + Mac could muster in their + intelligence, their Ivy League + educations, their + + rocket scientists + in their place, their lobbyists, + their ability to + + work the Hill."86 The costs + of the bailouts have been enormous + and are expected + +On line 5451: + through the third quarter + of the two companies lost + billion, wiping out + +On line 5453: + combined capital + that they had reported at + the end of and the + +On line 5453: + capital raised by + Fannie in Treasury narrowed + the gap with billion + +On line 5453: + support. FHFA has + estimated that costs through + will range from billion + +On line 5453: + projected that the + economic cost of the GSEs’ + downfall, including + +On line 5453: + support as well as + actual dollar outlays, + could reach billion by + +On line 5457: + T DONE AT MY PAY + GRADE" Fannie’s two most senior + executives were + +On line 5457: + FCIC hearing how their + charter could have been changed to + make the company + +On line 5459: + approximately + million from to testified + that "the thing that would + +On line 5459: + the institution + more sound or have produced a + different outcome + +On line 5459: + have been for it to + have become over time a more + normal financial + +On line 5459: + capital, able to + be SEPTEMBER long or short + in the market, able + +On line 5459: + And if the trade for + that would have been, you know, a + cut in the so-called + + implicit ties with + the government, I think that + would have—that would have been + +On line 5459: + to answered only + that making such decisions + "wasn’t done at my + +On line 5461: + model of Fannie + Mae and Freddie Mac (the GSEs), + as private-sector, + +On line 5461: + government backing + and a public mission, was + fundamentally + + flawed. We find that the + risky practices of Fannie Mae—the + Commission’s case study + +On line 5461: + to its fall: practices + undertaken to meet Wall + Street’s expectations + +On line 5461: + regain market share, + and to ensure generous + compensation for + +On line 5461: + Development (HUD) + did contribute marginally to + these practices. The GSEs + +On line 5461: + activities, in + part, on the broad and sustained + public policy + +On line 5461: + at Fannie Mae, which, + combined with its excessive + leverage permitted + +On line 5463: + failure. Corporate + governance, including risk + management, failed at + +On line 5463: + skewed compensation + methodologies. The Office of + Federal Housing + + Enterprise Oversight + (OFHEO) lacked the authority + and capacity + +On line 5463: + legislation and + regulatory actions + that would have strengthened + + oversight of them and + restricted their risk-taking + activities. In + +On line 5465: + decision by the + federal government and + the GSEs to increase + +On line 5465: + risk to support the + collapsing mortgage market + was made despite the + +On line 5465: + the mortgage market, + they led to increased losses + at the GSEs, which were + +On line 5465: + by taxpayers, and + reflected the conflicted + nature of the GSEs’ + +On line 5467: + maintained their value + throughout the crisis and did + not contribute to + + the significant + financial firm losses that + were central to the + +On line 5479: + financial crisis. + SEPTEMBER THE BANKRUPTCY + OF LEHMAN CONTENTS "Get + +On line 5483: + conservatively + funded" "This is not sounding + good at all".......................................................................327 "Spook the + +On line 5489: + "Imagination hat" + "Heads of family" "Tell those + sons of bitches to + +On line 5493: + like it is going + to end pretty"..................................................335 "The only + alternative was + +On line 5497: + should be a simple + financial concept: if your + assets are worth more + +On line 5497: + liabilities, + you are solvent; if not, you + are in danger of + +On line 5497: + bankruptcy. But on + the afternoon of Friday, + September experts + +On line 5497: + the country’s biggest + commercial and investment + banks met at the Wall + +On line 5497: + of the Federal + Reserve to ponder the fate + of Lehman Brothers, and + +On line 5501: + whether or not the 157- + year-old firm was solvent. Only + two days earlier, + +On line 5501: + end of August. Over + the previous nine months, the + bank had lost billion + +On line 5501: + more than billion in + new capital, leaving it + with more reported + +On line 5503: + than it had a year + earlier. But this arithmetic + reassured hardly + +On line 5503: + investment bank. Fed + officials had been discussing + Lehman’s solvency for + +On line 5503: + the stakes were very high. + To resolve the question, the + Fed would not rely + +On line 5503: + questions about whether Lehman + was reporting assets at + market value. As + +On line 5503: + York Fed official + wrote to colleagues in July, + "Balance-sheet capital + +On line 5503: + too relevant if + you’re suffering a massive + run."1 If there is a + +On line 5503: + firm can only get + fire-sale prices for assets, even large + amounts of capital + +On line 5505: + disappear almost + overnight. The bankers thought Lehman’s real + estate assets were + +On line 5511: + Lehman’s unreliable + valuation methods, the + bankers had good reason + + for their doubts. None of + the bankers at the New York Fed + that weekend believed + +On line 5511: + billion in real + estate assets (excluding + real estate held + + for sale) on Lehman’s books + was an accurate figure. + If the assets were + +On line 5511: + only half that amount + (a likely scenario, given + market conditions), + +On line 5511: + then Lehman’s billion in + equity would be gone. In + a fire sale, some might + + sell for even less than + half their stated value. "What + does solvent mean1" JP + +On line 5513: + the FCIC asked if Lehman + had been solvent. "The answer + is, I don’t know. I + +On line 5513: + could not answer that + question."2 JP Morgan’s Chief Risk + Officer Barry + +On line 5513: + the FCIC that "from a + pure accounting standpoint, it + was solvent," although + + "it obviously + was financing its assets + on a very leveraged + +On line 5515: + former Lehman Brothers + CEO Richard Fuld insisted his + firm had been solvent: + +On line 5515: + no capital hole + at Lehman Brothers. At the end + of Lehman’s third quarter, + +On line 5515: + Fed Chairman Ben Bernanke + disagreed: "I believe it had + a capital hole." + +On line 5515: + Henry Paulson, and + SEC Chairman Christopher Cox agreed + it was "just way too + + big a hole. And my + own view is it’s very likely + that the company + +On line 5515: + insolvent, even, not + just illiquid."5 Others, such as + Bank of America + + CEO Ken Lewis, who that + week considered acquiring + Lehman with government + + support, had no doubts + either. He told the FCIC that + Lehman’s real estate + +On line 5517: + and other assets + had been overvalued by to + billion—a message he + +On line 5519: + a few days before + Lehman declared bankruptcy.6 It + had been quite a week; + +On line 5519: + quite a weekend. The + debate will continue over + the largest bankruptcy + +On line 5519: + nothing will change the + basic facts: a consortium + of banks would fail to + + agree on a rescue, + two last-minute deals would fall through, and + the government would + +On line 5519: + practical reasons, + for philosophical reasons, + and because, as Bernanke + + told the FCIC, if the + government had lent money, + "the firm would fail, and + + not only would we + be unsuccessful but we + would have saddled the + +On line 5521: + tens of billions of + dollars of losses."7 "GET MORE + CONSERVATIVELY + +On line 5523: + FUNDED" After the + demise of Bear Stearns in March most + observers—including Bernanke, + +On line 5523: + Geithner, and + Cox8—viewed Lehman Brothers as the next + big worry among the + +On line 5523: + large investment banks. + Geithner said he was + "consumed" with finding + +On line 5525: + Vice Chairman Donald + Kohn told Bernanke that in the wake + of Bear’s collapse, some + + institutional + investors believed it was a + matter not of whether + +On line 5525: + but when.10 One set of + numbers in particular + reinforced their doubts: + +On line 5527: + JP Morgan announced + its acquisition of Bear + Stearns, the market through + +On line 5527: + credit default swaps + on Lehman’s debt) put the cost of + insuring million + +On line 5527: + of Lehman’s five-year senior + debt at annually; for + Merrill Lynch, the cost + +On line 5529: + The chief concerns were + Lehman’s real estate–related + investments and its + +On line 5529: + on short-term funding + sources, including billion of + commercial paper + +On line 5529: + repos at the end + of the first quarter of There + were also concerns + +On line 5529: + about the firm’s more than + derivative contracts with + a myriad of + + counterparties.11 As + they did for all investments + banks, the Fed and SEC + +On line 5531: + withstand the kind of + run that had taken down Bear + Stearns1 Solvency and + + liquidity were + essential and related. + If money market + +On line 5531: + Lehman’s assets were worth + less than Lehman’s valuations, + they would withdraw funds, + +On line 5531: + more collateral, + and curtail lending. That could + force Lehman to sell its + +On line 5533: + and liquidity + virtually overnight. Bear proved + it could happen. "The + +On line 5533: + but the Fed, as a + consequence of its banking + mandate, had more of + +On line 5533: + Sirri, head of the + SEC’s Division of Trading + and Markets, told the + +On line 5533: + facto primary + regulator because of + its balance sheet, its + +On line 5533: + The SEC wanted to + be collaborative, and + so came to accept + + the Fed’s focus on + capital. However, as + time progressed, both saw + + the importance of + liquidity with respect + to the problems at + + the large investment + banks."12 In fact, both problems had + to be resolved. Bear’s + +On line 5535: + precipitated + Lehman’s "first real financing + difficulties" since + +On line 5535: + Treasurer Paolo + Tonucci told the FCIC.13 Over the + two weeks following + +On line 5535: + (PDCF),14 but had to + be careful to avoid seeming + overreliant on the + +On line 5537: + cash, which would signal + funding problems. Lehman built up + its liquidity + +On line 5537: + billion at the end + of May, but it and Merrill + performed the worst among + + the four investment + banks in the regulators’ + liquidity stress + +On line 5539: + the spring and summer + of Meanwhile, the company + was also working + +On line 5539: + estate held for sale) + from billion to billion at + the end of May and + +On line 5539: + billion at the end + of the summer. Second, it + raised new capital + +On line 5541: + stock and senior and + subordinated debt from + April through June Treasury + +On line 5541: + issues."15 But other + difficulties loomed. Fuld would + later describe Lehman’s + + main problem as one + of market confidence, and + he suggested that + +On line 5541: + investors taking "naked + short" positions (short selling + Lehman’s securities + +On line 5541: + them), hoping Lehman would + fail, and potentially even + helping it fail by + + eroding confidence. + "Bear went down on rumors and + a liquidity + +On line 5541: + "Immediately + there-SEPTEMBER after, the rumors and + the naked short sellers + + came after us."16 The + company pressed the SEC to + clamp down on the naked + +On line 5541: + Division of Risk, + Strategy and Financial + Innovation shared + +On line 5541: + the FCIC a study it + did concerning short selling. + As Chairman Mary Schapiro + +On line 5541: + manipulative + short selling was the cause of + the collapse of Bear + +On line 5541: + the difficulties + faced by other investment + banks during the fall + +On line 5541: + of The SEC to date + has not brought short selling charges + related to the + +On line 5543: + of these investment + banks.18 On March Lehman reported + better-than-expected + +On line 5543: + earnings of million + for the first quarter of Its + stock jumped nearly to + +On line 5543: + Portfolio.com called + Lehman’s write-downs "suspiciously + minuscule."19 In a + +On line 5543: + in May, David Einhorn + of Greenlight Capital, which + was then shorting Lehman’s + +On line 5543: + noted the bank’s large + portfolio of commercial + real estate loans + +On line 5543: + "There is good reason + to question Lehman’s fair value + calculations. I + +On line 5543: + that greater transparency + on these valuations would + not inspire market + +On line 5545: + reasons that observers + might have been skeptical of + management at Lehman. + +On line 5547: + Brothers’ [board], they had + an actress, a theatrical + producer, and an + +On line 5547: + and not one person + who understood financial + derivatives."21 The + +On line 5547: + Library gave Lehman a + D rating in June a grade + it downgraded to + +On line 5547: + On June Lehman announced + a preliminary billion + loss for its second + +On line 5547: + loss since it became + a public company in + The share price fell to + +On line 5547: + Three days later Lehman + announced it was replacing + Chief Operating + +On line 5547: + Joseph Gregory and + Chief Financial Officer + Erin Callan. The stock slumped + +On line 5551: + again, to "THIS IS NOT + SOUNDING GOOD AT ALL" After + Lehman reported its + +On line 5551: + final second-quarter + results on June the New York + Fed’s on-site monitor + +On line 5551: + Harlow, reported + that there had been "no adverse + information on + +On line 5551: + or unsecured [funds]."23 + The announced liquidity + numbers were better + +On line 5553: + capital numbers. + Nevertheless, Lehman’s lenders and + supervisors were + +On line 5553: + The next morning, William + Dudley, then head of the New + York Fed’s Markets Group + +On line 5553: + current president), + emailed Bernanke, Geithner, Kohn, + and others that the + +On line 5553: + extended because + it "remains critical to + the stability" + +On line 5553: + the PDCF, Lehman might + have experienced a full + blown liquidity + +On line 5555: + he wrote.24 Just one week + after the earnings release, + Harlow reported + +On line 5555: + difficulties. Four + financial institutions + had "trading issues" + +On line 5555: + Lehman and had reduced + their exposure to the firm, + including Natixis, + +On line 5557: + investment bank that + had already eliminated + all activity + + with Lehman. JP Morgan + reported that large pension + funds and some smaller + + Asian central banks were + reducing their exposures + to Lehman, as well as + +On line 5559: + to Merrill Lynch. And + Citigroup requested a + to billion "comfort + +On line 5559: + exposure to Lehman, + settling later for billion.25 + In an internal + +On line 5559: + Fontana, the head of risk + management in Citigroup’s + global financial + + institutions group, + wrote that "loss of confidence + [in Lehman] is huge at + +On line 5559: + adviser in the + Federal Reserve’s banking + supervision and + +On line 5561: + was short and direct: + "This is not sounding good at + all."27 On June results + +On line 5561: + the regulators’ + most recent stress test showed that + Lehman would need billion + +On line 5561: + more than the billion + in its liquidity pool + to survive a loss + +On line 5563: + secured borrowings.28 + Lehman’s borrowings in the overnight + commercial paper + +On line 5563: + billion at the end + of November to billion + at the end of May + +On line 5565: + that matured overnight and + were collateralized by + illiquid assets.29 As + +On line 5565: + securities, such + as illiquid mortgage-related + securities—which could + +On line 5565: + the PDCF and of + which investors were becoming + increasingly wary.30 + +On line 5567: + Lehman’s largest tri-party + repo lenders—notified JP + Morgan, Lehman’s clearing + +On line 5567: + with Lehman," because JP + Morgan was "unwilling to + negotiate in + +On line 5567: + Dreyfus, another + large money market fund and + a Lehman tri-party + + repo lender, also + pulled its repo line from the + firm.32 "SPOOK THE MARKET" + +On line 5571: + the Fed considered + the risks of the tri-party + repo market, it + + also mulled over more + specific measures to help + Lehman. The New York Fed + +On line 5571: + FDIC both rejected + the company’s proposal + to convert to a + +On line 5571: + a proposal which + Geithner told Fuld was + "gimmicky" and "[could not] + +On line 5571: + proposal by the + Fed’s Dudley followed the Bear + Stearns model: billion + +On line 5571: + Lehman’s assets would be + held by a new special-purpose + vehicle, financed + +On line 5571: + by billion of Lehman’s + equity and a billion + loan from the Fed. This + +On line 5571: + remove the illiquid + assets from the market and + potentially avert + + a fire sale that could + render Lehman insolvent.34 It + didn’t go anywhere. + + But when that idea was + floated in July, the need + for such action was + +On line 5573: + so by August. In + an August email to colleagues + at the Federal + +On line 5573: + the deputy director + of the Federal Reserve + Board’s Division of + +On line 5573: + significantly + harm financial markets and + the economy if + +On line 5573: + SEPTEMBER to more + accurately assess the + potential effects + +On line 5575: + not know nearly enough + about over-the-counter derivatives + activities at + +On line 5577: + total number of + OTC derivative contracts + they had, the total + +On line 5577: + of the contracts, and + their estimated market + value, but they did + + not publicly report + the terms of the contracts or + the counterparties. + + Thus, there was no way + to know who would be owed how + much and when payments + +On line 5577: + to analyze the + possible impact of a + Lehman bankruptcy on + +On line 5579: + financial markets. + Parkinson reviewed a standing + recommendation + + to form a "default + management group" of senior + executives of + +On line 5579: + recommendation + was from the private-sector + Counterparty Risk + +On line 5579: + Policy Group, the + same group that had alerted the + Fed to the backlog + +On line 5579: + accelerating + the formation of this group + while being careful + +On line 5579: + concerns about any one + market participant.36 On + August Parkinson emailed + +On line 5579: + York Fed officials + that he was worried that no + sensible game plan + +On line 5579: + be formulated + without more information.37 + He was informed that + +On line 5579: + two days earlier + to obtain derivative-related + information, that + + they still needed more + information, and that the + meeting had "caused a + +On line 5579: + which in turn required + assurances that requests for + information would + +On line 5581: + York Fed officials + were also "very reluctant" + to request copies of + +On line 5581: + Lehman’s derivatives + counterparties, because such + a request would send + + a "huge negative + signal."39 The formation of + the industry group + + seemed "less provocative," wrote + a New York Fed official, + but could still "spook the + +On line 5583: + information was + important, but attempting + to collect it was + +On line 5583: + difficulties in + unraveling the complex + dependencies among + +On line 5583: + Lehman subsidiaries and their + counterparties, which would keep + lawyers and accountants + +On line 5585: + busy for a long time.42 + On August Treasury’s Steve Shafran + informed Parkinson that + + Secretary Paulson + agreed on the need to collect + information on + +On line 5585: + derivatives.43 It + just had to be done in a + way that minimized + +On line 5585: + circulated a + draft letter requesting the + information from + +On line 5585: + would ask E. Gerald + Corrigan, the Goldman + Sachs executive + + and former New York + Fed president who had co-chaired + the Counterparty + +On line 5585: + report, to form an + industry group to advise + on information + +On line 5585: + troubled investment + bank. Parkinson, Shafran, and others + would also create + +On line 5585: + for an investment + bank failure at Secretary + Paulson’s request. Events over + +On line 5587: + week would render these + efforts moot. n September + executives from + +On line 5589: + executives at + JP Morgan, Lehman’s tri-party + repo clearing bank, + +On line 5589: + the third-quarter results + that it would announce two weeks + later. A billion + +On line 5589: + an investment by + Korea Development Bank + or others, the sale + +On line 5589: + of real estate + assets, and the division + of the company + +On line 5589: + bank" and "bad bank" with + private equity sponsors.45 + The executives + +On line 5591: + September more than + New York Fed officials were + notified of a + +On line 5591: + the next morning "to + continue the discussion + of near-term options for + +On line 5591: + nonbank." They received + a list documenting Lehman’s + tri-party repo + +On line 5591: + at roughly billion. + Before its collapse, Bear Stearns’s + exposure had been + +On line 5591: + that counterparties + provided of Lehman’s repo + financing, and that + +On line 5591: + provided by Lehman’s + clearing banks could become a + problem. Indeed, JP + + Morgan, Citigroup, + and Bank of America had + all demanded more + + collateral from + Lehman, with the threat they might "cut + off Lehman if they don’t + +On line 5593: + On Tuesday morning, + September news there would be + no investment from + +On line 5593: + Development Bank + shook the market. Lehman’s stock plunged + from the day before, + +On line 5593: + for an afternoon + call with Bernanke, Geithner + directed his staff + + to "put together + a quick ‘what’s different1 what’s + the same1’ list about [Lehman] + +On line 5595: + [Bear Stearns], as well as + about mid-March (then) vs. early Sept + (now)."47 The Fed’s Parkinson + +On line 5595: + Treasury’s Shafran about his + concerns that Lehman would announce + further losses the + +On line 5595: + week, that it might not + be able to raise equity, + and that even though its + +On line 5597: + had been, Lehman remained + vulnerable to a loss + of confidence.48 At + +On line 5597: + Paulson convened a + call with Cox, Geithner, + Bernanke, and Treasury staff + +On line 5597: + Lehman bankruptcy."49 At + P.M., Treasury Chief of Staff Jim + Wilkinson emailed Michelle Davis, + +On line 5597: + Treasury, to express + his distaste for government + assistance: "We need + +On line 5597: + to talk. I just can’t + stomach us bailing out lehman. + Will be horrible + +On line 5599: + the press don’t u think."50 + That same day, Fuld agreed to post + an additional + +On line 5601: + collateral to + JP Morgan. Lehman’s bankruptcy + estate would later + +On line 5601: + did so because of + JP Morgan’s improper threat + to withhold repo + +On line 5601: + to Lehman.51 Steven Black, JP + Morgan’s president, said he + requested billion + +On line 5601: + to post billion.52 He + did not believe the request + put undue pressure + + on Lehman. On Tuesday + night, executives of Lehman + and JP Morgan met + +On line 5601: + at Lehman’s request to + discuss options for raising + capital. The JP + +On line 5601: + Junior Varsity," + JP Morgan executives + reported to Black. + +On line 5601: + have no proposal + and are looking to us for + ideas/credit line to + + bridge them to the first + quarter when they intend to + split into good bank/bad + +On line 5601: + Black responded, "Let’s + give them an order for the + same drugs SEPTEMBER + +On line 5601: + have apparently + been taking to think we would + do something like that."53 + + The Lehman bankruptcy + estate has a different + view. It alleges Black + +On line 5601: + firm might be willing + to purchase Lehman preferred stock, + but instead sent over + +On line 5603: + risk managers to probe + Lehman’s confidential records and + plans.54 The bankruptcy + + estate alleges that + later that night, JP Morgan + demanded that Lehman + +On line 5603: + preannouncing its + third-quarter earnings at the next + morning. The amendments + +On line 5603: + and gave JP Morgan + additional control over + Lehman bank accounts.55 Again, + +On line 5603: + executed the + agreements because JP Morgan + executives led + +On line 5603: + believe its bank would + refuse to extend intraday + credit if Lehman did + +On line 5605: + do so. JP Morgan + denies this. Black told the FCIC, + "JPMC never told Lehman + +On line 5605: + would stop extending + credit and clearing if the + September Agreements + +On line 5605: + not executed + before the markets opened on + [Wednesday,] September + +On line 5607: + Before the market + opened on Wednesday, Lehman announced + its billion third-quarter + +On line 5607: + a billion write-down. + Four hours later, Matthew Rutherford, + an adviser to + + Treasury, emailed colleagues + that several large money + funds had reduced their + + exposure to Lehman, + although there was not yet "a + wholesale pull back of + +On line 5609: + the largest fund complex, + stressed that while they hadn’t made + any significant + +On line 5609: + were still in the process + of making decisions and + wanted to update + + me later in the + day," Rutherford wrote. By Friday, + Fidelity would have + +On line 5609: + to Lehman to less than + billion from over billion the + previous Friday; + +On line 5609: + to an FCIC survey + of market participants, + in the week prior + +On line 5609: + in March, Fidelity + had pulled its entire billion + repo line to that + +On line 5613: + Federal Reserve, + working groups were directed + to "spend the next few + +On line 5613: + BofA acquisition + transaction might look, how a + private consortium + +On line 5613: + equity investors + transaction might look, and how + a Fed takeout of + +On line 5613: + look."58 That day, New York + Fed Senior Vice President + Patricia Mosser + + circulated her + opinion on Dudley’s request + for "thoughts on how to + +On line 5613: + Lehman." She laid out three + options: find a buyer at + any price, wind down Lehman’s + +On line 5613: + into bankruptcy. + Regarding option Mosser + said it "should be done + +On line 5615: + requires minimal + temporary support. No more + Maiden Lane LLCs and + +On line 5615: + [the] Fed. Moral hazard + and reputation cost is + too high. If the Fed + +On line 5615: + in March in terms of + temporary liquidity + backstops is useless. + +On line 5615: + long run MUCH worse than + option Option bankruptcy, + would be "[a] mess on + +On line 5617: + level, but fixes + the moral hazard problem."59 n + Wednesday night, a New + +On line 5617: + circulated a + "Liquidation Consortium" + game plan to colleagues.60 + +On line 5617: + one room senior-level + representatives of Lehman’s + counterparties in + +On line 5617: + credit default swap, + and over-the-counter derivatives + markets—everyone + +On line 5617: + would suffer most if + Lehman failed—and have them explore joint + funding mechanisms + + to avert a failure. + According to the proposed + game plan, Secretary + +On line 5619: + the participants + they had until the opening + of business in Asia + +On line 5619: + following Monday + morning (Sunday night, New York + time) to devise a + +On line 5619: + The game plan stated + that "we should have in mind a + maximum number + + of how much we are + willing to finance before + the meeting starts, but + +On line 5621: + our willingness to + do so to the consortium."61 + Indeed, Paulson would + + tell the consortium + when it met two days later + that the government + +On line 5623: + let Lehman fail.62 Former + Bank of America CEO Ken + Lewis told the FCIC that + +On line 5623: + called him on Wednesday, + September and asked him to + take another look + + at acquiring Lehman, + assuring him that Fuld was + ready to deal. Paulson + +On line 5623: + for Fuld and Lewis to + discuss an acquisition + in July, but Fuld + +On line 5623: + been interested + in selling the entire firm + at that time. Because + + of this history, + Lewis expressed his concerns to + Paulson that Fuld would + + not want to sell the + entire company or would + not be willing to + +On line 5623: + a team of Bank of + America executives + began reviewing + +On line 5623: + books, and on the next + day, Fuld sounded optimistic + about a deal. But Bank + +On line 5623: + determined that Lehman’s + assets were overvalued, and + Lewis told Paulson there + +On line 5623: + Paulson told Lewis—as Lewis + informed the FCIC—to put on his + "imagination hat" + + and figure out a + deal. His insistence kept the + Bank of America + +On line 5623: + Friday, September + Lewis called Paulson to repeat + his assessment—no + + government support, + no deal. Apparently Fuld + had been kept out of + + the loop, and began + to call Lewis at home. Lewis’s wife + told Fuld that Lewis would + +On line 5625: + come to the phone and + to stop calling.63 On Thursday + September an email + +On line 5625: + McCabe, a Goldman Sachs + executive, to Dudley + and others set the + +On line 5625: + "It is not pretty, + This is getting pretty scary + and ugly again. They + + [Lehman] have much bigger + counter-party risk than Bear + did, especially + +On line 5625: + market is getting + very spooked, nervous. Also have + Aig, Wamu concerns. + + This is just spinning + out of control again. Just fyi, + this is shaping up + + as going to be + a rough day."64 Bernanke was informed + that if Lehman failed, "it + +On line 5627: + a much more complex + proposition to unwind their + positions than it + +On line 5627: + have been to unwind + the positions held by Bear + Stearns," because Lehman was + +On line 5629: + twice the size of Bear + Stearns."65 Some believed government + action was required. + +On line 5629: + a senior New York + Fed official, forwarded + to her colleagues an + +On line 5629: + fund manager Louis + Bacon suggesting the New + York Fed could "attempt + +On line 5629: + or support the LEH + situation" but noting + that "none of the above + +On line 5629: + the fundamental + problem, which is too many bad + assets that need to + +On line 5633: + outline of a plan + to create a "Lehman Default + Management Group," a + +On line 5633: + Lehman counterparties + and creditors who would make + plans to cope with a + +On line 5633: + bankruptcy. They would + agree to hold off on fully + exercising their + + rights to close out their + trades with Lehman; instead, they would + establish a process + +On line 5633: + midnight on Thursday, + Boesky notified colleagues that + panicked hedge funds had + +On line 5633: + they were "expecting + [a] full blown recession" and + that there was a "full + + expectation that + Leh goes, wamu and then ML + [Merrill Lynch]." They were + + "ALL begging, pleading + for a large scale solution + which spans beyond just + + LEH." Boesky compared the + level of panic to the + failure of Bear Stearns—"On + +On line 5635: + scale of to where is + Bear-Stearns-week-panic, I would put sentiment + today at a At + + almost the same time, + JP Morgan demanded that + Lehman post another + +On line 5635: + "by the opening of + business tomorrow in New + York"; if it didn’t, + +On line 5635: + would "exercise our + right to decline to extend + credit to you."69 JP + +On line 5637: + Dimon, President + Black, and CRO Zubrow had first made + the demand in a + +On line 5637: + call earlier that + evening to Lehman CEO Fuld, CFO Ian + Lowitt, and Treasurer + +On line 5637: + Tonucci told the JP + Morgan executives on + the call that Lehman could + +On line 5637: + the demand. Dimon + said Lehman’s difficulties in + coming up with the + +On line 5637: + were not JP Morgan’s + problem, Tonucci told the FCIC. + "They just wanted the + +On line 5639: + made the point that it’s + too much cash to mobilize. + There was no give on + + that. Again, they said ‘that’s + not our problem, we just want + the cash.’"71 When Tonucci + +On line 5643: + billion tomorrow, + Dimon replied, "Nothing, maybe we + will."72 Under normal + +On line 5643: + Tonucci would not have + tolerated this treatment, + but circumstances were + + far from normal. "JPM + as ‘clearing bank’ continues + to ask for more cash + + collateral. If + we don’t provide the cash, they + refuse to clear, we fail," + +On line 5643: + in an email to Lehman + executives on Friday, + September So Lehman + +On line 5643: + in cash only by + pulling virtually every + unencum-bered asset + +On line 5645: + posted billion of + collateral by Lehman was + "inappropriate" + +On line 5645: + was "illiquid" and "could + not be reasonably valued." + Moreover, Zubrow said the + +On line 5645: + shortfall was greater than + billion.74 Lehman’s former CEO, Fuld, + told the FCIC that he + +On line 5645: + to post the billion + because JP Morgan said it + would be returned to + + Lehman at the close of + business the following day.75 + The Lehman bankruptcy + + estate made the same + allegation. This dispute + is now the subject + +On line 5645: + litigation; the + Lehman bankruptcy estate is + suing JP Morgan + +On line 5649: + the billion—and the + original billion.76 "HEADS OF + FAMILY" Should Lehman + +On line 5649: + go bankrupt1 Within + the government, sentiments + varied. On Friday + +On line 5649: + Paulson headed to + New York to "sort through his Lehman + mess," Wilkinson wrote that + +On line 5649: + still "[couldn’t] imagine + a scenario where we put in + [government] money + +On line 5649: + Governor Warsh wrote, + in response to a colleague’s + hope the Fed would not + +On line 5649: + to protect some of + Lehman’s debt holders, "I hope we + don[’]t protect anything!"78 + + But on Friday, Fed + Chairman Bernanke was taking no + chances. He stayed behind + +On line 5649: + Washington, in case + he had to convene the Fed’s + board to exercise + +On line 5651: + emergency lending + powers.79 Early Friday evening, + Treasury Secretary + + Paulson summoned the + "heads of family"—the phrase used + by Harvey Miller, Lehman’s + + bankruptcy counsel, + to describe the CEOs of the + big Wall Street firms80—to + +On line 5651: + a private-sector + solution was the only + option to prevent + +On line 5651: + Lehman bankruptcy. The + people in the room needed + to come up with a + +On line 5651: + set of options to + help limit damage to the + system. A sudden + +On line 5651: + wind-down could harm the + capital markets and pose + the significant + +On line 5651: + precipitous drop + in asset prices, resulting + in collateral + +On line 5651: + liquidity: that + is, systemic risk. He could not + offer the prospect of + +On line 5651: + resolution of + the situation, as had + been done in for Long-Term + +On line 5651: + Management. Paulson + did offer the Fed’s help through + regulatory + + approvals and access + to lending facilities, + but emphasized that + +On line 5651: + would not provide "any + form of extraordinary + credit support."81 As + +On line 5651: + York Fed General + Counsel Tom Baxter told the + FCIC, Paulson made it + +On line 5653: + be no government + assistance, "not a penny."82 + H. Rodgin Cohen, + +On line 5653: + veteran Wall Street + lawyer who has represented + most of the major + +On line 5653: + that the government’s + "not a penny" posture was + a calculated + +On line 5653: + know exactly what + the government was thinking, + but my impression + +On line 5653: + they were playing a + game of chicken or poker + or whatever. It + +On line 5653: + politically + difficult to rescue Lehman. + There had been a lot + +On line 5653: + Bear Stearns. I believe + the government thought that it + could, with respect to + + a game of chicken, + persuade the private sector + to take a big chunk" + +On line 5655: + The Fed’s internal + liquidation consortium + game plan would seem to + +On line 5655: + it contemplated + a financial commitment, + even though that was not + +On line 5655: + be divulged.84 Moreover, + notwithstanding Paulson’s "not a + penny" statement, the + +On line 5655: + of the exchequer, + Alistair Darling, said that + Paulson told him that + +On line 5655: + regulatory + assistance to support a + transaction if it + +On line 5657: + consortium meeting + on Friday night, Citigroup + CEO Vikram Pandit asked + +On line 5657: + was also going + to talk about AIG. Timothy + Geithner said + +On line 5661: + on Lehman."86 "TELL THOSE SONS + OF BITCHES TO UNWIND" What + would happen if JP + +On line 5661: + refused to provide + intraday credit for Lehman + in the tri-party + +On line 5661: + market on Monday, + September The Fed had been + considering this + +On line 5661: + summer. As Parkinson + noted, the fundamental + problem was that even + +On line 5661: + for bankruptcy, the + SEC would want Lehman’s broker-SEPTEMBER dealer + to live on and would + +On line 5661: + to grab tri-party + collateral.87 Parkinson told + the FCIC staff that Zubrow + +On line 5661: + the weekend that JP + Morgan would not unwind Lehman’s + repos on Monday + +On line 5661: + Fed did not expand + the types of collateral + that could be financed + +On line 5661: + the PDCF lending + facility. Earlier + in the year, Parkinson + +On line 5661: + said that JP Morgan’s + refusal to unwind would be + unforgiveable. Now + +On line 5663: + told Geithner + to "tell those sons of bitches + to unwind."88 Merrill + +On line 5663: + told the FCIC that by + Saturday morning, the group + of executives + +On line 5663: + they were overvalued + by anywhere from to billion. + Thain thought that was more + +On line 5663: + executives would + be willing to finance and, + therefore, Thain believed + + Lehman would fail.89 If Lehman + failed, Thain believed, Merrill would + be next. So he had + + called Ken Lewis, the CEO + of Bank of America, and + they met later that + +On line 5663: + of America’s + New York corporate apartment. + By Sunday, the two + +On line 5663: + Bank of America + would acquire Merrill for per + share, payable in Bank of + + America stock. On + Saturday afternoon, Lehman’s + counsel provided + +On line 5665: + with a document + describing how Lehman’s default + on its obligations + +On line 5665: + of defaults through to + the [subsidiaries] which have large OTC + [derivatives] books."90 + +On line 5665: + other senior Fed + officials subsequently + participated + +On line 5665: + General Counsel + Scott Alvarez cautioned others + not to mention the + +On line 5665: + JP Morgan, because + he did not want to "suggest + Fed willingness to + +On line 5669: + or anyone else."92 By + Saturday night, however, + it appeared that the + + parade of horrors + that would result from a Lehman + bankruptcy had been + + avoided. An agreement + apparently had been reached. + Barclays would purchase + +On line 5669: + of assets financed + by the private consortium + (even though the bankers in + +On line 5669: + to Barclays, had told + Lehman President Bart McDade that + Barclays was willing + +On line 5669: + private consortium + agreement to assist the deal.93 + It seemed a deal would + +On line 5671: + completed.94 "THIS DOESN’ + T SEEM LIKE IT IS GOING + TO END PRETTY" But + +On line 5671: + terribly wrong. At + A.M., Barclays CEO John Varley + and President Robert + +On line 5671: + Authority (FSA) + had declined to approve the + deal.95 The issue boiled + +On line 5671: + to a guarantee—the + New York Fed required Barclays + to guarantee Lehman’s + +On line 5671: + from the sale until + the transaction closed, much as + JP Morgan had done + +On line 5671: + March.96 Under U.K. law, + the guarantee required a + Barclays shareholder + +On line 5671: + could take to days. Though + it could waive that requirement, + the FSA asserted + + that such a waiver + would be unprecedented, that + it had not heard about + +On line 5671: + until Saturday + night, and that Barclays did not + really want to + +On line 5673: + obligation anyway. + eithner pleaded with + FSA Chairman Callum + +On line 5673: + waive the shareholder + vote, but McCarthy wanted the New + York Fed to provide + +On line 5673: + instead of Barclays.97 + Otherwise, according to + the FSA, "Barclays would + +On line 5673: + had to provide a + (possibly unlimited) + guarantee, for an + +On line 5673: + covering prior + and future exposures and + liabilities + +On line 5673: + of all transactions + entered into prior to + the purchase, even in + +On line 5675: + For Paulson, such a + guarantee by the Fed was + unequivocally + + out of the question.99 + The guarantee could have put + the Fed on the hook + + for tens of billions + of dollars. If the run on + Lehman had continued + +On line 5677: + guarantee, Barclays’ + shareholders could reject the + acquisition, and + +On line 5679: + possession of an + insolvent bank. Baxter told + the FCIC that Barclays + + had known all along that + the guarantee was required, + because JP Morgan + + had to provide the + same type of guarantee when + it acquired Bear Stearns. + +On line 5679: + Baxter said he was + "stunned" at this development. + He believed that the + +On line 5679: + reason Barclays said + it could not guarantee Lehman’s + obligations was the + +On line 5681: + Treasury’s Wilkinson emailed + JP Morgan Investment Bank + CEO Jes Staley that + +On line 5681: + in a meeting with + Paulson and Geithner + and that things did not + +On line 5683: + doesn’t seem like it + is going to end pretty."101 + In another note + +On line 5683: + later, he added that + there would be no government + assistance: "No way + +On line 5683: + here writing the usg + coms [United States government + communications] + +On line 5683: + plan for orderly + unwind also just did a + call with the WH [White + +On line 5683: + and usg is united + behind no money. No way + in hell Paulson could + +On line 5685: + blink now we will know + more after this [CEO meeting] + this morning but I + + think we are headed + for winddown unless bar-clays + deal gets untangled."102 + + It did not. Paulson + made a last-ditch pitch to his U.K. + counterpart, Darling, + +On line 5687: + admitted that he + had vetoed the transaction: + "Yeah I did. Imagine + + if I had said yes + to a British bank buying a + very large American + +On line 5687: + bank which collapsed the + following week." He would have + found himself telling a + +On line 5687: + "Everybody sitting + in this room and your children + and your grandchildren + +On line 5687: + grandchildren would be + paying for years to come." That + Bank of America + +On line 5687: + taken itself out + of the picture may have played + a role in Darling’s + + decision: "My first + reaction was ‘If this is + such a good deal how + +On line 5687: + American bank is + going to go near it1’" So + Darling concluded + +On line 5687: + Barclays to accept + the guarantee, which could have + a grave impact on + +On line 5687: + was simply out of + the question: "I spoke to Hank + Paulson and said ‘Look, + +On line 5687: + way we could allow + a British bank to take over the + liability + + of an American + bank,’ which in effect meant the + British taxpayer was + + underwriting an + American bank."104 Following + that decision in + +On line 5689: + Brothers was, for all + practical purposes, dead. + Cohen, Lehman’s counsel + +On line 5689: + the time, told the FCIC, + "When Secretary Paulson came + out of the meeting + +On line 5689: + with Geithner + and Cox, they called Lehman’s presi-SEPTEMBER dent + and me over and said, + +On line 5689: + have the consortium, + but the British government won’t + do it. Darling said + +On line 5691: + he did not want the + U.S. cancer to spread to the + U.K.’"105 At around P.M., Lehman’s + +On line 5693: + others—reconvened + at Lehman’s offices to "digest + what obviously + +On line 5693: + that the New York Fed + would provide more flexible + terms for the PDCF + +On line 5693: + include expanding + the types of collateral + borrowers could use.106 + + McDade, Kirk, Lowitt, and Miller + returned to the New York Fed + building and met with + + the Fed’s Baxter and + Dudley, the SEC’s Sirri, and + others to discuss + +On line 5695: + to McDade and Kirk, the + government officials—led + by Baxter— made it + +On line 5695: + against the expanded + types of collateral, as + other firms could. The + + sentiment was clear + but the reasons were vague, McDade + told the FCIC. He said + +On line 5695: + to allow Lehman to + provide the expanded types + of collateral + +On line 5695: + the difference in + Lehman’s being able to obtain + the funding needed + +On line 5697: + open for business on + Monday.107 Baxter explained to + the FCIC, however, + +On line 5697: + the expanded types + of collateral.108 A New + York Fed email written + +On line 5697: + P.M. on that Sunday, + September stated that Lehman’s + counsel was informed + +On line 5697: + the expansion of + PDCF-eligible collateral but that + such collateral + + would not be available + to the broker-dealer if it + filed for bankruptcy.109 + +On line 5699: + meeting show that the + Fed rejected Lehman’s request + for an even broader + +On line 5699: + of collateral + to be eligible for + PDCF financing + + and preferred that Lehman’s + holding company—but not + the broker-dealer— file + +On line 5701: + bankruptcy and that + the broker-dealer "be wound down + in an orderly + +On line 5701: + a letter dated + September the New York Fed + informed Lehman Senior + +On line 5701: + that the broker-dealer + could finance expanded types + of collateral + +On line 5701: + the PDCF, but that + letter was not sent until + A.M. on September + +On line 5701: + filed for bankruptcy.111 + The Lehman broker-dealer borrowed + to billion from the + +On line 5703: + each day over the next + three days.112 As Kirk recounted + to the FCIC, during + +On line 5703: + Sunday meeting at + the New York Fed, government + officials stepped out + +On line 5703: + an hour and came back + to ask: "Are you planning on + filing bankruptcy + + tonight1"113 A surprised Miller + replied that "no one in the room + was authorized to + +On line 5703: + file the company, + only the Board could and the + Board had to be called + +On line 5703: + a meeting and have + a vote. There would be some lag + in terms of having + +On line 5703: + file it. There was a + practical issue that you + couldn’t get it done + +On line 5703: + directors of Lehman’s + U.K. subsidiary—LBIE—would be personally + liable if they did + +On line 5703: + bankruptcy by the + opening of business Monday. + As Kirk recalled, "They + +On line 5703: + told us ‘we would like + you to file tonight. It’s the right + thing to do, because + +On line 5703: + something else which we + can’t tell you that will happen + this evening. We would like + +On line 5703: + before the opening + of trading Monday morning.’"115 + The second event would + +On line 5703: + be the announcement + of Bank of America’s + acquisition of + +On line 5703: + bankruptcy would be + "Armageddon."116 Lehman had prepared + a presentation + +On line 5703: + a Lehman bankruptcy + would be catastrophic. It + would take at least five + +On line 5703: + years to resolve, cost + to billion, and cause major + disruptions in the + + United States and abroad.117 + Baxter told the FCIC, "I knew + that the consequences + + were going to be + bad; that wasn’t an issue. + Lehman was in denial + + at that point in time. + There was no way they believed + that this story ends + +On line 5705: + a Lehman bankruptcy + they kept thinking that they were + going to be bailed + +On line 5705: + the taxpayer of + the United States. And I’m not + trying to convince + +On line 5705: + that that belief was + a crazy belief because they + had seen that happen + +On line 5705: + the Bear case." Baxter’s + mission, however, was to + "try to get them to + +On line 5705: + weren’t going to + be rescued, and then focus + on what their real + + options were, which were + drift into Monday morning + with nothing done and + + then have chaos break out, + or alternatively file." + He concluded, "From + +On line 5705: + point of view, first thing + was to convince Harvey that + it was far better + +On line 5705: + pandemonium + break out. And then he had to + have discussions with + +On line 5705: + Lehman Board because they + had a fiduciary duty + to resolve what was + +On line 5707: + other stakeholders."118 + "The only alternative + was that Lehman had to + + fail," Miller testified + to the FCIC.119 He stated that + Baxter provided + +On line 5709: + government’s plan for + the fallout from bankruptcy, + but assured him that + + the situation + was under control. Then, Miller + told the FCIC, Baxter + +On line 5711: + Lehman delegation + to leave the Fed offices. "They + basically threw + +On line 5711: + said. Miller remembered + telling his colleagues as they left + the building, "‘I don’t + + think they like us.’" Miller + continued: We went back to + the headquarters, and + +On line 5715: + pandemonium + up there— it was like a scene + from [the film] It’s a + +On line 5715: + Wonderful Life with + the run on the savings and + loan crisis. [A]ll of + +On line 5717: + paparazzi running around. + There was a guy there in a + sort of a Norse god + +On line 5717: + with a helmet and + a picket sign saying "Down + with Wall Street." There were + +On line 5717: + in and out. Bart McDade + was reporting to the board + what had happened. Most + + of the board members + were stunned. Henry Kaufman, in + particular, was + + asking "How could this + happen in America1"120 The + group informed the board + +On line 5719: + the Barclays deal had + fallen apart. The government + had instructed the + +On line 5719: + file for bankruptcy. + SEC’s Cox called. With Tom Baxter + also on the line, + +On line 5719: + the situation + was serious and required + action. The board asked + +On line 5719: + was directing them + to file for bankruptcy. Cox + and Baxter conferred + +On line 5719: + few minutes, and then + answered that the decision + was the board’s to make. + +On line 5719: + board again asked if Cox + and Baxter were telling them to + file for bankruptcy. + +On line 5719: + that they believed the + gov-SEPTEMBER ernment’s position had + been made perfectly + + clear at the meeting + at the Fed earlier in + the day.121 Following + +On line 5721: + call, McDade advised the + board that Lehman would be unable + to obtain funding + +On line 5721: + file for bankruptcy. + The company filed at A.M. + on Monday morning.122 + +On line 5725: + FCIC that government + officials understood a + Lehman bankruptcy would + + be catastrophic: + We never had any doubt about + that. It was going + + to have huge impacts + on funding markets. It would + create a huge loss + + of confidence in + other financial firms. It + would create pressure + +On line 5727: + Merrill and Morgan + Stanley, if not Goldman, which + it eventually + +On line 5727: + would probably bring + the short-term money markets + into crisis, which + + we didn’t fully + anticipate; but, of course, + in the end it did + +On line 5727: + market mutual + funds under pressure. So there + was never any doubt + +On line 5727: + our minds that it would + be a calamity, catastrophe, + and that, you know, we + + should do everything + we could to save it.123 "What’s the + connection between + +On line 5729: + General Motors1" + he asked rhetorically. "Lehman + Brothers’ failure meant + +On line 5729: + commercial paper + that they used to finance went + bad." Bernanke noted that + +On line 5729: + particular one + named the Reserve Primary + Fund, held Lehman’s paper + + and suffered losses. + He explained that this "meant there + was a run in the + +On line 5729: + market mutual + funds, which meant the commercial + paper market spiked, + +On line 5731: + "As the financial + industry came under stress," + Paulson told the FCIC, + +On line 5731: + and when Lehman collapsed, + even major industrial + corporations found + +On line 5731: + difficult to sell + their paper. The resulting + liquidity crunch + +On line 5731: + relied on this short + term funding and had failed to + anticipate how + +On line 5733: + commercial paper + market could become in times + of stress."125 Harvey Miller + +On line 5733: + "the bankruptcy of + Lehman was a catalyst for + systemic consequences + +On line 5733: + the world. It fostered + a negative reaction + that endangered the + + viability + of the financial system. + As a result of + +On line 5733: + expectations of + the financial markets and + others, a major + + loss of confidence + in the financial system + occurred."126 On the day + +On line 5735: + for bankruptcy, the + Dow plummeted more than points; + billion in value + + from retirement plans, + government pension funds, and + other investment + +On line 5737: + and affiliates + with billion in assets and + liabilities, + +On line 5737: + contracts, llowing its + counterparties to have the + option of seizing + +On line 5737: + collateral and + terminating the contracts. + After the parent + +On line 5737: + company filed, about + insolvency proceedings + of its subsidiaries in + +On line 5737: + about claims—exceeding + billion—have been filed against Lehman + as of September + +On line 5737: + Miller told the FCIC that + Lehman’s bankruptcy "represents + the largest, most complex, + +On line 5737: + in the United States." + The costs of the bankruptcy + administration + +On line 5737: + billion; as of this + writing, the proceeding is + expected to last + +On line 5739: + least another two + years.128 In his testimony + before the FCIC, Bernanke + +On line 5741: + Lehman to fail were both + legal and practical. From + a legal standpoint, + +On line 5741: + are not allowed to + lend without a reasonable + expectation of + + repayment. The loan + has to be secured to the + satisfaction of + +On line 5741: + this was before TARP. + We had no ability to + inject capital + +On line 5741: + afternoon email from + Bernanke to Fed Governor Warsh + indicated that + +On line 5741: + more than billion in + capital assistance would + have been needed to + +On line 5741: + failure. "In case I + am asked: How much capital + injection would have + +On line 5743: + needed to keep LEH + alive as a going concern1 + I gather $12B or + +On line 5745: + guys together with + Fed liquidity support + was not enough."130 In March, + +On line 5745: + Fed had provided + a loan to facilitate + JP Morgan’s purchase + +On line 5745: + Act. But, even with this + authority, practical + considerations + +On line 5745: + in play. Bernanke explained + that Lehman had insufficient + collateral and + +On line 5745: + Fed, had it acted, + would have lent into a run: + "On Sunday night of + + that weekend, what was + told to me was that—and I have + every reason to + + believe—was that there + was a run proceeding on + Lehman, that is people + + were essentially + demanding liquidity + from Lehman; that Lehman did + +On line 5745: + enough collateral + to allow the Fed to lend + it enough to meet that + + run." Thus, "If we lent + the money to Lehman, all that + would happen would be + +On line 5747: + the run [on Lehman] would + succeed, because it wouldn’t + be able to meet the + + demands, the firm would + fail, and not only would we + be unsuccessful + +On line 5747: + we would [have] saddled + the [t]axpayer with tens of + billions of dollars + + of losses."131 The Fed + had no choice but to stand by + as Lehman went under, + +On line 5749: + As Bernanke acknowledged + to the FCIC, however, his + explanation for + +On line 5749: + the explanation + he offered days after the + bankruptcy—at that time, + +On line 5749: + that he believed the + market was prepared for the + event.132 On September + +On line 5749: + he testified: "The + failure of Lehman posed risks. But + the troubles at Lehman + +On line 5749: + and investors clearly + recognized—as evidenced, for + example, by the + +On line 5749: + insuring Lehman’s debt + in the market for credit + default swaps—that the + +On line 5749: + a significant + possibility. Thus, we + judged that investors and + +On line 5749: + had had time to take + pre-cautionary measures."133 In + addition, though the + + Federal Reserve + subsequently asserted + that it did not have + +On line 5749: + save Lehman because the + firm did not have sufficient + collateral to + +On line 5749: + secure a loan from + the Fed under section the + authority to + +On line 5749: + provision is very + broad. It requires not that loans + be fully secured + +On line 5749: + they be "secured to + the satisfaction of the + Federal Reserve + +On line 5749: + Counsel Scott Alvarez + concluded that requiring + loans under to be + +On line 5749: + fully secured would + "undermine the very purpose + of section which was + +On line 5749: + credit available in + unusual and exigent + circumstances to help + + restore economic + activity."135 To CEO Fuld + and others, the Fed’s + +On line 5751: + officials discussed + and dismissed many ideas in the + chaotic days leading + +On line 5751: + to the bankruptcy, + the Fed did not furnish to + the FCIC any written + +On line 5751: + Lehman lacked sufficient + collateral to secure + a loan under Fuld + +On line 5753: + FCIC that in fact, "Lehman + had adequate financeable + collateral. [O]n + +On line 5753: + bankruptcy filing, + Lehman financed itself and did + not need access to + +On line 5753: + that Sunday night was + a liquidity bridge. We + had the capital. + + Along with its excess + available collateral, Lehman + also could have used + +On line 5753: + its Neuberger Berman + subsidiary—as did AIG some two days + later." Fuld also + +On line 5753: + assertions about Lehman’s + capital hole. He told the + FCIC, "As of August + +On line 5757: + different from the + negative or billion ‘holes’ + claimed by some." Moreover, + +On line 5757: + maintained that Lehman would + have been saved if it had been + granted bank holding + +On line 5759: + the week after Lehman’s + bankruptcy.136 The Fed chairman + denied any bias against + +On line 5759: + his view, the only + real resolution short + of bankruptcy had + +On line 5759: + to find a buyer. + Bernanke said: "When the potential + buyers were unable + +On line 5759: + carry through—in the + case of Bank of America, + because they changed their + + minds and decided + they wanted to buy Merrill + instead; in the case + +On line 5759: + Barclays, [because they + withdrew] we essentially + had no choice and had + +On line 5761: + let it fail."137 During + the September meeting of + the Fed’s Federal + +On line 5761: + Market Committee, + some members stated that the + government should not + + have prevented Lehman’s + failure because doing so + would only strengthen + +On line 5761: + "too big to fail" and + erode market discipline. They + noted that letting + +On line 5761: + the only way to + provide credibility + to the assertion + +On line 5763: + firm was "too big to + fail" and one member stated + that the market was + +On line 5763: + firm could have a broad + and disruptive effect on + financial markets + +On line 5763: + Federal Reserve + did not have. Bernanke’s view was that + only a fiscal + +On line 5765: + wide-scale failure of + financial institutions.138 + Merrill’s Thain made it + +On line 5765: + Bank of America, + formerly Lehman’s potential + suitor. Thain blamed the + +On line 5765: + out Lehman on politicians + and regulators who feared + the political + +On line 5765: + of rescuing the + firm. "There was a tremendous amount + of criticism of + + what was done with Bear + Stearns so that JP Morgan would + buy them," Thain told he + +On line 5765: + a criticism of + bailing out Wall Street. It was + a combination + +On line 5765: + Street and a belief + that there needed to be a + reinforcement of + +On line 5765: + There was never a + discussion about the legal + ability of the + +On line 5765: + do this." He noted, + "There was never discussion + to the best of my + + recollection that + they couldn’t [bail out Lehman]. It + was only that they + +On line 5767: + told the FCIC that in + his opinion, "allowing Lehman + to go bankrupt was + +On line 5767: + biggest mistake of + the whole financial crisis." + He wished that he and + +On line 5767: + convince Paulson and + Geithner to prevent + Lehman’s failure: "As I + +On line 5767: + think about what I would + do differently after + that weekend is try + +On line 5769: + grab them and shake them + that they can’t let this happen. + They were not very much + +On line 5769: + mood to listen. They + were not willing to listen + to the idea that there + +On line 5769: + to be government + support. The group of us should + have just grabbed them and + + shaken them and said, + ‘Look, you guys could not do this.’ + But we didn’t, and + +On line 5771: + were not willing to + entertain that discussion."140 + FCIC staff asked Thain if + +On line 5771: + explicitly said + to Paulson, Geithner, + or anyone else, "You + + can’t let this happen." + Thain replied, "We didn’t do it + strongly enough. We said + +On line 5773: + to them, ‘Look, this is + going to be bad.’ But it + wasn’t like, ‘No you + +On line 5775: + of that select group, + JP Morgan’s Dimon, had a + different view. He + +On line 5775: + the FCIC, "I didn’t + think it was so bad. I hate + to say that. But I + +On line 5777: + it was almost the + same if on Monday morning + the government had + +On line 5777: + saved Lehman. You still would + have terrible things happen. + AIG was going to + + have their problems that + had nothing to do with Lehman. + You were still going + +On line 5777: + runs on the other + banks and you were going to + have absolute fear + +On line 5777: + the global markets. + Whether Lehman itself got saved or + not the crisis would + + have unfolded along + a different path, but it + probably would have + +On line 5779: + York Fed General + Counsel Baxter told the FCIC + that there would have been + +On line 5779: + Baxter put it, "I + think that if the Federal + Reserve had lent to + +On line 5779: + in a way that some + people think—without adequate + collateral and + +On line 5779: + hearing and other + hearings would have only been + about how we wasted + +On line 5783: + money."143 SEPTEMBER + The Commission concludes the + financial crisis + +On line 5785: + proportions with the + collapse of Lehman Brothers. Lehman’s + collapse demonstrated + +On line 5785: + contributed to the + failures or near failures of + the other four large + +On line 5785: + (OTC) derivatives + dealing), enormous leverage, and + reliance on short-term + +On line 5785: + While investment banks + tended to be initially + more vulnerable, + +On line 5785: + from many of the same + weaknesses, including their + involvement in the + +On line 5787: + Lehman, like other large + OTC derivatives dealers, + experienced runs + +On line 5787: + its derivatives + operations that played a + role in its failure. + +On line 5787: + complicated its + bankruptcy, and the impact + of its bankruptcy + +On line 5787: + other financial + institutions contributed + significantly + + to the severity + and depth of the financial + crisis. Lehman’s failure + + resulted in part + from significant problems + in its corporate + +On line 5789: + exacerbated + by compensation to its + executives and + +On line 5791: + to rescue Lehman for + a variety of reasons, + including the lack + + of a private firm + willing and able to acquire + it, uncertainty + +On line 5791: + and political + reaction, and erroneous + assumptions that Lehman’s + + failure would have a + manageable impact on the + financial system + +On line 5791: + After the fact, they + justified their decision + by stating that the + +On line 5793: + inconsistency + of federal government + decisions in not + +On line 5793: + Stearns and the GSEs, and + immediately before + rescuing AIG, added + +On line 5799: + uncertainty and + panic in the financial + markets. SEPTEMBER + +On line 5805: + AIG CONTENTS "Current + liquidity position + is precarious" + +On line 5811: + effect" "Like a gnat + on an elephant" Nine billion + dollars is a lot + + of money, but as + AIG executives and the + board examined their + +On line 5811: + sheet and pondered the + markets in the second week + of September they + +On line 5811: + were almost certain + billion in cash could not keep + the company alive + +On line 5811: + through the next week.1 The + AIG corporate empire held + more than trillion in + +On line 5811: + insurance subsidiaries + whose regulators did not + allow the cash to + +On line 5811: + up to the holding + company, much less out to + troubled subsidiaries such + +On line 5813: + liabilities, + especially those due in + the near future, were + +On line 5815: + much larger than the + billion on hand. On Friday, + September AIG was + +On line 5817: + facing challenges on + a number of fronts. It had + to fund billion of + +On line 5817: + on that day3 because + traditional investors—for + example, money + +On line 5817: + the company had + another billion coming + due the following + +On line 5817: + On another front, + the repo lenders—who had the + comfort of holding + +On line 5817: + billion in mostly + overnight funding)5—were nonetheless + becoming skittish + +On line 5817: + the perceived weakness + of the company and the + low quality of + +On line 5819: + securities.6 On + a third front, AIG had already + put up billions of + +On line 5819: + in collateral + to its credit default swap + counterparties. By + +On line 5821: + counterparties were + demanding billion, and AIG + had posted billion. + +On line 5821: + By September the + calls had soared to billion, and + AIG had paid billion—$7.6 + + billion to Goldman + alone—and it looked very likely + that AIG would need to + + post billions more in + the near future.7 That day, S&P + and Moody’s both warned of + +On line 5821: + coming downgrades to + AIG’s credit rating, which, if + they happened, would lead + +On line 5829: + downgrade would also + trigger liquidity puts + that SEPTEMBER AIG + +On line 5829: + commercial paper, + requiring AIG to come up + with another to + +On line 5833: + was increasingly + strained by its securities + lending business. As + +On line 5833: + securities, AIG + received cash from borrowers, + typically equal + +On line 5835: + to between and of + the market value of the + securities they + +On line 5835: + the value of the + securities.10 Furthermore, + AIG had invested + +On line 5835: + assets, whose value + had fallen. Since September + state regulators + +On line 5835: + of the New York State + Insurance Department (NYSID).11 + Still, by the end of + +On line 5835: + invested billion + in cash in mortgage-related + securities, which + +On line 5835: + value to billion. + By late August the parent + company had to + +On line 5835: + provide billion to + its struggling securities + lending subsidiary, and + +On line 5835: + the securities.12 + According to Dinallo, + the collateral + + call disputes between + AIG and its credit default + swap counterparties + +On line 5835: + an orderly wind + down of the securities + lending business, and + +On line 5837: + That Friday, AIG’s board + dispatched a team led by Vice + Chairman Jacob Frenkel + +On line 5837: + top officials at + the Federal Reserve Bank + of New York.14 Elsewhere + +On line 5837: + Paulson and New York + Fed President Timothy + Geithner were + +On line 5837: + Wall Street bankers that they + had the weekend to devise + a solution to + +On line 5837: + bankruptcy without + government assistance. Now + came this emergency + +On line 5837: + "Bottom line," the New + York Fed later reported + of that meeting, "[AIG’s] + +On line 5837: + [Financial Products] + have days before they are out + of liquidity."15 + + AIG posed a simple + question: how could it obtain + an emergency loan + +On line 5839: + Federal Reserve’s + authority1 Without a + solution, there was + +On line 5839: + this conglomerate, + despite more than trillion in + assets, would survive + +On line 5843: + IS PRECARIOUS" + AIG’s visit to the New York + Fed may have been an + + emergency, but it + should not have been a surprise. + With the Primary + +On line 5843: + investment banks that + qualified as primary + dealers; AIG did not + +On line 5845: + funding to even more + large institutions that were + systemically + +On line 5845: + to look closely at + two trillion-dollar holding + companies, AIG and + +On line 5845: + Capital. Both were + large participants in the + commercial paper + +On line 5847: + outstanding paper, + GE Capital with billion.16 + In ugust, the New York + +On line 5847: + up a team to study + the two companies’ funding + and liquidity + +On line 5849: + Supervision (OTS) + regulators to discuss + AIG.17 The OTS said that + +On line 5851: + comfortable with [the] + firm’s current liquidity + [and] confident that + + the firm could access + the capital markets with + no problem if it + +On line 5853: + New York Fed did not + agree. On August Kevin Coffey, + an analyst from + +On line 5853: + Financial Sector + Policy and Analysis + unit, wrote that despite + +On line 5853: + and liquidity + pressure" and "appears to need + to raise substantial + +On line 5853: + address the impact + of deteriorating + asset values on + + its capital and + available liquidity as + well as to address + +On line 5855: + funding mismatches."19 + Coffey listed six concerns: + AIG’s significant + +On line 5855: + on AIG Financial + Products’ credit default swap + book and related + +On line 5855: + margin calls, for which + AIG had posted billion in + collateral by + +On line 5855: + obligations due to + outstanding liquidity + puts; ratings-based triggers + +On line 5855: + collateral calls + if AIG were downgraded; and + limited standby + +On line 5855: + facilities to + manage sudden cash needs. He + noted Moody’s and S&P + +On line 5857: + and liquidity + following AIG’s second-quarter + earnings. The agencies + + warned they would downgrade + AIG if it did not address + these issues.20 Four days + +On line 5859: + echoed much of Coffey’s + internal analysis. The + report, "Don’t Buy AIG: + +On line 5859: + Downgrades, Capital + Raise on the Horizon," warned that + "we foresee billion + +On line 5859: + economic losses + from [AIG’s credit default swap] + book, which could result + +On line 5861: + resulting in a + significant shift in the + risk quality of + +On line 5861: + have seen this credit + overhang story before with + another stock in + +On line 5861: + and foresee outcomes + similar in nature but + on a much larger + +On line 5861: + referring to Bear + Stearns. Ira Selig, a manager + at the New York Fed, + +On line 5861: + the Goldman report + to Coffey and others. "The + bottom line: large scale + +On line 5861: + of collateral + could substantially weaken + AIG’s balance sheet," the + +On line 5863: + manager wrote.22 On + September the New York Fed’s + Danielle Vicente noted + +On line 5863: + worsened: "AIG’s current + liquidity position + is precarious + +On line 5863: + the substantial off + balance sheet liquidity + needs." Liquidating + +On line 5863: + liabilities + would mean substantial losses + and "potentially" + +On line 5863: + she wrote. Borrowing + against AIG’s securities through + the Fed’s PDCF might + +On line 5863: + while satisfying + immediate cash needs, but + Vicente questioned whether + +On line 5865: + "necessary for the + survival of the firm."23 Arguably, + however, AIG’s volatile + +On line 5865: + commitments—including + collateral calls, contract + terminations, and + +On line 5865: + liquidity puts—could + be as high as SEPTEMBER + billion if AIG was + +On line 5865: + in addition to + the to billion of cash it + had on hand at the + +On line 5867: + agencies waited to + see how AIG would address its + liquidity and + +On line 5867: + credit default swaps + and investment portfolios, + about rating agency + +On line 5867: + capital. Indeed, + Goldman’s August report on + AIG concluded that + +On line 5869: + rating agencies were + in denial about impending + losses.25 By early + +On line 5869: + no longer in denial. + At the Friday, September + meeting at the New + +On line 5871: + "facing serious + liquidity issues that + threaten[ed] its survival + +On line 5871: + downgrade, possibly + after a rating agency + meeting September + +On line 5871: + trigger billions of + dollars in collateral + calls, liquidity + +On line 5871: + AIG’s stock had fallen + significantly (shares hit + an intraday low + +On line 5871: + of Friday, down from + a close the day before) and + credit default swap + +On line 5871: + day,27 indicating + that protection on million + of AIG debt would cost + +On line 5871: + AIG reported it + was having problems with its + commercial paper, + +On line 5871: + roll only billion + of the billion that matured + on September In + +On line 5871: + and even refusing + to provide repo funding.29 + Assets were illiquid, + +On line 5871: + declined, borrowing + was restricted, and raising + capital was not + + viable. "SPILLOVER EFFECT" + The New York Fed knew that a + failure of AIG would + +On line 5875: + dramatic, far-reaching + consequences. By the evening of + September after + +On line 5875: + looked increasingly + realistic. Hayley Boesky + of the New York Fed + + emailed William Dudley and + others. "More panic from [hedge + funds]. Now focus is + +On line 5875: + AIG," she wrote. "I am + hearing worse than LEH. Every + bank and dealer has + + exposure to them."30 + Shortly before midnight, New + York Fed Assistant + +On line 5877: + emailed Geithner, + Dudley, and other senior + officials about AIG: + + "The key take-away is + that they are potentially + facing a severe + +On line 5877: + the course of the next + several (approx. days if + they are downgraded. + +On line 5877: + risk exposures are + concentrated among the largest + international + +On line 5877: + lines, derivatives, + securities lending, etc.) + meaning [there] could be + +On line 5879: + to those firms in the + event of AIG’s failure."31 New York + Fed officials met + +On line 5879: + Saturday morning, + and gathered additional + information about + +On line 5879: + according to New + York Fed General Counsel + Tom Baxter, it "seemed + +On line 5879: + sector solution + would materialize for + AIG."32 Indeed, Christopher + +On line 5879: + Flowers, head of J. + C. Flowers Co., a private + equity firm, had + +On line 5879: + AIG CEO Robert Willumstad + the prior Thursday, and the + two had called Warren + + Buffett to discuss + a possible deal. Willumstad + told the FCIC hat he + +On line 5879: + in contact with about + a dozen private equity + firms over the weekend.33 + + AIG executives + also worked with then-Superintendent Eric + Dinallo to help + +On line 5881: + that would have allowed + AIG’s regulated subsidiaries + to essentially + +On line 5881: + reported to AIG + executives during a + conference call on + +On line 5881: + particularly + optimistic [about financial + assistance], given + +On line 5883: + [the Fed’s] 13-3 lending + [authority]."34 And by the + end of the day on + +On line 5883: + to the Fed to be + pursuing private-sector + leads. "It was clear from + + the conversation + that Flowers [is] actively + involved in working + + with everything (AIG, + regulators, bankers, etc) in + putting together both + +On line 5883: + Patricia Mosser, + a senior vice president + at the New York Fed, + +On line 5885: + LaTorre and others.35 On + Sunday morning, September + Adam Ashcraft of the New + +On line 5885: + circulated a + memo, "Comment on Possible + 13-3 Lending to AIG," + + discussing the effect + of a fire sale by AIG on + asset markets.36 In + +On line 5885: + accompanying + email, Ashcraft wrote that the "threat" by + AIG to sell assets + + was "a clear attempt + to scare policymakers + into giving [AIG] + +On line 5885: + discount window, and + avoid making otherwise hard + but viable options: + + sell or hedge the CDO + risk (little to no impact + on capital), sell + +On line 5887: + or raise capital."37 + Before a P.M. meeting, LaTorre + sent an analysis, + +On line 5887: + and cons of lending + to AIG," to colleagues. The pros + included avoiding + + a messy collapse and + dislocations in markets + such as commercial + +On line 5887: + If AIG collapsed, it + could have a "spillover effect on + other firms involved + +On line 5889: + European banks that + had lowered credit risk—and, as + a result, lowered + +On line 5891: + by buying credit + default swaps from AIG would lose + that protection if + +On line 5893: + failed. AIG’s bankruptcy + would also affect other + companies because + +On line 5893: + a trillion over-the-counter + derivatives portfolio + of which trillion was + +On line 5893: + concentrated in + large counterparties. The memo + also noted that + +On line 5893: + an AIG failure "could + cause dislocations in CDS + market [that] could leave + +On line 5895: + significantly + unbalanced."38 The cons of a + bailout included a + + "chilling effect" on + private-sector solutions + thought to be under + +On line 5895: + a Fed loan would be + insufficient to keep AIG + afloat, "undermining + +On line 5895: + 13-3 lending as a + policy tool"; an increase + in moral hazard; the + + perception that it + would be "incoherent" to + lend to AIG and not + +On line 5895: + hole. LaTorre concluded, + "Without punitive terms, lending + [to AIG] could reward + +On line 5895: + which included AIG’s + unwillingness to sell or + hedge some of its CDO + +On line 5897: + LaTorre referred to had + hit a wall, however. By + Sunday afternoon, + +On line 5897: + by AIG’s board. Flowers + told the FCIC that under his + proposal, his firm + +On line 5897: + Allianz, the giant + insurance company, would + have each invested + +On line 5897: + stock of AIG subsidiaries. + With SEPTEMBER approval from + the NYSID, the subsidiaries + +On line 5897: + parent company, + and the parent company + would get access to + +On line 5899: + Fed. Then, Allianz would + take control of AIG almost + immediately. + +On line 5899: + that he was surprised + by AIG’s unwillingness to + negotiate. "I’m + +On line 5899: + saying it would have + worked or that it was perfect + as written, but it + + was astounding to + me that given what happened, + nobody bothered to + + check this [deal] out," he + said.40 Willumstad referred to the + Flowers deal as a + + "so-called offer"—he + did not consider it to + be a "serious + +On line 5901: + immediately." + With respect to the other + potential investors + +On line 5901: + the weekend, Willumstad + said that negotiations + were unsuccessful + +On line 5901: + required government + assistance—something Willumstad + had been assured by + + the "highest levels" + would not be forthcoming.41 On + Monday morning—after Lehman had + + declared bankruptcy, + and with no private-sector + solution on the + + horizon—the Fed + initiated an effort + to have JP Morgan + +On line 5903: + Sachs assemble a + syndicate of banks to lend + about billion to keep + +On line 5905: + In the afternoon, + the rating agencies announced + their assessments, which + +On line 5905: + than expected. All + three rating agencies announced + downgrades of AIG: S&P + + by three notches to + A-, and Moody’s and Fitch by two + notches to A2 and + +On line 5905: + downgrades triggered an + additional billion in + cash collateral + +On line 5905: + Financial Products’ + credit default swaps. Goldman + Sachs alone requested + +On line 5909: + hit billion, and AIG’s + payouts increased to billion.44 + The company’s stock + +On line 5909: + closing price of the + previous Friday—a fraction + of its all-time + +On line 5911: + not agree on a deal, + despite the expectations + of Fed officials. + +On line 5911: + morning of the 15th, + everyone decided that, + ‘we’ve got to protect + +On line 5911: + own balance sheet,’ and + the banks that were going to + provide the billion + + decided that they + were not going to," Baxter + told the FCIC.45 Sarah Dahlgren, + +On line 5911: + senior New York Fed + official, agreed with Baxter. + Lehman’s bankruptcy "was + +On line 5913: + told the Commission.46 + After the markets closed, AIG + informed the New York + +On line 5913: + access the short-term + commercial paper market.47 + Regulators spent + + the next several + hours preparing for a late-night + teleconference with + + Geithner. The + "Lead point," according to an + email circulated + +On line 5913: + monitoring group, + was that "the size, name, franchise + and market presence + +On line 5913: + and retail) [of AIG] + raise questions about potential + worldwide contagion, + +On line 5913: + this franchise become + impaired."48 Late that night, for the + second time since the + +On line 5913: + Federal Reserve + Board invoked section of the + Federal Reserve + + Act to bail out a + company. As it had done + for Bear Stearns, the New + +On line 5913: + with the support of + the Treasury, would rescue a + brand-name financial + +On line 5915: + The Federal Open + Market Committee was briefed + about AIG. Members were + + told that AIG faced a + liquidity crisis but + that it was unclear + +On line 5915: + addition, the staff + noted that money market + funds had even broader + +On line 5915: + than to Lehman and that + the parent company could + run out of money + + quite soon, even within + days.49 n Tuesday morning, the + Fed put a number + +On line 5917: + table: it would loan + billion so that AIG could meet + its immediate + +On line 5917: + The collateral + would be the assets of the + parent company + +On line 5917: + The Fed stated that + "a disorderly failure + of AIG could add to + +On line 5917: + higher borrowing + costs, reduced household wealth, and + materially + + weaker economic + performance."50 By Wednesday, a + share of AIG sold for + +On line 5919: + as little as The + previous eight years’ profits + of billion would be + +On line 5921: + billion loss for this + one year, But billion would soon + prove insufficient. + +On line 5921: + Treasury added billion + under its Troubled Asset + Relief Program (TARP).51 + +On line 5921: + the Congressional + Oversight Panel, taxpayer + funds committed to + +On line 5921: + billion. The panel + faulted the government for + deciding to bail + +On line 5921: + AIG too hastily: "With + AIG, the Federal Reserve + and Treasury broke new + + ground. They put the U.S. + taxpayer on the line for + the full cost and full + + risk of rescuing + a failing company."52 The + Treasury Department + +On line 5921: + report "overlooks the + basic fact that the global + economy was on + +On line 5921: + brink of collapse and + there were only hours in which + to make critical + +On line 5925: + "LIKE A GNAT ON AN + ELEPHANT" The Office of Thrift + Supervision has + +On line 5925: + Acting Director + Scott Polakoff testified that + supervisors failed + +On line 5927: + told the FCIC that as + late as September he had + "no clue—no idea—what [AIG’s] CDS + + liability + was."55 According to Mike Finn, + the director for + +On line 5929: + OTS’s northeast region, + the OTS’s authority to + regulate holding + +On line 5929: + safety and soundness + of the FDIC-insured subsidiary of AIG + and not to focus + +On line 5929: + impact on AIG of + an uninsured subsidiary like AIG + Financial Products.56 + +On line 5929: + the European Union’s + Financial Conglomerates + Directive (FCD)—responsibilities the + + OTS had actively + sought. The directive required + foreign companies + +On line 5931: + have the equivalent + of a "consolidated + supervisor" in + +On line 5931: + home country. Starting + in the OTS worked to persuade + the European Union + +On line 5931: + was capable of + serving as AIG’s "home country + consolidated + +On line 5931: + supervisor."57 In + the agency wrote: "AIG and its + subsidiaries are subject + +On line 5931: + supervision, OTS + will conduct continuous + on-site reviews of AIG + +On line 5931: + its subsidiaries."58 Yet even + Reich told FCIC staff that he + did not understand + +On line 5933: + under the FCD. The + former director said he + was never sure what + + authority the + OTS had over AIG Financial + Products, which he said + +On line 5937: + the OTS’s claim that it + lacked authority over AIG + Financial Products + +On line 5937: + its own actions: the + OTS did in fact examine + the subsidiary, albeit + +On line 5937: + Cassano, the head of + the subsidiary. Joseph Gonzales, + the examiner + +On line 5937: + April to November + told FCIC staff, "I overheard one + employee saying + + that Joe Cassano felt + that [the OTS was] overreaching + our scope by going + + into FP."60 The OTS + did not look carefully at + the credit default + +On line 5939: + AIG did describe the + nature of its super-senior + portfolio in its + +On line 5939: + reports at that time, + including the dollar amount + of total credit + + default swaps that it + had written. Gonzales said + that the OTS did not + +On line 5939: + about the CDS during + the period.61 After a + limited review + +On line 5939: + week before Goldman + sent AIG Financial Products + its first demand for + + collateral— the + OTS concluded that the risk + in the CDS book was + +On line 5941: + to be measured and + decided to put off a + more detailed review + +On line 5941: + The agency’s stated + reason was its limited + time and staff resources.63 + +On line 5943: + credit default swap + positions. Yet the OTS did + not initiate an + +On line 5943: + the credit default + swaps until September 2008—ten + days before AIG went + +On line 5943: + on October more + than a month after AIG failed. + It was, former OTS + +On line 5945: + "in hindsight, a bad + choice."64 Reich told the FCIC that + before AIG had not + + been a great concern. + He also acknowledged that + the OTS had never + +On line 5945: + Products unit, and thus + couldn’t regulate it. "At + the simplest level, + +On line 5945: + organization + like OTS cannot supervise + AIG, GE, Merrill Lynch, + +On line 5945: + and entities that + have worldwide offices. I would + be the first to say + +On line 5945: + that it has total + responsibility over + AIG and all of its + +On line 5947: + subsidiaries it’s like a + gnat on an elephant— there’s no + way." Reich said that + +On line 5947: + impractical and + unrealistic. I think + we thought we could grow + +On line 5949: + I think that was sort + of pie in the sky dreaming."65 + Geithner agreed, + + and told Reich so + bluntly. Reich told the FCIC + about a phone call from + +On line 5949: + after the rescue. + "About all I can remember + is the foul language + +On line 5949: + other end of the + line," Reich said. He recalled + Geithner telling + +On line 5953: + handed me a bag + of sh*t.’ I just listened."66 The + Commission concludes + +On line 5953: + was rescued by the + government primarily + because its enormous + +On line 5953: + capital reserves, + or hedging its exposure—a + profound failure in + +On line 5955: + deregulation of + over-the-counter (OTC) derivatives, + including credit + +On line 5955: + requirements that would + have lessened the likelihood + of AIG’s failure. The + + OTC derivatives + market’s lack of transparency + and of effective + +On line 5957: + exacerbated + the collateral disputes + of AIG and Goldman + +On line 5957: + regulatory + arbitrage by setting up + a major business + +On line 5957: + locating much of + the business in London, and + selecting a weak + +On line 5959: + (OTS). The OTS failed to + effectively exercise + its authority + +On line 5959: + affiliates: it + lacked the capability + to supervise an + +On line 5959: + and complexity + of AIG, did not recognize + the risks inherent + +On line 5959: + not understand its + responsibility to + oversee the entire + +On line 5961: + Financial Products. + Furthermore, because of the + deregulation of + +On line 5961: + from regulating + AIG’s sale of credit default + swaps even though they were + +On line 5961: + been regulated + as insurance contracts, AIG + would have been required + +On line 5961: + reserves, would not have + been able to enter into + contracts requiring + +On line 5961: + not have been able to + provide default protection + to speculators; + + thus AIG would have been + prevented from acting in + such a risky manner. + +On line 5963: + interconnected + with many large commercial banks, + investment banks, and + +On line 5963: + through counterparty + credit relationships on + credit default swaps + +On line 5963: + activities such + as securities lending + that its potential + + failure created + systemic risk. The government + concluded AIG was + +On line 5963: + and committed more + than billion to its rescue. + Without the bailout, AIG’s + +On line 5963: + and collapse could have + brought down its counterparties, + causing cascading + +On line 5973: + financial system. + CRISIS AND PANIC CONTENTS + Money market funds: + +On line 5975: + "Dealers weren’t even + picking up their phones" Morgan + Stanley: "Now we’re the + +On line 5981: + "It’s yours".........................................................................365 Wachovia: "At + the front end of the dominoes + as other dominoes + +On line 5985: + TARP: "Comprehensive + approach" AIG: "We needed to + stop the sucking chest + + wound in this patient".....................376 + Citigroup: "Let the world know + we will not pull a + +On line 5991: + "A shotgun wedding" + September 2008—the date of the + bankruptcy of Lehman + +On line 5991: + the takeover of Merrill + Lynch, followed within hours by + the rescue of AIG—marked + +On line 5991: + beginning of the + worst market disruption in + postwar American + + history and an + extraordinary rush to + the safest possible + +On line 5991: + that many other large + financial institutions + were on the edge of + + failure, and the Lehman + bankruptcy seemed to prove that + at least some of them + +On line 5993: + not have access to + the federal government’s + safety net. John Mack, + +On line 5993: + Stanley during the + crisis, told the FCIC, "In the + immediate wake + +On line 5993: + Morgan Stanley and + similar institutions + experienced a + +On line 5993: + bank,’ as investors lost + confidence in financial + institutions and + +On line 5995: + investment banking + business model came under + siege."1 "The markets were + +On line 5995: + bad, the volatility, + the illiquidity, some things + couldn’t trade at all, + +On line 5995: + completely locked, the + markets were in terrible + shape," JP Morgan CEO + +On line 5995: + recalled to the FCIC. + He thought the country could face + unemployment. "We + + could have survived it + in my opinion, but it would + have been terrible. + +On line 5995: + would have stopped lending, + marketing, investing and + probably laid off + +On line 5997: + done it in three weeks. + You get companies starting + to take actions like + +On line 5999: + Treasury Secretary + Timothy Geithner + told the FCIC, "You had + + people starting to + take their deposits out of very, + very strong banks, long way + + removed in distance + and risk and business from the + guys on Wall Street that + +On line 5999: + the epicenter of + the problem. And that is a + good measure, classic + +On line 5999: + an interview in + December Geithner + said that "none of [the + + biggest banks] would have + survived a situation + in which we had let + + that fire try to burn + itself out."4 Fed Chairman Ben + Bernanke told the FCIC, "As + +On line 6001: + that September and + October of was the worst + financial crisis + +On line 6001: + the Great Depression. + If you look at the firms that + came under pressure + +On line 6001: + period only + one was not at serious + risk of failure. So + +On line 6001: + of maybe the of the + most important financial + institutions in + +On line 6001: + the United States, were + at risk of failure within + a period of + +On line 6003: + week or two."5 As it + had on the weekend of Bear’s + demise, the Federal + +On line 6003: + announced new measures + on Sunday, September to + make more cash available + + to investment banks + and other firms. Yet again, it + lowered its standards + +On line 6003: + collateral that + investment banks and other + primary dealers + +On line 6003: + borrowing under + the two programs to support + repo lending, the + +On line 6003: + Term Securities + Lending Facility (TSLF).6 + And, providing a + +On line 6003: + borrow cash from their + insured depository + affiliates. The + + investment banks drew + liberally on the Fed’s + lending programs. By + +On line 6005: + end of September, + Morgan Stanley was getting + by on billion of + +On line 6007: + life support; Goldman + was receiving billion.7 But + the new measures did + +On line 6007: + market panic. Among + the first to be directly + affected were the + +On line 6007: + money market funds + and other institutions + that held Lehman’s billion + +On line 6007: + paper and made loans + to the company through the + tri-party repo + +On line 6007: + known exposure to + that jeopardy, including the + Reserve Management + +On line 6009: + Reserve Primary + Fund and Wachovia’s Evergreen + Investments. Other + +On line 6009: + direct connections + to Lehman included the hedge + funds, investment banks, + +On line 6011: + Lehman’s more than over-the-counter + derivatives contracts. For + example, Deutsche Bank, + +On line 6013: + and UBS together + had more than outstanding trades + with Lehman as of May + +On line 6015: + law to terminate + their derivatives contracts + with Lehman upon its + +On line 6015: + and to the extent + that Lehman owed them money on + the contracts they could + +On line 6015: + Lehman collateral + that they held. However, any + additional amount + + owed to them had to + be claimed in the bankruptcy + proceeding. If they + +On line 6015: + collateral with + Lehman, they would have to make a + claim for the return + +On line 6015: + collateral, and + disputes over valuation + of the contracts would + +On line 6015: + would delay payment + and most likely result in + losses. Moreover, any + +On line 6017: + these contracts were now + gone, increasing risk.8 Investors + also pulled out of + + funds that did not have + direct Lehman exposure. The + managers of these funds, + +On line 6017: + billion out of the + commercial paper market + in September and + + shifted billions of + dollars of repo loans to + safer collateral, + +On line 6017: + further pressure on + investment banks and other + finance companies + +On line 6019: + Interbank Lending + As concerns about the health of + bank counterparties + +On line 6019: + interest rates to + compensate for the risk. The + one-month LIBOR-OIS spread + + measures the part of + the interest rates banks paid + other banks that is + +On line 6019: + this credit risk. Strains + in the interbank lending + markets appeared just + +On line 6021: + the crisis began + in and then peaked during the + fall of pended on + +On line 6021: + paper market died, + the biggest corporations + in America thought + +On line 6021: + finished," Harvey Miller, + the bankruptcy attorney + for the Lehman estate, + + told the FCIC.10 Investors + and uninsured depositors + yanked tens of billions + +On line 6023: + of banks whose real + estate exposures might be + debilitating + +On line 6023: + Wachovia) in favor + of those whose real estate + exposures appeared + +On line 6023: + JP Morgan). Hedge funds + withdrew tens of billions of + dollars of assets + +On line 6023: + in custody at the + remaining investment banks + (Goldman Sachs, Morgan + +On line 6023: + Bank of America + acquisition wouldn’t close + for another three + +On line 6025: + commercial banks with + prime brokerage businesses + (JP Morgan, Credit + +On line 6025: + banks had more diverse + sources of liquidity than + the investment banks + +On line 6025: + well as large bases of + insured deposits. JP Morgan + and BNY Mellon, the + +On line 6025: + on their intraday + exposures, demanding more + collateral than + +On line 6025: + from the remaining + investment banks and other + primary dealers. + + Many banks refused to + lend to one another; the + cost of interbank + +On line 6027: + Monday, September + the Dow Jones Industrial + Average fell more + +On line 6027: + than points, or the largest + single-day point drop since the + terrorist attacks. + +On line 6029: + financial markets + and firms--when the Dow Jones fell + and financial stocks + +On line 6029: + fell For the month, the + S&P would lose billion of its + value, a decline + +On line 6031: + of 9%—the worst month since + September And specific + institutions would + +On line 6035: + direct hits. MONEY + MARKET FUNDS: "DEALERS WEREN’ T + EVEN PICKING UP THEIR + +On line 6037: + Reserve Primary + Fund had million invested + in Lehman’s commercial + +On line 6037: + Fund was the world’s first + money market mutual + fund, established in + +On line 6037: + in conservative + assets such as government + securities and + +On line 6037: + of deposit and had + for years enjoyed Moody’s and S&P’s + highest ratings for + +On line 6039: + and liquidity. + In March the fund had advised + investors that it had + +On line 6039: + underperformed" its + rivals, owing to a "more + conservative and + + risk averse manner" of + investing—"for example, + the Reserve Funds do + +On line 6039: + it quietly but + dramatically changed that + strategy. Within + +On line 6039: + commercial paper + grew from zero to one-half of + Reserve Primary’s + +On line 6039: + was the fastest-growing + money market fund complex + in the United States + +On line 6043: + 2008—doubling in the first + eight months of alone.12 Earlier + in Primary Fund’s + + managers had loaned Bear + Stearns money in the repo + market up to two + +On line 6043: + near-collapse, pulling its + money only after Bear + CEO Alan Schwartz appeared + +On line 6043: + days, Primary Fund + Portfolio Manager Michael + Luciano told the FCIC. + +On line 6043: + said he assumed that + the federal government + would similarly + +On line 6043: + if Lehman or one of + the other investment banks, + which were much larger + +On line 6043: + apparent systemic + risks, ran into trouble. These + firms, Luciano said, were + +On line 6045: + fail.13 On September + when Lehman declared bankruptcy, + the Primary Fund’s + +On line 6045: + fund’s total assets + of billion. That morning, the + fund was flooded with + +On line 6045: + custodian bank, + initially helped the fund meet + those requests, largely + + through an existing + overdraft facility, but + stopped doing so at + +On line 6045: + representatives + reportedly described State + Street’s action as "the + +On line 6045: + assurances from the + fund’s investment advisors, + Bruce Bent Sr. and Bruce + +On line 6047: + investors requested + an additional billion + later on Monday + +On line 6049: + Tuesday, September + Meanwhile, on Monday, the fund’s + board had determined + +On line 6049: + the Lehman paper was + worth cents on the dollar. That + appraisal had quickly + +On line 6049: + closed Tuesday, Reserve + Management publicly announced + that the value of + + its Lehman paper was + zero, "effective 4:00PM New + York time today." As + +On line 6049: + the fund broke the buck.16 + Four days later, the fund sought + SEC permission to + +On line 6051: + redemptions. Other + funds suffering similar + losses were propped up + +On line 6051: + asset management + unit, Evergreen Investments, + announced that it would + +On line 6051: + that held about million + in Lehman paper. On Wednesday, + BNY Mellon announced + +On line 6051: + Institutional + Cash Reserves fund and four of + its trademark Dreyfus + +On line 6051: + funds. BNY Mellon would + take an after-tax charge of + million because of + +On line 6051: + Over the next two years, + money market funds—36 based in + the United States, in + + Europe17—would receive + such assistance to keep their + funds from breaking the + +On line 6053: + the Primary Fund + broke the buck, the run took an + ominous turn: it even + +On line 6053: + market funds with no + direct Lehman exposure. This + lack of exposure + +On line 6053: + generally known, + since the SEC requires these funds + to report details + +On line 6053: + their investments at + least quarterly. Investors pulled + out simply because + +On line 6053: + feared that their fellow + investors would run first. "It was + overwhelmingly clear + + that we were staring + into the abyss—that there wasn’t + a bottom to this—as + + the outflows picked up + steam on Wednesday and Thursday," + Fed economist Patrick + + McCabe told the FCIC. "The + overwhelming sense was that this + was a catastrophe + + that we were watching + unfold."18 "We were really + cognizant of the fact + +On line 6057: + weren’t backstops in + the system that were resilient + at that time," the Fed’s + +On line 6057: + said. "Liquidity + crises, by their nature, invoke + rapid, emergent episodes—that’s what + +On line 6059: + By their nature, they + spread very quickly."19 An early + and significant + +On line 6059: + casualty was + Putnam Investments’ billion + Prime Money Market + +On line 6059: + on Wednesday with a + wave of redemption requests. + The fund, unable to + +On line 6059: + assets quickly enough, + halted redemptions. One week + later, it was sold + +On line 6061: + Investors. Within a + week, investors in prime money + market funds—funds that + +On line 6061: + in highly rated + securities—withdrew billion; + within three weeks, they + +On line 6061: + money was mostly + headed for other funds that + bought only Treasuries + +On line 6061: + was more money than + those funds could invest, and they + had to turn people + +On line 6061: + As a result of + the unprecedented demand + for Treasuries, the yield + +On line 6065: + on four-week Treasuries fell + close to levels not seen since + World War II. Money + + market mutual + funds needing cash to honor + redemptions sold their + +On line 6065: + illiquid investments. + Unfortunately, there was + little market to + +On line 6065: + in Money Market + Funds anecdotally that the + dealers weren’t even + +On line 6065: + phones. The funds had to + get rid of their paper; they + didn’t have anyone + + to give it to," McCabe + said.21 And holding unsecured + commercial paper + +On line 6067: + was now simply out + of the question: fund managers + wanted no part of + + the next Lehman. An FCIC + survey of the largest money + market funds found that + +On line 6067: + were unwilling to + purchase commercial paper + from financial firms + +On line 6067: + the week after Lehman. + Of the respondents, the five + with the most drastic + +On line 6067: + commercial paper + cut their holdings by half, from + billion to billion.22 + +On line 6067: + to unprecedented + increases in the rates on + commercial paper, + +On line 6067: + commercial paper + to pay their immediate + expenses such as + +On line 6067: + inventories. The + cost of commercial paper + borrowing spiked in + +On line 6067: + dramatically + surpassing the previous + highs in (see figure + +On line 6069: + a broad-based run on + commercial paper markets," + Geithner told + + the FCIC. "And so you + faced the prospect of some of the + largest companies in + +On line 6069: + and the United States + losing the capacity + to fund and access + +On line 6069: + markets."23 Three decades of + easy borrowing for those with + top-rated credit in + +On line 6069: + very liquid market + had disappeared almost overnight. + The panic threatened + +On line 6069: + of dollars in Cost + of Short-Term Borrowing cash and + assets every day + +On line 6069: + upon which consumers + rely—for example, to + use their credit cards + +On line 6069: + debit cards. "At that + point, you don’t need to map out + which particular + + mechanism—it’s not + relevant anymore—it’s + become systemic and + +On line 6071: + it needs to be stopped," + Palumbo said.24 The government + responded with two + +On line 6071: + lending programs on + Friday, September Treasury + would guarantee the + +On line 6071: + net asset value + of eligible money + market funds, for a + + fee paid by the funds.25 + And the Fed would provide loans + to banks to purchase + +On line 6071: + commercial paper + from money market funds.26 In + its first two weeks, this + +On line 6073: + money market funds. + With the financial sector + in disarray, the + +On line 6073: + a temporary ban + on short-selling on the stocks of + about banks, insurance + +On line 6075: + and securities + firms. This action, taken on + September followed + +On line 6075: + temporary ban put + in place over the summer on + naked short-selling—that is, + +On line 6075: + without arranging + to deliver it to the + buyer—of financial stocks + +On line 6077: + manipulation." + Meanwhile, Treasury Secretary + Henry Paulson and + +On line 6077: + they needed a more + systematic approach to + dealing with troubled + +On line 6077: + authority from + Congress for TARP. "One hing that + was constant about the + + crisis is that we + were always behind. It was + always morphing + + and manifesting + itself in ways we didn’t + expect," Neel Kashkari, then + +On line 6077: + secretary of the + treasury, told the FCIC. "So we + knew we’d get one shot + +On line 6077: + authority and + it was important that we + provided ourselves + +On line 6077: + flexibility. + We specifically designed + the authority + +On line 6077: + basically to + do whatever we needed + to do." Kashkari "spent the + +On line 6077: + weeks basically + living on Capitol Hill."27 As + discussed below, the + +On line 6081: + MORGAN STANLEY: "NOW + WE’RE THE NEXT IN LINE" Investors + scrutinized the two + +On line 6081: + large, independent + investment banks after the + failure of Lehman and + +On line 6081: + Stanley. On Monday, + September the annual + cost of protecting + +On line 6083: + Morgan Stanley debt + through credit default swaps jumped + to $682,000—from on Friday—about + + double the cost for + Goldman. "As soon as we come + in on Monday, we’re + +On line 6083: + the eye of the storm + with Merrill gone and Lehman gone," + John Mack, then Morgan + + Stanley’s CEO, said to + the FCIC. He later added, "Now + we’re the next in line."28 + +On line 6085: + the regulators’ + liquidity stress tests months + earlier. But the + +On line 6085: + Wong, Morgan Stanley’s + treasurer, heard early from + his London office + +On line 6085: + a counterparty + on derivatives trades.30 He + called those banks and they + + agreed to keep their trades + with Morgan Stanley, at least + for the time being. + +On line 6087: + through novations had + contributed to the demise of + Bear and Lehman. Repo + +On line 6089: + funds, likewise did not + panic immediately. + On Monday, only + +On line 6091: + of them requested + slightly more collateral.31 + But the relative + +On line 6091: + was fleeting. Morgan + Stanley immediately + became the target + +On line 6091: + hedge fund run. Before + the financial crisis, it + had typically + +On line 6091: + brokers like Morgan + Stanley who were worried about + their exposures to + +On line 6091: + fund clients. Now the roles + were reversed. The Lehman episode had + revealed that because + + prime brokers were able + to reuse clients’ assets to + raise cash for their own + +On line 6093: + could be frozen or lost + in bankruptcy proceedings.32 + To protect themselves, + +On line 6093: + of prime brokers in + bank holding companies, such + as JP Morgan; big + + foreign banks, such as + Deutsche Bank and Credit Suisse; + and custodian + +On line 6093: + Mellon and Northern + Trust, which they believed were safer + and more transparent. + + Fund managers told the + FCIC that some prime brokers took + aggressive measures + +On line 6095: + hedge fund customers from + demanding their assets. For + example, "Most [hedge + +On line 6095: + cash movement from [prime + brokers] primarily through + a fax," the hedge fund + +On line 6095: + Jonathan Wood told the FCIC. + "What tends to happen in very + stressful times is those + +On line 6095: + lost. I’m not sure that’s + just coincidental that + was collateral + +On line 6095: + whatever lending + [prime brokers] had against you and + they didn’t want to + +On line 6099: + [away]."33 Soon, hedge funds would + suffer unprecedented runs + by their own investors. + +On line 6099: + an FCIC survey of + hedge funds that survived, investor + redemption requests + +On line 6099: + of client funds in the + fourth quarter of This pummeled + the markets. Money + +On line 6101: + in hedge funds totaled + trillion, globally, at the + end of but because + +On line 6101: + their market impact + was several times larger. + Widespread redemptions + +On line 6101: + further depressing + market prices. Many hedge funds would + halt redemptions or + +On line 6105: + On Monday, hedge funds + requested about billion from + Morgan Stanley.36 Then, + +On line 6105: + on Tuesday morning, + Morgan Stanley announced a + profit of billion + +On line 6105: + the three months ended + August about the same as that + period a year + +On line 6107: + Mack had decided + to release the good news a + day early, but this + + move had backfired. "One + hedge fund manager said to + me after the fact + +On line 6109: + he thought preannounc-ing + earnings a day early was + a sign of weakness. + + So I guess it was, + because people certainly + continued to short + +On line 6109: + sell our stock—I don’t know + if they were shorting it but + they were certainly + +On line 6109: + the FCIC.37 Wong said, "We + were managing our funding + but really there + +On line 6109: + that were happening + as a result of the Lehman + bankruptcy that were + +On line 6109: + affect, really + ripple through and affect some + of our clients, our more + +On line 6111: + sophisticated + clients."38 The hedge fund run became + a billion torrent + + on Wednesday,39 the day + after AIG was bailed out and + the day that "many of + +On line 6111: + sophisticated + clients started to liq-uefy," as + Wong put it.40 Many of + +On line 6111: + borrowed billion from + the Fed’s PDCF on Tuesday, + billion on Wednesday, + +On line 6113: + triggered the event that + Fed policymakers had + worried about over the + + summer: an increase + in collateral calls by + the two tri-party + +On line 6113: + banks, JP Morgan and + BNY Mellon. As had happened + during the Bear episode, + +On line 6113: + became concerned about + their intraday exposures + to Morgan Stanley, + +On line 6113: + Goldman. On Sunday + of the Lehman weekend, the Fed + had lowered the bar + +On line 6113: + collateral that + it would take for overnight lending + through the PDCF. But + +On line 6113: + not designed to take + the place of the intraday + funding provided + +On line 6113: + JP Morgan and BNY + Mellon, and neither of them + wanted to accept + +On line 6113: + the lower-quality + collateral that the Fed + was accepting for + +On line 6113: + would not make those loans + to the three investment banks + without requiring + +On line 6115: + more collateral. + "Big intraday issues at + the clearing banks," the + +On line 6115: + Eichner informed + New York Fed colleagues in an + early Wednesday email. + +On line 6115: + and are asking for + cash/securities. Lots of + desk level noise around + +On line 6119: + Stanley] and [Merrill + Lynch] and taking the name. Not + pretty."41 "Taking the + +On line 6121: + a counterparty + on a trade. On Thursday, BNY + Mellon requested + +On line 6123: + in collateral + from Morgan Stanley. nd New + York Fed officials + +On line 6125: + Morgan was "thinking" + about requesting billion on + top of a billion + +On line 6125: + deposit.42 According + to a Fed examiner + at Citigroup, a + +On line 6125: + from that firm had said + that "Morgan [Stanley] is the + ‘deer in the headlights’ + +On line 6125: + significant stress + in Europe. It’s looking like + Lehman did a few weeks + +On line 6127: + Commercial paper + markets also seized up for + Morgan Stanley. From + +On line 6127: + Friday, September + to the end of September, + the amount of the firm’s + +On line 6127: + commercial paper + had fallen nearly and it + had rolled over only + +On line 6127: + comparison, on + average Morgan Stanley + rolled over about million + + every day in the + last two weeks of August.44 On + Saturday, Morgan + +On line 6129: + briefed the New York Fed + on the situation. By + this time, the firm had + +On line 6129: + billion in PDCF + funding and billion in TSLF + funding from the Fed.45 + +On line 6129: + billion to billion + in one week. Repo lenders had + pulled out billion and + +On line 6129: + had taken billion + out of Morgan Stanley’s prime + brokerage. That run + +On line 6129: + vastly exceeded + the company’s most severe + scenario in stress tests + +On line 6131: + one month earlier.46 + During the week, Goldman Sachs + had encountered a + +On line 6131: + liquidity pool + had fallen from about billion + on the previous + +On line 6131: + of the week, its Fed + borrowing totaled billion + from the PDCF and + +On line 6133: + Blankfein, Goldman’s CEO, + told the FCIC, We had tremendous + liquidity through + + the period. But + there were systemic events going + on, and we were very + +On line 6133: + you are asking me + what would have happened but for + the considerable + +On line 6133: + we were in—it was a + more nervous position than + we would have wanted + +On line 6133: + the government help. + We weren’t relying on + those mechanisms. I + +On line 6133: + good about it, but we + were going to bed every + night with more risk than + +On line 6133: + have, either for our + business or for the system + as a whole—risk, not + + certainty.47 Bernanke told + the FCIC that the Fed believed + the run on Goldman + + that week could lead to + its failure: "[Like JP Morgan,] + Goldman Sachs I would + +On line 6135: + also protected + themselves quite well on the whole. + They had a lot of + +On line 6135: + in the investment + banking category rather + than the commercial + +On line 6135: + category, when + that huge funding crisis hit + all the investment + + banks, even Goldman Sachs, + we thought there was a real + chance that they would go + + under."48 Although it + did not keep pace with Morgan + Stanley’s use of the + + Fed’s facilities, + Goldman Sachs would continue + to access the Fed’s + +On line 6135: + PDCF borrowing + to a high of billion in + October and its + +On line 6137: + both Morgan Stanley + and Goldman Sachs applied to + the Fed to become + +On line 6137: + companies. "In my + 30-year history, [Goldman and + Morgan Stanley] had + +On line 6137: + Federal Reserve + supervision—[but after + Lehman,] those franchises + +On line 6139: + they were next unless + they did something drastic. That + drastic thing was to + +On line 6139: + holding companies," + Tom Baxter, the New York Fed’s + general counsel, + +On line 6139: + the FCIC.49 The Fed, in + tandem with the Department + of Justice, approved + +On line 6139: + two applications + with extraordinary speed, + waiving the standard + +On line 6139: + company into + a national bank, subject + to supervision + +On line 6139: + of the Comptroller + of the Currency (OCC), and + Goldman converted + +On line 6139: + that was a member + of the Federal Reserve + System, subject to + + supervision by + the Fed and New York State. The + Fed would begin to + + supervise the two + new bank holding companies. + The two companies + +On line 6141: + emergency access + to the discount window for + terms of up to days.51 + +On line 6141: + more important, "I + think the biggest benefit + is it would show you + + that you’re important + to the system and the Fed + would not make you a + + holding company + if they thought in a very short + period of time + +On line 6141: + be out of business," + Mack told the FCIC. "It sends a + signal that these two + +On line 6143: + to survive."52 In a + show of confidence, Warren + Buffett invested + +On line 6143: + invested billion + in Morgan Stanley. Mack said + he had been waiting + +On line 6143: + confirmation of + Mitsubishi’s investment when, late + Sunday afternoon, + +On line 6143: + Bernanke, Geithner, + and Paulson. "Basically + they said they wanted + + me to sell the firm," + Mack told the FCIC. Less than an + hour later, Mitsubishi + +On line 6145: + its investment and + the regulators backed off.53 + Despite the weekend + +On line 6145: + the run on Morgan + Stanley continued. "Over the + course of a week, a + + decreasing number + of people [were] willing to + do new repos," Wong + + said. "They just couldn’t + lend anymore."54 By the end of + September, Morgan + +On line 6149: + But Morgan Stanley’s + liquidity depended + critically on + +On line 6149: + borrowing from two + Fed programs, billion from the + PDCF and billion + + from the TSLF. Goldman + Sachs’s liquidity pool had + recovered to about + +On line 6151: + backed by billion from + the PDCF and billion from + the TSLF. OVERTHECOUNTER + +On line 6153: + had been declining + as investors grew more concerned + about counterparty + +On line 6153: + of these markets slowed + to a crawl; in some cases, + there was no market + +On line 6153: + trades whatsoever. + A sharp and unprecedented + contraction of the + + market occurred.56 "The + OTC derivatives markets + came to a grinding + +On line 6155: + viability + of every participant + regardless of their + +On line 6155: + by liquidating + their positions in other + assets those swaps were + + designed to hedge." This + market was nregulated + and largely opaque, with + +On line 6155: + public reporting + requirements and little or + no price discovery. + +On line 6155: + participants in + the market became concerned + about the exposures + +On line 6155: + creditworthiness + of their counterparties and + the value of their + +On line 6157: + That uncertainly + caused an abrupt retreat from the + market. Badly hit + +On line 6157: + for derivatives + based on nonprime mortgages. Firms + had come to rely + +On line 6157: + indices to value + their nonprime mortgage assets. + The ABX.HE.BBB- 06-2, + +On line 6159: + whose decline in had + been an early bellwether for + the market crisis, + +On line 6159: + had been trading around + cents on the dollar since May. + But trading on this + +On line 6159: + had become so thin, + falling from an average + of about transactions + +On line 6161: + week from January + to September to fewer + than transactions per + +On line 6161: + week in October + that index values weren’t + informative.58 So, + +On line 6161: + was a valid price for + these assets1 Price discovery + was a guessing game, + +On line 6163: + it had been under + normal market conditions. + The contraction of + +On line 6163: + the valuation + of mortgage securities. + Derivatives had + +On line 6163: + used to manage all + manner of risk—the risk that + currency exchange + + rates would fluctuate, + the risk that interest rates + would change, the risk that + +On line 6163: + so that positions + could be adjusted daily + and at little cost. + +On line 6163: + everyone wanted + to reduce exposure to + everyone else. There + + was a rush for the + exits as participants + worked to get out of + +On line 6165: + was worried about the + risk inherent in the next + trade, there often was + +On line 6165: + next trade—and volume + fell further. The result was + a vicious circle + +On line 6167: + and efficient price + discovery, every firm’s risk + management became + +On line 6167: + The usual hedging + mechanisms were impaired. An + investor that wanted + + to trade at a loss + to get out of a losing + position might not + + find a buyer, and + those that needed hedges would find + them more expensive + +On line 6169: + of liquidity + in derivatives markets. + First, the number of + +On line 6169: + contracts in a broad + range of OTC derivatives + sharply declined. Since its + +On line 6169: + by federal statute + in December this market + had increased more than + +On line 6169: + to the end of the + year, however, outstanding + notional amounts of + +On line 6169: + period since the + Bank for International + Settlements began + +On line 6169: + Moreover, it occurred + during a period of + great volatility in + +On line 6169: + markets. At such a + time, firms usually turn to + the derivatives + + market to hedge their + increased risks—but now they fled + the market. The lack + + of liquidity + in derivatives markets + was also signaled + + by the higher prices + charged by OTC derivatives + dealers to enter + +On line 6171: + bear additional + risks when markets are illiquid, + and they pass the cost + + of those risks on to + market participants. The + cost is evident + + in the increased "bid-ask + spread"—the difference between the + price at which dealers + + were willing to buy + contracts (the bid price) and the + price at which they were + +On line 6171: + to sell them (the ask + price). As markets became less + liquid during the + +On line 6171: + worried that they might + be saddled with unwanted + exposure. As a + + result, they began + charging more to sell contracts + (raising their ask price), + +On line 6171: + In addition, they + offered less to buy contracts + (lowered their bid price), + +On line 6171: + uncreditworthy + counterparties. The increase + in the spread in these + + contracts meant that the + cost to a firm of hedging + its exposure to + +On line 6171: + or of another + firm also increased. The cost + of risk management + +On line 6175: + December when they + reached their height of trillion in + notional amount, and + +On line 6177: + latest figures as + of June when they had fallen + to trillion.60 In sum, + + the sharp contraction + in the OTC derivatives + market in the fall + +On line 6177: + unwind their contracts + or to effectively hedge + their business risks at + +On line 6177: + when uncertainty + in the financial system + made risk management + +On line 6181: + top priority. + WASHINGTON MUTUAL: "IT’S + YOURS" In the eight days + +On line 6181: + depositors pulled + billion out of Washington + Mutual, which now + +On line 6181: + imminent collapse. + WaMu had been the subject of + concern for some time + + because of its poor + mortgage-underwriting standards + and its exposures + +On line 6181: + the lowest-tier + investment-grade rating, + in July, and then + +On line 6183: + expected franchise + erosion."61 The Office of Thrift + Supervision (OTS) + + determined that the + thrift likely could not "pay its + obligations and meet + +On line 6185: + the bank on Thursday, + September appointing the + Federal Deposit + +On line 6185: + Corporation as + receiver; many unsecured + creditors suffered + +On line 6185: + losses. With assets + of billion as of June WaMu + thus became the largest + +On line 6185: + U.S. history to + fail—bigger than IndyMac, bigger + than any bank or thrift + +On line 6185: + in the 1980s and 1990s. + JP Morgan paid billion to + acquire WaMu’s banking + +On line 6185: + from the FDIC on the + same day; on the next day, WaMu’s + parent company + +On line 6187: + thrift) filed for Chapter + bankruptcy protection. FDIC + officials told the + + FCIC that they had known + in advance of WaMu’s troubles + and thus had time to + +On line 6187: + the transaction with + JP Morgan. JP Morgan CEO + Jamie Dimon said that + + his bank was already + examining WaMu’s assets + for purchase when FDIC + +On line 6187: + Sheila Bair called him and + asked, "Would you be prepared to + bid on WaMu1" "I said + + yes we would," Dimon + told the FCIC. "She called me up + literally the + +On line 6187: + next day and said—‘It’s yours.’ + I thought there was another + bidder, by the way, + +On line 6187: + otherwise I would + have bid a dollar—not billion], + but we wanted to + +On line 6189: + FDIC funds to protect + unsecured creditors, which + it could have done by + +On line 6189: + exception" under + the FDIC Improvement Act of + (Recall that FDICIA + + required that failing + banks be dismantled at the + least cost to the FDIC + +On line 6189: + the Fed, and Treasury + agree that a particular + company’s collapse + +On line 6189: + risk to the entire + financial system; it had + not been tested in + +On line 6189: + FDIC Chairman Bair stood + behind the decision. "I + absolutely do + + think that was the right + decision," she told the FCIC. + "WaMu was not a well-run + +On line 6191: + She characterized + the resolution of WaMu + as "successful."64 The + + FDIC’s decision would + be hotly debated. Fed + General Counsel + + Scott Alvarez told the + FCIC that he agreed with Bair that + "there should not have been + + intervention in + WaMu."65 But Treasury officials + felt differently: + + "We were saying that’s + great, we can all be tough, and + we can be so tough + +On line 6191: + financial system + into the Great Depression," + Treasury’s Neel Kashkari told + +On line 6191: + the FCIC. "And so, I + think, in my judgment that was + a mistake. [A]t that + + time, the economy + was in such a perilous state, + it was like playing + + with fire."66 WACHOVIA: "AT + THE FRONT END OF THE DOMINOES + AS OTHER DOMINOES + +On line 6197: + having bought Golden + West, was the largest holder of + payment-option ARMs, + +On line 6197: + that had helped bring down + WaMu and Countrywide. Concerns + about Wachovia—then the + +On line 6197: + escalating for + some time. On September the + Merrill analyst + +On line 6197: + the company’s stock + to "underperform," pointing + to weakness in its + +On line 6197: + executives met + Fed officials to ask for + an exemption from + + rules that limited + holding companies’ use of + insured deposits to + +On line 6199: + liquidity needs. + The Fed did not accede; staff + believed that Wachovia’s + + cash position was + strong and that the requested + relief was a "want" + +On line 6203: + But they changed their minds + after the Lehman bankruptcy, + immediately + +On line 6203: + conference calls to + discuss liquidity with + Wachovia management. + +On line 6203: + the Fed supported + the company’s request to + use insured deposits + +On line 6203: + Wells Fargo Chairman + Richard M. Kovacevich told Robert + Steel, Wachovia’s CEO and + +On line 6203: + be interested + in acquiring the besieged + bank, and the two agreed + +On line 6203: + later in the week. + The same day, Fed Governor + Kevin Warsh suggested + +On line 6203: + Steel also talk to + Goldman. As a former vice + chairman of Goldman, + +On line 6203: + easily approach + the firm, but the ensuing + conversations were + + short; Goldman was not + interested.68 Throughout the + following week, it + +On line 6205: + Wachovia needed to + merge with a stronger financial + institution. Then, + +On line 6205: + on September "raised + creditor concern about the + health of Wachovia," the + +On line 6205: + Alvarez told the FCIC. + "The day after the failure + of WaMu, Wachovia Bank + +On line 6205: + the withdrawal of + significant amounts from their + accounts," Alvarez said. + +On line 6205: + Wachovia. It appeared + likely that Wachovia would soon + become unable to + +On line 6205: + its operations."69 + Steel said, "As the day progressed, + some liquidity + +On line 6205: + intensified as + financial institutions + began declining + + to conduct normal + financing transactions with + Wachovia."70 David Wilson, + +On line 6207: + the Currency’s lead + examiner at Wachovia, + agreed. "The whole world changed" + + for Wachovia after + WaMu’s failure, he said.71 The FDIC’s + Bair had a slightly + + different view. WaMu’s + failure "was practically + a nonevent," she told + +On line 6207: + FCIC. "It was below + the fold if it was even on + the front page barely + +On line 6209: + given everything + else that was going on."72 The + run on Wachovia Bank, + +On line 6211: + fourth-largest commercial bank, + was a "silent run" by uninsured + depositors and + +On line 6211: + computers, rather than + by depositors standing + in lines outside bank + +On line 6211: + By noon on Friday, + September creditors were + refusing to roll + +On line 6211: + commercial paper + and brokered certificates of + deposit.74 The FDIC’s John + +On line 6211: + Wachovia lost billion + of deposits and billion of + commercial paper + + and repos that day.75 + By the end of the day on + Friday, Wachovia told + + the Fed that worried + creditors had asked it to + repay roughly half + +On line 6213: + its long-term debt—$50 billion + to billion.76 Wachovia "did not + have to pay all these + +On line 6213: + (they had not matured), + but would have difficulty + [borrowing from these + + lenders] going forward + given the reluctance to + repay early," Richard + + Westerkamp, the Richmond + Fed’s lead examiner at + Wachovia, told the FCIC.77 + +On line 6215: + one day, the value + of Wachovia’s 10-year bonds fell from + cents to cents on the + +On line 6215: + dollar, and the cost + of buying protection on + million of Wachovia + +On line 6217: + stock fell wiping out + billion in market value. + Comptroller of the + + Currency John Dugan, + whose agency regulated + Wachovia’s commercial + +On line 6217: + liquidity was + unstable.78 "Wachovia was at + the front end of the + +On line 6219: + other dominoes fell," + Steel told the FCIC.79 Government + officials were not + +On line 6219: + business on Monday, + September without a deal + in place.80 "Markets were + +On line 6219: + considerable strain + after the events involving + Lehman Brothers, AIG, and + +On line 6219: + the Fed’s Alvarez told + the FCIC. "There were fears that the + failure of Wachovia + +On line 6219: + investors to doubt the + financial strength of other + organizations + +On line 6221: + making it harder + for those institutions to + raise capital."81 Wells + +On line 6221: + buying Wachovia; by + Friday, Citigroup had as + well. Wachovia entered + +On line 6221: + both companies on + Friday and the two suitors + immediately + +On line 6223: + was whether the FDIC would + provide assistance in an + acquisition. Though + +On line 6223: + application of + the systemic risk exception + under FDICIA. Over + +On line 6223: + the ystemic risks if + the FDIC did not intervene + and if creditors + +On line 6225: + losses. The signs for + the bank were discouraging. + Given the recent + +On line 6225: + OCC predicted in + an internal analysis + that Wachovia could face + +On line 6225: + of additional + cash outflows the following + week—including, most + +On line 6227: + prominently, billion + of further deposit outflows, + as well as billion + +On line 6227: + customers. Yet Wachovia + had only billion in cash + and cash equivalents. + +On line 6227: + OCC estimated + that the company could use + its collateral + +On line 6227: + to raise another + billion through the Fed’s discount + window, the repo + +On line 6227: + and the Federal + Home Loan Banks, even those efforts + would bring the amount on + +On line 6231: + potential billion + outflow.84 During the weekend, + the Fed argued that + +On line 6233: + FDIC assistance if + necessary. Its analysis + focused on the firm’s + +On line 6235: + participants, and + stated that asset sales by + mutual funds could + + cause short-term funding + markets to "virtually + shut down."85 According + +On line 6237: + by the Richmond Fed, + mutual funds held billion + of Wachovia debt, which + +On line 6237: + systemic consequences"; + and investment banks, "already + weak and exposed to + +On line 6237: + of confidence," owned + billion of Wachovia’s billion + debt and deposits. These + +On line 6237: + PDCF, to support + operations in the event + of a Wachovia[-led] + +On line 6239: + In addition, Fed + staff argued that a Wachovia + failure would cause banks + +On line 6239: + Secretary Paulson + had recused himself from the + decision because + +On line 6239: + his ties to Steel, but + other members of Treasury + had "vigorously + +On line 6239: + saving Wachovia.88 White + House Chief of Staff Josh Bolten called + Bair on Sunday to + +On line 6241: + for the systemic risk + exception.89 At about P.M. on + Sunday, September + +On line 6241: + Wells’s Kovacevich told + Steel that he wanted more time + to review Wachovia’s + +On line 6241: + commercial real + estate holdings, and could not + make a bid before + +On line 6241: + if there were to be + no FDIC assistance. So Wells + and Citigroup came + + to the table with + proposals predicated + on such assistance. + +On line 6241: + to cover the first + billion of losses on a + pool of billion worth + +On line 6241: + of assets as well + as of subsequent losses, + if they grew large enough, + +On line 6241: + the FDIC’s losses at + billion. Citigroup wanted + the FDIC to cover + +On line 6241: + on a different, + and larger, pool of billion + worth of assets, but + +On line 6241: + of losses and an + additional billion a + year for three years, while + +On line 6241: + the FDIC billion in + Wachovia preferred stock and stock + warrants (rights to buy + +On line 6241: + a predetermined + price) as compensation; the + FDIC would cover any + +On line 6245: + be between billion + and billion. On the basis + of that analysis + +On line 6245: + of the offers, they + estimated that the Wells + proposal would cost + +On line 6245: + billion, whereas the + Citigroup proposal would + cost the FDIC nothing. + +On line 6245: + the FDIC would provide + assistance directly to + the bank so that it + +On line 6247: + survive as a stand-alone + entity.91 But the FDIC still + hadn’t decided + +On line 6247: + support the systemic + risk exception. Its board—which + included the heads + +On line 6247: + the OCC and OTS—met at + A.M. on Monday, September + to decide Wachovia’s + +On line 6247: + the markets opened.92 FDIC + Associate Director Miguel + Browne hewed closely to + +On line 6247: + analysis prepared + by the Richmond Fed: Wachovia’s + failure carried the + +On line 6247: + knocking down too many + dominoes in lines stretching in + too many directions + +On line 6247: + people, including + American taxpayers. He + also raised concerns + +On line 6247: + potential global + implications and reduced + confidence in the + +On line 6247: + remained reluctant + to intervene in private + financial markets + +On line 6247: + but ultimately + agreed. "Well, I think this is, you + know one option of + +On line 6247: + of not-very-good options," + she said at the meeting. "I + have acquiesced in + +On line 6247: + decision based on + the input of my colleagues, + and the fact the statute + +On line 6247: + makers a say in + this process. I’m not completely + comfortable with it + +On line 6247: + need to move forward + with something, clearly, because + this institution + +On line 6249: + in a tenuous + situation."93 To win the + approval of Bair and + +On line 6249: + OTS director who + served on the FDIC board), Treasury + ultimately agreed + +On line 6249: + step of funding all + government losses from the + proposed transaction.94 + + Without this express + commitment from Treasury, the + FDIC would have been the + +On line 6249: + to bear losses out + of its Deposit Insurance + Fund, which then held about + +On line 6249: + billion; normally, + help would have come from Treasury + only after that + + fund was depleted.95 + According to the minutes + of the meeting, Bair + +On line 6249: + that Treasury agree to + fund losses, given that "it + has vigorously + +On line 6253: + the winning bidder: + Citigroup. "It was the fog + of war," Bair told the + + FCIC. "The system was + highly unstable. Who was + going to take the + +On line 6255: + that Wachovia would have + a depository run + on Monday1"97 Wachovia’s + + board quickly voted + to accept Citigroup’s bid. + Wachovia, Citigroup, + +On line 6255: + executed an + exclusivity agreement + that prohibited + +On line 6257: + other potential + acquirers.98 In the midst of + the market turmoil, + +On line 6257: + Committee met at + the end of September at + about the time of the + +On line 6257: + invocation of + the systemic risk exception. + "The planned merger of + +On line 6257: + large institutions + led to some concern among FOMC + participants that + + bigger and bigger + firms were being created + that would be ‘too big + + to fail,’" according + a letter from Chairman Bernanke + to the FCIC. He added + +On line 6257: + this concern, and voiced + my hope that TARP would create + options other than + +On line 6257: + managing problems + at large institutions and + that subsequently, + +On line 6257: + regulatory + reform, we might develop + good resolution + +On line 6259: + fail."99 itigroup and + Wachovia immediately + began working on + +On line 6259: + the deal—even as Wachovia’s + stock fell to on September + the day that TARP was + +On line 6259: + by lawmakers. They + faced tremendous pressure from the + regulators and + +On line 6259: + markets to conclude + the transaction before the + following Monday, + +On line 6259: + not acquiring the + holding company, just the + bank, and Citigroup + + wanted to change some + of the original terms. Then + came a surprise: on + +On line 6259: + morning, October + Wells Fargo returned to the + table and made a + +On line 6259: + bid to buy all of + Wachovia for a share—seven + times Citigroup’s bid, + +On line 6261: + over the timing of + Wells Fargo’s new proposal, + particularly + + given IRS Notice + 2008-83. This administrative + ruling, issued just + +On line 6261: + write off the losses + of an acquired company + immediately, + +On line 6261: + spreading them over time. + Wells told the SEC that the IRS + ruling permitted + +On line 6261: + to reduce taxable + income by billion in the + first year following + +On line 6261: + acquisition rather + than by billion per year for + three years. However, + +On line 6261: + said this "was itself + not a major factor" in + its decision to + +On line 6261: + that Wells’s revised bid + reflected additional + due diligence, the point + +On line 6261: + made to Wachovia CEO + Steel at the time.101 But the FDIC’s + Bair said Kovacevich + + told her at the time + that the tax change had been a + factor leading to + +On line 6263: + Wells’s revised bid.102 On + Thursday, October three days + after accepting + +On line 6263: + offer, Wachovia’s board + convened an emergency P.M. + session to discuss + +On line 6265: + bid. The Wachovia board + voted unanimously in + favor. At about A.M. + +On line 6265: + General Counsel + Jane Sherburne, and FDIC Chairman + Bair called Citigroup + +On line 6265: + that Wachovia had signed + a definitive merger + agreement with Wells. Steel + +On line 6265: + notes. Pandit was stunned. + "He was disappointed. That’s + an understatement," + +On line 6265: + told the FCIC.103 Pandit + thought Citigroup and Wachovia + already had a deal. + +On line 6267: + Steel and Sherburne dropped + off the phone call, Pandit asked + Bair if Citigroup + +On line 6267: + keep its original + loss-sharing agreement to purchase + Wachovia if it matched + +On line 6267: + Wells’s offer of a + share. Bair said no, reasoning + that the FDIC was not + + going to stand in + the way of a private deal. + Nor was it the role + +On line 6267: + the agency to help + Citigroup in a bidding + war. She also told + + the FCIC that she had + concerns about Citigroup’s own + viability + +On line 6267: + acquired Wachovia for + that price. "In reality, + we didn’t know how + +On line 6267: + Citigroup was at + that point," Chairman Bair said. "Here + we were selling a + +On line 6269: + another troubled + institution. I think if + that deal had gone through, + +On line 6271: + to have been bailed out + again."104 Later Friday morning, + Wachovia announced the + +On line 6271: + the blessing of the + FDIC. "This agreement won’t require + even a penny from + +On line 6271: + FDIC," Kovacevich said + in the press release. Steel added + that the "deal enables + +On line 6271: + keep Wachovia intact + and preserve the value of + an integrated + +On line 6273: + support."105 On Monday, + October Citigroup filed + suit to enjoin Wells + +On line 6273: + acquisition of + Wachovia, but without success. + The Wells Fargo deal + +On line 6275: + would close at midnight + on December for per share. + IRS Notice 2008-83 was + +On line 6275: + later conducted + an investigation of + the circumstances of + +On line 6275: + reported that the + purpose of the notice was + to encourage strong + +On line 6275: + acquire weak banks by + removing limitations + on the use of tax + +On line 6275: + that the notice may + have been an improper change + of the tax code by + +On line 6275: + to change the tax code. + A congressional report + estimated that + +On line 6275: + the notice saved about + billion of tax revenues over + years.106 However, the + + Wells controller, Richard Levy, + told the FCIC that to date Wells + has not recognized + + any benefits from + the notice, because it has + not yet had taxable + + income to offset.107 + TARP: "COMPREHENSIVE APPROACH" + Ten days after the + +On line 6279: + provided nearly + billion to investment banks + and commercial banks + + through the PDCF and + TSLF lending facilities, + in an attempt to + +On line 6279: + the Fed and Treasury + had announced unprecedented + programs to support + + money market funds. + By the end of September, + the Fed’s balance sheet + +On line 6281: + had grown to trillion. + But the Fed was running out + of options. In the + +On line 6283: + could not replenish + financial institutions’ + capital, which was + +On line 6283: + on bad assets made + it difficult for investors + to determine which + + institutions could + survive, even with all the Fed’s + new backstops. In short, + +On line 6285: + financial system + was slipping away from its lender + of last resort. On + +On line 6285: + and Treasury proposed + what Secretary Paulson called + a "comprehensive + +On line 6285: + the mounting crisis + in the financial system + by purchasing the + +On line 6285: + weighing down many banks’ + balance sheets.108 In the early + hours of Saturday, + +On line 6285: + Morgan Stanley were + preparing to become bank + holding companies, + + Treasury sent Congress + a draft proposal of the + legislation for + +On line 6285: + It would give Treasury + the authority to spend + as much as billion + +On line 6287: + was not promising. For + example, Senate Banking + Committee Chairman + +On line 6287: + Dodd said on Tuesday, + "This proposal is stunning + and unprecedented + +On line 6287: + its scope—and lack + of detail, I might add." "There + are very few details + +On line 6287: + Member Richard Shelby + said. "Rather than establishing + a comprehensive, + +On line 6287: + crisis, I believe + this legislation merely + codifies Treasury’s + +On line 6289: + hoc approach."109 Paulson + told a Senate committee + on Tuesday, "Of course, + + we all believe that + the very best thing we can do + is make sure that the + + capital markets + are open and that enders are + continuing to + + lend. And so that is + what this overall program does, + it deals with that."110 Bernanke + +On line 6289: + the Joint Economic + Committee Wednesday: "I think + that this is the most + +On line 6289: + financial crisis + in the post-War period for + the United States, and + +On line 6289: + we have seen in many + previous examples of + different countries + + and different times, + choking up of credit is + like taking the lifeblood + +On line 6289: + from the economy."111 + He told the House Financial + Services Committee + +On line 6291: + the same day, "People + are saying, ‘Wall Street, what does + it have to do with + +On line 6291: + way they are thinking + about it. Unfortunately, + it has a lot to + + do with them. It will + affect their company, it + will affect their job, + + it will affect their + economy. That affects their + own lives, affects their + +On line 6291: + borrow and to save + and to save for retirement + and so on."112 By the + +On line 6291: + Sunday, September + as bankers and regulators + hammered out Wachovia’s + +On line 6293: + negotiators had + agreed on the outlines of a + deal. Senator Mel + +On line 6293: + secretary and then + a member of the Banking + Committee, told the + +On line 6295: + about a meeting with + Paulson and Bernanke that Sunday: + I just remember + +On line 6295: + Armageddon. The thing + that was the most frightening + about it is that even + + with them asking for + extraordinary powers, + that they were not at + +On line 6295: + prevent the kind of + financial disaster that + I think really + +On line 6295: + the Great Depression. + And obviously to a + person like myself + + I think you think, "Wow, + if these guys that are in the + middle of it and + +On line 6295: + the titles that they + hold believe this to be as + dark as they’re painting + +On line 6297: + it must be pretty + darned dark."113 Nevertheless, on + Monday, September + +On line 6297: + acquisition of + Wachovia, the House rejected + TARP by a vote of8 + +On line 6297: + The markets’ response + was immediate: the Dow + Jones Industrial + +On line 6299: + plunged points, or almost + To broaden the bill’s appeal, + TARP’s supporters made + + changes, including a + temporary increase in the + cap on FDIC’s deposit + +On line 6301: + from to per customer + account.114 On Wednesday evening, the + Senate voted in + +On line 6301: + by a margin of + to On Friday, October + the House agreed, to and + +On line 6301: + President George W. + Bush signed the law, which had grown + to pages. TARP’s stated + +On line 6303: + for the Federal + Government to purchase and + insure certain types + +On line 6303: + the purposes of + providing stability + to and preventing + +On line 6303: + financial system + and protecting taxpayers."115 + To provide oversight + +On line 6303: + billion program, the + legislation established + the Congressional + +On line 6305: + Program (SIGTARP). But + the markets continued to + deteriorate. + +On line 6305: + Monday, October + the Dow closed below for the + first time in four years; + +On line 6305: + by the end of the + week it was down almost points, + or below its peak + +On line 6305: + in October The + spread between the interest + rate at which banks lend + +On line 6305: + Treasuries—a closely watched + indicator of market + confidence—hit an + +On line 6305: + the dollar value + of outstanding commercial + paper issued by + +On line 6305: + and nonfinancial + companies had fallen by + billion in the month + + between Lehman’s failure + and TARP’s enactment. Even firms + that had survived the + +On line 6305: + disruptions in the + commercial paper markets + were now feeling the + +On line 6305: + October the Fed + created yet another + emergency program, + +On line 6305: + Commercial Paper + Funding Facility, to + purchase secured and + +On line 6305: + program, which allowed + firms to roll over their debt, would + be widely used by + +On line 6305: + and nonfinancial + firms. The three financial firms + that made the greatest + + use of the program + were foreign institutions: + UBS (which borrowed a + +On line 6305: + billion), and Barclays + billion). Other financial + firms included GE + +On line 6305: + Capital billion), + Prudential Funding billion), + and Toyota Motor + +On line 6305: + Verizon billion), + Harley-Davidson billion), McDonald’s, million) and + Georgia Transmission + +On line 6307: + million).117 Treasury was + already rethinking TARP. The + best way to structure + +On line 6307: + would the government + determine fair prices in an + illiquid market1 Would + +On line 6307: + holding these assets + agree to sell them at a fair + price if doing so + + would require them to + realize losses1 How could + the government avoid + +On line 6307: + would take time to solve, + and Treasury wanted to bring + stability to + +On line 6309: + as possible. The + key concern for markets and + regulators was + + that they weren’t sure + they understood the extent + of toxic assets + +On line 6309: + was allowed under + the TARP legislation, which + stated that Treasury, + +On line 6309: + stock, if they deemed such + purchases necessary to + promote financial + +On line 6309: + However, the new + proposal would pose a host + of new problems. By + +On line 6309: + become a major + shareholder in the private + financial sector. + +On line 6311: + Sunday, October + after agreeing to the terms + of the capital + +On line 6311: + and Geithner + selected a small group of + major financial + +On line 6311: + immediately + offer capital: the four + largest commercial bank + +On line 6311: + companies (Bank of + America, Citigroup, JP + Morgan, and Wells), the + + three remaining large + investment banks (Goldman and + Morgan Stanley, which + + were now bank holding + companies, and Merrill, which + Bank of America + + had agreed to acquire), + and two important clearing + and settlement banks + +On line 6311: + State Street). Together, + these nine institutions held + more than trillion in + +On line 6313: + all assets in U.S. + banks. Paulson summoned the firms’ + chief executives + +On line 6313: + to Washington on + Columbus Day, October Along + with Bernanke, Bair, Dugan, and + +On line 6313: + Paulson explained that + Treasury had set aside billion + from TARP to purchase + +On line 6313: + nstitutions under + the newly formed Capital + Purchase Program (CPP). + +On line 6313: + Treasury would purchase + senior preferred stock that would + pay a dividend + +On line 6313: + for the first five years; + the rate would rise to thereafter + to encourage the + +On line 6313: + pay the government + back. Firms would also have to + issue stock warrants + + to Treasury and agree + to abide by certain standards + for executive + + compensation and + corporate governance. The + regulators had + + already decided + to allocate half of these + funds to the nine firms + +On line 6315: + assembled that day: + billion each to Citigroup, + JP Morgan, and Wells; + +On line 6315: + to Merrill, Morgan + Stanley, and Goldman; billion + to BNY Mellon; and + +On line 6317: + Street. "We didn’t want + it to look or be like a + nationalization" + +On line 6317: + of nonvoting stock, + and the terms were intended + to be attractive.119 + + Paulson emphasized + the importance of the banks’ + participation + +On line 6317: + provide confidence + to the system. He told the + CEOs: "If you don’t take + +On line 6317: + tells you that you are + undercapitalized you + may not like the terms + + if you have to come + back to me."120 All nine firms took + the deal. "They made a + + coherent, I thought, + a cogent argument about + responding to this + +On line 6317: + dramatically + worse. It wasn’t leading to + a run on some of + +On line 6317: + but it was getting + worse in the marketplace," JP + Morgan’s Dimon told + + the FCIC.121 To further + reassure markets that it + would not allow the + +On line 6319: + institutions to + fail, the government also + announced two new FDIC + +On line 6321: + the next day. The first + temporarily guaranteed + certain senior debt + +On line 6321: + FDIC-insured institutions + and some holding companies. + This program was used + +On line 6321: + had billion in debt + backed by the FDIC outstanding + in January and + +On line 6323: + end of according + to public filings; Morgan + Stanley had billion + +On line 6323: + at the end of and + billion at the end of GE + Capital, one of + +On line 6323: + heaviest users of + the program, had billion of + FDIC-backed debt outstanding + +On line 6323: + end of and billion + at the end of Citigroup + had billion of FDIC + +On line 6325: + debt outstanding at + the end of and billion at + the end of JPMorgan Chase + +On line 6327: + billion outstanding + at the end of and billion + at the end of The + +On line 6327: + deposit insurance + to certain non-interest-bearing + deposits, like checking + +On line 6327: + Because of the risk + to taxpayers, the measures + required the Fed, the + +On line 6327: + Treasury to declare + a systemic risk exception + under FDICIA, as + +On line 6329: + to facilitate + Citigroup’s bid for Wachovia. + Later in the week, + +On line 6329: + to qualifying + "healthy" and "viable" banks, thrifts, and + holding companies, + +On line 6329: + firms had received.123 The + appropriate federal + regulator—the Fed, + + FDIC, OCC, or OTS— would + review applications and + pass them to Treasury + +On line 6331: + final approval. The + program was intended not + only to restore + + confidence in the + banking system but also + to provide banks with + +On line 6335: + mitigation."124 "The + whole reason for designing + the program was so + +On line 6335: + banks would take it, would + have the capital, and that + would lead to lending. + +On line 6335: + whole purpose," Paulson + told the FCIC. However, there + were no specific + +On line 6335: + banks to make loans to + businesses and households. "Right + after we announced + +On line 6335: + we had critics start + saying, ‘You’ve got to force + them to lend,’" Paulson + + said. Although he said + he couldn’t see how to do + this, he did concede + +On line 6335: + the program could have + been more effective in this + regard.125 The enabling + + legislation did + have provisions affecting + the compensation + +On line 6335: + shareholders. Over time, + these provisions would become + more stringent, and the + + following year, in + compliance with another + measure in the act + +On line 6335: + create the Office + of the Special Master for + TARP Executive + +On line 6337: + Program by the end + of ultimately, it would + invest billion in + +On line 6341: + institutions.126 In + the ensuing months, Treasury + would provide much of + +On line 6341: + loss guarantees), and + Bank of America billion). + On December it + +On line 6341: + make investments in + and loans to automobile + manufacturers + + and auto finance + companies, specifically + General Motors, + +On line 6343: + Chrysler Financial.127 On + January President Bush + notified Congress + +On line 6343: + that he intended + not to access the second + half of the billion + + in TARP funds, so that + he might "‘ensure that such funds + are available early’ + +On line 6345: + administration."128 + As of September 2010—two years + after TARP’s creation—Treasury had + +On line 6347: + billion in losses + had been incurred.129 About billion + of the outstanding + +On line 6347: + in the Capital + Purchase Program. Treasury still + held large stakes in GM + +On line 6347: + Ally Financial + (formerly known as GMAC; and + Chrysler Moreover, billion + +On line 6347: + remained invested + in AIG in addition to + billion of loans from + +On line 6347: + the New York Fed and + a billion non-TARP equity + investment by the + +On line 6347: + two of AIG’s foreign + insurance companies.130 By + December all nine + +On line 6347: + invited to the + initial Columbus Day meeting + had fully repaid + +On line 6349: + was only one of + more than two dozen emergency + programs totaling + +On line 6349: + in place during the + crisis to stabilize the + financial system + +On line 6349: + rescue specific + firms. Indeed, TARP was not even + the largest.132 Many of these + +On line 6349: + are discussed in this + and previous chapters. For + just some examples: + +On line 6351: + and PDCF programs + peaked at billion and billion, + respectively. Its + +On line 6351: + market funding peaked + at billion in January + and its Commercial + +On line 6351: + at billion, also + in January When it was + introduced, the FDIC’s + +On line 6351: + guarantee senior + debt for all FDIC-insured nstitutions + stood ready to backstop + +On line 6353: + trillion in agency + mortgage–backed securities.134 + AIG: "WE NEEDED TO + +On line 6357: + PATIENT" AIG would be + the first TARP recipient + that was not part of + +On line 6357: + Capital Purchase + Program. It still had two big + holes to fill, despite + +On line 6357: + the New York Fed. Its + securities-lending business + was underwater + +On line 6357: + despite payments in + September and October + of billion that the + +On line 6357: + loan had enabled; and + it still needed billion to + pay credit default + +On line 6359: + On November the + government announced that it + was restructuring + +On line 6359: + the New York Fed loan + and, in the process, Treasury would + purchase billion in + + AIG preferred stock. As + was done in the Capital + Purchase Program, in + +On line 6359: + for the equity + provided, Treasury received + stock warrants from AIG + +On line 6361: + day, the New York Fed + created two off-balance-sheet + entities to hold + +On line 6361: + associated + with securities lending + (Maiden Lane II) and + + CDS (Maiden Lane III). + Over the next month, the New York + Fed loaned Maiden Lane + +On line 6361: + that it could purchase + mortgage-backed securities from + AIG’s life insurance + +On line 6361: + subsidiaries. This enabled + those subsidiaries to pay back their + securities-lending + +On line 6361: + bringing to billion + the total payments AIG would + make with government + +On line 6363: + payments are listed + in figure Maiden Lane III + was created with + +On line 6363: + from the New York Fed + and an AIG investment of + billion, supported + +On line 6363: + went to buy CDOs from + of AIG Financial Products’ + CDS counterparties. + +On line 6363: + The CDOs had a face + value of billion, which AIG + Financial Products + +On line 6363: + guaranteed through its + CDS.136 Because AIG had already + posted billion in + +On line 6363: + collateral to + its counterparties, Maiden + Lane III paid billion + +On line 6363: + those counterparties, + providing them with the full + face amount of the CDOs + + in return for the + cancellation of their rights + under the CDS.137 A + + condition of this + transaction was that AIG waive + its legal claims against + +On line 6365: + those counterparties. + These payments are listed in + figure Goldman Sachs + +On line 6365: + received billion in + payments from Maiden Lane III + related to the + +On line 6365: + had purchased from AIG. + During the FCIC’s January + hearing, Goldman CEO + +On line 6365: + Blankfein testified + that Goldman Sachs would not have + lost any money if + +On line 6365: + had purchased credit + protection to cover the + difference between + +On line 6365: + by AIG.138 Documents + submitted to the FCIC by + Goldman after the + +On line 6365: + the firm owned billion + of credit protection in + the form of CDS on + +On line 6365: + million), which itself + had to be propped up by the + government, and Lehman + +On line 6365: + was bankrupt by the + time AIG was rescued.139 In an + FCIC hearing, Goldman + +On line 6367: + the billion of CDS + protection that it purchased + from AIG was part of + +On line 6367: + meaning that Goldman + sold billion in offsetting + protection to its + +On line 6369: + clients; it provided + information to the FCIC + indicating that + +On line 6369: + received from Maiden + Lane III was entirely paid + to its clients.141 Without + +On line 6371: + find the billion some + other way. oldman also + produced documents + +On line 6371: + that showed it received + billion from AIG related + to credit default + +On line 6371: + on CDOs that were not + part of Maiden Lane III. Of + that billion, billion + + was received after, + and thus made possible by, + the federal bailout + +On line 6371: + And most—$2.9 billion—of the + total was for proprietary + trades (that is, trades made + +On line 6371: + than on behalf of + a client) largely relating + to Goldman’s Abacus + +On line 6371: + CDOs. Thus, unlike the + billion received from AIG on + trades in which Goldman + +On line 6371: + owed the money to + its own counterparties, this + billion was retained + +On line 6373: + incur any losses + on their investments—because + AIG, once it was backed + +On line 6375: + government, paid claims + to CDS counterparties at + of face value—has + +On line 6375: + November SIGTARP + faulted the New York Fed for + failing to obtain + +On line 6375: + said that seven of + the top eight counterparties + had insisted on + +On line 6375: + that the New York Fed + had agreed because efforts to + obtain concessions + +On line 6377: + all counterparties + had little hope of success.143 + SIGTARP was highly + +On line 6377: + of the New York Fed’s + negotiations. From the + outset, it found, the + +On line 6377: + York Fed was poorly + prepared to assist AIG. To + prevent AIG’s failure, + +On line 6377: + York Fed had hastily + agreed to the billion bailout on + substantially the + +On line 6377: + negotiating + strategy for the outcome, + which it described as + +On line 6377: + transfer of "billions + of dollars of cash from the + Government to AIG’s + +On line 6377: + policy makers + contend that assistance to + AIG’s counterparties + +On line 6379: + not a relevant + consideration."145 In June + TARP’s Congressional + +On line 6379: + Panel criticized + the AIG bailout for having a + "poisonous" effect on + +On line 6379: + government’s failure + to require "shared sacrifice" + among AIG’s creditors + +On line 6379: + the government and + the markets, signaling an + implicit "too big + + to fail" guarantee + for certain firms. The report + said the New York Fed + +On line 6381: + would have led to an + instant ratings downgrade and + precipitated + + a run on AIG.147 New + York Fed officials told the + FCIC that they had very + + little bargaining + power with counterparties + who were protected + +On line 6381: + contracts. And, after + providing a billion loan, + the government could + +On line 6381: + "Counterparties said + ‘we got the collateral, + the contractual + +On line 6381: + been rescued by the + Fed, Uncle Sam’s behind you, + why would we let you + +On line 6381: + a contract you agreed + to1" New York Fed General + Counsel Tom Baxter + +On line 6381: + the FCIC. "And then the + question was, should we use our + regulatory + +On line 6381: + have been completely + inappropriate, an abuse + of power, and not + +On line 6383: + we were willing to + even contemplate."148 Sarah Dahlgren, who + was in charge of the + +On line 6383: + Lane III transaction + at the New York Fed, said the + government could not + +On line 6383: + was a financial + meltdown," she told the FCIC. "The + credibility + + of the United States + government was on the line."149 + SIGTARP acknowledged + + that the New York Fed + "felt ethically restrained + from threatening an + +On line 6383: + bankruptcy because + it had no actual plans + to carry out such + +On line 6383: + the counterparties’ + contractual rights with AIG," + which were "certainly + +On line 6385: + Geithner has + said he was confident that + full reimbursement + + was "absolutely" + the right decision. "We did + it in a way that + +On line 6385: + was not just least cost + to the taxpayer, best deal + for the taxpayer, + +On line 6387: + helped avoid much, much more + damage than would have happened + without that."151 New York + +On line 6387: + officials told the + FCIC that threats to AIG’s survival + continued after + +On line 6387: + the billion loan on + September "If you don’t fix + the [securities] + +On line 6387: + lending or the CDOs, + [AIG would] blow through the billion. + So we needed to + + stop the sucking chest + wound in this patient," Dahlgren said. + "It wasn’t just AIG—it + +On line 6389: + financial markets. + It kept getting worse and worse + and worse."153 Baxter told + + the FCIC that Maiden + Lane III stopped the "hemorrhage" + from AIG Financial + +On line 6393: + to counterparties + by drawing on the billion + government loan. In + + addition, because + Maiden Lane III received the + CDOs underlying + +On line 6393: + CDS, "as value comes + back in those CDOs, that’s value + that is going to + +On line 6393: + be first used to pay + off the Fed loan; the likely + outcome of Maiden + + Lane III is that we’re + going to be paid in full," + he said.154 In total, + +On line 6395: + the Fed and Treasury + had made available over billion + in assistance to + +On line 6395: + reduced to billion, + primarily through the sale + of AIG business units.156 + + CITIGROUP: "LET THE + WORLD KNOW THAT WE WILL NOT PULL + A LEHMAN" The failed bid + +On line 6401: + reflected badly + on Citigroup. Its stock fell + on October the + +On line 6403: + Wachovia announced that + it preferred Wells’s offer, and + another within + +On line 6403: + "Having agreed to do + the deal was a recognition + on our part that we + + needed it," Edward + "Ned" Kelly III, vice chairman + of Citigroup, told + +On line 6405: + "And if we needed + it and didn’t get it, what + did that imply for + +On line 6407: + firm going forward1"157 + Roger Cole, then head of banking + supervision at + +On line 6407: + acquisition as + a turning point, the moment + "when Citi really + +On line 6407: + [by the market] as + an indication of bad + management at Citi + + that they lost the deal, + and had it taken away from + them by a smarter, more + +On line 6407: + Wells Fargo team," Cole + told the FCIC. "And then here’s an + organization + +On line 6407: + doesn’t have the core + funding [insured deposits] that + we were assuming + +On line 6409: + that they would get by + that deal."158 Citigroup’s stock rose + the day after the + +On line 6409: + Day announcement that + it would receive government + capital, but the + +On line 6409: + did not last. Two days + later, Citigroup announced + a billion net loss + +On line 6409: + in subprime and Alt-A + mortgages, commercial real + estate investments, + +On line 6409: + and structured nvestment + vehicle (SIV) write-downs. The + bank’s stock fell in the + +On line 6409: + following week and, + by November hit single + digits for the first + +On line 6411: + time since The market’s + unease was heightened by press + speculation that + +On line 6411: + company’s board had + lost confidence in senior + management, Kelly + +On line 6411: + said.159 On November + the company announced that + the value of the + +On line 6411: + SIVs had fallen by + billion in the month since it + had released third-quarter + +On line 6411: + therefore going to + bring the remaining billion + in off-balance-sheet SIV + +On line 6411: + its books. Investors clipped + almost another off the + value of the stock, + +On line 6411: + its largest single-day + drop since the October stock + market crash. Two days + +On line 6413: + later, the stock closed + at Credit defaults swaps on + Citigroup reached a + +On line 6413: + to make perceptions + become a reality + for the bank: "[Investors] + +On line 6415: + spreads and say, ‘Is this + some place I really want + to put my money1’ + + And that’s not just in + terms of wholesale funding, that’s + people who also + +On line 6417: + watched the stock price, the + daily liquidity, and + the CDS spreads with alarm. + +On line 6417: + Kingdom’s Financial + Services Authority (FSA) + imposed a billion + +On line 6417: + London-based broker-dealer. + FDIC examiners knew that + this action would be + + "very damaging" to + the bank’s liquidity and + worried that the FSA + + or other foreign + regulators might impose + additional cash + + requirements in the + following week.162 By the close + of business Friday, + +On line 6417: + widespread concern that + if the U.S. government failed + to act, Citigroup + +On line 6417: + "crisis proportions." + Among regulators at the + FDIC and the Fed, there + + was no debate.163 Fed + Chairman Bernanke told the FCIC, "We + were looking at this + +On line 6417: + firm [in the fall of + and saying, ‘Citigroup is + not a very strong firm, + +On line 6417: + it’s only one firm + and the others are okay,’ but + not recognizing + + that that’s sort of like + saying, ‘Well, four out of your + five heart ventricles + +On line 6417: + the fifth one is lousy.’ + They’re all interconnected, + they all connect to + +On line 6419: + other; and, therefore, + the failure of one brings the + others down."164 The FDIC’s + +On line 6419: + colleague Michael Krimminger + on November: "Given that + the immediate + +On line 6419: + to address that is + by letting counterparties + know that they will be + +On line 6419: + both at the bank and + holding company level. + [T]he main point is to + +On line 6419: + the world know that we + will not pull a Lehman." Krimminger, + special adviser + +On line 6419: + FDIC chairman, agreed: "At + this stage, it is probably + appropriate to + + be clear and direct + that the US government will + not allow Citi to + +On line 6421: + own calculations + suggested that a drop in + deposits of just would + +On line 6421: + expect a outflow + of deposits per day. Unless + Citigroup received + +On line 6421: + injection of funds, + its coffers would be empty + before the weekend. + +On line 6421: + remained convinced that + the company was sound and + that the market was + +On line 6421: + Pandit argued, "This + was not a fundamental + situation, it + +On line 6421: + about the capital + we had, not about the funding + we had at that time, + +On line 6421: + with the stock price where + it was perception becomes + reality."166 All + +On line 6421: + were questioning what + everything was worth at the + time. [T]here was a flight + +On line 6421: + just to quality + and safety, but almost a + flight to certainty," + +On line 6423: + Pandit’s adviser, + told the FCIC.167 The FDIC dismissed + Citigroup’s request + +On line 6423: + liquidity" could + be quickly eliminated + as depositors + +On line 6423: + Officials also + believed the company did + not have sufficient + +On line 6423: + addition to the + billion from TARP, Citigroup + was already getting + +On line 6423: + by on substantial + government support. As of + November it had + +On line 6423: + collateralized + liquidity programs and + million under the + +On line 6423: + Facility. And + it had borrowed billion from + the Federal Home + +On line 6423: + would have a total + of billion in senior debt + guaranteed by the + +On line 6425: + guarantee program. + On Sunday, November FDIC + staff recommended + +On line 6425: + its board that a third + systemic risk exception be + made under FDICIA.168 + +On line 6425: + decided that a + proposed resolution had + to be announced over + +On line 6425: + weekend to buttress + investor confidence before + markets opened Monday. + +On line 6427: + staff.169 Regulators + were also concerned that the + economic effects + +On line 6427: + Citigroup failure + would undermine the impact + of the recently + +On line 6431: + Citigroup with an + additional billion in + TARP funds in exchange + +On line 6431: + with an dividend.171 + This injection of cash brought + the company’s TARP + +On line 6431: + of preferred stock and + the government’s guarantee + of certain assets.172 + +On line 6431: + Citigroup and the + government would identify + a billion pool of + + assets around which a + protective "ring fence" would be + placed. In effect, this + +On line 6431: + Citigroup and the + federal government. "There + was not a huge amount + +On line 6433: + in coming to that + billion] number," Citigroup’s + Kelly told the FCIC. + +On line 6433: + deal was structured to + "give the market comfort that + the catastrophic + + risk has been taken + off the table."173 When its terms + were finalized in + +On line 6433: + the guaranteed pool, + which contained mainly loans and + residential and + +On line 6435: + Citigroup assumed + responsibility for + the first billion in + +On line 6435: + materialize, + Treasury would absorb the first + billion using TARP + +On line 6435: + FDIC would absorb the + next billion from the Deposit + Insurance Fund (for + + which it had needed + to approve the systemic risk + exception), and the + +On line 6435: + balance. In return, + Citigroup agreed to grant the + government billion + +On line 6435: + as well as warrants + that gave the government the + option to purchase + + additional shares.174 + After analyzing the + uality of the + + protected assets, + FDIC staff projected that the + Deposit Insurance + + Fund would not incur + any losses.175 Once again, the FDIC + Board met late on a + +On line 6437: + Brief dissent on the + P.M. conference call came from + OTS Director John + + Reich, who questioned + why similar relief had + not been extended + + to OTS-supervised thrifts that failed + earlier. "There isn’t any + doubt in my mind that + + this is a systemic + situation," he said. But + he added, In hindsight, + + I think there have been + some systemic situations + prior to this one + +On line 6439: + were not classified + as such. The failure of IndyMac + pointed the focus + +On line 6439: + which was WaMu, and its + failure pointed to Wachovia, + and now we’re looking + +On line 6439: + Citi and I wonder + who’s next. I hope that all of + the regulators, + +On line 6439: + including Treasury + and the Fed, are looking at + these situations + +On line 6439: + fear there has been some + selective creativity + exercised in the + +On line 6439: + what is systemic and + what’s not and what’s possible + for the government + +On line 6441: + and what’s not.176 The FDIC + Board approved the proposal + unanimously. The + +On line 6441: + bell, and the markets + responded positively: + Citigroup’s stock price + +On line 6441: + almost closing at + The ring fence would stay in place + until December + +On line 6443: + repaying billion + in TARP funds. In December + Treasury announced the + +On line 6445: + of its final shares + of Citigroup’s common stock.177 + BANK OF AMERICA: + +On line 6447: + SHOTGUN WEDDING" With + Citigroup stabilized, the + markets would quickly + +On line 6447: + to the next domino: + Bank of America, which had + swallowed Countrywide + +On line 6447: + in the year and, on + September had announced it + was going to take + +On line 6447: + Merrill Lynch as well. + The merger would create the + world’s largest brokerage + +On line 6447: + reinforce Bank of + America’s position + as the country’s largest + + depository + institution. Given the + share prices of the two + +On line 6449: + time, the transaction + was valued at billion. But + the deal was not set + +On line 6449: + In the interim, + the companies continued + to operate as + +On line 6449: + CEO John Thain and Bank + of America CEO Ken Lewis + had represented + +On line 6449: + separately at + the Columbus Day meeting at + Treasury. Treasury would + +On line 6449: + the full billion in + Bank of America only + after the Merrill + +On line 6451: + October, Merrill + Lynch reported a net loss + for the third quarter + +On line 6453: + In its October + earnings press release, Merrill + Lynch described write-downs + +On line 6455: + told investors on the + conference call that Merrill’s + strategy was to + +On line 6455: + less than billion in + asset-backed-security CDOs and + no Alt-A positions + +On line 6455: + at all. "We’re down to + million in subprime on our + trading books," Thain said. + +On line 6457: + cut our non-U.S. mortgage + business positions in half."178 + The Fed approved the + +On line 6457: + November noting + that both Bank of America + and Merrill were well + + capitalized and + would remain so after the + merger, and that Bank + +On line 6457: + financial resources + to effect the proposal."179 + Shareholders of both + +On line 6459: + Bank of America + executives began to + have second thoughts, Lewis + +On line 6459: + FCIC. In mid-November, Merrill + Lynch’s after-tax losses for + the fourth quarter had + +On line 6459: + projected to reach + about billion; the projection + grew to about billion + +On line 6459: + December billion + by December and billion + by December Lewis + +On line 6459: + Merrill’s losses had + "accelerated pretty + dramatically."181 + +On line 6461: + the fourth quarter."182 In + a January conference + call, Lewis and CFO Joe + +On line 6461: + told investors that the + bank had not been aware of the + extent of Merrill’s + + fourth-quarter losses at + the time of the shareholder + vote. "It wasn’t an + +On line 6461: + not identifying + the assets," Ken Lewis said. "It + was that we did not + +On line 6461: + the significant + deterioration, which + happened in mid- to + + late December that + we saw."183 Merrill’s Thain contests + that version of events. + +On line 6461: + the FCIC that Merrill + provided daily profit + and loss reports to + +On line 6461: + of America and + that bank executives should + have known about losses + +On line 6463: + they occurred.184 The SEC + later brought an enforcement + action against Bank of + +On line 6463: + about billion of known + and expected Merrill Lynch + losses before the + +On line 6463: + the SEC’s complaint, these + insufficient disclosures + deprived shareholders + +On line 6463: + fairly evaluate + the merger. In February + Bank of America + +On line 6465: + would pay million to + settle the SEC’s action.185 On + December Lewis called + + Treasury Secretary + Paulson to inform him that + Bank of America + +On line 6465: + the material + adverse change (MAC) clause of the + merger agreement, which + +On line 6465: + renegotiate the + terms of the acquisition. + "The severity of + +On line 6465: + were high enough that we + should at least consider a + MAC," Lewis told the FCIC. + +On line 6465: + acceleration, + we thought, was beyond what should + be happening. And + + then secondly, you + had a major hole being + created in the + +On line 6467: + That afternoon, Lewis + flew from North Carolina to + Washington to meet + +On line 6467: + the Fed with Paulson + and Fed Chairman Bernanke. The two + asked Lewis to "stand down" + +On line 6469: + while they considered + the situation.187 Paulson + and Bernanke concluded + +On line 6469: + an attempt by Bank + of America to invoke + the MAC clause "was not + +On line 6469: + legally reasonable + option." They believed that Bank + of America would + +On line 6469: + action, and that the + attendant litigation + would likely result + +On line 6469: + of America still + being contractually + bound to acquire a + +On line 6469: + weaker Merrill Lynch. + Moreover, Bernanke thought the market + would lose faith in Bank + +On line 6469: + management, given + that review, preparation, nd + due diligence had been + +On line 6469: + officials also + believed that invoking the + clause would lead to a + +On line 6469: + result in further + deterioration at + the two companies.188 + +On line 6471: + Merrill nor its CEO, + John Thain, was informed of these + deliberations + +On line 6471: + of America. Lewis + told the FCIC that he didn’t + contact Merrill Lynch + +On line 6471: + "adversarial + relationship" if it could + be avoided.189 When Thain + +On line 6471: + of America had + contemplated putting the MAC + clause into effect, + +On line 6471: + success: "One of the + things we negotiated + very heavily was + +On line 6473: + [It] specifically + excluded market moves [and] + pretty much nothing + + happened to Merrill + in the fourth quarter other + than the market move."190 + +On line 6475: + December Paulson + informed Lewis that invoking + the clause would demonstrate + + a "colossal loss of + judgment" by the company. + Paulson reminded + +On line 6475: + regulator, had + the legal authority + to replace Bank of + +On line 6475: + they embarked on a + "destructive" strategy that + had "no reasonable + + legal basis."191 Bernanke + later told his general + counsel: "Though we did + +On line 6475: + order Lewis to go + forward, we did indicate + that we believed that + + going forward [with + the clause] would be detrimental + to the health (safety + +On line 6477: + of his company." + Congressman Edolphus Towns of + New York would later + + refer to the Bank + of America and Merrill + Lynch merger as "a + +On line 6479: + discuss a rescue + package similar to the + one for Citigroup, + +On line 6479: + preferred shares and an + asset pool similar to + Citigroup’s ring fence. + +On line 6479: + staff ’s analysis + was essentially the same + as it had been for + + Citigroup. Meanwhile, + Lewis decided to "deescalate" + the situation, + +On line 6479: + the secretary of + the treasury and the chairman + of the Fed say that + + invoking the MAC + would cause systemic risk, "then it + obviously gives + +On line 6481: + you pause."193 At a board + meeting on December Lewis + told his board that the + +On line 6481: + and Treasury believed + that a failed acquisition + would pose systemic risk + +On line 6481: + would lead to removal + of management and the board + at the insistence + + of the government, + and that the government would + provide assistance + + "to protect [Bank of + America] against the adverse + impact of certain + + Merrill Lynch assets," + although such assistance could + not be provided + +On line 6485: + time for the merger’s + close on January The board + decided not to + + exercise the MAC + and to proceed as planned, with + the understanding + + that the government’s + assistance would be "fully + documented" by + +On line 6485: + were announced in mid-January.195 + "Obviously if [the MAC + clause] actually + + would cause systemic risk + to the financial system, + then that’s not good for + +On line 6485: + America," Lewis told + the FCIC. "Which is finally + the conclusion that + +On line 6487: + and the board came to."196 + The merger was completed + on January with + +On line 6487: + of billion announced + in September had fallen + to billion, thanks to + +On line 6487: + decline in the stock + prices of the two companies + over the preceding + +On line 6487: + America received + the billion in capital + from TARP that had been + +On line 6491: + Merrill Lynch, adding to + the billion it had received + in October.197 In + +On line 6491: + investments, at the + end of Bank of America + and Merrill Lynch had + +On line 6493: + through the Term Auction + Facility and billion + through the PDCF and + +On line 6493: + previous fall, Bank + of America’s legacy + securities arm + +On line 6495: + had borrowed as much + as billion under TSLF and + as much as billion + +On line 6497: + end of the bank had + issued billion in senior + debt guaranteed by + +On line 6497: + FDIC under the debt + guarantee program.198 And it + had borrowed billion + + from the Federal + Home Loan Banks. Yet despite Bank + of America’s + + recourse to these many + supports, the regulators + worried that it would + +On line 6499: + the fourth-quarter earnings + were weak.199 The regulators + wanted to be ready + +On line 6499: + announce the details + of government support in + conjunction with Bank + + of America’s + disclosure of its fourth-quarter + performance. They had + + been working on the + details of that assistance + since late December,200 + +On line 6499: + of billion, was rolled + over every night, and Merrill + "legacy" businesses + +On line 6499: + one-notch downgrade in the + new Bank of America’s + credit rating would + +On line 6499: + common equity + was low and, given the stressed + market conditions, + +On line 6499: + most basic measure + of capital—worried the + market, which seemed to + +On line 6499: + midst of the crisis, + regulatory measures + of capital were + +On line 6501: + informative. On + January the Federal + Reserve and the FDIC, + +On line 6501: + on the terms:202 Treasury + would use TARP funds to purchase + billion of Bank of + +On line 6501: + an dividend. The + bank and the three pertinent + government agencies—Treasury, the + +On line 6501: + an asset pool of + billion, primarily from + the former Merrill + + Lynch portfolio, whose + losses the four entities + would share. The pool was + +On line 6501: + ring fence. In this case, + Bank of America would be + responsible for + +On line 6501: + on the pool, and the + government would cover of + any additional + +On line 6501: + Should the government + losses materialize, + Treasury would cover + +On line 6501: + up to a limit + of billion, and the FDIC up + to a limit of + +On line 6501: + Ninety percent of + any additional losses + would be covered by + +On line 6503: + The FDIC Board had a + conference call at P.M. on + Thursday, January + +On line 6503: + and voted for the + fourth time, unanimously, to + approve a systemic + +On line 6505: + morning, January + Bank of America disclosed + that Merrill Lynch had + +On line 6505: + a billion net loss + on real estate-related + write-downs and charges. It + +On line 6505: + announced the billion + TARP capital investment + and billion ring fence + + that the government + had provided. Despite the + government’s support, + +On line 6507: + of America’s + stock closed down almost from the + day before. ver the + + next several months + Bank of America worked with + its regulators + +On line 6507: + assets that would be + included in the asset + pool. Then, on May Bank + + of America asked + to exit the ring fence deal, + explaining that the + +On line 6507: + had determined that + losses would not exceed the + billion that Bank of + +On line 6507: + the company was + eventually allowed to + terminate the deal, + + it was compelled to + compensate the government + for the benefits + + it had received from + the market’s perception that + the government would + +On line 6509: + to pay a million + termination fee: million + to Treasury, million + +On line 6511: + million to the FDIC. + The Commission concludes that, + as massive losses + +On line 6511: + system in the fall + of many institutions failed, + or would have failed but + + for government bailouts. + As panic gripped the market, + credit markets seized + +On line 6511: + trading ground to a + halt, and the stock market plunged. + Lack of transparency + +On line 6511: + to the crisis: the + exposures of financial + institutions to + +On line 6511: + losses were unknown + to market participants, + and indeed many firms + +On line 6513: + exposures. The scale + and nature of the over-the-counter + (OTC) derivatives + +On line 6513: + fuel the panic + in the fall of millions of + contracts in this opaque + +On line 6513: + among a vast web of + financial institutions + through counterparty + +On line 6513: + thus exposing the + system to a contagion + of spreading losses + +On line 6513: + that were major OTC + derivatives dealers added + to uncertainty + +On line 6513: + the market. The "bank + runs" on these institutions + included runs on + +On line 6513: + operations through + novations, collateral + demands, and refusals + +On line 6515: + series of actions, + inactions, and misjudgments + left the country with + +On line 6515: + the total collapse + of our financial system + or spend trillions of + +On line 6515: + system and prevent + catastrophic damage to + the economy. In + +On line 6515: + government rescued + a number of financial + institutions deemed + +On line 6515: + big to fail"—so large + and interconnected with + other financial + +On line 6515: + important in one + or more financial markets + that their failure would + + have caused losses and + failures to spread to other + institutions. The + +On line 6517: + institutions through + failures and mergers during + the crisis, the U.S. + + financial sector + is now more concentrated + than ever in the + +On line 6517: + concentration places + greater responsibility + on regulators + +On line 6526: + effective oversight + of these institutions. PART + V The Aftershocks + +On line 6540: + CONTENTS Households "I’m + not eating. I’m not sleeping"...................................................390 + Businesses: "Squirrels + +On line 6546: + to close shortfalls" The + financial sector: "Almost + triple the level of + + three years earlier".....................400 + Panic and uncertainty + in the financial + +On line 6548: + into the longest + and deepest recession in + generations. The + +On line 6548: + squeeze in financial + markets cascaded throughout + the economy. In + +On line 6550: + the Commission, Bank + of America CEO Brian + Moynihan described the + +On line 6550: + of the financial + crisis on the economy: + "Over the course of the + + crisis, we, as an + industry, caused a lot of + damage. Never has + + it been clearer how + poor business judgments we have + made have affected + +On line 6550: + Street."1 Indeed, Main Street + felt the tremors as the upheaval + in the financial + +On line 6550: + dollars in household + wealth evaporated within + months, and reported + +On line 6552: + hit at its peak in + October As the housing + bubble deflated, + + families that had + counted on rising housing + values for cash and + +On line 6552: + became anchored to + mortgages that exceeded the + declining value + +On line 6552: + cumulatively + putting the brakes on economic + growth—the classic "paradox + +On line 6554: + thrift," described almost + a century ago by John + Maynard Keynes. In the + +On line 6554: + frozen, for financial + institutions, companies + found that cheap and easy + +On line 6554: + was gone for them, too. + It was tougher to borrow to + meet payrolls and to + +On line 6554: + businesses that had + neither credit nor customers + trimmed costs and laid off + +On line 6554: + Still today, credit + availability is tighter than + it was before the + + crisis. Without jobs, + people could no longer afford + their house payments. Yet + + even if moving could + improve their job prospects, they were + stuck with houses they + +On line 6556: + families entered + foreclosure and millions more + fell behind on their + +On line 6556: + simply walked away from + their devalued properties, + returning the keys + + to the banks—an action + that would destroy families’ + credit for years. The + +On line 6556: + foreclosed and abandoned + properties dragged home prices down + still more, depressing + +On line 6556: + surrounding real + estate in neighborhoods across + the country. Even those + + who stayed current on + their mortgages found themselves whirled + into the storm. Towns + +On line 6558: + several years had + come to expect and rely + on the housing boom + +On line 6558: + tax revenue vanish. + As their resources dwindled, these + communities found + + themselves saddled with + the municipal costs they + had taken on in + +On line 6558: + expand services for + a growing population. + Sinking housing prices + +On line 6560: + fire protection. At + FCIC hearings around the country, + regional experts + +On line 6560: + has been severe. From + to for example, banks in + Sacramento had stopped + +On line 6562: + Bankers still complain to + him not only that demand + from borrowers has + +On line 6562: + but also that they + may be subject to increased + regulatory + +On line 6562: + they do make new loans. + In September when the FCIC + held its Sacramento + +On line 6562: + was still languishing. + "Unless we begin to turn + around demand, unless + +On line 6562: + begin to turn around + the business situation, + the employment is + +On line 6562: + increase here in the + Sacramento area, and housing + is critical to + +On line 6566: + a vicious circle," + Williams testified.2 The effects + of the financial + +On line 6566: + individual + U.S. households and businesses, + big and small, and around + +On line 6566: + Policy makers + on the state, national, and + global levels are + +On line 6566: + with the aftermath, + as are the homeowners and + lenders now dealing with + +On line 6568: + complications that + entangle the foreclosure + process. HOUSEHOLDS: "I’M NOT + +On line 6570: + in December By + many measures, its effects on + the job market were + + the worst on record, as + reflected in the speed and + breadth of the falloff in + +On line 6570: + the rise of the ranks + of underemployed workers, + and the long stretches + +On line 6570: + time that millions of + Americans were and still are + surviving without + +On line 6570: + work. The economy + shed million jobs in 2008—the largest + annual plunge since + +On line 6570: + the United States had + lost another million jobs. + Through November the + +On line 6572: + jobs, putting only a + small dent in the declines. The + underemployment + +On line 6572: + those with part-time work + who would prefer full-time + jobs, and those who need + +On line 6574: + but say they are too + discouraged to search—increased + from in December + +On line 6576: + December reaching + in October This was the + highest level since + +On line 6576: + calculations for + that labor category + were first made in As + +On line 6576: + of November the + underemployment rate stood + at The average + +On line 6578: + individuals + spent unemployed spiked from weeks + in June to weeks in + +On line 6578: + June and weeks in June + Fifty-nine percent of all job + seekers, according + + to the most recent + government statistics, searched + for work for at least + +On line 6580: + labor market is + daunting across the board, but it + is especially + +On line 6580: + among African American + workers, whose jobless rate is + about percentage points + +On line 6580: + above the national + average; workers between + the ages of and years + +On line 6582: + the impact has been + especially severe in + certain professions: + + unemployment in + construction, for instance, climbed + to an average + +On line 6586: + averaged during + the first months of Real gross + domestic product, + +On line 6586: + output adjusted + for inflation, fell at an + annual rate of + +On line 6586: + in the third quarter + of and in the fourth quarter. + After falling again + +On line 6586: + in the first half of + and then modestly growing + in the second half, + +On line 6586: + average GDP for + the year was lower than in + the biggest drop since + +On line 6590: + market, Edward Lazear, + chairman of President George + W. Bush’s Council of + +On line 6590: + during the crisis, + told the Commission that the + financial crisis + + was linked with today’s + economic problems: "I think + most of it had to + +On line 6590: + through prevented firms + from investing in the way + that they otherwise + +On line 6590: + and I think that slows + the rehiring of workers + and still continues + +On line 6592: + problem in labor + markets."3 In June the nation + officially emerged + +On line 6592: + the recession that + had begun months earlier. + The good news still had + +On line 6592: + not reached many of the + million Americans who were + out of work, who could + +On line 6592: + full-time work, or + who had stopped looking for work + as of November + +On line 6592: + McDermott of Bakersfield + told the FCIC she started a + business refilling + + printer ink cartridges, + but in a tight economy, + she didn’t earn enough + + to make a living. + She said she had been searching + for a full-time + +On line 6594: + Households suffered the + impact of the financial + crisis not only + + in the job market + but also in their net worth + and their access to + +On line 6596: + Of the trillion lost + from to the first quarter of + in household net wealth—the + +On line 6596: + difference between + what households own and what they + owe—about trillion was + +On line 6596: + house prices, with much of + the remainder due to the + declining value + +On line 6596: + financial assets. + As a point of reference, + GDP in was trillion. + +On line 6596: + a separate point, + the amount of wealth lost in the + dot-com crash early + +On line 6596: + the decade was trillion, + with far fewer repercussions + for the economy + + as a whole. The painful + drop in real estate and + financial asset + +On line 6598: + values followed a + trillion run-up in household debt + from to Aided by + + the gains in home prices + and, to a lesser degree, + stock prices, households’ net + +On line 6600: + a peak of trillion + in the second quarter of + The collapse of the + +On line 6600: + stock markets erased much + of the gains from the run-up—while + household debt remained + +On line 6600: + exceeding even the + levels of As of the third + quarter of despite + +On line 6600: + stock and housing prices + and a decline in household + borrowing, household + +On line 6602: + totaled trillion, a + drop-off from its pinnacle just + three years earlier + +On line 6604: + Nationwide, home prices + dropped from their peak in to their + low point early in + +On line 6606: + The homeownership + rate declined from its peak of + in to as of the + +On line 6606: + fall of Because so + many American households own + homes, and because for + +On line 6606: + housing represents + their single most important + asset, these declines + +On line 6608: + via home equity + loans or cash-out refinancing + has fallen sharply. At + + an FCIC hearing in + Bakersfield, California, + Marie Vasile explained how + +On line 6608: + her family had + relocated miles into + the mountains to a + + rental house to help her + husband’s fragile health.5 Their old + home was put up for + + sale and languished on + the market, losing value. + Eventually, she + + and her husband found + buyers willing to take their + house in a "short sale"—that + +On line 6610: + a sale at a price + less than the balance of the + mortgage. But because + + the lender was acting + slowly to approve that deal, + they risked losing the + + sale and then going + into foreclosure. "To top + this all off," Vasile told + +On line 6612: + husband is in the + position of possibly + losing his job. So + + not only do I + have a house that I don’t know + what’s happening to, + + I don’t know if he’s + going to have a job come + December. This is + +On line 6612: + I can handle. I’m + not eating. I’m not sleeping." + Serious mortgage + +On line 6612: + are late days or more + or homes in the foreclosure + process—have spread since the + +On line 6612: + the eastern states in + the Midwest (Ohio, Indiana, + Illinois, Wisconsin, + +On line 6614: + in By fall this rate + had risen to Other regions + also endured high + +On line 6614: + so-called sand states, where + the housing crisis was the + worst. The third quarter + +On line 6616: + data company + CoreLogic identified the housing + markets with the worst + +On line 6616: + of "distressed" sales, which + include short sales and sales of + foreclosed properties. + + Las Vegas led the + list in mid-2010, with distressed sales + accounting for more + +On line 6616: + of all home sales.7 "The + state was overbuilt and some jobs + were predicated + + on a level of + growth and consumer spending that + seemed to evaporate + +On line 6616: + an economic and + marketing analyst who + follows the Nevada + +On line 6618: + testified to the + Commission.8 The performance + of the stock market + + in the wake of the + crisis also reduced wealth. + The Standard and Poor’s + +On line 6618: + a third in 2008—the largest + single-year decline since 1974—as big + institutional + +On line 6618: + they perceived as safe. + Individuals felt these + effects not only + +On line 6618: + their current budgets + but also in their prospects for + retirement. By one + +On line 6618: + retirement accounts + such as 401(k)s lost trillion, or + about a third of their + +On line 6618: + December While the + stock market has recovered + somewhat, the S&P as + +On line 6620: + was still about below + where it was at the start of + Similarly, stock + +On line 6620: + worldwide plummeted + more than in but rebounded + by in according + +On line 6622: + Index stock fund (which + represents a collection + of global stocks). The + +On line 6622: + fallout jeopardized + some public pension plans—many + of which were already + +On line 6622: + budget officials + warned that losses of billion, + unaddressed, could cause + +On line 6622: + and teachers—to go + bust in two decades. The state cut + retiree benefits + +On line 6622: + public pension funds + lost billion, or a fourth of + their value, in the + +On line 6622: + six months following + the downturn, in part because + of investments in + +On line 6624: + securities.11 Even + before the fall of consumer + confidence had been + + on a downward slope + for months. The Conference Board + reported in May + +On line 6624: + that its measure of + consumer confidence fell to + the lowest point since + +On line 6624: + plummeted to a + new low; it has recovered + somewhat since then but + +On line 6626: + nobody willing to + make a decision. nobody + willing to take a + +On line 6626: + in the economic + environment, and that goes + for both the state and + +On line 6626: + developer and + appraiser Gregory Bynum + testified at the + +On line 6628: + in wealth and by job + insecurity, households + have cut back on debt. + + Total credit card + debt expanded every year + for two decades until + +On line 6628: + peaked at billion at + the end of Almost two years + later, that total + +On line 6630: + billion. The actions + of banks have also played an + important role: since + +On line 6630: + standards, reduced lines + of credit on credit cards, + and increased fees and + +On line 6630: + interest rates. In + the third quarter of of banks + imposed standards on + + credit cards that were + tighter than those in place in the + previous quarter. + +On line 6632: + In the fourth quarter, + did so, meaning that many banks + tightened again. In fact, + +On line 6632: + banks tightened credit + card standards quarter after + quarter until the + +On line 6632: + summer of Only + in the latest surveys have + even a small numbers + + of banks begun to + loosen them.15 Faced with financial + difficulties, over + +On line 6634: + approximately + million in Together, the + decline in households’ + + financial resources, + banks’ tightening of lending + standards, and consumers’ + +On line 6636: + of confidence have + led to large cuts in spending. + Consumer spending, which + +On line 6636: + the United States makes + up more than two-thirds of GDP, fell + at an annual + +On line 6636: + rate of roughly in + the second half of and then + fell again in the first + +On line 6636: + half of Gains since then + have been modest. Spending on + cars and trucks fell by + +On line 6638: + end of and the spring + of in part because consumer + financing was less + +On line 6640: + as because of job + and wage losses. BUSINESSES: + "SQUIRRELS STORING NUTS" + +On line 6642: + When the financial + panic hit in September + business financing + +On line 6642: + Firms that could roll over + their commercial paper faced + higher interest + + rates and shorter terms. + Those that could not roll over their + paper relied on + +On line 6644: + bank loans—or used their + own cash reserves. Large firms, one + analyst said at + +On line 6644: + time, turned to their cash + balances like "squirrels storing + nuts." Jeff Agosta, an + +On line 6644: + the government not + supported the commercial + paper market, "We + + would have been eating + grasshoppers and living in tents. + Things could have been that + +On line 6644: + While his expression + was hyper-bolic, the fear + was very real. The + +On line 6644: + of credit and the + sharp drop in demand took its + toll on businesses. + +On line 6644: + U.S. companies filed + for bankruptcy protection. + That figure more than + +On line 6644: + to nearly in Firms’ + long-term plans suddenly had to + be reevaluated—the + +On line 6644: + decisions persist, + even though credit markets have + recovered somewhat. + +On line 6646: + for the banks, by mid-2007 + they had begun to restrict + access to credit + +On line 6646: + The Federal Open + Market Committee noted + this tightening when + +On line 6646: + September that it + was cutting the federal + funds rate. After the + +On line 6646: + companies such as + Gannett Corporation, FairPoint + Communications, + + and Duke Energy + drew down their existing lines + of credit because + +On line 6648: + worried about getting + shut out of credit markets.20 + Without access to + +On line 6648: + cash reserves dwindling, + and with uncertainty about + the economy high, + +On line 6648: + off workers or cut + their investments, inhibiting + growth and reducing + +On line 6648: + U.S. companies were + somewhat or very affected + by credit constraints, + +On line 6648: + headlines chronicled + the problems: scarce capital + forced midsize firms to + +On line 6648: + such as Merck and + Wyeth; and tech companies alike + laid off employees + +On line 6648: + the recession took + hold. Some businesses struggled + to cover payrolls + +On line 6650: + paper market to + resume functioning at more + normal rates and terms. + +On line 6652: + with the central bank’s + help, nearly of banks tightened + credit standards and + +On line 6654: + employ nearly of + the country’s private-sector + workforce, "loans to small + +On line 6654: + are especially + vital to our economy," + Federal Reserve + +On line 6654: + Elizabeth Duke told + Congress early in Unlike + the larger firms, which + +On line 6654: + disrupted all these + sources, making credit more scarce + and more expensive. + +On line 6656: + businesses by the + National Federation + of Independent + +On line 6656: + in of respondents + called credit "harder to get." + That figure compares + +On line 6660: + a previous peak, + at around during the credit + crunch of Fed Chairman + +On line 6660: + Ben Bernanke said in a + July speech that getting a + small business loan was + +On line 6660: + "very difficult." He + also noted that banks’ loans + to small businesses + +On line 6662: + from more than billion + in the second quarter of + to less than billion + +On line 6664: + factor—hesitancy + to take on more debt in an + anemic economy—is + +On line 6664: + behind some of the + statistics tracking lending + to small businesses. + +On line 6664: + Bankers of America, + C. R. Cloutier, president + and CEO of Midsouth + +On line 6664: + Lafayette, Louisiana, + told the FCIC, "Community + banks are willing to + +On line 6664: + return and survive. + However, quality loan + demand is down. I + +On line 6664: + customers are scared about + the economic climate and + are not borrowing. + +On line 6666: + demanding it."26 Still, + creditworthy borrowers + seeking loans face tighter + +On line 6666: + evidence suggest. + Historically, banks charged + a percentage point + + premium over their + funding costs on business loans, + but that premium + +On line 6668: + had hit points by year-end + and had continued to rise + in raising the costs + +On line 6670: + also declined when + the housing market collapsed. + During the boom, many + + business owners had + tapped the rising equity + in their homes, taking + +On line 6670: + home equity loans. + Seventeen percent of small + employers with a + +On line 6670: + housing prices declined, + their ability to use this + option was reduced + +On line 6670: + blocked altogether + by the lenders. Jerry Jost told + the FCIC he borrowed + +On line 6670: + daughter start a bridal + dress business in Bakersfield + several years ago. + +On line 6670: + his daughter’s business + languished. The Jost family + has exhausted its + +On line 6672: + reliable incomes.29 + The standards for credit card + loans, another source + +On line 6672: + financing for small + businesses, also became + more stringent. In the + +On line 6672: + Officer Survey, + a majority of banks + indicated that + +On line 6672: + small businesses were + tighter than "the longer-run average + level that prevailed + +On line 6672: + had continued to + tighten their terms on business + credit card loans to + +On line 6672: + businesses, for both + new and existing accounts, + since the end of But + +On line 6672: + the July update + of the Fed survey showed the + first positive signs + +On line 6672: + banks were easing up + on underwriting standards + for small businesses.31 + + In an effort to + assist small business lenders, the + Federal Reserve + +On line 6674: + in March created + the Term Asset-Backed Securities + Loan Facility + + (TALF), a program to + aid securitization + of loans, including + +On line 6676: + loans, student loans, and + small business loans. Another + federal effort + + aimed at improving + small businesses’ access to + credit was guidance + +On line 6676: + Federal Reserve + and other regulators, + advising banks to + +On line 6676: + to meet the credit + needs of "creditworthy small + business borrowers" + +On line 6676: + the assurances that + government supervisors + would not hinder those + +On line 6678: + Yet the prevailing + headwinds have been difficult + to overcome. Without + + access to credit, + many small businesses that had + depleted their cash + + reserves had trouble + paying bills, and bankruptcies + and loan defaults rose. + +On line 6678: + business loans increased + to in from in Overall, the + current state of the + +On line 6678: + business sector is + a critical factor in + the struggling labor + + market: ailing small + businesses have laid people + off in large numbers, + +On line 6682: + paper, were constrained + as well. The business finance + company CIT Group + +On line 6682: + was one such firm. Even + billion in additional + capital support + +On line 6682: + federal Troubled + Asset Relief Program (TARP) + program did not save + +On line 6682: + CIT from filing for + bankruptcy protection in + November Still, some + +On line 6682: + smaller businesses, + such as GE Capital, a + commercial lender with + +On line 6682: + offer financing. + GE Capital’s commercial + paper borrowing + +On line 6684: + of the company’s + borrowing did worsen. In + it registered to + +On line 6684: + up to billion in + commercial paper through one + government program + +On line 6684: + and issued billion + in long-term debt and billion in + commercial paper + + under another + program.34 That GE Capital + had trimmed commercial + +On line 6684: + paper before the + crisis to less than of its + total debt, or about + +On line 6684: + also softened the + effects of the crisis on + the company. "A + + decision was made + that it would be prudent for + us to reduce our + +On line 6684: + on the commercial + paper market, and we did," + Mark Barber, the deputy + +On line 6688: + of GE Company + and GE Capital, told the + Commission. The firm + +On line 6688: + more than billion in + cash on its balance sheet, with + billion in back-up + + bank lines of credit, + if needed.35 The decline in + global trade also + +On line 6690: + the U.S. economy + as well as economies across the world. + As the financial + +On line 6690: + in Europe and the + United States, exports collapsed + in nearly every + +On line 6690: + trading country.36 The + decline in exports shaved more + than percentage points + +On line 6692: + growth in the third and + fourth quarters of Recently, + exports have begun + +On line 6692: + to recover, and + as of the fall of they are + back near precrisis + +On line 6696: + MOVING" Commercial + real estate—offices, + stores, warehouses—also + + took a pounding, an + indicator both of the + sector’s reliance on + +On line 6696: + lending markets, which + were impaired by the crisis, + and of its role as + +On line 6696: + Companies do not + need more space if they go out + of business, lay off + + workers, or decide + not to expand. Weak demand, + in turn, lowers rents + +On line 6696: + give their big tenants + incentives to stay put. One + example: two huge + +On line 6696: + estate brokerages + with headquarters in New York + City received nine months’ + +On line 6698: + for signing leases + in and In fall commercial + vacancy rates were + +On line 6698: + still sky-high, with of all + office space unoccupied. + And the actual + +On line 6700: + "shadow vacancies"—a + couple of desks here, part of + a floor there—that tenants + +On line 6700: + before demand picks + back up. In the absence of + demand, banks remain + +On line 6700: + to lend to all but + the safest projects involving the + most creditworthy + +On line 6700: + their bad properties, + creating a log jam," one + developer told + +On line 6702: + moving."39 In Nevada, + where tourism and construction once + fed the labor force, + +On line 6702: + property took a + huge hit. Office vacancies + in Las Vegas are + +On line 6704: + their low of midway + through Vacancies in retail + commercial space in + +On line 6706: + with historical + vacancy rates of to The + economic downturn + +On line 6706: + retailers into + bankruptcy, emptying out + the anchor retail + +On line 6706: + centers. As demand + for vacant property fell, + land values in and + +On line 6708: + few developers + nationally could afford + to build or buy, right + +On line 6708: + of Lehman’s bankruptcy + meant that Monday Properties + came up short in its + +On line 6708: + across the river from + Washington, D.C. Potential + tenants wanted to + +On line 6708: + the developer + had financing; potential + lenders wanted to know + +On line 6708: + tenants. "It’s a bit + of a cart-and-horse situation," + said CEO Anthony + +On line 6708: + who in October + took the big risk of starting + construction on the + +On line 6708: + institutions put + commercial real estate + developers and + + commercial landlords + in binds when overex-tended banks + suddenly pulled out + +On line 6708: + loans. And when banks ailed + and were taken over by the + Federal Deposit + +On line 6708: + commercial landlords + overnight lost major bank tenants + and the long-term leases + +On line 6710: + that went with them.42 In + California, at least banks + have failed since Almost + +On line 6710: + real estate loans + were underwater as of + February meaning + +On line 6710: + market value of + the property. Commercial + real estate loans + +On line 6712: + commercial mortgages + were also securitized, + and by August the + +On line 6712: + rate on these packaged + mortgages neared 9%—the highest in + the history of + + the industry and + an ominous sign for real + estate a full two + +On line 6712: + after the height of + the financial storm.45 At the + end of the default + +On line 6714: + rate had been Near the + end of it was not at all + clear when or even if + +On line 6714: + had hit bottom. Green + Street Advisors of Newport + Beach, California, + +On line 6714: + tracks real estate + investment trusts, believed that + it reached its nadir in + +On line 6716: + between and has been + recovered, according to + Mike Kirby, Green Street’s + +On line 6718: + added, "values remain + roughly shy of their peak."47 That’s + one perspective. On + +On line 6718: + Service, whose REAL + Commercial Property Price + Index tracks sales of + +On line 6718: + buildings, says it is + too early to make a call. + Moody’s detected some + +On line 6718: + the spring and fall of + and Managing Director + Nick Levidy said, "We + +On line 6718: + real estate prices + to remain choppy until + transaction volumes + +On line 6718: + The largest commercial + real estate loan losses + are projected for + +On line 6718: + beyond, according + to a report issued by + the Congressional + +On line 6718: + Panel.49 And, looking + forward, nearly billion in + commercial real + +On line 6720: + debt will come due from + through GOVERNMENT: "STATES STRUGGLED + TO CLOSE SHORTFALLS" State + +On line 6722: + companies and their + workers but also state and + local governments + +On line 6722: + saw their tax revenue + fall—just when people who had lost + their jobs, or were in + +On line 6722: + services included + Medicaid, unemployment + compensation, and + +On line 6722: + mental health care, for + children, and for the homeless. + "At least states struggled + +On line 6722: + current fiscal year," + recently reported the + Center on Budget + +On line 6724: + Washington think tank.51 + "A critical aspect of + our situation + +On line 6724: + in Sacramento and + throughout the state is that these + increased demands for + +On line 6726: + occurring at a + time that resources are being + dramatically + +On line 6728: + Commission.52 Unlike + the federal government, + almost every state + +On line 6728: + produce a balanced + budget, so running a deficit + is not an option. + +On line 6728: + a senior fiscal + analyst with the Council + of State Governments, + + told the FCIC that the + budget shortfalls facing the + states "are staggering + + numbers. It’s not just + the big states; it’s almost all + states." He said the "great + +On line 6728: + occurring in state + finances means states are forced to + "reorient their whole + +On line 6728: + the kind of programs + and services they offer their + citizens."53 In the + +On line 6728: + fiscal year alone, which + started July states must come + up with billion in + +On line 6728: + or new revenue to + balance their budgets, one study + estimated.54 By + +On line 6728: + the fall of there was + some good news: revenue from some + taxes and fees in + + some states had started + to pick up, or at least slowed + their rate of decline.55 + +On line 6730: + Conference of State + Legislatures declared that + the states "are waiting + +On line 6730: + the economy will + sustain this nascent revenue growth. + And despite recent + +On line 6730: + improvements, more gaps + loom as states confront the phase + out of federal + +On line 6732: + tax increases and + growing spending pressures."56 Some + states were hit harder + +On line 6732: + particularly + affected by the crisis + or because they came + +On line 6732: + budget problems. In + New Jersey Governor Chris + Christie proposed chopping + +On line 6732: + a quarter—of the state + budget to eliminate a + deficit. California + +On line 6732: + the summer and fall + to close a billion shortfall, + an amount larger than + + the entire budgets + of some states. Nonetheless, the + state’s independent + +On line 6732: + analysis office + said in November that the + deficit had instead grown + +On line 6732: + to billion—$6 billion + in the billion budget for + this year and billion + +On line 6732: + year commencing in + June As people lost jobs, many + also lost their health + +On line 6734: + Americans into + the Medicaid program in + alone, an increase—the largest + +On line 6734: + early days of this + government health insurance + plan, according to + + the Kaiser Family + Foundation, a nonprofit + organization + +On line 6734: + research. Every state + showed an enrollment increase: + in nine states it was + +On line 6736: + of Medicaid with + the federal government. + Congress included + +On line 6738: + in the stimulus + package to help them with this + expense, and it has + +On line 6738: + the assistance through + June at a reduced level. + If the economy + + has not improved by + then, Kaiser predicts, paying for + this program will be + +On line 6740: + huge potential source + of trouble for the states.59 The + National League of + + Cities recently said + that U.S. cities are in their worst + fiscal shape in at + +On line 6740: + of a century + and probably have not yet + hit bottom—even after + +On line 6740: + straight years of falling + revenue.60 Because property + taxes are one of + +On line 6740: + source of revenue for + most local governments, and + because some local + +On line 6740: + values, their revenue + is likely to continue + to decline for at + +On line 6742: + years.61 "The effects of + a depressed real estate + market, low levels + +On line 6742: + confidence, and high + levels of unemployment + will likely play out + +On line 6742: + through and beyond," the + survey of cities reported. + The authors of the + +On line 6742: + survey projected + that revenue would fall in and + cities’ budgets would shrink + +On line 6742: + another the largest + cutbacks in the years for which + the group has published + + the report.62 nvestors now + look askance at once-solid + state and local bonds, + +On line 6744: + borrowing costs for + many states and making their task + of balancing the + + budget even harder. + Municipalities in + Florida, the state + +On line 6744: + third-highest rate of home + foreclosures, saw borrowing + costs rise when they sold + +On line 6746: + million in bonds in + September Impact at the + federal level + +On line 6748: + government’s response + to the financial crisis + and the ensuing + +On line 6750: + aggressive fiscal + and monetary policies in + history," said the + +On line 6750: + initiatives remain + controversial to this day, + with critics calling + +On line 6752: + ineffective or + both."63 The government’s fiscal + initiatives began + +On line 6752: + recession started: + the Economic Stimulus + Act of signed into + +On line 6752: + law in February, + provided roughly billion + in tax rebates for + +On line 6752: + tax incentives for + businesses. In October + at the height of the + +On line 6752: + and in early the + American Recovery and + Reinvestment Act of + +On line 6752: + was enacted to + stimulate the weakening + economy, costing + +On line 6754: + another billion + in tax cuts and government + spending. Beginning + +On line 6754: + rate cuts in mid-2007 through + the implementation of + the TALF in early + +On line 6754: + Federal Reserve + provided support to the + economy throughout + +On line 6754: + crisis. Aside from its + emergency lending programs + put in place during + +On line 6754: + the economy from + September to October + 2010—primarily by + +On line 6754: + as "quantitative + easing."64 And in November + officials announced + +On line 6756: + designed to keep long-term + and short-term interest rates + down. In October + +On line 6756: + reported that the + TARP program would cost far less + than the billion that + +On line 6758: + the fall of because + banks had begun to repay + the Treasury in In + +On line 6758: + Treasury said, TARP would + wind up costing about billion, + mostly owing to + +On line 6760: + the Congressional + Budget Office (CBO) put its + cost at billion.66 As + +On line 6762: + earlier, the CBO + projects that the economic cost + of the GSEs’ downfall, + +On line 6762: + the financial cost + of government support and + actual dollar + +On line 6764: + could reach billion by + Overall, as spending increased + and revenues declined + +On line 6764: + deficit grew from billion + in to trillion in And it + is estimated + +On line 6768: + to trillion in THE + FINANCIAL SECTOR: "ALMOST + TRIPLE THE LEVEL OF + +On line 6770: + YEARS EARLIER" While + the overall economy has + struggled, the story + +On line 6770: + financial sector + is somewhat different. Like + other sectors of + +On line 6770: + industry has cut + jobs. After growing steadily + for years, employment + +On line 6772: + on the financial + industry, such as Charlotte, + North Carolina, have + +On line 6772: + unemployment rate + in the Charlotte area rose from + in to a recent + +On line 6776: + February Between + January and December + banks have failed; most were + + small and medium-size + banks.68 The number of small banks + on the FDIC’s list of + +On line 6776: + institutions rose + from in the second quarter + of to in the third + +On line 6776: + a number of large + financial institutions + failed or nearly failed + +On line 6776: + the crisis, on the + whole they have done better since + the fall of Total + +On line 6776: + sector profits peaked + at billion in and then fell + to billion in the + +On line 6776: + lowest level since + the early 1990s. They have since + rebounded in and + +On line 6776: + Financial sector + profits were billion in and + reached an annual + +On line 6778: + billion in the fall + of Within the financial + sector, commercial + +On line 6778: + bank profits rose from + billion in the first quarter + of to billion in + +On line 6778: + the first quarter of + The gains were concentrated + among the larger banks.70 + +On line 6778: + banks with assets greater + than billion, profits more than + doubled, from billion + +On line 6780: + from the first quarter + of to the first quarter of + For commercial banks + +On line 6780: + less than billion in + assets, profits rose only + from less than billion + +On line 6782: + The securities + industry has reported + record profits and is + + once again distributing + large bonuses. Just for those who + work in New York City, + +On line 6782: + bonuses at Wall Street + securities firms in were + billion, up from the + +On line 6782: + percent to more than + After reporting billion + of losses during + +On line 6782: + reported that in + "industry profits reached a + record billion—almost triple + +On line 6792: + years earlier."74 THE + FORECLOSURE CRISIS CONTENTS + Foreclosures on the + +On line 6794: + rise: "Hard to talk about + any recovery" Initiatives + to stem foreclosures: + +On line 6796: + disregard" Flaws in + the process: "Speculation and + worst-case scenarios" + +On line 6802: + Neighborhood effects: + "I’m not leaving"..............................................................408 FORECLOSURES + ON THE RISE: "HARD TO + +On line 6804: + RECOVERY" Since the + housing bubble burst, about four + million families + +On line 6804: + homes to foreclosure1 + and another four and a + half million2 have slipped + +On line 6804: + economic damage + finally abates, foreclosures + may total between + +On line 6804: + has hurt families + and undermined home values + in entire zip codes, + +On line 6804: + support services, and + depleted state coffers. Even + if the economy + + began suddenly + booming the country would need + years to recover. + +On line 6806: + to the foreclosure + rate was historically + less than But the trend + +On line 6806: + the housing market + collapsed has been dramatic: + In of all houses, + +On line 6808: + out of received at + least one foreclosure filing.4 + In the fall of in + +On line 6808: + every outstanding + residential mortgage loans + in the United States + +On line 6808: + payment past due but + not yet in foreclosure—an + ominous warning that + +On line 6808: + may not have crested.5 + Distressed sales account for the + majority of + +On line 6812: + Returning to the + borrowers whose loans were pooled + into CMLTI 2006- NC2: + +On line 6812: + by September many + had moved or refinanced their + mortgages; by that point, + +On line 6812: + entered foreclosure + (mostly in Florida and + California), and + +On line 6812: + modifications. + Of the still active loans then, + were seriously + +On line 6814: + or currently in + foreclosure. The causes of + foreclosures have been + +On line 6814: + by many academics and + government agencies. Two events + are typically + +On line 6820: + unemployment or + other financial hardship, + or because mortgage + +On line 6820: + increase. And second + (in the opinion of many, now + the more important + +On line 6820: + home’s value becomes + less than the debt owed—in other + words, the borrower + +On line 6822: + "The evidence is + irrefutable," Laurie Goodman, a + senior managing + +On line 6822: + Amherst Securities, + told Congress in "Negative + equity is the + +On line 6822: + When the borrower + has negative equity, + unemployment acts + +On line 6822: + of many possible + catalysts, increasing the + probability + +On line 6824: + of default."8 After + falling from their peak in to + the spring of home prices + +On line 6826: + regions.9 Nationwide, + million households, or.5% of those + with mortgages, owe more + + on their mortgages than + the market value of their + house (see figure.1). In + +On line 6826: + Nevada, of homes with + mortgages are under water, + the highest rate in + +On line 6828: + prevalence and extent + of negative equity, + the phenomenon + +On line 6828: + defaults" has also + been on the rise: homeowners + purposefully walk + +On line 6828: + mortgage obligations + when they perceive that their homes + are worth less than what + +On line 6828: + owe and they believe + that the value will not be + going up anytime + +On line 6830: + the fall of three states + particularly hard hit + by foreclosures—California, Florida, + + and Nevada—reported some + recent improvement in the + initiation of + + foreclosures, but in + November Nevada’s rate was still + five times higher than + +On line 6830: + Foreclosure starts climbed + in states from their levels a + year earlier, with + +On line 6830: + has unemployment), + Indiana unemployment), + and South Carolina + +On line 6832: + to the Mortgage Bankers + Association. In Ohio, + the city of Cleveland + +On line 6832: + surrounding Cuyahoga + County are bulldozing blocks + of abandoned houses + + down to the dirt with + the aim of creating a + northeastern Ohio "bank" + +On line 6832: + for the future. To + do this, authorities seize + blighted properties + +On line 6832: + unpaid taxes, and + they take donations of homes + from the Department + +On line 6832: + Housing and Urban + Development, Fannie Mae, + and some private lenders.11 + + Now, the county finds + itself under increasing + duress, having endured + +On line 6834: + in After years of + high unemployment and a + fragile economy, + +On line 6834: + took vulnerable + residents and "shoved them over + the edge of the cliff," + +On line 6836: + Cuyahoga’s treasurer, + told the Commission.13 In a + spring survey, of the + + responding mayors + ranked the prevalence of nonprime + or subprime mortgages + +On line 6836: + first or second on + a list of factors causing + foreclosures in their + +On line 6836: + the mayors, said they + expected the foreclosure + problems to stay the + +On line 6838: + or worsen in their + cities over the next year.14 "There has + been no meaningful + +On line 6838: + inventory of + distressed properties found in + the housing market," + +On line 6838: + of Inside Mortgage + Finance Publications, told + a congressional + +On line 6838: + "It is hard to talk + about any recovery of the + housing market when + +On line 6842: + Many mortgage holders + find themselves underwater; + that is, owing more + +On line 6854: + Michigan, and Nevada. + SHARE OF LOANS WITH NEGATIVE + EQUITY, WA ME + + MT ND NA OR VT + ID MN NH NY SD MA WY + WI CT MI RI PA + + NV IA NJ NE OH + DE UT IL IN DC CA CO + WV MD VA KS MO + + KY NC TN AZ NM + OK AR SC MS AL GA U.S. + average TX LA + +On line 6964: + SOURCE: CoreLogic Figure.1 "There + was a fundamental change + in our financial + + services sector that + really is the reason + we’re in this crisis, + +On line 6964: + and is the reason + we’re seeing and will see in + total probably + +On line 6964: + we’re done, between and + million foreclosure filings + in this country," John + +On line 6964: + of the National + Community Reinvestment + Coalition, explained to + +On line 6964: + by the way, a few + hundred thousand people, even + a million people + +On line 6964: + into foreclosure, + you can kind of blame and say, + ‘Well they should have known + +On line 6964: + million American + families can’t all be wrong. + They can’t all be greedy + +On line 6972: + INITIATIVES TO STEM + FORECLOSURES: "PERSISTENTLY + DISREGARD" The same + + system that was so + efficient at creating + millions of mortgage + + loans over the past decade + has been ineffective at + resolving problems + +On line 6972: + market, including + the efforts of homeowners + to modify their + +On line 6972: + to encourage banks + to adjust interest rates, + spread loan payments over + +On line 6972: + mortgage debts. But to + date, federal auditors + and independent + +On line 6972: + watchdogs have given + the federal government’s + and the banks’ mortgage + +On line 6974: + The Home Affordable + Modification Program + (HAMP) is falling short + +On line 6974: + of the to million + families targeted for + help by the end of + +On line 6974: + program’s resources come + from the federal TARP funds.) + As of December + +On line 6974: + modification + of only mortgages.17 Meanwhile, + the banks report that + +On line 6974: + approved million loan + alterations of various + kinds, although many of + +On line 6974: + payments into a + new mortgage and thus result + in higher monthly + +On line 6976: + modification + and foreclosure assistance + programs is unclear. + +On line 6978: + just getting started. + New Jersey, for instance, will + begin a million + +On line 6978: + some residents who + face foreclosure because of + unemployment or + +On line 6980: + their mortgages.19 During + a series of hearings in + communities around + +On line 6980: + country affected + by the housing crisis, the + Commission heard from + +On line 6980: + difficulties they + had encountered in seeking + to modify their + +On line 6980: + homes. Borrowers who + have been paying down mortgages + for years and have built + +On line 6980: + to being turned down + for loan modifications, + because the lender would + +On line 6982: + that they simply sell + their homes. Kirsten Keefe, a senior + staff attorney with + + the Empire Justice + Center in Albany, New York, + brought this issue to + +On line 6982: + attention in March + Speaking to the Federal + Reserve Board’s Consumer + +On line 6982: + identified trends among + borrowers in New York who + tried to qualify + + for the government’s + HAMP program. "We are also + routinely hearing + +On line 6982: + are being denied + HAMP modifications," she + said.20 Diane Thompson, + +On line 6982: + Housing, and Urban + Affairs in November about + the challenges of the + +On line 6982: + borrowers have been + able to obtain permanent + modifications. + +On line 6982: + and that some servicers + persistently disregard + HAMP applications."21 + +On line 6984: + encourage banks to + view foreclosure as quicker, + cleaner, and often + +On line 6986: + modifying the + terms of existing mortgages.22 + or them, foreclosure + +On line 6986: + response to default + because, the data suggest, + many borrowers who + + receive temporary + or permanent forgiveness + on their terms will slide + + into default again.23 + Also, servicers may receive + substantial fees for + +On line 6986: + a mortgage through the + foreclosure process, creating + an incentive to + +On line 6988: + modification.24 + Frequently, there’s another + complication to + +On line 6988: + modification: + the second mortgages that were + layered onto first + +On line 6988: + sold by banks into + the securitization + machine. The second + +On line 6988: + by the same lenders who + typically service the + mortgage: that is, they + +On line 6988: + the monthly payments + and provide customer service + to borrowers. If + + a first mortgage is + modified or foreclosed on, + the entire value + +On line 6988: + the second mortgage + may be wiped out. Under these + circumstances, the lender + +On line 6988: + second lien has an + incentive to delay a + modification + +On line 6988: + a new loan that would + make the mortgage payments more + affordable to the + +On line 6990: + country’s leading banks + now hold on their books more than + billion in second + +On line 6990: + To the extent the + banks have reported these loans + as performing, the + +On line 6990: + marked down on their books. + The actual value of + these second mortgages + +On line 6990: + could be much less than + their billion-plus reported + value.27 The danger + +On line 6990: + servicer is holding + the second lien, the servicers + are looking after + +On line 6990: + keep up the payments + on their second mortgage when + they cannot afford + + to make payments on + both obligations. According + to Laurie Goodman, + +On line 6990: + modifications + to work, the holders of the + second mortgages will + +On line 6992: + modifications + difficult. For example, + there are competing + +On line 6994: + from a foreclosure + may be enough to pay off the + investors holding the + +On line 6994: + securities, while + the holders of the lower + tranches would likely + + be wiped out. As a + result, the holders of the + lower-rated tranches + +On line 6994: + modification, + if it produced more cash flow + than a foreclosure. + +On line 6996: + and public sectors + to address the foreclosure + crisis have focused + +On line 6996: + encouraging short + sales. In theory, short sales + should help borrowers, + +On line 6996: + dilapidated + homes that encourage crime; and + lenders avoid some of the + +On line 6996: + Nonetheless, such deals + frequently stall because the + process is cumbersome, + +On line 6996: + and eats up resources. + For example, lenders can be + reluctant to sign + +On line 6996: + on the buyer’s bid + because they are not sure that + the home is being + +On line 6996: + highest possible + price. In addition, when there + are two mortgages, the + +On line 7000: + the first and second + mortgages must both agree to the + resolution. FLAWS + +On line 7004: + AND WORSTCASE SCENARIOS" + In additional issues + have come to the fore, + +On line 7004: + revealed systemic flaws + in how lenders documented + and processed mortgages + +On line 7004: + procedural and + documentation problems + with foreclosure have + +On line 7004: + out in court cases + and academic studies for + years, but were ignored + +On line 7006: + of foreclosures rose + so dramatically. All + of the nation’s state + +On line 7006: + general banded + together in the fall of + to investigate + +On line 7006: + harmed by improper + foreclosures. For example, + lenders have relied on + +On line 7006: + who substituted + speed for accuracy by + signing, and sometimes + +On line 7006: + affidavits claiming + personal knowledge of facts + about mortgages that they + +On line 7006: + actually know + to be true. One such "robo-signer," + Jeffrey Stephan of GMAC, + +On line 7008: + affidavits in a + month— roughly per minute, in a + 40-hour workweek—making + +On line 7008: + highly unlikely + that he verified payment + histories in each + +On line 7008: + case of foreclosure.29 + In addition, a number + of court cases have + +On line 7008: + legal standing to + foreclose—that is, being the + entity with the + +On line 7010: + to repossess a + home.30 The problem of legal + standing arose because + +On line 7010: + speed up processing, + the financial industry + created Mortgage + +On line 7010: + Systems, Inc. (MERS), an + organization made up + of mortgage lenders. It + +On line 7010: + in servicing rights + and ownership interests + in mortgage loans. MERS + +On line 7010: + the "mortgagee of record" + on behalf of its members, + a status that is + + meant to give it the + legal right to foreclose if + the borrower fails + +On line 7010: + pay the loan. MERS has + registered million mortgages + since launching in and + +On line 7012: + outstanding as of + November The standing of + MERS or its designees + +On line 7012: + foreclose has been called + into question by courts and + academics, however.32 + +On line 7012: + Committee on the + foreclosure crisis, New York + State Supreme Court Justice + +On line 7012: + Winslow testified that + "standing has become such a + pervasive issue + +On line 7012: + I frequently use + the term ‘presumptive mortgagee + in foreclosure’" to + +On line 7014: + unrecorded transfers + of the legal ownership + of the [m]ortgage," it + +On line 7014: + whether MERS continued + to be the mortgagee after + subsequent sales of + + the loan, according + to Winslow.33 Moreover, courts have held + that MERS does not own + +On line 7014: + underlying note + and therefore cannot transfer + the note or the deed + + of trust, or foreclose + upon the property.34 Winslow + also highlighted + +On line 7016: + deficiencies in + MERS’ standing, many involving + sloppy paperwork: + +On line 7016: + gaps in the chain of + title, including printouts + of the title that + +On line 7016: + from information + provided previously; + retroactive assignments + +On line 7016: + notes and mortgages in + an effort to clean up the + paperwork problems + +On line 7016: + on assignments and + affidavits attesting to + the ownership of + + the note and mortgage; + and questionable notary stamps + on assignments.35 On + +On line 7018: + a bankruptcy court + ruled that the Bank of New York + could not foreclose on + +On line 7020: + loan it had purchased + from Countrywide, because MERS + had failed to endorse + + or deliver the + note to the Bank of New York + as required by the + +On line 7020: + it was customary + for Countrywide to maintain + possession of the + + note and related + loan documents when loans were + securitized.36 Across + +On line 7022: + market, some mortgage + securities holders have + sued the issuers of + +On line 7022: + succeed, investors that + own mortgage-backed securities + could force the issuers + +On line 7022: + then be the owners + of the securities and + would bear the risk of + +On line 7024: + a report issued + in November said it is + on the lookout for + +On line 7024: + pervasive and, more + importantly, throw into + doubt the ownership + +On line 7024: + foreclosed properties + but also pooled mortgages, the + consequences could be + +On line 7024: + This sentiment was + echoed by University of + Iowa law professor + + Katherine Porter who has + studied foreclosures and the + law: "It is lack of + +On line 7024: + be that is turning + the allegations into + a crisis. Lack of + +On line 7024: + feeds speculation + and worst-case scenarios."40 Adam + Levitin, a Georgetown + +On line 7024: + professor of law, + has estimated that the + claims could be in the + +On line 7026: + dollars, rendering + major U.S. banks insolvent.41 + NEIGHBORHOOD EFFECTS: + +On line 7028: + NOT LEAVING" For the + millions of Americans who + paid their bills, never + + flipped a house, and had + never heard of a CDO, the + financial crisis + +On line 7028: + bewildering, and + painful. A crisis that started + with a housing boom + +On line 7028: + a bubble has come + back full circle to forests of + "for sale" signs—but this + +On line 7028: + few buyers. Stores have + shuttered; employers have cut + jobs; hopes have fled. Too + +On line 7028: + Americans today + find themselves in suburban + ghost towns or urban + +On line 7028: + where properties are + vacant and construction cranes + do not lift a thing + +On line 7030: + never bought into + the madness, are also among + the victims as lenders + +On line 7030: + property after + landlords default on loans. Renters + can lose the roof over + +On line 7030: + heads as well as their + security deposits. In + Minneapolis, + +On line 7030: + testimony by + Deputy Assistant Secretary + Erika Poethig + +On line 7032: + Representatives + Subcommittee on Housing + and Community + + Opportunity.42 + For children, a repossessed + house—whether rented or + + bought—is destabilizing. + The impact of foreclosures + on children around the + +On line 7038: + enormous. One-third of the + children who experienced + homelessness after + +On line 7038: + did so because of + foreclosures of the housing + that their parents owned + +On line 7038: + a recent study.43 One + school official in Nevada + told the Commission + +On line 7038: + educational + system created by the + economic crisis.44 + +On line 7040: + resources. Coast to coast, + communities are trying + to stretch housing aid + +On line 7040: + help people displaced + by foreclosures. In Nevada, + for example, Clark + +On line 7040: + County, which contains + million people living in + and around Las Vegas, + +On line 7040: + cut its Financial + Housing Assistance program, + despite the clear needs + +On line 7040: + the community. + Gail Burks, the president and + chief executive + +On line 7040: + Nevada Fair Housing + Center, told the Commission + that her group finds that + +On line 7040: + through the foreclosure + process are in despair. "It’s very + stressful. There are times + +On line 7040: + the couples we are + helping end up divorcing, + sometimes before the + +On line 7042: + is over. We’ve also + seen threats of suicide."45 And the + stories continue. + +On line 7042: + from Discovery Bay, + California, testified + to the Commission + +On line 7042: + son-in-law refinanced their + mortgage into an adjustable-rate + mortgage. When the time + +On line 7042: + to adjust upward, + new financial troubles made + the payments more than + + the family could + afford. Because the market + value of the home + + was nearly equal to + their mortgage debt, the family’s + attempts to get the + + mortgage modified + were fruitless. They lined up a + buyer for a short + +On line 7044: + medical problems + created yet another + challenge, the couple + + and their four children + moved in with Mann. "The children + were relocated + +On line 7044: + schools, and the adults dealt + with the pain and emotional + suffering while they + +On line 7044: + trying to rebuild + their lives," Mann said. The couple + filed for bankruptcy. + + Two months after the + bankruptcy was completed, + the lender asked them if + +On line 7046: + mortgage.46 In Cape Coral, + Florida, Dawn Hunt and her + husband, a mailman, + + and their two children + live in an attractive ranch-style + home they bought for about + +On line 7046: + It was a quiet, + 20-year-old subdivision where most + of the residents + +On line 7046: + were homeowners. In + and builders rushed to the area and + threw up dozens of new + +On line 7048: + empty lots. Homebuilder + Comfort Homes of Florida + LLC broke ground for a + + house across the street from + the Hunts, but did not complete + it. This fall, the house + +On line 7050: + an empty shell. No + stucco was ever applied + to the concrete block + +On line 7050: + and the house had no + interior walls. A wasp + nest decorated + +On line 7050: + electrical box near + the front door. The untended + grass had grown four feet + +On line 7052: + spurs in the brush made + it difficult to approach + the property. Two + + doors down from the Hunts, + another house was also + vacant, left empty + +On line 7052: + family split up + and moved a year earlier. + They abandoned a car + + in the garage. The roof + leaked, and a blue plastic tarp + put in place to keep + +On line 7052: + out now flaps in the + breeze. The Hunts called the police + after vandals broke + +On line 7054: + one night; intruders + have been back twice more in the + daylight.47 ow of the + +On line 7054: + the Hunts’ neighborhood + are in default, are in the + foreclosure process, or + +On line 7054: + back by the bank.48 Most + of the other houses in + the community + + are occupied by + renters whose absentee landlords + bought the houses when + + the homeowners lost + their homes to their banks. The Hunts’ + house has lost two-thirds of + +On line 7054: + from the peak of the + market. Nonetheless, even though + the neighborhood is + +On line 7054: + as lovely as it + used to be, Dawn Hunt told the + FCIC, "I’m not leaving."49 + +On line 7056: + of the holders of + first and second mortgages and + of mortgage servicers; + +On line 7056: + policy makers, + regulators, financial + institutions, and + +On line 7056: + modifications. + The resulting disputes and + inaction have caused + +On line 7060: + housing market and + financial institutions. + Dissenting Statement + +On line 7086: + DOUGLAS HENNESSEY HOLTZ-EAKIN + Vice Chairman BILL THOMAS CAUSES + OF THE FINANCIAL + +On line 7092: + ECONOMIC CRISIS + CONTENTS Introduction.......................................................................................................413 How + Our Approach Differs + +On line 7096: + Stages of the Crisis..............................................................................................417 + The Ten Essential Causes + of the Financial + +On line 7098: + Crisis........................417 The Credit + Bubble: Global Capital + Flows, Underpriced Risk, + +On line 7102: + Reserve Policy.................................................................................419 + The Housing Bubble Turning + Bad Mortgages into + +On line 7106: + Toxic Financial + Assets Big Bank Bets and Why + Banks Failed................................................................427 Two Types of + +On line 7119: + Panic....................................................................................435 The System + Freezing INTRODUCTION We + have identified ten + +On line 7119: + that are essential + to explaining the crisis. + In this dissenting + +On line 7123: + We explain how our + approach differs from others’; + We briefly describe the + +On line 7125: + the crisis; We list + the ten essential causes + of the crisis; and + +On line 7129: + walk through each cause in + a bit more detail. We find + areas of agreement + +On line 7129: + unfortunately + the areas of disagreement + are significant + +On line 7131: + we dissent and present + our views in this report. We + wish to compliment + + the Commission staff + for their investigative work. + In many ways it helped + +On line 7133: + and conclusions. Due + to a length limitation + recently imposed + +On line 7133: + by six members of + the Commission,1 this report + focuses only + +On line 7133: + causes essential + to explaining the crisis. + We regret that the + + limitation means + that several important + topics that deserve + +On line 7141: + fuller discussion get + only a brief mention here. + DISSENTING STATEMENT + +On line 7145: + OUR APPROACH DIFFERS + FROM OTHERS’ During the course + of the Commission’s + +On line 7145: + frequent arguments + that there was a single cause + of the crisis. For + +On line 7145: + banking sector, or + unregulated over-the-counter + derivatives, or + + the greed of those in + the financial sector and + the political + + influence they had + in Washington. In each case, + these arguments, when + +On line 7147: + explanations, are + too simplistic because they + are incomplete. While + +On line 7147: + of these factors were + essential contributors + to the crisis, each + +On line 7149: + insufficient as + a standalone explanation. + The majority’s + +On line 7149: + opposite problem–it + is too broad. Not everything + that went wrong during + +On line 7149: + the crisis, and while + some causes were essential, + others had only + +On line 7149: + minor impact. Not + every regulatory + change related to + +On line 7149: + to the crisis was + a cause. The majority’s + almost 550-page report + + is more an account + of bad events than a focused + explanation of + +On line 7151: + happened and why. When + everything is important, + nothing is. As an + +On line 7151: + derivatives did + not in any meaningful way + cause or contribute + +On line 7151: + financial crisis. + Neither the Community + Reinvestment Act nor + +On line 7151: + of the Glass-Steagall firewall + was a significant cause. + The crisis can be + +On line 7153: + resorting to these + factors. We also reject + as too simplistic + +On line 7153: + hypothesis that + too little regulation + caused the crisis, as + +On line 7153: + as its opposite, + that too much regulation + caused the crisis. We + +On line 7153: + amount of financial + regulation should reflect + the need to address + +On line 7153: + example, high-risk, + nontraditional mortgage + lending by nonbank + +On line 7153: + contributing to the + financial crisis. Poorly + designed government + +On line 7153: + market outcomes and + contributed to the creation + of unsound mortgages + + as well. Countrywide’s + irresponsible lending + and AIG’s failure were + +On line 7153: + regulation and + supervision, while Fannie + Mae and Freddie Mac’s + +On line 7153: + purpose with private + gains and then socializing + the losses. Both the + +On line 7153: + government" and "too + much government" approaches + are too broad-brush to + + explain the crisis. + The majority says the + crisis was avoidable + +On line 7155: + the United States had + adopted across-the-board more restrictive + regulations, in + + conjunction with more + aggressive regulators + and supervisors. + + This conclusion by + the majority largely + ignores the global + +On line 7157: + For example: A + credit bubble appeared in + both the United States + +On line 7161: + factors common to + both regions. KEITH HENNESSEY, + DOUGLAS HOLTZ-EAKIN, House Price + + Appreciation + in Selected Countries, 2002-2008 + The United States was + +On line 7165: + of many countries to + experience rapid house price + growth INDEX United + +On line 7233: + Ireland SOURCES: Standard + and Poors, Nationwide, Banco + de España, AusStats, FNAIM, + +On line 7235: + the credit bubble + beyond housing. Credit spreads + declined not just for + +On line 7235: + asset classes like + commercial real estate. + This tells us to look + +On line 7237: + credit bubble as + an essential cause of the + U.S. housing bubble. + +On line 7237: + tells us that problems + with U.S. housing policy + or markets do not + +On line 7239: + by themselves explain + the U.S. housing bubble. There + were housing bubbles + +On line 7239: + the United Kingdom, + Spain, Australia, France and Ireland, + some more pronounced than + +On line 7239: + the United States. Some + nations with housing bubbles + relied little on + + American-style mortgage + securitization. A + good explanation + +On line 7239: + housing bubble should + also take into account + its parallels in + + other nations. This + leads us to explanations + broader than just U.S. + +On line 7241: + that while failures in + U.S. securitization + markets may be an + +On line 7243: + essential cause, we + must look for other things that + went wrong as well. Large + + financial firms failed + in Iceland, Spain, Germany, and + the United Kingdom, + + among others. Not all + of these firms bet solely on + U.S. housing assets, + +On line 7251: + regulatory + and supervisory regimes + than U.S. commercial + +On line 7251: + banks. In many cases + these European systems have + stricter regulation + +On line 7251: + the United States, and + still they faced financial firm + failures similar + +On line 7253: + those in the United + States. These facts tell us that our + explanation for + +On line 7253: + credit bubble should + focus on factors common + to both the United + +On line 7253: + and Europe, that the + credit bubble is likely + an essential cause + + of the U.S. housing + bubble, and that U.S. housing + policy is by + +On line 7253: + explanation of + the crisis. Furthermore, any + explanation that + +On line 7253: + heavily on a + unique element of the U.S. + regulatory + +On line 7253: + supervisory + system is likely to be + insufficient to + +On line 7253: + standards up our list + of causes, and it moves the + differences between + +On line 7255: + of U.S. commercial + and investment banks down that + list. Applying these + + international + comparisons directly to + the majority’s + +On line 7257: + these questions: If the + political influence + of the financial + +On line 7257: + in Washington was + an essential cause of the + crisis, how does that + +On line 7259: + Belgium, the Netherlands, + France, Spain, Switzerland, Ireland, and + Denmark1 How can the + +On line 7259: + housing bubbles in + Spain, Australia, and the United + Kingdom, countries with + +On line 7261: + different than that + in the United States1 How can + the corporate and + +On line 7261: + of investment banks + explain the decisions of + many U.S. commercial + + banks, several large + American university + endowments, and some + +On line 7261: + public employee + pension funds, not to mention + a number of large + +On line 7265: + and midsize German + banks, to take on too much U.S. + housing risk1 How did + +On line 7267: + precipitate bank + regulatory failures + across Europe1 Not all + +On line 7267: + factors identified + by the majority were + irrelevant; they + +On line 7269: + current financial + and economic crisis in + the United States." By + +On line 7269: + international + parallels, emphasizing + only arguments + +On line 7269: + causes and effects, + the majority’s report + is unbalanced and + + leads to incorrect + conclusions about what caused the + crisis. We begin + +On line 7275: + explanation by + briefly describing the stages of + the crisis. KEITH + +On line 7277: + OF THE CRISIS As + of December the United + States is still in an + +On line 7277: + itself in August + and ended in early The + primary features + + of that financial + crisis were a financial + shock in September + +On line 7277: + and panic triggered + a severe contraction in + lending and hiring + +On line 7279: + a recession that + began in December and + continued until + +On line 7279: + June and from which we + are only now beginning + to recover. While + +On line 7279: + the recession is + technically accurate, + it obscures a more + +On line 7279: + developments with + the broader economy. We + describe recent U.S. + +On line 7281: + five stages: A series + of foreshocks beginning in + August followed by + +On line 7281: + slowdown and then a + mild recession through August + as liquidity + +On line 7283: + institutions failed; + A severe financial shock + in September in + +On line 7283: + failed, nearly failed, or + changed their institutional + structure; triggering + +On line 7285: + financial panic + and the beginning of a + large contraction in + +On line 7287: + in the last few months + of followed by The end of + the financial shock, + +On line 7289: + and rescue at the + beginning of followed by + A continued and + +On line 7289: + contraction in the + real economy and the + beginning of the + +On line 7291: + period. As of + December the United States + is still in the last + +On line 7291: + financial system + is still recovering and + being restructured, + +On line 7291: + economy struggles + to return to sustained strong + growth. The remainder + +On line 7291: + comments focuses + on the financial crisis + in the first three stages + + by examining + its ten essential causes. + THE TEN ESSENTIAL + +On line 7297: + causes, global and + domestic, are essential + to explaining the + +On line 7299: + crisis. I. Credit + bubble. Starting in the late + 1990s, China, other + +On line 7301: + nations built up large + capital surpluses. They + loaned these savings to + + the United States and + Europe, causing interest + rates to fall. Credit + +On line 7301: + cost of borrowing + to finance risky investments + declined. A credit + +On line 7301: + in the United States + and Europe, the most notable + manifestation + +On line 7309: + in high-risk mortgages. + U.S. monetary policy + may have contributed + +On line 7311: + credit bubble but + did not cause it. II. Housing + bubble. Beginning + + in the late 1990s and + accelerating in the + 2000s, there was a large + +On line 7311: + housing bubble in + the United States. The bubble + was characterized + +On line 7311: + in house prices well above + the historical trend and + by rapid regional + +On line 7311: + and Florida. Many + factors contributed to the + housing bubble, the + +On line 7313: + enormous losses for + homeowners and investors. III. + Nontraditional + +On line 7313: + credit spreads, overly + optimistic assumptions about + U.S. housing prices, and + +On line 7313: + markets led to poor + origination practices and + combined to increase + +On line 7313: + flow of credit to + U.S. housing finance. Fueled + by cheap credit, firms + +On line 7313: + cases deceptive, + in many cases confusing, + and often beyond + +On line 7315: + to repay. At the + same time, many homebuyers and + homeowners did not + +On line 7315: + understand the terms + of their mortgages and to make + prudent financial + +On line 7317: + IV. Credit ratings + and securitization. + Failures in credit + +On line 7317: + bad mortgages into + toxic financial assets. + Securitizers + + lowered the credit + quality of the mortgages + they securitized. + +On line 7317: + securities and + their derivatives as safe + investments. Buyers + + failed to look behind + the credit ratings and do + their own due diligence. + +On line 7319: + risk. Managers of many + large and midsize financial + institutions in + +On line 7319: + housing risk. Some did + this knowingly by betting + on rising housing + + prices, while others paid + insufficient attention + to the potential + + risk of carrying + large amounts of housing risk on + their balance sheets. This + +On line 7319: + large but seemingly + manageable mortgage losses + to precipitate + +On line 7321: + of large financial + institutions. VI. Leverage + and liquidity + + risk. Managers of these + financial firms amplified + this concentrated + +On line 7321: + little capital + relative to the risks they + were carrying on + +On line 7321: + a hair trigger by + relying heavily on + short-term financing + +On line 7321: + commercial paper + markets for their day-to-day + liquidity. They + +On line 7321: + liquidity bets + that overnight money would always + be available. Both turned + +On line 7321: + several cases, + failed solvency bets triggered + liquidity crises, + + causing some of the + largest financial firms to fail + or nearly fail. Firms + +On line 7321: + HENNESSEY, DOUGLAS HOLTZ-EAKIN, + kets that made it difficult + for some to access + +On line 7323: + when needed. VII. Risk + of contagion. The risk of + contagion was an + +On line 7325: + financial system + was vulnerable because + policymakers + +On line 7325: + afraid of a large firm’s + sudden and disorderly + failure triggering + +On line 7327: + In other cases, + unrelated financial + institutions failed + +On line 7327: + similar failed bets + on housing. Unconnected + financial firms failed + + for the same reason + and at roughly the same time + because they had the + +On line 7327: + problem: large housing + losses. This common shock meant + that the problem was + +On line 7329: + this common shock. IX. + Financial shock and panic. + In quick succession + +On line 7329: + restructurings of + ten firms triggered a global + financial panic. + +On line 7329: + financial system + began to evaporate as + the health of almost + +On line 7331: + in the United States + and Europe was questioned. X. + Financial crisis + + causes economic + crisis. The financial shock + and panic caused a + + severe contraction + in the real economy. + The shock and panic + +On line 7333: + real economy + continues through today. We + now describe these ten + +On line 7335: + the crisis in more + detail. THE CREDIT BUBBLE: + GLOBAL CAPITAL + +On line 7339: + credit bubble in + the United States and Europe. + Credit spreads narrowed + +On line 7339: + cost of borrowing + to finance risky investments + declined relative + +On line 7339: + safe assets such as + U.S. Treasury securities. + The most notable of + + these risky investments + were high-risk mortgages. The U.S. + housing bubble was + +On line 7341: + visible effect + of the credit bubble but + not the only one. + +On line 7341: + and leveraged loans were + all boosted by the surplus + of inexpensive + +On line 7343: + explanations for + the credit bubble: global + capital flows, the + +On line 7347: + policy. Global + capital flows Starting in + the late 1990s, China, + +On line 7355: + less than they earned. As + DISSENTING STATEMENT China + and other Asian economies + +On line 7355: + their savings grew as + well. In addition, boosted + by high global oil + +On line 7355: + nations built up large + capital surpluses and + looked to invest in + +On line 7355: + of inexpensive + capital flowed into the + United States, making + +On line 7357: + Americans used the + cheap credit to make riskier + investments than in + +On line 7357: + dynamic was at + work in Europe. Germany saved, + and its capital + +On line 7359: + to Ireland, Italy, Spain + and Portugal. Fed Chairman + Ben Bernanke describes the + +On line 7359: + financial account + surplus growth (the mirror of + current account deficit + +On line 7359: + rose had greater house price + appreciation [from to + The relationship + +On line 7359: + statistically + and economically, and + about percent of the + +On line 7361: + countries is explained."2 + Global imbalances are an + essential cause of + +On line 7361: + crisis and the most + important macroeconomic + explanation. Steady + +On line 7363: + domestic lending, + especially in high-risk + mortgages. The repricing + +On line 7365: + capital can but + does not necessarily + have to lead to an + +On line 7365: + in risky investments. + Increased capital flows to + the United States and + + Europe cannot alone + explain the credit bubble. + We still don’t know whether + +On line 7367: + was the result of + rational or irrational + behavior. Investors + +On line 7367: + have changed, making them + willing to accept lower + returns for high-risk + +On line 7369: + may have adopted a + bubble mentality and + assumed that, while they + +On line 7369: + paying a higher + price for risky assets, they could + resell them later + +On line 7369: + more. Or they may have + mistakenly assumed that + the world had gotten + +On line 7369: + that the risk of bad + outcomes (especially in + U.S. housing markets) + +On line 7371: + of these reasons, over + a period of many years + leading up to the + +On line 7371: + grew willing to pay + more for risky assets. When the + housing bubble burst + + and the financial + shock hit, investors everywhere + reassessed what return + +On line 7371: + demand for a risky + investment, and therefore what + price they were willing + + to pay for a risky + asset. Credit spreads for all + types of risk around the + +On line 7371: + increased suddenly + and sharply, and the prices of risky + assets plummeted. + +On line 7371: + was most evident + in but not limited to + the U.S. market for + +On line 7371: + nontraditional + mortgages. The credit bubble + burst and caused tremendous + +On line 7375: + Federal Reserve + significantly affects + the availability + +On line 7375: + price of capital. + This leads some to argue that + the Fed contributed + +On line 7375: + increased demand for + risky in-KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, + vestments by keeping + +On line 7375: + too long. Critics of + Fed policy argue that, + beginning under + +On line 7375: + and continuing + under Chairman Bernanke, the Fed + kept rates too low for + +On line 7377: + long and created + a bubble in housing. Dr. + John B. Taylor is + +On line 7377: + of this argument. + He argues that the Fed set + interest rates too + +On line 7377: + low in and that these + low rates fueled the housing + bubble as measured + + by housing starts. He + suggests that this Fed-created + housing bubble was + + the essential cause + of the financial crisis. + He further argues + + that, had federal + funds rates instead followed the + path recommended + +On line 7377: + Rule (a monetary + policy formula for + setting the funds rate), + +On line 7377: + boom and subsequent + bust would have been much smaller. + He also applies + + this analysis to + European economies and concludes + that similar forces + +On line 7379: + at play. Current Fed + Chairman Bernanke and former Fed + Chairman Greenspan disagree + +On line 7379: + Taylor’s analysis. + Chairman Bernanke argues that the + Taylor Rule is a + +On line 7379: + rule of thumb, but that + "simple policy rules" are + insufficient for + + making monetary + policy decisions.3 He + further argues that, + +On line 7379: + the construction of + the particular Taylor + Rule, the monetary + + policy stance of + the Fed may not have diverged + significantly + +On line 7379: + its historical + path. Former Chairman Greenspan adds + that the connection + +On line 7379: + interest rates and + house prices is weak—that even if + the Fed’s target for + +On line 7379: + lending between banks + was too low, this has little + power to explain + +On line 7383: + policy questions: + How heavily should the Fed + weigh a policy + +On line 7383: + set interest rates1 + Should monetary policy + be mostly rule-based or + +On line 7385: + discretionary1 If the + Fed thinks an asset bubble + is developing, + +On line 7387: + it use monetary + policy to try to pop + or prevent it1 Were + +On line 7389: + rates too low in Did + too-low federal funds rates cause + or contribute to + + the housing bubble1 + This debate is complex and + thus far unresolved. + +On line 7391: + policy does not + necessarily lead to + smaller credit spreads. + + There are open questions + about the link between short-term + interest rates and + +On line 7391: + housing starts are the + best measure of the housing + bubble, the timing + +On line 7391: + in the European + comparison, and whether the + magnitude of the + +On line 7391: + can be explained by + the gap between the Taylor + Rule prescription and + + historic rates. At the + same time, many observers argue + that Taylor is right + +On line 7391: + were too low during + this period, and therefore + that his argument + +On line 7393: + least plausible if + not provable. We conclude that + global capital + + flows and risk repricing + caused the credit bubble, and + we consider them + +On line 7393: + did not by itself + cause the credit bubble, nor + was it essential + +On line 7395: + and energy on + exploring these questions about + global capital + +On line 7403: + thousands of staff hours + on investigation, and + not nearly enough on + +On line 7407: + investigation + and analysis. Conclusions: + The credit bubble + +On line 7409: + an essential cause + of the financial crisis. + Global capital + +On line 7411: + price of capital + in the United States and much + of Europe. Over time, + +On line 7413: + they required for risky + investments. Their preferences + may have changed, they may + +On line 7413: + irrational bubble + mentality, or they may + have mistakenly + +On line 7415: + inflated prices for + risky assets. U.S. monetary + policy may have + + contributed to the + credit bubble but did not + cause it. THE HOUSING + + BUBBLE The housing + bubble had two components: + the actual homes + + and the mortgages that + financed them. We look briefly at + each component and + +On line 7421: + a housing bubble + in the United States—the + price of U.S. housing + + increased by more than + could be explained by market + developments. This + +On line 7425: + Nevada, Arizona, and + Florida. Conventional + wisdom is that a + +On line 7425: + to spot while you’re in + one, and painfully obvious + after it has burst. + + Even after the U.S. + housing bubble burst, there is + no consensus on + + what caused it. While we + still don’t know the relative + importance of the + +On line 7429: + Florida, Nevada, + and parts of California + all experienced + +On line 7429: + that far exceeded + the national average. + More people fueled + +On line 7431: + for houses. Land use + restrictions. In some areas, + local zoning rules + +On line 7431: + restrictions, as well + as natural barriers + to building, made it + +On line 7431: + new houses to meet + increased demand resulting + from population + +On line 7433: + supply is constrained + and demand increases, prices + go up. Over-optimism. + +On line 7433: + driving up prices, shared + expectations of future + price increases can + +On line 7435: + explanation of + a bubble. Easy financing. + Nontraditional + +On line 7435: + made it easier + for potential homebuyers + to borrow enough to + + buy more expensive + homes. This doesn’t mean they could + afford those homes or + +On line 7435: + payments in KEITH + HENNESSEY, DOUGLAS HOLTZ-EAKIN, the long + run, but only that + +On line 7437: + had insufficient + incentive to encourage + borrowers to get + + sustainable mortgages. + Some combination of the + first two factors may + +On line 7439: + in parts of the Sand + States, but these don’t explain the + nationwide increase + + in prices. The closely + related and nationwide + mortgage bubble was + +On line 7441: + most significant + manifestation of a + more generalized + + credit bubble in + the United States and Europe. + Mortgage rates were low + +On line 7441: + the risk of losses, + and risky borrowers, who in + the past would have been + +On line 7443: + found it possible + to obtain a mortgage.4 In + addition to the + +On line 7443: + nontraditional + mortgage products was a key + cause of this surge in + +On line 7443: + lending. Use of these + products increased rapidly from + the early part of + +On line 7443: + lowered the credit + quality of the mortgages + they would accept, and + +On line 7443: + rating agencies that + overrated the subsequent + securities and + +On line 7443: + increase in mortgages + that required little to no + documentation. + +On line 7445: + affordability + would normally have constrained + demand, but lenders and + +On line 7445: + products to paper + over this affordability + issue. These mortgage + + products included + interest-only adjustable rate + mortgages (ARMs), pay-option + +On line 7445: + monthly payments, and + negative amortization + products in which the + + initial payment did + not even cover interest + costs. These exotic + +On line 7445: + products would often + result in significant + reductions in the + +On line 7445: + with even a standard + ARM. Not surprisingly, they + were the mortgages of + +On line 7447: + borrowers focused + on minimizing initial + monthly payments. Fed + + Chairman Bernanke sums up + the situation this way: + "At some point, both lenders + +On line 7447: + became convinced that + house prices would only go up. + Borrowers chose, and + +On line 7447: + that they could not be + expected to service in + the longer term. They were + + provided these loans + on the expectation that + accumulating + +On line 7447: + mortgages. For a time, + rising house prices became a + self-fulfilling + +On line 7447: + but ultimately, + further appreciation + could not be sustained + +On line 7449: + explanation posits + a relationship between + the surge in housing + + prices and the surge in + mortgage lending. There is not + yet a consensus + +On line 7449: + the cause and which the + effect. They appear to have + been mutually + + reinforcing. In + understanding the growth of + nontraditional + +On line 7451: + to determine the + relative importance of + causal factors, but again + +On line 7453: + can at least list those + that are important: Nonbank + mortgage lenders like New + +On line 7453: + at the state level. + Weak disclosure standards and + underwriting rules + +On line 7461: + irresponsible + lenders to issue DISSENTING + STATEMENT mortgages that + +On line 7461: + probably never + be repaid. Federally + regulated bank + +On line 7463: + brokers were paid for + new originations but did + not ultimately + +On line 7463: + losses on poorly + performing mortgages. Mortgage + brokers therefore had + +On line 7465: + information about + borrowers. Many borrowers + neither understood + +On line 7465: + terms of their mortgage + nor appreciated the + risk that home values + +On line 7465: + others borrowed too + much and bought bigger houses + than they could ever + +On line 7467: + reasonably expect + to afford. All these factors + were supplemented + +On line 7467: + homeownership but + created hidden costs to + taxpayers and the + +On line 7467: + Elected officials + of both parties pushed housing + subsidies too far. + +On line 7469: + mortgage fraud problems. + Excruciating anecdotes + showed that mortgage fraud + +On line 7469: + the housing bubble. + There is no question that this + fraud did tremendous harm. + +On line 7469: + (like Florida), the + Commission was unable to + measure the impact + +On line 7471: + fraud relative to + the overall housing bubble. + The explosion of + +On line 7471: + for the creation of + so many bad mortgages. Lending + standards were lax enough + +On line 7471: + could remain within + the law but still generate + huge volumes of bad + +On line 7471: + housing bubble and + the crisis would have occurred + even if there had been + +On line 7471: + classify mortgage + fraud not as an essential + cause of the crisis + +On line 7473: + contributing factor + and a deplorable effect of + the bubble. Even if + +On line 7473: + of fraudulent loans + was not substantial enough to + have a large impact + +On line 7473: + have been a leading + indicator of deeper + structural problems in + +On line 7477: + in the late 1990s and + accelerating in the + 2000s, there was a large + +On line 7477: + housing bubble in + the United States. The bubble + was characterized + +On line 7477: + house prices well above the + historical trend and by + more rapid regional + +On line 7481: + primarily by + the broader credit bubble. + The causes of the + +On line 7481: + population growth, + land use restrictions, bubble + psychology, and + +On line 7483: + the mortgage bubble + and its relationship to + the housing bubble + +On line 7483: + underwriting rules + for bank and nonbank mortgage + lenders alike, the way in + +On line 7483: + mortgage brokers were + compensated, borrowers + who bought too much house + +On line 7483: + didn’t understand + or ignored the terms of their + mortgages, and elected + +On line 7483: + who over years piled on + layer upon layer of + government housing + +On line 7485: + subsidies. Mortgage + fraud increased substantially, + but the evidence + +On line 7487: + enough to conclude that + it was an essential cause. + TURNING BAD MORTGAGES + +On line 7489: + ASSETS The mortgage + securitization process + turned mortgages into + +On line 7489: + government-sponsored + enterprises (GSEs) Fannie + Mae and Freddie Mac, + +On line 7489: + capital to flow + from investors to homebuyers. + Without it, mortgage + +On line 7489: + be limited to + banks and other portfolio + lenders, supported by + +On line 7489: + makes homeownership + more affordable. It also + can diversify + +On line 7489: + different types of + lenders. If everything else is + working properly, + +On line 7491: + else was not working + properly. Some focus their + criticism on the + +On line 7491: + obligations (CDOs) were + engineered from different + bundled payment streams + +On line 7493: + securities. Some + argue that the conversion + of a bundle of + +On line 7493: + debt obligation, was + a problem. They argue that + complex financial + + derivatives caused + the crisis. We conclude that + the details of this + +On line 7493: + to understanding + the essential causes of + the crisis. If the + +On line 7493: + reconfiguring + streams of mortgage payments has + little effect. The + + total amount of risk + in a mortgage is unchanged + if the pieces are put + +On line 7495: + in a different + way. Unfortunately, the + system did not work + +On line 7497: + made things worse. Fannie + Mae and Freddie Mac, as well + as Countrywide and + +On line 7497: + credit quality + standards of the mortgages they + securitized.6 A + +On line 7497: + were generally + of poorer quality. This + turned a bad mortgage + +On line 7499: + worse security. + Mortgage originators took + advantage of these + +On line 7499: + standards and the easy + flow of credit to relax + the underwriting + + discipline in the + loans they issued. As long as + they could resell a + +On line 7507: + complexity of + housing-related assets and + the many steps between + +On line 7507: + the importance of + credit rating agencies and + made independent + +On line 7507: + more difficult. In + this respect, complexity + did contribute to + + the problem, but the + other problems listed here + are more important. + +On line 7509: + optimistic ratings + to the CDOs built from mortgage-backed + securities.7 By + +On line 7509: + rating these bundles + of mortgage-backed security + payments too highly, + +On line 7511: + financial assets. + Borrowers, originators, + securitizers, + + rating agencies, and + the ultimate buyers of + the securities + +On line 7511: + were packaged all failed + to exercise prudence and + perform due diligence + +On line 7513: + credit ratings. Many + financial institutions + chose to make highly + + concentrated bets + on housing prices. While in some + cases they did that + + with whole loans, they were + able to more easily and + efficiently do + +On line 7515: + domestically + and internationally, + gave pref-erential + +On line 7515: + to highly rated + debt, further empowering + the rating agencies + +On line 7517: + desirability + of mortgage-backed structured products. + There is a way that + + housing bets can be + magnified using a form + of derivative. + + A synthetic CDO + is a security whose + payments mimic that + +On line 7517: + a CDO that contains + real mortgages. This is a + "side bet" that allows + +On line 7517: + to assume the same + risk as if you held pieces of + actual mortgages. + +On line 7517: + to increase their bets + on housing, they were able to + use synthetic CDOs. + +On line 7517: + CDOs, however, are + zero-sum, since for every + investor making a + +On line 7517: + housing performance + will fall there must be other + investors with equal-sized + +On line 7519: + These are related + but different problems. While + many involve the word + + "derivative," it + is a mistake to bundle + them together and + + say, "Derivatives + or CDOs caused the crisis." In + each case, we assign + +On line 7519: + and institutions + rather than to the financial + instruments they used. + +On line 7523: + than "derivatives + and CDOs caused the financial + crisis," it is more + +On line 7525: + accurate to say: + Securitizers lowered + credit quality + +On line 7531: + investors and others + failed to perform sufficient + due diligence; KEITH + +On line 7533: + arbitrage toward + lower capital standards; + Some investors used these + +On line 7535: + diversify risk; + and Others used synthetic + CDOs to amplify + + their housing bets. The + dangerous imprecision + of the term "shadow + +On line 7537: + report begins with + an extensive discussion + of the failures of + +On line 7537: + it defines as a + "financial institutions + and activities + +On line 7537: + respects parallel + banking activities but + are subject to less + +On line 7537: + report suggests that + the shadow banking system + was a cause of the + + financial crisis. + "Shadow banking" is a term + used to represent + +On line 7539: + issues within the + financial system. Indeed, + "shadow banking" can + +On line 7539: + to any financial + activity that transforms + short-term borrowing + +On line 7539: + lending without a + government backstop. This term + can therefore include + +On line 7543: + as diverse as: The + tri-party repo market; + Structured Investment + +On line 7545: + other off-balance-sheet + entities used to increase + leverage; Fannie Mae + +On line 7549: + monoline insurers, + commercial paper, money + market mutual + + funds, and investment + banks. As discussed in other + parts of this paper, + + some of these items were + important causes of the + crisis. No matter + +On line 7551: + roles in causing or + contributing to the crisis, + however, they are + +On line 7551: + is a mistake to + group these issues and problems + together. Each should + + be considered on + its merits, rather than painting + a poorly defined + +On line 7553: + a common brush of + "too little regulation." + BIG BANK BETS AND WHY + +On line 7555: + FAILED The story so + far involves significant + lost housing wealth and + +On line 7555: + Yet even larger past + wealth losses did not bring the + global financial + + system to its knees. + The key differences in this + case were leverage and + +On line 7555: + and highly leveraged + financial institutions + in the United States + +On line 7555: + Europe. This leverage + magnified the effect of + a housing loss on + +On line 7555: + capital reserve, + and the concentration meant + these losses occurred + +On line 7563: + STATEMENT In effect, + many of the largest financial + institutions in + +On line 7563: + hundreds of smaller + ones, bet the survival of their + institutions on + + housing prices. Some did + this knowingly; others not. + Many investors made three + +On line 7567: + probability + that housing prices would decline + significantly; + +On line 7569: + different regions, + so that a local housing + bubble bursting in + +On line 7569: + would not happen at + the same time as one bursting + in Florida; and + +On line 7571: + defaults, in which an + underwater homeowner + voluntarily + +On line 7573: + mortgage. When housing + prices declined nationally + and quite severely + +On line 7573: + certain areas, these + flawed assumptions, magnified + by other problems + +On line 7573: + created enormous + financial losses for firms + exposed to housing + +On line 7575: + of the financial + and economic crisis was + appallingly bad risk + +On line 7575: + by the leaders of + some of the largest financial + institutions in + +On line 7575: + States and Europe. Each + failed firm that the Commission + examined failed in + +On line 7577: + because its leaders + poorly managed risk. Based on + testimony from + +On line 7577: + of the largest failed firms + and the Commission staff ’s + investigative work, + +On line 7577: + can group common risk + management failures into + several classes: + +On line 7579: + risk. Firm managers bet + massively on one type of + asset, counting on + + high rates of return + while comforting themselves that + their competitors were + +On line 7581: + same. Insufficient + capital. Some of the failed + institutions were + +On line 7585: + was financed with of + equity capital and + of debt. This made these + +On line 7585: + were going well, but + incredibly sensitive + to even a small loss, + +On line 7585: + a percent decline + in the market value of + these assets would leave + + them technically + insolvent. In some cases, + this increased leverage + +On line 7585: + In other cases, + firms used Structured Investment + Vehicles, asset-backed + +On line 7585: + conduits, and other + off-balance-sheet entities to + try to have it both + +On line 7585: + financial sector + and creates a financial + accident waiting + +On line 7585: + firms should have had much + larger capital cushions + and/or mechanisms + +On line 7587: + markets. Just as each + lacked sufficient capital + cushions, in each case + +On line 7587: + firm’s liquidity + cushion ran out within days. + The failed firms appear + +On line 7587: + strategies on the flawed + assumption that both the firm + and KEITH HENNESSEY, + +On line 7587: + would always be healthy + and functioning smoothly. By + failing to provide + +On line 7589: + put their firm’s survival + on a hair trigger. Poor risk + management systems. + +On line 7589: + of firms were unable + to easily aggregate + their housing risks across + + various business + lines. Once the market began + to decline, those firms + + that understood their + total exposure were able + to effectively + +On line 7589: + hedge their risk before + the market turned down too far. + Those that didn’t were + +On line 7591: + with toxic assets + in a disintegrating + market. Solvency + +On line 7593: + heard testimony + from the former heads of Bear + Stearns, Lehman, Citigroup, + + and AIG, among others. + A common theme pervaded + the testimony + +On line 7595: + of these witnesses: + We were solvent before the + liquidity run + +On line 7597: + information and + started an unjustified + liquidity run. + +On line 7599: + happened, given enough + time we would have recovered + and returned to a + +On line 7601: + position of strength. + Therefore, the firm failed because + we ran out of time, + +On line 7603: + each case, experts and + regulators contested + the former CEO’s "we + +On line 7603: + difficult to prove + otherwise, especially + because the answer + +On line 7603: + when solvency is + measured. After a few days + of selling assets + + at fire-sale prices during + a liquidity run, a + highly leveraged firm’s + + balance sheet will look + measurably worse. In each case, + whether or not the firm + +On line 7603: + that those pulling back from + doing business with the firm + were not irrational. + +On line 7603: + each of the cases + we examined, there were huge + financial losses + +On line 7605: + each case, the CEO was + willing to admit that he + had poorly managed + +On line 7605: + admit that his firm + was insolvent or nearly + so. In each case the + +On line 7605: + managers knew or should + have known that they were risking + the solvency and + +On line 7609: + the survival of their + firms. Conclusions: Managers of + many large and midsize + +On line 7609: + housing risk on their + balance sheets. In doing so + they turned a building + +On line 7609: + failing financial + institutions. Some did this + knowingly; others, + +On line 7621: + placed their firms on a + hair trigger by becoming + dependent upon + + short-term financing + from commercial paper and + repo markets for + +On line 7621: + failed solvency bets + that their housing investments + were solid, and failed + + liquidity bets + that overnight money would always + be there no matter + +On line 7621: + several cases, + failed solvency bets triggered + liquidity crises, + +On line 7623: + the largest financial + firms to fail or nearly fail. + "Investment banks caused + +On line 7625: + the Commission was + the relative importance + of a firm’s legal + +On line 7625: + institutions. For + example, Commissioners + agreed that investment + +On line 7625: + too lightly (barely) + regulated by the SEC + leading up to the + +On line 7625: + regulation of + these firms failed. As a result, + no regulator + +On line 7625: + or liquidity + buffers. There was agreement among + Commissioners that + +On line 7625: + contributing factor + to the failure of these firms. + The Commission split, + + however, on whether + the relatively weaker + regulation of + +On line 7627: + cause of the crisis. + Institutional structure + and differential + +On line 7627: + various types of + financial institutions + were less important + +On line 7627: + regulatory + regimes. Investment banks failed in + the United States, and + +On line 7627: + many commercial banks, + large and small, despite a stronger + regulatory + +On line 7627: + supervisory + regime. Wachovia, for example, + was a large insured + + depository + institution supervised + by the Fed, OCC, and + +On line 7627: + experienced a + liquidity run that led + to its near failure + +On line 7627: + of the FDIC’s systemic + risk exception. Insurance + companies failed as + + well, notably AIG and + the monoline bond insurers. + Banks with different + +On line 7629: + to be rescued in + the United Kingdom, Germany, + Iceland, Belgium, the + +On line 7629: + these nations had far + stricter regulatory and + supervisory + +On line 7629: + than the United States. + The bad loans in the United + Kingdom, Ireland, and + + Spain were financed by + federally-regulated + lenders–not by "shadow + +On line 7631: + Rather than attributing + the crisis principally + to differences in + +On line 7633: + more sense to look for + common factors: Different + types of financial + +On line 7635: + financial firms in + the United States and Europe + poorly managed their + +On line 7639: + liquidity risk. + KEITH HENNESSEY, DOUGLAS HOLTZ-EAKIN, + TWO TYPES OF SYSTEMIC + + FAILURE Government + policymakers were afraid + of large firms’ sudden + +On line 7641: + as a result. At + times, intervention itself + contributed to fear + +On line 7641: + uncertainty about + the stability of the + financial system. + +On line 7645: + two types of systemic + failure. Systemic failure type + one: contagion We + + begin by defining + contagion and too big to + fail. If financial + + firm X is a large + counterparty to other + firms, X’s sudden and + +On line 7649: + weaken the finances + of those other firms and cause + them to fail. We call + +On line 7649: + direct financial + link between firms, the failure + of one causes the + +On line 7649: + X is too big to + fail if policymakers + fear contagion so + +On line 7649: + are unwilling to + allow it to go bankrupt + in a sudden and + +On line 7649: + in large part based on + how much counterparty risk + other firms have to + +On line 7651: + may also act if + they worry about the effects + of a failed firm on + + a particular + financial market in which + that firm is a large + + participant. The + determination of too + big to fail rests in + +On line 7653: + policymakers + who must decide whether to "bail + out" a failing firm. + +On line 7653: + are uncertain about + the size of counterparty + credit risk or about + +On line 7653: + of an important + financial market, or if + broader market or + +On line 7655: + conditions make them + more risk averse. This logic can + explain the actions + +On line 7657: + cases in In March, + the Fed facilitated + JPMorgan’s purchase of Bear + +On line 7657: + by providing a + bridge loan and loss protection + on a pool of Bear’s + +On line 7657: + policymakers + were concerned about the failure + of Bear Stearns itself + +On line 7657: + direct effects on + other firms, their decision + to act was heightened + +On line 7657: + uncertainty about + potential broader market + instability + +On line 7657: + potential impact + of Bear Stearns’ sudden failure + on the tri-party + +On line 7659: + In September, the + Federal Housing Finance + Agency (FHFA) put + +On line 7659: + Mae and Freddie Mac + into conservatorship. + Policymakers + + in effect promised that + "the line would be drawn between + debt and equity," + +On line 7661: + such that equity + holders were wiped out but GSE + debt would be worth cents + +On line 7661: + dollar. They made this + decision because banking + regulators (and + +On line 7661: + treated Fannie and + Freddie debt as equivalent + to Treasuries. A bank + +On line 7661: + of its assets in + debt issued by General + Electric or AT&T, but + + can hold it all in + Fannie or Freddie debt. The + same is true for many + + other investors in + the United States and around the + world–they assumed that GSE + + debt was perfectly + safe and so they weighted it + too heavily in + +On line 7669: + DISSENTING STATEMENT + this counterparty risk faced + by many financial + + institutions meant + that any write-down of GSE debt + would trigger a chain + + of failures throughout + the financial system. In + addition, GSE debt + +On line 7669: + as collateral + in short-term lending markets, + and by extension, + +On line 7669: + would have led to a + sudden massive contraction + of credit beyond + +On line 7669: + occur. Finally, + mortgage markets depended + so heavily on + +On line 7671: + effectively halt + the creation of new mortgages. + All three reasons led + + policymakers + to conclude that Fannie Mae + and Freddie Mac were + +On line 7673: + too big to fail. In + September, the Federal + Reserve, with support + +On line 7673: + AIG, preventing it + from sudden disorderly + failure. They took this + +On line 7673: + was a huge seller + of credit default swaps to + a number of large + + financial firms, and + they were concerned that an AIG + default would trigger + +On line 7673: + those firms’ balance sheets, + forcing counterparties to + scramble to replace + +On line 7673: + and potentially + triggering a cascade of + failures. AIG also + + had important lines + of business in insuring + consumer and business + +On line 7673: + been threatened by a + failure of AIG’s financial + products division + +On line 7673: + decision to aid + AIG was also influenced + by the extremely + +On line 7675: + institutional + failures in prior days and + weeks. In November, + +On line 7675: + Treasury provided + assistance to Citigroup. + Regulators feared + +On line 7675: + would both undermine + confidence the financial + system gained after + +On line 7679: + to the failures of + Citi’s major counterparties. + Conclusion: The risk + +On line 7679: + financial system + was vulnerable because + policymakers + +On line 7679: + afraid of a large firm’s + sudden and disorderly + failure triggering + +On line 7681: + allow them to fail + suddenly. Systemic failure + type two: a common + +On line 7683: + flu, then a common + shock is like food poisoning. + A common factor + + affects a number + of firms in the same way, and + they all get sick at + + the same time. In a + common shock, the failure of + one firm may inform + + us about the breadth or + depth of the problem, but the + failure of one firm + +On line 7685: + not cause the failure + of another. The common + factor in this case + + was concentrated + losses on housing-related + assets in large and + +On line 7689: + in the United States + and some in Europe. KEITH + HENNESSEY, DOUGLAS HOLTZ-EAKIN, + +On line 7689: + financial sector. + Policymakers were not + just dealing with a + +On line 7691: + firm that might transmit + its failure to others. They + were dealing with a + +On line 7691: + large, midsize, and small + financial institutions + took large losses at + + roughly the same time. + Conclusion: Some financial + institutions failed + +On line 7695: + similar failed bets + on housing. Unconnected + financial firms were + + failing for the same + reason and at roughly the + same time because they + + had the same problem + of large housing losses. This + common shock meant the + +On line 7697: + this common shock. We + examine two frequently + debated topics + +On line 7701: + events of September + "The government should not have + bailed out Some argue + +On line 7703: + is too big to fail, + and that policymakers + erred when they "bailed out" + +On line 7703: + and Freddie, AIG, and + later Citigroup. In our + view, this misses the + +On line 7703: + were presented, for + example, with the news that + "AIG is about to fail" + + and counseled that its + sudden and disorderly + failure might trigger + +On line 7703: + preceding failures + of Fannie Mae and Freddie + Mac, the Merrill Lynch + +On line 7703: + Reserve Primary + Fund breaking the buck, market + confidence was on + +On line 7703: + chain reaction could + cause a run on the global + financial system. + +On line 7703: + just a run on a + bank, but a generalized + panic that might crash + +On line 7705: + is, the risk of an + event comparable to the + Great Depression. For + +On line 7705: + policymaker, + the calculus is simple: + if you bail out AIG + +On line 7705: + you’re wrong, you will have + wasted taxpayer money + and provoked public + + outrage. If you don’t + bail out AIG and you’re wrong, the + global financial + + system collapses. + It should be easy to see why + policymakers + + favored action–there + was a chance of being wrong + either way, and the + +On line 7705: + being wrong without + action were far greater than the + costs of being wrong + +On line 7711: + Geithner, and + Paulson should not have chosen + to let Lehman fail" This + +On line 7711: + the most frequently + discussed element of the + financial crisis. + +On line 7713: + make this case one must + argue: Bernanke, Geithner, + and Paulson had a + +On line 7715: + option available to + them other than Lehman filing + bankruptcy. They knew + +On line 7723: + considered it, and + rejected it. DISSENTING + STATEMENT They were wrong + +On line 7725: + to do so. They had + a reason for choosing to + allow Lehman to fail. + +On line 7727: + yet to find someone + who can make a plausible + case on all four counts. + + We think that these three + policymakers would have + saved Lehman if they thought + + they had a legal + and viable option to do + so. In hindsight, we + +On line 7727: + they were right at the + time–they did not have a legal + and viable option + +On line 7729: + have accused these three + of making a mistake. These + critics usually + + argue that these three + should have saved Lehman. When asked what + else they could have done, + + the critic’s usual + response is, "I don’t know, but + surely they could have + +On line 7731: + something. They chose not + to and caused the crisis." Those + who want to label + +On line 7733: + mistake are obliged to + suggest an alternate course + of action. The Fed’s + +On line 7733: + for Bear Stearns, and FDIC + and Treasury’s assistance for + Wachovia, followed a + +On line 7733: + each case, the failing + firm or the government found + a buyer, and the + +On line 7733: + the case of Bear Stearns, + the government subsidized + the purchase, and in + + the case of Wachovia, + the government made clear that + assistance would be + +On line 7733: + it were needed. The + specific mechanics of + the subsidy differed + +On line 7733: + two cases, but in + each bailout the key condition + was the presence of + + a willing buyer. + Lehman had no willing buyer. + Bank of America + +On line 7735: + other American + financial institution + was willing or able + +On line 7735: + For months, government + officials had tried and failed + to facilitate + +On line 7735: + of "Lehman weekend," the + most viable candidate was + the British bank Barclays. + + To make the purchase, + Barclays needed either a + shareholder vote, which + + would take several + weeks to execute, or the + permission of their + +On line 7737: + They could get neither + in the time available. Lehman was + therefore facing an + +On line 7739: + liquidity run + without a path to success. + There was no buyer. + +On line 7739: + might be a buyer, + some weeks in the future. Bernanke, + Geithner, and + +On line 7739: + confronted with the + question of whether to provide + an effectively + +On line 7741: + its disappearing + liquidity while Lehman searched + for a buyer. This + + loan would have to come + from the Fed, since before the + enactment of the + +On line 7741: + no authority + to provide such financing. + The law limits the + + Fed in these cases. + The Fed can only provide + secured loans. They were + + able to make this work + for Bear Stearns and AIG because + there were sufficient + +On line 7741: + collateral. Fed + officials argue that Lehman + had insufficient + + un-pledged assets to + secure the loan it would have + needed to survive. + +On line 7743: + to provide credit. + Was there another option1 + The Fed leaders would + +On line 7743: + had to direct the + staff to re-evaluate in + a more optimistic + +On line 7743: + analysis of Lehman’s + balance sheet to justify + a secured loan. They + +On line 7743: + have had to decide + to provide liquidity + support to KEITH + + HENNESSEY, DOUGLAS HOLTZ-EAKIN, + Lehman for an indefinite + time period while + +On line 7743: + searched for a buyer. + That asset revaluation + would later have come + +On line 7743: + the likely large and + potentially uncapped cost + to the taxpayer. + +On line 7743: + the meantime, other + creditors to Lehman could have + cashed out at cents on + +On line 7745: + leaving taxpayers + holding the bag for losses. + Fed Chairman Bernanke, his + + general counsel + Scott Alvarez, and New York Fed + general counsel + +On line 7745: + Jr. all argued in + sworn testimony that this + option would not have + +On line 7745: + suggested that it + also would have been unwise + because, in effect, + +On line 7745: + have been providing + an open-ended commitment to + allow Lehman to shop + +On line 7745: + Bernanke testified that + such a loan would merely waste + taxpayer money + + for an outcome that + was quite unlikely to change. + Based on their actions + +On line 7747: + policymakers + would have taken any available + option they thought was + + legal and viable. + This was an active team that + was in all cases + +On line 7747: + to reduce the risk + of catastrophic outcomes. + Fed Chairman Bernanke said + + that he "was very, very + confident that Lehman’s demise was + going to be a + +On line 7747: + it implausible + to conclude that they would have + broken pattern on + +On line 7747: + one case at such an + obviously risky moment + if they had thought they + +On line 7749: + it inconceivable + that policymakers could + be confronted with + + a situation + in which there was no legal + and viable course of + +On line 7753: + to avoid financial + catastrophe. In this case, that + is what happened. THE + + SHOCK AND THE PANIC + Conventional wisdom is + that the failure of + +On line 7755: + Brothers triggered the + financial panic. This is + because Lehman’s failure + +On line 7755: + the debate about whether + government officials could + have saved Lehman is so + +On line 7757: + The focus on Lehman’s + failure is too narrow. The + events of September + +On line 7759: + a chain of one firm + failure after another: + Sunday, September + +On line 7759: + FHFA put Fannie + Mae and Freddie Mac into + conservatorship. + +On line 7761: + This was followed by + "Lehman weekend at the New York + Fed," which was in fact + + broader than just Lehman. + At the end of that weekend, + Bank of America + +On line 7763: + buy Merrill Lynch, Lehman + was filing for bankruptcy, + and AIG was on the + +On line 7767: + Tuesday, September + the Reserve Primary Fund, + a money market + + mutual fund, "broke + the buck" after facing an + investor run. Its net + +On line 7771: + below meaning that + an investment in the fund + had actually + +On line 7771: + a money market + fund. On the same day, the Fed + approved an billion + +On line 7779: + from sudden failure. + DISSENTING STATEMENT Thursday, + September the Bush + +On line 7779: + appropriate funds + for a new Troubled Asset + Relief Program (TARP) + +On line 7783: + September the Fed + agreed to accept Goldman Sachs + and Morgan Stanley + +On line 7783: + putting them under the + Fed’s regulatory purview. + After this, there were + +On line 7787: + and later sold it + to JPMorgan. Monday, September + the TARP bill failed to + +On line 7789: + Citigroup. Wednesday, + October the Senate passed + a revised TARP bill. + +On line 7789: + days later, the House + passed it, and the President + signed it into law. + +On line 7791: + than Citigroup, bought + Wachovia. As the month progressed, + interbank lending + +On line 7791: + indicating the + heightened fear and threatening + a complete freeze of + +On line 7793: + panic was triggered + and then amplified by the + close succession of + + these events, and not just + by Lehman’s failure. Lehman was the + most unexpected + +On line 7793: + succession, but it’s + a mistake to attribute the + panic entirely + +On line 7793: + Lehman’s failure. There was + growing realization by + investors that mortgage + +On line 7797: + system, but nobody + knew precisely where they lay. + Conclusion: In quick + +On line 7797: + restructuring of + ten firms triggered a global + financial panic. + +On line 7797: + financial system + began to evaporate as + the health of almost + +On line 7799: + institution in + the United States and Europe + was questioned. We briefly + +On line 7803: + of these failures. The + Reserve Primary Fund The + role of the Reserve + +On line 7803: + mutual fund faced + escalating redemption + requests and had to + +On line 7803: + its holdings of Lehman + debt. On Tuesday, September + it broke the buck in + +On line 7803: + a disorganized + manner. Investors who withdrew + early recouped cents + +On line 7803: + the dollar, with the + remaining investors bearing + the losses. This spread + +On line 7803: + situated funds + might follow. By the middle + of the following + +On line 7805: + prime money market + mutual fund investors had + withdrawn billion. When + +On line 7805: + began to convert + their holdings to Treasuries and + cash. Corporations + +On line 7805: + short-term financing + suddenly had to draw down + their backstop lines of + + credit. No one had + expected these corporate + lines of credit to + +On line 7809: + would have to pull back + on other activities. + The role of Fannie + + Mae and Freddie Mac + in causing the crisis The + government-sponsored + +On line 7809: + and Freddie Mac were + elements of the crisis + in several ways: + +On line 7811: + They were part of the + securitization process + that lowered mortgage + +On line 7813: + credit quality + standards. As large financial + institutions whose + +On line 7813: + the too big to fail + problem. Policymakers + were unwilling to + +On line 7815: + because: Financial + institutions around the world + bore significant + +On line 7817: + counterparty risk + to them through holdings of GSE + debt; Certain funding + +On line 7821: + depended on their + continued existence. They + were by far the most + +On line 7823: + to the taxpayer + and are an ongoing cost. + There is vigorous + +On line 7823: + to "private label" + securitizers. There is + also vigorous + + debate about why these + two firms got involved in this + problem. We think both + +On line 7823: + are less important + than the multiple points of + contact Fannie Mae + +On line 7825: + enormous portfolios + of housing-related assets, + and the issuers of + + debt that was treated + like government debt by the + financial system. + +On line 7825: + Freddie Mac did not + by themselves cause the crisis, + but they contributed + +On line 7829: + number of ways. THE + SYSTEM FREEZING Following + the shock and panic, + +On line 7829: + with escalating + frictions. Some funding markets + collapsed entirely. + +On line 7829: + stabilized slowly + as the panic subsided + and the government + + stepped in to backstop + markets and firms. We highlight + three funding markets + +On line 7831: + funds market where banks + loan excess reserves to one + another overnight. Even + +On line 7839: + DISSENTING STATEMENT + banks were unable to get overnight + loans, compounding an + +On line 7841: + September repo + rates increased substantially, + and haircuts ballooned. + +On line 7843: + mortgages were no longer + acceptable collateral. + Commercial paper. + + The failure of Lehman + and the Reserve Primary + Fund breaking the buck + + sparked a run on prime + money market mutual + funds. Money market + +On line 7843: + investing in the + commercial paper market, + leading to a rapid + +On line 7845: + commercial paper. + The inability to find + funding, financial + +On line 7845: + markets for other + kinds of debt collapsed rapidly + in and still have not + + recovered fully, + cutting off a substantial + source of financing + +On line 7847: + credit cards, car loans, + student loans, and small business + loans. Decreased credit + +On line 7847: + housing bubble, and + additional wealth losses + from a declining + +On line 7847: + a sharp contraction + in consump-tion and output + and an increase in + +On line 7849: + contracted at an + annual rate of percent + in the third quarter + +On line 7851: + of percent in the + fourth quarter, and percent in + the first quarter of + +On line 7851: + contraction in the + fourth quarter of was the worst + in nearly three decades. + +On line 7851: + not previously + been directly affected + by the financial + +On line 7851: + new investments, while + families put spending plans + on hold. After the + + panic began, the + rate at which the economy + shed jobs jumped, going + +On line 7851: + from an average + of jobs lost per month in the + first three quarters of + +On line 7851: + to an average + of over jobs lost per month in + the fourth quarter of + +On line 7851: + the first quarter of + The economy continued + to lose jobs through most + +On line 7853: + in October and + remaining above percent for + the rest of and the + +On line 7855: + months of While the shock + and panic therefore appear + to have ended in + +On line 7855: + real economy + continues through today. Firms + and families are + +On line 7855: + deleveraging and are + uncertain about both future + economic growth and + +On line 7855: + final tragedy of the + financial and economic + crisis is that the + + needed recovery + is slow and looks to be so + for a while longer. NOTES + +On line 7859: + of the Commission + on December limited + dissenters to nine pages + +On line 7859: + No limits apply + to the official version + submitted to the + +On line 7861: + Congress. Ben S. Bernanke, + "Monetary Policy and + the Housing Bubble," + +On line 7863: + Georgia, January + (www.federalreserve.gov/ + newsevents/speech/bernanke20100103a.htm). + +On line 7869: + Ibid. KEITH HENNESSEY, + DOUGLAS HOLTZ-EAKIN, "Risky borrowers" + does not mean poor. While + + many risky borrowers + were low-income, a borrower + with unproven income + +On line 7871: + vacation home was + also risky. Bernanke, "Monetary + Policy and the + +On line 7871: + the motivations + of the different types of + securitizers + +On line 7871: + think that both types of + securitizers were in + part responsible + +On line 7871: + less important than + the existence of lower + standards and how this + +On line 7873: + by credit rating + agencies was an essential + cause of the crisis, + +On line 7873: + hypotheses include: + bad analytic models + that failed to account + +On line 7873: + industry model + that encouraged the rating + agencies to skew their + +On line 7873: + a lack of market + competition due to their + government-induced + +On line 7875: + the crisis, the three + key policymakers were + Treasury Secretary + +On line 7875: + Paulson, Federal + Reserve Chairman Ben Bernanke, and + Federal Reserve + +On line 7875: + New York President + Timothy Geithner. + Other officials + +On line 7875: + FHFA Director + Jim Lockhart’s GSE actions and + FDIC Chairman Sheila Bair’s + +On line 7875: + the fall of During + the financial recovery + and rebuilding stage + +On line 7875: + in early the three + key policymakers were + Treasury Secretary + +On line 7877: + Summers. Ben S. Bernanke, + testimony before the + FCIC, Hearing on Too + +On line 7883: + Federal Reserve, + September transcript, p. F + I NA N C IA + + L C R I S + I S I N Q U I + RY C OM M I + + S S I O N + D I S S E N T + I N G S TAT + + E M E N T + PETER J. WALLISON ARTHUR + F. BURNS FELLOW IN + +On line 7910: + INSTITUTE Contact: + pwallison@aei.org INTRODUCTION + Why a Dissent1 Th + +On line 7912: + question I have been + most frequently asked about the + Financial Crisis + +On line 7912: + Commission (the "FCIC" + or the "Commission") is why + Congress bothered to + + authorize it at + all. Without waiting for the + Commission’s insights + + into the causes + of the fi nancial crisis, + Congress passed and the + +On line 7912: + Act (DFA), far reaching + and highly consequential + regulatory + +On line 7912: + and the President + acted without seeking to + understand the true + +On line 7912: + of the President’s + chief of staff —"Never let a + good crisis go to + +On line 7912: + FCIC’s work was not the + full investigation to + which the American + +On line 7912: + useful purpose by + focusing attention again + on the fi nancial + + crisis and whether—with + some distance from it—we can draw + a more accurate + + assessment than the + media did with what is oft + en called the "fi rst + +On line 7912: + history." To avoid + the next fi nancial crisis, + we must understand + +On line 7912: + caused the one from which + we are now slowly emerging, + and take action to + + avoid the same mistakes + in the future. If there is + doubt that these lessons are + +On line 7912: + ongoing eff orts + to amend the Community + Reinvestment Act of + +On line 7912: + Congress, a group of + Democratic congressmembers + introduced HR Th + +On line 7914: + bill, which was lauded + by House Financial Services + Committee Chairman + + Barney Frank as his + "top priority" in the + lame duck session of + +On line 7914: + have extended the + CRA to all "U.S. nonbank fi + nancial companies," + +On line 7914: + thus would apply, to + even more of the national + economy, the same + +On line 7914: + social policy + mandates responsible for + the mortgage meltdown + + and the fi nancial + crisis. Fortunately, the + bill was not acted + +On line 7914: + it is unlikely + that supporters of H.R. will + have the power to + +On line 7914: + in the next Congress, + but in the future other + lawmakers with views + +On line 7914: + to Barney Frank’s may + seek to mandate similar + requirements. At that + +On line 7914: + the government’s use + of private entities for + social policy + + purposes will be + a full understanding of + how these policies were + +On line 7916: + majority erred + in assuming that it knew + the causes of the + +On line 7916: + of pursuing a + thorough study, the Commission’s + majority used + +On line 7916: + seek only the facts + that supported its initial + assumptions—that the + +On line 7916: + by "deregulation" + or lax regulation, greed + and recklessness on + +On line 7916: + fi nancial system + addicted to excessive + risk-taking. Th e + +On line 7918: + not seriously + investigate any other + cause, and did not eff + +On line 7928: + nancial crisis. Th + e majority’s report + covers in detail + + many elements of + the economy before the + fi nancial crisis + +On line 7930: + the authors did not + like, but generally failed + to show how practices + +On line 7930: + had gone on for many + years suddenly caused a world-wide + fi nancial crisis. + +On line 7930: + the majority’s + report turned out to be a + just so story about + +On line 7930: + fi nancial crisis, + rather than a report on what + caused the fi nancial + +On line 7934: + Caused the Financial + Crisis1 George Santayana is oft + en quoted for the + + aphorism that "Th ose + who cannot remember the + past are condemned to + +On line 7936: + it." Looking back on + the fi nancial crisis, we + can see why the study + +On line 7938: + why revisionist + histories are so easy to + construct. Th ere are + +On line 7942: + many factors that could + have caused an historical + event; the diffi cult + +On line 7944: + were the signifi cant + ones—the ones without which + history would have + +On line 7944: + diff erent. Using + this standard, I believe that + the sine qua non of + +On line 7944: + fi nancial crisis + was U.S. government housing + policy, which led + +On line 7944: + to the creation of + million subprime and other + risky loans—half of all + +On line 7946: + in the United States— + which were ready to default as + soon as the massive + + 1997-2007 housing bubble + began to defl ate. If + the U.S. government + +On line 7948: + fi nancial crisis + of would never have occurred. + Initiated by + +On line 7948: + pressed by HUD in both + the Clinton and George W. Bush + Administrations, + +On line 7948: + government’s housing + policy sought to increase + home ownership in + +On line 7948: + standards. In pursuit + of this policy, HUD used + (i) the aff ordable + +On line 7948: + government-sponsored + enterprises (GSEs) Fannie + Mae and Freddie Mac, + +On line 7948: + of the Federal + Housing Administration + (FHA), and (iii) a "Best + + Practices Initiative" + for subprime lenders and mortgage + banks, to encourage + +On line 7948: + and other high risk + lending. HUD’s key role in the + growth of subprime and + +On line 7950: + mortgage lending is + covered in detail in Part + III. Ultimately, + +On line 7950: + entities, as well + as insured banks covered by + the CRA, were compelled + +On line 7950: + mortgage borrowers + who were at or below the + median income + +On line 7952: + areas in which they + lived. Th is competition + caused underwriting + + standards to decline, + increased the numbers of weak + and high risk loans far + +On line 7954: + market would produce + without government infl + uence, and contributed + +On line 7956: + to the growth of the + 1997-2007 housing bubble. When the + bubble began to + + defl ate in mid-2007, + the low quality and high + risk loans engendered + +On line 7960: + ect of these defaults + was exacerbated by + the fact that few if + +On line 7962: + Freddie Mac had been + acquiring large numbers of + subprime and other + +On line 7964: + the unexpected + delinquencies and defaults that + began to appear + +On line 7964: + mid-2007, investors fl ed + the multi-trillion dollar + market for mortgage-backed + +On line 7966: + MBS backed by subprime + and other risky loans—to fractions + of their former prices. + +On line 7966: + required fi nancial + institutions to write down + the value of their + +On line 7968: + causing great investor + and creditor unease. Th + e mechanism by + +On line 7968: + were transmitted to + the fi nancial system as + a whole is covered + +On line 7970: + detail in Part II. + In this environment, the + government’s rescue + +On line 7970: + Bear Stearns in March of + temporarily calmed investor + fears but created + +On line 7970: + and other market + participants reasonably + believed aft er the + +On line 7970: + Bear that all large fi + nancial institutions would + also be rescued + + if they encountered + fi nancial diffi culties. + However, when Lehman + +On line 7972: + Bear—was allowed to + fail, market participants + were shocked; suddenly, + +On line 7972: + forced to consider + the fi nancial health of their + counterparties, many + +On line 7972: + appeared weakened by + losses and the capital + writedowns required by + +On line 7974: + accounting. Th is + caused a halt to lending and + a hoarding of cash—a + +On line 7980: + panic that we know + as the fi nancial crisis + of Weren’t Th ere + + Other Causes of + the Financial Crisis1 Many + other causes of + +On line 7982: + fi nancial crisis + have been cited, including + some in the report + +On line 7982: + but for the reasons + outlined below none of them + alone—or all in + +On line 7984: + explanation of + the crisis. Low interest + rates and a fl ow + + of funds from abroad. Claims + that various policies or + phenomena—such + + as low interest + rates in the early 2000s or + fi nancial fl ows + +On line 7984: + housing bubble, do + not adequately explain + either the bubble + + or the destruction + that occurred when the bubble + defl ated. Th + +On line 7988: + had housing bubbles + in the past—most recently + in the late 1970s and + +On line 7988: + 1980s—but when these bubbles + defl ated they did not + cause a fi nancial + +On line 7990: + housing bubbles in + the 2000s, some even larger than + the U.S. bubble, but + +On line 7990: + their bubbles defl + ated the housing losses + were small. Only in + +On line 7990: + did the defl ation + of the most recent housing + bubble cause a fi + +On line 7992: + and a serious + fi nancial crisis. Th e + reason for this is + + that only in the + U.S. did subprime and other + risky loans constitute + +On line 7992: + the bubble defl + ated. It wasn’t the size + of the bubble that + + was the key; it was + its content. Th e 1997-2007 U.S. + housing bubble was + +On line 7996: + a class by itself. + Nevertheless, demand by + investors for the high + +On line 7996: + off ered by subprime + loans stimulated the growth + of a market for + +On line 7998: + these loans. Th is was + an important element + in the fi nancial + +On line 7998: + although the number + of mortgages in this market + was considerably + +On line 7998: + the number fostered + directly by government + policy. Without + + the huge number of + defaults that arose out of U.S. + housing policy, + +On line 7998: + the mortgages in the + private market would not have + caused a fi nancial + +On line 8000: + regulation or + deregulation as a cause + of the fi nancial + + crisis are also + defi cient. First, no signifi + cant deregulation + +On line 8006: + occurred in the last + years. Th e repeal of a + Dissenting Statement + + portion of the Glass-Steagall + Act, frequently cited as + an example of + +On line 8010: + in the fi nancial + crisis.1 Th e repeal was + accomplished through the + +On line 8014: + Act of which allowed + banks to affi liate for + the fi rst time since + +On line 8014: + fi rms engaged in + underwriting or dealing + in securities. + +On line 8022: + trouble because of + a securities affi + liate. Th e banks + +On line 8022: + losses because they + held low quality mortgages + or MBS were engaged + +On line 8022: + permitted by Glass-Steagall; + the investment banks that got + into trouble—Bear Stearns, Lehman + + and Merrill Lynch—were + not affi liated with + large banks, although they + + had small bank affi + liates that do not appear + to have played any role + +On line 8026: + Federal Deposit + Insurance Corporation + Improvement Act of + +On line 8026: + the regulation + of banks and savings and loan + institutions (S&Ls) + +On line 8026: + debacle in the + late 1980s and early 1990s, and + it is noteworthy + + that FDICIA—the most stringent + bank regulation since the + adoption of deposit + +On line 8034: + banking business. Th + e large investment banks—Bear, Lehman, + Merrill, Goldman Sachs + + and Morgan Stanley—all + encountered diffi culty + in the fi nancial + +On line 8036: + and the Commission + majority’s report lays + much of the blame for + +On line 8036: + at the door of the + Securities and Exchange + Commission (SEC) for + +On line 8036: + them. It is true that + the SEC’s supervisory + process was weak, but many + +On line 8038: + S&Ls—stringently regulated + under FDICIA—also failed. Th is casts + doubt on the claim that + + if investment banks + had been regulated like + commercial banks— or + +On line 8040: + er insured deposits + like commercial banks—they would + not have encountered + +On line 8044: + diffi culties. Th + e reality is that + the business model + + of the investment + banks was quite diff erent from + banking; it was to + + fi nance a short-term + trading business with short-term + liabilities + +On line 8048: + en called repos). Th + is made them especially + vulnerable in + +On line 8048: + that occurred in but + it is not evidence that + the existence of + +On line 8048: + or the quality + of their regulation, was + a cause of the fi + +On line 8050: + crisis. Failures of + risk management. Claims that there + was a general + +On line 8050: + management in fi + nancial institutions or + excessive leverage + + or risk-taking are + part of what might be called a + "hindsight narrative." + + With hindsight, it is + easy to condemn managers for + failing to see the + +On line 8050: + the housing bubble + or the underpricing of + risk that now looks so + + clear. However, the + FCIC interviewed hundreds of + fi nancial experts, + + including senior + offi cials of major banks, + bank regulators + +On line 8054: + investors. It is not + clear that any of them—including + the redoubtable Warren + + Buff ett—were suffi + ciently confi dent about an + impending crisis + + that they put real + money behind their judgment. + Human beings have + +On line 8056: + to believe that things + will continue to go in + the direction they + + are going, and are + good at explaining why this + must be so. Blaming + + the crisis on the + failure to foresee it is + facile and of little + +On line 8060: + that virtually + all participants in the + fi nancial system + +On line 8060: + foresee this crisis—as + they failed to foresee every + other crisis—does + + not tell us anything + about why this crisis occurred + or what we should do + +On line 8062: + See, e.g., Peter J. + Wallison, "Deregulation + and the Financial + +On line 8070: + and structured products. + Securitization—oft en + pejoratively + +On line 8070: + the "originate to + distribute process"—has also + been blamed for the fi + + nancial crisis. But + securitization is + only a means of + +On line 8070: + was a cause of the + fi nancial crisis, so was + lending. Are we then + +On line 8072: + has been used to fi + nance car loans, credit card loans + and jumbo mortgages + +On line 8072: + eligible for + acquisition by Fannie + Mae and Freddie Mac. + + Th e problem was + not securitization + itself, it was the + + weak and high risk loans + that securitization + fi nanced. Under the + + category of + securitization, it + is necessary to + +On line 8078: + collateralized + debt obligations, known as CDOs. + Th ese instruments + +On line 8078: + assets" because they + were ultimately backed by + the subprime mortgages + +On line 8078: + in huge numbers when + the bubble defl ated, + and it was diffi + +On line 8080: + where those losses would + ultimately settle. CDOs, + accordingly, for + + all their dramatic + content, were just another + example of the + + way in which subprime + and other high risk loans were + distributed throughout + + the world’s fi nancial + system. Th e question still + remains why so many + +On line 8086: + Credit default swaps + and other derivatives. + Despite a diligent + + search, the FCIC never + uncovered evidence that + unregulated + + derivatives, and + particularly credit + default swaps (CDS), was + +On line 8090: + contributor to + the fi nancial crisis through + "interconnections". + +On line 8094: + only company + known to have failed because of + its CDS obligations + + was AIG, and that fi + rm appears to have been an + outlier. Blaming + +On line 8096: + fi nancial crisis + because one company did + not manage its risks + +On line 8096: + like blaming lending + generally when a bank + fails. Like everything + + else, derivatives + can be misused, but there is + no evidence that + +On line 8098: + generally. For + example, Lehman Brothers was + a major player + +On line 8098: + but the Commission + found no indication that + Lehman’s failure to meet + +On line 8098: + cant losses to any + other fi rm, including + those that had written + + CDS on Lehman itself. + Predatory lending. Th e + Commission’s report + +On line 8104: + predatory lending + for the large build-up of subprime + and other high risk + + mortgages in the fi + nancial system. Th is might + be a plausible + +On line 8106: + there were evidence + that predatory lending was + so widespread as to + +On line 8106: + volume of high risk + loans that were actually + originated. In + +On line 8108: + unscrupulous lenders take + advantage of unwitting + borrowers. Th is + +On line 8108: + loans were predatory + borrowers, or engaged in + mortgage fraud, because + +On line 8108: + took advantage of + low mortgage underwriting + standards to benefi + + t from mortgages they + knew they could not pay unless + rising housing prices + +On line 8110: + to sell or refi + nance. Th e Commission was + never able to shed + +On line 8110: + light on the extent + to which predatory lending + occurred. Substantial + +On line 8110: + activities by + some lenders and mortgage brokers, + but without giving + +On line 8110: + of how many such loans + were originated. Further, + the majority’s + +On line 8110: + acknowledge that most + of the buyers for subprime + loans were government + +On line 8110: + private companies + complying with government + aff ordable housing + +On line 8120: + Agreement1 Aft er the + majority’s report is + published, many people + +On line 8120: + was not possible + to achieve a bipartisan + agreement on the facts. + +On line 8120: + a surprise that I + am asking the same question. + If the Commission’s + +On line 8120: + an objective and + thorough investigation, + many of the points I + +On line 8120: + would have been known to + the other commissioners + before reading this + +On line 8120: + and perhaps would have + been infl uential with them. + Similarly, I + +On line 8120: + found facts that changed my + own view. But the Commission’s + investigation + +On line 8120: + or carried out in + a way that could ever have + garnered my support + +On line 8122: + members. One glaring + example will illustrate + the Commission’s lack + +On line 8124: + objectivity. + In March Edward Pinto, a + resident fellow + + at the American + Enterprise Institute (AEI) + who had served as chief + + credit offi cer + at Fannie Mae, provided + to the Commission + + staff a 70-page, fully + sourced memorandum on the + number of subprime + +On line 8128: + nancial crisis. In + that memorandum, Pinto + recorded that he had + +On line 8128: + later work showed that + there were approximately + million).2 Since there are + +On line 8128: + about million mortgages + in the U.S., Pinto’s research + indicated that, + + as the fi nancial + crisis began, half of all + U.S. mortgages were of + +On line 8128: + liable to default + when housing prices were no longer + rising. In August, + +On line 8128: + initial research with + a paper documenting + the eff orts of the + +On line 8132: + Th is research raised + important questions about the + role of government + + housing policy + in promoting the high risk + mortgages that played such + + a key role in both + the mortgage meltdown and the + fi nancial panic + +On line 8132: + investigation + of the causes of the fi + nancial crisis would + + have looked carefully + at this research, exposed it + to the members of + +On line 8132: + testimony, and + tested the accuracy + of Pinto’s research. + + But the Commission + took none of these steps. Pinto’s + research was never + +On line 8132: + the other members + of the FCIC, or even to the + commissioners who + +On line 8132: + considering the + role of housing policy + in the fi nancial + +On line 8134: + ignores hypotheses + about the causes of the fi + nancial crisis that + +On line 8134: + would have considered, + while focusing solely on + theories that have + +On line 8138: + currency but far + less plausibility. Th + is is not the way + + a serious and + objective inquiry should have + been carried out, but + +On line 8142: + Commission used its + resources and its mandate. Th + ere were many other + + defi ciencies. Th + e scope of the Commission’s + work was determined + +On line 8146: + of public hearings + that was handed to us in + early December + +On line 8148: + had never discussed + the possible causes of + the crisis, and we + + were never told why + those particular subjects + were important or + + were chosen as the + key issues for a set of + hearings that would form + +On line 8150: + memo), http://www.aei.org/paper/100174. + Edward Pinto, "Government + Housing Policies in + +On line 8156: + Financial Crisis: + A Forensic Study," http//ww.aei.org/docLib/Government-Housing-Policies-Financial-Crisis-Pinto-102110.pdf. Peter + J. Wallison of + +On line 8158: + Commission’s work. Th + e Commission members did + not get together + +On line 8160: + the causes of the + fi nancial crisis until + July, well aft er + +On line 8162: + it was too late to + direct the activities + of the staff Th e + +On line 8164: + of witnesses, and + the majority’s report + is full of statements + +On line 8166: + as "Smith told the FCIC + that…." However, unless the + meeting was public, + +On line 8166: + commissioners were + not told that an interview + would occur, did not + +On line 8166: + interviewed, were not + encouraged to attend, and + of course did not have + +On line 8166: + to question these sources + or understand the contexts + in which the quoted + +On line 8168: + is notably lacking + in their report; opinions in + general are not + +On line 8172: + for challenge. Th e + Commission’s authorizing + statute required that the + +On line 8174: + Commission report + on or before December + Th e original + + plan was for us to + start seeing draft s of the + report in April. We + + didn’t see any draft + s until November. We + were then given an + +On line 8176: + submit comments in + writing, but never had an + opportunity + +On line 8176: + wording as a group + or to know whether our comments + were accepted. We + + received a complete + copy of the majority’s + report, for the fi + +On line 8180: + time, on December + It was almost double-spaced + pages long. Th e date + +On line 8182: + for approval of the + report was eight days later, + on December Th + + at is not the way + to achieve a bipartisan + report, or the full + +On line 8190: + of any group that takes + the issues seriously. + Th is dissenting + +On line 8190: + is organized as + follows: Part I summarizes + the main points of the + +On line 8190: + how the failure of + subprime and other high risk + mortgages drove the growth + +On line 8190: + bubble and weakened + fi nancial institutions + around the world when these + + mortgages began to + default. Part III outlines in + detail the housing + +On line 8190: + approximately + one half of all U.S. mortgages + in were subprime or + +On line 8196: + low quality. Part + IV is a brief conclusion. + Dissenting Statement + +On line 8202: + were many contributing + factors, the housing bubble + of 1997-2007 would not have + +On line 8202: + its dizzying heights or + lasted as long, nor would the + fi nancial crisis + +On line 8202: + played by the housing + policies of the United States + government over the + +On line 8204: + by the middle of + there were approximately + million subprime and + +On line 8204: + outstanding—with an + aggregate value of over + trillion.4 Th ese were + +On line 8206: + in the past, and the + losses associated + with the delinquency + +On line 8206: + these mortgages fully + account for the weakness and + disruption of the + + fi nancial system + that has become known as the + fi nancial crisis. + + Most subprime and Alt-A + mortgages are high risk loans. A + subprime mortgage is + +On line 8208: + borrower who has + blemished credit, usually + signifi ed by a + +On line 8208: + has failed in Unless + otherwise indicated, + all estimates for + +On line 8208: + number of subprime + and Alt-A mortgages outstanding, + as well as the use + +On line 8208: + specifi c terms such + as loan to value ratios + and delinquency rates, + +On line 8208: + Institute. Pinto + is also a consultant + to the housing fi + +On line 8208: + industry and a + former chief credit offi + cer of Fannie Mae. + +On line 8210: + is posted on both + my and Pinto’s scholar pages + at AEI as follows: + +On line 8212: + http://www.aei.org/docLib/Pinto-Sizing-Total-Exposure.pdf, which accounts for + all million high risk loans; http://www.aei.org/docLib/ + Pinto-Sizing-Total-Federal-Contributions.pdf, which covers the + +On line 8212: + loans that were held or + guaranteed by federal + agencies and the four + +On line 8214: + made these loans under + CRA; and http:// www.aei.org/docLib/Pinto-High-LTV-Subprime-Alt-A.pdf, which covers + the acquisition + +On line 8216: + government agencies + from the early 1990s. Th e + information in + +On line 8220: + is fully cited + to original sources. Th ese + memoranda were + +On line 8220: + data exhibits to + a Pinto memorandum + submitted to the + +On line 8220: + in January and + revised and updated in + March (collectively, + +On line 8222: + "Triggers memo"). One of + the confusing elements + of any study of the + + mortgage markets is + the fact that the key defi + nitions have never + +On line 8222: + agreed upon. For many + years, Fannie Mae treated as + subprime loans only + +On line 8222: + Mortgage Finance, a + common source of data on + the mortgage market, + +On line 8222: + recorded as subprime + only those loans reported + as subprime by the + +On line 8222: + Fannie and Freddie. + Other loans were recorded as + prime, even if they had + + credit scores that would + have classifi ed them as + subprime. However, + +On line 8222: + score of less than is + generally regarded + as a subprime loan, + +On line 8222: + how originated. + Th at is the standard, for + example, used by + +On line 8226: + Comptroller of the + Currency. In this statement + and in Pinto’s work + +On line 8226: + subprime loans, and loans + to borrowers with FICO + scores of less than are + +On line 8226: + Fannie and Freddie + reported only a very + small percentage of + +On line 8226: + loans as subprime, so + in eff ect the subprime loans + acquired by Fannie + +On line 8226: + others in order + to derive something closer + to the number and + + principal amount of + the subprime loans outstanding + in the fi nancial + +On line 8226: + given time. One of + the important elements + of Edward Pinto’s + + work was to show that + Fannie and Freddie, for many + years prior to the + + fi nancial crisis, + were buying loans that should have + been classifi ed + + as subprime because + of the borrowers’ credit + scores and not simply + +On line 8226: + were originated + by subprime lenders. Fannie and + Freddie did not do + +On line 8228: + by the federal + government. Th is lack of + disclosure on the + +On line 8228: + of the GSEs appears + to have been a factor in + the failure of many + +On line 8238: + defl ated in + Dissenting Statement the past + to meet other fi + + nancial obligations. + Before changes in government + policy in the + +On line 8238: + 1990s, most borrowers + with FICO scores below did + not qualify as + +On line 8242: + had diffi culty + obtaining mortgage credit + other than through the + +On line 8244: + a relatively + small number of specialized + subprime lenders. An Alt-A + +On line 8244: + one that is defi + cient by its terms. It may have + an adjustable rate, lack + +On line 8244: + require payment of + interest only, or be + made to an investor + +On line 8246: + key defi ciency + in many Alt-A mortgages is a + high loan-to-value + +On line 8246: + a low downpayment. + A low downpayment for a + home may signify + + the borrower’s lack + of fi nancial resources, and + this lack of "skin in + +On line 8246: + en means a reduced + borrower commitment to + the home. Until they + +On line 8246: + subject to HUD’s aff + ordable housing requirements, + beginning in the + + early 1990s, Fannie + and Freddie seldom acquired + loans with these defi + + ciencies. Given the + likelihood that large numbers + of subprime and Alt-A + +On line 8248: + would default once the + housing bubble began to + defl ate in mid- + +On line 8248: + eff ects for the U.S. + economy and fi nancial + system—the key question + + for the FCIC was to + determine why, beginning + in the early 1990s, + +On line 8248: + deteriorate + so signifi cantly that it + was possible to + +On line 8252: + and Alt-A mortgages. Th + e Commission never made + a serious study + +On line 8252: + this question, although + understanding why and how + this happened must be + + viewed as one of the + central questions of the fi + nancial crisis. From + +On line 8254: + was limited to + validating the standard + narrative about the + +On line 8254: + crisis—that it was caused + by deregulation or lack + of regulation, + +On line 8254: + were either never + considered or were treated + only superfi + +On line 8254: + In criticizing + the Commission, this statement + is not intended + +On line 8254: + criticize the staff + which worked diligently and eff + ectively under + +On line 8256: + cult circumstances, and + did extraordinarily + fi ne work in the + +On line 8258: + were directed to + cover. Th e Commission’s + failures were failures + +On line 8266: + Resulted in an + Unprecedented Number of + Risky Mortgages Th ree + +On line 8266: + were primarily + responsible for the growth + of subprime and Alt-A + +On line 8266: + mortgages in the U.S. + economy between and and + for the decline in + +On line 8272: + ensued. Th e GSEs’ + Aff ordable Housing Mission. + Th e fact that high + +On line 8274: + mortgages formed almost + half of all U.S. mortgages by + the middle of was + + not a chance event, nor + did it just happen that banks + and other mortgage + +On line 8274: + decided on their + own to off er easy credit + terms to potential + +On line 8276: + beginning in the + 1990s. In Congress enacted + Title XIII of + +On line 8276: + Act), legislation + intended to give low and + Public Law 102-550, Stat. + +On line 8282: + October Peter + J. Wallison moderate + income7 borrowers + + better access to + mortgage credit through Fannie + Mae and Freddie Mac. + +On line 8284: + became a set of + regulations that required + Fannie and Freddie + +On line 8284: + reduce the mortgage + underwriting standards they + used when acquiring + +On line 8284: + from originators. + As the Senate Committee + report said at the + +On line 8286: + e purpose of [the + aff ordable housing] goals is + to facilitate + +On line 8286: + Mae and Freddie Mac + of an ongoing business + eff ort that will be + +On line 8290: + racial minorities and + inner-city residents."8 + Th e GSE Act, and + +On line 8290: + motion a series + of changes in the structure of + the mortgage market + +On line 8290: + particularly + the gradual degrading + of traditional + +On line 8290: + Accordingly, in + this dissenting statement, I + will refer to the + +On line 8290: + and Alt-A mortgages that + were acquired because of the + aff ordable housing + +On line 8290: + as well as other + subprime and Alt-A mortgages, as + non-traditional + +On line 8292: + Th e GSE Act was + a radical departure + from the original + +On line 8292: + the GSEs as managers + of a secondary market in + prime mortgages. Fannie + + Mae was established + as a government agency + in the New Deal era + +On line 8292: + mortgages from banks and + other loan originators, + providing them with + +On line 8292: + funds with which to make + additional mortgages. In + it was authorized + +On line 8292: + government-sponsored + enterprise (GSE)9—a shareholder-owned + company with a + +On line 8292: + mission to maintain + a liquid secondary market + in mortgages. Freddie + +On line 8292: + another GSE in + Fannie and Freddie carried + out this mission eff + +On line 8292: + 1990s, and in the process + established conservative + lending standards for + +On line 8292: + willing to purchase, + including such elements + as downpayments of + +On line 8296: + GSE Act, however, + created a new "mission" + for Fannie Mae and + +On line 8296: + to establish and + administer what was in + eff ect a mortgage + + quota system in + which a certain percentage + of all Fannie and + +On line 8296: + had to be loans to + low-and- moderate income (LMI) + borrowers—defi + + ned as persons with + income at or below the + median income + +On line 8298: + living in certain + low income communities. + Th e AH goals put + +On line 8298: + and Freddie into + direct competition with + the FHA, which was then + +On line 8298: + HUD that functions as + the federal government’s + principal subprime + +On line 8300: + as percent of area + median income (AMI) and + moderate income + +On line 8302: + as percent of AMI. + Report of the Committee + on Banking Housing + +On line 8302: + Aff airs, United States + Senate to accompany + S. Report 102-282, May + +On line 8304: + government sponsored + enterprises because they + had been chartered by + +On line 8304: + exemption from the + Securities Act of and + the Securities + +On line 8304: + Exchange Act of and + a line of credit at the + Treasury that signaled + +On line 8304: + capital markets + (which continued to call them + "Agencies") assumed that + + in the event of fi + nancial diffi culties the + government would stand + + behind them. Th is + implied government backing + gave them access to + +On line 8310: + that was lower cost + than any AAA borrower and + oft en only a + +On line 8316: + basis points over the + applicable Treasury rate. + Dissenting Statement + +On line 8320: + Over the next years, HUD + consistently enhanced and + enlarged the AH goals. + +On line 8320: + the GSE Act, Congress + had initially specifi ed + that percent of the + +On line 8324: + mortgage purchases + meet the AH goals. Th is was + increased to percent + +On line 8326: + and percent in By + the main LMI goal was percent, + and a special aff + +On line 8326: + subgoal had been added + requiring that percent of + the loans acquired by + +On line 8326: + the GSEs be made to + borrowers who were at or + below percent of + +On line 8326: + (AMI). Table page shows + that Fannie and Freddie met + the goals in almost + +On line 8330: + year between and Th + ere is very little data + available concerning + + Fannie and Freddie’s + acquisitions of subprime + and Alt-A loans in the + +On line 8332: + so it is diffi + cult to estimate the GSEs’ + year-by-year acquisitions + +On line 8332: + er the AH goals went + into eff ect. However, + Pinto estimates + +On line 8332: + these purchases at + approximately trillion + (see Table page As + +On line 8332: + Table page on June + immediately prior + to the onset of + +On line 8332: + nancial crisis, the + GSEs held or had guaranteed + million subprime and + +On line 8336: + was percent of their + total mortgage exposure + of million loans, which + +On line 8336: + the million mortgages + outstanding in the U.S. on + that date. Fannie and + +On line 8336: + far the dominant + players in the U.S. mortgage + market before the + +On line 8336: + set the standards for + the rest of the mortgage fi + nancing industry. + +On line 8340: + Reinvestment Act. In + the regulations under + the Community + +On line 8340: + Reinvestment Act (CRA)10 + were tightened. As initially + adopted in the CRA + +On line 8340: + banks and S&Ls reach out + to low-income borrowers in + communities they + +On line 8342: + new regulations, + made eff ective in for the + fi rst time required + +On line 8342: + communities and + to low-income borrowers.11 A + qualifying CRA + +On line 8342: + was one made to a + borrower at or below + percent of the AMI, + +On line 8342: + thus was similar + to the loans that Fannie and + Freddie were required + +On line 8344: + HUD’s AH goals. In the + National Community + Reinvestment Coalition + +On line 8344: + organization + for community activist + organizations, + +On line 8344: + approval for mergers + committed in agreements with + community groups + +On line 8346: + over trillion in CRA + loans.12 A substantial portion + of these commitments + + appear to have been + converted into mortgage + loans, and thus would have + +On line 8346: + substantially to + the number of subprime and + other high risk loans + +On line 8348: + in Part III, this was + not done. Accordingly, the + GSE Act put Fannie + +On line 8348: + FHA, and the banks that + were seeking CRA loans into + competition for + +On line 8348: + same mortgages—loans to + borrowers at or below + the applicable + +On line 8350: + Practices Initiative. + In HUD added another group + to this list when it + +On line 8350: + up a "Best Practices + Initiative," to which members + of the Mortgage Pub.L. + +On line 8364: + was explicitly + intended to encourage + a reduction in + +On line 8364: + to increase access + by low income borrowers + to mortgage credit. + +On line 8364: + was by far the largest + member of this group and by + the early 2000s was + + also competing, + along with others, for the same + NTMs sought by Fannie + +On line 8366: + and Freddie, FHA, and + the banks under the CRA With + all these entities + + seeking the same loans, + it was not likely that all + of them would fi nd + +On line 8366: + the traditional + mortgage lending standards that + Fannie and Freddie + + had established. It + also created ideal + conditions for a + +On line 8366: + since every one of + these competing entities + was seeking NTMs not + + for purposes of + profi t but in order to + meet an obligation + +On line 8368: + by the government. + Th e obvious way to + meet this obligation + +On line 8372: + 1990s, traditional + underwriting standards had + come to be seen as + +On line 8372: + ownership by LMI + families. In a Senate + Banking Committee + +On line 8372: + will respond to the + most conservative standards + unless [Fannie Mae + + and Freddie Mac] are + aggressive and convincing + in their eff orts to + +On line 8374: + historically + narrow underwriting."13 In + this light, it appears + + that Congress set out + deliberately in the + GSE Act not only + +On line 8374: + change the culture of + the GSEs, but also to set + up a mechanism + +On line 8374: + standards over time, so + that home ownership would be + more accessible + +On line 8374: + For example, the + legislation directed + the GSEs to study "Th + +On line 8376: + that—(A) establish a + downpayment requirement for + mortgagors of percent + +On line 8376: + less;14 (B) allow the + use of cash on hand as a + source of downpayments; + +On line 8376: + borrowers who have + a credit history of + delinquencies if the + +On line 8376: + the 12-month period + ending on the date of the + application for + +On line 8378: + understood at the + time. I have been unable to + fi nd any studies + +On line 8378: + in response to this + congressional direction, + but HUD treated these + +On line 8378: + use the AH goals as + a mechanism for eroding + the traditional + + standards. HUD was very + explicit about this, as shown + in Part II. In the + +On line 8378: + was accomplished by + gradually expanding + the requirements and + + enlarging the AH + goals over succeeding years, so + that the only way + +On line 8378: + Freddie could meet the + AH goals was by purchasing + increasing numbers + +On line 8378: + Because the GSEs were + the dominant players in + the mortgage market, + +On line 8378: + that were subject to + government control—FHA and the banks + Allen Fishbein, "Filling + +On line 8382: + the GSEs’ minimum + downpayment was percent, and + was accompanied + +On line 8384: + underwriting. Th + e congressional request + was to break through that + +On line 8394: + limitation. GSE + Act, Section 1354(a). Dissenting + Statement under CRA—to + +On line 8394: + lending in order + to fi nd the mortgages they + needed to comply + +On line 8396: + also true of the + mortgage banks—the largest of which + was Countrywide—that + +On line 8396: + bound to promote aff + ordable housing through HUD’s Best + Practices Initiative. + +On line 8398: + By the result of + these government programs was + an unprecedented + +On line 8398: + subprime and other + high risk mortgages in the U.S. + fi nancial system. + +On line 8398: + which agencies or fi + rms were holding the credit + risk of these mortgages- + +On line 8402: + fi nancial crisis + began. As Table makes clear, + government agencies, + +On line 8402: + or had guaranteed + million of the NTM loans that + were outstanding at + +On line 8404: + about million NTMs had + been distributed to investors + through the issuance of + +On line 8408: + private issuers such + as Countrywide and other + subprime lenders. Th e + + fact that the credit + risk of two-thirds of all the NTMs + in the fi nancial + +On line 8408: + by the government + or by entities acting + under government + +On line 8408: + the central role of + the government’s policies in + the development + + of the 1997-2007 housing + bubble, the mortgage meltdown + that occurred when the + +On line 8408: + fi nancial crisis + and recession that ensued. + Similarly, the + +On line 8408: + million NTMs were held + by investors and fi nancial + institutions in + + the form of PMBS shows + that this group of NTMs were less + important as a + +On line 8412: + report focuses + almost entirely on the + million PMBS, and is + +On line 8416: + the government’s role + in the fi nancial crisis. + Table Entity + +On line 8436: + Mac million trillion + FHA and other Federal* + million trillion CRA + +On line 8444: + HUD Programs million + trillion Total Federal + Government million + +On line 8454: + Other (including + subprime and million trillion + Alt-A PMBS issued by + +On line 8466: + Administration, + Federal Home Loan Banks and + others. To be sure, + +On line 8466: + eff orts to increase + home ownership through the AH + goals succeeded. Home + +On line 8466: + the U.S. increased from + approximately percent + in (where it had been + +On line 8468: + to over percent in + Almost everyone in and + out of government + +On line 8468: + goal In the process known + as securitization, + securities backed + +On line 8468: + a pool of mortgages + (mortgage-backed securities, or + MBS) and issued by + +On line 8470: + issued by the GSEs + or Ginnie Mae) or private + MBS (PMBS). See Edward + +On line 8474: + Exhibit to the + Triggers Memo, April p.4. http://www.aei.org/ + docLib/Pinto-Sizing-Total-Federal-Contributions.pdf. Census Bureau + +On line 8482: + data. Peter J. + Wallison of U.S. housing + policy—until the + +On line 8484: + costs became clear with + the collapse of the housing + bubble in Th en + +On line 8486: + elaborate process of + shift ing the blame began. The + Great Housing Bubble + +On line 8488: + Its Effects Figure + below, based on the data + of Robert J. Shiller, shows + + the dramatic growth + of the 1997-2007 housing bubble + in the United States. + +On line 8488: + home prices in the U.S. + had increased substantially + for ten years. Th e + +On line 8490: + in real dollar + terms had been almost percent, + ten times greater than any + +On line 8490: + bubble in modern + times. As discussed below, there + is good reason to + +On line 8490: + previous bubbles + because of the government’s + housing policies, which + +On line 8490: + increased the demand + for housing by funneling + more money into + +On line 8490: + and the government + had not promoted the growth + of subprime lending. + +On line 8498: + Shiller Th at the 1997-2007 + bubble lasted about twice as + long as the prior + +On line 8498: + in itself. Mortgage + quality declines as a + housing bubble grows + + and originators + try to structure mortgages that + will allow buyers + +On line 8498: + monthly payments for + more expensive homes; the fact + that the most recent + +On line 8500: + destructiveness when + it defl ated. Why did + this bubble last so + + long1 Housing bubbles + defl ate when delinquencies + and defaults begin + +On line 8500: + that the risks of a + collapse are mounting. One by + one, investors cash in + +On line 8500: + leave. Eventually, + the bubble tops out, those who + are still in the game + + run for the doors, and + a defl ation in prices sets + in. Generally, + +On line 8500: + the past, this process took + three or four years. In the case + of the most recent + +On line 8508: + it took ten. Th e + reason for this longevity is + that one Dissenting + +On line 8510: + participant in + the market was not in it + for profi t and was + + not worried about the + risks to itself or to those + it was controlling. + +On line 8510: + by making mortgage + credit available to low and + moderate income + +On line 8510: + institutions it + controlled or could infl uence + through regulation + +On line 8510: + keep pumping money + into housing long aft er + the bubble, left to + +On line 8512: + debating whether the + Fed’s monetary policy + in the early 2000s + +On line 8514: + rates too low for too + long. Naturally enough, Ben + Bernanke and Alan Greenspan have + +On line 8514: + that the Fed was not + at fault. On the other hand, + John Taylor, author + +On line 8514: + Taylor rule, contends + that the Fed’s violation + of the Taylor rule + +On line 8516: + principal cause of + the bubble. Raghuram Rajan, + a professor at + + the Chicago Booth School + of Business, argues that the + Fed’s low interest + +On line 8516: + bubble, but that the + Fed actually followed + this policy in + +On line 8516: + rather than defl ation.19 + Other theories blame huge + infl ows of funds + +On line 8516: + or from countries that + were recycling the dollars + they received from trade + +On line 8518: + with the U.S. Th ese + debates, however, may be + missing the point. It + +On line 8518: + where the funds that built + the bubble actually + originated; the + +On line 8518: + why they were transformed + into the NTMs that were prone + to failure as soon + +On line 8520: + great bubble defl + ated. Figure illustrates + clearly that the 1997-2007 + +On line 8520: + on a foundation + of million subprime and Alt-A + mortgages and shows the + +On line 8520: + the cumulative + growth in the dollar amount of + NTMs and the growth of + + the bubble over time. + It includes both GSE and CRA + contributions to + +On line 8520: + normal baseline of + percent,20 and estimated + CRA lending under + + the merger-related + commitments of the four large + banks—Bank of America, + +On line 8520: + Citibank and JPMorgan Chase—that, with + their predecessors, made most + of the commitments. + +On line 8520: + above, these commitments + were made in connection with + applications to + +On line 8522: + approvals of mergers + or acquisitions. Th e + dollar amounts involved + +On line 8522: + report by the NCRC,21 + and adjusted for announced + loans and likely rates + +On line 8526: + Bernanke testimony + before the FCIC, September + Alan Greenspan, in "Th e + +On line 8528: + Draft March Taylor, in + testimony before the + FCIC on October + +On line 8528: + Taylor, Getting Off + Track, Hoover Institution Press, + and Raghuram Rajan, + +On line 8532: + the World Economy, + Princeton University Press, + pp. 108-110. It appears + +On line 8532: + GSEs’ normal intake + of mortgages included about + percent that were made + +On line 8532: + were at or below + the median income in + the area in which they + +On line 8532: + eligible for + AH credit. It was only + when the AH goals rose + +On line 8532: + in that government + policy required the GSEs + to acquire more AH + + qualifying loans + than they would have purchased as + a matter of course. + +On line 8532: + the case of the CRA + contributions, the baseline + is and includes the + +On line 8532: + made by the four largest + banks and their predecessors + listed in the NCRC + + report, adjusted + for the loans actually + announced by the banks + +On line 8534: + er that date. In the + National Community + Reinvestment Coalition + +On line 8534: + amount of CRA loans that + banks had committed to make + in connection with + +On line 8536: + that these commitments + exceeded trillion. Th e + original report + +On line 8540: + s/report-silver-brown.pdf. A + portion of these commitments + were in fact fulfi + +On line 8540: + CRA qualifying + loans. A full discussion of + these commitments and + +On line 8548: + Section III. Peter + J. Wallison production + line also includes + +On line 8548: + almost trillion in + NTM lending by Countrywide + Financial under + +On line 8552: + Practices Initiative.22 + Figure Th e Eff ect of + Government Policies + + on the Growth of the + Bubble It is not true that + every bubble--even a + + large bubble-- has the + potential to cause a fi + nancial crisis when + +On line 8556: + ates. Th is is clear + in Table below, prepared + by Professor Dwight + + Jaff ee of the Haas + Business School at U.C. Berkley. Th + e table shows that + +On line 8558: + of which also had + large bubbles during the 1997-2007 + period—the losses + +On line 8558: + mortgage delinquencies + and defaults when these bubbles + defl ated were + + far lower than the + losses suff ered in the U.S. + when the 1997-2007 defl + +On line 8576: + Western Europe and + the United States Month Impaired + or Foreclosures Year + +On line 8640: + Belgium Denmark France + Ireland Italy Portugal Spain + Sweden UK U.S. All + +On line 8668: + for U.S. Data. Th + e underlying reasons + for the outcomes in + +On line 8668: + Banking Committee + in September by Dr. Michael + Lea, Director of + +On line 8668: + Corky McMillin Center for + Real Estate at San Diego + State University: + + Th e default and + foreclosure experience + of the U.S. market + +On line 8672: + been far worse than in + other countries. Serious + default rates remain + +On line 8672: + than percent in all + other countries and less than + percent in Australia + +On line 8672: + Of the countries in + this survey only Ireland, + Spain and the UK have + + seen a signifi cant + increase in mortgage default + during the crisis. + +On line 8676: + for this result. First + sub-prime lending was rare or + non-existent outside + +On line 8680: + U.S. Th e only + country with a signifi cant + subprime share was the + +On line 8680: + percent of mortgages + in Subprime accounted for + percent of mortgages + +On line 8680: + less than percent in + Australia and negligible + proportions elsewhere. + +On line 8682: + less "risk layering" + or off ering limited + documentation + +On line 8684: + or no downpayment. + Th ere was little "no doc" + lending…the proportion + + of loans with little + or no downpayment was less + than the U.S. and the + +On line 8684: + in house prices in most + countries was also less…[L]oans in + other developed + +On line 8686: + routinely go aft + er borrowers for defi + ciency judgments.24 Th + +On line 8688: + destructiveness of + the 1997-2007 bubble came from its + composition—the + +On line 8688: + its size is also + illustrated by data + on foreclosure starts + +On line 8688: + the Mortgage Bankers Dwight + M. Jaff ee, "Reforming the + U.S. Mortgage Market + +On line 8690: + rough Private Market + Incentives," Paper prepared + for presentation + +On line 8690: + Government Sponsored + Enterprises," Federal + Reserve Bank of St. + +On line 8692: + Table Dr. Michael J. + Lea, testimony before + the Subcommittee + + on Security + and International Trade + and Finance of the + +On line 8702: + Association + (MBA).25 Th is data allows + a comparison + +On line 8702: + the foreclosure starts + that have thus far come out of + the 1997-2007 bubble and + +On line 8702: + foreclosure starts in + the two most recent housing + bubbles (1977-1979 and 1985-1989) + +On line 8704: + Figure Aft er the + housing bubble that ended + in when almost all + + mortgages were prime loans + of the traditional type, + foreclosure starts in + +On line 8704: + ensuing downturn + reached a high point of only + percent in Aft er + +On line 8704: + the next bubble, which + ended in and in which a + high proportion of + +On line 8704: + the traditional + type, foreclosure starts reached a + high of percent in + +On line 8704: + aft er the collapse + of the 1997-2007 bubble—in which half + of all mortgages were + +On line 8704: + the unprecedented + level (thus far) of percent + in And this was true + +On line 8706: + orts to prevent or + delay foreclosures. All the + foregoing data + +On line 8706: + signifi cant for a + proper analysis of the + role of government + + policy and NTMs + in the fi nancial crisis. + What it suggests is + + that whatever eff + ect low interest rates or + money fl ows from + +On line 8706: + had in creating + the great U.S. housing bubble, + the defl ation of + +On line 8706: + bubble need not have + been destructive. It wasn’t + just the size of the + +On line 8708: + also the content. + Th e enormous delinquency + rates in the U.S. (see + +On line 8708: + developed countries + did not have the numbers of + NTMs that were present in + +On line 8710: + nancial system when + the bubble defl ated. + As shown in later + +On line 8710: + these mortgage defaults + were translated into huge + housing price declines + +On line 8710: + from there—through the PMBS they + were holding—into actual + or apparent fi + +On line 8710: + weakness in the banks + and other fi rms that held + these securities. + + Accordingly, if + the 1997-2007 housing bubble had + not been seeded with + +On line 8712: + it is likely that + the fi nancial crisis would + never have occurred. + +On line 8718: + government adopted + aff ordable housing policies, + mortgages of this kind + +On line 8720: + a conventional + mortgage—generally had + a fi xed rate, oft + +On line 8720: + en for or years, a + downpayment of to percent, + and was made to a + + borrower who had + a job, a steady income and + a good credit record. + + Before the GSE Act, + even subprime loans, although made + to borrowers with + +On line 8720: + involved substantial + downpayments or existing + equity in homes.27 + +On line 8724: + delinquency rates of + the NTMs that were outstanding + on June Th e grayed + +On line 8728: + virtually all + the NTMs. Th e contrast in + quality, based on + +On line 8728: + rates, between these loans + and Fannie and Freddie prime + loans in lines and is + +On line 8732: + Survey. See Pinto, + "Government Housing Policies + in the Lead-Up to the + +On line 8742: + November p.58, http://www.aei.org/docLib/Government-Housing-Policies-Financial-Crisis-Pinto-102110.pdf. + Id., p.42. Dissenting Statement + Table Delinquency + +On line 8750: + Delinquency Rate Days + and in Foreclosure) High Rate + Subprime (including + +On line 8766: + Freddie private MBS + holdings) Option Arm million + Alt-A (inc. Fannie/Freddie/FHLBs million† + +On line 8784: + holdings) Fannie Subprime/Atl-A/Nonprime + million Freddie Subprime/Alt-A/Nonprime million + Government million + +On line 8808: + Jumbo Prime million + Non-Agency Conforming Prime Fannie + Prime million Freddie + +On line 8818: + Loans million Includes + an estimated million + subprime (FICO<660) that + + were (i) not high rate + and (ii) non-prime CRA and HUD Best + Practices Initiative + +On line 8824: + are included in + the "CRA and HUD Programs" line + in Table Excludes + +On line 8828: + Fannie subprime/Alt-A/nonprime. Excludes + Freddie subprime/Alt-A/nonprime. Excludes loans owned + or securitized + +On line 8832: + and conforming prime + counted together. Total + delinquency data + +On line 8836: + Processing Services, + LPS Mortgage Monitor, June + Based on Fannie Mae + +On line 8836: + Converted from a + serious delinquency rate + days in foreclosure) + +On line 8836: + an estimated + Total Delinquency Rate days + and in foreclosure). + +On line 8838: + Converted from a + serious delinquency rate + days in foreclosure) + +On line 8838: + an estimated + Total Delinquency Rate days + and in foreclosure). + +On line 8842: + Origin and Growth of + Subprime PMBS It was only + in that the market + +On line 8842: + securities backed + by subprime loans or other + NTMs—reached billion. In that + +On line 8842: + year, the top fi ve + issuers were GMAC-RFC billion), + Lehman billion), CS First + +On line 8846: + Boston billion), Bank + of America billion) and + Ameriquest billion).29 Th e + +On line 8848: + issuances of PMBS that + year totaled billion, of which + billion in PMBS were + + issued by Wall Street + fi nancial institutions. + In subsequent years, + + as the market grew, + Wall Street institutions fell + behind the major + +On line 8848: + issuers, so that by + 2005—the biggest year for subprime + PMBS issuance—only Lehman + +On line 8848: + fi ve issuers and + Wall Street issuers as a group + were only percent + +On line 8854: + that year.30 Id., Figure + Inside Mortgage Finance, Th + e Mortgage Market + +On line 8864: + Statistical Annual—Vol. + II, p143. Id., p.140. Peter J. + Wallison One of + + the many myths about the + fi nancial crisis is that + Wall Street banks led the + + way into subprime + lending and the GSEs followed. + Th e Commission + +On line 8866: + this idea as a way + of explaining why Fannie + and Freddie acquired + +On line 8868: + NTMs. Th is notion + simply does not align with the + facts. Not only were + +On line 8868: + Street institutions + small factors in the subprime + PMBS market, but well + +On line 8868: + much bigger players + than the entire PMBS market + in the business of + +On line 8868: + acquiring NTM and + other subprime loans. Table + page shows that Fannie + +On line 8868: + had already acquired + at least billion in NTMs by + Obviously, the + + GSEs did not have to + follow anyone into NTM + or subprime lending; + +On line 8868: + that market before + Table also shows that in + when the entire PMBS + +On line 8868: + billion, Fannie and + Freddie acquired billion in + whole subprime mortgages + +On line 8868: + billion in other + NTMs, demonstrating again that the + GSEs were no strangers to + +On line 8870: + lending well before + the PMBS market began to + develop. Further + +On line 8870: + into subprime or + NTM lending is provided + by Fannie’s 10-K. Th + +On line 8874: + percent of Fannie’s + credit obligations (either + in portfolio or + +On line 8874: + FICO credit scores + below as of December + percent at the end + +On line 8874: + of and percent at + the end of So Fannie and + Freddie were active + + and major buyers + of subprime loans in years when + the PMBS market had + +On line 8874: + total issuances of + only billion and billion + In other words, it + +On line 8874: + be more accurate + to say that Wall Street followed + Fannie and Freddie + +On line 8874: + lending rather than vice + versa. At the same time, the + GSEs’ purchases of + +On line 8874: + loans throughout the 1990s + stimulated the growth of + the subprime lending + +On line 8874: + which ultimately + became the mainstay of the + subprime PMBS market + +On line 8876: + 2000s. was the biggest + year for PMBS subprime issuances, + and Ameriquest billion) and + +On line 8878: + billion) were the two + largest issuers in the top Th + ese numbers were still + + small in relation + to what Fannie and Freddie + had been buying since + +On line 8882: + in Th e total + in Table for Fannie and + Freddie between and + +On line 8882: + approximately + trillion for subprime loans and + over trillion for all + +On line 8884: + as a group. Because + subprime PMBS were rich in NTM + loans eligible + +On line 8884: + credit under HUD’s + AH goals, Fannie and Freddie + were also the largest + +On line 8884: + of subprime PMBS from + to acquiring percent of + the total issuances, + +On line 8884: + billion.32 In Table + above, which organizes mortgages + by delinquency rate, + +On line 8884: + these purchases are + included in line which had + the highest rate of + +On line 8888: + subprime—designated + as subprime by the lender when + originated—and thus had + +On line 8888: + and usually a + higher interest rate than + prime loans; many also + +On line 8890: + were responsible + for both the poor quality + of the subprime and + +On line 8890: + mortgages that backed the + PMBS and for the enormous size + to which this market + +On line 8894: + Th is was true not + only because Fannie and + Freddie 10-K, Table + +On line 8898: + http://www.sec.gov/Archives/edgar/data/310522/000095013303001151/ w84239e10vk.htm#031. See Table + of "High LTV, Subprime and Alt-A + Originations Over + + the Period 1992-2007 + and Fannie, Freddie, FHA and + VA’s Role" found at http://www.aei.org/docLib/Pinto-High-LTV-Subprime-Alt-A.pdf. + +On line 8906: + Dissenting Statement + stimulated the growth of + that market through their + +On line 8906: + of PMBS, but also + because the huge infl ow + of government or + +On line 8906: + into the housing + market turned what would have been + a normal housing + + bubble into a + bubble of unprecedented + size and duration. + +On line 8910: + is encouraged and + enabled unprecedented growth + in the PMBS market + +On line 8912: + of the AH goals, the + competition between the + GSEs and the FHA, the + + eff ect of HUD’s Best + Practices Initiative, and bank + lending under the + +On line 8912: + continuing fl + ow of funds into weaker + and weaker mortgages. + +On line 8916: + is had the eff ect + of extending the life of + the housing bubble + +On line 8918: + increasing its size. + Th e growth of the bubble + in turn disguised the + +On line 8918: + subprime mortgages it + contained; as housing prices rose, + subprime borrowers + +On line 8918: + were able to refi + nance their mortgages, using the + equity that had + +On line 8918: + in their homes solely + through rising home prices. Without + the continuous + +On line 8918: + have begun showing + up within a year or two, + bringing the subprime + +On line 8918: + market to a halt. + Instead, the bubble lasted + ten years, permitting + +On line 8920: + to grow until it + reached almost trillion. Second, + as housing prices rose + +On line 8920: + was necessary for + borrowers to seek riskier + mortgages so they could + + aff ord the monthly + payments on more expensive + homes. Th is gave rise + +On line 8922: + and riskier forms of + mortgage debt, such as option + ARMs (resulting in + +On line 8922: + and interest-only + mortgages. Mortgages of this kind + could be suitable for + + some borrowers, but + not for those who were only + eligible for + +On line 8922: + loans. Nevertheless, + subprime loans were necessary + for PMBS, because they + + generally bore + higher interest rates and + thus could support the + + yields that investors were + expecting. As subprime loans + were originated, + + Fannie and Freddie + were willing consumers of those + that might meet the AH + + goals; moreover, because + of their lower cost of funds, + they were able to buy + + the "best of the worst," + the highest quality among + the NTMs on off er. + + Th ese factors—the + need for higher yielding loans + and the ability + +On line 8926: + pay up for the loans + they wanted—drove private sector + issuers further out + + on the risk curve as + they sought to meet the demands + of investors who were + +On line 8928: + to subprime PMBS. From + the investors’ perspective, as + long as the bubble + +On line 8928: + were off ering the + high yields associated + with risk but were not + +On line 8934: + who testifi ed + before the Commission agreed + that the fi nancial + +On line 8934: + the mortgage meltdown + that began when the housing + bubble began to + +On line 8934: + of these witnesses, + however, including the + academics consulted + + by the Commission, + the representatives of + the rating agencies, + +On line 8936: + offi cers of fi + nancial institutions that + were ultimately + +On line 8936: + institutions and + even the renowned investor Warren + Buff ett,33 seems to have + +On line 8940: + dimensions See Buff + ett, testimony before + the FCIC, June Peter + +On line 8942: + Wallison of the + NTM problem or recognized + its signifi cance + +On line 8946: + Th e Commission + majority’s report notes + that "there were warning + +On line 8948: + Th ere always are + if one searches for them; they + are most visible + +On line 8948: + which the Commission + majority, and many of + the opinions it cites + +On line 8948: + engaged. However, + as Michael Lewis’s acclaimed book, Th + e Big Short, showed so + +On line 8952: + the fi nancial world + were actually willing + to bet money— even + +On line 8954: + favorable odds—that + the bubble would burst with huge + losses. Most seem to + + have assumed that NTMs + were present in the fi nancial + system, but not in + + unusually large + numbers. Even today, there are + few references in + +On line 8956: + number of NTMs that + had accumulated in + the U.S. fi nancial + +On line 8956: + before the meltdown + began. Yet this is by far + the most important + +On line 8956: + about the fi nancial + crisis. None of the other + factors off ered by + +On line 8956: + majority to + explain the crisis—lack of + regulation, poor + +On line 8956: + foresight, Wall Street greed + and compensation policies, + systemic risk caused by + + credit default swaps, + excessive liquidity + and easy credit—do + + so as plausibly + as the failure of a large + percentage of the + +On line 8958: + NTMs that existed + in the fi nancial system + in It appears that + +On line 8958: + destructiveness of + this bubble’s collapse because + of a chronic lack + + of information + about the composition of + the mortgage market. + +On line 8958: + for example, aft + er the defl ation of the + bubble had begun, + +On line 8960: + Brothers analysts + issued a highly detailed + report entitled + +On line 8960: + Owns Residential + Credit Risk1"34 In the tables + associated + + with the report, they + estimated the total + unpaid principal + +On line 8960: + balance of subprime + and Alt-A mortgages outstanding + at trillion, about half + +On line 8962: + number at the time. + Based on this assessment, when + they applied a stress + +On line 8962: + market under the + ‘stressed’ housing conditions could + be about billion, which + +On line 8962: + over a fi ve-to + six-year horizon." In the end, of + course, the losses were + +On line 8962: + accounting almost + immediately, rather than + over a fi ve to + +On line 8962: + failure of these two + analysts to recognize + the sheer size of the + +On line 8964: + market, even as late + as is the important point. + Along with most other + +On line 8964: + were not aware of the + true composition of the + mortgage market in + +On line 8964: + housing conditions + they applied, they projected + that the GSEs would suff + +On line 8964: + losses of billion + (net of mortgage insurance + coverage) and that + +On line 8966: + income would be more + than suffi cient to cover + these losses. Based on + +On line 8968: + Federal Housing + Finance Agency (FHFA), the + GSEs’ credit losses + +On line 8970: + the Lehman analysts’ + September estimate. Th + e analysts could + + only make such a + colossal error if they did + not realize that + +On line 8972: + the GSEs’ credit risk + portfolio consisted of + subprime and Alt-A loans + +On line 8972: + (see Table supra) or + that these weak loans would account + for about of the GSEs’ + +On line 8972: + 2007-34 Vikas Shilpiekandula + and Olga Gorodetski, "Who + Owns Resident a + +On line 8974: + Brothers Fixed Income + U.S. Securitized Products + Research, September + +On line 8982: + Dissenting Statement + It is also instructive + to compare the Lehman + +On line 8982: + of subprime loans would + suff er lifetime losses of + percent under "stressed" + +On line 8982: + later, more informed + estimates. In early for + example, Moody’s made + +On line 8982: + estimate for the + vintage and projected a + percent loss rate aft + +On line 8986: + had actually + occurred.36 Th e Lehman loss rate + projection suggests + + that the analysts + did not have an accurate + estimate of the + +On line 8986: + in Indeed, I have + not found any studies in the + period before + +On line 8988: + seemed to understand + how many NTMs were in the fi + nancial system at + +On line 8988: + It was only aft + er the fi nancial crisis, + when my AEI colleague, + +On line 8988: + information from + various unrelated + and disparate sources that + + the total number + of NTMs in the fi nancial + markets became clear. + +On line 8988: + a result, all loss + projections before Pinto’s + work were bound to be + +On line 8990: + of the Commission + majority’s report, which + criticizes fi rms, + +On line 8990: + and ratings agency + analysts for failure to + perceive the losses + +On line 8990: + hindsight. It appears + that information about the + composition of + + the mortgage market + was simply not known when the + bubble began to + +On line 8992: + Commission never + attempted a serious + study of what was known + +On line 8992: + mortgage market in + apparently satisfi + ed simply to blame + +On line 8992: + participants for + failing to understand the + risks that lay before + +On line 8996: + information was + actually available. Th + e mortgage market + +On line 8996: + investors. How could all + these people have missed something + as important as + +On line 8996: + have assumed in the + bubble years that Fannie and + Freddie continued + +On line 8996: + same conservative + underwriting policies they + had previously + +On line 8998: + Until Fannie and + Freddie were required to meet + HUD’s AH goals, they rarely + +On line 8998: + mortgages. Indeed, the + very defi nition of a + traditional prime + + mortgage was a loan + that Fannie and Freddie would + buy. Lesser loans were + + rejected, and were + ultimately insured by + FHA or made by a + +On line 9000: + small group of subprime + originators and investors. + Although anyone who + +On line 9000: + regulations, and + thought through their implications, + would have realized + +On line 9000: + must have been shift ing + their buying activities + to low quality + +On line 9000: + to uncover the + new buying pattern. Investors + believed that there was + + no signifi cant risk + in MBS backed by Fannie and + Freddie, since they were + +On line 9000: + In addition, the + GSEs were exempted by law + from having to fi + + le information + with the Securities and + Exchange Commission + +On line 9000: + free from disclosure + obligations and questions from + analysts about the + +On line 9002: + mortgages. When Fannie + voluntarily began + fi ling reports with + +On line 9002: + SEC in it disclosed + Fannie Mae, Second Quarter + Credit Supplement, + +On line 9006: + q2credit_summary.pdf. + "Moody’s Projects Losses of Almost + Half of Original + +On line 9012: + mortgages had FICO + scores of less than 660—the common + defi nition of + + a subprime loan. Th + ere are occasionally + questions about whether a + +On line 9016: + the appropriate + dividing line between prime + and subprime loans. Th + +On line 9018: + e federal bank + regulators use as the + dividing line,37 and + +On line 9018: + published for the fi + rst time with its 10-K, Fannie + included loans with + +On line 9018: + below to disclose + its exposure to loans that + were other than prime. + +On line 9018: + As of December + borrowers with a FICO + of less than had a + +On line 9018: + delinquency rate about + four times that for borrowers + with a FICO equal + +On line 9018: + or greater than compared + to Fannie did not point out + in its fi ling that + +On line 9018: + a FICO score of + less than was considered a + subprime loan. Although + +On line 9018: + Fannie was exposed + to billion in subprime loans + it reported in + +On line 9022: + its 10-K (not fi led + with the SEC until May that: + "Th e percentage + +On line 9022: + mortgage credit book + of business consisting of + subprime mortgage loans + +On line 9022: + Fannie Mae MBS backed + by subprime mortgage loans was + not material + +On line 9024: + as of December + 2005."[emphasis supplied]39 Fannie + was able to make this + + statement because it + defi ned subprime loans as + loans it purchased from + +On line 9028: + lenders. Th us, in its + 10-K report, Fannie stated: + "Subprime mortgage loans + +On line 9028: + originated by + lenders specializing in these + loans or by subprime + + divisions of large + lenders, using processes unique + to subprime loans. In + +On line 9028: + exposure, we have + classifi ed mortgage loans + as subprime if the + +On line 9028: + are originated + by one of these specialty + lenders or a subprime + + division of a + large lender."40[emphasis supplied] Th + e credit scores on + +On line 9030: + and the riskiness + associated with these + credit scores, were not + +On line 9030: + as late as its 10-K + report, Fannie was able to + make the following + +On line 9030: + likely that at that + point it held or guaranteed + enough subprime loans to + +On line 9032: + substantial number + of these loans were to default: + Subprime mortgage loans, + +On line 9032: + in our portfolio + or backing Fannie Mae MBS, + represented less + +On line 9034: + of and [emphasis + supplied] We estimate that + subprime mortgage loans + +On line 9034: + loans, represented + approximately of our + single-family + +On line 9034: + of business as of + December compared with and + as of December + +On line 9038: + ese statements could have + lulled market participants + and others—including + +On line 9040: + of Comptroller of + the Currency, Federal + Reserve, Federal + +On line 9044: + Offi ce of Th + rift Supervision advised + in its "Expanded + +On line 9046: + for Subprime Lending + Programs", published in http://www.federalreserve.gov/Boarddocs/SRletters/2001/sr0104a1.pdf that + "the term ‘subprime’ refers + +On line 9046: + borrowers. Subprime + borrowers typically + have weakened credit + +On line 9046: + that include payment + delinquencies and possibly + more severe problems + +On line 9046: + as charge-off s, judgments, + and bankruptcies." A FICO + score of or below + + was evidence of + "relatively high default + probability." + +On line 9052: + Derived from Table + Fannie Mae, 10-K report, fi + led May Fannie Mae, + +On line 9062: + pp. and Fannie Mae, + Form 10K, p.129. Fannie Mae, Form + 10K, p.130. Dissenting + +On line 9064: + Lehman analysts—into + believing that Fannie and + Freddie did not hold + +On line 9064: + had not guaranteed + substantial numbers of high + risk loans, and thus that + + there were many fewer + such loans in the fi nancial + system than in fact + + existed. Of course, + in the early 2000s there was + no generally + +On line 9066: + of the term "subprime," + so Fannie and Freddie could + defi ne it as + +On line 9066: + and the assumption + that the GSEs only made prime + loans continued to + +On line 9066: + supported by their + public disclosures. So when + Fannie and Freddie + +On line 9066: + aggregators they + did not report those mortgages + as subprime or Alt-A, + +On line 9066: + industry practice + by placing virtually + all the GSEs’ loans in + +On line 9066: + Fannie and Freddie’s + peculiar and self-serving + loan classifi cation + +On line 9066: + recipients of + information about the GSEs’ + mortgage positions + +On line 9066: + seemed to assume that + all these mortgages were prime loans, + as they had always + + been in the past, and + added them to the number of + prime loans outstanding. + +On line 9066: + Accordingly, by + there were approximately + million more NTMs in + +On line 9068: + prime loans—than most market + participants realized. + Appendix shows that + +On line 9068: + be percent higher + than expected if there were + million NTMs in the + +On line 9068: + fi nancial system + instead of million prime loans. + Appendix shows that + +On line 9068: + percent higher than + expected if the feedback + eff ect of mortgage + + delinquencies—causing + lower housing prices, in a + downward spiral—were + +On line 9070: + ese diff erences in + projected losses could have + misled the rating + +On line 9070: + into believing + that, even if the bubble were + to defl ate, the + +On line 9070: + on mortgage failures + would not be so substantial + as to have a more + + than local eff ect + and would not adversely aff + ect the AAA tranches + +On line 9074: + never looked into + this issue, or attempted + to determine what + +On line 9074: + to be the number + of subprime and other NTMs + outstanding in the + +On line 9074: + possible in the + Commission’s public hearings, + I asked analysts + +On line 9074: + many NTMs they believed + were outstanding before the + fi nancial crisis + + occurred. It was clear + from the responses that none + of the witnesses + +On line 9074: + ever considered + that question, and it appeared + that none suspected + + that the number was + large enough to substantially + aff ect losses aft + +On line 9076: + er the collapse of + the bubble. It was only + on November aft + +On line 9076: + been taken over by + the federal government, + that the company + +On line 9076: + in its 10-Q report + for the third quarter of that + it had classifi + +On line 9076: + Alt-A originators, + and not loans that were subprime + or Alt-A because of + +On line 9078: + its classifi cation + criteria, Fannie stated, + "[H]owever, we have + + other loans with some + features that are similar + to Alt-A and subprime + + loans that we have not + classifi ed as Alt-A or + subprime because they + +On line 9080: + cation criteria."43 Th + is hardly described the true + nature of Fannie’s + +On line 9084: + the issue of the + number of NTMs outstanding + before the crisis + +On line 9092: + Wallison never + addresses the question. HUD’s + role in pressing for + +On line 9092: + standards escaped the + FCIC’s attention entirely, + the GSEs’ AH goals are + + mentioned only in + passing, CRA is defended, + and neither HUD’s Best + + Practices Initiative + nor FHA’s activities are + mentioned at all. No + + reason is advanced + for the accumulation + of subprime loans in + +On line 9092: + idea—implicit in the + majority’s report—that + it was profi table. + +On line 9092: + the majority’s + report is Hamlet without + the prince of Denmark. + +On line 9094: + Commission’s entire + investigation seemed to + be directed at + + minimizing the + role of NTMs and the role of + government housing + + policy. In this + telling, the NTMs were a "trigger" + for the fi nancial + +On line 9094: + but once the collapse + of the bubble had occurred + the "weaknesses and + +On line 9096: + of the fi nancial + system— which had been there all + along—caused the crisis. + +On line 9100: + regulation of + the so-called "shadow banking + system" and over-the-counter + +On line 9100: + their baleful presence + hadn’t been noted until + the unprecedented + +On line 9104: + Conclusion What is + surprising about the many views + of the causes of + +On line 9104: + been published since the + Lehman bankruptcy, including + the Commission’s own + +On line 9104: + (i) a general + agreement that the bubble and + the mortgage meltdown + +On line 9104: + precipitating + causes—sometimes characterized + as the "trigger"—of the + +On line 9104: + how it came to be + that mortgage underwriting + standards declined to + +On line 9104: + point that the bubble + contained so many NTMs that were + ready to fail as soon + +On line 9104: + the bubble began + to defl ate. Instead of + thinking through what would + +On line 9104: + report—pivoted + immediately to blame + the "weaknesses and + +On line 9106: + considering whether + any system could have survived + such a blow. One of + +On line 9106: + examples of this + approach was presented by + Larry Summers, the + + head of the White House + economic council and one + of the President’s + +On line 9106: + advisers. In a + private interview with a + few of the members + + of the Commission + (I was not informed of the + interview), Summers + +On line 9106: + asked whether the mortgage + meltdown was the cause of the + fi nancial crisis. + + His response was that + the fi nancial crisis was + like a forest fi + + re and the mortgage + meltdown like a "cigarette + butt" thrown into a + +On line 9106: + dry forest. Was the + cigarette butt, he asked, the + cause of the forest + + fi re, or was it + the tinder dry condition + of the forest144 Th + +On line 9108: + the idea that it was + the tinder-dry forest. Th eir + central argument + +On line 9110: + crisis because of + the "vulnerabilities" + inherent in the + +On line 9116: + at the time—the absence + FCIC, Summers interview, p.77. + Dissenting Statement + +On line 9118: + regulation, lax + regulation, predatory + lending, greed on Wall + +On line 9118: + ineff ective risk + management, and excessive + leverage, among other + +On line 9120: + factors. One of the + majority’s singular + notions is that years + +On line 9120: + deregulation" had + "stripped away key safeguards" against a + crisis; this ignores + +On line 9120: + in the wake of the + S&L crisis, Congress adopted + the FDIC Improvement + +On line 9120: + by far the toughest + bank regulatory law + since the advent of + +On line 9120: + insurance and was + celebrated at the time + of its enactment + +On line 9120: + nally giving the + regulators the power + to put an end to + +On line 9124: + forest metaphor turns out + to be an excellent way + to communicate + +On line 9124: + erence between the + Commission’s report and this + dissenting statement. + +On line 9124: + a "cigarette butt" + was million high risk NTMs with + a total value + +On line 9124: + over trillion. Let’s use + a little common sense here: + trillion in high risk + +On line 9124: + "cigarette butt;" they + were more like an exploding + gasoline truck in that + +On line 9126: + Th e Commission’s + report blames the conditions + in the fi nancial + +On line 9126: + blame million subprime + and Alt-A mortgages—half of all + mortgages outstanding + + in the U.S. in 2008—and + a number that appears to + have been unknown to + +On line 9126: + at the time. No fi + nancial system, in my view, + could have survived the + +On line 9126: + large numbers of high + risk mortgages once the bubble + began to defl + + ate, and no market + could have avoided a panic + when it became clear + +On line 9126: + and delinquencies among + these mortgages far exceeded + anything that even the + +On line 9130: + Th is conclusion + has signifi cant policy + implications. If + +On line 9130: + nancial crisis was + caused by government housing + policies, then the Dodd-Frank + +On line 9134: + was to reduce or + eliminate the government’s + involvement in the + +On line 9134: + mortgage markets, not + to impose signifi cant new + regulation on + +On line 9140: + nancial system. Th + e balance of this statement + will outline (i) how + +On line 9140: + default among the NTMs + were transmitted as losses + to the fi nancial + +On line 9140: + summarized above caused + the accumulation of + an unprecedented + +On line 9146: + in the U.S. and around + the globe. II. HOW MILLION NTMS + PRECIPITATED + +On line 9148: + CRISIS Although the + Commission never defi + ned the fi nancial + +On line 9148: + to investigate, + it is necessary to do + so in order to + + know where to start and + stop. If, for example, the + fi nancial crisis + +On line 9148: + continuing, then + the eff ect of government + policies such as the + +On line 9150: + Repurchase Program + (TARP) should be evaluated. + However, it seems + +On line 9150: + the Commission to + concentrate on what caused the + unprecedented events + +On line 9150: + largely in the fall + of and for this purpose Ben + Bernanke’s defi nition + +On line 9154: + nancial crisis seems + most appropriate: Th e + credit boom began + +On line 9154: + surfaced with subprime + mortgages—mortgages off ered to + less-creditworthy + +On line 9154: + house prices in parts of + the country began to fall. + Mortgage delinquencies + +On line 9154: + and the downturn in + house prices intensifi ed, + trends that continue + + today. Investors, stunned + by losses on assets they + had believed to be + +On line 9154: + severe losses on + mortgages and other loans—cut + back their lending. Th + +On line 9158: + crisis deepened [in + September when the failure + or near-failure of + +On line 9158: + major fi nancial + fi rms caused many fi nancial + and credit markets + +On line 9160: + freeze up."45 In other + words, the fi nancial crisis + was the result of + +On line 9160: + losses suff ered by + fi nancial institutions + around the world when U.S. + +On line 9160: + in large numbers; the + crisis became more severe + in September when + +On line 9160: + several major + fi nancial fi rms—which held + or were thought to hold + +On line 9162: + nancial markets to + freeze up. Th is summary + encapsulates a + +On line 9162: + interconnected + events, but it makes clear that the + underlying cause + + of the fi nancial + crisis was a rapid decline + in the value of + +On line 9162: + c and widely held + asset: U.S. residential + mortgages. Th e next + +On line 9164: + is how, exactly, + these delinquencies and losses + caused the fi nancial + +On line 9168: + Th e following + discussion will show that it + was not all mortgages + +On line 9168: + securities that + were the source of the crisis, + but primarily + +On line 9170: + were generally + prime mortgages, did not suff er + substantial losses + + at the outset of + the mortgage meltdown, although + as the fi nancial + + crisis turned into + a recession and housing + prices continued to + + fall, losses among prime + mortgages began to approach + the level of prime + + mortgage losses that + had occurred in past housing + crises. However, those + +On line 9170: + losses on NTMs, which + reached levels of delinquency + and default between + +On line 9170: + the loans in question) + because the loans involved were + weaker as a class + +On line 9172: + in any previous + housing crisis. Th e fact + that they were also + +On line 9180: + in number than any + Speech at Morehouse College, April + Dissenting Statement + +On line 9184: + housing price declines + that fueled the fi nancial + crisis. How Failures + +On line 9188: + were Transmitted to + the Financial System When + the housing bubble + + began to defl + ate in mid-2007, delinquency rates + among NTMs began to + +On line 9188: + mortgages were weak and + high risk, their delinquency rates + were relatively + + low. Th is was a + consequence of the bubble + itself, which infl + + ated housing prices + so that homes could be sold with + no loss in cases + +On line 9190: + borrowers could not + meet their mortgage obligations. + Alternatively, + +On line 9190: + liberal appraisal + rules—created a form of + free equity in + + a home, allowing + the home to be refi nanced + easily, perhaps + + even at a lower + interest rate. However, + rising housing prices + + eventually reached + the point where even easy credit + terms could no longer keep + +On line 9190: + rolling, and at that point + the bubble fl attened and + weak mortgages became + + exposed for what they + were. As Warren Buff ett has + said, when the tide goes + +On line 9194: + who’s swimming naked. Th + e role of the government’s + housing policy + + is crucial at this + point. As discussed earlier, + if the government + +On line 9194: + not been directing + money into the mortgage + markets in order + +On line 9194: + in home ownership, + NTMs in the bubble would have + begun to default + +On line 9196: + originated. Th + e continuous infl + ow of government + +On line 9196: + government-backed funds, + however, kept the bubble + growing—not only + +On line 9196: + tended to suppress + the signifi cant delinquencies + and defaults that had + +On line 9198: + previous bubbles + to an end in only three + or four years. Th at + +On line 9200: + why PMBS based on NTMs + could become so numerous + and so risky without + +On line 9200: + the delinquencies and + defaults that caused earlier + bubbles to defl + +On line 9200: + time to continue + originations, Countrywide + and others were able + +On line 9200: + billion) to billion) + without engendering the + substantial increase + + in delinquencies that + would ordinarily have + alarmed investors and brought + + the bubble to a + halt.46 Indeed, the absence of + delinquencies had the + + opposite eff ect. + As investors around the world saw + housing prices rise in + + the U.S. without any + signifi cant losses even among + subprime and other + + high-yielding loans, they + were encouraged to buy PMBS + that—although rated AAA—still off + +On line 9202: + ered attractive yields. + In other words, as shown in + Figure government + +On line 9202: + policies—AH goals imposed on + the GSEs, the decline in FHA + lending standards, HUD’s + + pressure for reduced + underwriting standards among + mortgage bankers, and CRA + +On line 9204: + for insured banks— by + encouraging the growth of + the bubble, increased + +On line 9206: + worldwide demand for + subprime PMBS. Th en, in mid-2007, + the bubble began + +On line 9214: + e Mortgage Market + Statistical Annual—Volume II, MBS + database. Peter J. + +On line 9222: + The Defaults Begin + Th e best summary of + how the defl ation + +On line 9222: + housing bubble led + to the fi nancial crisis + was contained in the + +On line 9222: + testimony that + FDIC chair Sheila Bair delivered + to the FCIC in a + +On line 9224: + to experience + serious liquidity + challenges related + +On line 9224: + prices fell, recently + originated subprime and + non-traditional + + mortgage loans began + to default at record rates. Th + ese developments + +On line 9228: + securities and + related derivative + instruments held by + + major fi nancial + institutions in the U.S. + and around the world. Th + +On line 9234: + diffi culty in + determining the value + of mortgage-related + + assets and, therefore, + the balance-sheet strength of large banks + and non-bank fi nancial + +On line 9234: + these institutions + to become wary of lending + to one another, + + even on a short-term + basis.47 [emphasis supplied] + All the important + + elements of what + happened are in Chairman Bair’s + succinct statement: (i) + +On line 9236: + because of concerns + about the credit quality + of NTMs; (ii) housing + + prices fell; NTMs began + to default at record rates; (iii) + it was diffi cult + +On line 9240: + of MBS, and thus the + fi nancial condition of + the institutions + +On line 9240: + consequence of this + uncertainty—especially + aft er the failure + + of Lehman—fi nancial + institutions would not lend + to one another. + +On line 9246: + at phenomenon + was the fi nancial crisis. + Th e following + +On line 9246: + show how each of these + steps operated to bring + down the fi nancial + +On line 9250: + To understand the + transmission mechanism, it + is necessary to + +On line 9250: + the one hand, and the + MBS that were distributed by + government agencies + + such as FHA/Ginnie Mae and + the GSEs (referred to jointly + as "Agencies" in this + +On line 9252: + shown in Table by + the million NTMs in the U.S. + fi nancial system + +On line 9252: + as (i) whole mortgages, + (ii) MBS guaranteed by the + GSEs, or insured or + +On line 9252: + by a government + agency or a bank under + the CRA, or (iii) as + + PMBS securitized + by private fi rms such as + Countrywide. Th e + +On line 9254: + had an aggregate + unpaid principal balance + of more than trillion, + +On line 9254: + by PMBS consisted + of million mortgages with an + aggregate unpaid + +On line 9254: + mortgage delinquencies + and defaults multiplied in + the U.S. fi nancial + +On line 9254: + were transmitted to + fi nancial institutions + through their holdings of + +On line 9254: + this happen, and what + role was played by government + housing policy1 + +On line 9256: + and PMBS pass through to + investors the principal and + interest received + + on the mortgages in + a pool that backs an issue + of securities; + +On line 9256: + diff erence between + them is the way they protect + investors against credit + +On line 9256: + possibility + of losses in the event that + the mortgages in the + +On line 9260: + begin to default. + Th e Agencies insure or + place a guarantee + +On line 9260: + "Systemically + Important Institutions + and the Issue of + +On line 9266: + ‘Too-Big-to-Fail,’" Testimony + to the FCIC, September p.3. + Dissenting Statement + +On line 9270: + securities are + rated or considered to + be AAA. PMBS rely + +On line 9270: + classifi cation and + subordination system + known as "tranching" to + + provide some investors + in the pool with a degree + of assurance that + +On line 9270: + er losses because + of mortgage defaults. In the + tranching system, diff + + erent classes of + securities are issued + by the pool. Th e + +On line 9274: + classes to receive + payments of principal and + interest from the + + mortgages in the pool + are subordinated to + the rights of other + +On line 9274: + the superior + classes are more likely to + receive payment even + +On line 9278: + are some defaults among + the mortgages in the pool. Th + rough this mechanism, + +On line 9280: + approximately + percent of an issue of + PMBS could be rated + + AAA or AA, even if + the underlying mortgages + are NTMs that have a + +On line 9280: + rate of delinquency + than prime loans. In theory, + for example, if + + the historic rates of + loss on a pool of NTMs is, + say, fi ve percent, + +On line 9280: + ten percent of the + securities holders who + are in the classes + + rated lower than + AAA or AA. Of course, if the + losses are greater than + +On line 9280: + what happened as the + recent bubble began to + defl ate—they will + +On line 9280: + into the higher + classes and substantially + reduce their value.48 + +On line 9280: + whether, in or mortgage + delinquencies and defaults had + actually caused + +On line 9280: + losses in the AAA + tranches of PMBS, but the rate + at which delinquencies + + and defaults among NTMs + were occurring throughout the + fi nancial system + +On line 9284: + a matter of great + concern to investors. Th is + means that investors in + +On line 9286: + and government-backed + Agency MBS had diff erent + experiences when + +On line 9288: + began to defl + ate. Th ose who invested + in Agency MBS did + + not suff er losses + (the U.S. government has thus + far protected all + + investors in Agency + MBS), while those who invested + in PMBS were exposed + +On line 9288: + if the losses on + the underlying mortgages + were so great that they + + threatened to invade + the AAA and AA classes. Even + if no cash losses + + had actually + been suff ered, the holders of + PMBS would see a sharp + +On line 9288: + the market value + of their holdings as investors—shocked + by the large number + +On line 9288: + mortgages—fl ed the + asset-backed market. So when we + look for the direct + +On line 9288: + mortgage failures on + the fi nancial condition + of various fi + +On line 9288: + institutions in + the fi nancial crisis we + should look only to + +On line 9290: + by the Agencies. In + addition, the default and + delinquency ratios + +On line 9290: + ratios among the loans + held or guaranteed by the + Agencies. Many of the + +On line 9290: + backed the PMBS were the + self-denominated + subprime loans (that is, + + made by subprime lenders + explicitly to subprime + borrowers) and were + +On line 9290: + classifi ed in + the worst-performing categories + in Table In part, + +On line 9290: + of the NTMs held or + guaranteed by the Agencies + was due to the fact + + that the Agencies were + not buying for economic + purposes—to make profi + + ts—but only to + meet government requirements + such as the AH goals. + + Th ey did not want + or need the higher-yielding and + thus more risky mortgages + +On line 9292: + backed the PMBS, because + they did not need higher yields + in order to sell + +On line 9292: + MBS. In addition, + because of their lower cost + funding, the Agencies + +On line 9292: + pay more for the NTMs + they bought and thus could acquire + the "best of the worst." + +On line 9292: + thorough description + of the tranching system, and + many more details about + +On line 9292: + protecting senior + tranches, is contained in Gary + B. Gorton, Slapped By + +On line 9294: + Invisible Hand: + Th e Panic of Oxford + University Press, + +On line 9304: + Wallison PMBS are + Connected to All Other + NTMs Th rough Housing + +On line 9306: + not mean that only + the failure of the PMBS was + responsible for + +On line 9306: + nancial crisis. In + a sense, all mortgages are linked + to one another + +On line 9306: + and housing prices in + turn are highly sensitive + to delinquencies and + +On line 9308: + on mortgages. Th is + is a characteristic + of mortgages that is + +On line 9308: + credit card holder + defaults on his obligations + it has little eff + +On line 9308: + on a mortgage the + resulting foreclosure has + an eff ect on the + + value of all homes + in the vicinity and thus + on the quality + +On line 9310: + all mortgages on those + homes. Accordingly, the PMBS + were intimately + +On line 9310: + housing prices—to the + NTMs securitized by the + Agencies. Because there + +On line 9310: + so many more NTMs held + or securitized by the + Agencies (see Table + +On line 9310: + numbers—even + in cases where they had a + lower average + +On line 9310: + of delinquency and + default than the NTMs that backed + the PMBS—was the major + +On line 9310: + pressure on housing + prices throughout the United States. + Weakening housing + + prices, in turn, caused more + mortgage defaults, among both NTMs + in general and + +On line 9310: + particular NTMs + that were the collateral + for PMBS. In other + +On line 9310: + PMBS were weakened by + the delinquencies and defaults + among the much larger + + number of mortgages + held or guaranteed as MBS + by the Agencies. In + + reality, then, + the losses on the PMBS were + much higher than they + + would have been if the + government’s housing policies + had not brought into + +On line 9312: + NTMs that were failing + in unprecedented numbers. + Th ese failures drove + +On line 9316: + the PMBS. Finally, + the funds that the government + directed into + + the housing market + in pursuit of its social + policies enlarged the + +On line 9320: + it in time. Th e + longer housing bubbles grow, the + riskier the mortgages + +On line 9320: + lenders are constantly + trying to fi nd ways to + keep monthly mortgage + +On line 9320: + growing, the risks that + were building within it were + obscured. Borrowers + + who would otherwise + have defaulted on their loans, + bringing an end to + +On line 9320: + bubble, were able to + use the rising home prices to + refi nance, sometimes + +On line 9320: + rates relatively + low, investors did not have a + reason to exit + + the mortgage markets, + and the continuing fl + ow of funds into + +On line 9320: + mortgages allowed the + bubble to extend for an + unprecedented years. + +On line 9324: + is in turn enabled + the PMBS market to grow to + enormous size and thus + +On line 9324: + more calamitous eff ect + when it fi nally collapsed. + If the government + +On line 9324: + continuing source + of funding for the bubble + had not been pursued, + +On line 9324: + is doubtful that there + would have been a PMBS market + remotely as large + +On line 9324: + one that developed, + or that—when the housing bubble + collapsed—the losses to + +On line 9326: + would have been as great. + PMBS, as Securities, are + Vulnerable to + + Investor Sentiment + In addition to their link + to the Agencies’ NTMs + +On line 9328: + particularly + vulnerable to changes in + investor sentiment + +On line 9334: + of the crisis. Th + ere are many reasons for the + popularity + +On line 9342: + example, the Basel + regulations provided + that mortgages held in + +On line 9342: + their superior + liquidity compared to + whole mortgages—required + +On line 9342: + bank to hold only + percent risk-based capital, while + whole mortgages required + +On line 9346: + Th is made all forms + of MBS, including PMBS, much + less expensive to + + hold than whole mortgages. + In addition, mortgages in + securitized form + +On line 9346: + easily, and used + more readily as a source + of liquidity + +On line 9348: + of the benefi ts + of securitized mortgages + are also detriments + + when certain mortgage + market conditions prevail. + If housing values + +On line 9348: + on whole mortgages are + recognized only slowly + in bank fi nancial + +On line 9348: + the larger market. + PMBS, however, are far more + vulnerable to + +On line 9348: + sentiment than whole + mortgages held on bank balance + sheets. First, because they + +On line 9348: + information about + the underlying mortgages + than whole mortgages in + + the same principal + amount. PMBS markets tend to be + thin, because PMBS pools + +On line 9348: + one another. If + investors believe that mortgages + in general are + +On line 9348: + and delinquencies, they + may abandon the market for + all PMBS, causing the + +On line 9350: + PMBS price level to + fall precipitously. For + example, in his + +On line 9350: + the Invisible + Hand, Professor Gary Gorton + of Yale notes that the + +On line 9350: + index, initially + published in late for the fi + rst time gave investors + + a picture of how + others saw the value of + a selected group + + of PMBS pools. Th e + index showed steeply declining + values, which caused many + +On line 9354: + to withdraw from the + market. Gorton observed: "I + view the ABX indices + +On line 9354: + hitherto unknown + information, namely, the + aggregated view + + that subprime was worth + signifi cantly less…It is not + clear whether the housing + +On line 9354: + by the ability + to short the subprime housing + market or whether house + +On line 9354: + were going down and + the implications of this + were aggregated + +On line 9358: + indices"49 Whatever + the underlying reason, + as shown in Figure + +On line 9360: + what happened in the + fi nancial crisis. Th e + result was a crash + +On line 9362: + the MBS market as + investors fl ed what looked like + major oncoming + +On line 9370: + losses. Gorton, Slapped + by the Invisible Hand, + note pp.121-123. Peter J. + +On line 9380: + MBS market reacts + to the bubble’s defl ation + Source: Th ompson Reuters + +On line 9386: + profound adverse eff + ect on the liquidity + of all fi nancial + +On line 9386: + that were exposed to + PMBS. As noted above, one of + the benefi ts of + +On line 9386: + PMBS, especially + those with AAA ratings, was that + they were readily + +On line 9386: + they were considered + sound and secure investments, + carried on balance + +On line 9386: + par and suitable to + serve as collateral for + short term fi nancing + +On line 9386: + agreements, or "repos." + In a repo transaction, + a borrower sells + + a security + to a lender with an option + to repurchase it + +On line 9386: + provides the lender with + a return appropriate + for a secured loan. + +On line 9388: + lender assumes that if + its counterparty defaults + the collateral + +On line 9388: + high quality and + liquidity, it loses + much of its value + +On line 9390: + not actually + suff ered losses. Th is is + what happened to AAA-rated + + PMBS as housing prices + fi rst leveled off and then + began to fall in + +On line 9392: + in at rates no one + had expected. As discussed + more fully below, + +On line 9392: + lost their value for + liquidity purposes, + making it diffi + +On line 9396: + themselves using these + assets as collateral + for repos. Th is + +On line 9402: + Chairman Bair referred + in her testimony. Th + e near-failure of + +On line 9402: + example of how + the unexpected collapse + of the PMBS market + +On line 9402: + ultimately its + inability to survive + the resulting loss + +On line 9406: + staff ’s review of + the liquidity problems + of Bear Stearns showed that + + the loss of the PMBS + market was the single event + that was crippling for + +On line 9406: + eliminated a + major portion of the fi + rm’s liquidity + +On line 9410: + Dissenting Statement + pool—AAA-rated PMBS—as a useful source of + repo fi nancing. + +On line 9410: + prepared for hearings + on May and percent of Bear’s + short term funding was + +On line 9410: + secured and only + percent unsecured. "As of + January the FCIC + +On line 9412: + billion of Bear Stearns’ + repo collateral was + composed of agency + +On line 9412: + was in non-agency + securitized asset backed + securities [i.e., + +On line 9414: + and billion was in + whole loans."50 Th e Agency MBS + was unaff ected + + by the collapse of + the PMBS market, and could still + be used for funding. + +On line 9418: + about percent of Bear’s + readily available sources of + funding consisted + + of PMBS that became + unusable for repo fi + nancing when the PMBS + + market disappeared. + Th e loss of this source of + liquidity put + +On line 9420: + serious jeopardy; + rumors swept the market about + Bear’s condition, and + +On line 9422: + began withdrawing + funds. Bear’s offi cers told the + Commission that the + +On line 9422: + quarter—the quarter in + which it failed; ironically + they also told the + +On line 9424: + short term funding from + commercial paper to MBS + because they believed + +On line 9424: + would be more stable. + In the week beginning March + according to the + +On line 9424: + Bear had over billion + in cash reserves, but by March + the liquidity + +On line 9424: + fallen to billion.51 + It was clear that Bear—solvent + and profi table or + +On line 9424: + not survive a run + that was fueled by fear and + uncertainty about + +On line 9424: + liquidity and + the possibility of + its insolvency. + +On line 9426: + should be noted that + the Commission’s staff focused + on Bear because the + +On line 9426: + business model of + investment banks, which relied + on relatively + +On line 9428: + other short term fi + nancing, was inherently + unstable. Th e + + need to rescue Bear + was thought to be evidence + of this fact. Clearly, + +On line 9430: + ve independent + investment banks—Bear, Lehman Brothers, + Merrill Lynch, Morgan + +On line 9430: + fi nancial crisis. + Only two of them remain + independent fi + + rms, and those two are + now regulated as bank + holding companies + + by the Federal + Reserve. Nevertheless, it + is not clear that the + +On line 9430: + and Freddie which were + also regulated more + stringently than the + + investment banks but + not as stringently as banks. + Th e investment + +On line 9432: + the test created + by the mortgage meltdown and + the subsequent fi + + nancial crisis, but + neither did a large number + of insured banks— IndyMac, + +On line 9434: + largest—that were much more + heavily regulated + and, in addition, + +On line 9434: + ered insured deposits + and had access to the Fed’s + discount window if + +On line 9436: + to deal with runs. Th + e view of the Commission + majority, that + +On line 9438: + to the fi nancial + crisis, seems misplaced for this + reason. Th ey are + + better classifi + ed not as contributors + to the fi nancial + +On line 9440: + as victims of the + panic that ensued aft er + the housing bubble + + and the PMBS market + collapsed. Bear went down because + the delinquencies and + +On line 9442: + unprecedentedly + large number of NTMs caused the + collapse of the PMBS + +On line 9448: + Findings on Bear Stearns + (Preliminary Draft April p.16. + Id., p.45. Peter J. + +On line 9450: + usefulness of AAA-rated + PMBS as assets that Bear and + others relied on + + for both capital + and liquidity, and thus + raised questions about the + +On line 9450: + ability to meet + its obligations. Investment + banks like Bear Stearns were + + not commercial banks; + instead of using short term + deposits to hold long + +On line 9452: + hallmark of a bank— + their business model relied + on short-term funding + + to carry the short + term assets of a trading + business. Contrary to + +On line 9452: + majority, there + is nothing inherently + wrong with that business + +On line 9452: + could not survive an + unprecedented fi nancial + panic as severe + + as that which followed + the collapse in value of + an asset class as + + large and as liquid + as AAA-rated subprime PMBS. Mortgage + Defaults at Record Rates + +On line 9454: + also pointed to + the relationship between + the decline in the + +On line 9454: + balance sheet strength" of + fi nancial institutions + that held these assets. + +On line 9454: + the loss transmission + mechanism. Securitized + assets held by fi + +On line 9454: + institutions are + subject to the rules of fair + value accounting, + +On line 9456: + to market under + certain circumstances. Th us, + banks and other fi + +On line 9458: + institutions that + are holding securitized + mortgages in the form + +On line 9458: + be subject to large + accounting losses—but not + necessarily + +On line 9460: + Accordingly, once + large numbers of delinquencies + and losses started + +On line 9460: + up in the mortgage + markets generally and + in the mortgage pools + + that backed the PMBS, it + was not necessary for all + the losses to be + +On line 9460: + before the PMBS lost + substantial value. All that + was necessary was + +On line 9462: + these assets become + seriously impaired. Th + is is exactly + +On line 9462: + consequences for fi + nancial institutions that + held PMBS but also + +On line 9466: + that made them appear + unstable and possibly + insolvent. Th ese + +On line 9466: + anticipated. + As one Federal Reserve + study put it, "Th e + +On line 9468: + pressure on prices of + structured fi nance products across + the whole spectrum of + +On line 9468: + securities, even + those with only minimal + ties to the riskiest + + underlying assets…[I]n + addition to discounts from + higher expected + +On line 9468: + large mark-to-market + discounts are generated + by uncertainty + +On line 9468: + the quality of + the underlying assets, + by illiquidity, + + and by price volatility…Th is + illiquidity discount is + the main reason why + +On line 9470: + in most similar + analyses, is larger than the + expected credit + +On line 9472: + the spread refl ects + only anticipated + credit losses. As + +On line 9472: + dramatically + in Figure the collapse of + the market for PMBS + +On line 9474: + a seminal event + in the history of the + fi nancial crisis. + + Even though delinquencies + had only just begun to + show up in mortgage + +On line 9474: + pools, the absence of + a functioning Daniel Beltran, + Laurie Pounder and Charles + +On line 9476: + "Foreign Exposure + to Asset-Backed Securities of + U.S. Origin," Board of + + Governors of the + Federal Reserve System, + International + +On line 9484: + Discussion Papers + August pp. 11-14. Dissenting + Statement market meant + + that PMBS simply could + not be sold at anything but + distress prices. Th e + + inability of + fi nancial institutions + to liquidate their + +On line 9488: + accounting rules, and + was the crux of the crisis. + In eff ect, a whole + +On line 9488: + of assets—involving + almost trillion—came to be + called "toxic assets" + +On line 9488: + had to be written + down substantially on the + balance sheets of fi + +On line 9488: + world. Although this made + fi nancial institutions + look weaker than they + +On line 9488: + were, the PMBS they held, + despite being unmarketable + at that point, were in + +On line 9488: + still fl owing cash + at close to expected rates. + Instead of a slow + + decline in value— + which would have occurred if whole + mortgages were held on + +On line 9490: + and gradually + deteriorated in + quality—the loss of + + marketability of + these securities caused a + crash in value. Th + +On line 9494: + discuss the signifi + cance of mark-to-market + accounting in its + + report. Th is was + a serious lapse, given + the views of many that + +On line 9498: + an important role + in the fi nancial crisis. + Many commentators + +On line 9498: + that the resulting + impairment charges to balance + sheets reduced the GAAP + +On line 9498: + making them appear + fi nancially weaker than + they actually + + were if viewed on the + basis of the cash fl ows + they were receiving.53 + +On line 9502: + unanticipated + and unprecedented losses + started to appear + +On line 9502: + generally and + in the PMBS mortgage pools now + spread to fi nancial + +On line 9504: + losses. Th is process + was succinctly described in + an analysis of + +On line 9504: + accounting in the + fi nancial crisis issued + by the Institute + +On line 9506: + organization + of the world’s largest banks and fi + nancial fi rms: [O]ft + +On line 9508: + implementation + of fair-value accounting + adversely aff ect + + market sentiment, + in turn leading to further + write-downs, margin calls + +On line 9508: + capital impacts + in a downward spiral that + may lead to large-scale + +On line 9508: + re-sales of assets, and + destabilizing, pro-cyclical + feedback eff ects Th + +On line 9510: + to the conversion + of liquidity problems + into solvency + + problems.54 [emphasis + in the original] At least + one study attempted + +On line 9512: + Parisi-Capone estimated + the mark-to-market losses + on MBS backed by both + +On line 9514: + prime loans and NTMs. Th + eir estimate was slightly + over trillion, of which + +On line 9514: + banks and investment + banks were estimated to + have lost billion on + + a mark-to-market + basis.55 Th is would be a + dramatic loss if + +On line 9520: + it were realized. + In the U.S. banking system + had total assets + +On line 9520: + of trillion; the fi + ve largest investment banks had + FCIC Draft Staff Report, + +On line 9524: + Finance, "IIF Board of + Directors - Discussion + Memorandum on + +On line 9526: + Valuation in + Illiquid Markets," April p.1. Nouriel + Roubini and Elisa Parisi-Carbone, + +On line 9526: + Projected Loan and + Securities Losses in + U.S. Trillion of Which + +On line 9532: + Banks/Brokers," RGE Monitor, + January p.8. Peter J. + Wallison total + +On line 9532: + of trillion.56 If we + assume that the banks had a + leverage ratio of + +On line 9532: + 30-to-1, that would mean that + the equity capital + position of the + +On line 9532: + industry as a + whole would be about billion and + the same number for + +On line 9532: + the investment banks + would be about billion, for a + total of billion. + +On line 9534: + of the PMBS market + alone reduced the capital + positions of U.S. + +On line 9536: + a mark-to-market + basis. Th is does not mean + that any actual + +On line 9536: + were suff ered, only + that the assets concerned might + have to be written + + down or could not be + sold for the price at which they + were previously + +On line 9538: + fi rm’s balance sheet. + In addition, Roubini and + Parisi-Capone estimated + +On line 9538: + loss of billion on + unsecuritized subprime + and Alt-A mortgages.57 Th + +On line 9542: + market losses for + fi nancial institutions + outside the U.S. would + +On line 9542: + about percent of U.S. + losses, so there was likely + to be a major + +On line 9542: + banks and other fi + nancial institutions around + the world—depending, + +On line 9542: + at the time the PMBS + market stopped functioning. I + am not aware of any + + data showing the + mark-to-market eff ect of + the collapse of the + +On line 9542: + on other U.S. fi + nancial institutions, but + it can be assumed + + that they also suff + ered similar losses in + proportion to their + +On line 9544: + PMBS. Losses of this + magnitude would certainly + be enough—when combined + + with other losses + on securities and loans + not related to + + mortgages—to call into + question the stability + of a large number + + of banks, investment + banks and other fi nancial + institutions in + + the U.S. and around the + world. However, there was one + other factor that + + exacerbated + the adverse eff ect of the + loss of a market + +On line 9546: + Although accounting + rules did not require all PMBS + to be written down, + +On line 9546: + and counterparties + did not know which fi nancial + institutions were + + holding the weakest + assets and how much of their + assets would have to + +On line 9546: + it would reduce their + capital positions at + a time when investors + +On line 9548: + were anxious about their + stability. Th is was + the balance sheet eff + +On line 9550: + the third element + of Chairman Bair’s summary. + To summarize, then, + +On line 9550: + which the government’s + housing policies transmitted + losses—through PMBS—to the + +On line 9550: + institutions: (i) + the million NTMs acquired or + guaranteed by the + + Agencies were major + contributors to the growth + of the bubble and + +On line 9550: + extension in time; + (ii) the growth of the bubble + suppressed the losses + +On line 9550: + ordinarily + have brought the development + of NTM-backed PMBS to a + +On line 9550: + competition for + NTMs drove subprime lenders further + out the risk curve to + + fi nd high-yielding + mortgages to securitize, + especially when + +On line 9550: + loans did not appear + to be producing losses + commensurate with + +On line 9550: + the unprecedented + number of delinquencies and + defaults among all NTMs—the + +On line 9550: + majority of + which were held or guaranteed + by the Agencies—caused + +On line 9550: + to Timothy F. + Geithner, "Reducing + Systemic Risk in a + +On line 9550: + Financial System," + Remarks at the Economic + Club of New York, June + +On line 9560: + Projected Loan and + Securities Losses," p.7. + Dissenting Statement + +On line 9562: + accounting required + these institutions to write + down the value of + +On line 9562: + they held, as well as + their other mortgage-related + assets, reducing + +On line 9564: + their stability + and solvency. Government + Actions Create a + + Panic More than any + other phenomenon, the + fi nancial crisis + +On line 9566: + creditor panic. + In the classic study, Manias, + Panics and Crashes: + +On line 9566: + Financial Crises, Charles + Kindleberger and Robert Aliber + make a distinction + + between a remote + cause and a proximate cause + of a panic: "Causa + +On line 9566: + of any crisis is + the expansion of credit + and speculation, + + while causa proxima + is some incident that saps + the confi dence of + +On line 9566: + system and induces + investors to sell commodities, + stocks, real estate, + + bills of exchange, or + promissory notes and increase + their money holdings."58 + +On line 9566: + fi nancial panic + of it is reasonably clear + that the remote cause + + was the build-up of NTMs + in the fi nancial system, + primarily— as + + I have shown in this + analysis—as a result of + government housing + + policy. Th is + unprecedented increase in + weak and risky assets + + set the fi nancial + system up for a crisis + of some kind. Th e + +On line 9572: + into a full-fl + edged panic—the proximate + cause of the panic—was + +On line 9572: + action: the rescue + of Bear Stearns in March and the + subsequent failure + +On line 9572: + rescue Lehman Brothers + six months later. In terms of + its ultimate cost + +On line 9572: + the public, this was + one of the great policy + errors of all time, + + and the reasons for + the misjudgments that led to + it have not yet been + +On line 9576: + e lesson taught by + the rescue of Bear was that + all large fi nancial + +On line 9578: + rescued. Th e moral + hazard introduced by this + one act irreparably + + changed the position + of Lehman Brothers and every + other large fi rm + +On line 9578: + the world’s fi nancial + system. From that time forward, + (i) the critical + +On line 9578: + for more capital + became less critical; the + likelihood of a + + government bailout would + reassure creditors, so + there was no need to + +On line 9578: + further by raising + additional capital; + (ii) fi rms such as + + Lehman, that might have been + saved through an acquisition + by a larger fi + +On line 9578: + or an infusion + of fresh capital by a + strategic investor, drove + +On line 9578: + themselves waited for + the U.S. government to pick + up some of the cost, + +On line 9578: + it had with Bear—an + off er that never came in + Lehman’s case; and (iv) the + +On line 9578: + fund, apparently + assuming that Lehman would be + rescued, decided + +On line 9578: + it held; instead, with + devastating results for + the money market + + fund industry, it + waited to be bailed out on + the assumption that + +On line 9580: + be saved. But Lehman was + not saved, and its creditors + were not bailed out. At + +On line 9580: + large mark-to-market + losses among U.S. fi nancial + fi rms raised questions + +On line 9580: + institutions were + insolvent or unstable, + the demise of Lehman was + + a major shock. It + overturned all the rational + expectations about + +On line 9580: + government Charles P. + Kindleberger and Robert Aliber, + Manias, Panics, and + +On line 9580: + A History of + Financial Crises, 5th edition, + John Wiley Sons, Inc., + +On line 9586: + Wallison policies + that market participants + had developed aft + + er the Bear rescue. + With no certainty about who + was strong or who was + +On line 9586: + to U.S. government + securities. Banks—afraid that their + counterparties would + +On line 9586: + of their investments + or their corporate customers + would draw on lines of + + credit—began to + hoard cash. Banks wouldn’t lend to + other banks, even overnight. + +On line 9588: + Bair suggested, that + was the fi nancial crisis. + Everything aft er + +On line 9592: + simply cleaning up + the mess. Th is analysis + lays the principal + +On line 9592: + the unprecedented + number of NTMs that were brought + into the U.S. fi + +On line 9594: + government housing + policy. Th ese weak and + high risk loans helped to + +On line 9596: + the bubble, and when + the bubble defl ated + they defaulted in + +On line 9598: + losses in the PMBS + that were held by fi nancial + institutions in + +On line 9602: + stability. Th + e accumulation of + million subprime and + + Alt-A mortgages was not + a random event, or even the + result of major + + forces such as global + fi nancial imbalances or + excessively low + +On line 9602: + rates. Instead, these loans + and the bubble to which they + contributed were the + +On line 9606: + standards so that more + people could buy homes. While this + process was going on, + + everyone was pleased. + Homeownership in the U.S. + actually grew + +On line 9606: + But the result was + a fi nancial catastrophe + from which the U.S. has + +On line 9616: + still not recovered. + Dissenting Statement III. THE + U.S. GOVERNMENT’S ROLE + +On line 9624: + FOSTERING THE GROWTH + OF THE NTM MARKET Th e + preceding section + + of this dissenting + statement described the damage + that was done to the + +On line 9624: + number of defaults + and delinquencies that occurred + among the million NTMs + +On line 9624: + that were present there in + Given the damage they caused, + the most important + + question about the fi + nancial crisis is why so + many low quality + +On line 9624: + Another way to + state this question is to ask + why mortgage standards + +On line 9624: + so substantially + before and during the 1997-2007 + bubble, allowing + + so many NTMs to be + created. Th is massive + and unprecedented + +On line 9628: + standards had to have + a cause—some factor that was + present during the 1990s + +On line 9628: + thereaft er that was + not present in any earlier + period. Part III + +On line 9632: + e conventional + explanation for the fi + nancial crisis is + +On line 9632: + one given by Fed + Chairman Bernanke in the same speech + at Morehouse College + +On line 9634: + the outset of Part + II: Saving infl ows from + abroad can be benefi + +On line 9634: + infl ows invests + them well. Unfortunately, + that was not always + +On line 9634: + some other countries. + Financial institutions + reacted to the + +On line 9634: + of available funds by + competing aggressively + for borrowers, and, + + in the years leading + up to the crisis, credit + to both households and + +On line 9634: + and easy to obtain. + One important consequence + was a housing boom + + in the United States, + a boom that was fueled in + large part by a rapid + +On line 9634: + of this lending was + poorly done, involving, for + example, little + +On line 9636: + ability to make + the monthly payments. Lenders may + have become careless + +On line 9636: + like many people at + the time, expected that house + prices would continue + +On line 9636: + up equity in + their homes--and that credit would + remain easily + +On line 9636: + to refi nance if + necessary. Regulators + did not do enough to + + prevent poor lending, + in part because many of the + worst loans were made by + +On line 9636: + to little or no + federal regulation. + [Emphasis supplied]59 + + In other words, the + liquidity in the world + fi nancial market + +On line 9638: + banks to compete for + borrowers by lowering + their underwriting + +On line 9638: + Unregulated + originators made bad loans. + One has to ask: is + +On line 9638: + plausible that banks + would compete for borrowers + by lowering their + +On line 9640: + been competing for + years. Th at competition + involved off ering + +On line 9640: + most benefi ts to + potential borrowers. It + did not, however, + +On line 9650: + Dissenting Statement + or involve the weakening + of underwriting + +On line 9652: + the traditional + U.S. mortgage—were generally + or year amortizing + +On line 9652: + homebuyers who could + provide a downpayment of + at least 10-to-20 percent + +On line 9652: + had good credit records, + jobs and steady incomes. Because + of its inherent + + quality, this loan + was known as a prime mortgage. + Th ere were subprime + +On line 9656: + subprime lenders, but in + the early 1990s subprime lenders + were generally + + niche players that made + loans to people who could not + get traditional + +On line 9656: + loans; the number of + loans they generated was + relatively small + + and bore higher than + normal interest rates to + compensate for the + + risks of default. In + addition, mortgage bankers and + others relied on + +On line 9656: + insurance for loans + with low downpayments, impaired + credit and high debt + + ratios. Until the + 1990s, these NTMs were never more + than a fraction of + + the total number + of mortgages outstanding. Th + e reason that low + +On line 9658: + not generally + used is simple. Low standards + would result in large + +On line 9658: + mortgages defaulted, + and very few lenders wanted to + hold such mortgages. In + + addition, Fannie + and Freddie were the buyers + for most middle class + +On line 9658: + the United States, and + they were conservative in + their approach. Unless + +On line 9658: + originator made + a traditional mortgage + it was unlikely + +On line 9662: + another secondary + market buyer could be found + for it. Th is is + +On line 9662: + If you produce an + inferior product—whether it’s + a household cleaner, + +On line 9662: + or a loan—people + soon recognize the lack of + quality and you + +On line 9666: + business. Th is was + not the experience with + mortgages, which became + + weaker and riskier + as the 1990s and 2000s progressed. + Why did this happen1 + + In its report, the + Commission majority + seemed to assume that + +On line 9668: + of mortgages controlled + the quality of mortgages. + Much is made in the + +On line 9668: + so-called "originate + to distribute" idea, where an + originator is + + not supposed to care + about the quality of the + mortgages because they + +On line 9672: + be sold off Th e + originator, it is said, + has no "skin in the + +On line 9674: + e motivation + for making poor quality + mortgages in this telling + +On line 9674: + not only on the + origination but in each + of the subsequent + +On line 9678: + upside down. Mortgage + originators could make all + the low quality + + mortgages they wanted, + but they wouldn’t earn a dime + unless there was a + +On line 9682: + e real question, + then, is why there were buyers + for inferior + + mortgages and this, as + it turns out, is the same as + asking why mortgage + +On line 9682: + Professor Raghuram + Rajan notes in Fault Lines, "[A]s + brokers came to know + +On line 9682: + while, the problems were + hidden by growing house prices + and low defaults—easy + +On line 9682: + masked the problems caused + by easy credit—until house + prices stopped rising and + +On line 9684: + fl ood of defaults + burst forth."60 Who were these buyers1 + Table reporting + +On line 9684: + outstanding on June + identifi ed government + agencies and private + + organizations + required by the government + to acquire, hold or + +On line 9684: + securitize NTMs + as responsible for two-thirds + Raghuram G. Rajan, + +On line 9692: + Lines, p.44. Peter J. + Wallison of these mortgages, + about million. Th e + +On line 9694: + the private sector + as the securitizer + of the remaining + +On line 9694: + loans. In other words, + if we are looking for the + buyer of the NTMs + +On line 9694: + being created + by originators at the + local level, the + +On line 9698: + sector certainly + played a role, but it was a + subordinate one. + +On line 9698: + private sector did + was respond to demand—that’s what + the private sector + +On line 9698: + matter. Of its own + volition, it created + a demand that would + +On line 9702: + have been there. Th e + deterioration in + mortgage standards did + +On line 9702: + to the Commission + majority’s apparent + view—because banks and + +On line 9702: + suddenly started + to make defi cient loans; nor + was it because of + +On line 9706: + Fannie and Freddie, + mortgage banks and insured banks + of all kinds into + +On line 9706: + NTMs in order to + meet various government + requirements. Fannie + +On line 9706: + Freddie were subject + to increasingly stringent + aff ordable housing + + requirements; FHA was + tasked with insuring loans to + low-income borrowers + + that would not be made + unless insured; banks and S&Ls + were required by CRA + +On line 9706: + loans to the same group + of borrowers; mortgage bankers + who signed up for the + +On line 9706: + were required to make + the same kind of loans. Profi t + had nothing to do + +On line 9706: + these fi rms; they were + responding to government + direction. Under + +On line 9706: + should be no surprise + that underwriting standards + declined, as all of + +On line 9710: + In testimony + before the House Financial + Services Committee + +On line 9710: + Development, said + in reference to the GSEs: + "Seeing their market + +On line 9712: + share decline [between + and as a result of [a] + change of demand, the + +On line 9712: + made the decision + to widen their focus from safer + prime loans and begin + +On line 9712: + underwriting and + risk management standards along + the way. Th is would + +On line 9716: + companies themselves + –but ultimately also + for the American + +On line 9718: + Earlier, in a + "Report to Congress on the + Root Causes of the + +On line 9720: + Foreclosure Crisis," + in January HUD declared + "Th e serious + + fi nancial troubles + of the GSEs that led to their + being placed into + +On line 9722: + to the fact that the + GSEs were, indeed, overexposed + to unduly risky + + mortgage investments. + However, the evidence + suggests that the GSEs’ + +On line 9724: + or guarantee non-prime + loans was motivated much + more by eff orts to + +On line 9724: + need to satisfy + federal regulators." + [emphasis supplied] + + Finger-pointing in + Washington is endemic + when problems occur, + +On line 9726: + Report to Congress + on the Root Causes of the + Foreclosure Crisis + +On line 9736: + individuals + are constantly trying to + fi nd scapegoats for + +On line 9736: + bad decisions, but + HUD’s eff ort to blame Fannie + and Freddie for the + +On line 9738: + standard for running + from responsibility. + Contrast the statement + +On line 9738: + quoted above with this + statement by HUD in when it + was signifi cantly + +On line 9738: + goals: Lower-income and + minority families + have made major gains + + in access to the + mortgage market in the 1990s. + A variety of + +On line 9738: + including improved + housing aff ordability, + enhanced enforcement + +On line 9738: + more fl exible + mortgage underwriting, and + stepped-up enforcement of + +On line 9738: + observers believe that + one factor behind these gains + has been the improved + +On line 9738: + of Fannie Mae and + Freddie Mac under HUD’s aff + ordable lending goals. + +On line 9738: + increases in the + goals for 2001-03 will encourage + the GSEs to further + +On line 9740: + aff ordable lending.62 + [emphasis supplied] Or this + statement in when HUD + +On line 9740: + again increasing the + aff ordable housing goals for + Fannie and Freddie: + +On line 9742: + of Americans with + less than perfect credit or + who cannot meet some + +On line 9742: + requirements of the + prime market for reasons such + as inadequate + +On line 9742: + documentation, + limited downpayment or + cash reserves, or the + +On line 9742: + to take more cash out + in a refi nancing than + conventional loans + + allow, rely on + subprime lenders for access to + mortgage fi nancing. + +On line 9742: + the GSEs reach deeper + into the subprime market, + more borrowers will + +On line 9744: + liberal mortgage + fi nancing has contributed + to the increase in + + demand for housing. + During the 1990s, lenders have been + encouraged by HUD + +On line 9744: + regulators to + increase lending to low-income + and minority + +On line 9746: + government-sponsored + enterprises (GSE) housing + goals and fair lending + +On line 9746: + strongly encouraged + mortgage brokers and lenders to + market to low-income + +On line 9746: + or simply little + savings for a down payment. + Lenders have responded + +On line 9746: + low down payment loan + products and automated + underwriting, which + + has allowed them to + more carefully determine + the risk of the loan.64 + + [emphasis supplied] + Despite the recent eff ort + by HUD to deny + +On line 9748: + fostering the growth + of subprime and other high + risk mortgage lending, + +On line 9748: + in the early 1990s, + HUD led an ultimately + successful eff ort + +On line 9748: + standards in every + area of the mortgage market + where HUD had or could + +On line 9748: + administration + and extended almost to + the end of the Bush + +On line 9748: + involved FHA, which was + under the direct control + of HUD; Fannie Mae + +On line 9748: + Mac, which were subject + to HUD’s aff ordable housing + regulations; and + +On line 9750: + pursue HUD’s Issue + Brief: HUD’s Aff ordable Housing + Goals for Fannie Mae + +On line 9754: + and Freddie Mac, p.5. + Final Rule, http://fdsys.gpo.gov/fdsys/pkg/FR-2004-11-02/pdf/04-24101.pdf. HUD PDR, May + HUD Contract C-OPC-21895, Task + +On line 9754: + CHI-T0007, "Recent House Price + Trends and Homeownership Aff + ordability", p.85. + +On line 9760: + policies out of fear + that they would be brought under + the Community + +On line 9760: + not subject to HUD’s + jurisdiction, the new tighter + CRA regulations + +On line 9760: + became eff ective + in led to a process in which + community groups + +On line 9760: + obtain commitments + for substantial amounts of CRA-qualifying + mortgages and other + +On line 9762: + subprime borrowers + when banks were applying for + merger approvals.66 By + +On line 9762: + HUD believed it had + achieved the "revolution" it + was looking for: Over + +On line 9762: + past ten years, there has + been a ‘revolution in + aff ordable lending’ + +On line 9764: + historically + underserved households. Fannie + Mae and Freddie Mac + +On line 9764: + a substantial part + of this ‘revolution in + aff ordable lending’. + +On line 9764: + mid-to-late 1990s, they added + fl exibility to + their underwriting + + guidelines, introduced + new low-downpayment products, + and worked to expand + +On line 9764: + evaluating the + creditworthiness of loan + applicants. HMDA + +On line 9764: + to low income and + minority families + increased at much faster + +On line 9768: + nonminority + families.67[emphasis supplied] + Th is turned out to + +On line 9768: + an immense error + of policy. By even the + strongest supporters + +On line 9770: + as enforced by HUD + had recognized their error. + In an interview + +On line 9770: + and previously + the strongest congressional + advocate for aff + +On line 9770: + he had erred: "I hope + by next year we’ll have abolished + Fannie and Freddie + +On line 9770: + was a great mistake + to push lower-income people + into housing they + + couldn’t aff ord and + couldn’t really handle + once they had it." He + +On line 9772: + then added, "I had been + too sanguine about Fannie and + Freddie."68 The Decline + +On line 9776: + Standards Before the + enactment of the GSE Act + in and HUD’s adoption + +On line 9778: + review by Fannie + Mae of loans from October + to January over + +On line 9778: + ratios of percent + or less, while only percent + had LTV ratios of + +On line 9778: + lending was confi + ned primarily to FHA + (which was controlled by + +On line 9780: + who oft en sold the + mortgages they originated + to FHA. What caused these + +On line 9782: + majority, Steve + Cocheo, "Fair-lending pressure builds," ABA + Banking Journal, vol. + +On line 9788: + NCRC, CRA Commitments, + Federal Register,vol. + No. November Rules + +On line 9792: + and Regulations, + p.63585, http://fdsys.gpo. gov/fdsys/pkg/FR-2004-11-02/pdf/04-24101.pdf Larry + Kudlow, "Barney Frank + +On line 9802: + in author’s fi les. + Dissenting Statement echoing + Chairman Bernanke, seems to + +On line 9804: + originators, and + the desire for profi t. Th + e majority’s + +On line 9806: + off ers no other + explanation. However, + there is no diffi + +On line 9808: + of the reductions + in mortgage underwriting + standards for Fannie + + and Freddie, or for + the originators for whom + they were the buyers. + +On line 9810: + cally intended + to reduce underwriting + standards. Th e GSE + +On line 9812: + enabled HUD to put + Fannie and Freddie into + competition with + + FHA, and vice versa, + creating what became a + contest to lower + +On line 9814: + in a report, "FHA + loans constituted the largest + share of Countrywide’s + +On line 9818: + Freddie Mac began + accepting loans with higher + LTVs [loan-to-value + +On line 9820: + underwriting fl + exibilities."70 Under + the GSE Act, the HUD + +On line 9820: + aff ordable housing + goals for Fannie and Freddie. + Congress required that + + these goals include a + low and moderate income + goal and a special + +On line 9820: + ordable goal (discussed + below), both of which could be + adjusted in the + +On line 9820: + to consider in + establishing the goals were + national housing + +On line 9820: + "the ability of + the enterprises [Fannie + and Freddie] to lead + +On line 9824: + Th e Act also + established an interim + aff ordable housing + +On line 9824: + of percent for the + two-year period beginning + January Under + +On line 9824: + of the GSEs’ mortgage + purchases had to be aff + ordable housing loans, + +On line 9826: + to borrowers at + or below the AMI.71 Further, + the Act established + +On line 9828: + aff ordable" goal to + meet the "unaddressed needs of, + and aff ordable to, + + low-income families + in low-income areas and very + low-income families." + +On line 9830: + is category + was defi ned as follows: + "(i) percent shall be + +On line 9830: + low-income families + who live in census tracts in + which the median + +On line 9830: + exceed percent of + the area median income; + and (ii) percent shall + + be mortgages of very + low income families," which + were later defi + +On line 9830: + of AMI.72 Although the + GSE Act initially required + that the GSEs spend on + +On line 9830: + special aff ordable + mortgages "not less than percent + of the dollar amount + +On line 9830: + for the previous + year," HUD raised this requirement + substantially in + +On line 9832: + Ultimately, it + became the most diffi cult + aff ordable housing + +On line 9834: + Fannie and Freddie + to meet. Finally, the GSEs + were directed to: + +On line 9834: + assist primary + lenders to make housing credit + available in areas + +On line 9834: + depository + institutions to meet their + obligations under + +On line 9836: + the Community + Reinvestment Act of Th ere + will be more on the + +On line 9840: + mortgages later in + this section. Congress also + made clear in the act + + that its intention + was to call into question + the high quality + +On line 9840: + guidelines of the time. + It did so by directing + Fannie and Freddie + +On line 9842: + "examine— Fannie + Mae Foundation, "Making New + Markets: Case Study of + +On line 9856: + GSE Act, Section Id., + Section Id., Section Peter + J. Wallison Th + +On line 9858: + mortgages for houses + in mixed-use, urban center, and + predominantly + +On line 9862: + low-and moderate-income + families; Th e standards + employed by private + + mortgage insurers + and the extent to which such + standards inhibit + +On line 9868: + described in paragraph + and Th e implications + of implementing + +On line 9870: + (A) establish a + downpayment requirement for + mortgagors of percent + +On line 9870: + less; (B) allow the + use of cash on hand as a + source of downpayments; + +On line 9870: + borrowers who have + a credit history of + delinquencies if the + +On line 9870: + the 12-month period + ending on the date of the + application for + +On line 9872: + could not fi nd a + record of reports by Fannie + and Freddie required + + under this section + of the act, but it would have + been fairly clear to + + both companies, and + to HUD, what Congress wanted + in asking for these + + studies. Prevailing + underwriting standards were + inhibiting mortgage + + fi nancing for low + and moderate income (LMI) + families, and would + +On line 9872: + be substantially + relaxed in order to meet + the goals of the Act. + +On line 9872: + set out to assure + that downpayment requirements + were substantially + +On line 9872: + (eventually they + reached zero) and past credit + history became + +On line 9872: + much less important + issue when mortgages were made + (permitting subprime + +On line 9874: + to become far more + common). Until HUD enforced + the temporary AH + + goals originally + put in place by the GSE Act. + With the exception + + of the special aff + ordable requirements, which were + small at this point, these + +On line 9874: + were not burdensome. + In the ordinary course of + their business, the GSEs + + seem to have bought enough + mortgages made to borrowers + below the AMI to + +On line 9874: + the percent AH goal. + In however, HUD raised the + LMI goal to percent, + +On line 9874: + to and to percent + for subsequent years. In terms + of its eff ect on + + Fannie and Freddie, + HUD’s most important move at + this time was to set + +On line 9874: + and very low income + borrowers) of percent, which + increased to percent + +On line 9874: + in Eff orts to fi + nd loans to low or very low + income borrowers + +On line 9874: + percent and percent + of AMI, respectively) that + did not involve high + +On line 9878: + would prove diffi cult. + As early as November + even before the eff + + ect of these new and + higher goals, Fannie’s staff had + already recognized + +On line 9878: + Homebuyer Program + (CHBP), which featured a percent + loan-to-value (LTV) + +On line 9878: + signifi cant rates of + serious delinquency that + exceeded Fannie’s + +On line 9878: + expected rates by + 26percent in origination + year percent in and + +On line 9880: + its eff orts to erode + underwriting standards in + order to increase + +On line 9882: + entitled "Th e + National Homeownership + Strategy: Partners + +On line 9884: + American Dream." Th + e Strategy was prepared + by HUD, "under the + +On line 9886: + Secretary Henry + G. Cisneros, in response Id., + Section 1354(a). Fannie + +On line 9886: + Mae, "Opening Doors with + Fannie Mae’s Community + Lending Products," p.3. + +On line 9888: + Fannie Mae, Memo from + Credit Policy Staff to + Credit Policy + +On line 9898: + to a request from + President Clinton."77 Th e + fi rst paragraph of + +On line 9902: + e purpose of the + National Homeownership + Strategy is to + +On line 9904: + housing industry + organizations." Th e + Strategy paper + +On line 9904: + representatives + agreed to the formation of + working groups to help + +On line 9904: + clear that one of its + purposes was to increase + homeownership by + +On line 9904: + mortgage insurers, + and other members of the + partnership should work + +On line 9904: + fi nancing with high + loan-to-value ratios should + generally be + +On line 9904: + enhanced homebuyer + counseling and, where available, + supplemental sources + +On line 9904: + According to a + HUD summary, the purpose + of the Strategy + +On line 9906: + It continued: Th + e inability (either + real or perceived) + +On line 9906: + recognized as a + very serious barrier + to homeownership. + +On line 9910: + to a number of + initiatives designed to: Cut + transaction costs through + +On line 9914: + Reduce downpayment + requirements and interest + costs by making terms + +On line 9914: + and moderate-income + families, and creating + incentives to save + + for homeownership. + Increase the availability + of alternative + +On line 9916: + nancing products in + housing markets throughout the + country.80 [emphasis + +On line 9918: + and the National + Homeownership Strategy, + are especially + +On line 9918: + Table below, based + on a large sample of loans + from the 1990s, shows the + +On line 9918: + particularly + instructive to note that when + low downpayments (i.e., + + high LTVs) are combined + with low FICO scores (subprime + loans) the expected + +On line 9918: + For example, when + a loan with a FICO score + below is combined + +On line 9918: + with a downpayment + of fi ve percent, the risk + of default is times + +On line 9922: + it would be if the + downpayment were percent. HUD, + "Th e National + +On line 9930: + Chapter Action Th + e term "fl exible" has + a special meaning + +On line 9932: + it. See note supra. HUD, + Urban Policy Brief No.2, + August available at + +On line 9942: + hdbrf2.txt. Peter J. + Wallison Table High LTVs + enhance the risk of + +On line 9960: + Column Row FICO + Score LTV 71-80% LTV 81-90% LTV 91-95% + LTV Relation of + +On line 10022: + Column to Column + Row times Row 620-679 times Row 680-720 + times Row times Despite + +On line 10022: + requirements imposed + by the private sector as + one of the keys to + + the success of its + strategy to increase home + ownership through the + +On line 10022: + it had established + with the mortgage fi nancing + community: "Th + +On line 10030: + access to suffi + cient funds for a downpayment. + While members of the + +On line 10030: + already made signifi + cant strides in reducing this + barrier to home + +On line 10030: + purchase, more must be + done. In only percent of + home mortgages were made + +On line 10030: + with less than percent + downpayment. By August low + downpayment mortgage + +On line 10032: + loans had increased to + percent."82 [emphasis supplied] + HUD’s policy was + +On line 10032: + highly successful + in achieving the goals it sought. + In only one in + +On line 10032: + homebuyers bought a + home with a downpayment of + percent or less, but + +On line 10032: + by one in seven + buyers was providing a + downpayment at that + +On line 10032: + by the number was + less than one in three. Th e + gradual increase + +On line 10034: + LTVs and CLTVs (fi rst + and second loans combined to + produce a lower + +On line 10034: + under HUD’s policies + is shown in Figure Note the + date when HUD began + + to have some infl + uence over the downpayments that + the GSEs would accept. + +On line 10038: + increased its high LTV + (low downpayment) lending is + clearly described in + +On line 10040: + presentation to + HUD assistant secretary + Albert Trevino on + +On line 10040: + January "Analyses + of the market demonstrate the + greatest barrier + +On line 10040: + home ownership for + most renters are related to + wealth—the lack of money + +On line 10042: + grown considerably. + It is a key part of our + strategy to serve + +On line 10044: + and minority + borrowers." Th e fi gure + that accompanied + +On line 10046: + showed that Fannie’s home + purchase loans over percent LTV + had increased from one + +On line 10048: + in to percent in + "Deconstructing the Subprime + Debacle Using + +On line 10048: + of Underwriting + Quality and Economic + Conditions: A First + +On line 10056: + and America’s + Homebuyers," Presentation + to HUD Assistant + +On line 10068: + Percentage of Home + Purchase Volume with an LTV + or CLTV (Includes FHA + +On line 10070: + Combined Foreclosure + Start Rate for Conventional + and Government Loans + +On line 10072: + *Fannie‘s percentage + of home purchase loans with an + LTV or CLTV used as + +On line 10074: + conventional loans. + Sources: FHA Actuarial + Study, and HUD"s Offi + + ce of Policy + Development and Research + - Profi les of GSE + +On line 10080: + and in 2001-2004, and in + 2005-2007, and Fannie’s 10-K. Compiled + by Edward Pinto. + +On line 10084: + low downpayments and + delinquencies and defaults on + mortgages is shown in + +On line 10084: + compares the increase + in percent (or greater) CLTV or + LTV mortgages to the + +On line 10084: + in the foreclosure + start rate on all loans published + by the Mortgage Bankers + +On line 10088: + Delinquency Survey, + FHA Actuarial Study, + and HUD s Offi + + ce of Policy + Development and Research + - Profi les of GSE + +On line 10092: + and in 2001-2004, and in + 2005-2007, SMR’s "Piggyback Mortgage + Lending," and Fannie’s + +On line 10092: + used as the proxy on + the conventional market. + Compiled by Edward + +On line 10100: + Pinto. Peter J. + Wallison In HUD also + ruled that Fannie and + + Freddie could get AH + credit for buying PMBS that + were backed by loans to + +On line 10102: + lenders to create pools + of subprime mortgages that were + likely to be AH + +On line 10106: + ese were then sold through + Wall Street underwriters to + Fannie and Freddie, + +On line 10110: + which became the largest + buyers of these high risk PMBS + between and Th ese + +On line 10110: + pools were not bought for + profi t. As Adolfo Marzol, + Fannie’s Chief Credit + +On line 10112: + Offi cer, noted + to Fannie CEO Dan Mudd in + a memorandum, + +On line 10112: + "large private label + [PMBS] volumes were necessary + to achieve challenging + +On line 10114: + goals."86 Th ere is a + strong possibility that + by creating a + + market for PMBS backed + by NTMs Fannie and Freddie + enabled Wall Street—which had + +On line 10114: + securitizing + prime jumbo loans—to get its start + in developing + +On line 10116: + PMBS based on NTMs. HUD + pursued these policies throughout + the balance of the + +On line 10116: + Bush. Ultimately, + they would lead to the mortgage + meltdown in as vast + +On line 10116: + mortgages with low or + no downpayments and other + non-traditional + +On line 10116: + features suff used the + fi nancial system. But in + June, the dangers in + + HUD’s policies were not + recognized. As President + Clinton said in a + +On line 10116: + It will not require + legislation. It will not + add more federal + + programs or grow the + Federal bureaucracy."87 + Th e lesson here + +On line 10118: + the government can + accomplish a lot of its + goals without growing, + + as long as it has + the power to enlist the + private sector. Th + +On line 10122: + not mean, however, + as we have all now learned, that + the taxpayers will + + not ultimately + be faced with the costs. Th e + next signifi cant move + + in the AH goals was + made under HUD Secretary + Andrew Cuomo, and + +On line 10126: + it was a major + step. On July HUD issued + a press release with + +On line 10126: + the heading "Cuomo + Announces Action to Provide + trillion in Mortgages + +On line 10126: + Aff ordable Housing + for Million Families."88 Th + e release began: + +On line 10128: + the nation’s two largest + housing fi nance companies + to buy trillion in + +On line 10128: + over the next years to + provide aff ordable housing + for about million low-and + +On line 10132: + families." Th is + was followed by a quote from + President Clinton + +On line 10132: + the importance of + the initiative: "During the + last six and a half + +On line 10132: + and making housing + more aff ordable for all Americans…Today, + the homeownership + +On line 10134: + their homes. Today, we + take another signifi cant + step." Th e release + +On line 10134: + out that the AH goals + would be substantially raised + and that "[u]nder the + + higher goals, Fannie + Mae and Freddie Mac will buy + an additional + +On line 10134: + billion in mortgages + that will be used to provide + aff ordable housing + +On line 10134: + for million more low-and + moderate-income families + over the next years. Th + +On line 10138: + and families are + over and above the trillion in + mortgages for http://www.washingtonpost.com/wp-dyn/content/article/2008/06/09/AR2008060902626.html. See + +On line 10140: + Mae, internal memo, + Adolfo Marzol to Dan Mudd, + "RE: Private Label + +On line 10144: + on the National + Homeownership Strategy, + June HUD Press Release, + +On line 10152: + HUD No. 99-131, July + Dissenting Statement million + families that would + +On line 10154: + the current goals had + been retained." Th e release + also noted that + + "Fannie Mae Chairman + Franklin D. Raines joined Cuomo at + the news conference + +On line 10156: + the HUD action. Raines + committed Fannie Mae to + reaching HUD’s increased + +On line 10160: + substantial increase + in the AH goals was expressed + in HUD’s discussion + + of the rule-making: + "To fulfi ll the intent + of [the GSE Act], the + +On line 10160: + lead the industry + in ensuring that access + to mortgage credit + +On line 10160: + for very low-, low- and + moderate-income families + and residents of + +On line 10160: + recognizes that, to + lead the mortgage industry + over time, the GSEs will + + have to stretch to reach + certain goals and close the gap + between the secondary + +On line 10164: + is consistent with + Congress’ recognition that ‘the + enterprises will + +On line 10170: + to stretch their eff orts + to achieve’ the goals."89 [emphasis + supplied] Th e new + +On line 10170: + AH goals announced in + were not fi nally issued + until October + +On line 10172: + Th eir specifi cs + were stunning and drove Fannie + and Freddie into + +On line 10174: + far more challenging + era. Th e basic goal, an + LMI requirement of + +On line 10176: + percent, was raised to + percent, and the special aff + ordable goal was raised + +On line 10176: + percent to percent. + As a result, percent of + the increase in goals + +On line 10176: + the low-and very-low income + category—where the risks + were the greatest. A + +On line 10180: + HUD memo summarized + the new rules:90 For each year from + through the goals are: Low- + +On line 10180: + and moderate-income + goal. At least percent of the + dwelling units fi nanced by + +On line 10180: + mortgage purchases + should be for families with + incomes no greater than + +On line 10180: + (AMI), defi ned as + median income for the + metropolitan + +On line 10182: + nonmetropolitan county. + Th e corresponding goal + was percent for 1997-2000. + +On line 10184: + Special aff ordable + goal. At least percent of the + dwelling units fi nanced by + +On line 10184: + purchases should be + for very low-income families + (those with incomes no + +On line 10184: + than percent of AMI) + or for low-income families + (those with incomes no + +On line 10184: + greater than percent of + LMI) in low-income areas. Th + e corresponding + +On line 10188: + goal was percent for + 1997-2000. Underserved areas goal. + At least percent of + +On line 10188: + fi nanced by each GSE’s + mortgage purchases should be + for units located + +On line 10188: + underserved areas. + Research by HUD and others + has demonstrated that + +On line 10188: + high-minority + census tracts have high mortgage + denial rates and low + +On line 10188: + origination rates, + and this forms the basis for + HUD’s defi nition + +On line 10190: + underserved areas. + Th e corresponding goal + was percent for 1997-2000. + +On line 10192: + stimulated strong + interest at the GSEs for + CRA loans, substantial + +On line 10194: + which were likely to + be goals-qualifying. Th + is is evident + +On line 10200: + HUD, Offi ce of + Policy Development + and Research, Issue + +On line 10208: + No. January p.3. + Peter J. Wallison just + aft er HUD announced + + the latest increase + in the AH goals for the GSEs: + Your CRA business is + +On line 10208: + done nearly billion + in specially targeted + CRA business—all with + + depositories + like yours. But that is just the + beginning. Before + +On line 10208: + decade is over, Fannie + Mae is committed to fi + nance over billion in + +On line 10210: + and over billion in + CRA business altogether… + We want your CRA loans + +On line 10210: + they help us meet our + housing goals… We will buy them + from your portfolios, + +On line 10210: + purchase CRA mortgages + you make right at the point of + origination... You + + can originate CRA + loans for our purchase with one + of our CRA-friendly products, + +On line 10210: + down Fannie Or we + have special community + lending products with + +On line 10214: + "CRA your way".91 Th e + percent level in the new + HUD regulations + + was a turning point. + Fannie and Freddie had to + stretch a bit to reach + +On line 10214: + previous goal of + percent, but percent was a + signifi cant challenge. + +On line 10214: + Fannie Mae’s mission + regulator, HUD, imposed + ever-higher housing + +On line 10218: + were very diffi cult + to meet during my tenure + as CEO [2005-2008]. Th e + +On line 10220: + deal of time, resources, + energy, and personnel + were dedicated + +On line 10220: + fi nding ways to + meet these goals. HUD increased the + goals aggressively + +On line 10220: + over time to the point + where they exceeded the mark, + requiring Fannie + +On line 10220: + purchasing loans to + underserved areas. Fannie + Mae had to devote + +On line 10220: + great deal of resources + to running its business to + satisfy HUD’s goals + + and subgoals.92 Mudd’s + point can be illustrated + with simple arithmetic. + +On line 10222: + had to acquire a + goal-qualifying loan. Although + about percent of prime + + loans were likely to + be goal-qualifying in any + event (because they were + +On line 10222: + borrowers at or + below the applicable + AMI), most prime loans were + +On line 10224: + Subprime and other + NTM loans were goals-rich, but not + every such loan was + +On line 10224: + Accordingly, in + order to meet a percent + goal, the GSEs had to + +On line 10224: + ever larger amounts + of goals-rich NTMs in order + to acquire suffi + +On line 10230: + loans. Th us, in a + presentation to HUD in + Fannie argued that + +On line 10230: + goal (which was under + consideration by HUD + at the time) it would + +On line 10230: + acquire percent more + subprime loans than the goal in + order to capture + +On line 10230: + with the special aff + ordable category at + percent in the GSEs + +On line 10230: + numbers of NTM loans + from borrowers who were at + or below percent + + of the AMI. Th is + requirement drove Fannie and + Freddie even further + +On line 10234: + risk territory + in search of loans that would meet + this subgoal. Jamie S. + +On line 10238: + Presented in the + FCIC’s June letter, Answer to + Question How infl + + uential were HUD’s aff + ordable housing guidelines in + Fannie Mae’s purchase + +On line 10238: + subprime and Alt-A loans1 + Were Alt-A loans "goals-rich"1 Were Alt-A + loans net positive + +On line 10248: + development, June + Dissenting Statement Most of + what was going on + + here was under the + radar, even for specialists in + the housing fi nance + +On line 10250: + paper published in + fi nancial analyst Josh + Rosner recognized + +On line 10250: + standards although he + did not recognize how many + loans were subject to + +On line 10250: + past decade Fannie Mae + and Freddie Mac have reduced + required down payments + +On line 10252: + loans that they purchase + in the secondary market. Th + ose requirements have + +On line 10252: + from to to and in + the past few months Fannie Mae + announced that it would + +On line 10252: + market. Although they + are buying low down payment + loans, those loans must be + + insured with ‘private + mortgage insurance’ (PMI). On + homes with PMI, even the + +On line 10254: + can now be borrowed + through unsecured loans, gift s + or subsidies. Th + +On line 10256: + not only can the + buyer put zero dollars + down to purchase a + + new house but also + that the mortgage can fi nance + the closing costs…. [I]t + +On line 10258: + a large portion of + the housing sector’s growth in + the 1990’s came from the + +On line 10262: + to greater leverage has + the potential to become + a vicious cycle + +On line 10266: + Th e last increase + in the AH goals occurred in + when HUD raised the LMI + +On line 10266: + goal to percent for + percent for percent for and + percent for Again, the + +On line 10266: + special aff ordable + category outstripped the + general LMI goal, + +On line 10268: + Freddie to acquire + additional risky NTMs. Th + is category + +On line 10270: + to percent over the + period. In the release + that accompanied + +On line 10274: + HUD declared: Millions + of Americans with less than + perfect credit or + + who cannot meet some + of the tougher underwriting + requirements of the + +On line 10274: + documentation, + limited downpayment or + cash reserves, or the + +On line 10274: + to take more cash out + in a refi nancing than + conventional loans + + allow, rely on + subprime lenders for access to + mortgage fi nancing. + +On line 10274: + the GSEs reach deeper + into the subprime market, + more borrowers will + +On line 10274: + greater stability + and standardization create.96 + [emphasis supplied] + +On line 10276: + indeed reach deeper + into the subprime market, + confi rming in + +On line 10276: + March presentation + to HUD, "Higher goals force us + deeper into FHA + +On line 10276: + Mae’s acquisitions + of goal-qualifying loans (which + were primarily + +On line 10276: + Alt-A) increased (i) for + very low income borrowers + from percent of their + +On line 10276: + special aff ordable + borrowers from percent in + to percent in and + +On line 10276: + includes the other + two categories) from percent + in to percent in + +On line 10278: + New Millennium: + A Home Without Equity + is Just a Rental With + +On line 10290: + p.29. http://fdsys.gpo.gov/fdsys/pkg/FR-2004-11-02/pdf/04-24101.pdf, p.63601. Fannie + Mae, "Th e HUD Housing Goals", + March HUD, Offi ce + +On line 10294: + Research, Profi les of + GSE Mortgage Purchases, 1992-2000, + 2001-2004, and 2005-2007. Peter + +On line 10302: + Fannie and Freddie + were suffi ciently in need + of subprime loans to + + meet the AH goals that + their CEOs, as the following + account shows, went to + +On line 10302: + meeting of mortgage + bankers to ask for more subprime + loan production: Th + +On line 10304: + top executives + of Freddie Mac and Fannie + Mae [Richard Syron and + +On line 10304: + made no bones about their + interest in buying loans + made to borrowers + +On line 10304: + province of nonprime + and other niche lenders. …Fannie + Mae Chairman and [CEO] + +On line 10304: + San Francisco that + his company’s lender-customers + ‘need to learn the best + +On line 10304: + the subprime market + and bring the best from the prime + market into [the + + subprime market].’ He + off ered praise for nonprime lenders + that, he said, ‘are some + + of the best marketers + in fi nancial services.’… We + have to push products + +On line 10304: + opportunities + to people who have lesser + credit quality," + +On line 10306: + he said.99 [emphasis + supplied] Accordingly, by + when HUD put new and + + tougher AH goals into + eff ect, Fannie and Freddie + were using every + +On line 10306: + the goals, including + subprime loans, Alt-A loans and the + purchase of PMBS. Some + +On line 10306: + majority, have + claimed that the GSEs bought NTM loans + and PMBS for profi t—that + +On line 10306: + instruments did not + assist Fannie and Freddie + in meeting the AH + +On line 10306: + therefore must have been + acquired because they were profi + table. However, + +On line 10306: + data in Table + furnished to the Commission + by Fannie Mae shows + +On line 10306: + categories of NTMs—subprime + loans (i.e., loans to borrowers + with FICO scores less + +On line 10306: + than Alt-A loans and PMBS + (called PLS for "Private Label + Securities" in + + the table)— fulfi + lled the AH goals or subgoals + for the years and in + +On line 10310: + goal.) Table also + shows, signifi cantly, that the + gradual increase + +On line 10310: + NTMs closely followed + the gradual increase in + the goals between and + +On line 10312: + Neil Morse, "Looking for + New Customers," Mortgage Banking, + December It may + + be signifi cant that + the chairman of Freddie Mac + at the time, Leland + +On line 10312: + not attend the press + conference or pledge support + for HUD’s new goals. Raines + +On line 10312: + have forgotten his + pledge to Secretary Cuomo + and his speech to the + + mortgage bankers when he + wrote in a letter to Th + e Wall Street Journal + +On line 10316: + fi nancial collapse + of Fannie and Freddie are + pretty clear and a + +On line 10318: + of public record. Th + e company managers, their + regulator and + +On line 10318: + Treasury have all said + that the losses which crippled + the companies were + +On line 10318: + caused by the purchase + of loans with lower credit + standards between and + +On line 10320: + credit standards in + order to regain market + share aft er Wall Street + +On line 10324: + credit standards in + Dissenting Statement Table + Nontraditional + +On line 10328: + Mortgages and the Aff + ordable Housing Goals Year Low + Moderate Special + +On line 10340: + ordable Underserved + Income Base Goal Base Goal Base + Goal Actual* Goal + +On line 10534: + Goal Actual* Goal + Credit Score Originations + Alt-A Originations + +On line 10752: + Backed by Subprime of + unit fi nanced that qualifi + ed for base goals. Not + +On line 10754: + housing goals scoring + in Table also shows that + ordinary subprime + + loans, Alt-A loans and PMBS + backed by subprime loans were not + always suffi cient + +On line 10760: + meet the AH goals. For + Fannie Mae, disk produced for + FCIC, April Th roughout + +On line 10762: + I have not discussed + the GSEs’ compliance with the + "Underserved Base Goal," + +On line 10764: + Goal applied mostly + to minorities and involved + a diff erent set + +On line 10768: + decisions than the + LMI goal and the Special Aff + ordable Goal. Peter + +On line 10770: + J. Wallison this + reason, Fannie developed + special categories + +On line 10770: + to supplement what + they were getting from higher + quality NTMs. Th + +On line 10774: + My Community + Mortgage (MCM) and Expanded + Approval (EA). In many + +On line 10774: + these two categories + enabled Fannie to meet the + AH goals, but at the + +On line 10774: + higher delinquency + rates than occurred among higher + quality NTMs they + +On line 10774: + progressed and the AH + goals increased, Fannie had to + acquire increasing + +On line 10774: + in these categories, + and as shown in Table these + increasing numbers + +On line 10776: + Loans Produced Higher + Delinquency Rates at Fannie + Mae Goals by Vintage + +On line 10800: + Rate Prior EA/MCM + Housing Goals EA/MCM Housing + Goals EA/MCM Housing + +On line 10814: + EA/MCM Housing Goals + Just how desperate Fannie + and Freddie were to + +On line 10814: + AH goals is revealed + by Fannie’s behavior in + As reported in + +On line 10816: + the American Banker + on May "A House Financial + Services Committee + +On line 10818: + shared with lawmakers + Th ursday accused Fannie + Mae and Freddie Mac + +On line 10818: + several years in + a series of dubious + transactions to meet + +On line 10820: + e report cited + several large transactions + entered into by + +On line 10820: + under which sellers + were allowed to repurchase + loans without recourse. + +On line 10820: + example, it said + that in September Fannie + bought the option to + +On line 10820: + up to billion of + multifamily mortgage + loans from Washington + +On line 10820: + million, the report + said. Under the agreement, the + GSE permitted WaMu + +On line 10822: + the loans…’ Th is was + the largest multifamily + transaction ever + +On line 10822: + by Fannie Mae and + was critical for Fannie + Mae to reach the aff + +On line 10824: + of what happened here + is contained in WaMu’s 10-K for + Freddie had engaged + +On line 10824: + in a similar + but larger transaction with + WaMu in reported + +On line 10824: + income increased in + compared with partially due + to fees paid to the + +On line 10824: + the Federal Home + Loan Mortgage Corporation + ("FHLMC" or Freddie Mac"). + +On line 10828: + Company received + million in nonrefundable + fees to induce the + +On line 10828: + of the benefi cial + interest in those loans in + the form of mortgage-backed + +On line 10828: + issued by Freddie + Mac. Since the Company has + the unilateral + + right to collapse the + securities aft er one + year, the Company + + has eff ectively + retained control over the loans. + Accordingly, the + + assets continue + to be accounted for and + reported as loans. + +On line 10830: + is transaction was + undertaken by Freddie + Mac in order to + +On line 10830: + fulfi lling its aff + ordable housing goals as set + by the Department + +On line 10832: + and Freddie were both + paying holders of mortgages + to temporarily + +On line 10832: + to them possession + of goal-qualifying loans that + the GSEs could use to + +On line 10832: + satisfy the AH + goals for the year Aft er the + end of the year, the + +On line 10834: + to House Financial + Services Committee, April Rob + Blackwell, "Two GSEs Cut + +On line 10840: + Corners to Hit Goals, + Report Says," American Banker, + May p.1. Dissenting + + Statement absolute + right to reacquire these loans. Th + ere can be little + +On line 10846: + early as Fannie + and Freddie were under so + much pressure to fi + +On line 10846: + that they needed to + meet their aff ordable housing + obligations that they + +On line 10848: + substantial sums to + window-dress their reports to + HUD. The Affordable + +On line 10852: + were the Sole Reason + That the GSEs’ Acquired So Many + NTMs Up to this point, + +On line 10852: + HUD’s policy was + to reduce underwriting + standards in order + +On line 10852: + make mortgage credit + more readily available to + low-income borrowers, + +On line 10852: + Fannie and Freddie + not only took the AH goals + seriously but + + were willing to go + to extraordinary lengths + to make sure that they + +On line 10854: + them. Nevertheless, + it seems to have become an + accepted idea in + +On line 10856: + including in the + Commission majority’s + report—that Fannie + +On line 10856: + and Freddie bought large + numbers of subprime and Alt-A + loans between and in + +On line 10856: + to recover the + market share they had lost to + subprime lenders such as + +On line 10856: + ts. Although there is + no evidence whatever + for this belief—and a + +On line 10856: + of evidence to + the contrary—it has become + another urban + +On line 10856: + repeated so oft + en in books, blogs and other + media that it has + +On line 10860: + of reality.103 + Th e formulations of + the idea vary a bit. + +On line 10862: + earlier, HUD has + claimed— absurdly, in light of + its earlier eff + +On line 10864: + to reduce mortgage + underwriting standards— that + the GSEs were "chasing + +On line 10864: + nonprime market" or + "chasing market share and profi + ts," principally + +On line 10868: + this is another + example of private greed + doing harm, but it + +On line 10870: + trying to evade its + own culpability for + using the AH goals + +On line 10872: + between and Th e + Commission majority + also adopted a + + version of this idea + in its report, blaming the + GSEs’ loosening of + +On line 10872: + on a desire to + please stock market analysts + and investors, as well + +On line 10872: + increase management + compensation. None of HUD’s + statements about its eff + +On line 10872: + make it into the + Commission majority’s + report, which relied + +On line 10872: + on the idea that the + GSEs’ underwriting standards + were reduced by their + + desire to "follow + Wall Street and other lenders in + [the] rush for fool’s gold." + + Th ese claims place the + blame for Fannie and Freddie’s + insolvency—and the + +On line 10874: + the U.S. fi nancial + system immediately + prior to the fi + +On line 10876: + rms’ managements. Th + ey absolve the government, + particularly + +On line 10880: + e GSEs’ managements + made plenty of mistakes—and + won’t be defended + + here—but taking risks + to compete for market share + was not something they + +On line 10880: + did. Because of the + AH goals, Fannie and See, e.g., + Barry Ritholtz, "Get Me + +On line 10880: + Nation, Bailouts, Credit, + Real Estate, Really, + Really Bad Calls, + +On line 10880: + Believe that Fannie + and Freddie Caused the Crash" Beat + the Press Blog, Center + +On line 10892: + Wallison Freddie + were major buyers of NTMs + well before Wall Street + +On line 10892: + rms and the subprime + lenders who came to dominate + the business entered + +On line 10892: + PMBS market in any + signifi cant way. Moreover, the + GSEs did not (indeed, + +On line 10892: + not) appreciably + increase their purchases of + NTMs during the years + +On line 10892: + share to the real + PMBS issuers, Countrywide and + other subprime lenders. + + Th e following + discussion addresses each + of the claims about the + +On line 10898: + motives in turn, and + in the end will show that the + only plausible + +On line 10900: + for their actions was + their eff ort to comply with + HUD’s AH goals. Did the + + GSEs acquire NTMs to + "compete for market share" with + Wall Street or others1 + +On line 10904: + e idea that Fannie + and Freddie were newcomers + to the purchase of + +On line 10904: + NTMs between and and + reduced their underwriting + standards so they could + + compete for market + share with Wall Street or others, + is wrong. As shown in + +On line 10904: + GSEs’ acquisition + of subprime loans and other + NTMs began in the + + 1990s, when they fi rst + became subject to the AH + goals. Research shows that, + + in contravention + of their earlier standards, + the GSEs began to + +On line 10904: + high loan-to-value + (LTV) mortgages in shortly aft + er the enactment + +On line 10904: + the GSE Act and the + imposition of the AH + goals, and by 2001—before + +On line 10904: + at least billion in + NTMs, including over billion + in subprime loans.104 Far + + from following Wall + Street or anyone else into + subprime loans between + +On line 10904: + the GSEs had become + the largest buyers of subprime + and other NTMs many + +On line 10904: + PMBS market began + to develop. Given these + facts, it would be more + + accurate to say + that Wall Street and the subprime + lenders who later came + +On line 10904: + market followed the + GSEs into subprime lending. + Table does not show + +On line 10904: + signifi cant increase + in the GSEs’ acquisition + of NTMs from to and + +On line 10904: + acquired during this + period actually + decreased. Th is is + + consistent with the + fact—outlined below—that the GSEs did + not make any special + +On line 10908: + ort to compete for + market share during these years. + Pinto, "Government + +On line 10908: + in the Lead-up to + the Financial Crisis: A + Forensic Study," Chart p.148, + +On line 10916: + Dissenting Statement + Table GSE Purchases of + Subprime and Alt-A loans + +On line 10964: + billions 1997-2007 Subprime + PMBS Subprime loans** Alt-A PMBS Unk. + Unk, Unk. Unk. Unk. Alt-A + +On line 10998: + Unk. Unk, Unk. Unk. Unk. + High LTV loans**** Total***** *Total + purchases of PMBS + +On line 10998: + 1997-2001 are known. Subprime + purchases for these years were + estimated based + +On line 11000: + constituted of + total PMBS purchases in + **Loans where borrower’s + +On line 11002: + FICO Fannie and + Freddie used their various + aff ordable housing + +On line 11002: + individual + lender variance programs (many times + in conjunction with + +On line 11002: + systems once these came + into general use in + the late-1990s) to approve + +On line 11002: + they generally + did not classify these loans + as Alt-A. Classifi + + cation as Alt-A started + in the early-1990s. Th ere is + an unknown number + +On line 11006: + expanded seller + contributions, etc. Th e + volume of these loans + +On line 11008: + not included. ****Loans + with an original LTV or + original combined + +On line 11010: + estimate loans with + CLTV.>90% is unavailable prior + to Amounts for 2003-2007 are + +On line 11014: + to account for the + impact of loans with a CLTV + Th ese estimates + +On line 11014: + based on disclosures + by Fannie and Freddie that + at the end of their + +On line 11014: + CLTV was and percent + respectively higher than + their exposure to + +On line 11014: + with an LTV Fannie + reports on p. of its 10-K + that of its entire + +On line 11014: + Its Original LTV + percentage (without counting + the impact of any + +On line 11014: + negotiated) + is Freddie reports on p60 + of its Q2:2008 Q that + +On line 11014: + its portfolio had + an original combined LTV + Its OLTV percentage + +On line 11016: + 2nd) is While Fannie + and Freddie purchased only + the fi rst mortgage, + + these loans had the same + or higher incidence of + default as a loan + +On line 11018: + *****Since loans may have more + than one characteristic, + they may appear in + +On line 11020: + one category. + Totals are not adjusted + to take this into + +On line 11024: + e claim that the GSEs + loosened their underwriting + standards in order + +On line 11024: + specifi cally with + "Wall Street" can be easily + dismissed—unless the + +On line 11024: + others who have made + this statement are including + Countrywide (which was + +On line 11024: + lenders in the term "Wall + Street." Assuming, however, + that the Commission + + majority and + other commentators have + been using the term + +On line 11024: + to apply to the + commercial and investment + banks that operate + +On line 11024: + fi nancial markets + of New York, the data shows + that Wall Street was not + +On line 11024: + cant participant + in the subprime PMBS market + between and or at + + any time before or + aft er those dates. Th e top + fi ve players in + +On line 11028: + RFC billion), and New + Century billion). Other + than Lehman, some other + +On line 11028: + fi rms were scattered + through the list of the top but + were not signifi cant + +On line 11030: + group. In the biggest + year for subprime issuances, the + fi ve leaders were + +On line 11030: + and the total for + all Wall Street institutions + was billion, or about + +On line 11038: + Wallison percent + of the billion issued that + year.106 In Lehman had dropped + +On line 11038: + of the top fi ve + and Countrywide had taken + over the leadership + + among the issuers, but + Wall Street’s share had not signifi + cantly changed. By the + +On line 11038: + middle of the PMBS + market had declined to such + a degree that the + + market share numbers + were meaningless. However, + in that year the GSEs’ + + market share in NTMs + increased because they had to + continue buying + +On line 11038: + had defaulted or + left the business—in order to + comply with the AH + +On line 11038: + Accordingly, if + Fannie had ever loosened + its lending standards + + to compete with some + group, that group was not Wall Street. + Th e next question + +On line 11042: + standards to compete + with Countrywide, Ameriquest and the + other subprime lenders + +On line 11042: + were the dominant + players in the PMBS market + between and Again, the + + answer seems clearly + to be no. Th e subprime + PMBS market was very + +On line 11046: + when for the fi rst + time it exceeded billion + and reached billion in + +On line 11046: + subprime PMBS issuances.107 + Yet, Table shows that in alone + the GSEs bought billion + +On line 11046: + more than the total + amount securitized by all + the subprime lenders and + +On line 11050: + e discussion of + internal documents that + follows will focus + +On line 11052: + it was from Fannie + that the Commission received + the most complete set + +On line 11054: + By the early 2000s, + Countrywide had succeeded + in creating an + +On line 11054: + and underwriting + NTMs through PMBS. Other subprime + lenders, as noted above, + + were also major + issuers, but they sold their PMBS + through Wall Street fi rms + +On line 11058: + underwriters. Th + e success of Countrywide + and other subprime + +On line 11058: + as distributors + of NTMs through PMBS was troubling + to Fannie for two + +On line 11058: + First, Countrywide had + been Fannie’s largest supplier + of subprime mortgages; + + the fact that it could + now securitize mortgages + it formerly sold + + to Fannie meant that + Fannie would have more diffi + culty fi nding + + subprime mortgages that + were AH goals-eligible. + In addition, the + +On line 11062: + support in Congress + depended heavily on + meeting the AH goals + +On line 11062: + "leading the market" + in lending to low income + borrowers. In and + +On line 11062: + administration + and a growing number of + Republicans in + + Congress were calling + for tighter regulation of + Fannie and Freddie, + +On line 11064: + and the GSEs needed + allies in Congress to hold + this off Th e fact + +On line 11066: + lenders were taking an + increasing market share in + these years—suggesting that + + the GSEs were no longer + the most important sources of + low income mortgage + + credit—was thus a + matter of great concern to + Fannie’s management. + + Without strong support + among the Democrats in Congress, there + was a signifi cant + +On line 11068: + regulatory + legislation. Th is was + expressed at Fannie + +On line 11070: + and provoked wide-ranging + consideration within + the fi rm about how + +On line 11072: + although Fannie had + strong reasons for wanting to + compete for market + +On line 11072: + did not have either + the operational Inside + Mortgage Finance, Th + +On line 11076: + e Mortgage Market + Statistical Annual—Volume II, pp. + and Inside Mortgage + +On line 11086: + capacity to + do so. In the end, Fannie + was unable to take + +On line 11086: + signifi cant action + during the key years and that + would regain market + +On line 11088: + the subprime lenders or + anyone else. Th ey reduced + their underwriting + +On line 11090: + necessary to keep + pace with the increasing AH + goals, but not to go + +On line 11092: + those requirements. In + a key memo dated June (the + "Crossroads" memo), Tom Lund, + +On line 11092: + Vice President for + Single Family Business, + addressed the question + + of Fannie’s loss of + market share and how this share + position could be + + regained. Th e date + of this memo is important. + It shows that even in + +On line 11094: + the middle of there + was still a debate going + on within Fannie + +On line 11094: + for market share with + Countrywide and the other + subprime issuers. No + +On line 11094: + competition had + actually begun. Lund + starts the discussion + +On line 11094: + by saying "We are + at a strategic crossroad…[his + ellipses] We face two + +On line 11094: + choices: Stay the Course + [or] Meet the Market Where the + Market Is". "Staying + +On line 11094: + followed up to that + point (except as necessary + to meet HUD’s AH goals). + +On line 11094: + the AH goals required, + but also by acquiring + much riskier mortgages + +On line 11094: + Fannie—which specialized + in fi xed rate mortgages—had + been buying up to + +On line 11098: + time. Th ese riskier + potential acquisitions + would have included + +On line 11098: + numbers of Option + ARMs (involving negative + amortization) and + +On line 11100: + (or "layered") risks with + which Fannie had no prior + experience. Th + +On line 11102: + price..[and] a value + proposition for subprime." His + conclusion was as + +On line 11104: + the Market’ today." + "Th erefore," Lund continued, + "we recommend that + + we: Pursue a ‘Stay + the Course’ strategy and test + whether market changes are + +On line 11106: + In the balance of + the Crossroads memo, Lund notes that + subprime and Alt-A loans + +On line 11106: + driving the "leakage" + of "goals rich" products to PMBS + issuers. He points out + + the severity of + the loss of market share, but + never suggests that + +On line 11106: + Fannie was unequipped + to compete with Countrywide + and others at that + +On line 11106: + to an internal + FCIC staff investigation, + dated March other + +On line 11110: + (Executive Vice + President and Chief Business + Offi cer), Kenneth + +On line 11110: + Vice President for + Housing and Community + Development), and + +On line 11110: + Business)—all concurred + that Fannie should follow Lund’s + recommendation + + to "stay the course." Th + ere is no indication + in any of Fannie’s + +On line 11116: + er June that Lund’s "Stay + the Course" recommendation + was ever changed or + +On line 11116: + Freddie were supposed + to have begun to acquire + large numbers of NTMs + +On line 11116: + to meet the AH goals) + in order to compete with + Countrywide or (in + +On line 11120: + some telling) Wall Street. Th + us, in June one year aft er + the Lund Crossroads memo, + +On line 11122: + then the chairman of + the board, told Fannie’s senior + executives: is + +On line 11122: + "Single Family + Guarantee Business: Facing + Strategic Crossroads" June + +On line 11128: + transition year. To + be sure, there are still issues + to resolve. Th e + +On line 11130: + demanding. And from + a strategy standpoint, it + is clear that until + +On line 11130: + have eliminated + operations and control + weaknesses, taking + +On line 11130: + more risk or opening + new lines of business will be + viewed dimly by our + +On line 11132: + have confi rmation + that Fannie’s top offi cials + did not believe that + +On line 11134: + fi rm was in any + position—in the middle + of 2006—to take on the + +On line 11134: + be necessary s + to compete with Countrywide + and other subprime + +On line 11136: + that were selling PMBS + backed by subprime and other + NTMs. Moreover, there is + +On line 11136: + that Fannie either + never tried or was never + fi nancially able + +On line 11136: + share with Countrywide + and other subprime lenders from + to For example, + +On line 11136: + fi nancial data, + published by OFHEO, its former + regulator, in + +On line 11164: + Earnings Performance: + Net Income billions) -2.1 Net + Interest Income + +On line 11200: + billions) Guarantee + Fees billions) Net Interest + margin Average + +On line 11234: + Return on Common + Equity -8.3 Dividend + Payout Ratio N/M + +On line 11236: + period from to + To understand the signifi + cance of this, it + +On line 11236: + mortgage business works. + Most of Fannie’s guarantee + business—the business + + that competed with + securitizations of + PMBS by Countrywide + +On line 11236: + others—was done with + wholesale sellers of mortgage + pools. In these deals, the + +On line 11236: + Countrywide or a + Wells Fargo, would assemble + a pool of mortgages + +On line 11236: + for a guaranty + mechanism that would off er + the best pricing. In + +On line 11236: + case of a Fannie + MBS, the key issue was the + GSEs’ guarantee fee, + +On line 11236: + how much of the profi + t the issuer would be able + to retain. In the + +On line 11236: + a PMBS issue, it + was the amount and cost of the + credit enhancement + + needed to attain + a AAA rating for a large + percentage of the + + securities backed + by the mortgage pool. Th e + issuer had a choice + +On line 11242: + Freddie or one of + the Wall Street underwriters. + Th us, if Fannie + + wanted to compete + with the private issuers for + subprime and other + +On line 11244: + was only one way + to do it—by reducing + its guarantee fees + + (called "G-fees" at Fannie + and Freddie) and in this way + making itself a + +On line 11246: + than using a Wall + Street underwriter. Th e + fact that Fannie does + + not appear to have + done so is strong evidence + that it never tried + +On line 11246: + compete for share with + Countrywide and the other + subprime issuers aft + +On line 11250: + date of the Crossroads + memo in June Th e OFHEO fi + nancial summary + +On line 11250: + shows that Fannie in + reality had very Stephen + B. Ashley Fannie + +On line 11252: + remarks at senior + management meeting, June OFHEO, + "Mortgage Markets and + +On line 11260: + Its net income and + its return on equity + were all declining + +On line 11260: + this period, and + a cut in its G-fees would have + hastened this decline. + + Finally, there are + Fannie’s own reports about its + acquisitions of + +On line 11262: + restated, covered + periods through and Fannie’s + acquisition of + +On line 11266: + subprime loans barely + increased from through Th ese are + the numbers: Table + +On line 11298: + Mae’s Acquisition + of Subprime Loans, 2004-2007 FICO + FICO 620-<660 Th ese + +On line 11298: + are consistent with + Fannie’s eff ort to comply + with the gradual + +On line 11298: + increase in the AH + goals during the years through they + are not consistent + +On line 11298: + to substantially + increase its purchases of + subprime mortgages in + + order to compete + with fi rms like Countrywide + that were growing their + +On line 11300: + subprime and other + loans. Finally, Fannie’s 10-K + (which, as restated + +On line 11300: + covered and contains + a statement similar to + that made in confi + +On line 11300: + eff ort to compete + for subprime loans (except as + necessary to meet + + the AH goals), and that + in fact it lost market share + by declining to + +On line 11302: + [I]n recent years, an + increasing proportion of + single-family + +On line 11302: + as interest-only + mortgages, negative-amortizing + mortgages and sub-prime + +On line 11302: + mortgages has decreased. + We did not participate + in large amounts of these + +On line 11302: + non-traditional + mortgages in and because we + determined that the + +On line 11302: + ered for these mortgages + oft en off ered insuffi + cient compensation + +On line 11304: + associated + with these mortgages. Th ese trends + and our decision + +On line 11306: + in large amounts of these + non-traditional mortgages + contributed to a + +On line 11306: + issuers during this + period, with our market + share decreasing from + +On line 11308: + losing market share + to Countrywide and others + in and Fannie did + +On line 11308: + acquire unusual + numbers of subprime loans in + order to regain + +On line 11308: + it continued to + acquire only the subprime + and other NTM loans + +On line 11310: + were necessary to + meet the AH goals. Th at the + AH goals were Fannie’s + +On line 11310: + NTMs is shown by the + fi rm’s actions aft er the + PMBS market collapsed + +On line 11310: + At that point, Fannie’s + market share began to rise + as Countrywide and + +On line 11310: + not continue to + issue PMBS. Nevertheless, + despite the losses + +On line 11310: + subprime loans that were + beginning to show up in + the markets, Fannie + +On line 11312: + taken over by the + government in Fannie Mae, + 10-K. Th ese totals + +On line 11316: + not include Fannie’s + purchases of subprime PMBS. + http://www.fanniemae.com/ir/pdf/sec/2004/2004_form10K.pdf;jsessionid=N3RRJCZPD5SOVJ2FQSH SFGI, p.141 and + +On line 11330: + p.127. Fannie Mae, 10-K, + p.37. Peter J. Wallison + September Th e + +On line 11330: + reckless behavior + is obvious—they were still + subject to the AH + +On line 11330: + which were increasing + through this period. If they + had only acquired + + these NTMs to compete + with Countrywide and others + for market share the + + competition was + already over; their competitors + had abandoned the fi + +On line 11332: + is that Fannie did + not—or could not—increase its + market share between + +On line 11332: + question that market + share was not the reason they + had acquired so many + +On line 11334: + the time they failed in + September Beleaguered by + accounting problems, + +On line 11334: + evaluate the risks + of the new kinds of mortgages + they would have to buy, + +On line 11334: + had no option but + to stay the course they had been + following for years. + +On line 11336: + Th e NTMs they bought + during the period from + to were acquired to + + comply with the AH + goals and not to increase their + market share—as much + +On line 11336: + have preferred to do + so. Fannie’s market share fi + nally did increase + +On line 11336: + in when the asset-backed + market collapsed, Countrywide + weakened, and neither + +On line 11336: + else could continue + to securitize mortgages. + In a report to + +On line 11336: + of directors on + October Mudd reported + that Fannie’s market + +On line 11336: + share, which was percent + of the whole market at the + beginning of had + +On line 11340: + Fannie and Freddie + were buying NTMs because they + were profi table. Th + +On line 11344: + addressed in the next + section. Did Fannie acquire + NTMs because these loans + +On line 11346: + table1 From time to + time, commentators on the + GSEs have suggested + + that the GSEs’ real + motive for acquiring NTMs + was not that they had + +On line 11350: + comply with the AH + goals, but that they were seeking + the profi ts these risky + +On line 11352: + produced. Th is could + have been true in the 1990s, but + aft er the major + +On line 11354: + AH goals in Fannie + began to recognize that + complying with the + +On line 11354: + was reducing the + fi rm’s profi tability. By + Fannie was asking + +On line 11358: + relief from the goals. + Th e following table, + drawn from a FHFA + + publication, shows + the applicable AH goals + over the period + +On line 11360: + success in meeting + them. Fannie Mae, Minutes of + a Meeting of the + +On line 11368: + Board of Directors, + October p.18. Dissenting + Statement Table GSEs’ + +On line 11400: + Success in Meeting + Aff ordable Housing Goals, 1996-2007 + Low Mod Housing Goals + +On line 11574: + Actual Freddie + Actual Underserved Goal + Fannie Actual + +On line 11630: + Freddie exceeded + the AH goals virtually + each year, but not by + + signifi cant margins. + Th ey simply kept pace with + the increases in + +On line 11634: + as these requirements + came into force over the years. + Th is alone suggests + +On line 11636: + they did not increase + their purchases in order + to earn profi ts. If + + that was their purpose + they would have substantially + exceeded the goals, + +On line 11636: + fi nancing costs and + low capital requirements) + allowed them to pay + + more for the mortgages + they wanted than any of their + competitors. As HUD + +On line 11638: + in "Because the GSEs + have a funding advantage + over other market + +On line 11640: + their competitors and + increase their market share."115 As + early as there were + +On line 11640: + at Fannie about how + the percent LMI goal—which HUD + had signaled as its + +On line 11642: + move—would be met. In + a June memorandum,116 four + Fannie staff members + +On line 11642: + categories of rules + changes that would enable Fannie + to meet the goals more + +On line 11642: + HUD to change the goals + accounting (what goes into + the numerator + +On line 11642: + (ii) enter other + businesses where the pickings + might be goals-rich, such + + as manufactured + housing and, signifi cantly, + Alt-A and subprime ("Eff + +On line 11642: + Alt-A and A-markets + (the highest grade of subprime + lending) should also + +On line 11642: + business that will have + a salutary eff ect on our + low-and moderate-income + +On line 11644: + and (iii) persuade HUD + to adopt diff erent methods + of goals scoring. By + +On line 11644: + was eff ectively + in competition with banks + that were required to + +On line 11644: + low-income borrowers + targeted in HUD’s AH goals. + Rather than selling their + + CRA loans to Fannie + and Freddie, banks and S&Ls had + begun to retain + +On line 11644: + loans in portfolio. + In a presentation in + November Barry + + Zigas, a Senior + Vice President of Fannie, + noted that "Our own + +On line 11650: + -65142. Bell, Kinney, Kunde + and Weech, through Zigas and Marks + internal memo Frank + +On line 11660: + Housing Goals Options," + June Peter J. Wallison + S&Ls’ holding loans in + +On line 11662: + is due in part to + below-market CRA products."117 + In other words, banks + + and S&Ls subject to + CRA were making mortgage loans + at below market + + interest rates, and + thus could not sell them without + taking losses. Th + +On line 11666: + for Fannie because + it meant that in order to + capture these loans they + + would have to increase + what they were willing to pay + for these loans. Doing + +On line 11668: + would underprice the + risks they would be assuming. + It is important + +On line 11668: + recognize what was + happening. Fannie, and the + banks and S&Ls under + +On line 11668: + were now competing + for the same kinds of NTMs, and + were doing so by + +On line 11668: + subsidies. Simply + as a result of supply + and demand, all of + +On line 11670: + to pay higher prices + for these increasingly risky + mortgages. Th e banks + +On line 11670: + S&Ls that acquired these + loans could not sell them, without + taking a loss, when + + market interest + rates were higher than the rates + on the mortgages. Th + +On line 11672: + indication in + the documents that the FCIC + received from Fannie + + that competition + for subprime loans among the GSEs, + banks, S&Ls, and FHA was + +On line 11672: + principal causes + of the mortgage meltdown and + thus the fi nancial + +On line 11674: + January Fannie + began planning for how to + confront HUD before + +On line 11674: + round of increases + in the AH goals, expected + to occur in In + +On line 11674: + "Action Plan for the + Housing Goals Rewrite," dated + January Fannie + +On line 11674: + number of options, + and concluded that "Fannie + should strongly oppose: + +On line 11676: + goals increases and + new subgoals." (Slide In March as + Fannie prepared for + + new increases in + the AH goals, its staff prepared + a presentation, + + perhaps for HUD or + for policy defense in + public forums. Th + +On line 11680: + that the goals should not + be increased signifi cantly + in Slide stated: In + +On line 11680: + exceeded all our + goals for the 9th straight year. But + it was probably + + the most challenging + environment we’ve ever + faced. Meeting the goals + +On line 11680: + heroic 4th quarter + eff orts on the part of many + across the company. + +On line 11684: + were cancelled. Th e + midnight oil burned. Moreover, the + challenge freaked out the + +On line 11684: + because the tenseness + around meeting the goals meant that + we considered not + +On line 11684: + our liquidity + function—and did deals at risks + and prices we would not + +On line 11686: + becoming clear that + continuing increases + in the AH goals were + + having a major + adverse eff ect on Fannie’s + profi tability. In + +On line 11688: + memorandum to + Brian Graham (another + Fannie offi cial), + +On line 11690: + Market Research and + Policy Development, + wrote: "Meeting the goals + +On line 11692: + diffi cult markets + imposes signifi cant costs + on the Company + +On line 11692: + as much for housing + goals attainment as for the + economics of the + +On line 11700: + Housing Goals Rewrite," + January Fannie Mae, "Th + e HUD Housing Goals," + +On line 11708: + Graham, "RE: Mission + Legislation," September + Dissenting Statement + +On line 11710: + Activities,"121 the + authors noted in slide that + AH goal costs had risen + +On line 11710: + in to in Slide is + entitled: "Meeting Future + HUD Goals Appear Quite + +On line 11710: + and Potentially + Costly" and reports, "Based on + experience where + + goal acquisition + costs (relative to Fannie + Mae model fees) cost + +On line 11710: + between per goals unit + in the fi rst quarter to + per unit in the fourth + +On line 11710: + meeting the shortfall + could cost the company $6.5-$36.5 + million to purchase + +On line 11714: + suffi cient units." Th + e presentation concludes + (slide "Cost of mission + +On line 11718: + likely averaged + approximately million + per year." Earlier, + + I noted the eff + orts of Fannie and Freddie + to window-dress their + +On line 11720: + that would comply with + the AH goals, while giving the + seller the option + +On line 11720: + to reacquire the loans + at a later time. In we + begin to see eff + +On line 11720: + same window-dressing + in another way--delaying + acquisitions of + + non-goal-eligible + loans so Fannie can meet the + AH goals in that year; + +On line 11720: + goal-compliance on + Fannie’s profi tability. In + a presentation + +On line 11722: + Barry Zigas, the + key Fannie offi cial on + aff ordable housing, + +On line 11724: + option." Under that + initiative, Fannie would ask + seven major lenders + +On line 11728: + goal computation + and thus bring Fannie nearer + to goal compliance + +On line 11730: + quarter of Th e + cost of the deferral alone + was estimated + +On line 11732: + entitled "Update + on Fannie Mae’s Housing Goals + Performance,"123 Fannie + + noted several + "Undesirable Tradeoff s + Necessary to Meet + +On line 11734: + included signifi + cant additional credit + risk, and negative + +On line 11734: + economics are well + below target returns; some + deals are producing + +On line 11734: + "G-fees may not cover + expected losses"). One of + the most noteworthy + +On line 11734: + "Liquidity to + Questionable Products: Buying + exotic product + +On line 11734: + continuation + of risky lending; many products + present with signifi cant + +On line 11734: + at risk of payment + shock and loss of equity; + potential need to + +On line 11736: + our responsible + lending policies to get goals + business." Much of the + +On line 11736: + that unscrupulous and + unregulated mortgage + originators tricked + +On line 11740: + into taking on + bad mortgages. Th e idea that + predatory lending + +On line 11740: + a major source of + the NTMs in the fi nancial + system in is a + +On line 11740: + element of the + Commission majority’s + report, although the + +On line 11742: + able to provide any + data to support this point. + Th is Fannie slide + +On line 11742: + dubbed "predatory" might + actually have been made + to comply with the + +On line 11746: + possibility + is suggested, too, in a + message sent in to + +On line 11746: + CEO, Richard Syron, by + Freddie’s chief risk manager, + David Andrukonis, when + +On line 11746: + considering whether + to authorize a "Ninja" + (no income/no jobs/no + + assets) product that + he ultimately approved. + Andrukonis argued + +On line 11750: + for the perception + and reality Fannie + Mae, "Costs and Benefi + +On line 11754: + Zigas, "Housing Goals + and Minority Lending," + September Fannie + +On line 11754: + "Update on Fannie + Mae’s Housing Goals Performance," + Presentation to + +On line 11760: + U.S. Department of + Housing and Development, + October Peter + +On line 11762: + J. Wallison of + predatory lending, with this + product is great."124 But + +On line 11762: + product was approved + by Freddie, probably for + the reason stated + +On line 11764: + another Freddie + employee: "Th e Alt-A [(low + doc/no doc)] business + +On line 11766: + a contribution + to our HUD goals."125 On May a + Fannie staff memo to + +On line 11766: + Committee revealed + the serious credit and + fi nancial problems + +On line 11766: + acquiring subprime + mortgages to meet the AH goals. + Th e memo describes + +On line 11768: + "product enhancements + from Freddie Mac, FHA, Alt-A and + subprime lenders have all + +On line 11768: + rich loans…On the issue + of seller contributions + [in which the seller + +On line 11768: + FHA has expanded + their guidelines by allowing + contributions for + +On line 11768: + up to that can be + used toward closing, prepaid + expenses, discount + + points and other fi + nancing concessions."126 Th e + memorandum is + + eye-opening for what + it says about the credit risks + Fannie had to take + +On line 11772: + to get the goals-rich + loans it needed to meet HUD’s + AH requirements for + +On line 11772: + Table below shows + the costs of NTMs in terms of + the guarantee fee + + (G-fee) "gap." (In order + to determine whether a loan + contributed to a + +On line 11772: + pricing model that + took into account credit + risk as well as a + + number of other + factors; a G-fee "gap" was the + diff erence between + + the G-fees required by + the pricing model for a + particular loan + + to contribute to + a return on equity + and a loan that did + +On line 11776: + Th e table in + this memo shows the results for + three subprime products + +On line 11776: + consideration, + a year fi xed rate mortgage + (FRM), a year ARM, and + +On line 11776: + and year fi xed rate + mortgages. For simplicity, + this analysis will + +On line 11776: + discuss only the + year fi xed rate product. Th + e table shows that + +On line 11778: + the year FRM, with a + zero downpayment should be + priced according to + +On line 11778: + model at a G-fee + of basis points. However, + the memo reports that + +On line 11778: + is actually + buying loans like that at a + price consistent with + +On line 11778: + an annual fee + of basis points, producing + a gap (or loss from + +On line 11780: + model) of basis + points. Th e reason the gap + is so large is shown + +On line 11782: + on that zero-down + mortgage was percent. Th e + table then goes on + +On line 11784: + other possible + loan alternatives, with the + following results: + +On line 11786: + Mac, internal email, + Donna Cogswell on behalf of + David Andrukonis to + +On line 11788: + Dick Syron, "RE: No + Income/No Asset (NINA) Mortgages," + September Freddie + + Mac, internal email + from Mike May to Dick Syron, + "FW: FINAL NINA + +On line 11790: + October Fannie + Mae, internal memo, Single + Family Business + +On line 11790: + Development to + Single Family Business + Credit Committee, + +On line 11796: + PMD Proposal for + Increasing Housing Goal Loans," + May p.6. Dissenting + +On line 11798: + Table Fannie Mae + Took Losses on Higher Risk + Mortgages Necessary + +On line 11812: + analysis for "base" + MCM Model Fee Average + Gap enhancement-not + +On line 11840: + Interest First (IF) + -91.50 Seller Contribution + (SC) -77.50 Temporary + +On line 11864: + B/D (BD) -80.50 Zero + Down (ZD) -68.50 Manufactured + Housing (MH) -189.50 From + + this report, it is + clear that in order to meet + the AH goals Fannie + + had to pay up for + goals-rich mortgages, taking a + huge credit risk along + +On line 11868: + way. Th e dismal + fi nancial results that were + developing at + +On line 11868: + result of the AH + goals were also described in + Fannie’s 10-K report + +On line 11868: + losses of revenue + and higher credit losses + as a result of + +On line 11870: + the mortgages required + by the AH goals: [W]e have made, + and continue to + +On line 11870: + cant adjustments to + our mortgage loan sourcing and + purchase strategies in + + an eff ort to meet + HUD’s increased housing goals and + new subgoals. Th ese + +On line 11872: + than our typical + transactions. We have also + relaxed some of our + +On line 11872: + our investments in + higher-risk mortgage loan products + that are more likely + +On line 11872: + HUD’s goals and subgoals, + which could increase our credit + losses. [emphasis + +On line 11876: + "lower expected + returns" were reported in + February in a + +On line 11876: + the FCIC received from + Fannie, which noted that for + the "cash fl ow cost" + +On line 11876: + goals was million while + the "opportunity cost" + was million.129 In a + +On line 11876: + HUD on the AH goals, + dated April Fannie described + these costs as follows: + +On line 11878: + [of meeting the goals] + are opportunity costs + of foregone revenue. + +On line 11878: + opportunity + cost was about million, whereas + the cash fl ow cost + +On line 11878: + was about million. If + opportunity cost was + our shareholders would + +On line 11880: + indiff erent to + the deal. Th e cash fl ow + cost is the implied + +On line 11882: + time, "Alignment Meetings"—in + which Fannie staff considered + how they would meet the + +On line 11882: + goals—were taking place + almost monthly (according + to the frequency + +On line 11882: + presentations to + Alignment meetings occur in + the documentary + +On line 11882: + an Alignment Meeting + on June on a "Housing Goals + Forecast," three plans were + +On line 11886: + for meeting the AH + goals, even Id., p.8. Fannie Mae, + 10-K, p.146. Fannie Mae, + +On line 11886: + minus expected + loss. Expected revenue is + what will be received + +On line 11886: + actually charged + minus the model fee—the fee + that Fannie’s model + +On line 11886: + mortgage of the same + quality in order to + earn a fair market + +On line 11892: + capital. Fannie + Mae, "Housing Goals Briefi ng for + HUD," April Peter J. + +On line 11894: + gone. One of the plans + was forecast to result in + opportunity + +On line 11894: + two plans resulted + in opportunity costs + of million.131 In a + +On line 11894: + Forecast meeting on + July a "Plan to Meet Base + Goals," which probably + +On line 11894: + meant the topline LMI goal + including all subgoals, was + placed at billion for + +On line 11896: + to Brian Montgomery, + Assistant Secretary of + Housing, Fannie CEO + +On line 11896: + of the fi nancial + and economic conditions + then prevailing in + +On line 11896: + absence of a PMBS + market and the increasing + number of mortgage + +On line 11898: + goals for be declared + "infeasible." He noted + that HUD also has + + an obligation to + "consider the fi nancial + condition of the + +On line 11900: + en he continued: + "Fannie Mae submits that the + company took all + + reasonable actions + to meet the subgoals that were + both fi nancially + +On line 11900: + contribute to the + achievement of the subgoals….In Fannie + Mae relaxed certain + +On line 11900: + standards and purchased + some higher risk mortgage loan + products in an eff + +On line 11904: + the housing goals. Th + e company continued + to purchase higher + +On line 11904: + eff orts to acquire + goals-rich loans are partially + responsible for + +On line 11908: + statement confi rms + two facts that are critical + on the question of + +On line 11908: + Fannie (and Freddie) + acquired so many high risk loans + in and earlier + +On line 11908: + rst, the companies + were trying to meet the AH + goals established by + + HUD and not because + these loans were profi table. It + also shows that the + +On line 11910: + of HUD and others— + including the Commission + majority in + +On line 11910: + blame the managements + of Fannie and Freddie for + purchasing the loans + +On line 11912: + ultimately dragged + them to insolvency is + misplaced. Finally, + +On line 11912: + July report, the + Federal Housing Finance + Agency (FHFA, the + +On line 11912: + new regulator, + replacing OFHEO), noted that + Fannie and Freddie + +On line 11912: + followed the practice + of cross-subsidizing the + subprime and Alt-A loans + +On line 11914: + they acquired: Although + Fannie Mae and Freddie Mac + consider model-derived + +On line 11914: + their guarantees on + some mortgages using higher + returns they expect + +On line 11914: + earn on guarantees + of other loans. In both and + cross-subsidization + +On line 11914: + single-family + guarantee fees charged by the + Enterprises was + +On line 11914: + categories. In each + case, there were cross-subsidies + from mortgages that posed + + lower credit risk + on average to loans that + posed higher credit + + risk. Th e greatest + estimated subsidies + generally went + +On line 11920: + highest-risk mortgages.134 Th + e higher risk mortgages were + the ones most needed + +On line 11920: + Fannie and Freddie + to meet the AH goals. Needless + to say, there is no + +On line 11920: + cross-subsidize the + G-fees of loans that are acquired + because they are profi + +On line 11922: + tability must be + excluded as reasons that + Fannie (and Freddie) + +On line 11924: + "Housing Goals Forecast," + Alignment Meeting, June Fannie + Mae, Forecast Meeting, + +On line 11926: + July slide Fannie + Mae letter, Daniel Mudd to Asst. + Secretary Brian + +On line 11928: + Montgomery, December + p.6. FHFA, Fannie Mae and + Freddie Mac Single + +On line 11938: + Dissenting Statement + Th e only remaining + motive—and the valid + +On line 11942: + one—was the eff ect of + the AH goals imposed by HUD. + In aft er its takeover + +On line 11942: + government, Fannie + Mae fi nally published a + credit supplement + +On line 11944: + an accounting of + its subprime and Alt-A credit + exposure. Th e + +On line 11946: + reproduced below + in order to provide a + picture of the kinds + +On line 11946: + loans Fannie acquired + in order to meet the AH + goals. Loans may appear + +On line 11946: + category, so + the table does not reveal + Fannie’s total net + +On line 11946: + each category, + nor does it include Fannie’s + holdings of non-Fannie MBS + +On line 11946: + PMBS, for which it did + not have loan level data. + Note the reference + +On line 11946: + to billion in the + column for subprime loans. As + noted earlier, + + Fannie classifi + ed as subprime only those + loans that it purchased + +On line 11946: + However, Fannie + included loans with FICO + scores of less than in + +On line 11946: + they are not prime loans + but without classifying + them formally as + +On line 11948: + credit supplement, + fi led in August Fannie + eliminated the + +On line 11948: + loans in Table and + reported that as of June + it held the credit + +On line 11950: + risk on NTMs with a + total unpaid principal + amount of trillion. Th + +On line 11954: + e average loan + amount was for a total of + million NTM loans.135 Th + + is number does not + include Fannie’s holdings of + subprime PMBS as to + +On line 11990: + J. Wallison g + o b n rmin s m o + an s. Ju nf tio + +On line 12028: + rm 10-K. o Lo an + siness. C u o t lo + f b e k o + +On line 12050: + dministra o im + s siness o u bpr an + ae’s F vernmen g + +On line 12080: + A Su Lo it b + f B o o ed k usin + o o o udes g + +On line 12102: + e cr annie M + F s it B o t-A an + rtgag Al ed Lo + +On line 12132: + ederal H hich + incl efer t e Cr d + nal mo es, r n + + V th T ss, w + tio rtgag A), the F o + s wi sine ven it + +On line 12184: + a o O u n + L atio C ed Original + L R FI nal M + +On line 12212: + f b airs (V ly + co tio k o tal cr V + o s Aff mi o + +On line 12242: + th T o n ven + tn s wi tio no it b + le-fa an Ra o + +On line 12266: + etera g n o L + ed Original L ily C + f V tio e cr + + f sin d t o + n am rma th o rtgag + nce o le-F s wi + +On line 12318: + g an a ala r + inf o O artmen in L + t. o C ly mo + +On line 12348: + S re. al b mi + p ltuu th le-fa rinci + ncemen siness. F + +On line 12374: + s wi g gric u + an O teristics o o + C f b L aid + +On line 12398: + p FI f A p + it enha o k arac t + o o h f the + + sin ed f un o + e o s it C it b + encies, such as the + + D e o an ed + tag artmen tag ther cr ed + terest-Only Lo ep ts ag + +On line 12476: + d o In e cr + n es: Cr ercen r i ercen + t o e a g + + d the D rtgag + e- s eatur n urs tiv + as a p rtizin an + + t F t as a + p ega Lo m a eco ly + mo N uc Amo d + +On line 12556: + lated u vernmeno + mi ro rogra ncemen k + le-fa o g o + +On line 12576: + .S. G ey P lender + r re calc ties P y K + s a li nce it + +On line 12632: + enha verall + B an aci O o y the + U ed sura r the + + sin fi le b b + ty F o ro g L ed + th cr l ino uni + +On line 12678: + o es f it P + sur rmin s wi p ed o + r in mm an atio + +On line 12706: + nf o it loss nce + o ed k l lo o ue + R ae Cr o al + + d C atio o C + teed o n f al sura f + cr it B o-V b + + n ed ue R g + a e o an-t m ra e + in o u nce o + + tag annie M s)* + nal Cr o-val usin n et + L d J tio atio + +On line 12800: + nce o an-t ala ark + n re gua rtgag illio + o ven ala ue R + +On line 12832: + a ercen on atio o + M al es es s a al + b al B ss ss + +On line 12862: + le F p nce (b + p ate O ue R o o + ark-t o-V C es es + + an ural H ry mo + ab ala ily C y R al + ss ss rime o it + +On line 12908: + it L o T p + am rinci e Original + L e M an-t e + +On line 12932: + FI t lo as a + p al B o-V o d ed + ed b rinci p + + uenc it L it L + ears 2005-2007 d <660n u rima + ed gle-F aid P p + + p verag an-t + verag ed ed ark L + verag nce r + + the R rinci in + n elinq n Y A o A + A o-o aid p ec + +On line 13022: + f S te e U + tio ress ted ted o-M ted al + Residence a p + + t-A, S p f D + aid P us D h h h + it Enha A) o + +On line 13062: + n udes p p O + O ed-ra f Cr f Q3 Cr + f Q4 Cr f Cr + + vernmen xp s o + n are o verag eig + eig ark-t eig C C + +On line 13112: + ed o cl A U + Sh A Serio Origina + W Original L + +On line 13148: + W M W FI FI + Fix P C Cr o o o + o Al U E G + +On line 13160: + noted earlier, + in its limited review + of the role of the + +On line 13160: + in the fi nancial + crisis, the Commission spent + most of its time and + + staff resources on a + review of Fannie Mae, and + for that reason this + +On line 13160: + not substantially + diff erent at Freddie Mac. + In a document + +On line 13160: + June entitled "Cost + of Freddie Mac’s Aff ordable + Housing Mission," a + +On line 13160: + were made that show the + experience of Freddie + was no diff erent + +On line 13162: + subsidy prior to + but since then subsidies have + averaged million + +On line 13170: + baseline) aff ordable + single-family loans, but + not enough to fully + +On line 13174: + loans accounted for + the disproportionate share + of our realized + +On line 13176: + was predicted by + our models. (slide In Freddie + Mac failed two subgoals, + +On line 13176: + was subsequently + deemed infeasible by the + regulator due + +On line 13176: + Mac failed six goals and + subgoals, fi ve of which were + deemed infeasible. + +On line 13176: + enforcement action + was taken regarding the + sixth missed goal because + +On line 13180: + nancial condition. + (slide Goal-qualifying loans tend + to be higher risk. + +On line 13180: + income correlates + with various risk factors + such as less wealth, less + +On line 13184: + ratios, or lower + credit scores. (slide Targeted + aff ordable loans have + +On line 13184: + expected default + probabilities... Over one-half + of targeted aff + +On line 13184: + higher expected + default probabilities + than the highest of + +On line 13186: + non-goal-qualifying + loans. (Slide Th e use of the + aff ordable housing + +On line 13188: + major policy + error committed by HUD + in two successive + +On line 13188: + must be recognized + as such if we are ever + to understand what + + caused the fi nancial + crisis. Ultimately, the + AH goals extended + +On line 13188: + bubble, infused it + with weak and high risk NTMs, caused + the insolvency + +On line 13188: + Fannie and Freddie, + and—together with other + elements of U.S. + +On line 13190: + the principal cause + of the fi nancial crisis + itself. When Congress + +On line 13192: + (HERA), it transferred the + responsibility for + administering + +On line 13192: + aff ordable housing + goals from HUD to FHFA. In + FHFA modifi + +On line 13192: + of their most troubling + elements. As Fannie had + noted, if the AH + +On line 13194: + goals-eligible + borrowers in the market, + they were being forced + +On line 13194: + allocate credit, + taking it from the middle + class and providing + +On line 13194: + borrowers. In eff + ect, there was a confl ict + between their mission + +On line 13194: + advance aff ordable + housing and their mission to + maintain a liquid + +On line 13200: + Committee, Board of + Directors, June Peter J. + Wallison market + + for most mortgages in + the U.S. Th e new FHFA + rule does not require + + the GSEs to purchase + more qualifying loans than + the percentage of + + the total market + that these loans constitute.137 Th + is does not solve all + + the major problems + with the AH goals. In the sense + that the goals enable + +On line 13208: + inherently a + form of government credit + allocation. More + + signifi cantly, the + competition among the GSEs, + FHA and the banks that + +On line 13208: + required under the + CRA to fi nd and acquire + the same kind of loans + + will continue to + cause the same underpricing + of risk on these loans + + that eventually + brought about the mortgage meltdown + and the fi nancial + + crisis. Th is is + discussed in the next section + and the section on + +On line 13218: + the GSEs and FHA for + Subprime and Alt-A Mortgages One + of the important + +On line 13218: + HUD’s management of + the AH goals was that it placed + Fannie and Freddie + +On line 13220: + competition with + FHA, an agency within HUD. + Th is was already + +On line 13222: + Fannie documents + cited above. Fannie treated + this as a confl + +On line 13222: + interest at HUD, + but there is a strong case that + this competition + + is exactly what + HUD and Congress wanted. It + is important to + +On line 13222: + the context in which + the GSE Act was enacted + in In Congress had + +On line 13222: + Credit Reform Act.138 + One of its purposes was + to capture in the + + government’s budget + the risks to the government + associated + + with loan guarantees, + and in eff ect it placed a + loose budgetary limit + +On line 13222: + FHA guarantees. For + those in Congress and at HUD + who favored increased + +On line 13222: + communities, this + consequence of the FCRA may + have been troubling. What + + had previously + been a free way to extend + support to groups who + +On line 13222: + downpayment and the + indicia of willingness + and ability to + + pay—now appeared to be + potentially restricted. + Requiring the GSEs + +On line 13222: + take up the mantle + of aff ordable housing would + have looked at the time + +On line 13224: + funds in the private + markets and were off -budget + entities. Looked at + + from this perspective, + it would make sense for Congress + and HUD to place the + +On line 13226: + in competition, + just as it made sense to put + Fannie and Freddie + + in competition + with one another for aff + ordable loans. With all + +On line 13226: + competing for the + same kinds of loans, and with HUD’s + control of both FHA’s + +On line 13226: + reducing mortgage + underwriting standards, as + a means of making + +On line 13226: + income borrowers, + provides ample evidence + of HUD’s motives for + +On line 13228: + Goals; Enterprise Book-Entry + Procedures; Final Rule, CFR + Parts and Federal + +On line 13230: + p.55892. Title V of + the Congressional Budget + Act of Under the + +On line 13230: + HUD must estimate + the annual cost of FHA’s + credit subsidy for + +On line 13238: + receipts reduced by + its estimated payments. + Dissenting Statement + +On line 13240: + now a part of HUD + and administered by the + Federal Housing + +On line 13240: + (who is also the + Assistant Secretary of + Housing), FHA insures + +On line 13240: + It was established + to provide fi nancing to + people who could not + +On line 13242: + bank-originated + conventional loan. Th e + loans it insured had + +On line 13244: + a maximum LTV + of percent in Th is went + to percent in and + +On line 13244: + its maximum LTV + remaining at percent, FHA + maintained average + +On line 13244: + for its borrowers + just below from to During + this period, the + + average FICO + score for a conventional + subprime borrower + +On line 13244: + began to increase + its percentage of loans with + low downpayments. Th + + is had the predictable + eff ect on its delinquency + rates, as shown in the + +On line 13248: + below prepared by + Edward Pinto with data + from FHA, the FDIC, and + +On line 13252: + market share vis-a vis + the GSEs began to decline. + According to GAO + +On line 13252: + in FHA’s market share + among lower-income borrowers + was percent while the + +On line 13252: + share was percent. By + FHA’s share was percent, while the + GSEs’ share was percent. + +On line 13252: + borrowers with its + Community Homebuyer + Program (CHBP). In a + +On line 13254: + Credit Policy + group compared Fannie’s then-proposed + CHBP program to FHA’s + +On line 13254: + 1-to-4 family loan + program (Section 203(b)) and showed + that most of Fannie’s + +On line 13256: + competitive or + better. Kerry D. Vandell, + "FHA Restructuring + +On line 13256: + Alternatives and + Implications," Fannie Mae + Housing Policy + +On line 13258: + 308-309 GAO, "Federal + Housing Administration: + Decline in Agency’s + +On line 13258: + Process Developments + of Other Mortgage Market + Participants," GAO-07-645, + +On line 13266: + June pp. and Peter + J. Wallison FHA also + appears to have tried + + to lead the GSEs. In + 1999—just before the AH goals for + Fannie and Freddie + +On line 13266: + to be raised—FHA almost + doubled its originations + of loans with LTVs equal + +On line 13266: + than percent, going + from percent in to percent + in It also off + +On line 13266: + standards in order + to attract subprime business. + Th e following + +On line 13268: + from a Quicken ad + in January (emphasis + in the original),142 + +On line 13268: + is likely to have + been based on an FHA program + as it existed + +On line 13270: + in Borrowers can + purchase with a minimum + down payment. Without + + FHA insurance, many + families can’t aff ord the + homes they want because + +On line 13270: + a major roadblock. + FHA down payments range from to + of the sale price and + + are signifi cantly + lower than the minimum + that many lenders require + + for conventional + or sub-prime loans. With FHA loans, + borrowers need as + +On line 13272: + as of the "total + funds" required. In addition + to the funds needed + +On line 13272: + payment, borrowers + also have to pay closing + costs, prepaid fees for + +On line 13272: + interest, as well + as escrow fees which include + mortgage insurance, + + hazard insurance, + and months worth of property + taxes. A FHA-insured home + +On line 13274: + loan can be structured + so borrowers don’t pay more + than of the total + +On line 13278: + e combined total + of out-of-pocket funds can be + a gift or loan from + +On line 13278: + to use gift s from + family members and non-profi + t groups to cover + + their down payment and + additional closing costs + and fees. In fact, even + +On line 13280: + from a relative + is acceptable. FHA’s credit + requirements are fl + +On line 13280: + Compared to credit + requirements established by + many lenders for other + + types of home loans, FHA + focuses only on a + borrower’s last 12-24 + +On line 13280: + credit history. + In addition, there is no + minimum FICO + +On line 13280: + - mortgage bankers look + at each application on + a case-by-case basis. + +On line 13282: + with NO established + credit to receive a loan + with this program. FHA + +On line 13282: + allow borrowers + to have of their gross income + attributed to their + +On line 13282: + payment combined with + existing debt. FHA program + allows borrowers + +On line 13284: + to carry and in + some circumstances, even more. It + is important to + +On line 13284: + remember that is + the year that HUD was planning + a big step-up in the + +On line 13284: + special aff ordable + category that would be + most competitive + +On line 13286: + Th e last major + increase in the percent of + FHA’s loans with LTVs equal + +On line 13286: + greater than percent had + occurred in the year before + the GSE Act imposed + +On line 13286: + AH goals on Fannie + and Freddie, and in eff ect + directed them to + +On line 13286: + loans Integrated + Financial Engineering, + "Actuarial + +On line 13286: + of the Federal + Housing Administration + Mutual Mortgage + +On line 13286: + Fund (Excluding HECMs) + for Fiscal Year prepared for + U.S. Department of + +On line 13290: + To Off er FHA Home + Mortgages Nationally On + Th e Internet + +On line 13290: + Intuit expands + home ownership nationwide, + off ering consumers + +On line 13300: + Dissenting Statement + equal to or greater than percent + rose suddenly from + +On line 13302: + percent to percent.143 + Again, FHA, under the control + of HUD, appears to + +On line 13302: + that would lead them to + reduce their underwriting + standards. Since FHA is + +On line 13302: + its actions cannot + be explained by a profi t + motive. Instead, it + +On line 13302: + that FHA reduced its + lending standards as part of + a HUD policy + +On line 13306: + the same direction. + Th e result of Fannie’s + competition with + +On line 13306: + in high LTV lending + is shown in the following + fi gure, which compares + + the respective shares + of FHA and Fannie in the + category of + +On line 13306: + with LTVs equal to or + greater than percent, including + Fannie loans with a + +On line 13310: + LTV equal to or greater + than percent. Figure Whether a + conscious policy + +On line 13310: + GSEs and FHA ensued + immediately aft er + the GSEs were given + +On line 13312: + in Th e fact that + FHA, an agency controlled by + HUD, substantially + +On line 13312: + increased the LTVs it + would accept in (just before + the GSEs were given + +On line 13312: + (just before the GSEs + were required to increase their + aff ordable housing + +On line 13312: + the interest of + creating competition + between FHA and the + +On line 13316: + Th e eff ect was + to drive down underwriting + standards, which HUD had + +On line 13322: + and Subprime Lenders in + Affordable Housing In HUD + began a program + +On line 13322: + year, GAO, "Federal + Housing Administration: + Decline in Agency’s + +On line 13322: + Process Developments + of Other Mortgage Market + Participants," GAO-07-645, + +On line 13328: + pp. and Peter J. + Wallison the Mortgage Bankers + Association + +On line 13328: + nancing fi rms not + otherwise regulated + by the federal + +On line 13328: + not subject to HUD’s + legal authority—agreed to + join a HUD program + +On line 13332: + Initiative."144 Th e + circumstances surrounding this + agreement are somewhat + + obscure, but at least + one contemporary account + suggests that the MBA + + signed up to avoid an + eff ort by HUD to cover + mortgage bankers under + +On line 13332: + up to that point had + only applied only to + government-insured + +On line 13336: + agreement with HUD. Th + e agreement consisted of + two parts: MBA’s agreement + +On line 13336: + fair-lending issues in + consultation with HUD and + a model best-practices + +On line 13336: + mortgage banks could use + to devise their own agreements + with HUD. Th e fi + +On line 13338: + such agreement, signed by + Countrywide Funding Corp., the + nation’s largest mortgage + +On line 13338: + summarized [below]. + Many have seen the MBA agreement + as a preemptive + +On line 13338: + against congressional + murmurings that mortgage banks + should be pulled under + +On line 13340: + umbrella of the + CRA.145 As the fi rst member + of the MBA to sign, + +On line 13340: + seen as assisting + low-income mortgage lending, and + it became one of + +On line 13340: + subprime lenders who were + to prosper enormously as + Fannie and Freddie + + began to look for + sources of the subprime loans that + would enable them to + +On line 13340: + meet the AH goals. By + there were MBA signatories + to HUD’s Best Practices + +On line 13344: + e companies and + associations that sign + "Best Practices" Agreements + +On line 13344: + Fair Housing Act, but + also make a concerted + eff ort to exceed + +On line 13344: + the signatories + agree to administer a + review process for loan + +On line 13344: + all applicants have + every opportunity + to qualify for + + a mortgage. Th ey + also assent to making + loans of any size so + + that all borrowers + may be served and to provide + information on + +On line 13350: + loan programs for which + an applicant qualifi + es…. Th e results + +On line 13352: + the initiative are + promising. As lenders discover + new, untapped markets, + +On line 13352: + minority and + low-income loans applications + and originations + +On line 13354: + and minority + groups has increased throughout the + nation.146 Countrywide + + was by far the most + important participant + in the HUD program. + +On line 13356: + dollar commitment" + to lend to minority + and low income HUD’s + +On line 13356: + Practices Initiative + was described this way by HUD: + "Since HUD has signed Fair + +On line 13356: + partnerships that are + considered on the leading + edge. Th e Agreements + + not only off er + an opportunity to + increase low-income and + +On line 13358: + opportunity + principles into mortgage + lending standards. Th + + ese banks and mortgage + lenders, as represented by + Countrywide Home Loans, + +On line 13362: + a commitment to + affi rmatively further + fair lending." Available + +On line 13370: + ABA Banking Journal, + vol. http://www. questia.com/googleScholar.qst1docId=5001707340. HUD, "Building + Communities and + +On line 13378: + Markets for the 21st + Century," FY Report p.75, + http:// www.huduser.org/publications/polleg/98con/NewMarkets.pdf. Dissenting + + Statement families, + which in part it fulfi lled + by selling subprime + +On line 13380: + and other NTMs to + Fannie and Freddie. In a + report, the Fannie + +On line 13380: + Mae and Freddie Mac + began accepting loans with + higher LTVs and greater + +On line 13380: + underwriting fl + exibilities."147 In late + a few months before + + its rescue by Bank + of America, Countrywide + reported that it + +On line 13386: + element of the + vast increase in NTMs between + and was the role of + +On line 13388: + CRA.149 Th e act, which + is applicable only + to federally + +On line 13390: + institutions, was + originally adopted in + Its purpose in part + +On line 13390: + authority when + examining fi nancial + institutions to + +On line 13390: + credit needs of the + local communities in + which they are chartered + +On line 13392: + the Act authorized + the bank regulators to + withhold approvals for + +On line 13392: + and acquisitions + and branch network expansion + if the applying + +On line 13394: + satisfactory + CRA rating. CRA did not have + a substantial eff + +On line 13394: + er its enactment + until the regulations + under the act were + +On line 13394: + mortgages that they would + not otherwise have made. In + this sense, the CRA and + + Fannie and Freddie’s + AH goals are cut from the same + cloth. Th ere were two + +On line 13400: + one with the broadest + applicability, is + a requirement that + + all insured banks make + CRA loans in their respective + assessment areas. + +On line 13400: + assessment areas. + Banks (usually privately) + complain that they are + +On line 13400: + the regulators + to make imprudent loans to + comply with CRA. One + +On line 13400: + bank in a report + to its shareholders: Under + the umbrella of + +On line 13400: + Reinvestment Act (CRA), + a tremendous amount of pressure + was put on banks by + +On line 13402: + neighborhoods. Th e + regulators were very heavy + handed regarding + + this issue. I will + not dwell on it here but they + required [redacted name] + +On line 13402: + lending practices to + meet certain CRA goals, even though + we argued the changes + +On line 13404: + the other hand, the + regulators defend the + act and their actions + +On line 13404: + claim that the CRA had + a role in the fi nancial + crisis. Th e most + +On line 13406: + defense is a speech + by former Fed Governor + Randall Kroszner on + +On line 13408: + "Questions and Answers + from Countrywide about Lending," + December available + +On line 13422: + December in which + he said in pertinent part: + Only percent of + + all the higher-priced loans + [those that were considered CRA + loans because they bore + + high interest rates + associated with their + riskier character] + +On line 13422: + lenders to lower-income + borrowers or neighborhoods + in their assessment + +On line 13422: + geographies that are + the primary focus for + CRA evaluation + +On line 13424: + result undermines + the assertion by critics + of the potential + +On line 13424: + a substantial role + for the CRA in the subprime + crisis. [emphasis + +On line 13428: + Th ere are two points + in this statement that require + elaboration. First, + + it assumes that all + CRA loans are high-priced loans. Th + is is incorrect. + +On line 13432: + banks, in order to + be sure of obtaining the + necessary number + + of loans to attain + a satisfactory CRA + rating, subsidized + +On line 13434: + interest rates than + their risk characteristics + would warrant. Th is + +On line 13436: + true, in part, because + CRA loans are generally + loans to low income + + individuals; + as such, they are more likely + than loans to middle + + income borrowers + to be subprime and Alt-A loans + and thus sought aft er + + by FHA, Fannie and + Freddie and subprime lenders such + as Countrywide; this + + competition is + another reason why their + rates are likely to + +On line 13436: + lending under CRA + in their assessment areas + has probably not + + had a major eff + ect on the overall presence + of subprime loans in + +On line 13436: + fi nancial system, + it is not the element + about CRA that raises + +On line 13436: + concerns about how CRA + operated to increase + the presence of NTMs + +On line 13438: + the U.S. fi nancial + system generally. Th + ere is another + +On line 13440: + CRA’s role in the fi + nancial crisis likely to + be considerably + +On line 13442: + more signifi cant. In + the Riegle-Neal Interstate Banking + and Branching Effi + +On line 13444: + rst time allowed banks + to merge across state lines under + federal law (as + +On line 13444: + compacts). Under these + circumstances, the enforcement + provisions of the + +On line 13444: + to federal bank + regulators for merger + approvals. In a speech, + +On line 13444: + Bernanke stated that aft + er the enactment of the + Riegle-Neal legislation, + +On line 13444: + comment process to protest + bank applications on CRA + grounds. In instances of + +On line 13444: + applications, the + Federal Reserve Board and + other agencies held + +On line 13444: + the public and the + applicants to comment on + the lending records of + +On line 13444: + In response to these + new pressures, banks began to + devote more resources + + to their CRA programs."152 + Th is modest description, + although accurate + + as far as it goes, + does not fully describe the + eff ect of the law + +On line 13448: + the application + process on bank lending practices. + In the umbrella + +On line 13450: + groups," the National + Community Reinvestment + Coalition, published a + +On line 13450: + which recounted the + substantial success of its + members in using + +On line 13450: + provided by the + bank application process to + obtain trillions of + +On line 13450: + lending commitments + from banks that had applied to + Randall Kroszner, Speech + +On line 13454: + December Ben S. + Bernanke, "Th e Community + Reinvestment Act: Its + +On line 13462: + Evolution and New + Challenges," March p2. Dissenting + Statement federal + +On line 13466: + merger approvals. Th + e opening section of the + report states (bolded + +On line 13468: + the original):153 Since + the passage of CRA in lenders + and community + +On line 13470: + income neighborhoods. + Lenders and community groups + will oft en sign these + +On line 13472: + merge with another + institution or expand + its services. Lenders must + + seek the approval of + federal regulators + for their plans to merge + +On line 13474: + e four federal + fi nancial institution + regulatory + +On line 13474: + scrutinize the CRA + records of lenders and will assess + the likely future + +On line 13476: + performance of lenders. + Th e application process, + therefore, provides an + +On line 13478: + for lenders to sign CRA + agreements with community + groups that will improve + +On line 13484: + extension of the + public comment period + during its merger + +On line 13484: + joint request by a + bank and community group. + In its commentary + + to Regulation + Y, the Board indicates that + this procedure was + +On line 13484: + to facilitate + discussions between banks and + community groups + +On line 13484: + programs that help serve + the convenience and needs of + the community. + + In its Corporate + Manual, the Offi ce + of the Comptroller + + of the Currency + states that it will not off er + the expedited + +On line 13486: + process to a lender that + does not intend to honor + a CRA agreement made + +On line 13492: + the institution + that it is acquiring. See + Note supra. Peter J. + +On line 13502: + summary list of + year-by-year commitments: Table Year + Annual Dollars + +On line 13698: + millions) millions) Th + e size of these commitments, + which far outstrip the + +On line 13698: + areas, suggests the + potential signifi cance + of the CRA as a + +On line 13698: + of the fi nancial + crisis. It is noteworthy + that the Commission + +On line 13698: + was not willing even + to consider the signifi + cance of the NCRC’s + +On line 13698: + In connection with + its only hearing on the + housing issue, and + +On line 13700: + any research had been + done on the NCRC statements, the + Commission published + +On line 13700: + absolving CRA of + any responsibility + for the fi nancial + +On line 13704: + crisis.154 FCIC, "Th e + Community Reinvestment + Act and the Mortgage + +On line 13716: + Staff Report, http:// www.fcic.gov/reports/pdfs/2010-0407-Preliminary_Staff + _Report_-_CRA_and_the_Mortgage_Crisis. pdf. Dissenting Statement + To understand CRA’s + +On line 13716: + fi nancial crisis, + the relevant statistic is + the trillion in bank + +On line 13720: + commitments that the + NCRC cited in its report. + (Th is document + +On line 13720: + are relevant to + this discussion were removed + from the NCRC website, + + www.ncrc.org, aft er + they received publicity + but can still be found + +On line 13720: + cooperated + with community groups by + withholding approvals + +On line 13720: + applications for + mergers and acquisitions + until an agreement + +On line 13720: + satisfactory + to the community groups + had been arranged. It + +On line 13722: + not want the severe + criticism from Congress that + would have followed their + +On line 13722: + community groups + in reaching agreements with and + getting commitments + +On line 13722: + banks that had applied + for these approvals. In statements + in connection with + +On line 13722: + approved the Fed has + said that commitments by the + bank participants + +On line 13722: + future CRA lending + have no infl uence on the + approval process. A Fed + +On line 13724: + cial also told the + Commission’s staff that the Fed + did not consider + +On line 13724: + in connection with + merger applications. Th + e Commission did + +On line 13726: + to verify this + statement, but accepted it + at face value from + +On line 13728: + Fed staff offi cial. + Nevertheless, there remains + no explanation + +On line 13728: + making these enormous + commitments in connection + with mergers, but not + + otherwise. Th e + largest of the commitments, in + terms of dollars, were + +On line 13732: + by four banks or their + predecessors—Bank of America, JPMorgan Chase, + Citibank, and Wells Fargo—in + +On line 13744: + Wallison Table + Announced CRA Commitments in + Connection with a + +On line 13748: + Four Largest Banks and Th + eir Predecessors Final + bank Acquired or merged + +On line 13760: + announcement of a + CRA commitment Wells Fargo + First Union acquired by + +On line 13778: + by b.) Wachovia JPMorgan + Chemical merges with m.) Chase + Manufacturers + +On line 13792: + Savings acquired by + b.) Washington Mutual + Dime acquired by b.) + +On line 13802: + Mutual Bank One + acquired by JPMorgan Chase b.) Bank + of Continental + +On line 13808: + acquired by Bank of + America b.) America + Bank of America + +On line 13816: + by NationsBank, b.) which kept + the Bank of America name). + Bank of Boston b.) + +On line 13836: + acquired by Fleet Fleet + b.) Citibank Travelers b.) b.) + Cal Fed b.) Compiled + +On line 13842: + enormous size of the + commitments reported by + NCRC, the key questions + +On line 13842: + of these commitments + were actually fulfi + lled by the banks that + +On line 13842: + them, (ii) where are these + loans today, and (iii) how are + these loans performing1 + +On line 13846: + of this issue, there + are only partial answers + to these questions. Were + +On line 13850: + e banks that made these + commitments apparently + came under pressure + + from community + groups to fulfi ll them. In + an interview by + +On line 13850: + Brad Bondi of the + Commission’s staff Josh Silver + of the NCRC noted + +On line 13852: + groups did follow up + these commitments. Bondi: Who + follows up…to make + +On line 13852: + that these banks honor + their voluntary agreements or + their unilateral + +On line 13860: + Dissenting Statement + Silver: Actually part + of some of these CRA + +On line 13860: + was meeting with the + bank two or three times a year + and actually + +On line 13862: + through, ‘Here’s what you’ve + promised. Here’s what you’ve loaned.’ Th + at would happen on + +On line 13862: + one-on-one basis with the + banks and the community + organizations.156 + + Nevertheless, when + the Commission staff asked the + four largest banks (Bank of + +On line 13864: + Citibank, JPMorgan Chase and Wells + Fargo) for data on whether + the merger-related + +On line 13864: + amount, most of the banks + supplied only limited + information. Th + +On line 13868: + that they did not have + the information or that + it was too diffi + + cult to get, and the + information they supplied + was sketchy at best. In + +On line 13874: + to the Commission + by the banks, in letters from + their counsel, refl + +On line 13874: + than they had claimed in + press releases to have made + in fulfi llment + + of their commitments. + Th e press release amounts were + JPMorgan Chase (including + +On line 13876: + billion), and Bank of + America billion), totaled + trillion in CRA loans + +On line 13876: + to the Commission + by Edward Pinto in the + Triggers memo.157 No Wells + +On line 13876: + but in response to + questions from the Commission + Wells provided a + + great deal of data + in spread sheets that could not be + interpreted or + +On line 13876: + further discussion + with representatives of + the bank. However, + +On line 13876: + terminated the + investigation of the + merger-related CRA + +On line 13876: + in August before + the necessary data could + be gathered. For this + +On line 13876: + Wells data could not + be unpacked, interpreted + in discussion with + +On line 13880: + Aft er I protested + the limited eff orts of + the Commission on + +On line 13880: + attempt to restart the + investigation of the + merger-related CRA + +On line 13880: + only one bank had + responded by the deadline + for submission of + +On line 13880: + dissenting statement. + As with the bank responses, + additional work + +On line 13880: + to understand the + information received, and + there was no time, and + +On line 13882: + Commission staff to + follow up. As a result + of the dilatory + +On line 13882: + of the Commission’s + investigation, it was + impossible to + +On line 13882: + actually made + under their merger-related + CRA commitments by + + the four banks and their + predecessors. Th is in + turn impeded any + +On line 13884: + ort to fi nd out + where these loans are today and + hence their delinquency + +On line 13884: + It appears that in + many instances the Commission + management constrained + +On line 13884: + and interviews and + by preventing the staff from + following up with + +On line 13886: + that failed to respond + adequately to requests + for data. Where are + + these mortgages today1 + Where these loans are today must + necessarily + + be a matter of + speculation. Some of the + banks told the FCIC staff + +On line 13886: + do not distinguish + between CRA loans and other + loans, and so could not + +On line 13886: + this information. + Under the GSE Act, Fannie + and Freddie had an + +On line 13888: + rmative obligation + to help banks to meet their CRA + obligations, and they + + undoubtedly served + as a buyer for the loans + made by the largest banks + +On line 13888: + their predecessors + pursuant to Interview of + Josh Silver of the + +On line 13890: + Coalition, June Edward + Pinto, Exhibit to the + Triggers memo, dated + +On line 13898: + http://www.aei.org/docLib/ Pinto-Sizing-Total-Federal-Contributions.pdf. Peter J. + Wallison the commitments. + In a press release + +On line 13898: + in for example, + Fannie reported that it + had acquired billion + +On line 13902: + percent of Fannie’s + AH acquisitions for that + year. In the Triggers + +On line 13902: + based on his research, + Pinto estimated that + Fannie and Freddie + +On line 13902: + about percent of all + CRA loans over the period + from to and that, of + + the balance, about 10-15 + percent were insured by FHA, + 10-15 percent were sold + +On line 13904: + and the rest remain + on the books of the banks that + originated the + +On line 13904: + likely unsaleable in + the secondary market because + they were made at rates + +On line 13904: + insurance—again, the + competition for these loans + among the GSEs, FHA and + +On line 13904: + inevitably raised their prices + and thus underpriced their risk. + To sell these loans, the + + banks holding them would + have to take losses, which many + are unwilling to + +On line 13906: + Mortgage Disclosure + Act HMDA), banks are required + to provide data + +On line 13906: + the Fed from which the + delinquency rates on loans that + have high interest + +On line 13906: + be calculated. + It was assumed that these were + the loans that might bear + +On line 13906: + Fannie and Freddie, + FHA, Countrywide and other + subprime lenders and banks + +On line 13906: + CRA are all seeking + the same loans—roughly speaking, + loans to borrowers + + at or below the + AMI—it is likely that these loans + when actually + +On line 13906: + bear concessionary + interest rates so that their + rate spread is not be + +On line 13906: + It’s just supply and + demand. Accordingly, the + banks that made CRA loans + +On line 13906: + obligation to record + and report their delinquency + rates, and as noted + + above several of + the large banks that made major + commitments recorded + + by the NCRC told FCIC + staff that they don’t keep records about + the performance of + +On line 13908: + loans apart from other + mortgages. However, in the + past few years, Bank of + + America has been + reporting the performance + of CRA loans in its + + annual report + to the SEC on form 10-K. For + example, the bank’s + +On line 13912: + of nonperforming + residential mortgage loans. + Th is portfolio + +On line 13914: + our residential + mortgage portfolio carries + risk mitigation + +On line 13914: + small portion of our + CRA portfolio is covered + by this protection."160 + + Th is could be an + approximation for the + delinquency rate on + + the merger-related + CRA loans that the four banks made + in fulfi lling their + +On line 13916: + but without defi + nitive information on + the number of loans + +On line 13918: + banks’ current holdings + it is impossible to + make this estimate + +On line 13918: + counsel, another + bank reported serious + delinquency rates on + +On line 13918: + made pursuant to its + merger-related commitments + ranging from percent + +On line 13920: + largest sample showing + a percent delinquency rate. + "Fannie Mae Passes + +On line 13920: + Trillion American + Dream Commitment; Leads Market + in Bringing Housing + +On line 13932: + mi_m0EIN/is_2003_March_18/ai_98885990/pg_3/1tag=content;col1. Triggers memo, p.47. + Bank of America, 10-K, p.57. + Dissenting Statement + +On line 13934: + of this issue is + necessary, including on + the role of the bank + + regulators, in + order to determine what + eff ect, if any, the + +On line 13934: + commitments to make + CRA loans might have had on the + number of NTMs in + +On line 13942: + Th is dissenting + statement argues that the U.S. + government’s housing + +On line 13944: + fi nancial crisis + of Th ese policies fostered + the development + +On line 13944: + a massive housing + bubble between and and the + creation of million + +On line 13944: + and Alt-A loans, many of + which were ready to default as + soon as the housing + + bubble began to + defl ate. Th e losses + associated + +On line 13948: + weak and high risk loans + caused either the real or + apparent weakness + + of the major fi + nancial institutions around + the world that held these + +On line 13948: + of regulation, + predatory lending or the + other factors that + +On line 13948: + the report of the + FCIC’s majority were not + determinative + +On line 13952: + implications of + this conclusion are signifi + cant. If the crisis + +On line 13952: + by eliminating + or changing the government + policies and programs + +On line 13952: + were primarily + responsible for the fi + nancial crisis, then + + there was no need for + the Dodd-Frank Wall Street Reform and + Consumer Protection + +On line 13952: + Act of adopted by + Congress in July and oft + en cited as one + +On line 13958: + regulation that + the Dodd-Frank Act imposes on + the U.S. economy + +On line 13958: + almost certainly + have a major adverse eff + ect on economic + + growth and job creation + in the United States during + the balance of this + +On line 13958: + that had to be paid + for preventing another + fi nancial crisis + +On line 13958: + it’s one that will have + to be borne. But if it was + not necessary to + + prevent another + crisis—and it would not have been + necessary if the + + crisis was caused by + actions of the government + itself—then the Dodd-Frank Act + +On line 13960: + Finally, if the + principal cause of the fi + nancial crisis was + + ultimately the + government’s involvement in + the housing fi nance + +On line 13968: + the future should be + adjusted accordingly. + Dissenting Statement + + Hypothetical + Losses in Two Scenarios + (No feedback) Scenario + +On line 13974: + was known to market + professional during the + 2nd half of Scenario + +On line 13982: + trillion; Losses on + Prime=1.2%% (assumes foreclosure rate + severity); Losses + +On line 13988: + Average size of + mortgage: Losses in Scenario + Number of mortgages: + +On line 13992: + million Subprime/Alt-A million + PMBS million FHA/VA=5.2 million) + Aggregate Value: + +On line 14000: + billion trillion prime + X billion trillion subprime/Alt-A X + billion Overall loss + +On line 14010: + Scenario Number of + mortgages: million Prime: million + Subprime/Alt-A: Original subprime/Alt-A: + +On line 14012: + million Other subprime/Alt-A: + million F&F (excludes million + already counted in + +On line 14012: + million other loans + not securitized (mostly + held by the large banks)) + +On line 14018: + Aggregate Value: + Prime= trillion X million); Subprime/Alt-A + trillion X million) + +On line 14020: + foreclosures: billion + trillion X billion trillion + X billion) Overall + +On line 14022: + for an increase of + Note: No allowance for feedback + eff ect—that is, fall + + in home prices as a + result of larger number + of foreclosures in + +On line 14030: + eff ect, losses would + Dissenting Statement be even + larger in Scenario + +On line 14030: + because a larger + number of foreclosures would + drive down housing prices + +On line 14034: + is feedback eff ect + will likely cause total fi + rst mortgage losses + +On line 14040: + Hypothetical + Losses in Two Scenarios + (with feedback) Scenario + +On line 14040: + was known to market + professional during the + 2nd half of Scenario + +On line 14050: + Scenario Losses on + prime=1.2%% (assumes foreclosure rate + severity); Losses + +On line 14052: + subprime Alt-A=14% ((assumes + foreclosure rate severity); + Losses on FHA/VA=5.25% + +On line 14056: + subprime Alt-A=25% (assumes + foreclosure rate severity); + Losses on FHA/VA + +On line 14058: + unknown subprime/Alt-A=15% (assumes + foreclosure rate severity) + Average size of + +On line 14062: + mortgage: Prime: trillion/39 + million) Subprime/Alt-A/FHA/VA: trillion/13 million + Losses in Scenario + +On line 14070: + of mortgages: million + Prime=40 million Subprime/Alt-A=7.7 million PMBS + FHA, and VA=5.2 million + +On line 14076: + Aggregate Value: + Prime trillion X million); Subprime/Alt-A=$1.7 + trillion X million) + +On line 14078: + FHA/VA= billion ($130,000x5.2 + million) Total expected + foreclosures: million + +On line 14084: + billion trillion prime + X billion trillion subprime/Alt-A X + billion billion X + +On line 14096: + Dissenting Statement + Losses in Scenario Number + of mortgages: million + +On line 14104: + million Original + subprime/Alt-A: million FHA/VA: million + Other subprime/Alt-A: million + +On line 14104: + million other loans + not securitized (mostly + held by the large banks)) + +On line 14110: + Value: Prime= trillion + X million); Original Subprime/Alt-A + trillion X million) + +On line 14112: + FHA/VA= billion ($130,000x5.2 + million) Other subprime/Alt-A: trillion + ($154,000X13 million Total + +On line 14112: + million X million=0.95 + million, X million=3.5 million, + X million=3.9 million) + +On line 14112: + foreclosures: billion + trillion X billion trillion + X billion billion + +On line 14120: + billion) Overall loss + percentage: for an increase + of APPENDIX A: + +On line 14128: + ABX.HE A series + of derivatives indices + constructed from the + +On line 14128: + subprime mortgage–backed + securities; akin to an + index like the Dow + +On line 14132: + whose interest rate + changes periodically + over time. affordable + +On line 14132: + Goals originally + set by the Department of + Housing and Urban + + Development (now + by the Federal Housing + Finance Agency) for + +On line 14132: + and Freddie Mac to + allocate a specified + part of their mortgage + +On line 14138: + rate securities. + asset-backed commercial paper + Short-term debt secured + +On line 14140: + instrument secured + by assets such as mortgages, + credit card loans or + + auto loans. auction + rate securities Long-term bonds + whose interest rate + +On line 14146: + holding company + Company that controls a + bank. broker-dealer A + +On line 14146: + the subsidiary of an + investment bank, that buys and + sells securities + +On line 14148: + itself and others. + capital Assets minus + liabilities; + +On line 14148: + owns minus what it + owes. Regulators often + require financial + +On line 14150: + minimum levels + of capital. Capital + Purchase Program TARP + + program providing + financial assistance to + 700-plus U.S. financial + +On line 14150: + through the purchase of + senior preferred shares in the + corporations on + + standardized terms. CDO + see collateralized debt + obligation. CDO squared + +On line 14158: + holds other CDOs. CDS + see credit default swap. CFTC + see Commodity + +On line 14162: + the riskier portions + of mortgage-backed securities. + commercial paper + +On line 14164: + created by the + Federal Reserve in to + purchase three-month + +On line 14166: + federal agency + that regulates trading in + futures and options. + +On line 14176: + depository + institutions to make loans + and provide services + +On line 14178: + Securities and + Exchange Commission program + created in and + +On line 14178: + terminated in + that provided voluntary + supervision for + +On line 14182: + bank conglomerates. + Counterparty A party + to a contract. CP + +On line 14188: + A type of credit + derivative allowing + a purchaser of + +On line 14188: + transfer loan default + risk to a seller of the + swap. The seller agrees + +On line 14188: + pay the purchaser + if a default event occurs. + The purchaser does + +On line 14190: + by the swap. credit + enhancement Insurance or + other protection + + that may be purchased + for a loan or pool of loans + to offset losses + +On line 14192: + the event of default. + credit loss Loss from delayed + payments or defaults + +On line 14194: + loans. credit rating + agency Private company + that evaluates the + +On line 14194: + of securities + and provides ratings on those + securities; the + +On line 14196: + are Fitch Ratings, Moody’s + Investors Service, and Standard + Poor’s. credit risk Risk + +On line 14198: + a borrower will + fail to repay the loan. CSE + Consolidated + +On line 14200: + of a borrower’s + ability to repay a + loan, generally + + calculated by + dividing the borrower’s + monthly debt payments + +On line 14202: + income. delinquency + rate The number of loans for + which borrowers fail + +On line 14206: + for enforcement of + laws and administration + of justice, led by + +On line 14208: + of the federal + government; prints and mints all + currency and coins, + +On line 14208: + U.S. government debt + instruments, supervises + national banks and + +On line 14208: + Its mission includes + protecting the integrity + of the financial + +On line 14210: + depository + institution Financial + institution, such + +On line 14210: + thrift (savings and loan), + or credit union, that accepts + deposits, including + +On line 14212: + insured by the FDIC. + derivative Financial + contract whose price is + +On line 14212: + from the value of + an underlying asset, + rate, index, or event. + +On line 14218: + mortgage market. FCIC + Financial Crisis Inquiry + Commission. FDIC see + + Federal Deposit + Insurance Corporation. + Federal Deposit + +On line 14220: + examining and + supervising some of those + institutions, and + +On line 14222: + Federal Housing + Administration Part of + the Department of + +On line 14224: + government-sponsored + enterprises; created + by the Housing and + +On line 14224: + as successor to + the Office of Federal + Housing Enterprise + +On line 14226: + Federal Housing + Finance Board. Federal Open + Market Committee + + Its members are the + Board of Governors of the + Federal Reserve + +On line 14230: + Glossary System and + certain of the presidents + of the Federal + +On line 14230: + market conditions + and implements monetary + policy through such + +On line 14232: + setting interest + rates. Federal Reserve Bank + of New York One of + +On line 14232: + regulating bank + holding companies in New + York State and nearby + + areas. Federal + Reserve U.S. central banking + system created + +On line 14234: + panics, consisting + of the Federal Reserve + Board in Washington, + +On line 14234: + DC, and Federal + Reserve Banks around the country; + its mission is to + +On line 14234: + policy through such + means as setting interest + rates, supervising + +On line 14240: + Federal Housing + Finance Agency. FICO score + A measure of a + +On line 14242: + money laundering, + terroristfinancing, and + other financial + +On line 14246: + FinCEN see Financial + Crimes Enforcement Network. FOMC + see Federal Open + +On line 14248: + foreclosure Legal + process whereby a mortgage lender + gains ownership of + +On line 14250: + defaulted mortgage. + Freddie Mac Nickname for the + Federal Home Loan + +On line 14252: + financing for the + home mortgage market. Ginnie + Mae Nickname for the + +On line 14254: + pools of VA and FHA + mortgages. Glass-Steagall Act Banking Act + of creating the + +On line 14254: + from underwriting + or dealing in most types of + securities, barred + +On line 14254: + affiliating + with securities firms, and + introduced other + +On line 14254: + reforms. In the Gramm-Leach-Bliley + Act repealed the provisions + of the Glass-Steagall Act that + +On line 14256: + corporation, such + as Fannie Mae and Freddie + Mac, created by + +On line 14258: + its charter. Gramm-Leach-Bliley Act + legislation that lifted + certain remaining + +On line 14262: + difference between + the value of an asset + and the amount borrowed + +On line 14264: + hedge In finance, a + way to reduce exposure + or risk by taking + +On line 14266: + offered investment + vehicle exempted from + most regulation + +On line 14270: + investors. HOEPA see Home + Ownership and Equity + Protection Act. Home + +On line 14270: + Federal Reserve + new responsibility + to address abusive + +On line 14272: + including measures + to reform and regulate + the GSEs; created + +On line 14276: + hybrid CDO A CDO + backed by collateral found + in both cash CDOs and + +On line 14280: + Assets that cannot + be easily or quickly + sold. interest-only + +On line 14288: + until the end of + the loan term. Appendix A: + Glossary leverage A + +On line 14288: + is used to purchase + assets; for example, a + leverage ratio of + +On line 14292: + that of assets were + purchased with of debt and of + capital. LIBOR + + London Interbank + Offered Rate, an interest + rate at which banks are + + willing to lend to + each other in the London + interbank market. + +On line 14296: + can be quickly and + easily converted to + cash. liquidity + +On line 14296: + contract allowing + one party to compel the + other to buy an + +On line 14298: + ratio Ratio of + the amount of a mortgage to + the value of the + +On line 14298: + percentage. "Combined" + loan-to-value includes all + debt secured by the + +On line 14302: + mortgages. LTV ratio + see loan-to-value ratio. + mark-to-market The + +On line 14302: + amount of an asset + is adjusted to reflect + the market value. + + monoline Insurance + company, such as AMBAC + and MBIA, whose single + +On line 14306: + is to guarantee + financial products. mortgage + servicer Company + +On line 14308: + modifications, + settlements, and foreclosure + proceedings. mortgage + +On line 14308: + evaluating the + credit characteristics + of a mortgage and + +On line 14310: + security Debt + instrument secured by a + pool of mortgages, whether + +On line 14314: + net asset value. + negative amortization + loan Loan that allows + + a borrower to + make monthly payments that do + not fully cover + +On line 14316: + unpaid interest + added to the principal of + the loan. net asset + +On line 14316: + asset minus any + associated costs; for + financial assets, + +On line 14318: + changes each trading day. + net charge-off rate Ratio of loan + losses to total + +On line 14320: + sponsored by private + companies other than a + government-sponsored + +On line 14320: + as Fannie Mae or + Freddie Mac); also known as + private-label mortgage-backed + +On line 14322: + the outstanding amount + of over-the-counter derivatives + contracts, based on the + +On line 14324: + referenced assets. + novation A process by which + counterparties may + +On line 14326: + positions. OCC see + Office of the Comptroller + of the Currency. + +On line 14328: + Housing Enterprise + Oversight Created in to + oversee financial + +On line 14328: + Mae and Freddie Mac; + its responsibilities + were assumed in by + + its successor, the + Federal Housing Finance + Agency. Office of + +On line 14330: + supervises all + national banks and certain + branches and agencies + + of foreign banks in + the United States. Office of + Thrift Supervision + +On line 14332: + that regulates all + federally chartered and + many state-chartered savings + +On line 14334: + loans/thrift institutions + and their holding companies. + OFHEO see Office of + +On line 14336: + Housing Enterprise + Oversight. originate-to-distribute + When lenders make loans with + +On line 14338: + opposed to holding + the loans through maturity. + originate-to-hold When + + lenders make loans with the + intention of holding them + through maturity, + +On line 14338: + opposed to selling + them to other financial + institutions or + +On line 14344: + investors. Appendix + A: Glossary origination + Process of making a + +On line 14348: + and providing the + funds. OTS see Office of Thrift + Supervision. par + + Face value of a + bond. payment-option adjustable-rate + mortgage (also called + +On line 14350: + Mortgages that allow + borrowers to pick the amount + of payment each month, + + possibly low enough + to increase the principal + balance. PDCF see + +On line 14356: + pooling Combining + and packaging a group of + loans to be held by + +On line 14358: + Program established + by the Federal Reserve + in March that allowed + +On line 14362: + overnight to finance their + securities. principal + Amount borrowed. private + +On line 14362: + on the payment of + a mortgage provided by + a private firm at + +On line 14364: + the lender. private-label + mortgage-backed securities see + non-agency mortgage-backed + +On line 14366: + agreement (repo) A + method of secured lending where + the borrower sells + +On line 14366: + as collateral + and agrees to repurchase them + at a higher price + +On line 14368: + a short period, + often within one day. SEC + see Securities + +On line 14370: + Commission. section + Section of the Federal + Reserve Act under + +On line 14370: + may make secured loans + to nondepository + institutions, such + +On line 14372: + under "unusual + and exigent" circumstances. + Securities and + +On line 14372: + protecting investors + by enforcing federal + securities laws, + +On line 14372: + regulating stock + and security options + exchanges and other + +On line 14372: + markets, the issuance + and sale of securities, + broker-dealers, other + +On line 14374: + Process of pooling debt + assets such as mortgages, car + loans, and credit card + +On line 14374: + separate legal + entity that then issues + a new financial + +On line 14376: + or security + for sale to investors. shadow + banking Financial + + institutions and + activities that in some + respects parallel + +On line 14378: + include mutual + funds, investment banks, and hedge + funds. short sale The sale + +On line 14380: + a home for less than + the amount owed on the mortgage. + short selling To sell + +On line 14380: + security in + the expectation of a + decline in value. + +On line 14384: + purpose vehicle + Entity created to + fulfill a narrow + +On line 14384: + holds a portfolio + of assets such as mortgage-backed + securities or + +On line 14388: + advantages. SPV see + special purpose vehicle. + structured investment + + vehicle Leveraged + special purpose vehicle, + funded through medium-term + +On line 14390: + in highly rated + securities. synthetic + CDO A CDO that holds + +On line 14390: + swaps that reference + assets (rather than holding cash + assets), allowing + + investors to make bets + for or against those referenced + assets. systemic risk + +On line 14392: + financial terms, that + which poses a threat to the + financial system. + +On line 14394: + Deposit Insurance + Corporation Improvement + Act (FDICIA) under + +On line 14396: + may commit its funds + to rescue a financial + institution. TAF + +On line 14398: + Facility. TALF + see Term Asset-Backed Securities + Loan Facility. + +On line 14408: + see Troubled Asset + Relief Program. Appendix + A: Glossary Term Asset-Backed + +On line 14408: + Loan Facility + Federal Reserve program, + supported by TARP + +On line 14408: + of asset-based loans such + as auto loans, student loans, + and small business loans. + +On line 14414: + made up to billion + in Treasury securities + available to banks or + +On line 14416: + directly with the + Federal Reserve. tranche From + the French, meaning a + +On line 14416: + to refer to the + different types of mortgage-backed + securities and + + CDO bonds that provide + specified priorities + and amounts of returns: + +On line 14416: + returns and therefore + the lowest risk/interest rate; + mezzanine tranches + +On line 14416: + levels of risk/return; + and "equity" (also known + as "residual" or + +On line 14418: + any remaining cash + flows. Troubled Asset Relief + Program Government + +On line 14418: + in October to + purchase or insure up to + billion in assets + +On line 14422: + Condition in which + a business does not have enough + capital to meet + +On line 14424: + entity. Write-downs + Reducing the value of + an asset as it + + is carried on a + firm’s balance sheet because the + market value has + +On line 14432: + APPENDIX B: LIST + OF HEARINGS AND WITNESSES + Public Meeting of + +On line 14438: + October Martin + Baily, Senior Fellow in + Economic Studies, + +On line 14438: + School of Management, + Massachusetts Institute + of Technology + +On line 14440: + S. Scott, Nomura + Professor and Director + of the Program on + +On line 14442: + Graduate School of + Arts and Sciences (Department + of Economics) and + +On line 14442: + International + and Public Affairs John B. + Taylor, Mary and Robert + + Raymond Professor + of Economics and the Bowen + H. and Janice Arthur + +On line 14442: + Zingales, Robert C. McCormack + Professor of Entrepreneurship + and Finance and the + +On line 14442: + G. Booth Faculty + Fellow, University of + Chicago Booth School of + +On line 14444: + Roundtable Discussion, + Washington, DC, November + David A. Moss, The John + +On line 14444: + Carmen M. Reinhart, + Professor of Economics + and Director of + +On line 14446: + International + Economics, University + of Maryland Public + +On line 14448: + January Session + Financial Institution + Representatives + +On line 14450: + of the Board and Chief + Executive Officer, + Goldman Sachs Group, Inc. + +On line 14454: + of the Board and Chief + Executive Officer, + JPMorgan Chase Co. John J. + +On line 14456: + of the Board, Morgan + Stanley Brian T. Moynihan, + Chief Executive + +On line 14456: + President, Bank of + America Corporation + Session Financial + +On line 14458: + Michael Mayo, Managing + Director and Financial + Services Analyst, + +On line 14462: + Kyle Bass, Managing + Partner, Hayman Advisors, + LP Peter J. Solomon, + +On line 14462: + and Chairman, Peter + J. Solomon Company Session + Financial Crisis + +On line 14472: + B: List of Hearings + and Witnesses Mark Zandi, + Chief Economist and + +On line 14472: + Moody’s Economy.com + Kenneth T. Rosen, Chair, Fisher + Center for Real + + Estate and Urban + Economics, University + of California, + +On line 14474: + Policy Counsel, + Center for Responsible + Lending C. R. "Rusty" + +On line 14476: + Community Bankers + Association Public + Hearing, Washington, + +On line 14478: + Investigations + into the Financial Crisis—Federal + Officials Eric + +On line 14478: + of Justice Sheila C. + Bair, Chairman, U.S. Federal + Deposit Insurance + +On line 14478: + L. Schapiro, Chairman, U.S. + Securities and Exchange + Commission Session + +On line 14478: + the Financial Crisis—State + and Local Officials Lisa + Madigan, Attorney + +On line 14482: + of Illinois John W. + Suthers, Attorney General, + State of Colorado Denise + +On line 14482: + and President, North + American Securities + Administrators + +On line 14486: + Alvarez Mortgage Fraud + Task Force Forum to Explore + the Causes of the + + Financial Crisis, + American University + Washington College + +On line 14488: + Bobins Professor of + Economics, University + of Chicago Session + +On line 14492: + Household Finances and + Financial Literacy + Annamaria Lusardi, + +On line 14492: + Research Forum to + Explore the Causes of the + Financial Crisis, + +On line 14494: + Washington College + of Law, Washington, DC, Day + February Session + +On line 14494: + Lending Practices and + Securitization Chris + Mayer, Paul Milstein + +On line 14494: + of Real Estate, + Columbia University; + Visiting Scholar + + at the Federal + Reserve Bank of New York and + Research Associate + +On line 14496: + Booth Professor of + Banking, Finance, and Real + Estate; Co-chair, Fisher + +On line 14496: + Estate and Urban + Economics, University + of California, + +On line 14496: + and Other Complex + Financial Instruments Markus + Brunnermeier, Edwards + +On line 14496: + Economics, Princeton + University Appendix + B: List of Hearings + +On line 14502: + Session Firm Structure + and Risk Management Anil Kashyap, + Edward Eagle Brown + +On line 14502: + and Finance and Richard + N. Rosett Faculty Fellow, + University of + +On line 14506: + Banking Gary Gorton, + Professor of Finance, School + of Management, Yale + +On line 14506: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 14508: + Rayburn House Office + Building, Room Washington, DC, + Day April Session The + + Federal Reserve + Alan Greenspan, Former Chairman, Board + of Governors of + +On line 14512: + Origination and + Securitization Richard + Bitner, Managing + +On line 14512: + Confessions of a + Subprime Lender: An Insider’s + Tale of Greed, Fraud, and + +On line 14512: + Bowen, Former Senior + Vice President and Business + Chief Underwriter, + +On line 14516: + Session Citigroup + Subprime-Related Structured Products and Risk + Management Murray + +On line 14516: + Former Managing + Director, Independent + Risk, Citigroup, Inc. + +On line 14520: + Bushnell, Former Chief + Risk Officer, Citigroup, + Inc. Nestor Dominguez, Former + +On line 14522: + Maheras, Former Co-chief + Executive Officer, + Citi Markets Banking + +On line 14522: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 14524: + House Office Building, + Room Washington, DC, Day April + Session Citigroup + + Senior Management + Charles O. Prince, Former Chairman + of the Board and Chief + +On line 14528: + Citigroup, Inc. Robert + Rubin, Former Chairman of + the Executive + +On line 14532: + Inc. Session Office + of the Comptroller of the + Currency John C. + +On line 14532: + Comptroller, Office + of the Comptroller of the + Currency John D. + +On line 14532: + Former Comptroller, + Office of the Comptroller + of the Currency + +On line 14532: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 14534: + House Office building, + Room Washington, DC, Day April + Session Fannie Mae + +On line 14536: + Executive Vice + President and Chief Business + Officer, Fannie + +On line 14536: + President and Chief + Executive Officer, + Fannie Mae Session + +On line 14536: + Housing Enterprise + Oversight James Lockhart, Former + Director, Office + +On line 14540: + Appendix B: List + of Hearings and Witnesses + Public Hearing on + +On line 14542: + Room Washington DC, + Day May Session Investment + Banks and the Shadow + +On line 14542: + System Paul Friedman, + Former Senior Managing + Director, Bear Stearns + +On line 14542: + Co-chief Operating + Officer, Bear Stearns Session + Investment Banks and + +On line 14542: + Banking System James + E. Cayne, Former Chairman and + Chief Executive + +On line 14542: + Bear Stearns Alan D. Schwartz, + Former Chief Executive + Officer, Bear Stearns + +On line 14544: + Regulation of + Investment Banks Charles Christopher + Cox, Former Chairman, + +On line 14544: + Securities and + Exchange Commission William H. + Donaldson, Former + +On line 14544: + U.S. Securities + and Exchange Commission H. + David Kotz, Inspector + +On line 14544: + U.S. Securities + and Exchange Commission Erik + R. Sirri, Former + +On line 14546: + Trading Markets, U.S. + Securities and Exchange + Commission Public + +On line 14548: + Washington DC, Day + May Session Perspective on + the Shadow Banking + +On line 14550: + Henry M. Paulson + Jr., Former Secretary, U.S. + Department of the + +On line 14552: + Department of the + Treasury; Former President, + Federal Reserve + +On line 14558: + Chief Executive + Officer, GE Capital + Mark S. Barber, Vice + +On line 14560: + Capital Paul A. + McCulley, Managing Director, + PIMCO Steven R. Meier, + +On line 14560: + Street Public Hearing + on Credibility of + Credit Ratings, the + +On line 14560: + Based on Those Ratings, + and the Financial Crisis, + The New School Arnhold + +On line 14560: + Lang Community + Student Center, West 13th Street, + 2nd Floor, New York, NY, + +On line 14564: + Kolchinsky, Former Team + Managing Director, US + Derivatives, Moody’s + +On line 14564: + Nicolas S. Weill, Group + Managing Director, Moody’s + Investors Service Gary + +On line 14564: + US Derivatives, + Moody’s Investors Service Session + Credit Ratings and + +On line 14566: + McDaniel, Chairman and Chief + Executive Officer, + Moody’s Corporation + +On line 14568: + President and Chief + Operating Officer, + Moody’s Investors Service + +On line 14570: + Mark Froeba, Former + Senior Vice President, US + Derivatives, Moody’s + +On line 14574: + Appendix B: List + of Hearings and Witnesses + Public Hearing on + +On line 14578: + Room Washington, DC, + Day June Session Overview of + Derivatives Michael + +On line 14580: + Chair Professor of + Finance, University of + Maryland Michael Masters, + +On line 14582: + Officer, Masters + Capital Management, LLC + Session American + +On line 14584: + International + Group, Inc. Financial Products + Robert E. Lewis, Senior + +On line 14584: + President and Chief + Risk Officer, American + International + +On line 14590: + and Derivatives + Craig Broderick, Managing + Director, Head of + + Credit, Market, and + Operational Risk, Goldman + Sachs Group, Inc. Gary D. + +On line 14592: + President and Chief + Operating Officer, + Goldman Sachs Group, Inc. + + Public Hearing on + the Role of Derivatives + in the Financial + +On line 14596: + Office Building, Room + Washington DC, Day July + Session American + +On line 14598: + Inc. and Goldman Sachs + Group, Inc. Steven J. Bensinger, Former + Executive Vice + +On line 14602: + International + Group, Inc. Financial Services + Elias F. Habayeb, Former + +On line 14604: + International + Group, Inc. Financial Services + David Lehman, Managing + +On line 14604: + Goldman Sachs Group, Inc + David Viniar, Executive Vice + President and Chief + +On line 14608: + Supervisors and + Regulators Eric R. + Dinallo, Former + +On line 14608: + Former Managing + Director for Complex and + International + +On line 14614: + Washington DC, Day + September Session Wachovia + Corporation Scott + +On line 14614: + Alvarez, General + Counsel, Board of Governors + of the Federal + +On line 14614: + John H. Corston, Acting + Deputy Director, Division + of Supervision + +On line 14616: + Federal Deposit + Insurance Corporation + Robert K. Steel, Former + +On line 14618: + and Executive + Vice President, Federal + Reserve Bank of New + +On line 14626: + Appendix B: List + of Hearings and Witnesses + Richard S. "Dick" Fuld Jr., + +On line 14628: + Partner, Weil, Gotshal + Manges, LLP Barry L. Zubrow, Chief + Risk Officer, JPMorgan + +On line 14632: + Room Washington DC, + Day September Session The + Federal Reserve + + Ben S. Bernanke, Chairman, + Board of Governors of the + Federal Reserve + +On line 14636: + Federal Deposit + Insurance Corporation + Sheila C. Bair, Chairman, + +On line 14636: + Federal Deposit + Insurance Corporation + Public Hearing on + + the Impact of the + Financial Crisis—Greater Bakersfield, + Kern County Board of + +On line 14646: + City Councilwoman, + Ward Session Local Banking + Arnold Cattani, Chairman, + + Mission Bank Steve Renock, + President and CEO, Kern Schools + Federal Credit + + Union D. Linn Wiley, + Vice Chairman, CVB Financial + Corporation and + +On line 14648: + Citizens Business + Bank Session Residential + and Community + +On line 14650: + Gregory D. Bynum, + President, Gregory D. + Bynum and Associates, + +On line 14656: + Inc. Session Local + Housing Market Gary Crabtree, + Principal Owner, + + Affiliated + Appraisers Lloyd Plank, Lloyd E. + Plank Real Estate + +On line 14666: + Preferred Jeannie McDermott, + Small Business Owner Session + Forum for Public + +On line 14674: + Stephen Urner Marvin + Dean Marie Vasile Public Hearing + on the Impact of + +On line 14674: + Financial Crisis—State of + Nevada, University of + Nevada, Las Vegas, + +On line 14676: + Student Union Building, + Las Vegas, NV, September + Session Economic + + Analysis of the + Impact of the Financial + Crisis on Nevada + +On line 14678: + Applied Analysis + Session The Impact of the + Financial Crisis + + on Businesses of + Nevada Steve Hill, Founder, Silver + State Materials + +On line 14680: + Immediate Past + Chairman, Las Vegas Chamber + of Commerce William E. + +On line 14680: + Vice Chairman and Chief + Executive Officer, + Service 1st Bank of + +On line 14684: + List of Hearings and + Witnesses Wally Murray, + President and Chief + +On line 14684: + Philip G. Satre, Chairman, + International Gaming + Technology (IGT); + +On line 14686: + NV Energy, Inc. + Session The Impact of the + Financial Crisis + +On line 14686: + Bogden, United States + Attorney, State of Nevada + Gail Burks, President + +On line 14686: + Officer, Nevada + Fair Housing Center Brian + Gordon, Principal, + +On line 14688: + Session The Impact + of the Financial Crisis + on Nevada Public + +On line 14690: + Counties David Fraser, + Executive Director, + Nevada League of Cities + +On line 14692: + School District Session + Forum for Public Comment + Public Hearing on + +On line 14692: + of the Financial + Crisis—Miami, Florida, Florida + International + +On line 14694: + Modesto A. Madique Campus, + Miami, FL, September + Session Overview of + + Mortgage Fraud William K. + Black, Associate Professor + of Economics and + +On line 14698: + Missouri–Kansas City Ann Fulmer, + Vice President of Business + Relations, Interthinx; + +On line 14700: + Fraud Prevention and + Awareness Coalition Henry N. + Pontell, Professor + +On line 14706: + Mortgage Fraud Task Force, + Miami-Dade Police Department Jack + Rubin, Senior Vice + +On line 14706: + Bank Ellen Wilcox, Special + Agent, Florida Department + of Law Enforcement + +On line 14706: + The Regulation, + Oversight, and Prosecution + of Mortgage Fraud in + +On line 14706: + Regulation, State + of Florida Wilfredo + A. Ferrer, United + +On line 14706: + of Florida R. + Scott Palmer, Special Counsel and + Chief of the Mortgage + +On line 14706: + Task Force, Office of + the Attorney General, + State of Florida + +On line 14708: + the Financial Crisis—Sacramento, + California Department + of Education, + +On line 14710: + September Session + Overview of the Sacramento + Housing and Mortgage + +On line 14712: + the Impact of the + Financial Crisis on the + Region Mark Fleming, + +On line 14716: + Fraud and Predatory + Lending in the Sacramento + Region Karen J. Mann, + +On line 14716: + and Chief Appraiser, + Mann and Associates Real + Estate Appraisers + +On line 14720: + President, Putnam + Housing Finance Consulting + Appendix B: List + +On line 14722: + Kevin Stein, Associate + Director, California + Reinvestment Coalition + +On line 14722: + Attorney, Eastern + District of California + Session The Mortgage + +On line 14722: + Vicki Beal, Senior + Vice President, Transaction + Management, Clayton + +On line 14724: + Professor of Law, + Chapman University School + of Law D. Keith + +On line 14726: + Mutual’s Long Beach + Mortgage Session The Impact + of the Financial + +On line 14726: + and Families Pam + Canada, Chief Executive + Officer, NeighborWorks Home + +On line 14728: + Center–Sacramento Region Mona Tawatao, + Regional Counsel, Legal + Services of Northern + +On line 14732: + Credit Union Public + Testimony Presented + Allen Carpenter Lovie + +On line 14742: + data come from the + sources listed below. Board of + Governors of the + +On line 14742: + international + capital flows, and the size + and activity + +On line 14742: + Economic output + (GDP), spending, wages, and sector + profit Bureau of + +On line 14748: + origination of + mortgages, issuance of mortgage-backed + securities and + +On line 14750: + outstanding Markit + Group: ABX-HE index Mortgage Bankers + Association + +On line 14752: + Mortgage delinquency + and foreclosure rates 10-Ks, 10-Qs, + and proxy statements filed + +On line 14754: + Company-specific + information Many of the + documents cited + +On line 14754: + pages, along with other + materials, are available + on www.fcic.gov. + +On line 14763: + Prince, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 14763: + Government-Sponsored Enterprises + (GSEs), day session Citigroup + Senior Management, + +On line 14765: + p. Warren Buffett, + testimony before the + FCIC, Hearing on the + +On line 14765: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 14765: + Credit Ratings and + the Financial Crisis, June + transcript, p. Warren + +On line 14767: + FCIC, May Lloyd Blankfein, + testimony before the + First Public Hearing + +On line 14767: + the FCIC, day panel + Financial Institution + Representatives, + +On line 14769: + transcript, p. Ben S. + Bernanke, closed-door session with FCIC, + November Ben S. + +On line 14769: + Financial Crisis, + day session The Federal + Reserve, September + +On line 14771: + p. Alan Greenspan, written + testimony for the FCIC, + Subprime Lending and + +On line 14779: + Enterprises (GSEs), + day session The Federal + Reserve, April p. Notes + +On line 14783: + to Chapter Richard C. + Breeden, interview by FCIC, + October Paul A. + + McCulley, testimony + before the FCIC, Hearing on + the Shadow Banking + +On line 14785: + the Financial Crisis—Greater + Bakersfield, session Local + Banking, September + +On line 14787: + the Impact of the + Financial Crisis—State of Nevada, + session The Impact + + of the Financial + Crisis on Businesses of + Nevada, September + +On line 14789: + The Mortgage Market + Statistical Annual, + vol. The Primary + +On line 14789: + Finance, p. "Mortgage + Product by Origination." + Data provided + +On line 14789: + Association + of Realtors: national + home price data from + +On line 14789: + sales of existing + homes, comparing second-quarter + and second-quarter the + +On line 14791: + national peak in + prices. Core-based statistical area + house prices for Sacramento–Arden–Arcade–Roseville CA + +On line 14793: + CoreLogic data. Data + provided by CoreLogic, Home Price + Index for Urban + +On line 14793: + calculated house + price growth from January to + peak of each market. + +On line 14793: + Prices increased at least + in cities, at least in cities, at + least in cities, at least + +On line 14795: + in cities, and more than + in cities. Updated data + provided by James + +On line 14797: + Alan Greenspan, whose data + originally appeared in + "Sources and Uses of + +On line 14799: + Series, Federal + Reserve Board, 2007-20 (March "Mortgage + Originations Rise + +On line 14799: + Half of Demand for + Interest Only, Option + ARM and Alt-A Products + + Increases," Mortgage + Bankers Association press + release, October + +On line 14801: + the weekly wage of + New York investment banker was + of the average + +On line 14803: + privately employed + worker, Federal Reserve + Survey of Consumer + +On line 14807: + by FCIC. Angelo + Mozilo, interview by FCIC, + September Michael Mayo, + +On line 14809: + Financial Market + Participants, January + transcript, p. "Mortgage + +On line 14811: + in First Half of MBA + press release, October Yuliya + Demyanyk and Yadav + +On line 14811: + ARMs: Popular Loans, + Poor Performance," Federal + Reserve Bank of St. + +On line 14813: + Bridges (Spring Ann Fulmer, + vice president of Business + Relations, Interthinx + +On line 14813: + Mortgage Fraud), and Ellen + Wilcox, special agent, Florida + Department of Law + +On line 14813: + Fraud in Miami), + testimony before the + FCIC, Hearing on the + +On line 14817: + Michael Calhoun, Center + for Responsible Lending, + interview by FCIC, + +On line 14821: + meeting, Thursday, March + Federal Reserve Board, "Mean + Value of Mortgages + +On line 14821: + for Families with + Holdings," in SCF Chartbook, June + tables updated + +On line 14827: + Cruise, interview by + FCIC, August Ibid. Robert Kuttner, + interview by FCIC, + +On line 14829: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 14831: + the Shadow Banking + System, May transcript, p. James + Ryan, chief marketing + + officer at CitiFinancial + and John Schachtel, executive + vice president of + +On line 14833: + CitiFinancial, interview by + FCIC, February These points were + made to the FCIC by + +On line 14833: + Kevin Stein, associate + director, California + Reinvestment Coalition, + +On line 14833: + the Hearing on the + Impact of the Financial + Crisis—Sacramento, session Mortgage + +On line 14833: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 14833: + president and CEO, + Nevada Fair Housing Center, + at the Hearing on + +On line 14833: + the Impact of the + Financial Crisis—State of Nevada, + session The Impact + + of the Financial + Crisis on Nevada Real + Estate, September + +On line 14841: + June October March + October June October + Notes to Chapter Bob + +On line 14845: + interview by FCIC, + March James Rokakis, interview by + FCIC, November Ibid. + +On line 14847: + Edward M. Gramlich, + "Tackling Predatory Lending: + Regulation and + +On line 14855: + Stein, testimony + before the FCIC, transcript, pp. + U.S. Department of + +On line 14857: + Mortgage Lending" (June + Federal Reserve Board press + release, December + +On line 14859: + Sheila C. Bair, written + testimony for the FCIF, + First Public Hearing + +On line 14859: + day panel Current + Investigations into + the Financial Crisis—Federal + +On line 14863: + January Sheila C. + Bair, testimony before + the FCIC, First Public + +On line 14863: + day panel Current + Investigations into + the Financial Crisis—Federal + +On line 14867: + January transcript, + p. Sheila C. Bair, interview + by FCIC, March Mortgage + +On line 14871: + "Top B&C Lenders in Ibid., + "Subprime Origination by + State in and "Subprime + +On line 14875: + Stein, testimony + before the FCIC, September + transcript, p. Gail Burks, + +On line 14877: + interview by FCIC, + August Lisa Madigan, written + testimony for + +On line 14877: + Public Hearing of + the FCIC, day panel Current + Investigations + +On line 14879: + p. "Home Mortgage Lender + settled ‘Predatory Lending’ + Charges," Federal Trade + +On line 14881: + B&C Lenders in Madigan, + written testimony for + the FCIC, January + +On line 14885: + interview by FCIC, + May Prentiss Cox, interview + by FCIC, October + +On line 14893: + FCIC, October Cox, + interview; Madigan, written + testimony for + +On line 14897: + John D. Hawke Jr. and + John C. Dugan, written statements + for the FCIC, Hearing + +On line 14897: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 14897: + day session Office + of the Comptroller of the + Currency, April pp. + +On line 14903: + testimony for + the FCIC, January pp. Cox, + interview. Mortgage + +On line 14907: + by Product." Nonprime + Alt-A and subprime combined. Marc + S. Savitt, interview + +On line 14909: + by FCIC, November + Rob Barry, Matthew Haggman, and + Jack Dolan, "Ex-convicts + +On line 14911: + on the Impact of + the Financial Crisis—Miami, session + The Regulation, + +On line 14913: + Prosecution of + Mortgage Fraud in Miami, + September p. Savitt, + +On line 14917: + on the Impact of + the Financial Crisis— Greater + Bakersfield, session + +On line 14927: + Market, September + p. Ibid. Notes to Chapter Gary + Crabtree, interview + +On line 14927: + FCIC, August Crabtree, + written testimony for + the FCIC, September + +On line 14929: + "FBI Warns of Mortgage + Fraud ‘Epidemic’ from Terry + Frieden," CNN news report, + +On line 14931: + "FBI Vows to Crack Down + on Mortgage Fraud; Hot Real + Estate Market Drives + +On line 14933: + Says," Washington Post, + February Financial Crimes + Enforcement Network, + +On line 14933: + "Mortgage Loan Fraud: An + Industry Assessment Based + upon Suspicious + +On line 14935: + Enforcement Network, + "Annual Report: Fiscal + Year FinCEN response to + +On line 14937: + October William K. + Black, written testimony + for the FCIC, Hearing + +On line 14939: + of the Financial + Crisis— Miami, session + Overview of Mortgage + +On line 14949: + transcript, p. Ibid., p. + Ruhi Maker, interview by + FCIC, October Kirstin + +On line 14951: + Downey, "Many Buyers Opt + for Risky Mortgages," Washington + Post, May "After the + + Fall: Soaring house prices + have given a huge boost to + the world economy. + +On line 14953: + What happens when they + drop1" The Economist, June Fed + Chairman Alan Greenspan, "The + +On line 14957: + the Joint Economic + Committee, 109th Cong., 1st sess., + June Ibid. Fed Chairman + +On line 14959: + the Joint Economic + Committee, U.S. Congress, 110th + Cong., 1st sess., March Sheila + +On line 14961: + October transcript, + p. David Leonhardt, "Be Warned: Mr. + Bubble’s Worried Again," + +On line 14963: + New York Times, August + Raghuram Rajan, interview + by FCIC, November + +On line 14969: + Ibid. Ibid. Raghuram G. + Rajan, Fault Lines: How Hidden + Fractures Still Threaten + +On line 14971: + Economy (Princeton: + Princeton University Press, + p. Susan M. Wachter, + +On line 14977: + FCIC, Hearing on the + Impact of the Financial + Crisis— Miami, + +On line 14981: + FCIC, Hearing on the + Impact of the Financial + Crisis— Sacramento, + +On line 14981: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 14985: + Annual, vol. The + Secondary Market, p. "Non-Agency MBS + Issuance by Type," and + +On line 14987: + FCIC staff estimates + based on analysis of Moody’s + SFDRS data. Jamie + +On line 14987: + the FCIC, day panel + Financial Institution + Representatives, + +On line 14991: + transcript, p. Madelyn + Antoncic, interview by + FCIC, July Anton + + R. Valukas, Report of + Examiner, In re Lehman + Brothers Holdings Inc., + +On line 14995: + Chapter Case No. 08-13555 + (JMP), (Bankr. S.D.N.Y.), March with n. + Richard Bowen, interview + +On line 15001: + Rubin, David Bushnell, + Gary Crittenden, and Bonnie + Howard, November Notes + +On line 15005: + on Subprime Lending + and Securitization + and Government-Sponsored Entities + +On line 15007: + Citigroup Senior + Management, April transcript, p. + Brad S. Karp, counsel + +On line 15007: + to FCIC, November + in response to FCIC request + of September for + +On line 15011: + Bowen’s November email, + p. Bowen, interview. J. Kyle + Bass, testimony + +On line 15013: + Financial Market + Participants, January + transcript, pp. Herbert + + M. Sandler, "Comment + on Joint ANPR for Proposed + Revision to the + +On line 15013: + the Comptroller of + the Currency, Federal + Deposit Insurance + +On line 15015: + and Office of Thrift + Supervision, January + Lewis Ranieri, interview + +On line 15017: + Angelo Mozilo, + email to Eric Sieracki, + April re: 1Q2006 Earnings. + +On line 15021: + Mozilo, email to David + Sambol, April subject: sub-prime + seconds. David Sambol, + +On line 15021: + Angelo Mozilo, + April re: Sub-prime seconds (cc + Kurland, McMurray, and Bartlett). + +On line 15023: + to David Sambol, April + subject: re: Sub-prime seconds + (cc Kurland, McMurray, and + +On line 15027: + Federal Reserve + document obtained by FCIC, + produced November + +On line 15031: + FDIC, October John + Dugan, testimony before + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15033: + of the Currency, + April transcript, Sabeth Siddique, + interviews by FCIC, + +On line 15037: + interview. Mortgage + Insurance Companies of + America, quoted + +On line 15039: + Mortgages; Firms Want More + Loan Restrictions," Washington + Post, August William A. + +On line 15039: + before the Senate + Subcommittee on Housing + and Transportation and + +On line 15043: + September Siddique, + interviews, October and + September Consumer + +On line 15049: + June transcript. Siddique, + interview, October Bies, + interview. There is + +On line 15049: + finance assets. The + FCIC’s estimate is based on + the amount of structured + +On line 15049: + unrated agency + RMBS, along with an estimate + for structured finance + +On line 15049: + not rated by Moody’s, + using as sources Fannie Mae + and Freddie Mac, Bloomberg, + + American CoreLogic Loan + Performance, Fitch Ratings, Moody’s, + S&P, Thomson Reuters, and + +On line 15051: + Greenspan, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 15051: + Enterprises (GSEs), + day session The Federal + Reserve, April transcript, + +On line 15053: + news release, second + quarter, Second-quarter figures + were an improvement + +On line 15055: + Mark Zandi, written + testimony for the FCIC, + First Public Hearing + +On line 15055: + the FCIC, day panel + Financial Crisis Impacts + on the Economy, + +On line 15059: + Warren Peterson, + testimony before the + FCIC, Hearing on the + +On line 15061: + and Community + Real Estate, September + transcript, pp. Warren + +On line 15076: + of Systemic Risk in + the Financial Crisis, day + session September + +On line 15078: + Greenspan, "The Evolution + of Banking in a Market + Economy," remarks + +On line 15080: + Private Enterprise + Education, Arlington, + Virginia, April Charles Calomiris + + and Gary Gorton, "The + Origins of Banking Panics: + Models, Facts, and Bank + + Regulation," in + Calomiris, U.S. Bank Deregulation + in Historical + +On line 15080: + Perspective (Cambridge: + Cambridge University Press, + pp. Prior to the + + end of the Civil + War, banks issued notes instead + of holding deposits. + +On line 15082: + Runs on that system + occurred in and (ibid., pp. R. + Alton Gilbert, "Requiem + + for Regulation + Q: What It Did and Why It + Passed Away," Federal + +On line 15084: + Reserve Bank of St. + Louis Review no. (February + FCIC, "Preliminary + +On line 15088: + Staff Report: Shadow + Banking and the Financial + Crisis," May pp. Arthur + +On line 15088: + Financial Services + Industry, Competition, + Consolidation, + +On line 15090: + Frederic S. Mishkin, + "Asymmetric Information + and Financial Crises: + +On line 15090: + Financial Markets + and Financial Crises, ed. R. + Glenn Hubbard (Chicago: + +On line 15090: + of Chicago Press, p. + Wilmarth, "The Transformation of + the U.S. Financial + +On line 15092: + Services Industry, + p. Federal Reserve Board + Flow of Funds Release, + +On line 15094: + table L.208. Accessed + December Kenneth Garbade, + "The Evolution of + +On line 15094: + Federal Reserve + Bank of New York Economic + Policy Review + +On line 15094: + Federal Reserve + Bank of New York uses the + repo market: it + + sets interest rates + by borrowing Treasuries from + and lending them to + +On line 15096: + firms, many of which are + units of commercial banks. Alan + Blinder, interview + +On line 15098: + by FCIC, September + Paul Volcker, interview + by FCIC, October + +On line 15100: + "International + Financial Risk Management," + remarks before the + +On line 15102: + Foreign Relations, + November Richard C. Breeden, + interview by FCIC, + +On line 15104: + October Wilmarth, "The + Transformation of the U.S. + Financial Services + +On line 15106: + Industry, p. and + n. Thereafter, banks were only + required to lend on + +On line 15106: + terms based upon what + the market was offering. + They also could not + +On line 15106: + lend more than of their + capital to one subsidiary + or more than to all + +On line 15106: + Dealing in Certain + Securities," Federal + Reserve Bulletin no. + +On line 15106: + Bank-Ineligible Activities + of Subsidiaries of Bank Holding + Companies Engaged + +On line 15108: + in Securities," + Federal Register no. + (Dec. Julie L. Williams and + +On line 15110: + of Banking: Looking + to the Future," Business Lawyer + (May Fed Chairman Alan + +On line 15110: + Financial Services, + H.R. the Financial Services + Competitiveness + +On line 15114: + 105th Cong., 1st sess., May + FCIC staff calculations. FCIC + staff calculations. + +On line 15116: + staff calculations + using First American/CoreLogic, National + HPI Single-Family Combined (SFC). + +On line 15118: + before showed no year-over-year + national house price decline. + First American/CoreLogic, National + +On line 15120: + HPI Single-Family Combined (SFC). + For a general overview + of the banking and + + thrift crisis of the + 1980s, see FDIC, History of + the Eighties: Lessons for + +On line 15120: + the Future, vol. An + Examination of the + Banking Crises of the + + 1980s and Early 1990s + (Washington, DC: Federal + Deposit Insurance + +On line 15128: + and federally + insured banks with billion in + assets and savings + +On line 15128: + closed or received FDIC + or FSLIC assistance. See + Federal Deposit + +On line 15132: + (Aug. pp. William K. Black, + Associate Professor of + Economics and Law, + +On line 15132: + the Impact of the + Financial Crisis, session + Overview of Mortgage + +On line 15132: + September p. And + see Kitty Calavita, Henry + N. Pontell, and Robert + +On line 15132: + Till-man, Big Money + Crime: Fraud and Politics in + the Savings and Loan + +On line 15134: + University of + California Press, p. FDIC, + History of the + +On line 15136: + Financial System: + Recommendations for Safer, + More Competitive + +On line 15138: + Subcommittee on + Economic Stabilization + of the Committee + +On line 15138: + Finance, and Urban + Affairs on the "Economic + Implications of + +On line 15144: + History of the + Eighties: Lessons for the Future, + George G. Kaufman, "Too + + Big to Fail in U.S. + Banking: Quo Vadis1" in Too Big + to Fail: Policies and + +On line 15146: + Bailouts, ed. Benton E. + Gup (Westport, CT: Praeger, p. FCIC, + "Preliminary Staff + +On line 15148: + hearing before the + House Committee on Banking, + Housing, and Urban + +On line 15163: + to Escape Attempt + at Tighter Regulation," Wall + Street Journal, June and + +On line 15165: + Armando Falcon + Jr., written testimony + for the FCIC, Hearing + +On line 15165: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15167: + Federal Housing + Enterprise Oversight, April p. + Wayne Passmore, "The GSE + +On line 15167: + Ambiguity," + Federal Reserve Board Staff + Working Paper See + +On line 15169: + Estimates of the + Subsidies to the Housing + GSEs," April Federal + +On line 15171: + Report to Congress, + pp. Fannie Mae Charter Act + of §309(h), codified + +On line 15171: + Federal Housing + Enterprises Financial + Safety and Soundness + +On line 15171: + and replaced it with + more elaborate provisions. + Currently, the GSEs + +On line 15171: + borrowers as those + with income at or below + median income + +On line 15179: + on the National + Homeownership Strategy," + June President George + + W. Bush, "President’s + Remarks to the National + Association + +On line 15181: + Center, Columbus, Ohio, + October Andrew Cuomo, + interview by FCIC, + +On line 15183: + Mudd, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 15191: + Government-Sponsored Enterprises + (GSEs), day session Fannie Mae, + April transcript, pp. Notes + +On line 15195: + Chapter Richard Syron, + interview by FCIC, August + Senate Lobbying + +On line 15197: + Act Database (www.senate.gov/legislative/Public_Disclosure/ LDA_reports.htm); + figures on employees and + PACs compiled by the + +On line 15201: + April p. James Lockhart, + written testimony for + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15205: + Martinez, interview + by FCIC, September June E. + O’Neill, remarks before + +On line 15207: + Federal Housing + Finance Agency, Report to + Congress, tables and + +On line 15213: + Financial Markets + Association (SIFMA), + US ABS Outstanding. + +On line 15217: + interview by FCIC, + August Gillian Tett, Fool’s Gold: How + the Bold Dream of a + +On line 15217: + at J. P. Morgan + Was Corrupted by Wall Street + Greed and Unleashed a + +On line 15219: + Catastrophe (New York: + Free Press, pp. Emmanuel Derman, + interview by FCIC, + +On line 15225: + interview. Vincent + Reinhart, interview by FCIC, + September Lindsey, + +On line 15227: + futures contract is + a bilateral contract + in which one party, + + the long position, + is compensated if the + price or index or + + rate underlying + the contract rises while the + other party, the + +On line 15227: + is compensated + if it goes down. An options + contract grants the right + +On line 15227: + commodity or + financial instrument at + a particular + + price in the future; + the option holder derives + a benefit if + +On line 15227: + his or her favor. + In a swaps contract, the two + parties exchange streams + +On line 15229: + different benchmarks. + Securities options are + regulated by + +On line 15231: + Trading Commission, + Exemption for Certain Swap + Agreements, Final Rule, + +On line 15233: + the House Committee + on Banking and Financial + Services, 105th Cong., 2nd + +On line 15237: + System," GGD-94-133 (Report + to Congressional Requesters), + May Commodity + +On line 15237: + Trading Commission, + "Division of Enforcement" + (www.cftc.gov/anr/an-renf98.htm). + +On line 15239: + Statement by Treasury + Secretary Robert E. Rubin, + Federal Reserve + +On line 15239: + Chairman Alan Greenspan, and + Securities and Exchange + Commission Chairman + +On line 15241: + May Fed Chairman Alan + Greenspan, "The Regulation of + OTC Derivatives," + +On line 15241: + the House Committee + on Banking and Financial + Services, 105th Cong., 2nd + +On line 15243: + GAO, "Long-Term Capital + Management: Regulators + Need to Focus Greater + +On line 15243: + Systemic Risk," GAO/GGD-00-3 + (Report to Congressional + Requesters), October + +On line 15243: + of such contracts. Its + calculation is based on + the value of the + +On line 15243: + or rate that the swap + is based on. It therefore may + be of limited + + use in measuring + the potential exposure + of the parties to + +On line 15243: + For example, an + interest rate swap based on + changes in interest + +On line 15243: + on a million loan + would likely involve only + a small percentage + +On line 15245: + million notional + amount. On the other hand, price + changes on an oil swap + +On line 15245: + based on million worth + of oil could be even more than + the notional amount, + + depending on the + volatility in oil prices. For + credit default swaps, + +On line 15245: + detail later in + this volume, the notional + amount is usually + + a close measure of + the potential financial + exposure of the + +On line 15253: + issuer or seller + of the swap. Notes to Chapter + Fed Chairman Alan Greenspan, + +On line 15253: + Management," prepared + testimony before the + House Committee on + +On line 15255: + Financial Services, + 105th Cong., 2nd sess., October + Fed Chairman Alan Greenspan, + +On line 15255: + Futures Industry + Association, Boca + Raton, Florida, + +On line 15257: + the Commodity + Exchange Act," report of the + President’s Working + +On line 15259: + Markets, November + Gross market value is the + current price at which + +On line 15259: + sold or replaced on + the market. As such, that amount + reflects the current + +On line 15259: + a contract but does + not reflect the possible + future exposure + +On line 15263: + Greenspan, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 15263: + Government-Sponsored Entities (GSEs), + day session The Federal + Reserve, April transcript, + +On line 15265: + on Subprime Lending + and Securitization + and Government-Sponsored Entities + +On line 15267: + Senior Management, + April transcript, pp. Lawrence Summers, + interview by FCIC, + +On line 15271: + International + Economics, p. Final Rule—Amendment + to Regulations + +On line 15275: + on Basel, pp. For more + on derivatives, see FCIC, + "Preliminary Staff + +On line 15277: + June Warren Buffett, + testimony before the + FCIC, Hearing on the + +On line 15277: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 15279: + Credit Ratings and + the Financial Crisis, June + transcript, pp. Eric + +On line 15279: + Department, written + testimony for the FCIC, + Hearing on the Role + +On line 15279: + Supervisors and + Regulators, July p. + Rochelle Katz, State of New + +On line 15281: + Bertil Lundqvist, Skadden, Arps, + Slate, Meagher Flom, LLP, June Data + provided by AIG + +On line 15283: + International + Settlements, semiannual + OTC derivatives + +On line 15285: + CDS in September + was estimated to be + trillion at a time + +On line 15285: + was about trillion of + private-sector debt (written + testimony for + +On line 15287: + the FDIC, July p. + "AIGFP also participates + as a dealer in + +On line 15287: + wide variety of + financial derivatives + transactions" (AIG, Form + +On line 15287: + p. AIG’s notional + derivatives outstanding + were trillion at the + +On line 15287: + trillion of credit + derivatives, trillion of + currency swaps, and + +On line 15289: + staff calculations + using data from Office + of the Comptroller + +On line 15297: + call reports. Data + provided to the FCIC by + Goldman Sachs. Chapter + +On line 15300: + legislation, some + states had voluntarily + opened themselves up to + + out-of-state banks. FDIC, + History of the Eighties: + Lessons for the Future, + +On line 15300: + Examination + of the Banking Crises of the + 1980s and Early 1990s + +On line 15302: + DC: FDIC, p. These were + the largest banks as of See FCIC, + "Preliminary Staff + +On line 15306: + August p. Data + from SNL Financial (www.snl.com/). + Public Law 104-208, sec. + +On line 15308: + U.S.C. law in effect + as of January Arthur Levitt, + interview by FCIC, + +On line 15316: + October Notes to + Chapter John D. Hawke and John + Dugan, testimony + +On line 15316: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15318: + the Comptroller of + the Currency, April transcript, + pp. Fed Vice Chairman + +On line 15318: + W. Ferguson Jr., + "The Future of Financial + Services—Revisited," remarks at the + +On line 15318: + Financial Services + Conference, University + of Massachusetts, + +On line 15320: + Fed Chairman Alan Greenspan, + "Government Regulation + and Derivative + +On line 15320: + at the Financial + Markets Conference of the + Federal Reserve + +On line 15322: + Bank of Atlanta, Coral + Gables, Florida, February + Richard Spillenkothen, "Notes on the + +On line 15322: + years preceding the + financial crisis by a + former director + +On line 15324: + and regulation + at the Federal Reserve + Board to May p. See + +On line 15324: + Department of the + Treasury, Modernizing the + Financial System + +On line 15324: + of arbitrary or + inflexible behavior. + Agency pluralism, + +On line 15324: + other hand, may be + useful, since it can bring to + bear on general + + bank supervision + the different perspectives + and experiences + +On line 15324: + each regulator, + and it subjects each one, where + consultation and + +On line 15326: + required, to the checks + and balances of the others’ + opinion." Fed Chairman + +On line 15326: + Greenspan, statement before + the Senate Committee on + Banking, Housing, and + +On line 15326: + 103rd Cong., 2nd sess., March + reprinted in the Federal + Reserve Bulletin, May + +On line 15330: + Governors of the + Federal Reserve System, + F.Supp. (D.D.C. Kathleen Day, + +On line 15330: + Depression-Era Law about to Be + Rewritten, the Future Remains + Unclear," Washington + +On line 15334: + in "The Making of + a Law," ABA Banking Journal, + December The two-year + +On line 15334: + in section 4(a)(2) of + the Bank Holding Company + Act. The Fed could have + +On line 15336: + three one-year extensions + of that exemption. FCIC staff + computations based + +On line 15336: + includes insurance + companies, commercial banks, + securities and + +On line 15338: + bankers and brokers. U.S. + Department of the Treasury, + Modernizing the + +On line 15338: + System (February + Fed Chairman Alan Greenspan, "H.R. the + Financial Services + +On line 15338: + the House Committee + on Banking and Financial + Services, 105th Cong., 1st + +On line 15340: + May Katrina + Brooker, "Citi’s Creator, Alone with + His Regrets," New York + +On line 15344: + Times, January John + Reed, interview by FCIC, March + FDIC Institution + +On line 15346: + Directory; SNL + Financial. Fed Governor + Laurence H. Meyer, + +On line 15346: + Implications of + Financial Modernization + Legislation for + +On line 15348: + Women in Housing + and Finance, Washington, D.C., + December Ben S. + +On line 15348: + Financial Crisis, + day session The Federal + Reserve, September + +On line 15352: + Review Fed Chairman + Alan Greenspan, "Lessons from the Global + Crises," remarks before + +On line 15354: + DC, September David + A. Marshall, "The Crisis of + and the Role of the + +On line 15356: + Chicago, Economic + Perspectives (1Q Commercial + and industrial + +On line 15356: + at all commercial + banks, monthly, seasonally + adjusted, from the + +On line 15356: + staff calculation + of average change in loans + outstanding over any + +On line 15358: + consecutive months + in and Franklin R. Edwards, "Hedge + Funds and the Collapse + +On line 15366: + Management," Journal + of Economic Perspectives + Notes to Chapter "Hedge + +On line 15366: + of Long-Term Capital + Management," Report of the + President’s Working + +On line 15368: + Group on Financial + Markets, April p. Edwards, "Hedge + Funds and the Collapse + +On line 15370: + of Long-Term Capital + Management," pp. and Bloomberg. Ibid., + pp. Roger Lowenstein, When + + Genius Failed: The Rise + and Fall of Long-Term Capital + Management (New York: + +On line 15374: + "Hedge Funds, Leverage, and + the Lessons of Long-Term Capital + Management," pp. William + +On line 15374: + McDonough, president of + the Federal Reserve Bank + of New York, statement + +On line 15374: + the House Committee + on Banking and Financial + Services, 105th Cong., 2nd + +On line 15376: + sess., October GAO, + "Long-Term Capital Management: + Regulators Need + +On line 15376: + Greater Attention on + Systemic Risk," GAO/GGD-00-3 (Report + to Congressional + +On line 15380: + and the Lessons of Long-Term + Capital Management," pp. + Lowenstein, When Genius + +On line 15382: + the House Committee + on Banking and Financial + Services, October + +On line 15384: + Brimmer, "Distinguished + Lecture on Economics in + Government: Central + +On line 15384: + Markets," Journal of + Economic Perspectives, no. + (Spring (lecture by a + +On line 15384: + interventions in + and and concluding that the + Fed had consciously + + assumed a "strategic + role as the ultimate source + of liquidity + +On line 15384: + Federal Reserve + Bank of New York Economic + Policy Review + +On line 15390: + interview by FCIC, + September Fed Chairman Alan + Greenspan, "Do efficient + + financial markets + mitigate financial crises1" + remarks before the + +On line 15390: + Conference of the + Federal Reserve Bank of + Atlanta, October + +On line 15396: + "Hedge Funds, Leverage, and + the Lessons of Long-Term Capital + Management," p. Ibid. + +On line 15402: + Ibid. Philip Goldstein, et + al. v. SEC, Opinion, Case No. + 04-1434 (D.C. Cir. June Time, + +On line 15402: + Bob Woodward, Maestro: + Greenspan’s Fed and the American + Boom (New York: Simon + +On line 15406: + Board of Governors + of the Federal Reserve + System, Federal + +On line 15406: + Flow of Funds Accounts + of the United States, 4th Qtr. + p. (Table L.213, line + +On line 15408: + SEC Chairman William H. + Donaldson, "Testimony + Concerning Global + +On line 15408: + Settlement," before + the Senate Committee on + Banking, Housing and + +On line 15410: + Affairs, 108th Cong., 1st + sess., May SEC, "SEC Fact Sheet on + Global Analyst + +On line 15410: + Research Settlements," + April Financial Industry + Regulatory + +On line 15412: + news release, "NASD Fines + Piper Jaffray Million for IPO + Spinning," July Arthur + +On line 15412: + Wilmarth Jr., "Conflicts of + Interest and Corporate + Governance Failures + +On line 15412: + Banks During the Stock + Market Boom of the 1990s: The + Cases of Enron + +On line 15414: + Theory Working + Paper Fed Chairman Alan Greenspan, + "International + +On line 15416: + Services—Revisited." Spillenkothen, "Notes on the + performance of prudential + supervision in + +On line 15418: + the years preceding + the financial crisis," p. + "First the Put; Then the + +On line 15426: + p. Notes to Chapter + Fed Chairman Alan Greenspan, "Risk and + Uncertainty in + +On line 15426: + at the Meetings of + the American Economic + Association, + +On line 15426: + Diego, California, + January See also Fed + Governor Ben S. + +On line 15428: + Association + of Business Economics, New + York, October Fed + +On line 15428: + Alan Greenspan, "Reflections + on Central Banking," remarks + at a symposium + +On line 15430: + Federal Reserve + Board of Kansas City, Jackson + Hole, Wyoming, August Lawrence + +On line 15432: + Lindsey, interview + by FCIC, September The NYSE + decided in to + +On line 15434: + be publicly traded. + See Andrew von Norden - + flycht, "The Demise of + + the Professional + Partnership1 The Emergence and + Diffusion of Publicly-Traded + +On line 15436: + Peter Solomon, written + testimony for the FCIC, + First Public Hearing + +On line 15438: + Financial Market + Participants, January + p. Brian R. Leach, + +On line 15440: + by FCIC, March p. Jian + Cai, Kent Cherny, and Todd Milbourn, + "Compensation and + +On line 15440: + Banking and Finance," + Federal Reserve Bank of + Cleveland Economic + +On line 15442: + Frydman and Raven + E. Saks, "Historical Trends + in Executive + +On line 15444: + "Compensation and + Risk Incentives in Banking + and Finance." Goldman + +On line 15448: + Sachs, and 10-K; Morgan + Stanley, 10-K; Merrill Lynch, and + 10-K. "Gutfreund’s Pay + +On line 15452: + Is Cut," New York Times, + December Merrill Lynch, Proxy + Statement," p. Goldman + +On line 15454: + of Shareholders," March + p. Blankfein received base salary + and a year-end bonus of + +On line 15458: + Brothers, "Proxy Statement + for Year-end p. JP Morgan Chase, + Proxy Statement," p. New + + York State Office of + the State Comptroller, "New York + City Securities + +On line 15458: + Industry Bonus Pool," + February The bonus pool is + for securities + +On line 15460: + (NAICS employees who + work in New York City. "Banks Set + for Record Pay, Top Firms + +On line 15462: + Award Billion for Up + WSJ Study Finds," WSJ.com, January + Sandy Weill, interview + +On line 15464: + by FCIC, October + Lord Adair Turner, interview + by FCIC, November + +On line 15466: + Financial Crisis, + day session The Federal + Reserve, September + +On line 15468: + p. Testimony + of Armando Falcon Jr., + former director + +On line 15468: + Federal Housing + Enterprise Oversight, written + testimony for + +On line 15468: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15470: + Federal Housing + Enterprise Oversight, April pp. + Sheila C. Bair, written + +On line 15470: + Public Hearing of + the FCIC, day panel Current + Investigations + +On line 15472: + the Financial Crisis—Federal + Officials, January p. + Mary L. Schapiro, written + +On line 15472: + Public Hearing of + the FCIC, day panel Current + Investigations + +On line 15474: + the Financial Crisis—Federal + Officials, January p.18. + Bloomberg LLC, Financial + +On line 15474: + for JPM, Citigroup, + Bank of America, Goldman + Sachs, and Lehman Brothers. + +On line 15476: + SEC filings 10-K and + 10-Q; see the 10-K, p. Total + Assets and Fannie + +On line 15478: + held by Third Parties; + Federal Housing Finance + Agency, Report to + +On line 15482: + staff calculations. + SNL Financial Database and + SEC public filings. + +On line 15500: + John Snow, interview + by FCIC, October Ibid. Notes + to Chapter Chapter + +On line 15503: + the Impact of the + Financial Crisis—State of Nevada, + session The Impact + + of the Financial + Crisis on Nevada Real + Estate, September + +On line 15505: + p. Tom C. Putnam, + president, Putnam Housing + Finance Consulting, + +On line 15505: + FCIC, Hearing on the + Impact of the Financial + Crisis—Sacramento, session Mortgage + +On line 15505: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 15507: + Board of Governors + of the Federal Reserve + System, Federal + +On line 15507: + of Funds Accounts of + the United States, release date, + December Table + + L.1: Credit Market + Debt Outstanding, and Table + L.126: Issuers of Asset-Backed + +On line 15509: + Securities (ABS) + Jim Callahan, interview by + FCIC, October Lewis + +On line 15511: + chairman of Salomon + Brothers, interview by FCIC, + July Federal + + Deposit Insurance + Corporation, "Managing + the Crisis: The FDIC + +On line 15517: + RTC Experience" + (August pp. Ibid., Ibid., pp. The + figures throughout this + +On line 15517: + calculations, based + on analysis of loan-level + data from Blackbox + +On line 15517: + PDS database; Moody’s CDO + EMS database; and Citigroup, + Fannie Mae Term Sheet, + +On line 15519: + Brad S. Karp, counsel + for Citigroup, letter to + FCIC, November p. + +On line 15521: + of its tranches are + as given by Standard Poor’s. + Technically, this + +On line 15521: + tranches below the + equity tranche, also held + by Citigroup and + +On line 15523: + fund. Fed Chairman Ben + S. Bernanke, "The Community + Reinvestment Act: Its + +On line 15523: + New Challenges," speech at + the Community Affairs + Research Conference, + +On line 15527: + Glenn Canner and Wayne + Passmore, "The Community + Reinvestment Act and + + the Profitability + of Mortgage-Oriented Banks," Working Paper, + Federal Reserve + +On line 15527: + and moderate-income + borrowers have income that + is at most of area + +On line 15529: + Alan Greenspan, "Economic + Development in Low- and + Moderate-Income Communities," + +On line 15533: + John Dugan, interview + by FCIC, March Lawrence B. Lindsey, + interview by FCIC, + +On line 15535: + "The Evolution of + the Subprime Mortgage Market," + Federal Reserve + +On line 15537: + of St. Louis Review + no. (January/February Southern Pacific + Funding Corp, Form 8-K, + +On line 15539: + as of according + to FCIC staff calculations + using data from + +On line 15539: + The Mortgage Market + Statistical Annual, + vol. The Primary + +On line 15539: + Md.: Inside Mortgage + Finance Publications, p. + "Top B&C Lenders in Thomas + +On line 15539: + for the Effects of + Securitization: Tools + for Analysis," Moody’s + +On line 15541: + Research, October + "FDIC Announces Receivership of + First National Bank + +On line 15541: + Federal Deposit + Insurance Corporation + and Office of the + +On line 15543: + Comptroller of the + Currency joint press release, + September FCIC staff + +On line 15545: + using data from + Inside MBS ABS. See Marc Savitt, + interview by FCIC, + +On line 15549: + November Henry + Cisneros, interview by FCIC, + October Glenn Loney, + +On line 15551: + interview by FCIC, + April Senate Committee on + Banking, Housing, and + +On line 15551: + Regulatory + Improvement Act of 103rd Cong., + 1st sess., October + +On line 15565: + S. Rep. p. Ibid., p. + Notes to Chapter U.S.C. 1639(h) Loans + were subject to HOEPA + + only if they hit + the interest rate trigger + or fee trigger: i.e., + +On line 15565: + rate for the loan was + more than percentage points above + the yield on Treasury + +On line 15565: + a comparable + maturity or if the + total charges paid by + +On line 15565: + borrower at or + before closing exceeded + or of the loan amount, + +On line 15569: + on Banking, Housing, + and Urban Affairs, S. Rep. + p. Ibid., p. Board of + + Governors of the + Federal Reserve System + and Department of + + Housing and Urban + Development, "Joint Report + Concerning Reform + +On line 15571: + the Real Estate + Settlement Procedures Act" + (July p. Griffith + +On line 15571: + and Community + Affairs, Board of Governors + of the Federal + + Reserve System, "To + the Officers and Managers + in Charge of Consumer + +On line 15573: + GAO, "Large Bank Mergers: + Fair Lending Review Could Be + Enhanced with Better + +On line 15575: + Honorable Bernard Sanders, + House of Representatives), + November p. Fed + +On line 15577: + and Community + Affairs, Board of Governors + of the Federal + +On line 15577: + memorandum to + the Committee on Consumer + and Community + +On line 15577: + concerning the Board’s + Report to the Congress on + the Truth in Lending + +On line 15579: + Estate Settlement + Procedures Acts," April p. Board + of Governors of + +On line 15579: + Deposit Insurance + Corporation, Office of + the Comptroller of + +On line 15579: + Thrift Supervision, + "Interagency Guidance + on Subprime Lending" + +On line 15583: + quotation, p. U.S. + Department of the Treasury + and U.S. Department + +On line 15587: + president and chief + executive officer, + Nevada Fair Housing + +On line 15587: + Inc., testimony + before the FCIC, Hearing on + the Impact of the + +On line 15587: + Financial Crisis—State of + Nevada, session The Impact + of the Financial + +On line 15587: + on Nevada Real + Estate, September transcript, + p. 242–43.See also Kevin + +On line 15587: + Reinvestment Coalition, + written testimony for + the FCIC, Hearing on + +On line 15587: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 15587: + pp. See also his + testimony at the same + hearing, transcript, pp. + +On line 15587: + counsel, National + Consumer Law Center, Inc., and + Margot F. Saunders, + +On line 15587: + National Consumer + Law Center, Inc., interview + by FCIC, September + +On line 15589: + Thompson and Margot + F. Saunders, both of counsel, + National Consumer + +On line 15591: + Center, interview + by FCIC, September Gary Gensler, + interview by FCIC, + +On line 15593: + Bair, testimony + before the FCIC, First Public + Hearing of the FCIC, + +On line 15593: + day panel Current + Investigations into + the Financial Crisis—Federal + +On line 15597: + January transcript, + p. Sheila Bair, interview by + FCIC, March Sandra F. + +On line 15601: + by FCIC, April pp. Bair, + interview. Treasury and HUD, + "Curbing Predatory + +On line 15610: + Lending," p. Chapter + Figures represented the + compound average + +On line 15610: + staff calculations + from CoreLogic National Home Price + Index, Single-Family Combined + +On line 15612: + CoreLogic Loan Performance + HPI August Inside Mortgage + Finance, The Mortgage + +On line 15612: + Annual, vol. The + Primary Market (Bethesda, + Md.: Inside Mortgage + +On line 15612: + Finance, p. "Mortgage + Originations by Product." + Federal Reserve + +On line 15620: + press release, May Notes + to Chapter Fed Governor + Ben S. Bernanke, "The Great + +On line 15620: + Association, + Washington, D.C., February + See also Olivier + +On line 15620: + and John Simon, "The + Long and Large Decline in U.S. + Output Volatility," + +On line 15624: + Brookings Papers on + Economic Activity, + no. Fed Governor + +On line 15624: + "Deflation: Making + Sure ‘It’ Doesn’t Happen Here," + remarks before the + +On line 15626: + D.C., November FCIC + staff calculations from Board + of Governors of + +On line 15626: + Rate release, 3-month AA + Nonfinancial Commercial + Paper Rate, WCPN3M + +On line 15628: + U.S. Department of + Treasury, Daily Treasury Yield + Curve Rates, to Present. This + + example assumes + that the homeowner is able + to come up with a + +On line 15628: + payment to cover + of the higher-priced home. Here, the + difference would be + +On line 15630: + Agency, "Data on + the Risk Characteristics + and Performance of + +On line 15630: + and Financed in the + Secondary Market" (September + Table 2a: Share of + +On line 15630: + from through and Acquired + by the Enterprises or + Finances with Private-Label MBS + + by Loan-to-Value Ratio and + Borrower FICO Score at + Origination, Adjustable-Rate + +On line 15630: + Prime borrowers are + defined as those whose mortgages + are financed by the + +On line 15632: + government-sponsored + enterprises. Yuliya Demyanyk + and Otto Van Hemert, + +On line 15632: + (December table + Loan Characteristics at + Origination for + +On line 15634: + Different Vintages, + p. FCIC staff calculations + from CoreLogic/First American, + +On line 15634: + Price Index for Single-Family + Combined State HPI data, last + updated August + +On line 15634: + to the FCIC by CoreLogic. + Staff calculations of all + annual growth rates + +On line 15638: + Rates for the US to + Present. Brian K. Bucks, Arthur B. + Kennickell, and Kevin + + B. Moore, "Recent Changes + in US Family Finances: + Evidence from the + +On line 15638: + Survey of Consumer + Finances," Federal Reserve + Bulletin Tables 8A + +On line 15640: + A8. Congressional + Budget Office, "Housing Wealth + and Consumer Spending," + +On line 15644: + p. Mortgages may have + been refinanced more than once + in that year. FCIC staff + +On line 15644: + updated data + provided by Alan Greenspan and + James Kennedy, whose data + +On line 15644: + in "Sources and Uses + of Equity Extracted + from Homes," Finance and + +On line 15646: + Discussion Series, + Federal Reserve Board, 2007-20 + (March CBO, "Housing Wealth + +On line 15648: + and Consumer Spending," + p. Fed Chairman Alan Greenspan, "The + Economic Outlook," + +On line 15650: + the Congress," prepared + testimony before the + House Committee on + +On line 15656: + Bart McDade, interview + by FCIC, April Presentation + to the Lehman Board of + +On line 15660: + lenders during this time + period. New Century, + 10-K, March p. Final + +On line 15660: + J. Missal, Bankruptcy + Court Examiner, in RE: + New Century TRS + +On line 15662: + Chapter Case No. 07-10416 + (KJC), (Bankr. D.Del.), February p + New Century, 10-K, + +On line 15666: + quoted in Erick + Bergquist, "Under Scrutiny, Ameriquest + Details Procedures," + +On line 15674: + from Mortgage Market + Statistical Annual, + Notes to Chapter Lewis + +On line 15676: + M. Lacko and Janis + K. Pappalardo, "The Effect + of Mortgage Broker + +On line 15678: + Commission Bureau + of Economics Staff Report + (February p. Jay + +On line 15678: + the Impact of the + Financial Crisis—State of Nevada, + session The Impact + + of the Financial + Crisis on Nevada Real + Estate, September + +On line 15680: + Brian Bucks and Karen + Pence, "Do Borrowers Know Their + Mortgage Terms1" Journal + +On line 15686: + Capability," + report prepared for the FCIC, + February p. FCIC + +On line 15686: + estimates based on + analysis of Blackbox, S&P, + and IP Recovery, + +On line 15686: + Burton Hollifield, + and Patrik Sandas, in their + paper, "The Role of + +On line 15688: + Mortgage Brokers in + the Subprime Crisis," April William + C. Apgar and Allen + +On line 15688: + Organization + of Housing Finance and the + Changing Role of Community-Based + + Organizations," + working paper (Joint Center + for Housing Studies, + +On line 15690: + University, May + p. Herb Sandler, interview + by FCIC, September + +On line 15694: + Brokers (August pp. + Jamie Dimon, testimony + before the FCIC, First + +On line 15694: + of the FCIC, panel + Financial Institution + Representatives, + +On line 15698: + summary of the + National Appraisal Survey, + p. Dennis J. Black, + +On line 15700: + FCIC, Hearing on the + Impact of the Financial + Crisis— Miami, + +On line 15704: + FCIC, Hearing on the + Impact of the Financial + Crisis— Sacramento, + +On line 15704: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 15708: + on the Impact of + the Financial Crisis— Greater + Bakersfield, session + +On line 15710: + Market, September + transcript, p. Complaint, People + of the State of New + +On line 15710: + Corporation and + First American eAppraiseIT (N.Y. Sup. + Ct. November pp. + +On line 15712: + Martin Eakes, quoted + in Richard A. Oppel Jr. and + Patrick McGeehan, "Along with a + +On line 15714: + Trouble1" New York Times, + October Pam Flaherty, + quoted in Erick + +On line 15716: + Settles FTC Charges against + the Associates Record-Setting Million + for Subprime Lending + +On line 15722: + Loan Abuse," The New York + Times, May Federal Reserve + Board internal staff + +On line 15724: + Predatory Lending," + December pp. Federal + Reserve Board, Morning + +On line 15724: + Equity Lending, + July opening remarks by + Governor Gramlich, + +On line 15728: + Alvarez, interview + by FCIC, March Alan Greenspan, written + testimony for + +On line 15728: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15730: + (GSEs), day one, session + The Federal Reserve, April + p. Alan Greenspan, quoted + +On line 15730: + David Faber, And Then the + Roof Caved In: How Wall Street’s Greed + and Stupidity + +On line 15732: + Capitalism to + Its Knees (Hoboken, N.J.: Wiley, + pp. "Truth in Lending," + +On line 15740: + (quotation), Notes to + Chapter Robert B. Avery, Glenn + B. Canner, and Robert + +On line 15740: + under HMDA and + Its Application in Fair + Lending Enforcement," + +On line 15744: + by FCIC, March Sheila Bair, + testimony before the + FCIC, Hearing on Too + +On line 15744: + of Systemic Risk in + the Financial Crisis, day + session Federal + +On line 15746: + Deposit Insurance + Corporation, September + transcript, p. Dolores + +On line 15748: + of Nonbank Subsidiaries + of Bank Holding Companies," + August GAO, "Consumer + +On line 15748: + Agencies Face Challenges + in Combating Predatory + Lending," GAO (Report + +On line 15756: + FCIC, April Transcript pp. + Greenspan, interview. Ibid. Edward + M. Gramlich, "Booms and + +On line 15756: + The Case of Subprime + Mortgages," Federal Reserve + Bank of Kansas City + +On line 15758: + Economic Review + Edward Gramlich, quoted in + Greg Ip, "Did Greenspan Add + +On line 15758: + Woes1 Gramlich Says Ex-Colleague + Blocked Crackdown On Predatory + Lenders Despite Growing + +On line 15758: + Street Journal, June See + also Edmund L. Andrews, + "Fed Shrugged as Subprime + +On line 15760: + York Times, December + Patricia McCoy and Margot + Saunders, quoted in + +On line 15762: + Mounted on Subprime + Loan Abuses," Washington Post, + September GAO, "Large + +On line 15762: + Fair Lending Review + Could be Enhanced with Better + Coordination," + + GAO/GDD-00-16 (Report to the + Honorable Maxine Waters + and Honorable Bernard + +On line 15764: + Agencies Face Challenges + in Combating Predatory + Lending." "Federal + +On line 15764: + Announce Pilot Project + to Improve Supervision + of Subprime Mortgage + +On line 15766: + Lending," pp. "Higher-priced + mortgage loans" are defined in + the regulations + +On line 15766: + offer rates for a + comparable transaction" + (as published by the + +On line 15768: + at least for first-lien loans + or for subordinate-lien loans. + Alvarez, interview. + +On line 15770: + Raphael W. Bostic, Kathleen + C. Engel, Patricia A. + McCoy, Anthony Pennington-Cross, + + and Susan M. Wachter, + "State and Local Anti-Predatory Lending + Laws: The Effect of + +On line 15774: + Turmoil: Causes and + Consequences," testimony + before the Senate + +On line 15776: + Housing, and Urban + Affairs, 110th Cong., 1st sess., March + p. (Exhibit B), + +On line 15778: + Lisa Madigan, written + testimony for the FCIC, + First Public Hearing + +On line 15778: + day panel Current + Investigations into + the Financial Crisis—State + +On line 15782: + Reinvestment Coalition, + "CRA Commitments" Josh Silver, + NCRC, interview by + +On line 15784: + counsel for Bank of + America, letter to FCIC, + June p. Jessica + +On line 15784: + counsel for JPMorgan Chase, + letter to FCIC, December + Brad Karp, counsel for + +On line 15784: + letter to FCIC, March + in response to FCIC request; + Wells Fargo public + +On line 15786: + data provided + by Wells Fargo to the FCIC. + Karp, letter to FCIC, + +On line 15788: + March in response to + FCIC request. Carey, letter to + FCIC, December p. + +On line 15794: + Karp, counsel for JP + Morgan, letter to FCIC, May + p. Notes to Chapter + +On line 15796: + Agency, "Data on + the Risk Characteristics + and Performance of + +On line 15796: + all loans purchased or + securitized by the GSEs + or in private-label + +On line 15798: + data provided + by Wells Fargo covered of + loans. "Orders Issued + +On line 15800: + no. (April "Statement of + the Federal Financial + Supervisory + +On line 15800: + the Community + Reinvestment Act," Federal + Register (April This + +On line 15800: + Questions and Answers + Regarding Community + Reinvestment; Notice," + +On line 15806: + Disclosure; Final + Rules," Federal Register + no. (May Division + +On line 15806: + and Community + Affairs, memorandum to + Board of Governors, + +On line 15808: + "Order Approving + the Merger of Bank Holding + Companies," August + +On line 15812: + Lloyd Brown, interview + by FCIC, February Andrew + Plepler, interview + +On line 15816: + July Assuming + AAA tranche AA tranche A tranche BBB + tranche and equity + +On line 15818: + Another Meltdown," + March p. David Jones, interview + by FCIC, October + +On line 15818: + "Emerging Problems with + the Basel Capital Accord: + Regulatory + +On line 15820: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 15828: + the Shadow Banking + System, May transcript, p. Jones, + interview. Chapter + +On line 15831: + no or limited + documentation of the + borrower’s income, + +On line 15833: + or may be for an + investor-owned property. Inside + Mortgage Finance, The + +On line 15833: + The Secondary Market + (Bethesda, MD: Inside Mortgage + Finance, p. "Mortgage + +On line 15833: + Issuance" (showing Wall + St. securitizing a + third more than Fannie + +On line 15833: + and Freddie); p. "Non-Agency + MBS Issuance by Type." FCIC staff + calculations from + +On line 15837: + private label MBS). + Charles O. Prince, interview by + FCIC, March John Taylor, + +On line 15839: + September William A. + Fleckenstein and Frederick + Sheeham, Greenspan’s Bubbles: + +On line 15841: + Age of Ignorance + at the Federal Reserve + (New York: McGraw-Hill, p. Alan + +On line 15843: + Greenspan, "The Fed Didn’t + Cause the Housing Bubble," Wall + Street Journal, March See + +On line 15843: + Ben Bernanke, "Monetary + Policy and the Housing + Bubble," speech at the + +On line 15845: + January Alan Greenspan, + testimony before the + Senate Committee + + on Banking, Housing, + and Urban Affairs, 109th Cong., + 1st sess., February + +On line 15847: + Fed Chairman Ben S. + Bernanke, "The Global Saving Glut + and the U.S. Current + +On line 15849: + Economics, Richmond, + Virginia, March Frederic Mishkin, + interview by FCIC, + +On line 15851: + Gourinchas, written + testimony for the FCIC, + Forum to Explore + +On line 15857: + February pp. Paul + Krugman, interview by FCIC, + October Notes to + +On line 15861: + Wei Li, Keith Ernst, + and Kathleen Keest, "Losing Ground: + Foreclosures in the + +On line 15861: + Cost to Homeowners," + Center for Responsible + Lending, December + +On line 15863: + p. Mortgage Market + Statistical Annual, + vol. The Primary + +On line 15865: + Market, p. "Mortgage + Originations by Product." + Christopher Mayer, Karen + +On line 15867: + p. Mortgage Market + Statistical Annual, + "Non-Agency MBS Issuance by + +On line 15873: + for First Lien Guidance," + November Inside Mortgage + Finance. Countrywide, + +On line 15875: + (showing the growth in + Countrywide’s originations). + Angelo Mozilo, + +On line 15875: + Sub-prime Seconds. See + also Angelo Mozilo, + email to Sambol, Bartlett, + +On line 15875: + and Sieracki, re: + "Reducing Risk, Reducing + Cost," May Angelo + +On line 15879: + by FCIC. September + David Sambol, interview by + FCIC, September See + +On line 15879: + Investor Conference + Call, January transcript, p. + See also Jody Shenn, + +On line 15881: + to Boost Purchase Share," + American Banker, January + Patricia Lindsay, + +On line 15881: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15883: + Origination and + Securitization, April + p. Andrew Davidson, + +On line 15889: + 110th Cong., 1st sess., June + Email and data attachment + from former Golden + +On line 15889: + to FCIC, subject: "re: + Golden West Estimated + Volume of Adjustable + +On line 15893: + I," August Exhibits + and in Senate Permanent + Subcommittee on + +On line 15893: + exhibits, Wall Street and + the Financial Crisis: The + Role of High Risk Home + +On line 15893: + Loans, 111th Cong., 2nd sess., + April (hereafter cited as PSI + Documents), PDF pp. + +On line 15901: + available at http://hsgac.senate.gov/public/_files/Financial_Crisis/041310Exhibits.pdf. PSI + Documents, Exhibits and pp. + Ibid., pp. Ibid., p. Ibid., + +On line 15905: + "Option ARM Credit + Risk," August PSI Document + Exhibit p. PSI + +On line 15909: + Document listing + Countrywide originations + by quarter from to + +On line 15911: + a maximum CLTV + of and minimum FICO + of and July Loan + +On line 15915: + FICO). Countrywide + Loan Program Guide, dated March + Federal Reserve, + +On line 15917: + Guidance," November + pp. Angelo Mozilo, email + to Carlos Garcia + +On line 15925: + Stan Kurland), Subject: + "Bank Assets," August Notes to + Chapter Angelo + +On line 15925: + to Carlos Garcia + (cc: Kurland), subject: "re: Fw: + Bank Assets," August + +On line 15931: + p. Form 10-K, p. F-45. + See Washington Mutual, + Form 10-K, p. John Stumpf, + +On line 15933: + interview by FCIC, + September Countrywide, Form + 10-K, p. F-45; Form 10-K, + +On line 15937: + p. Form 10-K, p. Kevin + Stein, testimony before + the FCIC, Sacramento + +On line 15937: + the Impact of the + Financial Crisis–San Francisco, + day session Mortgage + +On line 15937: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 15941: + p. Mona Tawatao, in ibid., + p. Real Estate Lending + Standards, Federal + +On line 15945: + of the Comptroller + of the Currency, Board of + Governors of the + +On line 15945: + Deposit Insurance + Corporation, Office of + Thrift Supervision, + +On line 15947: + Standards: Final Rule," + SR January Office of + the Comptroller of + +On line 15947: + Deposit Insurance + Corporation, Office of + Thrift Supervision, + +On line 15949: + Lending," October + Final Report of Michael J. + Missal, Bankruptcy Court + +On line 15951: + No. 07-10416 (KJC), (Bankr. D.Del.), + February pp. Yuliya Demyanyk + and Otto Van Hemert, + +On line 15955: + Sandler, interview. + CoreLogic loan performance data + for subprime and Alt-A + +On line 15957: + data provided + to the FCIC. Christopher Mayer, + Karen Pence, and Shane M. + +On line 15959: + no. (Winter William Black, + testimony for the FCIC, + Miami Hearing + +On line 15959: + on the Impact of + the Financial Crisis, day + session Overview of + +On line 15965: + the FCIC, January + p. This particular deal + would be described as + +On line 15965: + credit enhancement + structure; see Gary Gorton, "The + Panic of paper + + presented at the + Federal Reserve Bank of + Kansas City’s Jackson + +On line 15967: + Conference, August + p. FCIC staff estimates based + on analysis of + +On line 15967: + from BlackBox, S&P, and Bloomberg. + The prospective loan pool for this + deal originally + +On line 15967: + contained mortgages. Eight + of these had been dropped from the + pool by the time the + +On line 15967: + may differ slightly + from those reported in the + deal prospectus because + +On line 15971: + on a pool of loans. + Ibid. Federal Register + (January The rules + +On line 15975: + Comptroller of the + Currency John Hawke, remarks + before Women in + +On line 15975: + Housing and Finance, + Washington, D.C., February + attached to OCC News + +On line 15977: + Release 2002-10, p. John + Hawke, quoted in Jess Bravin and + Paul Beckett, "Friendly + + Watchdog: Federal + Regulator Often Helps + Banks Fighting Consumers," + +On line 15979: + Bar-Gill and Elizabeth + Warren, "Making Credit Safer," + University of + +On line 15981: + Pennsylvania Law + Review 182-83, 192-94. See Watters + v. Wachovia Bank NA, + +On line 15983: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 15985: + the FCIC, day panel + Investigations into + the Financial Crisis—State + +On line 15993: + Local Officials, + January transcript, p. Notes + to Chapter John D. + +On line 15993: + testimony for + the FCIC, Public Hearing on + Subprime Lending and + +On line 15993: + Government-Sponsored Enterprises + (GSEs), day session Office of + the Comptroller of + +On line 15995: + Currency, April p. + Citigroup Warehouse Lines of + Credit with Mortgage + +On line 15997: + by Citigroup; staff + calculations. Charles O. Prince, + interview by FCIC, + +On line 16001: + Market in the Third + Quarter of February Moody’s + Review and Outlook: + +On line 16003: + Commercial Paper, + February Moody’s ABCP Reviews + of Park Granada and + +On line 16007: + Sienna. Moody’s ABCP + Program Review: Park Granada, + July Letters from + +On line 16007: + Forum (November + and State St. Bank (November + to the Office of + +On line 16011: + Thrift Supervision. + Darryll Hendricks, interview + by FCIC, August Citi + +On line 16013: + FCIC staff estimates + from prospectus and Citigroup + production dated + +On line 16017: + Mae Term Sheet. For the + more than institutional + investors around the world, + +On line 16017: + million figure is + based on FCIC staff estimates + that, in turn, were based + +On line 16019: + of Moody’s PDS database. + See Brad S. Karp, counsel for + Citigroup, letter + +On line 16019: + to FCIC, about senior + investors, October p. See + also Eric S. + +On line 16021: + Chase Co., letter to + FCIC, November Citigroup + letter to the FCIC, + +On line 16027: + S. Karp, letter to + FCIC, about mezzanine investors, + November p. The + + equity tranches + were not offered for public + sale but were retained + +On line 16029: + FCIC staff estimates + from prospectus and Citigroup + production dated + +On line 16033: + Lindsay, interview + by FCIC, March PSI Documents, + Exhibit 59a: "Long + +On line 16033: + and Exhibit 60a + (quoting page of WaMu Home Loans + Product Strategy + +On line 16035: + PowerPoint presentation). + John M. Quigley, "Compensation + and Incentives in + +On line 16037: + Berkeley Electronic + Press, October p. Barclays + Capital, Bear Stearns, + +On line 16037: + Paribas, Citigroup, Deutsche + Bank, Goldman Sachs, HSBC, JPMorgan, + Lehman Brothers, Morgan + +On line 16039: + average top-tier + pay worldwide in mortgages and + MBS sales and trading. + +On line 16039: + Report" (November + pp. and Options Group, Global + Financial Market + +On line 16043: + pp. See Merrill Lynch, + Proxy Statement, p. See FCIC staff + analysis of Moody’s + +On line 16045: + Form 10-Ks for years and + See FCIC staff calculations + based on Moody’s Form 10-Ks + +On line 16047: + Mortgages," September + FCIC staff estimate based on + analysis of Moody’s + +On line 16049: + databases. The ratings + from the three agencies measure + slightly different + +On line 16049: + Fitch base their ratings + on the probability + that a borrower + +On line 16049: + default; Moody’s bases its + ratings on the expected + loss to the investor. + +On line 16049: + differences, investors + and regulators tend to + view the ratings as + +On line 16049: + divided into + two categories: investment + grade securities + +On line 16049: + also referred to + as junk (for S&P; similar + levels for Moody’s are + +On line 16051: + to triple-A). Richard Cantor + and Frank Packer, "The Credit + Rating Industry," + +On line 16059: + FRBNY Quarterly + Review (Summer–Fall Notes to Chapter + Andrew J. Donahue, + +On line 16059: + Staff: Opening Remarks + before the Commission Open + Meeting," Washington, + +On line 16059: + also Lawrence J. White, + "Markets: The Credit Rating + Agencies," Journal of + +On line 16065: + the FCIC, Hearing on + the Credibility of + Credit Ratings, the + +On line 16065: + Based on Those Ratings, + and the Financial Crisis, + session The Ratings + +On line 16069: + See U.S.C. 78o-7(c)(2). Jerome S. + Fons, testimony before + the House Committee + +On line 16073: + on the Impact of + the Financial Crisis— Greater + Bakersfield, session + +On line 16075: + transcript, p. Gary Witt, + testimony before the + FCIC, Hearing on the + +On line 16075: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 16075: + and the Financial + Crisis, session The Ratings + Process, June transcript, p. + +On line 16077: + Moody’s Investors Service, + "Introducing Moody’s Mortgage + Metrics: Subprime Just + +On line 16079: + Moody’s Investors Service, + interview by FCIC, May "Moody’s + Mortgage Metrics: A + +On line 16085: + interview. Jay Siegel, + testimony before the + FCIC, Hearing on the + +On line 16085: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 16085: + and the Financial + Crisis, session The Ratings + Process, June transcript, p. + +On line 16089: + Stein, interview by + FCIC, May Moody’s Investors Service, + "Introducing Moody’s + +On line 16093: + interview. Jerome Fons, + interview by FCIC, April Moody’s + Rating Committee + +On line 16097: + FCIC staff estimates + based on analysis of Moody’s + PDS database. Invoice + +On line 16097: + Moody’s Investors Service + to Susan Mills, Citigroup + Global Markets Inc., + +On line 16101: + New Issue Billing Form, + Citigroup Mortgage Loan Trust + 2006-NC2, September FCIC + +On line 16101: + estimates based on + analysis of Moody’s SFDRS + data as of April + +On line 16103: + before the Senate + Banking Committee, 109th Cong., + 2nd sess., June "Freddie + +On line 16103: + Settle SEC Action + Relating to Multi-Billion Dollar + Accounting Fraud," SEC + +On line 16109: + the chart). OFHEO Special + Examination Report, + December In OFHEO + +On line 16109: + Examination + of Fannie Mae. OFHEO said that + management engaged + +On line 16109: + acts of misconduct, + involving well over a dozen + different forms of + +On line 16109: + principles. As in + the case of Freddie, OFHEO said + Fannie’s management + +On line 16109: + ambitious earnings-per-share + targets that were linked to their + own compensation. + +On line 16119: + third-quarter OFHEO Special + Examination Report, + September pp. Ibid., + +On line 16129: + Report to Congress," + June p. Notes to Chapter Alan + Greenspan, testimony + +On line 16129: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 16131: + Reserve, April transcript, + p. FHFA, "Mortgage Market + Note: Goals of Fannie + +On line 16131: + and Freddie Mac in + the Context of the Mortgage + Market: February + +On line 16133: + "FCIC calculations." + FHFA, Report to Congress, + pp. BlackRock Solutions, + +On line 16137: + December Robert Levin, + interview by FCIC, March Mark + Winer, interview + +On line 16139: + March John Weicher, + former FHA commissioner, + interview by FCIC, + +On line 16150: + March Letter from Robert + Levin to FCIC, June p. Chapter + Joe Donovan, Credit + +On line 16152: + staff calculations, + using data from the U.S. + Census, data in + +On line 16152: + and data in Moody’s + CDO Enhanced Monitoring + Service database. The + +On line 16154: + characteristics + that identified them as ABS + CDOs. Scott Eichel, quoted + +On line 16154: + Allison Pyburn, + "CDO Machine1 Managers, Mortgage + Companies, Happy + +On line 16158: + interview by FCIC, + March Jian Hu, "Assessing the + Credit Risk of CDOs + +On line 16158: + Analysts’ Challenges + and Solutions," Journal of + Structured Finance no. + +On line 16162: + Wing Chau, interview + by FCIC, November CDOs that + bought relatively + + senior tranches of + mortgage-backed securities were + known as high-grade; + +On line 16162: + that bought the BBB-rated and + other junior tranches were + known as mezzanine. + +On line 16164: + Donovan, quoted in + Gregory, "The ‘"What If ’s’ + in ABS CDOs." Laurie + +On line 16166: + NJ: John Wiley, p. + Hu, "Assessing the Credit + Risk of CDOs Backed by + +On line 16168: + Issuance dropped in to + billion and virtually + disappeared in FCIC + +On line 16170: + provided by Moody’s + CDO Enhanced Monitoring + System (EMS). FCIC staff + +On line 16172: + based on analysis + of Moody’s CDO EMS database. Nestor + Dominguez, interview by + +On line 16176: + FCIC, September Michael + Lamont, interview by + FCIC, September Chris + +On line 16180: + by FCIC, September + Lamont, interview. FCIC + staff calculations + +On line 16182: + CDO manager and + underwriter survey. Mark + Adelson, interview + +On line 16184: + by FCIC, October + FCIC staff calculations. Our + estimate assumes + +On line 16184: + of of the total + value of the deal—that is, the + lowest normally + +On line 16184: + the mortgage-focused + multisector CDOs in the + FCIC database. It does + +On line 16184: + as interest on + equity tranches retained + by the managers. CDO + +On line 16184: + to the FCIC survey + reported management fees + ranging from as low + +On line 16186: + "Summary of Key + Fee Provisions for Cash CDOs + as of January + +On line 16188: + prepared by Moody’s for + the FCIC. FCIC Hedge Fund Survey. + See FCIC website for + +On line 16192: + Bloomberg LLC, Financial + Analyst Function; Bear Stearns + Companies Inc., Form + +On line 16202: + Report," October + p. Notes to Chapter Moody’s, Kleros + Real Estate CDO + +On line 16202: + last updated May + 2008.The following discussion + of CMLTI 2006-NC2 relies + +On line 16208: + Moody’s CDO EMS database. + Ricciardi, interview. + For example, Kleros + +On line 16208: + were in Buckingham + CDO, Buckingham CDO II, and + Buckingham CDO III, + +On line 16214: + underwritten by + Barclays. Adelson, interview. + Chau, interview. James + +On line 16214: + Capital Structure" + (December in Mr. Market + Miscalculates: The + +On line 16222: + (POPS), January Dan + Sparks, interview by FCIC, June + Dominguez, interview. The + +On line 16222: + of the book value + of assets to equity + ranged from to times for + +On line 16222: + SIVs; the average + was times. Moody’s Investors Service, + "Moody’s Special Report: + +On line 16224: + Structured Investment + Vehicles," January p. + Mark Klipsch, quoted + +On line 16226: + Asset Management, + Collateral Manager + Presentation; Ralph + +On line 16226: + Cioffi, interview + by FCIC, October Bear Stearns + High-Grade Structured Credit + +On line 16226: + Fund, Ltd., financial + statements for the year ended + December (total + +On line 16226: + Fund, Ltd., financial + statements for the year ended + December (total + +On line 16228: + assets were James Cayne, + written testimony for + the FCIC, Hearing on + +On line 16228: + Banking System, day + session Investment Banks and + the Shadow Banking + +On line 16232: + AIMA’s Illustrative + Questionnaire for Due Diligence + of Bear Stearns High Grade + +On line 16232: + Strategies Fund; Bank of + America presentation + to Merrill Lynch’s Board + +On line 16234: + of Directors, "Bear + Steams Asset Management: What + Went Wrong." Bear Stearns High-Grade + +On line 16234: + ended December + Financial Statements, Bear Stearns + High-Grade Structured Credit + +On line 16234: + Fund, Ltd., financial + statements for the year ended + December BSAM fund + +On line 16236: + using data from + FCIC survey of hedge funds. The + hedge funds responding + +On line 16238: + had a total of + trillion in investments. IMF, + Global Financial + +On line 16240: + Report, April Table + page "Typical ‘Haircut’ or + Initial Margin." Alan + +On line 16248: + Schwartz, interview by + FCIC, April Cioffi, interview. + Ibid. Ibid. Bear Stearns High-Grade + +On line 16248: + stating that "the fund + is subject to conflicts of + interest." Bear Stearns + + High-Grade Structured Credit + Strategies Enhanced Leverage Fund, + L.P., Preliminary + +On line 16250: + stating that Klio I + collateral includes RMBS + and ABS and CDOs, Klio + +On line 16252: + RMBS and ABS and CDOs, + and Klio III collateral + includes RMBS and ABS + +On line 16266: + produced by Paul, Weiss, + Rifkind, Wharton Garrison, LLP. + Notes to Chapter Matt + +On line 16266: + Tannin, Bear Stearns, email + to Bella Borg-Brenner, Stillwater + Capital, March Greg + +On line 16268: + Quental, Bear Stearns, email + to Andrew Donnellan, Bear + Stearns, et al., June Charles + +On line 16270: + Prince, interview by + FCIC, March Regulators in + Japan and the United + +On line 16272: + Kingdom also came + down on the company in + and In September + +On line 16272: + Citibank’s ability to + operate branches in Japan + because of the bank’s + +On line 16272: + country, and in the + following year the United + Kingdom’s Financial + +On line 16272: + Citigroup million + for engaging in a bond + trading scheme labeled + +On line 16272: + Evil" by Citigroup + bond traders. Financial Services + Agency, Government + +On line 16274: + David Reilly, "Moving + the Market: Citigroup to + Take Million Hit in + +On line 16278: + Wall Street Journal, June + Prince, interview. Robert Rubin, + interview by FCIC, + +On line 16280: + March Dominguez, interview + by FCIC, March The CDO desk earned + revenues of million + +On line 16280: + Citigroup’s counsel, + letter to FCIC, March in re + the FCIC’s second and + +On line 16280: + Interrogatory + No. Janice Warne, interview + by FCIC, February + +On line 16280: + to FCIC, March "Response + to Interrogatory No. + Paul, Weiss, Citigroup’s + +On line 16284: + to FCIC, March "Response + to Interrogatory No. + Moody’s Investors Service, + + "CDOs with Short-Term Tranches: + Moody’s Approach to Rating Prime-1 + CDO Notes," February + +On line 16286: + p. Citigroup Inc., + Form 10-K, for the fiscal year + ended December + +On line 16296: + p. Dominguez, interview, + March Ibid.; Warne, interview. Dominguez, + interview, March Warne, + +On line 16298: + Committee, Coventree + Capital, "Liquidity + Put Option," draft as + +On line 16302: + of December p. + Ron Frake, interview by FCIC, + March "Formal Agreement" + +On line 16304: + Comptroller of the + Currency and Citibank, July + Moody’s Investors Service, + +On line 16304: + period ended + September p. Floyd Norris, + "As Bank Profits Grew, + +On line 16308: + Signs Went Unheeded," + New York Times, November Dominguez, + interview, March Paul, + +On line 16310: + counsel, letter to + FCIC, June "Responses of Nestor + Dominguez," p. OCC, "Subprime + +On line 16310: + Valuation and + Oversight Review—Conclusion Memorandum," + Memorandum from + +On line 16310: + Sullivan, RAD, and + Ron Frake, NBE, to John Lyons, Examiner-in-Charge, + Citibank, NA, January + +On line 16314: + Ibid. Tobias Brushammar + et al., memorandum to + Nestor Dominguez et al., "Re: + +On line 16314: + Liquidity Put + Valuation," October + pp. "Liquidity + +On line 16318: + "Liquidity Put + Discussion," produced by Citi. + Data provided + +On line 16322: + by Moody’s to the FCIC. + Gary Gorton, interview by + FCIC, May AIG, 10-K, p. + +On line 16322: + are assigned a "risk + weighting" or percentage that + is then multiplied + +On line 16324: + determine the amount + of risk-based capital. AIG, CDS + notional balances + +On line 16326: + through Q1, provided + to the FCIC. The total would + reach billion by (ibid.). + +On line 16336: + May Craig Broderick, + testimony before the + FCIC, Hearing on the + +On line 16336: + of Derivatives + in the Financial Crisis, + day session Goldman + +On line 16340: + pp. Moody’s, "CDOs with Short-Term + Tranches"; AIG, "Information + Pertaining to the + +On line 16344: + provided to the + FCIC. Park, interview. AIG, CDS + notional balances + +On line 16348: + year-end, through Q1. Alan Frost, + interview by FCIC, May AIG + Financial Products + +On line 16350: + Compensation Plan, + March p. Joseph Cassano, email to + All Users, re: Special + +On line 16356: + provided by AIG + to the FCIC. AIG, Form 8-K, filed + May "Fact Sheet on AIGFP," + +On line 16360: + by Hank Greenberg, p. + AIG, CDS notional balances + at year-end. Gene Park, email + + to Joseph Cassano, re: + "CDO of ABS Approach Going + Forward—Message to the Dealer + +On line 16362: + Henry M. Paulson + Jr., testimony before + the FCIC, Hearing on + +On line 16362: + System, day session + Perspective on the Shadow + Banking System, May + +On line 16364: + Henry M. Paulson + Jr., written testimony + for the FCIC, Hearing + +On line 16364: + System, day session + Perspective on the Shadow + Banking System, May + +On line 16366: + Goldman Sachs, and 10-K + (appendix 5a to Goldman’s + March letter to the + +On line 16370: + FCIC). Appendix 5c + to Goldman’s March letter to + the FCIC. Goldman’s March + +On line 16372: + letter to the FCIC, + p. (subprime securities). + "Protection Bought by + +On line 16372: + spreadsheet provided + by Goldman Sachs to the FCIC. + Specifically, IKB + +On line 16372: + purchased million of + Class A notes, million of Class + B notes, and million + +On line 16374: + C notes on June TCW + purchased million of Class A + notes in January + +On line 16376: + purchased million of + Class A notes in March See ibid., + Exhibit FCIC staff + +On line 16378: + data provided + by Goldman Sachs. "Protection + Bought by GS," spreadsheet. + +On line 16382: + FCIC calculations + based on data provided + by Goldman Sachs. FCIC + +On line 16386: + Sachs. Sparks, interview. + Of course, in theory the + net impact on the + +On line 16386: + system is not greater, + because there is a winner + for every loser + +On line 16390: + the derivatives + market. Sparks, interview. From + Goldman Sachs data + + provided to the + FCIC in a handout titled + "Amplification" + + and quoted at the + FCIC’s Hearing on the Role of + Derivatives in + +On line 16392: + Goldman Sachs Group, Inc. + and Derivatives, June FCIC + staff analysis based + +On line 16394: + data provided + by Goldman Sachs. Lloyd Blankfein, + chairman of the board + +On line 16394: + chief executive + officer, Goldman Sachs Group, + interview by FCIC, + +On line 16396: + Sparks, interview. Gary + Cohn, testimony before + the FCIC, Hearing on + +On line 16396: + of Derivatives + in the Financial Crisis, + day session Goldman + +On line 16400: + Parkinson, interview. + Michael Greenberger, before the + FCIC, Hearing on the + +On line 16400: + of Derivatives + in the Financial Crisis, + day session Overview + +On line 16406: + "Summary of Key + Provisions for Cash CDOs as + of January Gary + +On line 16406: + for the FCIC, Hearing + on Credibility of + Credit Ratings, the + +On line 16406: + on Those Ratings, and + the Financial Crisis, day + session The Ratings + +On line 16416: + to Chapter Ibid., Gary + Witt, testimony before + the FCIC, Hearing on + +On line 16416: + Credit Ratings, the + Investment Decisions Made + Based on those Ratings, + +On line 16418: + Financial Crisis, + day session The Ratings Process, + June transcript, pp. Moody’s + +On line 16418: + Service, "Moody’s Approach + to Rating Multisector + CDOs," September p. + +On line 16426: + FCIC, June p. Gary Witt, + follow-up interview by FCIC, + May Witt, interview, + +On line 16428: + For example, Moody’s + assumed that borrowers with + different credit + +On line 16428: + would not default at + the same time. The agency split + the securities + +On line 16428: + average FICO + score of the underlying + mortgages: prime (FICO + +On line 16428: + (FICO between and + and subprime (FICO under + Creating three FICO-based + +On line 16428: + subprime) resulted + in lower correlation + assumptions, because + +On line 16428: + securities in + different subcategories + were assumed to be + +On line 16428: + correlated. "Moody’s + Revisits Its Assumptions + Regarding Structured + +On line 16428: + Finance Default (and + Asset) Correlations for + CDOs," June pp. Gary Witt, + +On line 16430: + by FCIC, May Hedi + Katz, "U.S. Subprime RMBS in CDOs," + Fitch Special Report, + +On line 16430: + Quality," Standard + Poor’s Global Credit Portal + RatingsDirect, November p. + +On line 16432: + Mitchell, "Structured Finance: + Complexity, Risk and the + Use of Ratings," BIS + +On line 16434: + of CDO managers and + underwriters about the process + of creating and + +On line 16436: + rated triple-A between + and retained their original + rating years later, + +On line 16438: + were withdrawn. Kyle Bass, + testimony to the House + Financial Services + +On line 16438: + Government Sponsored + Enterprises, Hearing on + the Role of Credit + +On line 16442: + Policy Special + Comment, March p. Moody’s Investors + Service, "Announcement: + +On line 16444: + Its Key Assumptions + for Rating Structured Finance + CDOs," December Ben + +On line 16446: + Ann Rutledge, email to + FCIC, November Ann Rutledge + is a principal + + in R&R Consulting, + a coauthor of Elements + of Structured Finance + +On line 16446: + Moody’s Investor Service. + She and co-principal Sylvain + Raines first spoke to the + +On line 16450: + Special Report," the + following page headlines: U.S. + CDO Review Preview: + +On line 16450: + Levels Driven by + Resecuritization CDOs + and CLOs," February + +On line 16450: + CDO Review: Looking + Ahead to Record Year Follows Record + Year," February U.S. + +On line 16452: + Issuance Expected + in March Moody’s annual gross + revenues for ABS CDO + +On line 16452: + May See also Moody’s + Corporation 10-K, p. and + Moody’s Corporation, + +On line 16458: + FCIC, June transcript, p. + Witt, written testimony + for the FCIC, June p. + +On line 16464: + April Eric Kolchinsky, + interview by FCIC, April Witt, + interview, April FCIC + +On line 16470: + staff estimates based + on analysis of Moody’s CDO + EMS database. Notes to + +On line 16474: + by FCIC, May The chart + was labeled "Derivatives + (America)." Brian + +On line 16476: + Clarkson, interview + by FCIC, May Harvey Goldschmid, + interview by FCIC, + +On line 16478: + April Office of Thrift + Supervision, letter to + the SEC, February + +On line 16480: + Brothers, Inc., letter + to the SEC, March J.P. Morgan + Chase Co., letter to + +On line 16480: + the SEC, February + Deutsche Bank A.G. and Deutsche Bank Secs., + letter to the SEC, + +On line 16484: + February Harvey + Goldschmid, interview by FCIC, + April Closed meeting of + +On line 16486: + the Securities + and Exchange Commission, April + In the Division + +On line 16486: + Markets. For the sake + of simplicity, throughout + this report it is + +On line 16488: + the Division of + Market Regulation. Erik + Sirri, interview + +On line 16488: + April Although there are + more than SEC examiners, + collectively they + +On line 16488: + more than registered + representatives) as well + as other market + +On line 16492: + participants. Michael + Macchiaroli, interview by FCIC, + March The monitors + +On line 16492: + with senior business + and risk managers at each CSE + firm every month about + + general concerns + and risks the firms were seeing. + Written reports of + +On line 16492: + addition, the CSE + monitors met quarterly + with the treasury and + +On line 16494: + of each CSE firm to + discuss liquidity and + funding issues. Erik + +On line 16494: + Banking System, day + session SEC Regulation + of Investment Banks, + +On line 16496: + SEC memorandum, + Re: "CSE Examination + of Bear Stearns Co. Inc.," + +On line 16498: + Commission, Office + of Inspector General, + "SEC’s Oversight of Bear + +On line 16502: + No. 446-A, September + pp. Michael Macchiaroli, interview + by FCIC, April Robert Seabolt, + +On line 16504: + and Matthew Eichner, + October Matt Eichner, + interview by FCIC, + +On line 16508: + Entity Program," + p. Goldschmid, interview. GAO, + "Financial Markets + +On line 16508: + to Improve Oversight + of Leverage at Financial + Institutions," GAO-09-739 + +On line 16512: + Reform," remarks at + the National Economists + Club, Washington, D.C., + +On line 16518: + First Public Hearing + of the Financial Crisis + Inquiry Commission, + +On line 16518: + day panel Current + Investigations into + the Financial Crisis—Federal + +On line 16520: + transcript, p. The Fed + remained the supervisor + of JP Morgan at + +On line 16524: + by FCIC, October + Federal Reserve System, + "Financial Holding + +On line 16533: + Warren Peterson, + written testimony for + the FCIC, Hearing on + +On line 16537: + September pp. Gary + Crabtree, principal owner, + Affiliated + +On line 16545: + Market, September + p. Notes to Chapter Lloyd Plank, + Lloyd E. Plank Real + + Estate Consultants, + written testimony for + the FCIC, Hearing on + +On line 16547: + Market, September + p. CoreLogic Single Family + Combined (SFC) Home Price + +On line 16549: + accessed August FCIC + calculation of change from + January to April + +On line 16553: + Final Report of + Michael J. Missal, Bankruptcy Court + Examiner, In + +On line 16555: + Chapter Case No. 07-10416 + (KJC), (Bankr. D.Del), February pp. + (hereafter Missal). Ibid., p. + +On line 16559: + from Boca Raton: + Coverage from Selected + Sessions of ABS East + +On line 16563: + the Joint Economic + Committee, 109th Cong., 1st sess., + June Christopher Mayer, + +On line 16563: + testimony for + the FCIC, Forum to Explore + the Causes of the + +On line 16565: + pp. Antonio Fatás, + Prakash Kannan, Pau Rabanal, and + Alasdair Scott, "Lessons for + +On line 16567: + chapter James MacGee, "Why + Didn’t Canada’s Housing Market + Go Bust1" Federal + +On line 16569: + Economic Comment + (December Morris A. Davis, + Andreas Lehnert, and + +On line 16569: + F. Martin, "The Rent-Price + Ratio for the Aggregate + Stock of Owner-Occupied Housing," + +On line 16571: + Federal Reserve + Board Working Paper, May p. + Price data from CoreLogic + +On line 16571: + Index, Single-Family Combined. + Rent data is Bureau of + Labor Statistics, + +On line 16571: + Equivalent Rent for + Primary Residence; all + index figures are + +On line 16571: + Jan. Methods follow + from Federal Reserve Bank + of San Francisco + +On line 16573: + Realtors Housing + Affordability Index, + accessed from Bloomberg as + +On line 16575: + could not exceed of + the median family + monthly income. More + +On line 16575: + the methodology + can be found at National + Association + +On line 16579: + Chairman Phil Angelides, + December p. Kristopher S. + Gerardi, Christopher + + L. Foote, and Paul S. + Willen, "Reasonable People Did + Disagree: Optimism + + and Pessimism about the + U.S. Housing Market Before + the Crash," Federal + +On line 16581: + Public Policy + Discussion Paper No. 10-5, + August Donald L. + +On line 16581: + European Central + Bank Colloquium held in + honor of Otmar + +On line 16585: + Board of Governors, + memorandum from Josh Gallin + and Andreas Lehnert + +On line 16589: + to Vice Chairman [Roger] + Ferguson, "Talking Points on + House Prices," May p. Missal, + +On line 16591: + Black, testimony + before the FCIC, Hearing on + the Impact of the + +On line 16591: + Overview of Mortgage + Fraud, September transcript, p. + and email from William Black + +On line 16593: + December Reply + of Attorney General + Lisa Madigan (Illinois) + +On line 16595: + Financial Services + Subcommittee on Housing + and Community + +On line 16605: + Wilfredo Ferrer, + testimony before the + FCIC, Hearing on the + +On line 16607: + Florida, session + The Regulation, Oversight, + and Prosecution + +On line 16609: + the Impact of the + Financial Crisis—Miami, Florida, + session Overview of + +On line 16615: + interview by FCIC, + May David Gussmann, interview + by FCIC, March William H. + +On line 16619: + FCIC, Hearing on the + Impact of the Financial + Crisis— Miami, + +On line 16621: + of the Inspector + General, "The Internal + Effects of the FBI’s + +On line 16625: + September p. Chris + Swecker, interview by FCIC, + March Patrick Crowley, MortgageDaily.com, + +On line 16627: + Swecker, statement to + the House Financial Services + Subcommittee on + +On line 16629: + Opportunity, + October William Black, written + testimony for + +On line 16631: + the FCIC, September + p. Francisco San Pedro, + interview by FCIC, + +On line 16637: + OCC, letter to Bank + of America, June Darcy + Parmer, interview by + +On line 16639: + "Mortgage Loan Fraud: An + Industry Assessment Based + on SAR Analysis," + +On line 16641: + Financial Services + Subcommittee on Housing + and Community + +On line 16647: + April–June p. DOJ, letter + from Assistant Attorney + General Ronald Welch + +On line 16657: + Report," pp. Richard Spillenkothen, + interview by FCIC, March Michael + J. Mukasey, interview + +On line 16659: + by FCIC, October + DOJ response to FCIC request, + April see also DOJ + +On line 16661: + FCIC request, April William + Black, testimony before + the FCIC, September + +On line 16665: + of Law Enforcement, + testimony before the + FCIC, Hearing on the + +On line 16665: + p. "Participant + in Million Mortgage Fraud Scheme + Convicted by Polk + +On line 16667: + press release, August + Tenth Judicial Circuit in + and for Polk County, + + Florida, State of + Florida vs. Scott Almeida, + et al., OSWP No. + +On line 16671: + the FCIC, September + transcript, pp. Gary Gorton, "The + Panic of paper + + presented at the + Federal Reserve Bank of + Kansas City, Jackson + +On line 16673: + of Subprime Mortgage + Credit," Federal Reserve + Bank of New York Staff + +On line 16675: + No. March pp. Raymond + McDaniel, quoted in the transcript + of Moody’s Managing + +On line 16683: + president and chief + operating officer + of Clayton Holdings, + +On line 16685: + Inc., interview by + FCIC, September Frank Filipps, + interview by FCIC, + +On line 16687: + August Vicki Beal, + testimony before the + FCIC, Hearing on the + +On line 16687: + session The Mortgage + Securitization Chain: + From Sacramento to + +On line 16689: + also Martha Coakley, + Massachusetts Attorney + General, comment + +On line 16689: + regarding asset-backed + securities, Release No. + 33-9117; 34-61858; File No. S7-08-10, + +On line 16693: + D. Keith Johnson, + testimony before the + FCIC, Hearing on the + +On line 16695: + session The Mortgage + Securitization Chain: + From Sacramento to + +On line 16699: + transcript, pp. Ibid., p. + Beal, testimony before + the FCIC, September + +On line 16701: + p. John J. Goggins, + senior vice president and + general counsel, + +On line 16705: + Times Misconstruing + Commission Testimony," + September Johnson, + +On line 16711: + the FCIC, September + transcript, p. Tony Peterson, + interview by FCIC, + +On line 16713: + president in charge + of mortgage acquisition + due diligence, Deutsche Bank, + +On line 16713: + by FCIC, July William + Collins Buell VI, head of mortgage + acquisition, JP + +On line 16715: + September Richard M. + Bowen, written testimony + for the FCIC, Hearing + +On line 16715: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 16719: + FCIC, February FCIC + correspondence with Richard M. + Bowen. Inside Mortgage + +On line 16719: + The Secondary Market + (Bethesda, MD: Inside Mortgage + Finance, p. FCIC staff + +On line 16721: + based on analysis + of Moody’s CDO EMS database. See, + for example, James + +On line 16721: + Rule and Some Thoughts About + the Future," remarks to the + thirteenth annual + +On line 16723: + Association, + Hot Springs, Virginia, October + Shelley Parratt and + +On line 16725: + interview by the + FCIC, October C.F.R. Part 229.1111(a)(3), + "Pool Assets," revised + +On line 16727: + filed by Cambridge Place + Investment Management Inc., + dated July in + +On line 16727: + Management, Inc., v. + Morgan Stanley Co., Inc., Case + No. 10-27841, p. (hereafter + + Cambridge Complaint), and + Part V of complaint filed by + Federal Home Loan + +On line 16727: + County, Illinois (Chancery + Division), Federal Home + Loan Bank of Chicago + +On line 16729: + America Funding + Corp. et al., Case No. 10CH450B3, p. + Cambridge Complaint, pp. + +On line 16733: + president and chief + operating officer, + Clayton Holdings, Inc., + +On line 16735: + FCIC, June A QIB was + defined under Rule 144A to + include "entities, + + acting for its own + account or the accounts of + other qualified + +On line 16735: + buyers, that in the + aggregate owns and invests + on a discretionary + +On line 16735: + of issuers that are + not affiliated with + the entity." See + +On line 16741: + of Securities + to Institutions." Notes to + Chapter Dennis Voigt + +On line 16741: + before the FCIC, First + Public Hearing of the FCIC, + day session Current + +On line 16743: + Local Officials, + January p. Richard Breeden, + interview by FCIC, + +On line 16743: + See Public Law (Oct. + Rule 144A contained provisions + that ensured it did + + not expand to the + securities markets in + which retail investors + +On line 16747: + Supervision of + Large Complex Institutions," + October Alan Greenspan, + +On line 16747: + Evolution of Bank + Supervision," speech before + the American Bankers + +On line 16749: + Arizona, October + Eugene Ludwig, interview + by FCIC, September + +On line 16751: + Reserve Bank of New + York, "Report on Systemic Risk + and Supervision," + +On line 16753: + Rich Spillenkothen, "Notes on the + performance of prudential + supervision in + +On line 16753: + years preceding the + financial crisis by a + former director + +On line 16755: + and regulation + at the Federal Reserve + Board to May Susan + +On line 16757: + interview by FCIC, + October Bernanke, letter to + the FCIC, December + +On line 16761: + John Snow, interview + by FCIC, October Office + of the Comptroller + + of the Currency, + Board of Governors of the + Federal Deposit + +On line 16761: + Thrift Supervision, + and National Credit Union + Administration, + +On line 16763: + Management Guidance + for Home Equity Lending," + May Mortgage Market + +On line 16771: + Implications for + Guidance," PowerPoint, November Bies, + interview. Office + + of the Comptroller + of the Currency, Board of + Governors of the + +On line 16771: + Deposit Insurance + Corporation, Office of + Thrift Supervision, + +On line 16773: + Products," Federal + Register (December Paul + Smith, American Bankers + + Association, + letter to the Federal + Deposit Insurance + +On line 16773: + Board of Governors + of the Federal Reserve + System, Office of + +On line 16773: + Supervision, and + Office of the Comptroller + of the Currency, + +On line 16777: + from the American + Bankers Association (March + p. the American + +On line 16777: + Financial Services + Association (March p. + and Indymac Bank + +On line 16779: + (March p. The Housing + Policy Council of the + Financial Services + +On line 16781: + to the Office of + Thrift Supervision, March p. + Siddique, interview. + +On line 16783: + Appelbaum and Ellen + Nakashima, "Banking Regulator + Played Advocate Over + + Enforcer: Agency Let + Lenders Grow Out of Control, Then + Fail," Washington Post, + +On line 16787: + See, e.g. "Countrywide + Seeks to Become Savings Bank; + The Mortgage Lender Says + +On line 16787: + Apply to Convert + Its Charter So It Will Be + Regulated by + +On line 16789: + instead of Two," Los + Angeles Times, November + based on Bloomberg, Reuters. Kim + +On line 16791: + interview by FCIC, + August Countrywide, "Briefing + Paper: Meeting with + +On line 16799: + Chapter Angelo + Mozilo, email to John McMurray (cc + Dave Sambol, Carlos + +On line 16799: + Pay Options, August + John McMurray, email to Angelo + Mozilo (cc Kevin Bartlett, + +On line 16801: + Garcia, Dave Sambol, + re: Pay Options, August The + cost of borrowing + + is reflected by + credit spreads, the portion of + interest rates that + + compensate investors + for credit risk. Credit spreads + are the interest + +On line 16801: + above the so-called risk-free + interest rate, usually + measured in terms of + +On line 16805: + Loan Syndication + Trading Association, + "The US Loan Market + +On line 16807: + Loan Syndication + Trading Association, + "Financial Reform + +On line 16809: + and the Leveraged Loan + Market," presentation. Ibid., + Loan Syndication + +On line 16813: + April Michael Flaherty + and Dena Aubin, "For Private + Equity Market, + +On line 16817: + Charles Prince, quoted in + "Citigroup chief stays bullish on + buyouts," Financial + +On line 16817: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 16819: + Citigroup Senior + Management, April transcript, pp. + Roben Farzad, Matthew Goldstein, + +On line 16821: + Smart," Busi-nessWeek, September + Joseph Gyourko, "Understanding + Commercial Real + +On line 16821: + How Different from + Housing Is It1" NBER Working + Paper National + +On line 16823: + Economic Research, + February pp. CRE Finance + Council, Compendium + +On line 16827: + Exhibits Joe Keohane, + "Heartbreak Hotels," Portfolio, + November "Hilton Debt + +On line 16829: + Commercial Mortgage + Alert, February Tom Marano, + interview by FCIC, + +On line 16833: + Overview," Bear Stearns, March + p. Gyourko, "Understanding + Commercial Real + +On line 16835: + How Different from + Housing Is It1" p. New York + Federal Reserve + +On line 16835: + Lane LLC Holdings as + of Anton R. Valukas, Report + of Examiner, + +On line 16837: + In re Lehman Brothers + Holdings Inc., et al., Chapter + Case No. 08-13555 (JMP), (Bankr. + +On line 16841: + as Valukas). Ibid., Madelyn + Antoncic, "Lehman Brothers Risk + Management," August + +On line 16847: + by FCIC, July Valukas, + Antoncic, interview. Valukas, + Jody Shenn, "Lehman Said to + +On line 16849: + to Mortgage Market + through Aurora Unit (Update + Bloomberg, October SEC, + +On line 16851: + May July August + September October Erik + Sirri, interview + +On line 16857: + by FCIC, April Valukas, nn. + Valukas, The People of the State + of New York v. Ernst + +On line 16861: + LLP (N.Y. Sup. Ct. filed + Dec. Ronald Marcus, interview + by FCIC, July See + +On line 16861: + Marcus, OTS, "Report + of Examination Lehman + Brothers Holdings Inc.," + +On line 16871: + pp. Notes to Chapter + David Sambol, interview by + FCIC, September See + +On line 16871: + Form 10-K, February + p. See also Fannie Mae, + "Single-Family Conventional + +On line 16871: + "Single Family + Guarantee Business: Facing + Strategic Crossroads," June + +On line 16877: + Mudd, interview by + FCIC, March "Single Family + Guarantee Business: + +On line 16877: + "Single Family + Guaranty Business Strategic + Review Summary," + +On line 16879: + PowerPoint presentation, + July Citigroup, "Project Phineas: + Presentation to + +On line 16881: + Board of Directors," + executive summary, + July and "Single + +On line 16885: + by Fannie Mae. Tom + Lund, interview by FCIC, March + Christopher Dickerson + +On line 16885: + James B. Lockhart III, + "Proposed Appointment of the + Federal Housing + +On line 16887: + Association," + memorandum, September + p. Fannie Mae, 3Q + +On line 16889: + p. at Fannie Mae, + Form 10K, pp. By December + Freddie reported + +On line 16889: + of billion; billion + in loans to borrowers with + FICO scores below + +On line 16889: + high LTV; and billion + in loans for non-owner-occupied + homes. Federal Home + +On line 16891: + ended December + February p. Richard Syron, + interview by FCIC, + +On line 16899: + by FCIC, September + Saksena, interview. "OFHEO, + SEC Reach Settlement + +On line 16901: + Enterprise Oversight + press release, May "Freddie Mac + Voluntarily + +On line 16901: + Retained Portfolio," + Federal Home Loan Mortgage + Corporation press + +On line 16903: + OFHEO, Report of the + Special Examination + of Fannie Mae, May + +On line 16907: + James Lockhart, written + testimony for the FCIC, + Hearing on Subprime + +On line 16907: + Government-Sponsored Enterprises + (GSEs), day session Office of + Federal Housing + +On line 16911: + Enterprise Oversight, + April p. Ibid., p. Robert J. Levin, + Board of Director + +On line 16913: + PowerPoint presentation, + January Minutes of the + February meeting + +On line 16915: + Board of Directors + of Fannie Mae (approved on + April Stephen B. Ashley, + +On line 16915: + remarks prepared for + delivery at the Senior + Management Meeting, + +On line 16917: + National Mortgage + Association, Form 10-K, + for the fiscal year + +On line 16921: + data provided + by Fannie Mae. Federal + National Mortgage + +On line 16923: + National Mortgage + Association, Form 10-K, + May p. OFHEO, Report + +On line 16925: + Fannie Mae, May p. + Federal Home Loan Mortgage + Corporation, Form + +On line 16925: + 10-K, for the fiscal + year ended December filed + June pp. Federal + +On line 16929: + for the fiscal year + ended December filed March + pp. Notes to Chapter + +On line 16933: + Federal Home Loan + Mortgage Corporation, Proxy + Statement and Notice + +On line 16933: + Federal Home Loan + Mortgage Corporation, Proxy + Statement and Notice + +On line 16937: + (July Summary + Compensation Table, p. + (for figures). Ibid. OFHEO, + +On line 16945: + Examination + for Fannie Mae, May pp. Ibid., + p Ibid. Ibid., pp. Ibid. + +On line 16951: + interview by FCIC, + March Todd Hempstead, interview + by FCIC, March Daniel Mudd, + +On line 16955: + conservatorship + memo, September p. Minutes + of a Meeting of + +On line 16957: + the Fannie Mae Board + of Directors, April Minutes + of a Meeting of + +On line 16959: + Fannie Mae Board of + Directors, May Federal + National Mortgage + + Association, + Form 10-K, for the fiscal year + ended December + +On line 16963: + staff estimate based + on data provided by + Fannie Mae. "Deepen + +On line 16965: + Fannie Mae Strategic + Plan, Enrico Dallavecchia, email + to Daniel Mudd, "Budget + +On line 16967: + strategic investments," + July Enrico Dallavecchia, + email to Michael Williams, "RE:," + +On line 16969: + July Daniel Mudd, email + to Enrico Dallavecchia, "RE: + Budget and strategic + +On line 16973: + interview by FCIC, + March Freddie Mac, "Freddie Mac’s + Business Strategy, + +On line 16975: + Board of Directors + Meeting," March pp. Freddie Mac, + "Freddie Mac’s Business + +On line 16977: + March pp. OFHEO, Report + of Examination for + the Federal Home + +On line 16981: + "Mortgage Market Note + The Housing Goals of Fannie + Mae and Freddie Mac + +On line 16983: + to Provide Trillion + in Mortgages for Affordable + Housing for Million + +On line 16989: + Mudd, interview. Robert + Levin, interview by FCIC, March + "HUD Finalizes Rule + + on New Housing Goals + for Fannie Mae and Freddie + Mac," Department of + +On line 16991: + release, November + Mudd, testimony before + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 16995: + session: Fannie Mae, + April transcript, pp. See FHFA, + "Annual Report + +On line 16997: + for mortgage assets + outstanding MBS guaranteed. + Total assets MBS + +On line 17001: + are slightly greater. OFHEO, + Report to Congress," April Robert + Levin, interview by + +On line 17001: + Levin, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 17003: + Government-Sponsored Enterprises + (GSEs), day session Fannie Mae, + April transcript, pp. Tom + +On line 17007: + interview by FCIC, + March Dallavecchia, interview. Todd + Hempstead, interview + +On line 17015: + by FCIC, March Kenneth + Bacon, interview by FCIC, + March Notes to Chapter + +On line 17021: + Ashley, interview + by FCIC, March Levin, interview. + Mike Quinn, interview + +On line 17025: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 17027: + Oversight, April transcript, + pp. .written testimony, + p. Lockhart, written + +On line 17027: + FCIC, April p. Lockhart, + testimony before the + FCIC, April transcript, pp. + +On line 17031: + by FCIC, March Edward + DeMarco, interview by FCIC, March + Maria Fernandez (with + + Alfred Pollard, Chris + Dickerson, Jeffrey Spohn, and + Jamie Newell), interview + +On line 17033: + FCIC, March Mike Price (with + Janice Kuhl, Paul Manchester, + Charlotte Reid, Alfred + +On line 17035: + interview by FCIC, + February Department of + Housing and Urban + +On line 17035: + the Federal Home + Loan Mortgage Corporation + (Freddie Mac) for the + +On line 17035: + and Amendments to HUD’s + Regulation of Fannie + Mae and Freddie Mac," + +On line 17037: + no. Nov. FHFA, "The + Housing Goals of Fannie Mae + and Freddie Mac in + +On line 17041: + to Brian Montgomery + re affordable housing goals, + December "Deepen + +On line 17043: + Montgomery, Federal + Housing Commissioner, to + Daniel Mudd, Fannie Mae, + +On line 17043: + Federal Housing + Commissioner, to Richard F. + Syron, Fannie Mae, + +On line 17045: + typed letter, April "Cost + of Freddie Mac’s Affordable + Housing Mission," PowerPoint + +On line 17049: + presentation, June + pp. Freddie’s net income was + billion in billion + +On line 17049: + in billion in net + loss of billion in and net + loss of billion in + +On line 17049: + Federal Home Loan + Mortgage Corporation, Form + 10-K, for the fiscal + +On line 17051: + Data and Other + Operating Measures, p. + (for figures). "Cost and + +On line 17057: + January "Fannie + Mae’s Housing Goals," Audit Team + briefing, May "Fannie + +On line 17059: + Management Report," + PowerPoint presentation, July + "Cost of Freddie Mac’s + +On line 17070: + Affordable Housing + Mission," PowerPoint presentation, + June pp. Chapter Gary + +On line 17074: + interview by FCIC, + May Lewis Ranieri, interview by + FCIC, July Complaint, + +On line 17076: + SEC v. Goldman Sachs + Co. and Fabrice Tourre (S.D.N.Y. + April Office of the + +On line 17076: + Treasury; Office of + Thrift Supervision, Treasury; + Board of Governors + + of the Federal + Reserve System; Federal + Deposit Insurance + +On line 17078: + (Notice of final + interagency statement), + January Wing Chau, + +On line 17080: + interview by FDIC, + November FCIC, Survey of + CDO Managers, Schedule + +On line 17090: + to Chapter As two + market observers would later + write, "Starting in CDOs + +On line 17090: + CDO investors became + the dominant class of agents + pricing credit risk + +On line 17090: + absence of restraints, + lenders started originating + unreasonably risky + +On line 17090: + and continued to + do so into Mark Adelson + and David Jacob, "The + +On line 17092: + and Lessons," January + p. Scott Simon, quoted in + Allison Pyburn, + +On line 17094: + p. Armand Pastine, + quoted in ibid. According + to the FCIC database, + +On line 17094: + did manage one more + new CDO, Costa Bella CDO, + which was issued in + +On line 17096: + December Source on + downgrades: Bloomberg. Source on events on + default: Moody’s Investors + + Service, "Moody’s downgrades + ratings of Notes issued by + Maxim High Grade CDO + +On line 17100: + April and "Moody’s downgrades + ratings of Notes issued by + Maxim High Grade CDO + +On line 17104: + April ACA Capital, + 10-K, p. "ISDA Publishes + Template for Credit + + Default Swaps on Asset-Backed + Securities with Pay As + You Go Settlement," + +On line 17106: + Under the terms of + the pay-as-you-go swap, if the + referenced mortgage-backed + +On line 17106: + principal payments, + the pay-as-you-go protection + seller is required + +On line 17106: + of the shortfall. For + long investors—the protection + provider under the swap—the + + advantage was the + leverage embedded in the + trade: they did not have + +On line 17106: + come up with the cash + up front for the principal + amount of the bond; they + +On line 17106: + quarterly swap fees + in return for accepting + the risk of loss if + +On line 17110: + a shortfall. Laura + Schwartz, interview by FCIC, May + Laurie S. Goodman, + +On line 17112: + Derivatives (Frank + J. Fabozzi Series) (Hoboken, NJ: + John Wiley, p. Greg + +On line 17114: + interview by FCIC, + May FCIC staff estimates based + on analysis of + +On line 17116: + FCIC Hedge Fund Survey. + From July through December + several hedge funds + +On line 17116: + in mortgage-related + CDO equity tranches and + almost billion of + +On line 17116: + mortgage-related CDO + equity tranche issuance. Please + see FCIC website for + +On line 17116: + information about + the hedge fund survey. Note: the + FCIC did not survey + + hedge funds that fully + liquidated or closed. These + funds may have purchased + +On line 17120: + FCIC Hedge Fund Survey. + See FCIC website for details. + Rabobank’s counsel, letter + +On line 17122: + Fried of the Supreme Court + of NY, May Norma Flow of + Funds, information + +On line 17126: + by Merrill Lynch. Steven + Ross, email to FCIC, December + See letter from Rabobank’s + +On line 17126: + counsel, letter to + Judge Fried, May the letter was + never filed with the + +On line 17132: + Lynch. Information + provided by Merrill Lynch, + December Complaint, + +On line 17134: + Goldman Sachs Co. and + Fabrice Tourre. Ira Wagner, + interview by FCIC, + +On line 17142: + Schwartz, interview. John + Paulson, interview by FCIC, + October "Goldman + +On line 17142: + Pay Record Million to + Settle SEC Charges Related + to Subprime Mortgage + +On line 17146: + July Jamie Mai and + Ben Hockett, interview by + FCIC, April Sihan Shu, + +On line 17150: + FCIC, September Steven + Eisman, interview by FCIC, + April James Grant, "Inside + +On line 17150: + Mortgage Machine," in + Mr. Market Miscalculates: + The Bubble Years and + +On line 17160: + Eisman, interview. + Notes to Chapter Michael Burry, + interview by FCIC, + +On line 17166: + Paulson, interview. + Burry, interview. FCIC Hedge + Fund Survey. See FCIC + +On line 17168: + Geanakoplos, written + testimony for the FCIC, + Forum to Explore + +On line 17168: + Financial Crisis, + day session Risk Taking and + Leverage, February + +On line 17170: + p. OCC, "Subprime CDO + Valuation and Oversight + Review—Conclusion Memorandum," + + memorandum from + Michael Sullivan, RAD, and Ron + Frake, NBE, to John Lyons, + +On line 17170: + NA, January p. + Paul, Weiss, Citigroup’s counsel, + letter to FCIC, June + +On line 17174: + "Responses of Nestor + Dominguez." Richard Bookstaber, interview + by FCIC, May "RMBS and + +On line 17174: + a Percentage of + Citi-CDO Portfolio Notionals," + produced by Citi for + +On line 17176: + Federal Reserve + Bank of New York, Federal + Reserve Board, Office + +On line 17178: + with Firms," November + p. FCIC staff estimates, based + on analysis of + +On line 17180: + Moody’s CDO EMS database. + Paul, Weiss, Citigroup’s counsel, + letter to FCIC, March + +On line 17180: + request, "Response to + Interrogatory no. Paul, + Weiss, letter to FCIC, + +On line 17182: + interrogatory + no. p. Nestor Dominguez, interview + by FCIC, March Paul, Weiss, + +On line 17186: + letter of March pp. + Board Analyst Profile for + Citigroup Inc., April + +On line 17188: + SEC staff (Sam Forstein, Tim + McGarey, Mary Ann Gadziala, Kim Mavis, Bob + Sollazo, Suzanne McGovern, + +On line 17190: + Comptroller of the + Currency, memorandum, + Examination + +On line 17192: + (CRM), January p. + Ronald Frake, Comptroller of the + Currency, letter + +On line 17196: + York Operations + Review, May p. Federal + Reserve Bank of New + +On line 17196: + Bank Supervision + Group, "Operations Review + Report," December + +On line 17200: + Findings," Citigroup + Inc., January 2004–December + April Citigroup Inc., + +On line 17204: + a reduction that + had been implemented when + the issues began + +On line 17206: + and then added a raise. + Citigroup, Proxy Statement, p. + Comptroller of the + +On line 17208: + Federal Reserve + Bank of New York, letter to + Vikram Pandit and the + +On line 17210: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 17212: + the Shadow Banking + System, May transcript, p. Gene + Park, interview by + +On line 17216: + FCIC, May Andrew Forster, + email to Gary Gorton, Alan Frost, + et al., July Park, + +On line 17222: + interview. Gorton, + interview. Park, interview. + Gene Park, email to Joseph + +On line 17232: + Park, interview. Notes + to Chapter Data supplied + by AIG. The CDO—RFC + +On line 17232: + according to the + AIG credit committee. A + review by FCIC staff + +On line 17238: + (Financial Figures + are as of June August p. + Park, interview. Joseph + +On line 17242: + Cassano, interview + by FCIC, June Park, interview. + Dow Kim, interview + +On line 17246: + by FCIC, September + Stanley O’Neal, interview by + FCIC, September Kim, + +On line 17250: + staff estimates based + on analysis of Moody’s CDO + EMS database. Complaint, + +On line 17256: + Merrill Lynch, No. (N.Y.S. + June paragraph Kim, interview. + FCIC analysis based + +On line 17258: + Moody’s CDO EMS database. + Presentation to Merrill + Lynch and Co. Board of + +On line 17262: + "Leveraged Finance and + Mortgage/CDO Review," October p. + Chau, interview. FCIC + +On line 17264: + staff analysis of + Moody’s CDO EMS database. FCIC staff + estimates based on + +On line 17266: + information not + provided for Robeco High + Grade CDO I. FCIC staff + +On line 17270: + EMS database. Data + supplied by Merrill Lynch. FCIC + staff analysis of + + Moody’s CDO EMS database. + The total value of Baa + tranches issued by + +On line 17270: + the FCIC database was + million in and billion in + Aa tranches, billion + +On line 17272: + in and billion in + A tranches, million in and + billion in FCIC staff + +On line 17274: + telephone discussion + with SEC staff, September FCIC + staff analysis of + +On line 17276: + CDO EMS database. Chau, + interview; for number of + the CDOs he managed, + +On line 17280: + December produced + by AIG. Presentation to + the Merrill Lynch Board, + +On line 17280: + Mortgage/CDO Review," p. Jeff + Kronthal, former head of + Merrill Lynch’s Global + +On line 17280: + Real Estate and + Structured Products, interview + by FCIC, September + +On line 17284: + Al Yoon, "Merrill’s Own + Subprime Warnings Unheeded," + Reuters, October SEC, + +On line 17288: + memo to Erik Sirri + and others, February p. + Ibid., p. Yoon, "Merrill’s + +On line 17290: + Own Subprime Warnings + Unheeded." Kim, interview. + Senate Permanent + + Subcommittee on + Investigations, Fishtail, + Bacchus, Sundance, and + +On line 17290: + by U.S. Financial + Institutions, 107th Cong., 2nd + sess., January S-Prt + +On line 17292: + Practices" (Notice of + final interagency + statement), January + +On line 17294: + (see n. above). Office + of the Comptroller of the + Currency, Treasury; + +On line 17294: + Thrift Supervision, + Treasury; Board of Governors + of the Federal + +On line 17294: + Federal Deposit + Insurance Corporation; + and Securities + +On line 17304: + statement with request + for public comments),May Ibid., pp. Notes + to Chapter John C. + +On line 17304: + of the Currency, + written testimony for + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 17306: + Practices" (Notice of + final interagency + statement), January + +On line 17308: + p. Basel Committee + on Banking Supervision: + Joint Forum, "Credit + +On line 17316: + pp. SEC, Office of + Compliance Inspections and + Examinations, + +On line 17318: + the FCIC, Hearing on + the Credibility of + Credit Ratings, the + +On line 17318: + Those Ratings, and the + Financial Crisis, session + Credit Ratings and + +On line 17320: + interview by FCIC, + May Buffett, testimony + before the FCIC, June + +On line 17322: + p. Eric Kolchinsky, + written testimony for + the FCIC, Hearing on + +On line 17322: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 17324: + and the Financial + Crisis, session The Ratings + Process, June p. Brian + +On line 17326: + interview by FCIC, + May Gary Witt, interview by + FCIC, April John Rutherford + +On line 17326: + the president and + CEO of Moody’s Corporation + from the time of its + +On line 17328: + spin-off from Dun Bradstreet + in until he retired from + the firm in Jerome Fons, + +On line 17332: + interview by FCIC, + April Raymond McDaniel, interview + by FCIC, May Clarkson, + +On line 17338: + interview. Raymond + McDaniel, testimony before + the FCIC, Hearing on + +On line 17338: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 17340: + Credit Ratings and + the Financial Crisis, June + transcript, pp. Scott McCleskey, + +On line 17346: + the FCIC, Hearing on + the Credibility of + Credit Ratings, the + +On line 17346: + Based on Those Ratings, + and the Financial Crisis, + session The Credit + +On line 17350: + transcript, p. Clarkson, + interview; McDaniel, interview. + Witt, interview; Gary + +On line 17350: + the FCIC, Hearing on + the Credibility of + Credit Ratings, the + +On line 17350: + Based on those Ratings, + and the Financial Crisis, + Session The Credit + +On line 17352: + Brian Clarkson, email + to Ed Bankole, Pramila Gupta, + Michael Kanef, Andrew Kriegler, + +On line 17354: + AFG by analyst.xls," + July William May, email to Gus + Harris, subject: "RE: + +On line 17356: + and PEs," January + Yuri Yoshizawa, email to direct + report managing + +On line 17358: + directors, subject: + "3Q Market Coverage-CDO," October + Clarkson, interview. + +On line 17362: + McDaniel, interview. Witt, + testimony before the + FCIC, June transcript, pp. + +On line 17364: + Service: Managing + Director’s Town Hall Meeting, + September transcript, + +On line 17374: + policy issues + at Moody’s suggested by the + subprime/liquidity + +On line 17374: + ratings committee + to external pressures was + shown in the constant + +On line 17378: + obligation (CPDO) + scandal in Europe. Ibid., p. + David Teicher, project + +On line 17380: + Moody’s, interview by + FCIC, May Standard Poor’s, "Credit + FAQ: The Basics of + +On line 17382: + the FCIC, Hearing on + the Credibility of + Credit Ratings, the + +On line 17382: + Based on Those Ratings, + and the Financial Crisis, + session The Credit + +On line 17386: + Business Model, June + transcript, p. Witt, interview. + Clarkson, interview. + +On line 17392: + p. Eric Kolchinsky, + testimony before the + FCIC, Hearing on the + +On line 17392: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 17392: + and the Financial + Crisis, session The Ratings + Process, June transcript, pp. + +On line 17396: + Fu and Y Yoshizawa, + May Kolchinsky, testimony + before the FCIC, June + +On line 17400: + pp. Eric Kolchinsky, + interview by FCIC, April FCIC + staff estimates, based + +On line 17402: + analysis of Moody’s + SFDRS database. Riachra O’Driscoll, + email to Yuri Yoshizawa, + +On line 17404: + "Magnolia Class Ds," + April Kimball, memorandum, + "Credit policy + +On line 17406: + p. SEC, Office of + Compliance Inspections and + Examinations, + +On line 17415: + Moody’s Investors Services, + Inc.," p. Chapter William Dudley, + interview by FCIC, + +On line 17417: + The Secondary Market + (Bethesda, Md.: Inside Mortgage + Finance, p. "Non-Agency MBS + +On line 17419: + Issuance." Ben S. Bernanke, + chairman of the Federal + Reserve, letter to + +On line 17421: + Phil Angelides, chairman + of the FCIC, December Mark + Zandi, Celia Chen, and + +On line 17423: + Moody’s Economy.com, + October pp. CoreLogic Home Price + Index, Single-Family Combined + +On line 17427: + staff calculations, + January to January. + CoreLogic Census Bureau + + Statistical Area + (CBSA) Home Price Index, FCIC + staff calculations. + +On line 17429: + provided by Mark + Fleming, chief economist for + CoreLogic, in his written + +On line 17429: + FCIC, Hearing on the + Impact of the Financial + Crisis—Sacramento, session Overview + + of the Sacramento + Housing and Mortgage Markets + and the Impact of + +On line 17431: + Financial Crisis + on the Region, September + figures Mark Fleming, + +On line 17431: + FCIC, Hearing on the + Impact of the Financial + Crisis—Sacramento, session Overview + + of the Sacramento + Housing and Mortgage Markets + and the Impact of + +On line 17433: + Financial Crisis + on the Region, September + transcript, p. Mortgage + +On line 17435: + Delinquency Survey, + data provided to the + FCIC. Ibid., with FCIC staff + +On line 17437: + calculations. FCIC + staff analysis, "Analysis + of housing data," + +On line 17439: + FCIC by staff at the + Federal Reserve. Subprime + and Alt-A mortgages are + +On line 17439: + mortgages purchased or + guaranteed by Fannie Mae + or Freddie Mac. FHA + +On line 17441: + included mortgages + insured by the FHA or VA. + FCIC staff analysis. + +On line 17449: + Notes to Chapter A + recent analysis published + by FHFA comes to + +On line 17449: + See "Data on the + Risk Characteristics and + Performance of Single-Family + +On line 17451: + and Financed in the + Secondary Market," September + FCIC staff analysis, + +On line 17451: + of housing data + and comparison with Ed + Pinto’s analysis," + +On line 17451: + provided by the + Federal Reserve, Fannie + Mae and Freddie Mac + +On line 17451: + with a FICO score + below had an average + rate of serious + +On line 17451: + the GSEs stated that + the average serious + delinquency rates for + +On line 17451: + loans with FICO scores + less than in their guarantee + books was Fannie Mae + +On line 17453: + Credit Supplement, + p. Freddie Mac Fourth Quarter + Financial Results + +On line 17455: + p. In the sample + data provided by the + Federal Reserve, + +On line 17455: + Mae and Freddie Mac + mortgages with LTVs above had an + average rate of + +On line 17455: + the GSEs stated that + the average serious + delinquency rates for + +On line 17457: + Credit Supplement, + p. Freddie Mac Fourth Quarter + Financial Results + +On line 17459: + Federal Agency + Contributions to Subprime + and Alt-A Loans in U.S. + +On line 17459: + of Exhibit with + corrections through October + (www.aei.org/docLib/PintoFCICTriggersMemo.pdf). The million loans + +On line 17459: + total of million + mortgages in subprime or Alt-A + pools, which Pinto calls + +On line 17459: + FICO scores below + which he labels "subprime by + characteristic." + +On line 17459: + interest-only loans, + negative amortization + loans, or loans with an + +On line 17459: + second mortgage—greater + than which he collectively + refers to as "Alt-A by + + characteristic." + The last addi-tions include + an estimated + +On line 17461: + million loans insured + by the FHA and VA with an + LTV greater than out of + +On line 17461: + of roughly million + FHA and VA loans—and million loans + in bank portfolios + +On line 17461: + Credit Supplement, + p. Freddie Mac Fourth Quarter + Financial Results + +On line 17465: + March Edward Pinto, + "Yes, the CRA Is Toxic," City + Journal, Autumn Neil + +On line 17465: + Glenn Canner, "Did the + CRA Cause the Mortgage Market + Meltdown1" Federal + +On line 17465: + Board of Governors, + March The authors use the Home + Mortgage Disclosure + +On line 17465: + which cover roughly + of the mortgage market in + the United States—see Robert + + B. Avery, Kenneth + P. Brevoort, and Glenn B. Canner, + "Opportunities + +On line 17467: + in Using HMDA + Data," Journal of Real + Estate Research no. + +On line 17469: + California: The + Performance of CRA Lending + During the Subprime + +On line 17469: + November working + paper to be presented + at the Federal + +On line 17471: + and Mortgage Markets, + Washington, DC, December + FCIC, "Preliminary + +On line 17475: + Crisis," April Bank of + America response letter + to FCIC, August John + +On line 17479: + interview by FCIC, + March Lewis Ranieri, interview by + FCIC, July Nicolas + +On line 17483: + Weill, interview by + FCIC, May Ibid. Nicolas Weill, email + to Raymond McDaniel and + +On line 17487: + Report, January + pp. Moody’s Investors Service, "Moody’s + Downgrades Subprime First-lien + +On line 17491: + Research Announcement," + July Weill, interview. FCIC + staff estimates, based + +On line 17493: + on analysis of + Blackbox data. Data on + Bear Stearns provided + +On line 17501: + by JP Morgan to + the FCIC. Notes to Chapter Moody’s + Investors Service, "Moody’s + +On line 17501: + Downgrades billion of + Subprime First-Lien RMBS and Affirms + billion Aaa’s and Aa’s," + +On line 17503: + Report, October + pp. FCIC staff estimates, based + on analysis of + +On line 17505: + FCIC staff estimates, + based on analysis of Moody’s + SFDRS data as + +On line 17507: + Service, "The Impact + of Subprime Residential + Mortgage-Backed Securities + +On line 17509: + Special Comment, March + p. Yuri Yoshizawa, email to Noel + Kirnon and Raymond McDaniel, + +On line 17513: + Kolchinsky, subject: "CSFB + Pipeline information," March + Moody’s Investors Service, + +On line 17515: + Report, May p. Richard + Michalek, testimony before + the FCIC, Hearing on + +On line 17515: + Credit Ratings, the + Investment Decisions Made + Based on Those Ratings, + +On line 17517: + Model, June transcript, + pp. MCO Strategic Plan Overview," + presentation by + +On line 17521: + complaint, Chronology + Prepared by Eric Kolchinsky. + FCIC staff estimates + +On line 17521: + analysis of Moody’s + SFDRS; FCIC, "Preliminary + Staff Report: Credit + +On line 17523: + and the Financial + Crisis," June Eric Kolchinsky, + interview by FCIC, + +On line 17531: + Credit Ratings and + the Financial Crisis," pp. + Bingham McCutchen, Fannie + +On line 17531: + Mae counsel, letter + to FCIC, September (hereafter + "Bingham Letter"); O’Melveny + +On line 17531: + Meyers LLP, Freddie + Mac counsel, letter to FCIC, + September (hereafter + +On line 17533: + the Enterprises’ + Financial Performance: Third + Quarter tables and + +On line 17539: + Bingham Letter, Tab + Tab "Repurchase Collections + by Top Ten Sellers/Servicers." O’Melveny + +On line 17541: + "Bank of America + announces fourth-quarter actions with + respect to its home + +On line 17543: + January Mortgage + Insurance Companies of + America, Fact Book + +On line 17545: + (Insurance in Force) + p Documents produced for + the FCIC by United + +On line 17547: + Insurance, MGIC, + Genworth, RMIC, Triad, PMI, and + Radian. FCIC staff + + calculations based + on productions from Fannie + and Freddie. Figures + +On line 17549: + ARM Alt-A, and subprime + loans. FHFA, "Conservator’s + Report: Third Quarter + +On line 17549: + Accounting changes for + impairments have resulted + in offsetting gains + +On line 17551: + for PLS Documents," + Federal Housing Finance + Agency news release, + +On line 17553: + Burling LLP, Freddie + Mac counsel, letter to FCIC, + October see O’Melveny + +On line 17559: + Products," Part VII of + a NERA Insights Series, June + p. Defendants Wells + +On line 17559: + Corp. and Wells Fargo + Bank, N.A.’s Notice of Removal, + Charles Schwab Corp. v. BNP + +On line 17565: + Paribas Securities + Corp, et al., No. cv-10-4030 (N.D. Cal. + September Notes to + +On line 17567: + of Massachusetts, + "Attorney General Martha + Coakley and Goldman + +On line 17567: + Sachs Reach Settlement + Regarding Subprime Lending + Issues," May "Morgan + +On line 17569: + under Settlement + with AG Coakley’s Office," June + Complaint, Cambridge Place + +On line 17569: + v. Morgan Stanley + et al., No. 10-2741 (Mass. Super. + Ct. filed July p. + +On line 17573: + Sarah Johnson, "How Far + Can Fair Value Go1" CFO.com, May + Vikas Shilpiekandula and + + Olga Gorodetsky, "Who + Owns Residential Credit + Risk1" Lehman Brothers Fixed + +On line 17575: + U.S. Securitized + Products Research, September + Moody’s Investor Service, + +On line 17577: + Comment, September + Ben Bernanke, closed-door session with + the FCIC, November + +On line 17579: + Olga Gorodetsky, "Who + Owns Residential Credit + Risk1," September p. + +On line 17579: + Lehman analysts pegged + ultimate subprime and Alt-A + losses at billion. + + Those forecasts were based, + the analysts said, on a + scenario in which house + +On line 17579: + across the country. For + the securitization + figures, see Inside + +On line 17581: + Policy," Global + Financial Stability + Report, October + +On line 17583: + Global Financial + Stability Report, April + FCIC staff estimates, + +On line 17585: + and analysis of + Moody’s Structured Finance Default + Risk Service. Ben Bernanke, + +On line 17585: + Financial Crisis, + day session The Federal + Reserve, September + +On line 17594: + staff calculations + using data in worksheets + Markit ABX.HE. 06-1 + +On line 17596: + Research, CDO/CDS Update + The figures refer to the + BBB- index of + +On line 17600: + CDO/CDS Update p. SEC, + "Risk Management Reviews of + Consolidated + +On line 17602: + memo to Erik Sirri + and others, January Jim + Chanos, interview by + +On line 17604: + FCIC, October SEC, + "Risk Management Reviews of + Consolidated + +On line 17608: + March Henry Paulson, + quoted in Julie Haviv, "Bernanke + Allays Subprime Fears + +On line 17610: + Financial Crisis: + The Role of Investment Banks, + Senate Permanent + +On line 17612: + Subcommittee on + Investigation, 111th Cong., + 2nd sess., April pp. Michael + +On line 17612: + email to David Viniar and + Craig Broderick, December + Senate Permanent + +On line 17614: + pp. Daniel Sparks, email to + Tom Montag and Richard Ruzika, + December Senate + +On line 17616: + Gasvoda, email to Genevieve + Nestor and others, December + Senate Permanent + +On line 17620: + Investigations, + Exhibit Stacy Bash-Polley, email + to Michael Swenson and + +On line 17628: + Investigations, + Exhibit Notes to Chapter + Tetsuya Ishikawa, email to + +On line 17630: + Investigations, + Exhibit 170d. Fabrice Tourre, + email to Jonathan Egol and + +On line 17634: + Investigations, + Exhibit Fabrice Tourre, email + to Marine Serres, + +On line 17640: + using data from + GS Synthetic CDOs," produced + by Goldman Sachs. Gretchen + + Morgenson and Louise + Story, "Banks Bundled Bad Debt, + Bet Against It and Won," + +On line 17642: + York Times, December + Lloyd Blankfein, testimony + before the FCIC, First + +On line 17642: + FCIC, first day, panel + Financial Institution + Representatives, + +On line 17644: + January transcript, + pp. "Goldman Sachs Clarifies + Various Media + +On line 17646: + Hearing," Goldman Sachs + press release, January Gary + Cohn, testimony + +On line 17646: + the FCIC, Hearing on + the Role of Derivatives + in the Financial + +On line 17648: + session Goldman Sachs + Group, Inc. and Derivatives, + June transcript, p. Michael + +On line 17648: + statement, Hearing on + Wall Street and the Financial + Crisis: The Role of + +On line 17650: + pp. Complaint, Basis + Yield Alpha Fund v. Goldman + Sachs Group, Inc., et al. + +On line 17654: + January transcript, + p. Craig Broderick, written + testimony for + + the FCIC, Hearing on + the Role of Derivatives + in the Financial + +On line 17656: + Goldman Sachs Group, Inc. + and Derivatives, June p. + Craig Broderick, email + +On line 17658: + Exhibit High Grade + Risk Analysis, April p. High + Grade—Enhanced Leverage Q&/A, June + +On line 17658: + collateral in + our investment grade structures + collateralized + +On line 17660: + by "sub-prime" mortgages + is approximately On + the March investor call, + +On line 17660: + Tannin told investors + that "most of the CDOs that we + purchased are backed in + +On line 17662: + Call transcript, pp. Email + from matt.tannin@gmail.com to + matt.tannin@gmail.com, + +On line 17666: + Tannin, Bear Stearns, email + to Chavanne Klaus, MEAG New York, + March BSAM Conference + +On line 17668: + Call, April transcript, p. + Matt Tannin, Bear Stearns, email to + Klaus Chavanne, MEAG New + +On line 17668: + Matthew Tannin, email to + Steven Van Solkema, March Complaint, + SEC v. Cioffi, No. + +On line 17672: + (E.D.N.Y. June p. Jim + Crystal, Bear Stearns, email to Ralph + Cioffi (and others), + +On line 17674: + March Ralph Cioffi, Bear + Stearns, email to Ken Mak, Bear Stearns, + March Warren Spector, + +On line 17674: + FCIC, Hearing on the + Shadow Banking System, day + session Investment + +On line 17676: + Banks and the Shadow + Banking System, May transcript, + pp. Information + +On line 17680: + counsel to Bank of + America, September Ibid. + Alan Schwartz, interview + +On line 17680: + April Notably, as one + of only two tri-party + repo clearing banks, + +On line 17680: + more information + about BSAM’s lending obligations + than did most other + +On line 17680: + this superior + market knowledge later put + JP Morgan in a + +On line 17682: + step in and purchase + Bear Stearns virtually overnight. + Email from Goldman to + +On line 17684: + Van Solkema, Bear Stearns, + internal email, Summary + of CDO Analysis + +On line 17692: + Credit Model, April + Notes to Chapter Matt Tannin, + Bear Stearns, email from Gmail + +On line 17694: + to Ralph Cioffi, Bear + Stearns, at his Hotmail account, + April BSAM Conference + +On line 17698: + Call, April transcript. Iris + Semic, email to Matthew Tannin et + al., May Robert Ervin, email + +On line 17700: + May email from Goldman + (ficc-ops-cdopricing) to + rervin@bear.com, May BSAM + +On line 17700: + Pricing Committee + minutes, June Robert Ervin, email to + Greg Quental et al., + +On line 17700: + showing that losses + for the High Grade fund would be + if BSAM used the prices + +On line 17702: + desk was using, rather + than 11.45%—the loss without Lehman’s marks. + Email from "BSAM Hedge Fund + +On line 17704: + Management (Generic)," + May produced by JP Morgan. + BSAMFCIC-e0000013. An untitled + +On line 17704: + less; NAV estimate + reconciliation chart, + produced by JPMorgan, shows + +On line 17708: + Committee minutes, + June Ralph Cioffi, interview + by FCIC, October + +On line 17716: + Ralph Cioffi, email to + John Geissinger, June Schwartz, interview. + Ibid. Ibid.; CSE Program + +On line 17718: + to Erik Sirri and + others through Matthew Eichner, + July CSE Program + +On line 17720: + July Merrill Lynch + analysis, "Bear Stearns Asset + Mgm’t: What Went Wrong"; Paul + +On line 17720: + FCIC, April While most of + the Bear Stearns executives + interviewed by FCIC + +On line 17720: + did not recall the + percentage discount at which + the collateral + +On line 17720: + did believe that it + was significant (e.g., Robert + Upton, interview + +On line 17722: + April "While the High Grade + fund was not in default/had + not missed any margin + +On line 17722: + haircuts or not rolling + repo facilities." Bear + Stearns Packet dated + +On line 17722: + held on June produced + by the Securities and + Exchange Commission, + +On line 17726: + Mary Kay Scucci, April + Friedman, interview; Warren + Spector, interview + +On line 17728: + FCIC, March Sam Molinaro, + interview by FCIC, April Thomas + Marano, interview + +On line 17730: + Spector, interview + (on Marano’s being sent to + Marin). Fed Chairman Ben + +On line 17732: + to FCIC Chairman Phil + Angelides, December James Cayne, + interview by FCIC, + +On line 17734: + Consolidated + Supervised Entities," memo + to Erik Sirri and + +On line 17734: + Consolidated + Supervised Entities," memo + to Erik Sirri and + +On line 17738: + p. both produced by + SEC. Marano, interview. Bill + Jamison, internal + +On line 17740: + Federated. JPMorgan, + Directors Risk Policy + Committee, "Worldwide + +On line 17742: + the downgrades, see Moody’s + Investor Service, "Announcement: + Moody’s Downgrades Subprime + +On line 17744: + U.S. First-Lien Subprime RMBS + Classes Downgraded," July + p. Glenn Costello, "U.S. + +On line 17746: + Rating Surveillance + Update," Fitch Ratings, July + FCIC, "Preliminary + +On line 17748: + Staff Report: Credit + Ratings and the Financial + Crisis," June p. Steven + +On line 17750: + transcript, p. Andrew + Forster, telephone conversation, + July transcript, pp. + +On line 17758: + Martin Sullivan, + interview by FCIC, June Steve + Bensinger, interview by + +On line 17758: + Lewis, interview by + FCIC, June Kevin McGinn, interview + by FCIC, June Andrew + + Forster, Elias Habayeb, and Steve + Bensinger, testimony before + the FCIC, Hearing on + +On line 17758: + Derivatives in + the Financial Crisis, day + session American + +On line 17758: + International + Group, Inc. and Goldman Sachs Group, + Inc., July transcript, + +On line 17760: + former managing + director for Complex and + International + +On line 17760: + Thrift Supervision, + testimony before the + FCIC, Hearing on the + +On line 17760: + Financial Crisis, + day session Derivatives: + Supervisors and + +On line 17764: + transcript, pp. Alan Frost, + interview by FCIC, May Joseph + Cassano, interview + +On line 17766: + June "Information + Pertaining to the Multi-Sector CDS + Portfolio," produced + +On line 17768: + staff calculations. + Andrew Davilman, email to Alan + Frost, subject: "Sorry + +On line 17768: + bother you on"; Frost, + email to Davilman, subject: "Re: + Sorry to bother + +On line 17768: + on"; Davilman, email to + Frost, subject: "Re: Sorry to + bother you on"—all + +On line 17772: + to AIG Financial + Products Corp., July produced + by Goldman Sachs. AIG + +On line 17774: + 2006–December produced + by Goldman Sachs. Andrew Forster, + interview by FCIC, + +On line 17778: + Daniel Sparks, interview + by FCIC, May "Valuation + Pricing Related + +On line 17780: + Calls on Transactions + with AIG," produced by Goldman + Sachs. Jon Liebergall and + +On line 17782: + transcript, pp. David Viniar, + written testimony for + the FCIC, Hearing on + +On line 17782: + Derivatives in + the Financial Crisis, day + session American + +On line 17795: + Athan, email to Andrew + Forster, August Chapter Henry + Paulson, quoted in + +On line 17797: + Rout Doesn’t Threaten + Economy," Bloomberg, July Moody’s + Investors Service, "Moody’s + +On line 17797: + ABCP Program Index: + CP Outstanding as of Moody’s + Investors Service, "Moody’s + +On line 17799: + Overview: Rhineland Funding + Capital Corporation," + June As noted, in + +On line 17799: + capital charge for + liquidity puts equal to + of the base or Staff + +On line 17799: + by FCIC, September + See also Office of the + Comptroller of the + +On line 17801: + Treatment," August For + example, Citigroup would + have held million in + +On line 17801: + in liquidity + put exposure that it had + accumulated + +On line 17805: + CDOs it had issued. + IKB, Annual Report, June + p. Securities + +On line 17807: + Sachs Co. and Fabrice + Tourre, no. 10-CV-3229 (S.D.N.Y. April p. + IKB staff, interview + +On line 17807: + Securities and + Exchange Commission (plaintiff) + v. Goldman Sachs Co. + +On line 17807: + United States District + Court, Southern District of New + York, April at paragraph + +On line 17811: + the first quarter April-30 + June IKB press release, July + IKB staff, interview; + +On line 17811: + interview by FCIC, + November IKB, restated + Annual Report, + +On line 17813: + Meier, testimony + before the FCIC, Hearing on + the Shadow Banking + +On line 17821: + Banking System, May + transcript, p. Notes to Chapter + Angelo Mozilo, + +On line 17823: + LA-03370-A, November pp. + Angelo Mozilo, email to + Lyle Gramley, member + +On line 17823: + Board of Countrywide + Financial Corporation + (cc Michael Perry, chief + +On line 17825: + officer, IndyMac Bank), + August Eric Sieracki, + quoted in Mark DeCambre, + +On line 17827: + TheStreet.com, August "Minutes + of a Special Telephonic + Meeting of the Board + +On line 17829: + Fed Chairman Ben Bernanke, + letter to FCIC Chairman Phil + Angelides, December + +On line 17831: + Reserve Staff, memo to + Board of Governors of the + Federal Reserve + +On line 17835: + Ibid., pp. Countrywide + Financial Corporation, + Form 8-K, Exhibit + +On line 17835: + See also "Minutes + of a Special Telephonic + Meeting of the Boards + +On line 17837: + Corporation and + Countrywide Bank, FSB," August + Angelo Mozilo, + +On line 17839: + September Kenneth + Bruce, "Liquidity Is the + Achilles Heel," Merrill Lynch + +On line 17843: + August p. Mozilo, + interview; the article, + by E. Scott Reckard and + +On line 17843: + was titled "Credit + Crunch Imperils Lender: Worries + Grow about Countrywide’s + +On line 17845: + Angelo Mozilo, + quoted in "One on One with + Angelo Mozilo, + +On line 17845: + CEO of Countrywide + Financial," Nightly Business + Report, PBS, August + +On line 17845: + transcript; and in "CEO + Exclusive: Countrywide CEO, + Pt. The Call, CNBC, + +On line 17847: + interview by Maria + Bartiromo, August transcript, + p. Sebastian Boyd, + +On line 17849: + as Loan Losses Roil + Markets," Bloomberg, August "BNP Paribas + Investment Partners + + Temporally [sic] + Suspends the Calculation + of the Net Asset + +On line 17849: + the following funds: + Parvest Dynamic ABS, BNP + Paribas ABS EURIBOR + +On line 17853: + ABS EONIA," BNP Paribas + press release, August Paul A. + McCulley, testimony + +On line 17855: + Banking System, May + pp. Daniel M. Covitz, Nellie Liang, + and Gustavo A. + + Suarez, "The Evolution + of a Financial Crisis: + Panic in the Asset-Backed + +On line 17859: + Facilitate the + Orderly Functioning of + Financial Markets," + +On line 17863: + August Henry Tabe, + Moody’s Investors Service, "SIVs: An + Oasis of Calm in + +On line 17867: + Report, July p. + Ibid. Henry Tabe, interview + by FCIC, October + +On line 17869: + Liquidity: The + Path Toward Credit Market + Nor-malization," Moody’s + +On line 17875: + p. Information + provided to the FCIC by + Deloitte LLP’s counsel, + +On line 17877: + September Henry + Tabe, The Unravelling of + Structured Investment + +On line 17879: + Kent]: Thoth Capital, + p. The SEC indicated + it is aware of at + +On line 17879: + that were supported + by affiliates because + of SIV investments. + +On line 17879: + Securities and + Exchange Commission, "Money + Fund Reform" (Proposed + +On line 17887: + rule), June p. n. Notes + to Chapter Christopher Condon + and Rachel Layne, "GE Bond + +On line 17889: + Fund Investors Cash Out + After Losses from Subprime," + Bloomberg, November The + +On line 17889: + disclosed. See Shannon + D. Harrington and Sree Vidya + Bhaktavatsalam, "Bank + +On line 17889: + of America to + Liquidate Billion Cash Fund," + Bloomberg, December See + +On line 17889: + M. Grynbaum, "Mortgage + Crisis Forces the Closing of + a Fund," New York Times, + +On line 17891: + at Marshall Money + Market Funds, interview by + Crane Data, Money + +On line 17893: + Fund Intelligence, + January Credit Suisse + Institutional + +On line 17895: + December Note p. + Florida Legislature, + Office of Program + +On line 17899: + Memorandum, March + p. SBA report, "Update on + Sub-Prime Mortgage Meltdown + +On line 17908: + Bloomberg Professional, + Write downs and Credit Losses + vs. Capital Raised + +On line 17908: + data reported + for second half of Write-downs + are for losses to + +On line 17910: + holdings in structured + finance and mortgages. Roy C. + Smith, Paper Fortune$: + + Modern Wall Street: Where + It’s Been and Where It’s Going + (New York: St. Martin’s + +On line 17912: + Historical Prices + Index December CGS1U5; + CBSC1U5; and CLEH1U5. + +On line 17914: + refer to credit + default swaps on five-year senior + debt. Presentation + +On line 17918: + "Leveraged Finance and + Mortgage/CDO Review," October p. + Presentation to + +On line 17922: + interview by FCIC, + September Presentation + to Merrill Board of + +On line 17926: + pp. Presentation + to Merrill Lynch Risk Oversight + Committee, "Market + +On line 17928: + Update," September + p. Merrill Lynch, 1Q Earnings + Call transcript, April p. + +On line 17932: + 2Q Earnings Release, + July p. Merrill Lynch, 2Q + Earnings Call transcript, + +On line 17942: + Ibid. Kim, interview. + Stanley O’Neal, interview by + FCIC, September "ABS + +On line 17946: + Dale Lattanzio, July + p. O’Neal, interview. Merrill + Lynch, 3Q Earnings Call + +On line 17950: + chronology, Merrill + Lynch specific, p. Nancy + Moran and Rodney Yap, + +On line 17952: + Ranks No. on Payout + List, Group Says: Table (Update1)," + Bloomberg, November Kim + +On line 17954: + interview; Merrill + Lynch, Proxy Statement, April p. Charles + Prince, interview by + +On line 17958: + Rubin, interview + by FCIC, March Prince, interview. + Moody’s Investors Service, + +On line 17960: + Prince, testimony + before the FCIC, Hearing on + Subprime Lending and + +On line 17960: + Government-Sponsored Enterprises + (GSEs), day session Citigroup + Senior Management, + +On line 17970: + April transcript, p. Notes + to Chapter Prince, interview. + Tobias Brushammar, James + + Hua, Graham Jackson, + and Subra Viswanathan, Citigroup + memorandum to + + Nestor Dominguez, Janice Warne, + Michael Raynes, and Jo-Anne Williams, subject: + Liquidity Put + +On line 17972: + Xanthos, interview + by Financial Industry + Regulatory + +On line 17974: + (FINRA), March Susan + Mills, testimony before + the FCIC, hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 17978: + Murray Barnes, former + managing director of + Independent Risk, + +On line 17980: + March Notes on Senior + Supervisors’ Meeting with + Firms, meeting between + +On line 17980: + Federal Reserve + Bank of New York, Federal + Reserve Board, Office + +On line 17982: + Japan FSA, November + p. Janice Warne, interview + by FCIC, February + +On line 17986: + Dominguez, interview by + FCIC, March Dominguez, interview. Nestor + Dominguez, testimony + +On line 17986: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 17988: + Structured Products and + Risk Management, April transcript, + pp. Barnes, interview. + +On line 17996: + staff calculations. + Prince, testimony before + the FCIC, April transcript, + +On line 18000: + interview by FCIC, + April Bushnell, interview. Ellen + "Bebe" Duke, Citigroup + +On line 18004: + Risk, interview by + FCIC, March Barnes, interview. James + Xanthos, interview + +On line 18008: + Regulatory + Authority (FINRA), March + Barnes, interview. Prince, + +On line 18010: + the Executive + Committee and adviser, + interview by FCIC, + +On line 18012: + Thomas Maheras, former + co-CEO of Citi Markets Banking, + interview by FCIC, + +On line 18020: + Business and Subprime + Exposure, June p. Paul, Weiss, + Citigroup’s counsel, + +On line 18024: + Q&A transcript, July + Complaint, Securities and + Exchange Commission + +On line 18026: + v. Citigroup Inc., + 1:10-cv-01277 (D.D.C), July Federal + Reserve Board of New + +On line 18026: + to Vikram Pandit and + the Board of the Directors + of Citigroup, April + +On line 18030: + Maheras, interview, + and testimony before + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18046: + Prince, interview; Charles + Prince, email to Robert Rubin, re, + September A.M. (on + +On line 18048: + Maheras and super + seniors). Robert Rubin, email to + Charles Prince, September + +On line 18050: + Charles Prince, email to Robert + Rubin, September P.M. Robert + Rubin, interview + +On line 18056: + Prince, interview. Ibid. + Citigroup, "Risk Management + Review: An Update + +On line 18062: + Earnings Call transcript, + October Prince, interview. + Paul, Weiss, Citigroup’s + +On line 18062: + the FCIC’s second and + third supplemental requests, + March Citigroup, Proxy + +On line 18064: + for fiscal year March + p. Federal Reserve Board + of New York, letter + +On line 18064: + to Vikram Pandit and + the Board of Directors of + Citigroup, April p. + +On line 18066: + staff calculations + from Citigroup proxy statements + (information for + +On line 18066: + Paul, Weiss (on behalf + of Citigroup), letter to + FCIC, March "Response to + +On line 18068: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18070: + Citigroup Senior + Management, April transcript, pp. + John Reed, interview + +On line 18074: + Earnings Call credit + supplement, August Joseph St. + Denis, letter to + +On line 18078: + p. Joseph St. Denis, + interview by FCIC, April Gene + Park, interview by + +On line 18084: + Alan Frost, interview + by FCIC, May Pierre Micottis, + interview by FCIC, + +On line 18090: + 3Q07 review of AIG’s + super-senior CDS portfolio, + November p. Joseph + +On line 18094: + Cassano, interview + by FCIC, June Park, interview. + Goldman’s submissions + +On line 18094: + its valuation + and pricing related to + collateral calls + +On line 18100: + Andrew Forster, telephone + call to Jon Liebergall, July + transcript. PricewaterhouseCooper, memo to + +On line 18102: + AIGFP 2Q review files, + August Andrew Forster, email to + Joseph Cassano and Pierre + +On line 18104: + enclosing marks from + Merrill Lynch, AIG, Earnings Call + credit supplement, + +On line 18106: + estimates are based + on Federal Reserve Bank + of New York, "Maiden + +On line 18106: + Report," January + This probably isn’t a + complete list of their + + positions, because + not all CDO tranches are part + of the Maiden Lane + +On line 18106: + III portfolio. Of + the securities listed + in that document, + +On line 18106: + data on in Moody’s + CDO EMS database and Bloomberg. For + those securities, + +On line 18106: + downgrade and became + materially impaired + (i.e., were downgraded + +On line 18108: + suffered downgrades and + became materially + impaired. Alan Frost, email + +On line 18114: + Andrew Forster, August + Cassano, interview. Frost, email + to Forster, August Tom + +On line 18116: + email to Andrew Forster, + cc Adam Budnick, September + Joseph Cassano, email to + +On line 18124: + Elias Habayeb, November + Notes to Chapter Minutes of + the meeting of the + +On line 18126: + Audit Committee, + November p. Andrew Forster, + email to Joseph Cassano, + +On line 18128: + subject: GS Prices vs + Others, November Goldman, + submission to the + +On line 18128: + Pricing Related + to Initial Collateral + Calls on Transactions + +On line 18130: + with AIG," pp. Based on + staff analysis of data + provided to the + +On line 18130: + includes all tranches + of the ABX.HE 06-2. TABX is + constructed based on + +On line 18130: + obligations for the + 06-2 and 07-1 BBB and BBB- + tranches of the ABX. + +On line 18136: + Cassano, interview. + Andrew Forster, email to Alan Frost, + August Tim Ryan, PricewaterhouseCooper, + +On line 18140: + interview by FCIC, + June SEC staff briefing of FCIC + staff, June Joseph Cassano, + +On line 18140: + to Andrew Forster, Pierre + Micottis, James Bridgwater, + and Peter Robinson, + +On line 18142: + of meeting at AIGFP, + October See also PwC + audit team, memo re + +On line 18144: + 3Q07 review of AIG’s + super-senior CDS portfolio, + November pp. AIG, + +On line 18148: + Earnings Call transcript, + November pp. PwC audit + team memo, p. Goldman + +On line 18152: + Dooley, November + attaching memo from Andrew + Forster, "Collateral + +On line 18154: + Status." Andrew Forster, + "Collateral Call Status," + memo prepared for Joe + +On line 18156: + Cassano. Joe Cassano, + email to Bill Dooley, subject: + Collateral Calls, + +On line 18160: + Cassano, email to Bill + Dooley, subject: GS call back, + November Goldman + +On line 18162: + Financial Products + Corp., margin call, November + PwC audit team, memo, + +On line 18164: + meeting to discuss + super-senior valuations + and collateral + +On line 18166: + disputes, November + p. produced by PwC. Andrew + Forster, interview by + +On line 18170: + Martin Sullivan, + interview by FDIC, June PwC, + notes of meeting of + +On line 18178: + Paul Narayanan, November + Sullivan, interview. AIG + Investor Conference + +On line 18180: + December transcript, + pp. Joseph Cassano, email to Michael + Sherwood and David Viniar, + +On line 18182: + CDO Valuations, + January Andrew Davilman, + interview by FCIC, + +On line 18184: + interview by FCIC, + June "AIG/Goldman Sachs Collateral + Call Timeline," available + +On line 18188: + on FCIC website at + http://fcic.gov/ hearings/pdfs/2010–0701-AIG-Goldman-supporting-docs.pdf. PricewaterhouseCooper, memo + to AIG workpaper + +On line 18192: + Martin Sullivan, + testimony before the + FCIC, Hearing on the + +On line 18192: + Derivatives in + the Financial Crisis, day + session American + +On line 18196: + International + Group, Inc. and Derivatives, + June transcript, p. PricewaterhouseCooper, + +On line 18198: + the FCIC, Hearing on + the Role of Derivatives + in the Financial + +On line 18198: + session American + International Group, Inc. + and Derivatives, + +On line 18200: + Thrift Supervision, + letter to AIG General + Counsel and Board, March + +On line 18210: + Dudley, interview + by FCIC, October Notes to + Chapter Adam B. Ashcraft, + + Morten L. Bech, and W. + Scott Frame, "The Federal Home + Loan Bank System: The + + Lender of Next to Last + Resort1" Federal Reserve + Bank of New York Staff + +On line 18212: + Federal Reserve + Board, "October Senior Loan + Officer Opinion + +On line 18214: + Bank Lending Practices," + October Frederic Mishkin, + interview by FCIC, + +On line 18222: + October Dudley, + interview. Ibid. Ibid. Standard + Poor’s, "Detailed Results + +On line 18224: + of Subprime Stress Test + of Financial Guarantors," + RatingsDirect, February Alan + +On line 18228: + memo to Erik Sirri + and others, November p. + Roseman, interview, + +On line 18232: + memo to Erik Sirri + and others, January p. + Bill Lockyer, State + +On line 18232: + Report: Making the + Municipal Bond Market + Work for Taxpayers + +On line 18234: + Times (October p. + John J. McConnell and Alessio Saretto, + "Auction Failures and + +On line 18236: + School of Management, + Purdue University, April + p. Erik R. Sirri, + +On line 18238: + Exchange Commission, + "Municipal Bound Turmoil: + Impact on Cities, Towns + +On line 18238: + States," testimony + before the House Financial + Services Committee, + +On line 18240: + 2nd sess., March Georgetown + University, "Annual + Financial Report, + +On line 18244: + "The Sad Story of + Auction-Rate Securities, Barrons, + May "SEC Finalizes + +On line 18244: + Settlements with Bank + of America, RBC, and Deutsche + Bank," SEC press release, + +On line 18253: + Asset," Upper HedgeWorld + Prime Brokerage League Table, + accessible at + +On line 18253: + Zuckerman, "Hedge Funds, + Once a Windfall, Contribute + to Bear’s Downfall," Wall + +On line 18255: + Street Journal, March Jeff + Mayer and Thomas Marano, "Fixed + Income Overview," March + +On line 18259: + The Secondary Market + (Bethesda, MD: Inside Mortgage + Finance, pp. FCIC staff + +On line 18259: + based on Moody’s CDO EMS + database. Different numbers + are provided in + +On line 18261: + Jeff Mayer and Thomas + Marano, "Fixed Income Overview," + March p. Samuel Molinaro, + +On line 18263: + interview by FCIC, + April Michael Alix, interview + by FCIC, April SEC, "Risk + +On line 18267: + Colby and others, + May Robert Upton, interview + by FCIC, April SEC, "Risk + +On line 18271: + to Erik Sirri and + others, March Ibid. Bear Stearns, "Fitch + Presentation," PowerPoint + +On line 18275: + slides, August Upton, + interview. Bear Stearns, Form 10-K + for the year ended + +On line 18281: + Standard Poor’s, Global + Credit Portal RatingsDirect, "Research + Update: Bear Stearns Cos. + +On line 18295: + April Notes to Chapter + Matthew Eichner, interview + by FCIC, April Wendy de + +On line 18297: + FCIC, April Steven Meyer, + interview by FCIC, April Mike + Alix, interview + +On line 18303: + Timeline Regarding + Bear Stearns Companies Inc., April + produced by SEC. SEC + +On line 18309: + FCIC, Hearing on the + Shadow Banking System, day + session Investment + +On line 18309: + Banks and the Shadow + Banking System, May transcript, + p. Cayne, interview. + +On line 18315: + New York, "Tri-Party Repo + Infrastructure Reform," white + paper, May p. Seth + +On line 18317: + by FCIC, September + Information provided + by Federated + +On line 18319: + Goebel, Kevin Gaffney, and Norm + Lind (Fidelity employees), + interview by FCIC, + +On line 18323: + interview by FCIC, + March Timeline Regarding the + Bear Stearns Companies + +On line 18327: + pp. provided to + the FCIC. Alan Schwartz, interview + by FCIC, April Lucian + +On line 18331: + p. SNL Financial. + Thomas Marano, interview by + FCIC, April Paul Friedman, + +On line 18331: + in William Cohan, House + of Cards: A Tale of Hubris and + Wretched Excess on + +On line 18331: + York: Doubleday, p. + Although Friedman acknowledged + to the FCIC making + + the cited statements, + and many others as well, he + attributes them to anger + + and frustration over + Bear Stearns’s failure. Currently, + Friedman is employed + +On line 18331: + Securities, Inc., + where he works for Alan Schwartz, the + former president + +On line 18333: + Bear Stearns. Paul Friedman, + interview by FCIC, April The + Corporate Library, + +On line 18335: + Bear Stearns Companies + Inc.: Governance Profile," June + p. Cayne, interview. + +On line 18339: + Schwartz (interview by + FCIC) stated that bonuses for + individual + +On line 18339: + the Compensation + Committee, and the final + recommendation + +On line 18343: + for bonuses came from + the CEO. Alix, interview. + Bear Stearns, Performance + +On line 18343: + I-1 (provided to + the FCIC); Alix, interview. + The salary cap had been + +On line 18345: + from to in (Alix, + interview; Cayne, interview). + Bebchuk et al., "The + +On line 18345: + Table p. Table + p. Table p. The budget + authority for + +On line 18347: + in was million; in + it was billion. In Alix + received million in + +On line 18347: + compensation, Cayne + received more than million in + salary and bonus, and Schwartz + +On line 18347: + in salary and bonus. SNL + Financial; interviews with + Spector and Alix. + +On line 18353: + email to Alan Schwartz and + Richie Metrick, February Matthew + Eichner, email to + +On line 18359: + al., January Lou + Lebedin, interview by FCIC, + April Notes to Chapter + +On line 18367: + Stearns Companies Inc., + April produced by SEC. Upton, + interview. Minutes + +On line 18369: + Special Meeting of + Bear Stearns Board of Directors, + March Pat Lewis, Bear Stearns, + +On line 18371: + Matthew Eichner, Steven + Spurry, James Giles, and Kevin Silva, + March Matthew Eichner, + +On line 18373: + Brian Peters, March + David Fettig, "The History + of a Powerful + +On line 18375: + Federal Reserve + Bank of Minneapolis, + June James Embersit, + +On line 18377: + Deborah Bailey, + March In response to the FCIC’s + interrogatories, + +On line 18377: + Morgan produced a + list of all payments Bear Stearns + made to or received + +On line 18379: + OTC derivatives + counterparties from March through + March The spreadsheet was + +On line 18379: + in September by + Bear Stearns in response to a + request by the SEC + +On line 18379: + and Markets. The large + volume of novations away + from Bear Stearns during + +On line 18379: + the previous week + was confirmed by the New York + Federal Reserve + +On line 18379: + and Derivatives + Association. (New York + Federal Reserve + +On line 18381: + ISDA personnel, + interviews by FCIC, May and + Brian Peters, email + +On line 18383: + to Matthew Eichner, + March Stuart Smith, email to Bear + Stearns, March Marvin Woolard, + +On line 18387: + et al., March Kyle Bass, + interview by FCIC, April Bass, + interview. Debby + +On line 18389: + LaMoy, email to Faina Epshteyn, + March Faina Epshteyn, email to Debby + LaMoy, March Marvin Woolard, + +On line 18391: + Stuart Smith et al., + March CNBC video, Schwartz and CNBC’s + David Faber, original + +On line 18393: + air date March Yalman + Onaran, "Bear Stearns Investor Lewis May + Increase His Stake," Bloomberg + +On line 18395: + Matthew Eichner, email + to Erik Sirri, Robert Colby, + and Michael Macchiaroli, March + +On line 18397: + Minutes of Special + Meeting of Bear Stearns Board of + Directors, March pp. + +On line 18401: + Upton, interview. + Matthew Eichner, email to Erik + Sirri, Robert Colby, + +On line 18403: + and Michael Macchiaroli, March + Alan Schwartz, interview by FCIC; + Matthew Eichner, email + +On line 18405: + to Erik Sirri, Robert + Colby, and Michael Macchiaroli, March + Upton, interview. + +On line 18407: + Minutes of Special + Meeting of Bear Stearns Board of + Directors, March ("[Schwartz] + +On line 18407: + had been seventeen + billion dollars in cash with + a two billion eight + +On line 18407: + backstop, unsecured + line. The Board was told that twelve + to fifteen billion + + dollars had gone out + of TBSCI in the last two + days and that TBSCI + +On line 18409: + margin calls"). Upton, + interview; Goebel, Gaffney, and Lind, + interview; Steven Meier, + +On line 18411: + interview by FCIC, + March Michael Macchiaroli, interview + by FCIC, April Christopher + +On line 18411: + Banking System, day + session SEC Regulation + of Investment Banks, + +On line 18415: + Timeline Regarding + Bear Stearns Companies Inc., April + produced by SEC. Jamie + +On line 18417: + FCIC, October Alan + Schwartz, testimony before + the FCIC, Hearing on + +On line 18417: + Banking System, day + session Investment Banks and + the Shadow Banking + +On line 18421: + p. Schwartz, interview. + Schwartz., interview. Ibid.; Molinaro, + interview; Alix, + +On line 18425: + Chrin, interview by + FCIC, April Dimon, interview + by FCIC, October + +On line 18427: + of Directors, March + Federal Reserve, "Report + Pursuant to Section + +On line 18427: + Stabilization Act + of Loan to Facilitate + the Acquisition + +On line 18427: + Companies, Inc. by + JP Morgan Co.," pp. Ernst Young, + "Project LLC: Summary + +On line 18435: + Report," June p. Notes + to Chapter Contrary to what + is stated in the + +On line 18435: + board minutes (Special + Meeting of Bear Stearns Board of + Directors, March p. + +On line 18435: + staff interviewed Schwartz + he said that the a share price + came from JP Morgan, + +On line 18435: + Paulson. Schwartz also + told staff that because Bear did + not receive "a lot + +On line 18437: + it had to accept + JP Morgan’s offer of a + share. Chrin, interview. + +On line 18439: + Schwartz, testimony + before the FCIC, Hearing on + the Shadow Banking + +On line 18439: + session Investment + Banks and the Shadow Banking + System, May transcript, + +On line 18445: + Macchiaroli, interview. + Ben Bernanke, closed-door session with + FCIC, November Ibid. + +On line 18447: + Federal Reserve + Bank of New York, "Actions by + the New York Fed in + +On line 18449: + Banking, Housing, and + Urban Affairs, 110th Cong., 2nd + sess., April p. Henry + +On line 18449: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 18458: + Banking System, May + transcript, pp. Chapter David Wong, + interview by FCIC, + +On line 18460: + and Yalman Onaran, "Lehman’s + Fuld Says ‘Worst Is Behind Us’ + in Crisis (Update3), + +On line 18462: + April Henry Paulson, + testimony before the + FCIC, Hearing on the + +On line 18462: + System, day session + Perspective on the Shadow + Banking System, May + +On line 18464: + transcript, p. Viral + V. Acharya and T. Sabri Öncü, "The + Dodd-Frank Wall Street Reform + +On line 18464: + Protection Act and + a Little Known Corner of + Wall Street: The Repo + +On line 18468: + Street, July Sandie O’Connor, + JP Morgan, interview by + FCIC, March Jamie Dimon, + +On line 18470: + interview by FCIC, + October Adam Copeland, Antoine + Martin, Michael Walker, + +On line 18472: + Market Before the + Reforms," FRBNY Staff Report + No. November p. + +On line 18474: + Meier, testimony + before the FCIC, Hearing on + the Shadow Banking + +On line 18476: + the Shadow Banking + System, May transcript, p. William + Dudley, interview + +On line 18480: + by FCIC, October + Darryll Hendricks, interview + by FCIC, August James + + Cayne, testimony + before the FCIC, Hearing on + the Shadow Banking + +On line 18480: + session Investment + Banks and the Shadow Banking + System, May transcript, + +On line 18484: + Federal Reserve, + "Regulatory Reform: + Primary Dealer + +On line 18488: + R. Valukas, Report of + Examiner, In re Lehman + Brothers Holdings Inc., + +On line 18490: + et al., Chapter Case + No. 08-13555 (JMP), (Bankr. S.D.N.Y.), March + quotation, (hereafter + +On line 18500: + Hendricks, interview. + Lucinda Brickler, email to + Patrick Parkinson, July + +On line 18502: + memorandum to + Timothy Geithner, + July The billion + + figure is noted + in Patrick Parkinson, email to Ben + Bernanke et al., July + +On line 18508: + Patrick Parkinson, email to + Lucinda Brickler, July + Patrick Parkinson, email to + +On line 18518: + Bernanke et al., July + Ibid. Notes to Chapter Based on + chart in Federal + +On line 18522: + Largest Securities + Firms, August p. Ibid. Tobias + Adrian, Christopher Burke, + +On line 18524: + of New York, Current + Issues in Economics and + Finance no. (August + +On line 18528: + interview by FCIC, + April p. Fed Chair Ben Bernanke, "Lessons + from the Failure of + +On line 18530: + the House Financial + Services Committee, 111th Cong., + 2nd sess., April p. Valukas, + +On line 18530: + n. Examiner’s + Interview of Timothy + F. Geithner, + +On line 18536: + Nov. p. Valukas, Sirri, + interview. William Brodows and Til + Schuermann, Federal + +On line 18538: + Initial Assessment + of CSEs," May slides Federal + Reserve Bank of New + +On line 18546: + Liquidity Stress + Analysis," June p. Ibid., p. + Valukas, Ibid., Christopher Cox, + +On line 18548: + the House Financial + Services Committee, 111th Cong., + 2nd sess., April p. Patrick + +On line 18550: + Stability: A + Private Sector Perspective, + The Report of the + +On line 18552: + Meeting on Credit + Derivatives," September + Federal Reserve + +On line 18552: + Bank of New York, "Third + Industry Meeting Hosted + by the Federal + +On line 18554: + and Derivatives + Activities, First Quarter + Table the figures + +On line 18554: + the text are reached by + subtracting exchange traded + futures and options + +On line 18558: + derivatives. Chris + Mewbourne, interview by FCIC, + July This figure + +On line 18558: + a low in at the + height of the mortgage boom, of + billion in problem + +On line 18558: + under the Uniform + Financial Institutions + Rating System. FDIC + +On line 18558: + institutions—i.e., + the regulated banking + and thrift industry + +On line 18558: + Quarterly no. (March + Quarterly Banking Profile: + Second Quarter FDIC + +On line 18560: + Quarterly no. (June + By the problem list would swell + to banks, with assets + +On line 18560: + billion. Quarterly + Banking Profile: Fourth Quarter + FDIC Quarterly no. + +On line 18564: + Quarterly Banking + Profile: First Quarter p. Roger + Cole, interview by + +On line 18568: + interview with Michael + Solomon and Fred Phillips-Patrick, September + Federal Reserve + +On line 18570: + of New York, letter + to Charles Prince, April Federal + Reserve Bank of New + +On line 18572: + Reserve Board, "FRB New + York Operations Review: + Close Out Report," p. + +On line 18574: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 18576: + the Shadow Banking + System, May transcript, p. Steve + Manzari and Dianne + +On line 18578: + Dobbeck, interview by + FCIC, April Federal Reserve + Board, "Wachovia Case Study," + +On line 18584: + November and p. + Angus McBryde, interview by + FCIC, July Notes to + +On line 18586: + In addition, he + negotiated himself + three years of office + +On line 18586: + expense. Thompson had + previously received more + than million in salary + +On line 18586: + more than million in + his total compensation + from through exceeded + +On line 18588: + Federal Reserve + Bank of Richmond, letter to + Wachovia, July pp. + +On line 18594: + letter, pp. Ibid., pp. + Ibid., letter, p. Report of + Examination, + +On line 18598: + Directors meeting, + April p. Senate Permanent + Subcommittee on + + Investigations, + Wall Street and the Financial + Crisis: The Role of + +On line 18600: + High Risk Home Loans, 111th + Cong., 2nd sess., April Exhibits, p. + Senate Permanent + + Subcommittee on + Investigations, Wall Street + and the Financial + +On line 18600: + Crisis: Role of the + Bank Regulators, 111th Cong., + 2nd sess., April Exhibits, + +On line 18604: + Ivie, July Offices + of Inspector General, + Department of the + +On line 18604: + Federal Deposit + Insurance Corporation, + "Evaluation of + +On line 18606: + No. EVAL 10-002, April pp. + FDIC, Confidential Problem + Bank Memorandum, + +On line 18610: + Memorandum to + FDIC Regional Director, + September Treasury + +On line 18612: + Regulatory + Oversight of WaMu," pp. Quoted + in Damian Paletta, + +On line 18614: + Bank Regulators + to Use Warier Eye," Wall Street + Journal, August Sheila + +On line 18616: + Bair, interview by + FCIC, August Treasury and FDIC + IGs, "Evaluation + +On line 18618: + Currency, Large Bank + Supervision: Comptroller’s + Handbook, January + +On line 18622: + p. Cole, interview. + Rich Spillenkothen, "Observations and + Perspectives of the + +On line 18622: + and Regulation + at the Federal Reserve + Board from to on the + +On line 18622: + Years Preceding the + Financial Crisis," paper + prepared for the FCIC, + +On line 18626: + May p. Doug Roeder, + interview by FCIC, August + "Treasury Releases + +On line 18635: + release, March Chapter + Henry Paulson, interview + by FCIC, April Henry + +On line 18635: + Brink: Inside the Race + to Stop the Collapse of the + Global Financial + +On line 18639: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18641: + Housing Enterprise + Oversight, April transcript, p. Daniel + Mudd, letter to James + +On line 18645: + Daniel Mudd, letter to + shareholders, in Fannie Mae, + Annual Report," + +On line 18651: + interview by FCIC, + March Robert Levin, interview by + FCIC, March James Lockhart, + +On line 18653: + to Daniel Mudd, August + p. James Lockhart, letter to + Senator Charles Schumer, + +On line 18655: + August James Lockhart, + written testimony for + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18663: + Federal Housing + Enterprise Oversight, April pp. + Notes to Chapter Ibid., + +On line 18667: + Tony Ryan, and Jeremiah + Norton, Treasury officials, + interview by FCIC, + +On line 18671: + OFHEO Plan, But Wishing + Otherwise," American Banker, + December Fannie + +On line 18673: + Flexibility + on Fannie Mae, Freddie Mac + Mortgage Portfolios," + +On line 18677: + for the FCIC, April p. + Ben Bernanke, quoted in Eric + Dash, "Fannie Mae to + +On line 18679: + Portfolio," New York + Times, September Senator + Charles E. Schumer, letter + +On line 18679: + OFHEO Director James + B. Lockhart III, February + Schumer continued, "If + + you have decided + that you will be keeping the + capital surcharge + +On line 18679: + place I would like an + explanation as to why + you think upholding + +On line 18679: + capital relief + that could better position + the GSEs to provide + +On line 18683: + Results," Fannie Mae + press release, February Daniel + Mudd, interview by + +On line 18687: + March Robert Steel, email to + Jeremiah Norton, February + Michael Farrell, email to + +On line 18691: + Steel, March Emails between + Robert K. Steel and Daniel Mudd, March + Daniel Mudd, email to Robert + +On line 18693: + and Its Consequences," + p. attachment to email from + Jason Thomas to Robert + +On line 18695: + March Robert Steel, email to + David Nason, Tony Ryan, Jeremiah + Norton, and Neel Kashkari, + +On line 18701: + interview by FCIC, + March Paulson, interview. James + Lockhart, email to Daniel + +On line 18705: + Steel, and Dick Syron, + subject: "Re: announcement draft," + March Ibid. "OFHEO, Fannie + +On line 18705: + Announce Initiative + to Increase Mortgage Market + Liquidity," OFHEO + +On line 18709: + release, March Paulson, + interview. Joshua Rosner, "OFHEO + Got Rolled," GrahamFisher Weekly + +On line 18713: + Bisenius, interview + by FCIC, September "Freddie + Mac CEO Richard Syron + +On line 18719: + Mudd, letters to James + Lockhart, August and August + Timothy P. Clark + +On line 18719: + Reserve Board) and Scott + Alvarez (general counsel, + Federal Reserve + +On line 18721: + by FCIC, February + "Board Grants Federal Reserve + Bank of New York the + +On line 18721: + and Freddie Mac Should + Such Lending Prove Necessary," + Federal Reserve + +On line 18725: + press release, July + Alvarez, interview. Treasury + Secretary Henry + +On line 18725: + Financial Markets + and the Regulatory + Responses to Them, + +On line 18727: + Banking, Housing, and + Urban Affairs, 110th Cong., 2nd + sess., July "Statement + +On line 18735: + Clark, interview Mudd, + interview. Clark, interview. + Susan Eckert, Kevin + +On line 18741: + Bailey, and other + OCC staff, interview by FCIC, + February Notes to + +On line 18745: + Chapter Ibid. Office + of the Comptroller of the + Currency, "Observations—Allowance Process + +On line 18749: + H. Mudd (President + and CEO of Fannie Mae), "Re: + Notice of Proposed + +On line 18749: + letter to Richard F. + Syron (President and CEO + of Freddie Mac), "Re: + +On line 18751: + Proposed Capital + Classification at June + August "Draft—Mid-year Letter," + +On line 18753: + Dickerson, letter + to Daniel H. Mudd, September + Dickerson to Mudd, + +On line 18755: + September with "Draft + Mid Year Letter" attached. "Draft—Mid-year + Letter" (Fannie), pp. + +On line 18767: + p. Ibid., pp. "Draft Mid + Year Letter" (Freddie), pp. Ibid., + p. Mudd, interview. + +On line 18769: + to James B. Lockhart + III, memorandum, "Proposed + Appointment of the + +On line 18769: + the Federal Home + Loan Mortgage Corporation," + September (hereafter + +On line 18769: + conservatorship + memorandum); Christopher H. + Dickerson to James + +On line 18769: + III, memorandum, + Proposed Appointment of the + Federal Housing + +On line 18769: + Association," + September (hereafter Fannie + conservatorship + +On line 18773: + Paulson, On the Brink, + p. Lockhart, testimony + before the FCIC, April + +On line 18777: + transcript, p. Paulson, + interview; Paulson, On the + Brink, p. Paulson, On + +On line 18785: + Levin, interview. Mudd, + interview. FHFA, Fannie + conservatorship + +On line 18791: + conservatorship + memorandum, pp. Syron, + interview. Daniel Mudd, + +On line 18791: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18793: + day session Fannie + Mae, April transcript, p. Paul Nash, + FDIC, letter to FCIC, + +On line 18793: + questions to Sheila Bair’s + testimony during the + September hearing, + +On line 18799: + Kashkari, interview by + FCIC, November Tom Baxter, + interview by FCIC, + +On line 18803: + interview. Lockhart, + testimony before the + FCIC, April transcript, p. + +On line 18805: + System, Division + of Banking Supervision + and Regulation, + + memorandum to + the Board of Governors, "Stress + Scenarios on Bank + +On line 18807: + January p. Daniel + Mudd, written testimony + for the FCIC, Hearing + +On line 18807: + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18809: + day session Fannie + Mae, April p. John Kerr, Scott Smith, + Steve Corona (FHFA + +On line 18809: + and Alfred Pollard + (FHFA general counsel), + group interview by + +On line 18819: + March Notes to Chapter + Lockhart, interview. Edward + DeMarco, interview by + +On line 18823: + March Mudd, interview. + Henry Cisneros, interview + by FCIC, October + +On line 18827: + April transcript, p. Robert + Levin, testimony before + the FCIC, Hearing on + + Subprime Lending and + Securitization and + Government-Sponsored Enterprises + +On line 18836: + day session Fannie + Mae, April transcript, p. Chapter + Joseph Sommer, counsel, + +On line 18836: + of New York, email to + Patrick M. Parkinson, deputy research + director, Board of + +On line 18836: + of the Federal + Reserve System, et al., "Re: + another option + +On line 18840: + Dimon, interview + by FCIC, October Barry + Zubrow, testimony + +On line 18840: + of Systemic Risk in + the Financial Crisis, day + session Lehman Brothers, + +On line 18842: + p. Richard S. Fuld Jr., + testimony before the + FCIC, Hearing on Too + +On line 18842: + of Systemic Risk in + the Financial Crisis, day + session Lehman Brothers, + +On line 18844: + p. See also Fuld’s + written testimony at + same hearing, p. Ben + +On line 18844: + Financial Crisis, + day session The Federal + Reserve, September + +On line 18848: + by FCIC, October + Bernanke, testimony before + the FCIC, September + +On line 18850: + the examiner + that the Federal Reserve, + the SEC, and "markets + +On line 18850: + Lehman as the next most + vulnerable investment + bank because of its + +On line 18850: + R. Valukas, Report of + Examiner, In re Lehman + Brothers Holdings Inc., + +On line 18852: + et al., Debtors, Chapter + Case No. 08-13555 (JMP), (Bankr. S.D.N.Y.), + March (hereafter cited + +On line 18854: + Valukas); see also and + n. and nn. and n. and n. + and and n. Paulson, + +On line 18858: + following Bear Stearns’s + near collapse, he considered + Lehman to be the "most + +On line 18858: + exposed" investment + bank, see also and n. and + n. and n. and n. + +On line 18858: + Cox reported that + after Bear Stearns collapsed, Lehman + was the SEC’s "number + +On line 18860: + and n. see also + Timothy Geithner, + quoted in Valukas, and + +On line 18866: + n. Donald L. Kohn, + email to Bernanke, "Re: Lehman," June Valukas, + and n. Harvey R. + +On line 18866: + bankruptcy counsel + for Lehman Brothers, interview + by FCIC, August Lehman + +On line 18870: + September p. Erik + R. Sirri, interview by + FCIC, April Paolo R. + +On line 18872: + interview by FCIC, + August Specifically, Lehman + drew billion on March + +On line 18872: + billion on March and + billion on March billion on + March and and billion + +On line 18872: + Robert Azerad, vice + president, Lehman Brothers, Q2—Liquidity + Position (June p. + +On line 18872: + bankruptcy, Lehman drew + billion, billion, and billion, + on September and + +On line 18872: + Fed in providing + financing. Valukas, See also + David Weisbrod, senior + +On line 18872: + and Securities + Services–Risk Management, JPMorgan Chase Co., + email to James Dimon + +On line 18874: + et al., "Re: TriParty Close," + September Thomas A. Russo, + former vice chairman + +On line 18874: + legal officer, + Lehman Brothers, email to Richard S. + Fuld Jr., forwarding + + article by John + Brinsley (originally sent + to Russo by Robert + +On line 18874: + Says Investment Banks + Making Progress in Raising Funds," + Bloomberg, June (quoting Robert + +On line 18884: + June Notes to Chapter + Richard S. Fuld Jr., interview + by FCIC, April Valukas, and + +On line 18884: + also Russo, email + to Fuld, "Fw: Rumors of hedge + fund putting together + +On line 18884: + to have another + run at Lehman," March (forwarding + discussions with SEC + +On line 18886: + Bruce Karpati, and Stephanie Shuler, + Division of Enforcement, + SEC, interview by + +On line 18888: + to question 13—from FCIC, + asked after the hearing on + January Jesse Eisinger, + + "The Debt Shuffle: Wall + Street Cheered Lehman’s Earnings, but There + Are Questions about Its + +On line 18890: + David Einhorn, Greenlight + Capital, "Private Profits + and Socialized Risk," + +On line 18890: + also David Einhorn, + "Accounting Ingenuity," + speech at Ira W. Sohn + +On line 18894: + Conference, May pp. + Nell Minow, interview by + FCIC, September Nell + +On line 18894: + the House Committee + on Oversight and Government + Reform, Hearing on + +On line 18896: + October Kirsten J. + Harlow, email to Timothy + Geithner et + +On line 18898: + Primary Dealer + Update: June June William Dudley, + email to Timothy + +On line 18900: + Harlow, email to Kevin + D. Coffey, examining + officer, FRBNY, + +On line 18902: + al., "On-Site Primary + Dealer Update: June June Thomas + Fontana, Citigroup, email + +On line 18904: + Tim Clark, Federal + Reserve, email to Kevin Coffey, + Federal Reserve, + +On line 18908: + Stress Analysis," June + Based on chart in Federal + Reserve Bank of New + +On line 18910: + Largest Securities + Firms," August p. Federal + Reserve Bank of New + +On line 18912: + and senior trader, + Federated Investors, Inc., + email to Gail Shanley, + +On line 18912: + Investors, Inc., et al., + "Re: Federated SubCustodial Agreement—JPMC’s + comments," July Charles + + Witek, Federated + Investors, Inc., email to George V. + Van Schaick, Lehman Brothers, + +On line 18912: + Federated SubCustodial + Agreement—JPMC’s comments," April Despite the + FRBNY’s observation, + +On line 18912: + fully terminate + its repo relationships + with Lehman. In fact, as + +On line 18912: + exposure to Lehman + was billion, as reported + in the Commission’s + +On line 18914: + Survey of money + market mutual funds. Patrick + M. Parkinson, email to + +On line 18916: + David Marshall, email to + Patrick M. Parkinson, July Valukas, + (quoting Timothy + +On line 18918: + Brothers, interview + by FCIC, April William Dudley, email + to Geithner + +On line 18920: + "Re: Lehman Good Bank/Bad Bank + idea discussed last night," July + Patrick M. Parkinson, email + +On line 18920: + Steven Shafran, Department + of the Treasury, et al., "Fw: + Gameplan and Status + +On line 18924: + Patrick M. Parkinson, email + to Steven Shafran, August Patrick M. + Parkinson, email to Arthur + +On line 18926: + Theodore Lubke, Til Schuermann, + and William Brodows, August William Brodows, + email to Patrick Parkinson, + +On line 18936: + Ibid. Ibid. Parkinson, email + to Steven Shafran, August Ibid. Steven + Shafran, email to Patrick M. + +On line 18942: + Parkinson, August Patrick + M. Parkinson, email to Theodore Lubke, + September Notes to + +On line 18946: + Emil Cornejo, senior + vice president, Department + of the Treasury, Lehman + +On line 18946: + Janet Birney, senior + vice president, Department + of the Treasury, Lehman + + Brothers, et al., "JP + Morgan Agenda forwarded + for our review. FYI," + +On line 18948: + Agenda, September + Meg McConnell, FRBNY, email to Arthur + Angulo et al., + +On line 18952: + "Meeting tomorrow + at September Ibid. Patrick M. + Parkinson, email to Steven + +On line 18954: + Shafran, "Re: now I am + on a conf call," September + Henry M. Paulson + +On line 18954: + Brink: Inside the Race + to Stop the Collapse of the + Global Financial + +On line 18954: + Rita C. Proctor, + assistant to the chairman, + Board of Governors + + of the Federal + Reserve, email to Donald L. + Kohn et al., "This evening’s + +On line 18956: + conference call will + take place at P.M. instead of + P.M.," September Jim + +On line 18958: + Wilkinson, email to Michele + Davis, September Barry Zubrow, + interview by FCIC, + +On line 18960: + Weiss, counsel to Steven + Black, letter to FCIC, August + written responses + +On line 18964: + to FCIC questions in + email of August p. John J. + Hogan, JPMorgan Chase Co., email + +On line 18964: + D. Black, September + P.M.; Steven Black, email to John Hogan, + September P.M. See + +On line 18966: + and n. and Complaint, + In re Lehman Brothers Holdings, + Inc., et al., against JPMorgan + +On line 18966: + Bank, N.A., Chapter Case + No. 08-13555 (JMP) (Bankr. S.D.N.Y. May + pp. (hereafter cited + +On line 18972: + as Lehman Complaint). Ibid. + Black responses, August p. + Matthew Rutherford, email to + +On line 18974: + Department of the + Treasury, et al., September + Mark VanDerWeide, assistant + + general counsel, + Board of Governors of the + Federal Reserve + +On line 18974: + to Scott G. Alvarez, + general counsel, Board of + Governors of the + +On line 18978: + Mosser, email to William + Dudley et al., "thoughts on Lehman," + September See Michael + + Nelson, counsel and + vice president, FRBNY, email + to Christine Cumming, + +On line 18980: + questions," September + (attaching game plan), See Patrick + M. Parkinson, email to + + Donald Kohn et al., + "Fw: revised Liquidation + Consortium gameplan + +On line 18982: + questions," September + (attaching game plan). Ibid.; Thomas + Baxter, interview + +On line 18986: + Ken Lewis, interview + by FCIC, October Susan + McCabe, Goldman Sachs Group, + +On line 18986: + email to William Dudley + et al., "Hope you have the Radar + screens on early this + +On line 18988: + morning," September + Rita C. Proctor, email to + Bernanke, "Fw: Financial + +On line 18990: + materials for + the conference call). Hayley + Boesky, vice president, + +On line 18990: + Group, FRBNY, email to + Meg McConnell et al., forwarding + Louis Bacon, email to + +On line 18992: + short-circuiting + the market," September A.M. + Email chain between Jamie + +On line 18992: + and Jeff Stehm, subject + "Fw Default Management Group + Sep 2008.doc," September + +On line 18994: + Hayley Boesky, email to + Debby Perelmuter, senior vice + president, FRBNY, + +On line 18996: + email to Paolo R. + Tonucci, "Fw: Letter to Lehman," + Sept. (attaching JPMorgan + +On line 18998: + September Notice + to Lehman Brothers Holdings Inc.). + Jane Buyers-Russo, email to Bryn + +On line 18998: + Thomas, executive + director, Broker Dealer + Group, JPMorgan Chase Co., et + +On line 19000: + "Re: Lehman Brothers TriParty + Collateral," September + Paolo R. Tonucci, + +On line 19010: + FCIC, August See Valukas, + and n. Notes to Chapter Lehman + Complaint, pp. paragraphs + +On line 19012: + Barry Zubrow, written + testimony for the FCIC, + Hearing on Too Big + +On line 19012: + of Systemic Risk in + the Financial Crisis, day + session Lehman Brothers, + +On line 19016: + September p. Richard + S. Fuld, interview by FCIC, + August Lehman Complaint, + +On line 19018: + to Abby Aderman, + Russell Reynolds Associates, "Re: + Paulson Statement on + +On line 19020: + Financial Markets + and Taxpayers," September + Kevin M. Warsh, e-mail + +On line 19020: + Board of Governors + of the Federal Reserve + System, September + +On line 19026: + Valukas, Harvey R. Miller, + interview by FCIC, August + Tom Baxter, "Speaking + +On line 19026: + attached to email from + Helen Ay-ala, NYFRB, to Steven Shafron, + Treasure, September + +On line 19030: + Baxter, interview + by FCIC, August H. Rodgin + Cohen, interview + +On line 19034: + August Parkinson, email + to Kohn et al., September + Financial Services + + Authority of + the United Kingdom, "Statement + of the Financial + +On line 19036: + the Lehman bankruptcy + examiner, pp. paragraph + Paulson, On the Brink, + +On line 19042: + repo thoughts for this + weekend," September Patrick M. + Parkinson, interview + +On line 19042: + see also Patrick M. + Parkinson, email to Lucinda + Brickler et al., "Re: + +On line 19044: + option we should present + re triparty1" July John + Thain, interview by + +On line 19046: + to Alejandro LaTorre, + assistant vice president, + Credit, Investment + +On line 19046: + FRBNY, "memo re: Lehman’s + inter-company default + scenario," September + +On line 19048: + Alvarez, email to Ben + Bernanke et al., "Re: Fw: today + at p.m. w/Chairman Bernanke, Vice + +On line 19052: + email to Mark VanDerWeide, "Re: + tri-party," September Bart + McDade, interview by + +On line 19058: + the Brink, p. Baxter, + interview; Robert Diamond, + interview by FCIC, + +On line 19062: + Brink, pp. Financial + Services Authority of + the United Kingdom, + +On line 19064: + the Lehman bankruptcy + examiner, p. paragraph + Paulson, On the Brink, + +On line 19070: + Jim Wilkinson, email to + Jes Staley, September A.M. + Jim Wilkinson, email to + +On line 19074: + Staley, September + A.M. Paulson, On the Brink, p. + Alistair Darling, + +On line 19074: + United Kingdom Press + Association, "Darling + Vetoed Lehman Bros Takeover," + +On line 19078: + H. Rodgin Cohen, + interview by FCIC, August + Bart McDade, interview + +On line 19084: + by FCIC, August McDade, + interview, August Baxter, + interview. Thomas C. + +On line 19084: + Baxter, letter to + FCIC, October attaching + Exhibit James P. + +On line 19086: + Kirk, interview. Ibid., + attaching Exhibit Lehman + Brothers Holdings Inc., + +On line 19088: + "Minutes of the Board + of Directors, September + p. Ibid., attaching + +On line 19096: + Exhibits and Notes to + Chapter On September LBI + borrowed billion from + +On line 19096: + of collateral; + on September LBI borrowed + billion against billion + +On line 19096: + collateral; and + on September LBI borrowed + billion against billion + +On line 19102: + collateral. See + Valukas, and nn. Kirk, interview. + Miller, interview. Kirk, + +On line 19104: + Miller, interview. In + his interview, Kirk told FCIC + staff that he thought there + +On line 19106: + were more than million + derivatives contracts. McDade, + interview, August + +On line 19110: + of Systemic Risk in + the Financial Crisis, day + session Lehman Brothers, + +On line 19118: + September p. Miller, + interview. Ibid. Ibid. Ben S. + Bernanke, closed-door session + +On line 19122: + Henry M. Paulson + Jr., written testimony + for the FCIC, Hearing + +On line 19122: + System, day session + Perspective on the Shadow + Banking System, May + +On line 19130: + p. Ibid., p. Ibid., pp. + Bernanke, testimony before + the FCIC, September + +On line 19132: + transcript, p. Ben Bernanke, + email to Kevin Warsh, member, Board + of Governors of + +On line 19134: + System, September + Bernanke, testimony before + the FCIC, September + +On line 19138: + Financial Markets," + testimony before the + Senate Committee + + on Banking, Housing, + and Urban Affairs, 110th Cong., + 2nd sess., September + +On line 19140: + 343(A), as added by act + of July Stat. and amended + by acts of August + +On line 19142: + "Authority of + the Federal Reserve to + provide extensions + +On line 19142: + connection with a + commercial paper funding + facility (CPFF)," + +On line 19146: + March p. Fuld, written + testimony for the FCIC, + September pp. Bernanke, + +On line 19148: + with FCIC. Ben S. Bernanke, + chairman of the Federal + Reserve, letter to + +On line 19154: + Phil Angelides, chairman + of the FCIC, December Thain, + interview. Ibid. Ibid. + +On line 19158: + Role of Systemic Risk + in the Financial Crisis, + day session Wachovia + +On line 19167: + Baxter, letter to + FCIC, October p. Chapter + Federal Reserve + +On line 19173: + of New York, notes about + AIG meeting, September Ibid. + Ibid. "AIG Commercial + +On line 19173: + Paper Outstanding + Maturities—week of Sept 15th," + September produced + +On line 19181: + Group, Inc., Form 10-Q for + the quarterly period + ended June Notes to + +On line 19185: + Chapter FRBNY, notes + about AIG meeting. Goldman Sachs + International, + +On line 19185: + Invoice (margin call) + to AIG Financial Products + Corp., July data + +On line 19185: + CDOs supplied by AIG + (see Timeline of Goldman Sachs/AIG + collateral calls, + +On line 19187: + available at the FCIC + website at http://fcic.gov/ + hearings/pdfs/2010–0701-AIG-Goldman-supporting-docs.pdf); FRBNY, notes about + +On line 19189: + to Christine Cumming, + Timothy Geithner, + William Dudley, et al., + +On line 19195: + Eric Dinallo, + testimony before the + FCIC, Hearing on the + +On line 19195: + Financial Crisis, + day session Derivatives: + Supervisors and + +On line 19205: + the FCIC, July pp. + FRBNY, notes about AIG meeting. + Ibid. "Systemic Impact + +On line 19207: + Alejandro LaTorre to + Timothy Geithner, + September FRBNY, + +On line 19207: + internal memo about + August meeting with the AIG + team of the Office + +On line 19217: + August Ibid. Goldman + Sachs, company update on + AIG, August Ira Selig, + +On line 19221: + AIG," August FRBNY, + internal document about + AIG, September Ibid. + +On line 19229: + August FRBNY, notes + about AIG meeting, September + Ibid. "AIG Commercial + +On line 19231: + Paper Outstanding + Maturities—week of Sept 15th," + September FRBNY, + +On line 19233: + notes about AIG meeting, + September Hayley Boesky, email + to Bill Dudley et + +On line 19237: + September FRBNY, + emails of September and Thomas + Baxter, interview + +On line 19241: + by FCIC, November + Patricia Mosser, email to + Alejandro LaTorre et + +On line 19243: + call, September P.M. + Patricia Mosser, email to + Alejandro Latorre + +On line 19245: + et al., September + P.M. FRBNY, internal memo + about AIG, September + +On line 19247: + to Alejandro LaTorre + et al., "AIG and the discount + window," September + +On line 19253: + email to Adam Ashcraft et + al., September Ibid. J. C. + Flowers, interview + +On line 19257: + by FCIC, October + Robert Willumstad, interview by + FCIC, November Ibid. + +On line 19263: + (Tab of the AIG/Goldman Sachs + collateral call timeline). + Baxter, interview. + +On line 19269: + See Sarah Dahlgren, FRBNY, + interview by FCIC, April Ibid. + Alexander J. Psomas, + +On line 19277: + AIG Monitoring + and Analysis, September + Notes to Chapter Fed + +On line 19281: + "The AIG Rescue, Its + Impact on Markets, and the + Government’s Exit + +On line 19285: + Ibid., executive + summary, pp. Treasury spokesman + Andrew Williams, quoted + +On line 19285: + Son, "AIG’s Rescue Had + ‘Poisonous’ Effect, U.S. Panel + Says (Update1)," Bloomberg, June + +On line 19287: + International + Group’s Impact on the Global + Economy: Before, + +On line 19289: + Government Sponsored + Enterprises, 111th Cong., 1st + sess., March John Reich, + +On line 19293: + the Congressional + Oversight Panel, May C. K. + Lee, interview by + +On line 19293: + Albinson, managing + director, OTS, and Danièle Nouy, + secrétaire général + +On line 19295: + Commission Bancaire, + April OTS, Memo to Commission + Bancaire regarding + +On line 19299: + January Reich, + interview. Joseph Gonzalez, + interview by FCIC, + +On line 19303: + Ibid. OTS, Targeted + Review of AIG Financial + Products Corp., July + +On line 19307: + Sachs collateral + call timeline, p. Brad Waring, + interview by FCIC, + +On line 19320: + Chapter John J. Mack, + written testimony for + the FCIC, First Public + +On line 19320: + the FCIC, day panel + Financial Institution + Representatives, + +On line 19324: + by FCIC, October + Timothy Geithner, + interview by FCIC, + +On line 19326: + quoted by Robert Schmidt, + "Geithner Slams Bonuses, + Says Banks Would Have Failed + +On line 19330: + the Fed broadened the + PDCF to match the types of + collateral that + +On line 19330: + in the tri-party + repo system, including + non-investment-grade + +On line 19330: + had been limited + to investment-grade debt + securities. The + +On line 19330: + and AAA-rated mortgage-backed and + asset-backed securities. The + Fed also increased + + both the frequency + of TSLF auctions, to weekly + instead of every + + two weeks, and their size. + Federal Reserve Board press + release, September + +On line 19332: + Goldman Sachs had a + billion balance in TSLF, and + a billion balance + +On line 19332: + Reform: Usage of + Federal Reserve Credit + and Liquidity + +On line 19334: + around derivative + transactions at the time of + bankruptcy. See Debtors’ + +On line 19334: + the Bankruptcy Code + to Establish Procedures + for the Settlement + +On line 19334: + of Prepetition + Derivatives Contracts, Lehman + Brothers Holdings Inc., + +On line 19334: + No. 08-13555 (Bankr. S.D.N.Y. + Nov. p. See also Anton + R. Valukas, Report of + +On line 19334: + Examiner, In + re Lehman Brothers Holdings Inc., + et al., Chapter Case + +On line 19334: + (JMP), (Bankr. S.D.N.Y.), March + By November a special + facility to + +On line 19334: + derivatives trades + with Lehman had successfully + terminated most + +On line 19334: + massive unresolved + claims relating to over-the-counter + derivatives in + +On line 19334: + of May banks had filed + more than billion in claims for + losses related + +On line 19336: + contracts with Lehman. See + Debtors’ Motion for an Order + pursuant to Notes to + +On line 19338: + the Bankruptcy Code + to Establish Procedures + for the Settlement + +On line 19338: + of Prepetition + Derivatives Contracts, Lehman + Brothers Holdings Inc., + +On line 19338: + et al., No. 08-13555 (Bankr. + S.D.N.Y. Nov. [Docket No. p. + Debtors’ Motion for an + + Order Approving + Consensual Assumption + and Assignment of + +On line 19338: + Brothers Holdings Inc., + et al., No. 08-13555 (Bankr. S.D.N.Y. + Jan. [Docket No.2561], p. + +On line 19340: + fund holdings of all + types of taxable commercial + paper decreased from + +On line 19340: + the end of August + to billion at the end of + September (data + +On line 19340: + by ICI/Crane to the FCIC). + BNY Mellon, in its role as + tri-party clearing + +On line 19340: + that Treasury-backed repos + rose from billion to billion + of its tri-party + +On line 19340: + March and December + (data provided by BNY + Mellon to the FCIC). + +On line 19344: + Miller, interview by + FCIC, August The Reserve Fund, + Semi-annual report + +On line 19346: + Reserve Management + Company Inc., Resrv Partners + Inc., Bruce Bent Sr., Bruce + +On line 19346: + II, and The Reserve + Primary Fund (S.D.N.Y. May + p. (para. "Fidelity, + +On line 19348: + Past Months," Crane Data + News Archives, September The + Reserve Primary + +On line 19352: + Complaint against Reserve + Management Company Inc., + pp. (paras. p. (para. The + +On line 19352: + "The Primary Fund: + Plan of Liquidation and + Distribution of + +On line 19354: + December p. SEC + Complaint, pp. (paras. The Reserve, + "The Primary Fund: + +On line 19356: + Complaint, p. (para. The + SEC notes that the Primary + Fund likely broke the + +On line 19356: + prior to A.M. on + September because of the + redemption requests + +On line 19358: + that owing to an + administrative error, + its NAV should have been + +On line 19362: + as between A.M. and + P.M. on September (pp. paras. + Moody’s Investors Service + +On line 19362: + Money Market Funds," + August p. "Moody’s Proposes + New Money Market + +On line 19364: + September Patrick McCabe + and Michael Palumbo, interview + by FCIC, September + +On line 19370: + and GSE debt—increased + by billion during the same + period. McCabe and + +On line 19372: + of money market + mutual funds. Holdings for + the five firms decreased + +On line 19374: + FCIC, Hearing on the + Shadow Banking System, day + session Perspective + +On line 19378: + Banking System, May + transcript, p. McCabe and Palumbo, + interview. "Treasury + +On line 19378: + for Money Market + Funds," Treasury Department press + release, September + +On line 19378: + M. Paulson Jr. to + make available as necessary + the assets of the + +On line 19378: + Stabilization Fund + (ESF) for up to billion to + guarantee payments + +On line 19378: + mutual funds. The + original objective of + the ESF, established + +On line 19378: + by the Gold Reserve + Act of was to stabilize + the value of the + +On line 19378: + of the Depression. + It authorized the treasury + secretary, with the + +On line 19380: + president, to "deal + in gold, foreign exchange, and + other instruments + +On line 19382: + international + financial stability. + The program was called + +On line 19382: + Commercial Paper + Money Market Mutual + Fund Liquidity + +On line 19386: + Facility (AMLF). + Neel Kashkari, interview by FCIC, + November John Mack, + +On line 19390: + Federal Reserve, + internal email, October + p. David Wong, email to + +On line 19398: + and SEC officials, + September Notes to Chapter + Jonathan Stewart, FRBNY, + +On line 19400: + One year later, the + Senior Supervisors Group—a + cross-agency task force + +On line 19400: + the causes of the + financial crisis—would write, + "Before the crisis + +On line 19400: + investment banks post-Lehman], + many broker-dealers considered + the prime brokerage + +On line 19400: + be either a source + of liquidity or a + liquidity-neutral + +On line 19402: + unanticipated." + Senior Supervisors Group, + "Risk Management Lessons + +On line 19404: + of October p. + Jonathan Wood, Whitebox Advisors, + interview by FCIC, + +On line 19406: + The FCIC surveyed hedge + funds that survived the crisis. + Those in the three largest + +On line 19406: + ranked by size received + investor redemption requests + averaging of + +On line 19406: + the fourth quarter of + (the first available redemption + date after the Lehman + +On line 19410: + IFSL Research, "Hedge + Funds April David Wong, treasurer + of Morgan Stanley, + +On line 19416: + interview by FCIC, + October Mack, interview. + Wong, interview. Patrice + +On line 19416: + Stanley), email to William + Brodows (Federal Reserve BNY) + et al., September + +On line 19416: + in an attachment. + Hedge fund values are the Prime + Brokerage Outflows + +On line 19422: + Wong, interview. Matthew + Eichner, internal email, + September Angela + +On line 19424: + Miknius, email to NY Bank + Sup, September Amy G. White, + internal NYFBR + +On line 19426: + "Liquidity and + Financing Activity: + "Liquidity and + +On line 19426: + "Liquidity and + Financing Activity: + reports to the New + +On line 19428: + Federal Reserve. + Morgan Stanley Corporate + Treasury, "Meeting with + +On line 19428: + Federal Reserve: + September attachment to + Morgan Stanley email + +On line 19428: + in attachment to + Morgan Stanley email to NYFRB, + September Amy White, + +On line 19430: + emails, September and + Lloyd Blankfein, testimony + before the FCIC, First + +On line 19430: + the FCIC, day panel + Financial Institution + Representatives, + +On line 19434: + January transcript, + pp. Bernanke, closed-door session. Thomas + Baxter, interview + +On line 19436: + by FCIC, April The switch + to bank holding company + status required a + +On line 19436: + change. Both Morgan and + Goldman already owned banks that + they had chartered as + + industrial loan + companies, a type of bank + that is allowed to + +On line 19436: + supervision over + the bank’s parent or other + affiliated + +On line 19442: + Risk: Getting Started," + last updated November + Mack, interview. Mack, + +On line 19448: + Wong, interview. Amy + G. White, internal FRBNY + email, September It + +On line 19448: + be borne in mind that + lack of regulation of + this market rendered + + it extremely opaque. + Shortcomings in transparency, + lack of reporting + +On line 19450: + limited data + collection by third parties + make it difficult + +On line 19452: + crisis. Michael Masters, + testimony before the + FCIC, Hearing on the + +On line 19452: + of Derivatives + in the Financial Crisis, + day session Overview + +On line 19456: + release, December + "OTC derivatives market + activity in + +On line 19462: + International + Settlements press release, May + p. Notes to Chapter + +On line 19464: + OTC Derivatives + Market Statistics," Bank of + International + +On line 19468: + Moody’s, "Moody’s downgrades WaMu + Ratings; outlook negative," + September "OTS Fact + +On line 19470: + OTS 08–046A, September + p. Jamie Dimon, interview + by FCIC, October + +On line 19472: + of Systemic Risk in + the Financial Crisis, day + session Federal + +On line 19472: + Deposit Insurance + Corporation, September + exchange between Bair + +On line 19474: + Holtz-Eakin, pp. Scott Alvarez, + testimony before the + FCIC, Hearing on Too + +On line 19474: + Role of Systemic Risk + in the Financial Crisis, + day Session Wachovia + +On line 19478: + p. Kashkari, interview. + Greg Feldberg, "Wachovia Case Study," + presentation at + +On line 19478: + Georgia, p. These rules, + embodied in section 23A + of the Federal + +On line 19478: + limit the support + that a depository + institution can + +On line 19478: + corporate structure; + they are aimed at protecting + FDIC-insured depositors + +On line 19478: + activities that + occur outside of the bank + itself. Exemptions + +On line 19478: + assets within the + federal safety net of + insured deposits; they + +On line 19480: + bank liquidity) + during times of market stress. + Robert Steel, interview + +On line 19482: + August Scott Alvarez, + written testimony for + the FDIC, September + +On line 19484: + p. Robert Steel, written + testimony before the + FCIC, Hearing on Too + +On line 19484: + Role of Systemic Risk + in the Financial Crisis, + day session Wachovia + +On line 19490: + interview by FCIC, + August Sheila Bair, interview + by FCIC, August Richard + +On line 19492: + interview by FCIC, + August Wachovia was unable + to roll billion of + + asset-backed commercial + paper that Friday; James Wigand + and Herbert Held, memo + +On line 19494: + John Corston, acting deputy + director, Division of + Supervision and + +On line 19494: + Role of Systemic Risk + in the Financial Crisis, + day Session Wachovia + +On line 19498: + Rich Westerkamp, email to + FCIC, November Westerkamp said + that the estimate + +On line 19498: + early redemption + requests was based on a phone + conversation with + +On line 19498: + in Wachovia’s treasury + department, describing their + conversations with + +On line 19502: + investors; the figures + were never verified. Bair, + interview. Robert Steel, + +On line 19504: + interview by FCIC, + August Bair, interview; Steel, + interview; FDIC staff, + +On line 19512: + testimony for + the FCIC, September p. Steel, + interview. Ibid. Wigand + +On line 19514: + memo to the FDIC board, + September pp. Federal + Reserve staff, memo to + +On line 19516: + NA," September p. + John A. Beebe, Market Risk Team + Leader, Federal + +On line 19518: + Burns, VP-LCBO, "Wachovia + Large Funds Providers," September pp. + Federal Reserve + +On line 19520: + Risk Exception for + Wachovia Bank, NA," September + p. Bair, interview; + +On line 19520: + Federal Deposit + Insurance Corporation + Board of Directors, + +On line 19530: + September p. Notes + to Chapter Bair, interview. + FDIC memo to the FDIC + +On line 19530: + Directors, p. Corston, + written testimony for + the FDIC, September + +On line 19532: + p. Specifically, + under Wachovia’s proposal, + the FDIC would provide + +On line 19532: + billion of loans, while + Wachovia would absorb the first + billion in losses + +On line 19532: + incur losses on + the balance of the billion. + To offset that risk, + +On line 19532: + proposed that the FDIC + receive billion in preferred + stock and warrants on + +On line 19534: + shares (FDIC memo to the + FDIC Board of Directors, p. + The FDIC board has five + +On line 19534: + of the currency, + the director of OTS, and + three other members + +On line 19534: + the president. In + Too Big to Fail: The Inside + Story of How Wall + + Street and Washington + Fought to Save the Financial + System from Crisis—and + +On line 19534: + (New York: Viking, Andrew + Ross Sorkin (p. wrote that before + the September FDIC + +On line 19534: + Reserve Governor + Geithner and other + officials had a + +On line 19534: + call with Bair (Paulson + recused himself) during which + Geithner urged + +On line 19534: + acquire Wachovia by + guaranteeing some of its + potential losses. + +On line 19534: + that allowing the + FDIC to take over Wachovia would + have the effect of + +On line 19534: + shareholders and bond + holders, which, he was convinced, + would only spook the + + markets. He was still + furious with Bair for the + way she had abruptly + +On line 19538: + Federal Deposit + Insurance Corporation + Board of Directors + +On line 19540: + September transcript, + pp. Minutes of telephonic + meeting of the FDIC + +On line 19542: + board, September p. + Ibid.; the billion figure is + as of September + +On line 19542: + staff, memo to the Board + of Directors, subject: "Third + Quarter CFO Report + +On line 19544: + the Board," November + p. Minutes of telephonic + meeting of the FDIC + +On line 19548: + board, September p. + Bair, interview. Steel, written + testimony for + +On line 19548: + September p. On + the board’s vote and the agreement + in principle, see + +On line 19548: + Affidavit of Robert + K. Steel, dated October + filed in Wachovia Corp. + +On line 19550: + v. Citigroup, Inc., + Case No. 08-cv-085093-SAS (S.D.N.Y.), pp. and + exhibit A. Fed + +On line 19552: + Chairman Phil Angelides, + December Wachtell, Lipton, Rosen + Katz, on behalf of + +On line 19554: + to Division of + Corporation Finance, SEC, + November p. Richard + +On line 19560: + by FCIC, August Bair, + interview. Steel, interview. + Bair, interview. In + +On line 19560: + disagreed. He felt that + the highest priority + was to transfer the + +On line 19560: + banks’ troubled assets + from the financial system + to the government. + +On line 19560: + FDIC-assisted acquisition + would have removed potential + losses on billion + +On line 19560: + from the financial + system by transferring those + potential losses + +On line 19562: + without Government + Assistance," Wells Fargo press + release, October + +On line 19564: + Treasury Office of + the Inspector General, + interview by FCIC, + +On line 19566: + M. Thorson, "Inquiry + Regarding IRS Notice 2008-83," + September pp. Richard + +On line 19570: + release, September + Senators Christopher J. Dodd + and Richard C. Shelby, + +On line 19570: + Banking, Housing, and + Urban Affairs, Turmoil in + U.S. Credit Markets: + +On line 19574: + before the Senate + Banking Committee, Turmoil + in the U.S. Credit + +On line 19576: + the Joint Economic + Committee, 110th Cong., 2nd sess., + September transcript. + +On line 19584: + Bernanke, testimony + before the House Financial + Services Committee, + +On line 19584: + Financial Services: + Exploring Solutions for + the Market Crisis, + +On line 19586: + September transcript, + p. Mel Martinez, interview + by FCIC, September + +On line 19588: + as the Emergency + Economic Stabilization + Act of was coupled + +On line 19588: + acts, including the + Energy Improvement and + Extension Act of + +On line 19588: + Tax Extenders and + Alternative Minimum + Tax Relief Act of + +On line 19588: + Domenici Mental Health + Parity and Addiction + Equity Act of + +On line 19588: + originally said + that the deposit insurance + cap would revert to + +On line 19588: + at the beginning + of but later extended + the deadline through the + +On line 19590: + The quotation is + part of the formal title + of Public Law 110-343, + +On line 19592: + officially named + the Emergency Economic + Stabilization Act + +On line 19594: + Term Funding Markets," + Federal Reserve Board press + release, October + +On line 19596: + CPFF complemented + the Fed’s other commercial + paper program, the + +On line 19596: + which was created + shortly after the Reserve + Primary Fund broke + + the buck. While the AMLF + targeted money market + mutual funds, the + +On line 19600: + "Commercial Paper + Funding Facility (CPFF)." + Ken Lewis from Bank of + +On line 19600: + from BNY Mellon, Vikram + Pandit from Citigroup, Lloyd + Blankfein from Goldman, + + Jamie Dimon from JP + Morgan, John Thain from Merrill, + John Mack from Morgan + +On line 19602: + Richard Kovacevich from + Wells. Paulson, testimony + before the FCIC, May + +On line 19602: + Former assistant + treasury secretary Phillip Swagel + argued, "There is no + +On line 19602: + accept government + capital" ("The Financial + Crisis: An Inside + +On line 19602: + Brookings Papers on + Economic Activity, + conference draft, Spring + +On line 19604: + pp. Henry Paulson, + On The Brink: Inside the Race + to Stop the Collapse + +On line 19608: + Guarantee Program + consisted of two programs, + the Temporary Debt + +On line 19608: + and the Transaction + Account Guarantee Program + (TAGP). The TDGP at its + +On line 19608: + guaranteed billion + in outstanding senior debt; + see "FDIC Announces Plan + +On line 19608: + Bank Liquidity," + FDIC press release, October + The TAGP guaranteed + +On line 19610: + billion in deposits + at the end of "Factsheet on + Capital Purchase + +On line 19614: + November Paulson, + testimony before the + FCIC, May transcript, p. + +On line 19620: + Congress," February + p. Congressional Oversight + Panel, "September + +On line 19624: + Retrospective," p. + "Taxpayers Receive Billion + in Proceeds Today + +On line 19624: + Citigroup Common + Stock," Treasury Department press + release, December + +On line 19632: + to Chapter Office + of the Special Inspector + General for the + +On line 19632: + October table + p. (obligation figures as + of October and + +On line 19634: + as of September + The money market funding + is through the Asset-backed + + Commercial Paper + Money Market Mutual + Fund Liquidity + +On line 19636: + Facility (AMLF); + FCIC staff calculations. Board + of Governors of + +On line 19638: + Securities (MBS) + Purchase Program." The Fed had + created the first + +On line 19638: + vehicle in March + to take billion in assets + off the balance sheet + +On line 19638: + Bear Stearns, as described + in chapter See "AIG RMBS LLC + Facility: Terms + +On line 19638: + Counterparties to + CDS, GIA and Securities + Lending Transactions," + +On line 19638: + AIG press release, March + Attachment D: Payments to + AIG Securities + +On line 19640: + of New York, "Maiden + Lane III: Transaction Overview"; + Federal Reserve + +On line 19640: + release, November + "AIG CDO LLC Facility: + Terms and Conditions," + +On line 19640: + Federal Reserve + Bank of New York press release, + December FRBNY, + +On line 19640: + Transactions." billion + was paid to counterparties + and billion was paid + +On line 19646: + January transcript, + pp. Data provided to + Goldman Sachs to the + +On line 19648: + the FCIC, Hearing on + the Role of Derivatives + in the Financial + +On line 19648: + session American + International Group, Inc. + and Goldman Sachs Group, + +On line 19652: + email to FCIC, July + Ibid.; and data provided + by Goldman Sachs to + +On line 19654: + Affecting Efforts + to Limit Payments to AIG + Counterparties," pp. + +On line 19656: + said counterparties + insisted on coverage + because concessions + +On line 19656: + in contravention + of their fiduciary duty + to their shareholders"; + +On line 19656: + obligations, given + the government assistance; + costs already incurred + +On line 19656: + AIG default "would be + exacerbated if they + were paid less than par + +On line 19656: + "contractually + entitled" to receive the + par value of the + +On line 19658: + words, the decision + to acquire a controlling + interest in one + +On line 19658: + world’s most complex and + most troubled corporations + was done with almost + +On line 19658: + of the terms of the + transaction or the impact + that those terms might have + +On line 19662: + on the future of + AIG" (ibid., p. Ibid., summary, + p. Congressional + +On line 19662: + Panel, "June Oversight + Report: The AIG Rescue, Its + Impact on Markets, + +On line 19664: + and the Government’s + Exit Strategy," June pp. + Suzanne Kapner, "US + +On line 19666: + Panel Attacks AIG + Rescue," Financial Times, June + Baxter, interview. + +On line 19670: + Sarah Dahlgren, interview + by FCIC, April SIGTARP, "Factors + Affecting Efforts + +On line 19672: + Counterparties," p. + Timothy Geithner, + quoted in Jody Shenn, + + Bob Ivry, and Alan Katz, + "AIG 100-Cents Fed Deal Driven by + France Belied by French + +On line 19674: + interview by FCIC, + April Michael Alix, Federal + Reserve Bank of New + +On line 19680: + Observations on + Assistance Provided AIG," + GAO-09–4907 (Testimony: + +On line 19680: + House Committee on + Financial Services), March p. + Federal Reserve + +On line 19688: + AIG, "What AIG Owes the + US Government," updated + September Notes to + +On line 19692: + Edward J. Kelly + III, interview by FCIC, March + Roger Cole, interview + +On line 19696: + Kelly, interview. + James R. Wigand and Herbert J. + Held, memorandum + +On line 19700: + Kelly, interview. + Mark D. Richardson, email to John + H. Corston, Jason C. + +On line 19700: + Cave, et al., subject: + "RE: CONFIDENTIAL—Citigroup—Deterioration of Stock Price and CDS + Spreads," November Mark + + D. Richardson, email, to + John H. Corston, Jason C. Cave, + et al., subject: "11-21-08 + +On line 19702: + Citi Liquidity + call notes," November Wigand and + Held, November memo + +On line 19706: + closed-door session. Arthur + J. Murton, email to John V. + Thomas, Michael H. Krimminger, + +On line 19706: + et al., subject: "RE: + Proposed Conduit," November + Michael H. Krimminger, email + + to Arthur J. Murton, + John V. Thomas, et al., subject: + "RE: Proposed Conduit," + +On line 19708: + the Troubled Asset + Relief Program, 111th Cong., 2nd + sess., March transcript, p. + +On line 19712: + Regulators’ Use + of Systemic Risk Exception + Raises Moral Hazard + +On line 19712: + the Provision," GAO-10–100 + (Report to Congressional + Committees), April p. + +On line 19716: + Held, memo to the FDIC + board regarding Citigroup, + pp. Department of + + the Treasury response + to Congressional Oversight + Panel, Questions for + +On line 19718: + p. Citigroup and + the Troubled Asset Relief + Program, March p. "Joint + + Statement by Treasury, + Federal Reserve, and the + FDIC on Citigroup," + +On line 19722: + on Citigroup." In + total, Citigroup received + almost billion in + +On line 19722: + from the November + government assistance. Half + of the capital + +On line 19722: + Treasury’s billion TARP + investment in Citigroup + preferred stock; billion + + of the capital + benefits were derived from + a change in the risk + +On line 19722: + of the ring-fenced assets. + In addition, Citigroup + issued Treasury and + +On line 19722: + the FDIC billion in + preferred stock as payment for + the guarantee on + +On line 19722: + ring fence; the result, + after accounting for the + insurance feature + +On line 19724: + billion increase in + capital for Citigroup. + Kelly, interview. + +On line 19726: + The warrants gave the + government the right to buy + million shares at a + +On line 19726: + the stock was trading + at (Congressional Oversight + Panel, "November + +On line 19726: + Report: Guarantees + and Contingent Payments in + TARP and Related + +On line 19728: + Programs," November + pp. FDIC Board of Directors + meeting, closed session, + +On line 19732: + Year Retrospective," + October p. "Taxpayers + receive billion in + +On line 19732: + today from final + sale of Treasury Department + Citigroup common + +On line 19734: + Reports Third Quarter + Net Loss from Continuing + Operations of + +On line 19736: + Federal Reserve + System, "Order Approving + Bank of America + +On line 19736: + an Industrial + Loan Company," November + pp. To approve such + + a proposal, the + Bank Holding Company Act + requires the Fed to + + determine that a + transaction "can reasonably + be expected to + + produce benefits + to the public, such as greater + convenience, increased + + competition, or + gains in efficiency, that + outweigh possible + + adverse effects, such + as undue concentration + of resources, decreased + +On line 19738: + competition." U.S.C. + 1843(j)(2)(A). Timothy J. Mayopoulous, + former general + +On line 19738: + Committee, Bank of + America and Merrill Lynch: + How Did a Private + +On line 19746: + Investigation: + Bank of America–Merrill Lynch, February + p. available from House + +On line 19746: + the Subcommittee + on Domestic Policy, + Bank of America + +On line 19746: + Merrill Lynch: How Did + A Private Deal Turn into + a Federal Bailout1 + +On line 19748: + 1st sess., June Bank of + America, 4Q Earnings Call + transcript, January + +On line 19754: + interview by FCIC, + September Complaint, SEC v. + Bank of America + +On line 19754: + Jan. Final Consent + Judgment As to Defendant + Bank of America + +On line 19758: + the Subcommittee + on Domestic Policy, + Bank of America + +On line 19758: + Merrill Lynch: How Did + a Private Deal Turn into + a Federal Bailout1 + +On line 19760: + the Subcommittee + on Domestic Policy, + Bank of America + +On line 19760: + Merrill Lynch: How Did + a Private Deal Turn into + a Federal Bailout1 + +On line 19766: + II, 111th Cong., 1st sess., + June p. Lewis, interview. Thain, + interview Paulson, + +On line 19768: + Oversight Committee, + July pp. Chairman Ben Bernanke, + email to General + +On line 19768: + Alvarez, "Re: Fw: BAC," + December available from House + Oversight Committee, + +On line 19768: + Merrill Lynch: How Did + a Private Deal Turn into + a Federal Bailout1 + +On line 19772: + Representative + Edolphus Towns, in ibid., p. Lewis, + interview. Minutes + +On line 19772: + a Special Meeting + of Board of Directors of + Bank of America + +On line 19774: + June p. Minutes of + a Special Meeting of the + Bank of America + +On line 19778: + December available + in ibid., p. Lewis, interview. + See Department of + +On line 19778: + Ending November + November In addition + to drawing on these + + funds, it was also + a "substantial user" of + the Fed’s various + +On line 19778: + programs. The holding + company and its subsidiaries + had already borrowed + +On line 19778: + billion through the Term + Auction Facility. It + had also borrowed + +On line 19778: + Commercial Paper + Funding Facility and + billion under the + +On line 19778: + borrowed another + billion from the Fed’s two Bear + Stearns–era repo-support + +On line 19778: + would experience + liquidity problems if + the fourth-quarter earnings + +On line 19780: + weak. The amount of FDIC-guaranteed + debt that can be issued by + each eligible + + entity, or its + cap, is based on the amount of + senior unsecured + +On line 19782: + debt outstanding as + of September FRB and OCC + staff, memorandum + +On line 19784: + Financial Market + Participants," January + p. Sheila C. Bair, FDIC + +On line 19784: + the Subcommittee + on Domestic Policy, + Bank of America + +On line 19784: + Merrill Lynch: How Did + a Private Deal Turn into + a Federal Bailout1 + +On line 19786: + Part V, 110th Cong., 1st + sess., December p. FRB and + OCC staff memo to Rick + +On line 19786: + Mitchell Glassman, Sandra + Thompson, Arthur Murton, and John + Thomas, memorandum + +On line 19786: + Board of Directors, + subject: Bank of America, + etc., January pp. + +On line 19796: + December p. Notes + to Chapter Glassman et al., + memo to the FDIC board, + +On line 19796: + January p. They + agreed to this split because of + the assets for the + +On line 19796: + depository + institutions and were not. + See closed meeting of + +On line 19798: + Board of Directors, + January transcript, p. Closed + meeting of the FDIC + +On line 19800: + January transcript, + p. According to the FDIC + staff, "Liquidity + +On line 19800: + and the volume of + counterparty transactions + involved. Without a + +On line 19800: + to fund ongoing + operations. [Economic + developments] point + +On line 19800: + financial market + turmoil of recent months and + impaired economic + + performance that could + be expected to worsen + further if BAC and + +On line 19800: + business and consumer + confidence." Glassman et al., + memo to the FDIC board, + +On line 19809: + testimony for + the FCIC, First Public Hearing + of the Financial + +On line 19811: + January p. Clarence + Williams, written testimony + for the FCIC, Hearing + +On line 19813: + Financial Crisis— + Sacramento, session Impact + of the Financial + +On line 19815: + September p. and + testimony before the + FCIC, transcript, pp. Ed + +On line 19817: + November Jeannie + McDermott, testimony before + the FCIC, Hearing on + +On line 19819: + Bakersfield, session + Forum for Public Comment, + September transcript, + +On line 19823: + before the FCIC, in + ibid., transcript, pp. "National + Delinquency Survey," + +On line 19825: + Fourth Quarter March p. + Third Quarter November p. + CoreLogic, "U.S. Housing and + +On line 19827: + August November + p. Jeremy Aguero, principal + analyst, Applied + +On line 19827: + the Impact of the + Financial Crisis—State of Nevada, + session Economic + + Analysis of the + Impact of the Financial + Crisis on Nevada, + +On line 19831: + available at www.urban.org/url.cfm1ID=901206. Steven + K. Paulson, "Auditors Say + Colorado Pension Plan + +On line 19833: + Associated + Press, August Charles S. Johnson, + "Montana Pension Funds + +On line 19835: + Growing but Haven’t Made + Up Losses," The Billings Gazette, May + The Conference Board + +On line 19839: + May The Conference + Board news release, December + Gregory D. Bynum, + +On line 19841: + on the Impact of + the Financial Crisis— Greater + Bakersfield, session + +On line 19843: + and Community + Real Estate, September + transcript, p. Board of + +On line 19843: + Governors of the + Federal Reserve System, + October Senior + +On line 19845: + Business and Non-business + Filings by Year Jeff Agosta, + conference call with + +On line 19851: + "Annual Business + and Non-Business Filings by Year Board + of Governors of + +On line 19851: + Federal Reserve + System, July Senior Loan + Officer Opinion + +On line 19853: + Practices, August p. + Liz Moyer, "Revolver at the + Heads," Forbes, October + +On line 19855: + Murillo Campello, John + R. Graham, and Campbell R. + Harvey, "The Real + +On line 19863: + Crisis," Journal of + Financial Economics Notes + to Chapter Board of + +On line 19863: + Governors of the + Federal Reserve System, + January Senior + +On line 19865: + Survey, fourth-quarter p. + Elizabeth Duke, governor, + Federal Reserve + +On line 19865: + "Small Business Lending," + testimony before the + House Committee on + +On line 19869: + Business Economic + Trends," December p. Ben Bernanke, + "Restoring the Flow of + +On line 19869: + Federal Reserve + Meeting Series: "Addressing + the Financing Needs + +On line 19871: + of Small Businesses," + Washington, DC, July C. + R. "Rusty" Cloutier, past + +On line 19871: + the FCIC, day panel + Financial Crisis Impacts + on the Economy, + +On line 19873: + Federal Reserve + Statistical Release, E.2 + Survey of Terms of + + Business Lending, E.2 + Chart Data: "Commercial and + Industrial Loan + +On line 19875: + Spreads over Intended + Federal Funds Rate, by Loan + Size," spread for all sizes. + +On line 19877: + a Deep Recession," + National Federation + of Independent + +On line 19881: + interview by FCIC, + August Board of Governors + of the Federal + +On line 19883: + Opinion Survey on + Bank Lending Practices, April Board + of Governors of + +On line 19885: + Opinion Survey on + Bank Lending Practices, July + Emily Maltby, "Small + +On line 19885: + Biz Loan Failure Rate + Hits CNN Money, February + "SBA Losses Climb in + +On line 19887: + CEO, GE Capital, + testimony before the + FCIC, Hearing on the + +On line 19889: + the Shadow Banking + System, May transcript, p. GE, + Annual Report, + +On line 19891: + p. Mark S. Barber, + testimony before the + FCIC, Hearing on the + +On line 19895: + International + Financial Statistics, World + Tables: Exports, World + +On line 19897: + Jane Levere, "Office + Deals, Months Apart, Show Market’s Move," + New York Times, August + +On line 19899: + Commercial Real + Estate Quarterly Market + Survey, December + +On line 19901: + Applied Analysis, + testimony before the + FCIC, Hearing on the + +On line 19901: + Financial Crisis—State of + Nevada, session The Impact + of the Financial + +On line 19903: + Crisis on Nevada + Real Estate, September + transcript, p. Anton + + Troianovski, "High Hopes as + Builders Bet on Skyscrapers," Wall Street + Journal, September + +On line 19905: + Ibid.; Gregory Bynum, + president, Gregory D. + Bynum Associates, Inc., + +On line 19907: + Federal Deposit + Insurance Commission, "Failed + Bank List," January + +On line 19909: + February Oversight + Report, "Commercial Real + Estate Losses and + +On line 19911: + TreppWire, "CMBS Delinquency + Rate Nears Up BPs in August + after Leveling + +On line 19913: + in July, Rate Now + Monthly Delinquency Report, + September p. Allen + +On line 19913: + Kenney, "CRE Mortgage + Default Rate to Double by + REIT.com, June See also + +On line 19917: + "Default Rates Reach 16-Year + High," Globe St., February Ibid. + Green Street Advisors, + +On line 19925: + Notes to Chapter "Moody’s/REAL + Commercial Property Price + Indices, December + +On line 19925: + Moody’s Investors Service + Special Report, December + Moody’s Investors Service, + +On line 19929: + Losses," February + Oversight Report, February + pp. Dr. Kenneth T. + +On line 19929: + Real Estate and + Economics, University + of California + +On line 19929: + in testimony + before the FCIC, First Public + Hearing of the FCIC, + +On line 19931: + Crisis Impacts on + the Economy, January + Elizabeth McNichol, Phil + +On line 19933: + on the Impact of + the Financial Crisis—Sacramento, session + The Impact of the + +On line 19935: + September transcript, + p. Sujit CanagaRetna, interview + by FCIC, November + +On line 19937: + "NCSL Fiscal Brief: + Projected State Revenue Growth + in FY and Beyond," + +On line 19941: + Analyst’s Office, + "The Budget: California’s + Fiscal Outlook." Kaiser + +On line 19943: + the Uninsured, "Hoping + for Economic Recovery, + Preparing for Health + +On line 19943: + Medicaid Spending, + Coverage and Policy + Trends," September pp. + +On line 19947: + Intensify in + Cities," October Christopher W. + Hoene and Michael A. Pagano, + +On line 19949: + Fiscal Conditions + in National League of Cities, + October p. Ibid., + +On line 19951: + pp. Alan S. Blinder + and Mark Zandi, "How the Great + Recession Was Brought + +On line 19953: + Donald L. Kohn, vice + chairman, Federal Reserve + Board of Governors, + +On line 19953: + Actions during the + Financial Crisis and Lessons + for the Future," speech + +On line 19957: + p. Congressional + Budget Office, "Report on + the Troubled Asset + +On line 19959: + November White House + Office of Management and + Budget, FY2011 Budget + +On line 19961: + Receipts, Outlays, and + Surpluses or Deficits Total + Budget Deficit. FDIC, "Failed + +On line 19963: + Bank List." "Quarterly + Banking Profile: Third Quarter + FDIC Quarterly no. + +On line 19967: + no. and "Quarterly + Banking Profile: First Quarter + FDIC Quarterly no. + +On line 19967: + Board of Governors + of the Federal Reserve + System, Profit and + +On line 19969: + Sheet Developments + at U.S. Commercial Banks in + FDIC, Statistics on + +On line 19969: + Income and Expense, + All Commercial Banks—Assets more than + $1B—National, Standard Report + +On line 19971: + Income and Expense, + All Commercial Banks—Assets less than + $100M and Assets $100M + +On line 19971: + logged as "Net income + attributable to bank." "Wall + Street Bonuses Rose Sharply + +On line 19973: + Comptroller Thomas P. + DiNapoli press release, February + N.Y. State Comptroller + +On line 19985: + "Economic Trends in + New York State," October Notes + to Chapter Chapter + +On line 19990: + FCIC calculations + based on estimates from Hope + Now and Moodys.com. Mortgage + +On line 19990: + Survey (the source for + the rest of the delinquency + and foreclosure rates + +On line 19992: + Gordon, Center for + Responsible Lending, "HAMP, + Servicer Abuses, and + +On line 19992: + COP Hearing on TARP + Foreclosure Mitigation + Programs, 111th Cong., 2nd + +On line 19992: + October pp. CRL + testimony based on Rod + Dubitsky, Larry + +On line 19992: + Million Foreclosures + Expected," Credit Suisse + (December and Jan + +On line 19992: + and Credit Losses: + Projections and Policy + Options," Goldman Sachs + +On line 19994: + Global Economics + Paper (January p. "RealtyTrac + Year-End Report Shows Record + +On line 19994: + U.S. Properties with + Foreclosure Filings in 2009—An + Increase of Percent + +On line 19996: + and Percent from RealtyTrac, + January "Delinquencies and + Loans in Foreclosure + +On line 19996: + Foreclosure Starts Rise + in Latest MBA National + Delinquency Survey," + +On line 19998: + release, November + Mark Fleming, chief economist, + CoreLogic, testimony + +On line 19998: + FCIC, Hearing on the + Impact of the Financial + Crisis—Sacramento, session Overview + + of the Sacramento + Housing and Mortgage Markets + and the Impact of + +On line 20000: + Financial Crisis + on the Region, September + transcript, p. FCIC staff + +On line 20002: + estimates based on + analysis of BlackBox data. + Laurie S. Goodman, + +On line 20002: + Private Sector and + Government Response to the + Mortgage Foreclosure + +On line 20004: + 1st sess., December + p. The index declined from + in April to in March + +On line 20006: + Quarterly Decline + in Negative Equity," + CoreLogic Inc., December + +On line 20008: + the second quarter + of Jim Rokakis, treasurer of + Cuyahoga County, Ohio, + +On line 20010: + and in "Ohio County + Foreclosure Filings Cuyahoga + County," Policy + +On line 20014: + Ohio. Rokakis, interview. + The United States Conference + of Mayors, "Impact + +On line 20014: + Crisis on Vacant + and Abandoned Properties in + Cities: A 77-City Survey," + +On line 20016: + June pp. Guy Cecala, + prepared testimony for + the Congressional + +On line 20016: + COP Hearing on TARP + Foreclosure Mitigation + Programs, 111th Cong., 2nd + +On line 20024: + Jersey Housing and + Mortgage Financing Agency, + approved September + +On line 20028: + testimony to + the Senate Committee on + Banking, Housing, and + +On line 20028: + Mortgage Servicing + from Modification to + Foreclosure, 111th Cong., + +On line 20030: + November p. See, + for example, National + Consumer Law Center, + + "Why Servicers Foreclose + When They Should Modify and + Other Puzzles of + +On line 20038: + Notes to Chapter Joseph + H. Evers, Office of the + Comptroller of the + +On line 20038: + COP Hearing on TARP + Foreclosure Mitigation + Programs, 111th Cong., 2nd + +On line 20038: + mortgage servicers have + modified loans since early + By the end of the + +On line 20038: + quarter of more than + of the modifications + were seriously + +On line 20038: + of foreclosure; and + had completed foreclosure. + The OCC examined + +On line 20038: + that were or more days + delinquent that were modified + during the second + +On line 20038: + modification, + of loans were delinquent by two + or more months; at nine + +On line 20038: + in arrears; at six + months, and at three months after + a loan change, nearly + +On line 20038: + OCC noted that more + recent modifications + have performed better + +On line 20042: + COP Hearing on TARP + Foreclosure Mitigation + Programs, 111th Cong., 2nd + +On line 20044: + sess., October p. + David J. Grais, partner with Grais + Ellsworth LLP, interview + +On line 20046: + Amherst Securities. + See PowerPoint presentation to + the Grais and Ellsworth LLP + +On line 20046: + Servicing Failures: + Protecting the Rights of RMBS + Investors," October + +On line 20054: + Financial Services + Committee, December See + Deposition of + +On line 20054: + Stephan, GMAC Mortgage LLC + v. Ann M. Neu a/k/a Ann Michelle + Perez, No. CA040805XXXX MB (Fla. + +On line 20056: + Cir. Ct. Dec. pp. See, + for example, Dwayne Ransom + Davis and Melisa Davis v. + + Countrywide Home Loans, + Inc.; Bank of America, N.A.; + BAC GP LLC; and BAC + +On line 20062: + Stability and + Foreclosure Mitigation," + November p. See, + +On line 20064: + Rdcv (Rutland Co. + Vt. Super. Ct. Oct. holding + that MERS did not have + +On line 20066: + foreclosure because + the note and mortgage had been + separated. The + +On line 20066: + F. Dana Winslow, written + testimony before the + House Committee on + +On line 20066: + Justice: Causes and + Effects of the Foreclosure + Crisis, 111th Cong., 2nd + +On line 20068: + sess., December pp. + Order, Objection to Claims + of Citibank, N.A. 4-6-10, (Bankr. + +On line 20068: + p. The order cites + In re Foreclosure Cases, + F. Supp. 2d (S.D. Oh. + +On line 20070: + In re Vargas, B.R. + (Bankr. C.D. Cal. Landmark Nat’l Bank + v. Kesler, P.3d (Kan. LaSalle + +On line 20072: + Sup. Ct. Winslow, written + testimony before the + House Committee on + +On line 20074: + pp. See John T. Kemp + v. Countrywide Home Loans, Inc., + Case No. 08-18700-JHW (D. N.J.), + +On line 20078: + pp. Grais, interview. + Adam J. Levitin, associate + professor of law, + +On line 20078: + University Law + Center, testimony to + Senate Committee + +On line 20078: + Banking, Housing, and + Urban Affairs, Problems in + Mortgage Servicing + +On line 20078: + Modification + to Foreclosure, 111th Cong., 2nd + sess., November p. + +On line 20082: + Panel, "November + Oversight Report," pp. Katherine + Porter, professor of + +On line 20084: + COP Hearing on TARP + Foreclosure Mitigation + Programs, October + +On line 20086: + p. Levitin, written + testimony before the + Senate Committee + +On line 20088: + Banking, Housing, and + Urban Affairs, p. Erika + Poethig, written + +On line 20088: + Subcommittee on + Housing and Community + Opportunity, + +On line 20088: + Foreclosure Crisis + on Public and Affordable + Housing in the Twin + +On line 20096: + sess., January p. + Notes to Chapter National + Association + +On line 20096: + and Youth (NAEHCY) and + First Focus, "A Critical + Moment: Child and Youth + +On line 20096: + Homelessness in Our + Nation’s Schools," July p. In + early NAEHCY and + +On line 20096: + Focus conducted + a survey of school districts. + When they were asked the + +On line 20096: + economic downturn, + attributed it to greater school + and community + +On line 20098: + Dr. Heath Morrison, + testimony before the + FCIC, Hearing on the + +On line 20100: + Nevada, session The + Impact of the Financial + Crisis on Nevada + +On line 20102: + transcript, pp. Gail Burks, + testimony before the + FCIC, Hearing on the + +On line 20102: + Financial Crisis—State of + Nevada, session The Impact + of the Financial + +On line 20104: + Crisis on Nevada + Real Estate, September + transcript, pp. Karen Mann, + +On line 20104: + and chief appraiser, + Mann and Associates Real + Estate Appraisers + +On line 20104: + FCIC, Hearing on the + Impact of the Financial + Crisis—Sacramento, session Mortgage + +On line 20104: + Fraud and Predatory + Lending in the Sacramento + Region, September + +On line 20106: + testimony, p. + Dawn Hunt, homeowner in Cape + Coral, FL, interview + +On line 20108: + by FCIC, December + Zip code default, foreclosures + and REO, S&P Global + +On line 20116: + RMBS database, July + Hunt, interview. INDEX The + index is available + diff --git a/data/haikus/haikus.txt b/data/haikus/haikus.txt new file mode 100644 index 0000000..8561bf6 --- /dev/null +++ b/data/haikus/haikus.txt @@ -0,0 +1,349012 @@ +Found 69802 haiku... + +On line 4: + current financial + and economic crisis in + the United States." In + +On line 4: + United States." In this + report, the Commission presents + to the President, + +On line 4: + Commission presents to + the President, the Congress, + and the American + +On line 4: + the President, the + Congress, and the American + people the results + +On line 4: + and the American + people the results of its + examination + +On line 4: + people the results + of its examination + and its conclusions + +On line 4: + the results of its + examination and its + conclusions as to + +On line 4: + examination + and its conclusions as to + the causes of the + +On line 6: + and its conclusions + as to the causes of the + crisis. More than two + +On line 6: + as to the causes + of the crisis. More than two + years after the worst + +On line 6: + to the causes of + the crisis. More than two years + after the worst of + +On line 6: + of the crisis. More + than two years after the worst + of the financial + +On line 6: + crisis. More than two + years after the worst of the + financial crisis, + +On line 6: + years after the worst + of the financial crisis, + our economy, as + +On line 6: + after the worst of + the financial crisis, our + economy, as well + +On line 6: + financial crisis, + our economy, as well as + communities and + +On line 6: + our economy, as + well as communities and + families across the + +On line 6: + and families across + the country, continues to + experience the + +On line 6: + the after-shocks. Millions + of Americans have lost their + jobs and their homes, and + +On line 6: + after-shocks. Millions of + Americans have lost their jobs + and their homes, and the + +On line 6: + of Americans have + lost their jobs and their homes, and + the economy is + +On line 6: + Americans have lost + their jobs and their homes, and the + economy is still + +On line 6: + have lost their jobs and + their homes, and the economy + is still struggling to + +On line 6: + their jobs and their homes, + and the economy is still + struggling to rebound. + +On line 6: + rebound. This report + is intended to provide + a historical + +On line 6: + is intended to + provide a historical + accounting of what + +On line 6: + a historical + accounting of what brought our + financial system + +On line 6: + accounting of what + brought our financial system + and economy to + +On line 6: + brought our financial + system and economy to + a precipice and to help + +On line 6: + to a precipice and to + help policy makers and + the public better + +On line 8: + better understand + how this calamity came to be. + The Commission was + +On line 8: + how this calamity came + to be. The Commission was + established as part + +On line 8: + be. The Commission + was established as part of + the Fraud Enforcement + +On line 8: + The Commission was + established as part of the + Fraud Enforcement and + +On line 8: + was established as + part of the Fraud Enforcement + and Recovery Act + +On line 8: + as part of the Fraud + Enforcement and Recovery + Act (Public Law 111-21) + +On line 8: + Fraud Enforcement and + Recovery Act (Public Law + 111-21) passed by Congress + +On line 8: + Act (Public Law 111-21) + passed by Congress and signed by + the President in + +On line 8: + (Public Law 111-21) passed + by Congress and signed by the + President in May + +On line 10: + by Congress and signed + by the President in May + This independent, + +On line 10: + by the President + in May This independent, + 10-member panel was + +On line 10: + President in May + This independent, 10-member + panel was composed + +On line 10: + panel was composed + of private citizens with + experience in + +On line 10: + with experience + in areas such as housing, + economics, finance, + +On line 10: + banking, and consumer + protection. Six members of + the Commission were + +On line 10: + Six members of the + Commission were appointed + by the Democratic + +On line 10: + were appointed by + the Democratic leadership + of Congress and four + +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: + for inquiry and called + for the examination + of the collapse of + +On line 12: + collapse of major + financial institutions + that failed or would have + +On line 12: + major financial + institutions that failed or + would have failed if not + +On line 12: + institutions that + failed or would have failed if not + for exceptional + +On line 12: + failed or would have failed + if not for exceptional + assistance from the + +On line 12: + have failed if not for + exceptional assistance + from the government. + +On line 12: + the government. This + report fulfills these mandates. + In addition, the + +On line 12: + This report fulfills + these mandates. In addition, + the Commission was + +On line 12: + In addition, the + Commission was instructed + to refer to the + +On line 12: + was instructed to + refer to the attorney + general of the + +On line 12: + to refer to the + attorney general of + the United States and + +On line 12: + any appropriate + state attorney general + any person that the + +On line 12: + the Commission found + may have violated the + laws of the United + +On line 12: + Commission found may + have violated the laws + of the United States + +On line 12: + have violated + the laws of the United States + in relation to + +On line 12: + violated the + laws of the United States in + relation to the + +On line 12: + the United States in + relation to the crisis. + Where the Commission + +On line 12: + relation to the + crisis. Where the Commission + found such potential + +On line 12: + found such potential + violations, it referred + those matters to the + +On line 12: + The Commission used + the authority it was + given to issue + +On line 12: + issue subpoenas + to compel testimony + and the production + +On line 12: + and the production + of documents, but in the + vast majority + +On line 12: + the production of + documents, but in the vast + majority of + +On line 12: + documents, but in + the vast majority of + instances, companies + +On line 12: + vast majority + of instances, companies and + individuals + +On line 14: + voluntarily + cooperated with this + inquiry. In the course + +On line 14: + cooperated + with this inquiry. In the course + of its research and + +On line 14: + with this inquiry. In + the course of its research and + investigation, + +On line 14: + course of its research + and investigation, the + Commission reviewed + +On line 14: + millions of pages of + documents, interviewed more + than witnesses, and + +On line 14: + interviewed more than + witnesses, and held days of + public hearings in + +On line 14: + witnesses, and held + days of public hearings in + New York, Washington, + +On line 14: + of public hearings + in New York, Washington, D.C., + and communities + +On line 14: + public hearings in + New York, Washington, D.C., and + communities across + +On line 14: + New York, Washington, + D.C., and communities across + the country that were + +On line 14: + York, Washington, D.C., + and communities across the + country that were hard + +On line 14: + and communities + across the country that were hard + hit by the crisis. + +On line 14: + communities across + the country that were hard hit + by the crisis. The + +On line 14: + the country that were + hard hit by the crisis. The + Commission also + +On line 14: + that were hard hit by + the crisis. The Commission + also drew from a + +On line 14: + hit by the crisis. + The Commission also drew + from a large body of + +On line 14: + drew from a large body + of existing work about the + crisis developed + +On line 14: + of existing work + about the crisis developed + by congressional + +On line 14: + government agencies, + academics, journalists, legal + investigators, + +On line 16: + academics, journalists, + legal investigators, + and many others. We + +On line 16: + journalists, legal + investigators, and many + others. We have tried + +On line 16: + investigators, + and many others. We have tried + in this report to + +On line 16: + We have tried in this + report to explain in clear, + understandable terms + +On line 16: + to explain in clear, + understandable terms how our + complex financial + +On line 16: + understandable terms + how our complex financial + system worked, how the + +On line 16: + complex financial + system worked, how the pieces fit + together, and how + +On line 16: + system worked, how the + pieces fit together, and how + the crisis occurred. + +On line 16: + pieces fit together, + and how the crisis occurred. + Doing so required + +On line 16: + together, and how + the crisis occurred. Doing + so required research + +On line 16: + and how the crisis + occurred. Doing so required + research into broad + +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: + management. To bring + these subjects out of the realm + of the abstract, we + +On line 16: + bring these subjects out + of the realm of the abstract, + we conducted case + +On line 16: + these subjects out of + the realm of the abstract, we + conducted case study + +On line 16: + Financial, Fannie + Mae, Goldman Sachs, Lehman Brothers, + Merrill Lynch, Moody’s, and + +On line 16: + Fannie Mae, Goldman + Sachs, Lehman Brothers, Merrill Lynch, + Moody’s, and Wachovia. We + +On line 16: + Mae, Goldman Sachs, Lehman + Brothers, Merrill Lynch, Moody’s, and + Wachovia. We looked more + +On line 16: + Lehman Brothers, Merrill + Lynch, Moody’s, and Wachovia. We looked + more generally + +On line 16: + Brothers, Merrill Lynch, + Moody’s, and Wachovia. We looked more + generally at + +On line 16: + Moody’s, and Wachovia. We + looked more generally at + the roles and actions + +On line 16: + and Wachovia. We looked + more generally at the + roles and actions of + +On line 16: + Wachovia. We looked more + generally at the roles + and actions of scores + +On line 18: + roles and actions of + scores of other companies. + We also studied + +On line 18: + We also studied + relevant policies put in + place by successive + +On line 18: + policies put in place + by successive Congresses and + administrations. + +On line 18: + successive Congresses + and administrations. And + importantly, we + +On line 18: + And importantly, + we examined the roles of + policy makers + +On line 18: + we examined the + roles of policy makers + and regulators, + +On line 18: + roles of policy + makers and regulators, + including at the + +On line 18: + Corporation, the + Federal Reserve Board, the + Federal Reserve + +On line 18: + Federal Reserve + Board, the Federal Reserve + Bank of New York, the + +On line 18: + Housing and Urban + Development, the Office + of the Comptroller + +On line 18: + Development, the + Office of the Comptroller + of the Currency, + +On line 18: + Comptroller of the + Currency, the Office of + Federal Housing + +On line 18: + of the Currency, + the Office of Federal + Housing Enterprise + +On line 18: + its successor, the + Federal Housing Finance + Agency), the Office + +On line 18: + Agency), the Office + of Thrift Supervision, the + Securities and + +On line 18: + Supervision, the + Securities and Exchange + Commission, and the + +On line 18: + Securities and + Exchange Commission, and the + Treasury Department. + +On line 20: + Exchange Commission, + and the Treasury Department. + Of course, there is much + +On line 20: + Commission, and the + Treasury Department. Of course, + there is much work the + +On line 20: + Treasury Department. + Of course, there is much work the + Commission did not + +On line 20: + Of course, there is much + work the Commission did not + undertake. Congress + +On line 20: + Commission did not + undertake. Congress did not + ask the Commission + +On line 20: + it to delve into + what caused the crisis. In that + sense, the Commission + +On line 20: + to delve into what + caused the crisis. In that sense, + the Commission has + +On line 20: + what caused the crisis. + In that sense, the Commission + has functioned somewhat + +On line 20: + caused the crisis. In + that sense, the Commission has + functioned somewhat like + +On line 20: + other transportation + accidents so that knowledge + of the probable + +On line 20: + accidents so that + knowledge of the probable + causes can help avoid + +On line 20: + of the probable + causes can help avoid future + accidents. Nor were + +On line 20: + can help avoid future + accidents. Nor were we tasked + with evaluating + +On line 20: + accidents. Nor were + we tasked with evaluating + the federal law + +On line 20: + the federal law + (the Troubled Asset Relief + Program, known as TARP) + +On line 20: + TARP) that provided + financial assistance to + major financial + +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 + +On line 22: + TARP. This report is + not the sole repository + of what the panel + +On line 22: + This report is not + the sole repository of + what the panel found. + +On line 22: + report is not the + sole repository of what + the panel found. A + +On line 22: + sole repository + of what the panel found. A + website will host a + +On line 22: + what the panel found. + A website will host a wealth + of information + +On line 22: + A website will host + a wealth of information + beyond what could be + +On line 22: + will host a wealth of + information beyond what + could be presented + +On line 24: + contain a stockpile + of materials—including + documents and emails, + +On line 24: + and emails, video of the + Commission’s public hearings, + testimony, and + +On line 24: + Commission’s public + hearings, testimony, and + supporting research—that + +On line 24: + testimony, and + supporting research—that can be + studied for years to + +On line 24: + supporting research—that + can be studied for years to + come. Much of what is + +On line 24: + can be studied for + years to come. Much of what is + footnoted in this + +On line 24: + for years to come. Much + of what is footnoted in + this report can be + +On line 24: + years to come. Much of + what is footnoted in this + report can be found + +On line 24: + come. Much of what is + footnoted in this report + can be found on the + +On line 24: + what is footnoted + in this report can be found + on the website. In + +On line 24: + can be found on the + website. In addition, more + materials that + +On line 24: + In addition, more + materials that cannot + be released yet for + +On line 24: + materials that + cannot be released yet for + various reasons + +On line 24: + cannot be released + yet for various reasons + will eventually + +On line 24: + yet for various + reasons will eventually + be made public through + +On line 24: + made public through the + National Archives and Records + Administration. + +On line 26: + National Archives + and Records Administration. + Our work reflects the + +On line 26: + extraordinary + commitment and knowledge of + the members of the + +On line 26: + and knowledge of the + members of the Commission + who were accorded + +On line 26: + Commission who were + accorded the honor of + this public service. + +On line 26: + who were accorded + the honor of this public + service. We also + +On line 26: + this public service. + We also benefited + immensely from the + +On line 26: + service. We also + benefited immensely + from the perspectives + +On line 26: + from the perspectives + shared with commissioners by + thousands of concerned + +On line 26: + thousands of concerned + Americans through their letters + and emails. And we are + +On line 26: + concerned Americans + through their letters and emails. And + we are grateful to + +On line 26: + and emails. And we are + grateful to the hundreds of + individuals + +On line 26: + individuals + and organizations that + offered expertise, + +On line 26: + personal accounts + in extensive interviews, + testimony, and + +On line 30: + and discussions with + the Commission. We want to + thank the Commission + +On line 30: + discussions with the + Commission. We want to thank + the Commission staff, + +On line 30: + particular, Wendy + Edelberg, our executive + director, for the + +On line 30: + director, for the + professionalism, passion, + and long hours they brought + +On line 30: + professionalism, + passion, and long hours they brought + to this mission in + +On line 30: + and long hours they brought + to this mission in service + of their country. This + +On line 30: + hours they brought to this + mission in service of their + country. This report + +On line 30: + brought to this mission + in service of their country. + This report would not + +On line 30: + to this mission in + service of their country. This + report would not have + +On line 30: + in service of their + country. This report would not + have been possible + +On line 30: + report would not have + been possible without their + extraordinary + +On line 32: + dedication. With + this report and our website, + the Commission’s work + +On line 32: + With this report and + our website, the Commission’s + work comes to a close. + +On line 32: + this report and our + website, the Commission’s work + comes to a close. We + +On line 32: + and our website, the + Commission’s work comes to a + close. We present what we + +On line 32: + the Commission’s work + comes to a close. We present what + we have found in the + +On line 32: + Commission’s work comes + to a close. We present what we + have found in the hope + +On line 32: + work comes to a close. + We present what we have found in + the hope that readers + +On line 32: + comes to a close. We + present what we have found in the + hope that readers can + +On line 32: + to a close. We present + what we have found in the hope + that readers can use + +On line 32: + a close. We present what + we have found in the hope that + readers can use this + +On line 32: + We present what we have + found in the hope that readers + can use this report + +On line 32: + present what we have found + in the hope that readers can + use this report to + +On line 32: + what we have found in + the hope that readers can use + this report to reach + +On line 32: + we have found in the + hope that readers can use this + report to reach their + +On line 32: + the hope that readers + can use this report to reach + their own conclusions, + +On line 32: + hope that readers can + use this report to reach their + own conclusions, even + +On line 32: + that readers can use + this report to reach their own + conclusions, even as + +On line 32: + this report to reach + their own conclusions, even as + the comprehensive + +On line 32: + their own conclusions, + even as the comprehensive + historical record + +On line 32: + the comprehensive + historical record of this + crisis continues + +On line 38: + record of this crisis + continues to be written. + CONCLUSIONS OF THE + +On line 38: + crisis continues + to be written. CONCLUSIONS + OF THE FINANCIAL + +On line 38: + continues to be + written. CONCLUSIONS OF THE + FINANCIAL CRISIS + +On line 38: + written. CONCLUSIONS + OF THE FINANCIAL CRISIS + INQUIRY COMMISSION + +On line 40: + Commission has been + called upon to examine + the financial and + +On line 40: + to examine the + financial and economic + crisis that has gripped + +On line 40: + the financial and + economic crisis that has + gripped our country and + +On line 40: + economic crisis + that has gripped our country and + explain its causes + +On line 40: + gripped our country and + explain its causes to the + American people. + +On line 40: + explain its causes + to the American people. + We are keenly aware + +On line 40: + its causes to the + American people. We are + keenly aware of the + +On line 40: + American people. + We are keenly aware of the + significance of + +On line 40: + We are keenly aware + of the significance of + our charge, given the + +On line 40: + economic damage + that America has suffered + in the wake of the + +On line 40: + that America has + suffered in the wake of the + greatest financial + +On line 40: + suffered in the wake + of the greatest financial + crisis since the Great + +On line 42: + wake of the greatest + financial crisis since the + Great Depression. Our + +On line 42: + crisis since the Great + Depression. Our task was first + to determine what + +On line 42: + Great Depression. Our + task was first to determine + what happened and how + +On line 42: + Depression. Our task + was first to determine what + happened and how it + +On line 42: + Our task was first to + determine what happened and + how it happened so + +On line 42: + what happened and how + it happened so that we could + understand why it + +On line 42: + and how it happened + so that we could understand + why it happened. Here + +On line 42: + how it happened so + that we could understand why + it happened. Here we + +On line 42: + it happened so that + we could understand why it + happened. Here we present + +On line 42: + we could understand + why it happened. Here we present + our conclusions. We + +On line 42: + our conclusions. We + encourage the American + people to join us + +On line 42: + We encourage the + American people to join + us in making their + +On line 42: + American people + to join us in making their + own assessments based + +On line 42: + us in making their + own assessments based on the + evidence gathered + +On line 42: + own assessments based + on the evidence gathered + in our inquiry. If + +On line 42: + assessments based on + the evidence gathered in + our inquiry. If we + +On line 42: + on the evidence + gathered in our inquiry. If + we do not learn from + +On line 42: + our inquiry. If we + do not learn from history, + we are unlikely + +On line 42: + inquiry. If we do + not learn from history, we + are unlikely to + +On line 42: + from history, we + are unlikely to fully + recover from it. + +On line 42: + we are unlikely + to fully recover from + it. Some on Wall Street + +On line 42: + are unlikely to + fully recover from it. + Some on Wall Street and + +On line 42: + fully recover + from it. Some on Wall Street and + in Washington with + +On line 42: + it. Some on Wall Street + and in Washington with a + stake in the status + +On line 42: + Some on Wall Street and + in Washington with a stake + in the status quo + +On line 42: + on Wall Street and in + Washington with a stake in + the status quo may + +On line 42: + and in Washington + with a stake in the status + quo may be tempted + +On line 42: + in Washington with + a stake in the status quo + may be tempted to + +On line 42: + Washington with a + stake in the status quo may + be tempted to wipe + +On line 42: + stake in the status + quo may be tempted to wipe + from memory the + +On line 42: + in the status quo + may be tempted to wipe from + memory the events + +On line 42: + quo may be tempted + to wipe from memory the + events of this crisis, + +On line 42: + may be tempted to + wipe from memory the events + of this crisis, or + +On line 42: + be tempted to wipe + from memory the events of + this crisis, or to + +On line 42: + wipe from memory + the events of this crisis, or + to suggest that no + +On line 42: + from memory the + events of this crisis, or to + suggest that no one + +On line 42: + events of this crisis, + or to suggest that no one + could have foreseen or + +On line 42: + or to suggest that + no one could have foreseen or + prevented them. This + +On line 42: + unravel myths, and + help us understand how the + crisis could have been + +On line 42: + help us understand + how the crisis could have been + avoided. It is an + +On line 42: + understand how the + crisis could have been avoided. + It is an attempt + +On line 42: + crisis could have been + avoided. It is an attempt + to record history, + +On line 42: + could have been avoided. + It is an attempt to record + history, not to + +On line 42: + avoided. It is an + attempt to record history, + not to rewrite it, + +On line 42: + an attempt to record + history, not to rewrite + it, nor allow it + +On line 42: + record history, not + to rewrite it, nor allow + it to be rewritten. + +On line 44: + history, not to + rewrite it, nor allow it + to be rewritten. To + +On line 44: + to rewrite it, nor + allow it to be rewritten. + To help our fellow + +On line 44: + it, nor allow it + to be rewritten. To help our + fellow citizens + +On line 44: + allow it to be + rewritten. To help our fellow + citizens better + +On line 44: + to be rewritten. To + help our fellow citizens + better understand + +On line 44: + conclusions at the + end of chapters in Parts III, + IV, and V of this + +On line 46: + end of chapters in + Parts III, IV, and V of this + report. The subject + +On line 46: + chapters in Parts III, + IV, and V of this report. + The subject of this + +On line 46: + Parts III, IV, and V + of this report. The subject + of this report is + +On line 46: + III, IV, and V of + this report. The subject of + this report is of + +On line 46: + IV, and V of this + report. The subject of this + report is of no + +On line 46: + report. The subject + of this report is of no + small consequence to + +On line 46: + this report is of + no small consequence to this + nation. The profound + +On line 46: + small consequence to + this nation. The profound events + of and were neither + +On line 46: + consequence to this + nation. The profound events of + and were neither bumps + +On line 46: + nation. The profound + events of and were neither bumps + in the road nor an + +On line 46: + bumps in the road nor + an accentuated dip + in the financial + +On line 46: + in the road nor an + accentuated dip in + the financial and + +On line 46: + accentuated + dip in the financial and + business cycles we + +On line 46: + in the financial + and business cycles we have + come to expect in + +On line 46: + the financial and + business cycles we have come + to expect in a + +On line 46: + come to expect in + a free market economic + system. This was a + +On line 46: + in a free market + economic system. This was + a fundamental + +On line 46: + system. This was a + fundamental disruption—a + financial upheaval, + +On line 46: + financial upheaval, + if you will—that wreaked havoc in + communities and + +On line 48: + communities and + neighborhoods across this country. + As this report goes + +On line 48: + and neighborhoods across + this country. As this report + goes to print, there are + +On line 48: + neighborhoods across this + country. As this report goes + to print, there are more + +On line 48: + across this country. As + this report goes to print, there + are more than million + +On line 48: + this report goes to + print, there are more than million + Americans who are + +On line 48: + goes to print, there are + more than million Americans + who are out of work, + +On line 48: + print, there are more than + million Americans who are + out of work, cannot + +On line 48: + million Americans + who are out of work, cannot + find full-time work, + +On line 48: + who are out of work, + cannot find full-time work, + or have given up + +On line 48: + out of work, cannot + find full-time work, or have + given up looking + +On line 48: + full-time work, or + have given up looking for + work. About four million + +On line 48: + work, or have given + up looking for work. About four + million families + +On line 48: + up looking for work. + About four million families + have lost their homes to + +On line 48: + work. About four million + families have lost their homes + to foreclosure and + +On line 48: + families have lost + their homes to foreclosure and + another four and + +On line 48: + homes to foreclosure + and another four and a + half million have slipped + +On line 48: + their mortgage payments. + Nearly trillion in household + wealth has vanished, with + +On line 48: + Nearly trillion in + household wealth has vanished, with + retirement accounts + +On line 48: + and life savings swept + away. Businesses, large and small, + have felt the sting of + +On line 48: + life savings swept away. + Businesses, large and small, have + felt the sting of a + +On line 48: + away. Businesses, large + and small, have felt the sting of + a deep recession. + +On line 48: + Businesses, large and + small, have felt the sting of a + deep recession. There + +On line 48: + and small, have felt the + sting of a deep recession. + There is much anger about + +On line 48: + small, have felt the sting + of a deep recession. There + is much anger about what + +On line 48: + have felt the sting of + a deep recession. There is + much anger about what has + +On line 48: + the sting of a deep + recession. There is much anger + about what has transpired, + +On line 48: + recession. There is + much anger about what has transpired, + and justifiably + +On line 48: + much anger about what has + transpired, and justifiably + so. Many people who + +On line 48: + about what has transpired, + and justifiably so. Many + people who abided + +On line 48: + and justifiably + so. Many people who abided + by all the rules now + +On line 48: + justifiably so. + Many people who abided by + all the rules now find + +On line 48: + so. Many people who + abided by all the rules now + find themselves out of + +On line 48: + abided by all the + rules now find themselves out of + work and uncertain + +On line 48: + by all the rules now + find themselves out of work and + uncertain about their + +On line 48: + rules now find themselves + out of work and uncertain + about their future prospects. + +On line 48: + now find themselves out + of work and uncertain about + their future prospects. The + +On line 48: + about their future prospects. + The collateral damage + of this crisis has + +On line 48: + their future prospects. The + collateral damage of + this crisis has been + +On line 48: + The collateral + damage of this crisis has + been real people + +On line 48: + this crisis has been + real people and real + communities. The + +On line 48: + been real people + and real communities. + The impacts of this + +On line 48: + people and real + communities. The impacts + of this crisis are + +On line 48: + communities. The + impacts of this crisis are + likely to be felt + +On line 48: + of this crisis are + likely to be felt for a + generation. And + +On line 48: + are likely to be + felt for a generation. + And the nation faces + +On line 48: + likely to be felt + for a generation. And + the nation faces no + +On line 50: + faces no easy path to + renewed economic strength. Like + so many Americans, + +On line 50: + so many Americans, + we began our exploration + with our own views and + +On line 50: + many Americans, we + began our exploration with + our own views and some + +On line 50: + our own views and some + preliminary knowledge about + how the world’s strongest + +On line 50: + how the world’s strongest + financial system came to + the brink of collapse. + +On line 50: + strongest financial + system came to the brink of + collapse. Even at the + +On line 50: + financial system + came to the brink of collapse. + Even at the time of + +On line 50: + came to the brink of + collapse. Even at the time of + our appointment to + +On line 50: + collapse. Even at the + time of our appointment to + this independent + +On line 50: + our appointment to + this independent panel, + much had already been + +On line 50: + this independent + panel, much had already been + written and said about + +On line 50: + already been written + and said about the crisis. Yet + all of us have been + +On line 50: + said about the crisis. + Yet all of us have been deeply + affected by what + +On line 50: + crisis. Yet all of + us have been deeply affected + by what we have learned + +On line 50: + Yet all of us have + been deeply affected by what + we have learned in the + +On line 50: + all of us have been + deeply affected by what we + have learned in the course + +On line 50: + of us have been deeply + affected by what we have + learned in the course of + +On line 50: + been deeply affected + by what we have learned in the + course of our inquiry. + +On line 50: + deeply affected by + what we have learned in the course + of our inquiry. We + +On line 50: + affected by what + we have learned in the course of + our inquiry. We have + +On line 50: + we have learned in the + course of our inquiry. We have + been at various + +On line 50: + have learned in the course + of our inquiry. We have been + at various times + +On line 50: + course of our inquiry. + We have been at various + times fascinated, + +On line 50: + been at various + times fascinated, surprised, + and even shocked by what + +On line 50: + at various times + fascinated, surprised, and + even shocked by what we + +On line 50: + times fascinated, + surprised, and even shocked by what + we saw, heard, and read. + +On line 50: + and even shocked by what + we saw, heard, and read. Ours has + been a journey of + +On line 50: + what we saw, heard, and + read. Ours has been a journey + of revelation. + +On line 52: + we saw, heard, and read. + Ours has been a journey of + revelation. Much + +On line 52: + read. Ours has been a + journey of revelation. + Much attention over + +On line 52: + revelation. Much + attention over the past two + years has been focused + +On line 52: + attention over the + past two years has been focused + on the decisions + +On line 52: + past two years has been + focused on the decisions + by the federal + +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 + +On line 52: + Those decisions—and + the deep emotions surrounding + them—will be debated + +On line 52: + decisions—and the + deep emotions surrounding them—will + be debated long + +On line 52: + them—will be debated + long into the future. But + our mission was to + +On line 52: + be debated long + into the future. But our + mission was to ask + +On line 52: + our mission was to + ask and answer this central + question: how did it + +On line 52: + to ask and answer + this central question: how did + it come to pass that + +On line 52: + ask and answer this + central question: how did it + come to pass that in + +On line 52: + this central question: + how did it come to pass that + in our nation was + +On line 52: + central question: how + did it come to pass that in + our nation was forced + +On line 52: + how did it come to + pass that in our nation was + forced to choose between + +On line 52: + did it come to pass + that in our nation was forced + to choose between two + +On line 52: + it come to pass that + in our nation was forced to + choose between two stark + +On line 52: + come to pass that in + our nation was forced to choose + between two stark and + +On line 52: + the total collapse + of our financial system + and economy or + +On line 52: + of our financial + system and economy or + inject trillions of + +On line 52: + and an array of + companies, as millions of + Americans still lost + +On line 54: + Americans still lost + their jobs, their savings, and their + homes1 In this report, + +On line 54: + still lost their jobs, their + savings, and their homes1 In this + report, we detail + +On line 54: + their jobs, their savings, + and their homes1 In this report, + we detail the events + +On line 54: + jobs, their savings, and + their homes1 In this report, we + detail the events of + +On line 54: + and their homes1 In this + report, we detail the events + of the crisis. But + +On line 54: + detail the events of + the crisis. But a simple + summary, as we + +On line 54: + events of the crisis. + But a simple summary, + as we see it, is + +On line 54: + the crisis. But a + simple summary, as we + see it, is useful + +On line 54: + simple summary, + as we see it, is useful + at the outset. While + +On line 54: + at the outset. While + the vulnerabilities + that created the + +On line 54: + that created the + potential for crisis were + years in the making, + +On line 54: + the making, it was + the collapse of the housing + bubble—fueled by + +On line 54: + was the collapse of + the housing bubble—fueled + by low interest + +On line 54: + the collapse of the + housing bubble—fueled by + low interest rates, + +On line 54: + bubble—fueled by + low interest rates, easy and + available credit, scant + +On line 54: + by low interest + rates, easy and available credit, + scant regulation, + +On line 54: + low interest rates, + easy and available credit, scant + regulation, and + +On line 54: + rates, easy and available + credit, scant regulation, + and toxic mortgages— + +On line 56: + available credit, scant + regulation, and toxic + mortgages— that was the + +On line 56: + regulation, and + toxic mortgages— that was the + spark that ignited + +On line 56: + toxic mortgages— that + was the spark that ignited + a string of events, which + +On line 56: + mortgages— that was the + spark that ignited a string + of events, which led to + +On line 56: + spark that ignited + a string of events, which led to + a full-blown crisis + +On line 56: + that ignited a + string of events, which led to a + full-blown crisis in + +On line 56: + string of events, which led + to a full-blown crisis in + the fall of Trillions + +On line 56: + of events, which led to + a full-blown crisis in the + fall of Trillions of + +On line 56: + fall of Trillions of + dollars in risky mortgages had + become embedded + +On line 56: + Trillions of dollars + in risky mortgages had become + embedded throughout + +On line 56: + as mortgage-related + securities were packaged, + repackaged, and sold to + +On line 56: + securities were + packaged, repackaged, and sold to + investors around the world. + +On line 56: + were packaged, repackaged, + and sold to investors around the + world. When the bubble + +On line 56: + packaged, repackaged, and + sold to investors around the world. + When the bubble burst, + +On line 56: + repackaged, and sold to + investors around the world. When the + bubble burst, hundreds + +On line 56: + sold to investors around + the world. When the bubble burst, + hundreds of billions + +On line 56: + world. When the bubble + burst, hundreds of billions of + dollars in losses + +On line 56: + bubble burst, hundreds + of billions of dollars in + losses in mortgages + +On line 56: + to those mortgages and + had borrowed heavily against + them. This happened not + +On line 56: + those mortgages and had + borrowed heavily against them. + This happened not just + +On line 56: + borrowed heavily + against them. This happened not just + in the United States + +On line 56: + heavily against them. + This happened not just in the + United States but around + +On line 56: + against them. This happened + not just in the United States + but around the world. The + +On line 56: + This happened not just + in the United States but around + the world. The losses + +On line 56: + happened not just in + the United States but around the + world. The losses were + +On line 56: + in the United States + but around the world. The losses + were magnified by + +On line 56: + States but around the world. + The losses were magnified + by derivatives + +On line 56: + but around the world. The + losses were magnified by + derivatives such + +On line 58: + crisis reached seismic + proportions in September + with the failure of + +On line 58: + in September with + the failure of Lehman Brothers + and the impending + +On line 58: + Lehman Brothers and the + impending collapse of the + insurance giant + +On line 58: + and the impending + collapse of the insurance + giant American + +On line 58: + giant American + International Group (AIG). + Panic fanned by a + +On line 58: + International + Group (AIG). Panic fanned by a + lack of transparency + +On line 58: + Group (AIG). Panic fanned + by a lack of transparency + of the balance sheets + +On line 58: + (AIG). Panic fanned by + a lack of transparency of + the balance sheets of + +On line 58: + interconnections + among institutions perceived + to be "too big to + +On line 58: + among institutions + perceived to be "too big to + fail," caused the credit + +On line 58: + perceived to be "too + big to fail," caused the credit + markets to seize up. + +On line 58: + to be "too big to + fail," caused the credit markets + to seize up. Trading + +On line 58: + be "too big to fail," + caused the credit markets to + seize up. Trading ground + +On line 58: + "too big to fail," caused + the credit markets to seize + up. Trading ground to + +On line 58: + big to fail," caused the + credit markets to seize up. + Trading ground to a + +On line 58: + fail," caused the credit + markets to seize up. Trading + ground to a halt. The + +On line 58: + credit markets to + seize up. Trading ground to a + halt. The stock market + +On line 58: + halt. The stock market + plummeted. The economy + plunged into a deep + +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: + that of our parents’ + generation. The changes in + the past three decades alone + +On line 60: + generation. The + changes in the past three decades alone + have been remarkable. + +On line 60: + changes in the past three + decades alone have been remarkable. + The CONCLUSIONS OF + +On line 60: + in the past three decades + alone have been remarkable. The + CONCLUSIONS OF THE + +On line 60: + three decades alone have been + remarkable. The CONCLUSIONS + OF THE FINANCIAL + +On line 60: + markets have become + increasingly globalized. + Technology has + +On line 60: + and complexity + of financial instruments + and transactions. There + +On line 60: + complexity of + financial instruments and + transactions. There is + +On line 60: + costs of financing + than ever before. And the + financial sector + +On line 60: + than ever before. + And the financial sector + itself has become + +On line 60: + financial sector + itself has become a much + more dominant force + +On line 60: + itself has become + a much more dominant force + in our economy. + +On line 62: + has become a much + more dominant force in our + economy. From to + +On line 62: + much more dominant + force in our economy. From + to the amount of debt + +On line 62: + more dominant force + in our economy. From to + the amount of debt held + +On line 62: + dominant force in + our economy. From to the + amount of debt held by + +On line 62: + in our economy. + From to the amount of debt held + by the financial + +On line 62: + economy. From to + the amount of debt held by the + financial sector + +On line 64: + the amount of debt held + by the financial sector + soared from trillion to + +On line 64: + of debt held by the + financial sector soared from + trillion to trillion, + +On line 64: + financial sector + soared from trillion to trillion, + more than doubling as + +On line 64: + trillion to trillion, + more than doubling as a share + of gross domestic + +On line 64: + to trillion, more than + doubling as a share of gross + domestic product. + +On line 66: + doubling as a share + of gross domestic product. + The very nature of + +On line 66: + as a share of gross + domestic product. The very + nature of many Wall + +On line 66: + of many Wall Street firms + changed—from relatively staid + private partnerships + +On line 66: + to publicly traded + corporations taking greater + and more diverse kinds + +On line 66: + taking greater and more + diverse kinds of risks. By the + largest U.S. commercial + +On line 66: + greater and more diverse + kinds of risks. By the largest U.S. + commercial banks held + +On line 66: + kinds of risks. By the + largest U.S. commercial banks held + of the industry’s + +On line 66: + risks. By the largest U.S. + commercial banks held of the + industry’s assets, + +On line 66: + commercial banks held + of the industry’s assets, + more than double the + +On line 66: + of the industry’s + assets, more than double the + level held in On + +On line 66: + industry’s assets, + more than double the level + held in On the eve + +On line 66: + more than double the + level held in On the eve + of the crisis in + +On line 66: + level held in On + the eve of the crisis in + financial sector + +On line 66: + of the crisis in + financial sector profits + constituted of + +On line 66: + constituted of + all corporate profits in + the United States, up + +On line 66: + corporate profits + in the United States, up from + in Understanding + +On line 66: + in the United States, + up from in Understanding + this transformation + +On line 66: + the United States, up + from in Understanding this + transformation has + +On line 66: + in Understanding + this transformation has been + critical to the + +On line 68: + been critical to + the Commission’s analysis. + Now to our major + +On line 68: + Now to our major + findings and conclusions, which + are based on the facts + +On line 68: + our major findings + and conclusions, which are based + on the facts contained + +On line 68: + major findings and + conclusions, which are based on + the facts contained in + +On line 68: + and conclusions, which + are based on the facts contained + in this report: they + +On line 68: + conclusions, which are + based on the facts contained in + this report: they are + +On line 68: + which are based on the + facts contained in this report: + they are offered with + +On line 68: + are based on the facts + contained in this report: they + are offered with the + +On line 68: + the facts contained in + this report: they are offered + with the hope that lessons + +On line 68: + facts contained in this + report: they are offered with + the hope that lessons may + +On line 68: + in this report: they + are offered with the hope that + lessons may be learned to + +On line 68: + this report: they are + offered with the hope that lessons + may be learned to help + +On line 68: + they are offered with + the hope that lessons may be learned + to help avoid future + +On line 70: + to help avoid future + catastrophe. We conclude this + financial crisis + +On line 70: + future catastrophe. + We conclude this financial + crisis was avoidable. + +On line 70: + crisis was avoidable. + The crisis was the result + of human action + +On line 70: + The crisis was the + result of human action + and inaction, not + +On line 70: + result of human + action and inaction, not + of Mother Nature + +On line 70: + of Mother Nature + or computer models gone + haywire. The captains + +On line 70: + models gone haywire. + The captains of finance and + the public stewards + +On line 70: + the public stewards + of our financial system + ignored warnings and + +On line 70: + financial system + ignored warnings and failed to + question, understand, + +On line 70: + ignored warnings and + failed to question, understand, + and manage evolving + +On line 70: + evolving risks within + a system essential to + the well-being of the + +On line 70: + within a system + essential to the well-being + of the American + +On line 70: + essential to the + well-being of the American + public. Theirs was a + +On line 70: + to the well-being of + the American public. Theirs + was a big miss, not + +On line 70: + the well-being of the + American public. Theirs was + a big miss, not a + +On line 72: + of the American + public. Theirs was a big miss, + not a stumble. While + +On line 72: + public. Theirs was a + big miss, not a stumble. While + the business cycle + +On line 72: + was a big miss, not + a stumble. While the business + cycle cannot be + +On line 72: + a stumble. While the + business cycle cannot be + repealed, a crisis + +On line 72: + cycle cannot be + repealed, a crisis of this + magnitude need not + +On line 72: + this magnitude need + not have occurred. To paraphrase + Shakespeare, the fault lies + +On line 72: + need not have occurred. + To paraphrase Shakespeare, the fault + lies not in the stars, + +On line 72: + not have occurred. To + paraphrase Shakespeare, the fault lies + not in the stars, but + +On line 72: + occurred. To paraphrase + Shakespeare, the fault lies not in + the stars, but in us. + +On line 74: + To paraphrase Shakespeare, + the fault lies not in the stars, + but in us. Despite + +On line 74: + paraphrase Shakespeare, the + fault lies not in the stars, but + in us. Despite the + +On line 74: + Shakespeare, the fault lies + not in the stars, but in us. + Despite the expressed + +On line 74: + the fault lies not in + the stars, but in us. Despite + the expressed view of + +On line 74: + fault lies not in the + stars, but in us. Despite the + expressed view of many + +On line 74: + not in the stars, but + in us. Despite the expressed + view of many on Wall + +On line 74: + in the stars, but in + us. Despite the expressed view + of many on Wall Street + +On line 74: + the stars, but in us. + Despite the expressed view of + many on Wall Street and + +On line 74: + Despite the expressed + view of many on Wall Street and + in Washington that + +On line 74: + view of many on Wall + Street and in Washington that + the crisis could not + +On line 74: + of many on Wall Street + and in Washington that the + crisis could not have + +On line 74: + in Washington that + the crisis could not have been + foreseen or avoided, + +On line 74: + the crisis could not + have been foreseen or avoided, + there were warning signs. + +On line 74: + crisis could not have + been foreseen or avoided, there + were warning signs. The + +On line 74: + not have been foreseen + or avoided, there were warning + signs. The tragedy was that + +On line 74: + have been foreseen or + avoided, there were warning signs. + The tragedy was that they + +On line 74: + or avoided, there were + warning signs. The tragedy was that + they were ignored or + +On line 74: + were warning signs. The + tragedy was that they were ignored + or discounted. There + +On line 74: + warning signs. The tragedy + was that they were ignored or + discounted. There was + +On line 74: + tragedy was that they were + ignored or discounted. There + was an explosion + +On line 74: + that they were ignored + or discounted. There was an + explosion in risky + +On line 74: + or discounted. There + was an explosion in risky + subprime lending and + +On line 74: + risky subprime lending + and securitization, + an unsustainable + +On line 74: + subprime lending and + securitization, an + unsustainable rise + +On line 74: + an unsustainable + rise in housing prices, widespread + reports of egregious + +On line 74: + in household mortgage + debt, and exponential growth + in financial firms’ + +On line 74: + growth in financial + firms’ trading activities, + unregulated + +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: + to quell the threats in + a timely manner. The prime + example is the + +On line 76: + threats in a timely + manner. The prime example + is the Federal + +On line 76: + a timely manner. + The prime example is the + Federal Reserve’s + +On line 76: + The prime example + is the Federal Reserve’s + pivotal failure to + +On line 76: + example is the + Federal Reserve’s pivotal + failure to stem the + +On line 76: + failure to stem the + flow of toxic mortgages, which + it could have done by + +On line 76: + to stem the flow of + toxic mortgages, which it could + have done by setting + +On line 76: + the flow of toxic + mortgages, which it could have done + by setting prudent + +On line 76: + toxic mortgages, which + it could have done by setting + prudent mortgage-lending + +On line 76: + mortgages, which it could + have done by setting prudent + mortgage-lending standards. + +On line 78: + mortgage-lending standards. + The Federal Reserve was + the one entity + +On line 78: + Reserve was the one + entity empowered to + do so and it did + +On line 78: + the one entity + empowered to do so and + it did not. The record + +On line 78: + examination + is replete with evidence + of other failures: + +On line 78: + with evidence of + other failures: financial + institutions made, + +On line 78: + bought, and sold mortgage + securities they never + examined, did not + +On line 78: + securities they + never examined, did not + care to examine, + +On line 78: + examined, did not + care to examine, or knew + to be defective; + +On line 78: + care to examine, + or knew to be defective; + firms depended on + +On line 78: + to examine, or + knew to be defective; firms + depended on tens + +On line 78: + to be defective; + firms depended on tens of + billions of dollars + +On line 78: + firms depended on + tens of billions of dollars + of borrowing that + +On line 78: + depended on tens + of billions of dollars of + borrowing that had + +On line 78: + tens of billions of + dollars of borrowing that + had to be renewed + +On line 78: + billions of dollars + of borrowing that had to + be renewed each and + +On line 78: + of borrowing that + had to be renewed each and + every night, secured + +On line 78: + had to be renewed + each and every night, secured + by subprime mortgage + +On line 78: + 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: + on credit rating + agencies as their arbiters of + risk. What else could one + +On line 78: + rating agencies as + their arbiters of risk. What else + could one expect on + +On line 78: + as their arbiters of + risk. What else could one expect + on a highway where + +On line 78: + their arbiters of risk. + What else could one expect on + a highway where there + +On line 78: + arbiters of risk. What + else could one expect on a + highway where there were + +On line 78: + of risk. What else could + one expect on a highway + where there were neither + +On line 78: + risk. What else could one + expect on a highway where + there were neither speed + +On line 78: + else could one expect + on a highway where there were + neither speed limits + +On line 78: + on a highway where + there were neither speed limits + nor neatly painted + +On line 78: + a highway where there + were neither speed limits nor + neatly painted lines1 + +On line 80: + widespread failures in + financial regulation + and supervision + +On line 80: + and supervision + proved devastating to the + stability of + +On line 80: + devastating to + the stability of the + nation’s financial + +On line 80: + the stability + of the nation’s financial + markets. The sentries + +On line 80: + nation’s financial + markets. The sentries were not + at their posts, in no + +On line 80: + financial markets. + The sentries were not at their + posts, in no small part + +On line 80: + markets. The sentries + were not at their posts, in no + small part due to the + +On line 80: + The sentries were not + at their posts, in no small part + due to the widely + +On line 80: + were not at their posts, + in no small part due to the + widely accepted + +On line 80: + at their posts, in no + small part due to the widely + accepted faith in + +On line 80: + self-correcting + nature of the markets and + the ability of + +On line 80: + the markets and the + ability of financial + institutions to + +On line 80: + the ability of + financial institutions + to effectively + +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: + Alan Greenspan and others, + supported by successive + administrations + +On line 80: + by the powerful + financial industry at + every turn, had stripped + +On line 80: + every turn, had stripped + away key safeguards, which could have + helped avoid catastrophe. + +On line 80: + away key safeguards, which + could have helped avoid catastrophe. + This approach had opened + +On line 80: + key safeguards, which could + have helped avoid catastrophe. This + approach had opened up + +On line 80: + up gaps in oversight + of critical areas with + trillions of dollars + +On line 80: + areas with trillions + of dollars at risk, such as + the shadow banking + +On line 80: + trillions of dollars + at risk, such as the shadow + banking system and + +On line 80: + of dollars at risk, + such as the shadow banking + system and over-the-counter + +On line 82: + race to the weakest + supervisor. Yet we do + not accept the view + +On line 82: + supervisor. Yet + we do not accept the view + that regulators + +On line 82: + we do not accept + the view that regulators + lacked the power to + +On line 82: + not accept the view + that regulators lacked the + power to protect + +On line 82: + regulators lacked + the power to protect the + financial system. + +On line 82: + power to protect + the financial system. They + had ample power + +On line 82: + financial system. + They had ample power in + many arenas and they + +On line 84: + had ample power + in many arenas and they chose + not to use it. To + +On line 84: + ample power in + many arenas and they chose not + to use it. To give + +On line 84: + many arenas and they + chose not to use it. To give + just three examples: + +On line 84: + arenas and they chose + not to use it. To give just + three examples: the + +On line 84: + chose not to use it. + To give just three examples: + the Securities + +On line 84: + not to use it. To + give just three examples: the + Securities and + +On line 84: + three examples: the + Securities and Exchange + Commission could have + +On line 84: + Commission could have + required more capital and + halted risky practices + +On line 84: + could have required more + capital and halted risky + practices at the big + +On line 84: + more capital and + halted risky practices at the + big investment banks. + +On line 86: + risky practices at the + big investment banks. It did + not. The Federal + +On line 86: + big investment banks. + It did not. The Federal + Reserve Bank of New + +On line 86: + banks. It did not. The + Federal Reserve Bank of + New York and other + +On line 86: + Federal Reserve + Bank of New York and other + regulators could + +On line 86: + New York and other + regulators could have clamped + down on Citigroup’s + +On line 86: + regulators could + have clamped down on Citigroup’s + excesses in the + +On line 86: + down on Citigroup’s + excesses in the run-up to + the crisis. They did + +On line 86: + to the crisis. They + did not. Policy makers + and regulators + +On line 86: + the crisis. They did + not. Policy makers and + regulators could + +On line 86: + the runaway mortgage + securitization train. + They did not. In case + +On line 86: + In case after case + after case, regulators + continued to rate + +On line 86: + the institutions + they oversaw as safe and sound + even in the face of + +On line 86: + safe and sound even in + the face of mounting troubles, + often downgrading + +On line 86: + sound even in the face + of mounting troubles, often + downgrading them just + +On line 86: + the face of mounting + troubles, often downgrading + them just before their + +On line 86: + of mounting troubles, + often downgrading them just + before their collapse. + +On line 86: + downgrading them just + before their collapse. And where + regulators lacked + +On line 86: + before their collapse. + And where regulators lacked + authority, they + +On line 86: + regulators lacked + authority, they could have + sought it. Too often, + +On line 86: + Too often, they lacked + the political will—in + a political + +On line 86: + often, they lacked the + political will—in a + political and + +On line 86: + as the fortitude + to critically challenge + the institutions + +On line 86: + the fortitude to + critically challenge the + institutions and + +On line 86: + the institutions + and the entire system they + were entrusted to + +On line 88: + system occurred in + many instances as financial + markets evolved. But as + +On line 88: + in many instances as + financial markets evolved. But + as the report will + +On line 88: + financial markets + evolved. But as the report will + show, the financial + +On line 88: + the report will show, + the financial industry + itself played a key + +On line 88: + role in weakening + regulatory constraints + on institutions, + +On line 88: + regulatory + constraints on institutions, + markets, and products. + +On line 88: + and products. It did + not surprise the Commission + that an industry + +On line 88: + products. It did not + surprise the Commission that + an industry of + +On line 88: + Commission that an + industry of such wealth and + power would exert + +On line 88: + that an industry + of such wealth and power would + exert pressure on + +On line 88: + would exert pressure + on policy makers and + regulators. From + +On line 88: + regulators. From + to the financial sector + expended billion + +On line 88: + individuals + and political action + committees in the + +On line 88: + and political + action committees in the + sector made more than + +On line 88: + action committees + in the sector made more than + billion in campaign + +On line 88: + in the sector made + more than billion in campaign + contributions. What + +On line 88: + made more than billion + in campaign contributions. + What troubled us was + +On line 88: + more than billion in + campaign contributions. What + troubled us was the + +On line 88: + billion in campaign + contributions. What troubled + us was the extent + +On line 88: + contributions. What + troubled us was the extent + to which the nation + +On line 88: + troubled us was the + extent to which the nation + was deprived of the + +On line 88: + was the extent to + which the nation was deprived + of the necessary + +On line 88: + the extent to which + the nation was deprived of + the necessary strength + +On line 88: + extent to which the + nation was deprived of the + necessary strength and + +On line 88: + nation was deprived + of the necessary strength and + independence of + +On line 88: + the necessary strength + and independence of the + oversight necessary + +On line 88: + independence of + the oversight necessary to + safeguard financial + +On line 90: + safeguard financial + stability. We conclude + dramatic failures + +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: + of this crisis. There + was a view that instincts for + self-preservation + +On line 90: + view that instincts for + self-preservation inside + major financial + +On line 90: + self-preservation + inside major financial + firms would shield them from + +On line 90: + major financial + firms would shield them from fatal + risk-taking without + +On line 90: + firms would shield them from + fatal risk-taking without + the need for a steady + +On line 90: + fatal risk-taking + without the need for a steady + regulatory + +On line 90: + the need for a steady + regulatory hand, which, + the firms argued, would + +On line 90: + argued, would stifle + innovation. Too many of + these institutions + +On line 90: + innovation. Too + many of these institutions + acted recklessly, + +On line 90: + these institutions + acted recklessly, taking + on too much risk, with + +On line 90: + too much risk, with too + little capital, and with + too much dependence + +On line 90: + little capital, + and with too much dependence + on short-term funding. + +On line 90: + In many respects, this + reflected a funda-CONCLUSIONS OF THE + FINANCIAL CRISIS + +On line 90: + reflected a funda-CONCLUSIONS + OF THE FINANCIAL CRISIS + INQUIRY COMMISSION + +On line 90: + OF THE FINANCIAL + CRISIS INQUIRY COMMISSION + xix mental change in + +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: + Like Icarus, they never + feared flying ever closer + to the sun. Many of + +On line 94: + Icarus, they never feared + flying ever closer to + the sun. Many of these + +On line 94: + feared flying ever + closer to the sun. Many of + these institutions + +On line 94: + closer to the sun. + Many of these institutions + grew aggressively + +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: + CEO of Citigroup + told the Commission that a + billion position + +On line 94: + told the Commission + that a billion position + in highly rated + +On line 94: + billion position + in highly rated mortgage + securities would + +On line 94: + in highly rated + mortgage securities would + "not in any way have + +On line 94: + "not in any way have + excited my attention," + and the co-head of + +On line 94: + my attention," and + the co-head of Citigroup’s + investment bank said + +On line 94: + and the co-head of + Citigroup’s investment bank + said he spent "a small + +On line 94: + investment bank said + he spent "a small fraction of + of his time on those + +On line 94: + said he spent "a small + fraction of of his time on + those securities. + +On line 94: + fraction of of his + time on those securities. + In this instance, too + +On line 94: + of of his time on + those securities. In this + instance, too big to + +On line 94: + those securities. + In this instance, too big to + fail meant too big to + +On line 96: + In this instance, too + big to fail meant too big to + manage. Financial + +On line 96: + big to fail meant too + big to manage. Financial + institutions and + +On line 96: + too big to manage. + Financial institutions + and credit rating + +On line 96: + instances. Too often, + risk management became risk + justification. + +On line 98: + short-term gain—without + proper consideration + of long-term consequences. + +On line 98: + gain—without proper + consideration of long-term + consequences. Often, + +On line 98: + Often, those systems + encouraged the big bet—where + the payoff on the + +On line 98: + systems encouraged + the big bet—where the payoff + on the upside could + +On line 98: + encouraged the big + bet—where the payoff on the + upside could be huge + +On line 98: + the payoff on the + upside could be huge and the + downside limited. + +On line 98: + upside could be huge + and the downside limited. + This was the case up + +On line 98: + could be huge and the + downside limited. This was + the case up and down + +On line 98: + and down the line—from + the corporate boardroom to + the mortgage broker + +On line 98: + down the line—from the + corporate boardroom to the + mortgage broker on + +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: + things, about AIG senior + management’s ignorance of + the terms and risks of + +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 + +On line 100: + for bigger market + share, profits, and bonuses, which + led it to ramp up + +On line 100: + bigger market share, + profits, and bonuses, which led + it to ramp up its + +On line 100: + profits, and bonuses, + which led it to ramp up its + exposure to risky + +On line 100: + led it to ramp up + its exposure to risky loans + and securities + +On line 100: + it to ramp up its + exposure to risky loans and + securities as + +On line 100: + exposure to risky + loans and securities as + the housing market + +On line 100: + the housing market + was peaking; and the costly + surprise when Merrill + +On line 100: + was peaking; and the + costly surprise when Merrill + Lynch’s top management + +On line 100: + costly surprise when + Merrill Lynch’s top management + realized that the + +On line 100: + when Merrill Lynch’s top + management realized that + the company held + +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: + billions of dollars + in losses. We conclude a + combination of + +On line 104: + a combination + of excessive borrowing, + risky investments, and + +On line 104: + combination of + excessive borrowing, risky + investments, and lack + +On line 104: + risky investments, and + lack of transparency put the + financial system + +On line 104: + lack of transparency + put the financial system + on a collision + +On line 104: + of transparency put + the financial system on + a collision course + +On line 104: + transparency put the + financial system on a + collision course with + +On line 104: + financial system + on a collision course with + crisis. Clearly, this + +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 104: + is significant + enough by itself to warrant + our attention here. + +On line 106: + significant enough + by itself to warrant our + attention here. In + +On line 106: + enough by itself to + warrant our attention here. + In the years leading + +On line 106: + itself to warrant + our attention here. In the + years leading up to + +On line 106: + our attention here. + In the years leading up to + the crisis, too many + +On line 106: + leading up to the + crisis, too many financial + institutions, as + +On line 106: + the crisis, too many + financial institutions, + as well as 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 106: + of their investments + declined even modestly. For + example, as of + +On line 108: + even modestly. For + example, as of the five + major investment + +On line 108: + example, as of + the five major investment + banks—Bear Stearns, Goldman Sachs, + +On line 108: + banks—Bear Stearns, Goldman Sachs, + Lehman Brothers, Merrill Lynch, and + Morgan Stanley—were + +On line 108: + Lehman Brothers, Merrill + Lynch, and Morgan Stanley—were + operating with + +On line 108: + operating with + extraordinarily thin + capital. By one + +On line 108: + capital. By one + measure, their leverage ratios + were as high as to + +On line 108: + By one measure, their + leverage ratios were as high + as to meaning for + +On line 108: + measure, their leverage + ratios were as high as to + meaning for every + +On line 108: + leverage ratios were + as high as to meaning for + every in assets, + +On line 108: + ratios were as high + as to meaning for every + in assets, there was + +On line 108: + meaning for every + in assets, there was only + in capital to + +On line 108: + in assets, there was + only in capital to + cover losses. Less + +On line 108: + to cover losses. + Less than a drop in asset + values could wipe out + +On line 108: + losses. Less than a + drop in asset values could + wipe out a firm. To + +On line 108: + a drop in asset + values could wipe out a firm. + To make matters worse, + +On line 108: + in asset values + could wipe out a firm. To make + matters worse, much of + +On line 108: + could wipe out a firm. + To make matters worse, much of + their borrowing was + +On line 108: + firm. To make matters + worse, much of their borrowing + was short-term, in the + +On line 108: + To make matters worse, + much of their borrowing was + short-term, in the overnight + +On line 108: + borrowing had to + be renewed each and every + day. For example, + +On line 108: + be renewed each and + every day. For example, + at the end of Bear + +On line 108: + and every day. For + example, at the end of + Bear Stearns had billion + +On line 108: + example, at the + end of Bear Stearns had billion + in equity and + +On line 108: + Stearns had billion in + equity and billion in + liabilities + +On line 108: + liabilities + and was borrowing as much + as billion in the + +On line 108: + and was borrowing + as much as billion in the + overnight market. It was + +On line 108: + was borrowing as + much as billion in the overnight + market. It was the + +On line 108: + as much as billion + in the overnight market. It was + the equivalent of + +On line 108: + much as billion in + the overnight market. It was the + equivalent of a + +On line 108: + in the overnight market. + It was the equivalent of + a small business with + +On line 108: + the overnight market. It + was the equivalent of a + small business with in + +On line 108: + a small business with + in equity borrowing + million, with of that + +On line 108: + million, with of that + due each and every day. One + can’t really ask + +On line 108: + due each and every + day. One can’t really ask + "What were they thinking1" + +On line 108: + each and every day. + One can’t really ask "What + were they thinking1" when + +On line 108: + and every day. One + can’t really ask "What were + they thinking1" when it + +On line 108: + every day. One can’t + really ask "What were they + thinking1" when it seems + +On line 108: + One can’t really + ask "What were they thinking1" when + it seems that too many + +On line 108: + can’t really ask + "What were they thinking1" when it + seems that too many of + +On line 108: + really ask "What + were they thinking1" when it seems + that too many of them + +On line 108: + "What were they thinking1" + when it seems that too many of + them were thinking alike. + +On line 110: + were they thinking1" when + it seems that too many of them + were thinking alike. And + +On line 110: + they thinking1" when it + seems that too many of them were + thinking alike. And the + +On line 110: + when it seems that too + many of them were thinking alike. + And the leverage was + +On line 110: + seems that too many of + them were thinking alike. And the + leverage was often + +On line 110: + too many of them were + thinking alike. And the leverage + was often hidden—in + +On line 110: + "window dressing" of + financial reports available + to the investing + +On line 112: + financial reports + available to the investing + public. The kings of + +On line 112: + reports available to + the investing public. The + kings of leverage were + +On line 112: + to the investing + public. The kings of leverage + were Fannie Mae and + +On line 112: + public. The kings of + leverage were Fannie Mae and + Freddie Mac, the two + +On line 112: + kings of leverage were + Fannie Mae and Freddie Mac, + the two behemoth + +On line 112: + the end of Fannie’s + and Freddie’s combined leverage + ratio, including + +On line 114: + including loans they + owned and guaranteed, stood at + to But financial + +On line 114: + owned and guaranteed, + stood at to But financial + firms were not alone in + +On line 114: + and guaranteed, stood + at to But financial firms + were not alone in the + +On line 114: + firms were not alone in + the borrowing spree: from to + national mortgage + +On line 114: + the borrowing spree: + from to national mortgage + debt almost doubled, + +On line 114: + borrowing spree: from + to national mortgage debt + almost doubled, and + +On line 114: + national mortgage + debt almost doubled, and the + amount of mortgage debt + +On line 114: + debt almost doubled, + and the amount of mortgage debt + per household rose more + +On line 114: + almost doubled, and + the amount of mortgage debt per + household rose more than + +On line 114: + doubled, and the amount + of mortgage debt per household + rose more than from to + +On line 114: + the amount of mortgage + debt per household rose more than + from to even while wages + +On line 114: + amount of mortgage debt + per household rose more than from + to even while wages were + +On line 114: + debt per household rose + more than from to even while wages + were essentially + +On line 114: + to even while wages were + essentially stagnant. When + the housing downturn + +On line 114: + the housing downturn + hit, heavily indebted + financial firms and + +On line 116: + financial firms and + families alike were walloped. + The heavy debt taken + +On line 116: + firms and families + alike were walloped. The heavy debt + taken on by some + +On line 116: + institutions was + exacerbated by the + risky assets they were + +On line 116: + exacerbated + by the risky assets they were + acquiring with that + +On line 116: + by the risky assets + they were acquiring with that + debt. As the mortgage + +On line 116: + the risky assets they + were acquiring with that debt. + As the mortgage and + +On line 116: + they were acquiring + with that debt. As the mortgage + and real estate + +On line 116: + debt. As the mortgage + and real estate markets + churned out riskier and + +On line 116: + estate markets churned + out riskier and riskier loans + and securities, + +On line 116: + securities, many + financial institutions + loaded up on them. + +On line 116: + up on them. By the + end of Lehman had amassed billion + in commercial and + +On line 116: + the end of Lehman had + amassed billion in commercial + and residential + +On line 116: + and residential + real estate holdings and + securities, which + +On line 116: + securities, which + was almost twice what it held + just two years before, + +On line 116: + was almost twice what + it held just two years before, + and more than four times + +On line 116: + almost twice what it + held just two years before, and + more than four times its + +On line 116: + twice what it held just + two years before, and more than + four times its total + +On line 116: + two years before, and + more than four times its total + equity. And again, + +On line 116: + and more than four times + its total equity. And + again, the risk wasn’t + +On line 116: + again, the risk wasn’t + being taken on just by + the big financial + +On line 116: + risk wasn’t being + taken on just by the big + financial firms, but + +On line 116: + taken on just by + the big financial firms, but + by families, too. + +On line 116: + but by families, + too. Nearly one in mortgage + borrowers in and + +On line 116: + too. Nearly one in + mortgage borrowers in and + took out "option ARM" + +On line 116: + mortgage borrowers + in and took out "option ARM" + loans, which meant they could + +On line 116: + borrowers in and + took out "option ARM" loans, which + meant they could choose to + +On line 116: + and took out "option + ARM" loans, which meant they could choose + to make payments so + +On line 116: + took out "option ARM" + loans, which meant they could choose to + make payments so low + +On line 116: + out "option ARM" loans, + which meant they could choose to make + payments so low that + +On line 116: + ARM" loans, which meant they + could choose to make payments so + low that their mortgage + +On line 116: + which meant they could choose + to make payments so low that + their mortgage balances + +On line 116: + meant they could choose to + make payments so low that their + mortgage balances rose + +On line 118: + make payments so low + that their mortgage balances rose + every month. Within + +On line 118: + their mortgage balances + rose every month. Within the + financial system, + +On line 118: + balances rose every + month. Within the financial + system, the dangers + +On line 118: + every month. Within + the financial system, the + dangers of this debt + +On line 118: + financial system, + the dangers of this debt were + magnified because + +On line 118: + system, the dangers + of this debt were magnified + because transparency + +On line 118: + the dangers of this + debt were magnified because + transparency was not + +On line 118: + debt were magnified + because transparency was not + required or desired. + +On line 118: + magnified because + transparency was not required + or desired. Massive, + +On line 118: + 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: + unseen by others + in the market, heightened the + chances the system could + +On line 118: + by others in the + market, heightened the chances the + system could rapidly + +On line 118: + market, heightened the + chances the system could rapidly + unravel. In the + +On line 118: + the chances the system + could rapidly unravel. In + the early part of + +On line 118: + chances the system could + rapidly unravel. In the + early part of the + +On line 118: + rapidly unravel. + In the early part of the + 20th century, we + +On line 118: + In the early part + of the 20th century, we + erected a series + +On line 118: + the 20th century, + we erected a series of + protections—the + +On line 118: + protections—the + Federal Reserve as a + lender of last resort, + +On line 118: + Federal Reserve + as a lender of last resort, + federal deposit + +On line 118: + Reserve as a lender + of last resort, federal + deposit insurance, + +On line 118: + as a lender of last + resort, federal deposit + insurance, ample + +On line 118: + resort, federal + deposit insurance, ample + regulations—to + +On line 118: + deposit insurance, + ample regulations—to + provide a bulwark + +On line 118: + insurance, ample + regulations—to provide + a bulwark against the + +On line 118: + had regularly + plagued America’s banking + system in the 19th + +On line 118: + plagued America’s + banking system in the 19th + century. Yet, over + +On line 118: + banking system in + the 19th century. Yet, over + the past 30-plus years, we + +On line 118: + the 19th century. + Yet, over the past 30-plus years, we + permitted the growth + +On line 118: + over the past 30-plus years, + we permitted the growth of + a shadow banking + +On line 118: + we permitted the + growth of a shadow banking + system—opaque and laden + +On line 118: + growth of a shadow + banking system—opaque and laden + with short-term debt—that + +On line 118: + banking system—opaque + and laden with short-term debt—that + rivaled the size of + +On line 118: + and laden with short-term + debt—that rivaled the size of + the traditional + +On line 118: + debt—that rivaled the + size of the traditional + banking system. Key + +On line 118: + of over-the-counter derivatives—were + hidden from view, without the + protections we had + +On line 118: + derivatives—were hidden from + view, without the protections + we had constructed + +On line 118: + the protections we + had constructed to prevent + financial meltdowns. + +On line 118: + financial meltdowns. + We had a 21st-century + financial system + +On line 120: + financial system + with 19th-century safeguards. + When the housing and + +On line 120: + with 19th-century + safeguards. When the housing and + mortgage markets cratered, + +On line 120: + When the housing and + mortgage markets cratered, the lack + of transparency, the + +On line 120: + mortgage markets cratered, + the lack of transparency, the + extraordinary + +On line 120: + lack of transparency, + the extraordinary debt + loads, the short-term loans, + +On line 120: + of transparency, the + extraordinary debt loads, + the short-term loans, and + +On line 120: + extraordinary + debt loads, the short-term loans, and + the risky assets all + +On line 120: + debt loads, the short-term + loans, and the risky assets all + came home to roost. What + +On line 120: + short-term loans, and the + risky assets all came home to + roost. What resulted + +On line 120: + risky assets all came + home to roost. What resulted + was panic. We had + +On line 120: + assets all came home + to roost. What resulted was + panic. We had reaped + +On line 120: + all came home to roost. + What resulted was panic. + We had reaped what we + +On line 120: + came home to roost. What + resulted was panic. We + had reaped what we had + +On line 122: + What resulted was + panic. We had reaped what we + had sown. We conclude + +On line 122: + panic. We had reaped + what we had sown. We conclude + the government was + +On line 122: + reaped what we had sown. + We conclude the government + was ill prepared for + +On line 122: + what we had sown. We + conclude the government was + ill prepared for the + +On line 122: + sown. We conclude the + government was ill prepared + for the crisis, and + +On line 122: + government was ill + prepared for the crisis, and + its inconsistent + +On line 122: + response added to the + uncertainty and panic + in the financial + +On line 122: + uncertainty and + panic in the financial + markets. As part of + +On line 122: + and panic in the + financial markets. As part + of our charge, it was + +On line 122: + financial markets. + As part of our charge, it was + appropriate to + +On line 122: + As part of our charge, + it was appropriate to + review government + +On line 122: + of our charge, it was + appropriate to review + government actions + +On line 122: + appropriate to + review government actions + taken in response + +On line 122: + in response to the + developing crisis, not + just those policies or + +On line 122: + not just those policies + or actions that preceded + it, to determine + +On line 122: + just those policies or + actions that preceded it, + to determine if + +On line 122: + it, to determine + if any of those responses + contributed to or + +On line 124: + exacerbated + the crisis. As our report + shows, key policy + +On line 124: + our report shows, key + policy makers—the + Treasury Department, + +On line 124: + Treasury Department, + the Federal Reserve Board, + and the Federal + +On line 124: + Reserve Board, and the + Federal Reserve Bank of + New York—who were best + +On line 124: + and the Federal + Reserve Bank of New York—who + were best positioned + +On line 124: + Federal Reserve + Bank of New York—who were best + positioned to watch + +On line 124: + Bank of New York—who + were best positioned to watch + over our markets were + +On line 124: + of New York—who were + best positioned to watch over + our markets were ill + +On line 124: + were best positioned + to watch over our markets were + ill prepared for the + +On line 124: + best positioned to + watch over our markets were ill + prepared for the events + +On line 126: + over our markets were + ill prepared for the events of + and Other agencies + +On line 126: + our markets were ill + prepared for the events of and + Other agencies were + +On line 126: + ill prepared for the + events of and Other agencies + were also behind + +On line 126: + prepared for the events + of and Other agencies were + also behind the + +On line 126: + for the events of and + Other agencies were also + behind the curve. They + +On line 126: + Other agencies were + also behind the curve. They + were hampered because + +On line 126: + also behind the + curve. They were hampered because + they did not have a + +On line 126: + behind the curve. They + were hampered because they did + not have a clear grasp + +On line 126: + were hampered because + they did not have a clear grasp + of the financial + +On line 126: + they did not have a + clear grasp of the financial + system they were charged + +On line 126: + a clear grasp of the + financial system they were + charged with overseeing, + +On line 126: + financial system + they were charged with overseeing, + particularly + +On line 126: + charged with overseeing, + particularly as it + had evolved in the years + +On line 126: + particularly + as it had evolved in the years + leading up to the + +On line 126: + as it had evolved in + the years leading up to the + crisis. This was in + +On line 126: + had evolved in the years + leading up to the crisis. + This was in no small + +On line 126: + in the years leading + up to the crisis. This was + in no small measure + +On line 126: + the years leading up + to the crisis. This was in + no small measure due + +On line 126: + years leading up to + the crisis. This was in no + small measure due to + +On line 126: + leading up to the + crisis. This was in no small + measure due to the + +On line 126: + up to the crisis. + This was in no small measure + due to the lack of + +On line 126: + crisis. This was in + no small measure due to the + lack of transparency + +On line 126: + This was in no small + measure due to the lack of + transparency in key + +On line 126: + no small measure due + to the lack of transparency + in key markets. They + +On line 126: + small measure due to + the lack of transparency in + key markets. They thought + +On line 126: + measure due to the + lack of transparency in key + markets. They thought risk + +On line 126: + due to the lack of + transparency in key markets. + They thought risk had been + +On line 126: + of transparency in + key markets. They thought risk had + been diversified + +On line 126: + transparency in key + markets. They thought risk had been + diversified when, + +On line 126: + key markets. They thought + risk had been diversified + when, in fact, it had + +On line 126: + markets. They thought risk + had been diversified when, + in fact, it had been + +On line 126: + when, in fact, it had + been concentrated. Time and + again, from the spring of + +On line 126: + in fact, it had been + concentrated. Time and again, + from the spring of on, + +On line 126: + concentrated. Time + and again, from the spring of on, + policy makers + +On line 126: + and again, from the spring + of on, policy makers + and regulators + +On line 126: + again, from the spring of + on, policy makers and + regulators were + +On line 126: + of on, policy + makers and regulators + were caught off guard as + +On line 126: + an ad hoc basis + with specific programs to + put fingers in the + +On line 126: + ad hoc basis with + specific programs to put + fingers in the dike. + +On line 126: + fingers in the dike. + There was no comprehensive + and strategic plan for + +On line 126: + the dike. There was no + comprehensive and strategic + plan for containment, + +On line 126: + comprehensive and + strategic plan for containment, + because they lacked a + +On line 126: + interconnections + in the financial markets. + Some regulators + +On line 126: + in the financial + markets. Some regulators + have conceded this + +On line 126: + Some regulators + have conceded this error. + We had allowed the + +On line 126: + have conceded this + error. We had allowed the + system to race ahead + +On line 128: + the system to race + ahead of our ability to + protect it. While there + +On line 128: + of our ability + to protect it. While there was + some awareness of, or + +On line 128: + our ability to + protect it. While there was some + awareness of, or at + +On line 128: + to protect it. While + there was some awareness of, or + at least a debate + +On line 128: + protect it. While there + was some awareness of, or at + least a debate about, + +On line 128: + was some awareness of, + or at least a debate about, + the housing bubble, + +On line 128: + some awareness of, or + at least a debate about, the + housing bubble, the + +On line 128: + least a debate about, + the housing bubble, the record + reflects that senior + +On line 128: + the housing bubble, + the record reflects that senior + public officials + +On line 128: + the record reflects that + senior public officials + did not recognize + +On line 128: + reflects that senior + public officials did not + recognize that a + +On line 128: + officials did not + recognize that a bursting + of the bubble could + +On line 128: + recognize that a + bursting of the bubble could + threaten the entire + +On line 128: + that a bursting of + the bubble could threaten the + entire financial + +On line 128: + threaten the entire + financial system. Throughout + the summer of both + +On line 128: + entire financial + system. Throughout the summer + of both Federal + +On line 128: + financial system. + Throughout the summer of both + Federal Reserve + +On line 128: + system. Throughout the + summer of both Federal + Reserve Chairman Ben + +On line 128: + Throughout the summer + of both Federal Reserve + Chairman Ben Bernanke and + +On line 128: + the summer of both + Federal Reserve Chairman + Ben Bernanke and Treasury + +On line 128: + of both Federal + Reserve Chairman Ben Bernanke and + Treasury Secretary + +On line 128: + Federal Reserve + Chairman Ben Bernanke and Treasury + Secretary Henry + +On line 128: + that the turmoil in + the subprime mortgage markets + would be contained. When + +On line 128: + the turmoil in the + subprime mortgage markets would + be contained. When Bear + +On line 128: + the subprime mortgage + markets would be contained. When + Bear Stearns’s hedge funds, which + +On line 128: + 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 + +On line 128: + the collapse. Despite + the fact that so many other + funds were exposed to + +On line 128: + collapse. Despite the + fact that so many other funds + were exposed to the + +On line 128: + the fact that so many + other funds were exposed to + the same risks as those + +On line 128: + that so many other + funds were exposed to the same + risks as those hedge funds, + +On line 128: + so many other funds + were exposed to the same risks + as those hedge funds, the + +On line 128: + many other funds were + exposed to the same risks as + those hedge funds, the Bear + +On line 128: + funds were exposed to + the same risks as those hedge funds, + the Bear Stearns funds were + +On line 128: + were exposed to the + same risks as those hedge funds, the + Bear Stearns funds were thought + +On line 128: + exposed to the same + risks as those hedge funds, the Bear + Stearns funds were thought to + +On line 128: + risks as those hedge funds, + the Bear Stearns funds were thought to + be "relatively + +On line 128: + as those hedge funds, the + Bear Stearns funds were thought to be + "relatively unique." + +On line 128: + the Bear Stearns funds were + thought to be "relatively + unique." Days before the + +On line 128: + Stearns funds were thought to + be "relatively unique." Days + before the collapse + +On line 128: + be "relatively + unique." Days before the collapse + of Bear Stearns in March + +On line 128: + "relatively unique." + Days before the collapse of + Bear Stearns in March SEC + +On line 130: + unique." Days before the + collapse of Bear Stearns in March + SEC Chairman Christopher + +On line 130: + collapse of Bear Stearns + in March SEC Chairman Christopher + Cox expressed "comfort + +On line 130: + in March SEC Chairman + Christopher Cox expressed "comfort + about the capital + +On line 130: + SEC Chairman Christopher + Cox expressed "comfort about the + capital cushions" + +On line 130: + Christopher Cox expressed + "comfort about the capital + cushions" at the big + +On line 130: + expressed "comfort about + the capital cushions" at + the big investment + +On line 130: + capital cushions" + at the big investment banks. + It was not until + +On line 130: + cushions" at the big + investment banks. It was not + until August just + +On line 130: + big investment banks. + It was not until August + just weeks before the + +On line 130: + It was not until + August just weeks before the + government takeover of + +On line 130: + until August just + weeks before the government + takeover of Fannie Mae + +On line 130: + just weeks before the + government takeover of Fannie + Mae and Freddie Mac, + +On line 130: + the government takeover + of Fannie Mae and Freddie + Mac, that the Treasury + +On line 130: + Mae and Freddie Mac, + that the Treasury Department + understood the full + +On line 130: + Mac, that the Treasury + Department understood the + full measure of the + +On line 130: + conditions of those + two institutions. And just + a month before Lehman’s + +On line 130: + just a month before + Lehman’s collapse, the Federal + Reserve Bank of New + +On line 130: + before Lehman’s collapse, + the Federal Reserve Bank + of New York was still + +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: + then to place Fannie + Mae and Freddie Mac into + conservatorship, + +On line 132: + Freddie Mac into + conservatorship, followed + by its decision + +On line 132: + Lehman Brothers and then + to save AIG—increased uncertainty + and panic in the + +On line 134: + and then to save AIG—increased + uncertainty and panic + in the market. In + +On line 134: + in the market. In + making these observations, + we deeply respect and + +On line 134: + we deeply respect and + appreciate the efforts + made by Secretary + +On line 134: + appreciate the + efforts made by Secretary + Paulson, Chairman Bernanke, + +On line 134: + the efforts made by + Secretary Paulson, Chairman + Bernanke, and Timothy + +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: + so many others who + labored to stabilize our + financial system + +On line 134: + to stabilize our + financial system and our + economy in the + +On line 136: + economy in the + most chaotic and challenging + of circumstances. We + +On line 136: + the most chaotic and + challenging of circumstances. + We conclude there was + +On line 136: + a systemic breakdown + in accountability and + ethics. The integrity + +On line 136: + systemic breakdown in + accountability and ethics. + The integrity of + +On line 136: + ethics. The integrity + of our financial markets + and the public’s trust in + +On line 136: + The integrity of + our financial markets and + the public’s trust in those + +On line 136: + and the public’s trust in + those markets are essential + to the economic + +On line 136: + essential to the + economic well-being of our + nation. The soundness + +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: + expect businesses + and individuals to + pursue profits, at + +On line 136: + pursue profits, at + the same time that they produce + products and services + +On line 136: + the same time that they + produce products and services + of quality and + +On line 136: + they produce products + and services of quality + and conduct themselves + +On line 136: + produce products and + services of quality and + conduct themselves well. + +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, + +On line 138: + financial crisis. + This was not universal, but + these breaches stretched from + +On line 138: + was not universal, + but these breaches stretched from the + ground level to the + +On line 138: + but these breaches stretched + from the ground level to the + corporate suites. They + +On line 138: + the corporate suites. + They resulted not only + in significant + +On line 138: + in significant + financial consequences but + also in damage + +On line 138: + in damage to the + trust of investors, businesses, + and the public in + +On line 138: + damage to the trust + of investors, businesses, and + the public in the + +On line 138: + the trust of investors, + businesses, and the public + in the financial + +On line 140: + in the financial + system. For example, our + examination + +On line 140: + according to one + measure, that the percentage + of borrowers who + +On line 140: + one measure, that the + percentage of borrowers + who defaulted on + +On line 140: + just a matter of + months after taking a loan + nearly doubled from + +On line 140: + months after taking + a loan nearly doubled from + the summer of to + +On line 140: + after taking a + loan nearly doubled from the + summer of to late + +On line 140: + nearly doubled from + the summer of to late This + data indicates + +On line 140: + the summer of to + late This data indicates + they likely took out + +On line 140: + to late This data + indicates they likely took + out mortgages that they + +On line 140: + data indicates + they likely took out mortgages + that they never had + +On line 140: + they likely took out + mortgages that they never had + the capacity + +On line 140: + the capacity + or intention to pay. You + will read about mortgage + +On line 140: + or intention to + pay. You will read about mortgage + brokers who were paid + +On line 140: + pay. You will read about + mortgage brokers who were paid + "yield spread premiums" + +On line 140: + will read about mortgage + brokers who were paid "yield spread + premiums" by lenders + +On line 140: + brokers who were paid + "yield spread premiums" by lenders + to put borrowers + +On line 140: + who were paid "yield spread + premiums" by lenders to put + borrowers into + +On line 140: + "yield spread premiums" + by lenders to put borrowers + into higher-cost + +On line 140: + premiums" by lenders + to put borrowers into + higher-cost loans so + +On line 140: + to put borrowers + into higher-cost loans so + they would get bigger + +On line 140: + into higher-cost + loans so they would get bigger + fees, often never + +On line 140: + they would get bigger + fees, often never disclosed + to borrowers. The + +On line 140: + fees, often never + disclosed to borrowers. The + report catalogues + +On line 140: + mortgage fraud grew 20-fold + between and and then more than + doubled again between + +On line 142: + fraud grew 20-fold between + and and then more than doubled + again between and One + +On line 142: + grew 20-fold between and + and then more than doubled again + between and One study + +On line 142: + between and and then + more than doubled again between + and One study places the + +On line 142: + and and then more than + doubled again between and One + study places the losses + +On line 142: + more than doubled again + between and One study places the + losses resulting + +On line 142: + doubled again between + and One study places the losses + resulting from fraud + +On line 142: + between and One study + places the losses resulting + from fraud on mortgage + +On line 142: + and One study places the + losses resulting from fraud + on mortgage loans made + +On line 144: + resulting from fraud + on mortgage loans made between + and at billion. Lenders + +On line 144: + fraud on mortgage loans + made between and at billion. + Lenders made loans that they + +On line 144: + on mortgage loans made + between and at billion. Lenders + made loans that they knew + +On line 144: + loans made between and + at billion. Lenders made loans that + they knew borrowers + +On line 144: + made between and at + billion. Lenders made loans that they + knew borrowers could + +On line 144: + at billion. Lenders made + loans that they knew borrowers + could not afford and + +On line 144: + billion. Lenders made loans + that they knew borrowers could + not afford and that + +On line 144: + they knew borrowers + could not afford and that could + cause massive losses + +On line 144: + knew borrowers could + not afford and that could cause + massive losses to + +On line 144: + not afford and that + could cause massive losses to + investors in mortgage + +On line 144: + of the loans they were + originating could result + in "catastrophic + +On line 144: + originating could + result in "catastrophic + consequences." Less than + +On line 144: + in "catastrophic + consequences." Less than a year + later, they noted + +On line 144: + consequences." Less than + a year later, they noted + that certain high-risk + +On line 144: + a year later, they + noted that certain high-risk + loans they were making + +On line 144: + result not only + in foreclosures but also + in "financial and + +On line 144: + in foreclosures but + also in "financial and + reputational + +On line 146: + reputational + catastrophe" for the firm. But + they did not stop. And + +On line 146: + they did not stop. And + the report documents that + major financial + +On line 146: + sampled loans they were + purchasing to package and + sell to investors. They + +On line 146: + and sell to investors. + They knew a significant + percentage of the + +On line 146: + investors. They knew a + significant percentage + of the sampled loans + +On line 146: + a significant + percentage of the sampled + loans did not meet their + +On line 146: + percentage of the + sampled loans did not meet their + own underwriting + +On line 146: + sampled loans did not + meet their own underwriting + standards or those of + +On line 146: + of many prospectuses + provided to investors found + that this critical + +On line 148: + investors found that this + critical information + was not disclosed. THESE + +On line 148: + information was + not disclosed. THESE CONCLUSIONS + must be viewed in the + +On line 148: + THESE CONCLUSIONS must + be viewed in the context of + human nature and + +On line 148: + to pin this crisis + on mortal flaws like greed and + CONCLUSIONS OF THE + +On line 148: + crisis on mortal + flaws like greed and CONCLUSIONS + OF THE FINANCIAL + +On line 148: + on mortal flaws like + greed and CONCLUSIONS OF THE + FINANCIAL CRISIS + +On line 148: + greed and CONCLUSIONS + OF THE FINANCIAL CRISIS + INQUIRY COMMISSION + +On line 148: + CONCLUSIONS OF THE + FINANCIAL CRISIS INQUIRY + COMMISSION xxiii + +On line 148: + OF THE FINANCIAL + CRISIS INQUIRY COMMISSION + xxiii hubris would be + +On line 148: + COMMISSION xxiii + hubris would be simplistic. It + was the failure to + +On line 148: + be simplistic. It + was the failure to account + for human weakness + +On line 148: + simplistic. It was + the failure to account for + human weakness that + +On line 148: + was the failure to + account for human weakness + that is relevant + +On line 148: + failure to account + for human weakness that is + relevant to this + +On line 150: + for human weakness + that is relevant to this + crisis. Second, we + +On line 150: + that is relevant + to this crisis. Second, we + clearly believe the + +On line 150: + relevant to this + crisis. Second, we clearly + believe the crisis + +On line 150: + crisis. Second, we + clearly believe the crisis + was a result of + +On line 150: + Second, we clearly + believe the crisis was a + result of human + +On line 150: + we clearly believe + the crisis was a result + of human mistakes, + +On line 150: + believe the crisis + was a result of human + mistakes, misjudgments, + +On line 150: + mistakes, misjudgments, + and misdeeds that resulted + in systemic failures + +On line 150: + in systemic failures + for which our nation has paid + dearly. As you read + +On line 150: + failures for which our + nation has paid dearly. As + you read this report, + +On line 150: + for which our nation + has paid dearly. As you read + this report, you will + +On line 150: + which our nation has + paid dearly. As you read this + report, you will see + +On line 150: + has paid dearly. As + you read this report, you will + see that specific + +On line 150: + paid dearly. As you + read this report, you will see + that specific firms + +On line 150: + dearly. As you read + this report, you will see that + specific firms and + +On line 150: + this report, you will + see that specific firms and + individuals + +On line 150: + specific firms and + individuals acted + irresponsibly. + +On line 150: + individuals + acted irresponsibly. + Yet a crisis of + +On line 150: + Yet a crisis of + this magnitude cannot be + the work of a few + +On line 150: + a crisis of this + magnitude cannot be the + work of a few bad + +On line 150: + of this magnitude + cannot be the work of a + few bad actors, and + +On line 150: + magnitude cannot + be the work of a few bad + actors, and such was + +On line 150: + cannot be the work + of a few bad actors, and + such was not the case + +On line 150: + be the work of a + few bad actors, and such was + not the case here. At + +On line 150: + the work of a few + bad actors, and such was not + the case here. At the + +On line 150: + work of a few bad + actors, and such was not the + case here. At the same + +On line 150: + a few bad actors, + and such was not the case here. + At the same time, the + +On line 150: + few bad actors, and + such was not the case here. At + the same time, the breadth + +On line 150: + bad actors, and such + was not the case here. At the + same time, the breadth of + +On line 150: + actors, and such was + not the case here. At the same + time, the breadth of this + +On line 150: + and such was not the + case here. At the same time, the + breadth of this crisis + +On line 150: + such was not the case + here. At the same time, the breadth + of this crisis does + +On line 150: + was not the case here. + At the same time, the breadth of + this crisis does not + +On line 150: + not the case here. At + the same time, the breadth of this + crisis does not mean + +On line 150: + At the same time, the + breadth of this crisis does not + mean that "everyone + +On line 150: + the same time, the breadth + of this crisis does not mean + that "everyone is + +On line 150: + same time, the breadth of + this crisis does not mean that + "everyone is at + +On line 150: + breadth of this crisis + does not mean that "everyone + is at fault"; many firms + +On line 150: + of this crisis does + not mean that "everyone is + at fault"; many firms and + +On line 150: + is at fault"; many firms + and individuals did + not participate + +On line 150: + at fault"; many firms and + individuals did not + participate in + +On line 150: + individuals + did not participate in + the excesses that + +On line 152: + not participate + in the excesses that spawned + disaster. We do + +On line 152: + We do place special + responsibility with + the public leaders + +On line 152: + charged with protecting + our financial system, those + entrusted to run + +On line 152: + financial system, + those entrusted to run our + regulatory + +On line 152: + those entrusted to + run our regulatory + agencies, and the chief + +On line 152: + chief executives + of companies whose failures + drove us to crisis. + +On line 152: + executives of + companies whose failures drove + us to crisis. These + +On line 152: + of significant + responsibility and + obligation. Tone at + +On line 152: + and obligation. Tone + at the top does matter and, + in this instance, we + +On line 152: + obligation. Tone at + the top does matter and, in + this instance, we were + +On line 152: + Tone at the top does + matter and, in this instance, + we were let down. No + +On line 152: + the top does matter + and, in this instance, we were + let down. No one said + +On line 152: + top does matter and, + in this instance, we were let + down. No one said "no." + +On line 152: + does matter and, in + this instance, we were let down. + No one said "no." But + +On line 152: + matter and, in this + instance, we were let down. No + one said "no." But as + +On line 152: + in this instance, we + were let down. No one said "no." + But as a nation, + +On line 152: + this instance, we were + let down. No one said "no." But + as a nation, we + +On line 152: + instance, we were let + down. No one said "no." But as + a nation, we must + +On line 152: + let down. No one said + "no." But as a nation, we + must also accept + +On line 152: + must also accept + responsibility for + what we permitted + +On line 154: + what we permitted + to occur. Collectively, + but certainly not + +On line 154: + unanimously, we + acquiesced to or embraced + a system, a set + +On line 154: + we acquiesced to + or embraced a system, a + set of policies and + +On line 154: + to or embraced a + system, a set of policies + and actions, that gave + +On line 154: + a system, a set + of policies and actions, that + gave rise to our present + +On line 160: + a set of policies + and actions, that gave rise to + our present predicament. THIS + +On line 160: + and actions, that gave + rise to our present predicament. THIS + REPORT DESCRIBES THE + +On line 160: + to our present predicament. + THIS REPORT DESCRIBES THE EVENTS + and the system that + +On line 160: + THIS REPORT DESCRIBES + THE EVENTS and the system that + propelled our nation + +On line 160: + and the system that + propelled our nation toward + crisis. The complex + +On line 160: + propelled our nation + toward crisis. The complex + machinery of our + +On line 160: + toward crisis. The + complex machinery of our + financial markets + +On line 160: + complex machinery + of our financial markets + has many essential + +On line 160: + machinery of our + financial markets has many + essential gears—some + +On line 160: + of our financial + markets has many essential + gears—some of which played + +On line 160: + essential gears—some + of which played a critical + role as the crisis + +On line 160: + gears—some of which played + a critical role as the + crisis developed + +On line 160: + a critical role + as the crisis developed + and deepened. Here we + +On line 160: + crisis developed + and deepened. Here we render + our conclusions about + +On line 160: + Here we render our + conclusions about specific + components of the + +On line 160: + our conclusions about + specific components of + the system that we + +On line 160: + believe contributed + significantly to the + financial meltdown. + +On line 162: + pipeline lit and spread + the flame of contagion and + crisis. When housing + +On line 162: + lit and spread the flame + of contagion and crisis. + When housing prices fell + +On line 162: + and spread the flame of + contagion and crisis. When + housing prices fell and + +On line 162: + prices fell and mortgage + borrowers defaulted, the + lights began to dim + +On line 162: + mortgage borrowers + defaulted, the lights began + to dim on Wall Street. + +On line 164: + toxic mortgages from + neighborhoods across America + to investors around the + +On line 166: + from neighborhoods across + America to investors around + the globe. Many mortgage + +On line 166: + to investors around the + globe. Many mortgage lenders set the + bar so low that lenders + +On line 166: + 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: + Mutual had low- + or no-documentation + requirements. These trends + +On line 168: + lending, including + predatory and fraudulent + practices, became more + +On line 168: + Federal Reserve + and other regulators + and authorities + +On line 168: + regulators and + authorities heard warnings + from many quarters. Yet + +On line 168: + and authorities + heard warnings from many quarters. + Yet the Federal + +On line 168: + heard warnings from many + quarters. Yet the Federal + Reserve neglected + +On line 168: + Federal Reserve + neglected its mission "to + ensure the safety + +On line 168: + Reserve neglected + its mission "to ensure the + safety and soundness + +On line 168: + mission "to ensure + the safety and soundness of + the nation’s banking + +On line 168: + safety and soundness + of the nation’s banking and + financial system + +On line 168: + nation’s banking and + financial system and to + protect the credit + +On line 168: + financial system + and to protect the credit + rights of consumers." It + +On line 168: + protect the credit + rights of consumers." It failed to + build the retaining + +On line 168: + rights of consumers." It + failed to build the retaining + wall before it was + +On line 168: + of consumers." It failed + to build the retaining wall + before it was too + +On line 168: + It failed to build the + retaining wall before it + was too late. And the + +On line 168: + build the retaining + wall before it was too late. + And the Office of + +On line 168: + the retaining wall + before it was too late. And + the Office of the + +On line 168: + wall before it was + too late. And the Office of + the Comptroller of + +On line 168: + before it was too + late. And the Office of the + Comptroller of the + +On line 168: + was too late. And the + Office of the Comptroller + of the Currency + +On line 168: + late. And the Office + of the Comptroller of the + Currency and the + +On line 168: + the Office of Thrift + Supervision, caught up in + turf wars, preempted + +On line 168: + Supervision, caught + up in turf wars, preempted + state regulators + +On line 170: + wars, preempted state + regulators from reining + in abuses. While many + +On line 170: + state regulators + from reining in abuses. While + many of these mortgages + +On line 170: + regulators from + reining in abuses. While many + of these mortgages were + +On line 170: + reining in abuses. + While many of these mortgages were + kept on banks’ books, the + +On line 170: + in abuses. While many + of these mortgages were kept on + banks’ books, the bigger + +On line 170: + were kept on banks’ books, + the bigger money came from + global investors who + +On line 170: + the bigger money + came from global investors who + clamored to put their + +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: + had been conquered: the + investors held highly rated + securities they + +On line 170: + held highly rated + securities they thought were + sure to perform; the + +On line 170: + they thought were sure to + perform; the banks thought they had + taken the riskiest + +On line 170: + were sure to perform; + the banks thought they had taken + the riskiest loans off + +On line 170: + sure to perform; the + banks thought they had taken the + riskiest loans off their + +On line 170: + perform; the banks thought + they had taken the riskiest + loans off their books; and + +On line 170: + thought they had taken + the riskiest loans off their books; + and regulators + +On line 170: + they had taken the + riskiest loans off their books; and + regulators saw + +On line 170: + riskiest loans off their + books; and regulators saw + firms making profits + +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 + +On line 170: + keep demand going. + From the speculators who + flipped houses to the + +On line 170: + speculators who + flipped houses to the mortgage + brokers who scouted + +On line 170: + flipped houses to the + mortgage brokers who scouted + the loans, to the lenders + +On line 170: + the mortgage brokers + who scouted the loans, to the + lenders who issued the + +On line 170: + the loans, to the lenders + who issued the mortgages, to + the financial firms + +On line 170: + loans, to the lenders who + issued the mortgages, to the + financial firms that + +On line 170: + lenders who issued the + mortgages, to the financial + firms that created + +On line 170: + firms that created + the mortgage-backed securities, + collateralized + +On line 170: + collateralized + debt obligations (CDOs), CDOs squared, + and synthetic CDOs: + +On line 170: + obligations (CDOs), CDOs + squared, and synthetic CDOs: no + one in this pipeline + +On line 170: + squared, and synthetic + CDOs: no one in this pipeline + of toxic mortgages + +On line 170: + and synthetic CDOs: + no one in this pipeline of + toxic mortgages had + +On line 170: + CDOs: no one in this + pipeline of toxic mortgages + had enough skin in the + +On line 170: + one in this pipeline + of toxic mortgages had enough + skin in the game. They + +On line 170: + in this pipeline of + toxic mortgages had enough skin + in the game. They all + +On line 170: + pipeline of toxic + mortgages had enough skin in the + game. They all believed + +On line 170: + of toxic mortgages + had enough skin in the game. They + all believed they could + +On line 170: + mortgages had enough skin + in the game. They all believed + they could off-load their + +On line 170: + had enough skin in the + game. They all believed they could + off-load their risks on + +On line 170: + in the game. They all + believed they could off-load their + risks on a moment’s + +On line 170: + game. They all believed + they could off-load their risks on + a moment’s notice + +On line 170: + They all believed they + could off-load their risks on a + moment’s notice to + +On line 170: + they could off-load their + risks on a moment’s notice + to the next person + +On line 170: + could off-load their risks + on a moment’s notice to + the next person in + +On line 170: + off-load their risks on + a moment’s notice to the + next person in line. + +On line 170: + risks on a moment’s + notice to the next person + in line. They were wrong. + +On line 170: + notice to the next + person in line. They were wrong. + When borrowers stopped + +On line 170: + next person in line. + They were wrong. When borrowers + stopped making mortgage + +On line 170: + in line. They were wrong. + When borrowers stopped making + mortgage payments, the + +On line 170: + wrong. When borrowers + stopped making mortgage payments, + the losses—amplified + +On line 170: + When borrowers stopped + making mortgage payments, the + losses—amplified by + +On line 170: + stopped making mortgage + payments, the losses—amplified + by derivatives—rushed through + +On line 170: + losses—amplified by + derivatives—rushed through the pipeline. + As it turned out, these + +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 172: + to modifying + mortgages so families can + stay in their homes and + +On line 172: + can stay in their homes + and has created further + uncertainty about + +On line 174: + housing market and + financial institutions. + We conclude over-the-counter + +On line 174: + We conclude over-the-counter + derivatives contributed + significantly + +On line 174: + The enactment of + legislation in to ban + the regulation + +On line 174: + the regulation + by both the federal and + state governments of + +On line 174: + the federal and + state governments of over-the-counter + (OTC) derivatives + +On line 174: + federal and state + governments of over-the-counter (OTC) + derivatives was + +On line 174: + state governments of + over-the-counter (OTC) derivatives + was a key turning + +On line 174: + (OTC) derivatives + was a key turning point in + the march toward the + +On line 174: + was a key turning + point in the march toward the + financial crisis. + +On line 176: + in the march toward + the financial crisis. From + financial firms to + +On line 176: + to corporations, + to farmers, and to investors, + derivatives have + +On line 176: + to farmers, and to + investors, derivatives have + been used to hedge against, + +On line 176: + been used to hedge against, + or speculate on, changes in + prices, rates, or indices + +On line 176: + used to hedge against, or + speculate on, changes in prices, + rates, or indices or + +On line 176: + or speculate on, + changes in prices, rates, or indices + or even on events such + +On line 176: + speculate on, changes + in prices, rates, or indices or + even on events such as + +On line 176: + changes in prices, rates, or + indices or even on events such + as the potential + +On line 176: + prices, rates, or indices + or even on events such as the + potential defaults + +On line 176: + indices or even on + events such as the potential + defaults on debts. Yet, + +On line 176: + or even on events such + as the potential defaults + on debts. Yet, without + +On line 176: + even on events such as + the potential defaults on + debts. Yet, without any + +On line 176: + debts. Yet, without any + oversight, OTC derivatives + rapidly spiraled out + +On line 176: + rapidly spiraled out + of control and out of sight, + growing to trillion + +On line 176: + of control and out + of sight, growing to trillion + in notional amount. + +On line 176: + control and out of + sight, growing to trillion in + notional amount. This + +On line 176: + of sight, growing to + trillion in notional amount. + This report explains + +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 + +On line 178: + of mortgage-related + securities backed by risky + loans. Companies sold + +On line 178: + securities backed + by risky loans. Companies sold + protection—to the + +On line 178: + risky loans. Companies + sold protection—to the tune + of billion, in AIG’s + +On line 178: + sold protection—to + the tune of billion, in AIG’s + case—to investors in + +On line 178: + tune of billion, in + AIG’s case—to investors in these + newfangled mortgage + +On line 178: + newfangled mortgage + securities, helping to + launch and expand the + +On line 178: + to launch and expand + the market and, in turn, to + further fuel the + +On line 180: + to further fuel + the housing bubble. Second, + CDS were essential + +On line 180: + further fuel the + housing bubble. Second, CDS + were essential to + +On line 180: + the housing bubble. + Second, CDS were essential + to the creation of + +On line 180: + were essential to + the creation of synthetic + CDOs. These synthetic + +On line 180: + essential to the + creation of synthetic CDOs. + These synthetic CDOs + +On line 180: + on the performance + of real mortgage-related + securities. They + +On line 180: + securities. They + amplified the losses from + the collapse of the + +On line 180: + They amplified the + losses from the collapse of + the housing bubble + +On line 180: + multiple bets on + the same securities and + helped spread them throughout + +On line 180: + same securities + and helped spread them throughout the + financial system. + +On line 182: + spread them throughout the + financial system. Goldman + Sachs alone packaged and + +On line 182: + system. Goldman Sachs + alone packaged and sold billion + in synthetic CDOs + +On line 182: + and sold billion in + synthetic CDOs from July + CONCLUSIONS OF THE + +On line 182: + synthetic CDOs from + July CONCLUSIONS OF THE + FINANCIAL CRISIS + +On line 182: + July CONCLUSIONS + OF THE FINANCIAL CRISIS + INQUIRY COMMISSION + +On line 184: + CONCLUSIONS OF THE + FINANCIAL CRISIS INQUIRY + COMMISSION xxv to + +On line 184: + FINANCIAL CRISIS + INQUIRY COMMISSION xxv to + May Synthetic CDOs + +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 186: + is apart from how many + times these securities may + have been referenced + +On line 186: + apart from how many times + these securities may have + been referenced in + +On line 188: + in synthetic CDOs + created by other firms. + Finally, when the + +On line 188: + CDOs created by + other firms. Finally, when + the housing bubble + +On line 188: + and crisis followed, + derivatives were in the + center of the storm. + +On line 188: + derivatives were + in the center of the storm. + AIG, which had not been + +On line 188: + were in the center + of the storm. AIG, which had not + been required to put + +On line 188: + in the center of + the storm. AIG, which had not been + required to put aside + +On line 188: + the storm. AIG, which had + not been required to put aside + capital reserves + +On line 188: + not been required to + put aside capital reserves + as a cushion for + +On line 188: + been required to put + aside capital reserves as + a cushion for the + +On line 188: + put aside capital + reserves as a cushion for + the protection it + +On line 188: + a cushion for the + protection it was selling, + was bailed out when it + +On line 188: + for the protection + it was selling, was bailed out + when it could not meet + +On line 188: + the protection it + was selling, was bailed out when + it could not meet its + +On line 188: + it was selling, was + bailed out when it could not meet + its obligations. The + +On line 188: + its obligations. The + government ultimately + committed more than + +On line 188: + committed more than + billion because of concerns + that AIG’s collapse would + +On line 188: + billion because of + concerns that AIG’s collapse would + trigger cascading + +On line 188: + because of concerns + that AIG’s collapse would trigger + cascading losses + +On line 188: + that AIG’s collapse would + trigger cascading losses + throughout the global + +On line 188: + trigger cascading + losses throughout the global + financial system. + +On line 188: + losses throughout the + global financial system. + In addition, the + +On line 188: + the existence of + millions of derivatives + contracts of all types + +On line 188: + of derivatives + contracts of all types between + systemically + +On line 188: + panic, helping to + precipitate government + assistance to those + +On line 188: + to precipitate + government assistance to + those institutions. + +On line 190: + conclude the failures + of credit rating agencies + were essential cogs + +On line 190: + were essential cogs + in the wheel of financial + destruction. The three + +On line 190: + cogs in the wheel of + financial destruction. The + three credit rating + +On line 190: + wheel of financial + destruction. The three credit + rating agencies were + +On line 190: + destruction. The three + credit rating agencies were + key enablers of the + +On line 190: + of the financial + meltdown. The mortgage-related + securities at + +On line 190: + The mortgage-related + securities at the heart + of the crisis could + +On line 190: + heart of the crisis + could not have been marketed + and sold without their + +On line 190: + of the crisis could + not have been marketed and + sold without their seal + +On line 190: + the crisis could not + have been marketed and sold + without their seal of + +On line 190: + marketed and sold + without their seal of approval. + Investors relied on + +On line 190: + without their seal of + approval. Investors relied on + them, often blindly. + +On line 190: + regulatory + capital standards were hinged + on them. This crisis + +On line 190: + capital standards + were hinged on them. This crisis + could not have happened + +On line 190: + standards were hinged on + them. This crisis could not have + happened without the + +On line 190: + were hinged on them. This + crisis could not have happened + without the rating + +On line 190: + on them. This crisis + could not have happened without + the rating agencies. + +On line 190: + them. This crisis could + not have happened without the + rating agencies. Their + +On line 190: + crisis could not have + happened without the rating + agencies. Their ratings + +On line 190: + could not have happened + without the rating agencies. + Their ratings helped the + +On line 190: + happened without the + rating agencies. Their ratings + helped the market soar + +On line 190: + without the rating + agencies. Their ratings helped the + market soar and their + +On line 190: + the rating agencies. + Their ratings helped the market + soar and their downgrades + +On line 190: + rating agencies. Their + ratings helped the market soar + and their downgrades through + +On line 190: + agencies. Their ratings + helped the market soar and their + downgrades through and wreaked + +On line 190: + Their ratings helped the + market soar and their downgrades + through and wreaked havoc + +On line 190: + helped the market soar + and their downgrades through and wreaked + havoc across markets + +On line 190: + market soar and their + downgrades through and wreaked havoc + across markets and firms. + +On line 192: + their downgrades through and + wreaked havoc across markets and + firms. In our report, + +On line 192: + downgrades through and wreaked + havoc across markets and firms. + In our report, you + +On line 192: + through and wreaked havoc + across markets and firms. In our + report, you will read + +On line 192: + across markets and firms. + In our report, you will read + about the breakdowns at + +On line 192: + markets and firms. In + our report, you will read about + the breakdowns at Moody’s, + +On line 192: + firms. In our report, + you will read about the breakdowns + at Moody’s, examined + +On line 192: + In our report, you + will read about the breakdowns at + Moody’s, examined by + +On line 192: + our report, you will + read about the breakdowns at Moody’s, + examined by the + +On line 192: + you will read about the + breakdowns at Moody’s, examined + by the Commission + +On line 192: + read about the breakdowns + at Moody’s, examined by the + Commission as a + +On line 192: + at Moody’s, examined + by the Commission as a + case study. From to Moody’s + +On line 192: + examined by the + Commission as a case study. + From to Moody’s rated + +On line 192: + This compares with six + private-sector companies + in the United States + +On line 192: + six private-sector + companies in the United + States that carried this + +On line 192: + companies in the + United States that carried this + coveted rating + +On line 192: + in the United States + that carried this coveted + rating in early + +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 + +On line 194: + ultimately were + downgraded. You will also + read about the forces at + +On line 194: + were downgraded. You + will also read about the forces + at work behind the + +On line 194: + You will also read + about the forces at work behind + the breakdowns at Moody’s, + +On line 194: + read about the forces at + work behind the breakdowns at + Moody’s, including the + +On line 194: + about the forces at work + behind the breakdowns at Moody’s, + including the flawed + +On line 194: + at work behind the + breakdowns at Moody’s, including + the flawed computer + +On line 194: + behind the breakdowns + at Moody’s, including the flawed + computer models, + +On line 194: + computer models, + the pressure from financial + firms that paid for the + +On line 194: + models, the pressure + from financial firms that paid + for the ratings, the + +On line 194: + from financial firms + that paid for the ratings, the + relentless drive for + +On line 194: + firms that paid for the + ratings, the relentless drive + for market share, the + +On line 194: + the relentless drive + for market share, the lack of + resources to do the + +On line 194: + drive for market share, + the lack of resources to do + the job despite record + +On line 194: + market share, the lack + of resources to do the job + despite record profits, + +On line 194: + of resources to do + the job despite record profits, + and the absence of + +On line 194: + the job despite record + profits, and the absence of + meaningful public + +On line 194: + and the absence of + meaningful public oversight. + And you will see that + +On line 194: + meaningful public + oversight. And you will see that + without the active + +On line 194: + oversight. And you will + see that without the active + participation + +On line 194: + without the active + participation of the + rating agencies, the + +On line 194: + rating agencies, the + market for mortgage-related + securities could + +On line 194: + for mortgage-related + securities could not have + been what it became. + +On line 200: + been what it became. + THERE ARE MANY COMPETING VIEWS + as to the causes + +On line 200: + what it became. THERE + ARE MANY COMPETING VIEWS as + to the causes of + +On line 200: + it became. THERE ARE + MANY COMPETING VIEWS as to + the causes of this + +On line 200: + ARE MANY COMPETING + VIEWS as to the causes of + this crisis. In this + +On line 200: + to the causes of + this crisis. In this regard, + the Commission has + +On line 200: + of this crisis. In + this regard, the Commission + has endeavored to + +On line 200: + the Commission has + endeavored to address key + questions posed to us. + +On line 200: + has endeavored to + address key questions posed to + us. Here we discuss + +On line 200: + availability and + excess liquidity, the + role of Fannie Mae + +On line 200: + role of Fannie Mae + and Freddie Mac (the GSEs), and + government housing + +On line 200: + and Freddie Mac (the + GSEs), and government housing + policy. First, as + +On line 200: + GSEs), and government + housing policy. First, as + to the matter of + +On line 200: + government housing + policy. First, as to the + matter of excess + +On line 200: + policy. First, as + to the matter of excess + liquidity: in + +On line 200: + as to the matter + of excess liquidity: + in our report, we + +On line 200: + in our report, we + outline monetary policies + and capital flows + +On line 200: + monetary policies + and capital flows during + the years leading up + +On line 200: + and capital flows + during the years leading up + to the crisis. Low + +On line 200: + flows during the years + leading up to the crisis. + Low interest rates, + +On line 200: + years leading up to + the crisis. Low interest + rates, widely available + +On line 200: + up to the crisis. + Low interest rates, widely + available capital, + +On line 200: + international + investors seeking to put their + money in real + +On line 200: + investors seeking to + put their money in real + estate assets in + +On line 200: + to put their money + in real estate assets + in the United States + +On line 200: + put their money in + real estate assets in + the United States were + +On line 200: + in real estate + assets in the United States + were prerequisites + +On line 202: + a credit bubble. + Those conditions created + increased risks, which should + +On line 202: + 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: + not need to cause a + crisis. It was the failures + outlined above—including + +On line 202: + the failures outlined + above—including the failure to + effectively rein + +On line 202: + in excesses in + the mortgage and financial + markets—that were the + +On line 202: + markets—that were the + principal causes of this + crisis. Indeed, the + +On line 202: + principal causes + of this crisis. Indeed, the + availability of + +On line 202: + availability of + well-priced capital—both foreign + and domestic—is + +On line 204: + directions. Second, + we examined the role of + the GSEs, with Fannie + +On line 204: + we examined the + role of the GSEs, with Fannie + Mae serving as the + +On line 204: + the role of the GSEs, + with Fannie Mae serving as + the Commission’s case + +On line 204: + role of the GSEs, with + Fannie Mae serving as the + Commission’s case study + +On line 204: + GSEs, with Fannie Mae + serving as the Commission’s + case study in this area. + +On line 204: + government-sponsored + enterprises had a deeply + flawed business model + +On line 204: + enterprises had + a deeply flawed business model + as publicly traded + +On line 204: + a deeply flawed business + model as publicly traded + corporations with + +On line 204: + corporations with + the implicit backing of + and subsidies from + +On line 204: + with the implicit + backing of and subsidies + from the federal + +On line 204: + and subsidies from + the federal government + and with a public + +On line 206: + mortgage exposure + and market position were + significant. In + +On line 208: + market position + were significant. In and + they decided to + +On line 208: + were significant. + In and they decided to + ramp up their purchase + +On line 208: + significant. In + and they decided to ramp + up their purchase and + +On line 208: + and they decided + to ramp up their purchase and + guarantee of risky + +On line 208: + up their purchase and + guarantee of risky mortgages, + just as the housing + +On line 208: + guarantee of risky + mortgages, just as the housing + market was peaking. + +On line 208: + of risky mortgages, just + as the housing market was + peaking. They used their + +On line 208: + just as the housing + market was peaking. They used + their political + +On line 208: + market was peaking. + They used their political + power for decades to + +On line 208: + was peaking. They used + their political power + for decades to ward off + +On line 208: + for decades to ward off + effective regulation + and oversight—spending + +On line 210: + regulation and + oversight—spending million on + lobbying from to + +On line 210: + and oversight—spending + million on lobbying from + to They suffered from + +On line 210: + on lobbying from + to They suffered from many of + the same failures of + +On line 210: + of the same failures + of corporate governance + and risk management + +On line 210: + the same failures of + corporate governance and + risk management as + +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 212: + Treasury Department + had provided billion in + financial support + +On line 214: + We conclude that these + two entities contributed + to the crisis, but + +On line 214: + conclude that these two + entities contributed to + the crisis, but were + +On line 214: + to the crisis, but + were not a primary cause. + Importantly, GSE + +On line 214: + maintained their value + throughout the crisis and did + not contribute to + +On line 214: + throughout the crisis + and did not contribute to + the significant + +On line 214: + contribute to the + significant financial + firm losses that were + +On line 214: + the significant + financial firm losses that + were central to the + +On line 216: + were central to the + financial crisis. The GSEs + participated + +On line 216: + 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 risky mortgages, + but they followed rather than led + Wall Street and other + +On line 216: + risky mortgages, but they + followed rather than led Wall Street + and other lenders in + +On line 216: + but they followed rather + than led Wall Street and other + lenders in the rush for + +On line 216: + they followed rather than + led Wall Street and other lenders + in the rush for fool’s + +On line 216: + followed rather than led + Wall Street and other lenders in + the rush for fool’s gold. + +On line 216: + than led Wall Street and + other lenders in the rush for + fool’s gold. They purchased + +On line 216: + Street and other lenders + in the rush for fool’s gold. They + purchased the highest + +On line 216: + other lenders in the + rush for fool’s gold. They purchased + the highest rated + +On line 216: + in the rush for fool’s + gold. They purchased the highest + rated non-GSE mortgage-backed + +On line 216: + gold. They purchased the + highest rated non-GSE mortgage-backed + securities and + +On line 216: + added helium to + the housing balloon, but their + purchases never + +On line 216: + the housing balloon, + but their purchases never + represented a + +On line 216: + but their purchases + never represented a + majority of + +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: + securities in + with the share rising to in + and falling back to + +On line 218: + with the share rising + to in and falling back to + by They relaxed their + +On line 218: + loans and related + securities in order + to meet stock market + +On line 218: + market analysts’ + and investors’ expectations + for growth, to regain + +On line 218: + regain market share, + and to ensure generous + compensation for + +On line 218: + their executives + and employees—justifying + their activities + +On line 218: + executives and + employees—justifying their + activities on + +On line 218: + activities on + the broad and sustained public + policy support + +On line 218: + the broad and sustained + public policy support + for homeownership. + +On line 220: + for homeownership. + The Commission also probed + the performance of + +On line 220: + homeownership. The + Commission also probed the + performance of the + +On line 220: + of the loans purchased + or guaranteed by Fannie + and Freddie. While they + +On line 220: + and Freddie. While they + generated substantial + losses, delinquency + +On line 220: + substantial losses, + delinquency rates for GSE loans + were substantially + +On line 220: + rates for GSE loans were + substantially lower than + loans securitized + +On line 220: + securitized by + other financial firms. For + example, data + +On line 220: + financial firms. For + example, data compiled + by the Commission + +On line 220: + example, data + compiled by the Commission + for a subset of + +On line 220: + Commission for a + subset of borrowers with + similar credit + +On line 220: + of borrowers with + similar credit scores—scores + below 660—show that by + +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: + mortgages: versus We + also studied at length how + the Department of + +On line 222: + also studied at + length how the Department of + Housing and Urban + +On line 222: + Development’s (HUD’s) + affordable housing goals for + the GSEs affected + +On line 222: + affordable housing + goals for the GSEs affected + their investment in + +On line 222: + GSEs affected their + investment in CONCLUSIONS + OF THE FINANCIAL + +On line 222: + CONCLUSIONS OF THE + FINANCIAL CRISIS INQUIRY + COMMISSION xxvii risky + +On line 222: + OF THE FINANCIAL + CRISIS INQUIRY COMMISSION + xxvii risky mortgages. Based + +On line 222: + FINANCIAL CRISIS + INQUIRY COMMISSION xxvii risky + mortgages. Based on the + +On line 222: + on the evidence + and interviews with dozens of + individuals + +On line 222: + individuals + involved in this subject area, + we determined these + +On line 222: + this subject area, we + determined these goals only + contributed marginally + +On line 222: + area, we determined + these goals only contributed + marginally to Fannie’s + +On line 224: + Fannie’s and Freddie’s + participation in those + mortgages. Finally, + +On line 224: + participation + in those mortgages. Finally, + as to the matter + +On line 224: + mortgages. Finally, + as to the matter of whether + government housing + +On line 224: + the matter of whether + government housing policies + were a primary + +On line 224: + government housing + policies were a primary + cause of the crisis: + +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: + were put in place and + promoted by several + administrations + +On line 224: + and Congresses—indeed, + both Presidents Bill Clinton + and George W. Bush set + +On line 224: + both Presidents Bill + Clinton and George W. Bush set + aggressive goals to + +On line 226: + and George W. Bush set + aggressive goals to increase + homeownership. In + +On line 226: + set aggressive goals + to increase homeownership. + In conducting our + +On line 226: + homeownership. In + conducting our inquiry, we + took a careful look + +On line 226: + took a careful look + at HUD’s affordable housing + goals, as noted above, + +On line 226: + a careful look at + HUD’s affordable housing goals, + as noted above, and + +On line 226: + careful look at HUD’s + affordable housing goals, as + noted above, and the + +On line 226: + noted above, and the + Community Reinvestment + Act (CRA). The CRA was + +On line 226: + the Community + Reinvestment Act (CRA). The CRA + was enacted in + +On line 226: + Reinvestment Act (CRA). + The CRA was enacted in + to combat "redlining" + +On line 226: + Act (CRA). The CRA was + enacted in to combat + "redlining" by banks—the + +On line 226: + CRA was enacted + in to combat "redlining" by + banks—the practice of + +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: + without regard to + their creditworthiness. The + CRA requires banks and + +On line 226: + The CRA requires banks + and savings and loans to lend, + invest, and provide + +On line 226: + loans to lend, invest, + and provide services to the + communities from + +On line 226: + and provide services + to the communities from + which they take deposits, + +On line 228: + the CRA was not a + significant factor in + subprime lending or + +On line 228: + a significant + factor in subprime lending + or the crisis. Many + +On line 228: + factor in subprime + lending or the crisis. Many + subprime lenders were not + +On line 228: + in subprime lending + or the crisis. Many subprime + lenders were not subject + +On line 228: + subprime lending or + the crisis. Many subprime lenders + were not subject to + +On line 228: + or the crisis. Many + subprime lenders were not subject + to the CRA. Research + +On line 228: + subprime lenders were not + subject to the CRA. Research + indicates only + +On line 228: + subject to the CRA. + Research indicates only + of high-cost loans—a + +On line 228: + indicates only + of high-cost loans—a proxy for + subprime loans—had any + +On line 228: + of high-cost loans—a + proxy for subprime loans—had any + connection to the + +On line 228: + loans—a proxy for subprime + loans—had any connection to + the law. Loans made by + +On line 228: + for subprime loans—had + any connection to the law. + Loans made by CRA-regulated lenders + +On line 228: + subprime loans—had any + connection to the law. Loans + made by CRA-regulated lenders in + +On line 228: + any connection to + the law. Loans made by CRA-regulated lenders + in the neighborhoods + +On line 228: + connection to the + law. Loans made by CRA-regulated lenders in + the neighborhoods in + +On line 228: + law. Loans made by CRA-regulated + lenders in the neighborhoods in + which they were required + +On line 228: + Loans made by CRA-regulated lenders + in the neighborhoods in which + they were required to + +On line 228: + made by CRA-regulated lenders in + the neighborhoods in which they + were required to lend + +On line 228: + by CRA-regulated lenders in the + neighborhoods in which they were + required to lend were + +On line 228: + the neighborhoods in + which they were required to lend + were half as likely + +On line 228: + neighborhoods in which + they were required to lend were + half as likely to + +On line 228: + required to lend were + half as likely to default + as similar loans + +On line 228: + were half as likely + to default as similar + loans made in the same + +On line 228: + likely to default + as similar loans made in + the same neighborhoods + +On line 228: + as similar loans + made in the same neighborhoods + by independent + +On line 228: + the same neighborhoods + by independent mortgage + originators not + +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: + a nation, we set + aggressive homeownership + goals with the desire + +On line 230: + we set aggressive + homeownership goals with the + desire to extend + +On line 230: + extend credit to + families previously + denied access to + +On line 230: + denied access to + the financial markets. Yet + the government failed + +On line 230: + to the financial + markets. Yet the government + failed to ensure that + +On line 230: + the philosophy + of opportunity was + being matched by the + +On line 230: + being matched by the + practical realities + on the ground. Witness + +On line 230: + ground. Witness again the + failure of the Federal + Reserve and other + +On line 230: + Reserve and other + regulators to rein in + irresponsible + +On line 230: + irresponsible + lending. Homeownership peaked + in the spring of and + +On line 230: + peaked in the spring of + and then began to decline. + From that point on, the + +On line 230: + in the spring of and + then began to decline. From + that point on, the talk + +On line 230: + the spring of and then + began to decline. From that + point on, the talk of + +On line 230: + began to decline. + From that point on, the talk of + opportunity + +On line 230: + From that point on, the + talk of opportunity + was tragically + +On line 230: + that point on, the talk + of opportunity was + tragically at + +On line 230: + tragically at + odds with the reality + of a financial + +On line 236: + reality of + a financial disaster + in the making. WHEN + +On line 236: + of a financial + disaster in the making. + WHEN THIS COMMISSION + +On line 236: + disaster in the + making. WHEN THIS COMMISSION + began its work months + +On line 236: + the making. WHEN THIS + COMMISSION began its work + months ago, some imagined + +On line 236: + WHEN THIS COMMISSION + began its work months ago, some + imagined that the events + +On line 236: + COMMISSION began + its work months ago, some imagined + that the events of and + +On line 236: + its work months ago, some + imagined that the events of and + their consequences would + +On line 236: + some imagined that the + events of and their consequences + would be well behind + +On line 236: + imagined that the events + of and their consequences would + be well behind us + +On line 236: + that the events of and + their consequences would be well + behind us by the + +On line 236: + and their consequences + would be well behind us by + the time we issued + +On line 236: + their consequences would + be well behind us by the + time we issued this + +On line 236: + would be well behind + us by the time we issued + this report. Yet more + +On line 236: + be well behind us + by the time we issued this + report. Yet more than + +On line 236: + behind us by the + time we issued this report. + Yet more than two years + +On line 236: + us by the time we + issued this report. Yet more + than two years after + +On line 236: + than two years after + the federal government + intervened in an + +On line 236: + an unprecedented + manner in our financial + markets, our country + +On line 236: + markets, our country + finds itself still grappling with + the aftereffects + +On line 236: + aftereffects of + the calamity. Our financial + system is, in many + +On line 236: + system is, in many + respects, still unchanged from what + existed on the + +On line 236: + in many respects, still + unchanged from what existed + on the eve of the + +On line 236: + respects, still unchanged + from what existed on the + eve of the crisis. + +On line 236: + still unchanged from what + existed on the eve of + the crisis. Indeed, + +On line 236: + from what existed + on the eve of the crisis. + Indeed, in the wake + +On line 236: + existed on the + eve of the crisis. Indeed, + in the wake of the + +On line 236: + on the eve of the + crisis. Indeed, in the wake + of the crisis, the + +On line 236: + the crisis. Indeed, + in the wake of the crisis, + the U.S. financial + +On line 236: + in the wake of the + crisis, the U.S. financial + sector is now more + +On line 236: + the crisis, the U.S. + financial sector is now + more concentrated + +On line 236: + financial sector + is now more concentrated + than ever in the + +On line 236: + sector is now more + concentrated than ever + in the hands of a + +On line 236: + While we have not been + charged with making policy + recommendations, + +On line 236: + the very purpose of + our report has been to take + stock of what happened + +On line 236: + very purpose of our + report has been to take stock + of what happened so + +On line 236: + our report has been + to take stock of what happened + so we can plot a + +On line 236: + report has been to + take stock of what happened so + we can plot a new + +On line 236: + has been to take stock + of what happened so we can + plot a new course. In + +On line 236: + been to take stock of + what happened so we can plot + a new course. In our + +On line 236: + stock of what happened + so we can plot a new course. + In our inquiry, we + +On line 236: + of what happened so + we can plot a new course. In + our inquiry, we found + +On line 236: + we can plot a new + course. In our inquiry, we found + dramatic breakdowns + +On line 236: + dramatic breakdowns + of corporate governance, + profound lapses in + +On line 236: + profound lapses in + regulatory oversight, + and near fatal flaws + +On line 236: + regulatory + oversight, and near fatal flaws + in our financial + +On line 238: + and near fatal flaws + in our financial system. + We also found that + +On line 238: + near fatal flaws in + our financial system. We + also found that a + +On line 238: + series of choices + and actions led us toward + a catastrophe for + +On line 238: + led us toward a + catastrophe for which we were + ill prepared. These are + +On line 238: + catastrophe for which + we were ill prepared. These are + serious matters + +On line 238: + for which we were ill + prepared. These are serious + matters that must be + +On line 238: + we were ill prepared. + These are serious matters + that must be addressed + +On line 238: + were ill prepared. These + are serious matters that + must be addressed and + +On line 238: + that must be addressed + and resolved to restore faith + in our financial + +On line 238: + to restore faith in + our financial markets, to + avoid the next crisis, + +On line 238: + restore faith in our + financial markets, to avoid + the next crisis, and + +On line 238: + avoid the next crisis, + and to rebuild a system + of capital that + +On line 238: + rebuild a system + of capital that provides + the foundation for + +On line 240: + the foundation for + a new era of broadly shared + prosperity. The + +On line 240: + for a new era of + broadly shared prosperity. + The greatest tragedy would + +On line 240: + shared prosperity. + The greatest tragedy would be to + accept the refrain + +On line 240: + The greatest tragedy would + be to accept the refrain + that no one could have + +On line 240: + greatest tragedy would be + to accept the refrain that + no one could have seen + +On line 240: + would be to accept + the refrain that no one could + have seen this coming + +On line 240: + be to accept the + refrain that no one could have + seen this coming and + +On line 240: + the refrain that no + one could have seen this coming + and thus nothing could + +On line 240: + refrain that no one + could have seen this coming and + thus nothing could have + +On line 240: + no one could have seen + this coming and thus nothing + could have been done. If + +On line 240: + one could have seen this + coming and thus nothing could + have been done. If we + +On line 240: + have seen this coming + and thus nothing could have been + done. If we accept + +On line 240: + seen this coming and + thus nothing could have been done. + If we accept this + +On line 240: + and thus nothing could + have been done. If we accept + this notion, it will + +On line 242: + could have been done. If + we accept this notion, it + will happen again. This + +On line 242: + done. If we accept + this notion, it will happen + again. This report should + +On line 242: + If we accept this + notion, it will happen again. + This report should not + +On line 242: + this notion, it will + happen again. This report should + not be viewed as the + +On line 242: + it will happen again. + This report should not be viewed + as the end of the + +On line 242: + as the end of the + nation’s examination + of this crisis. There + +On line 242: + end of the nation’s + examination of this + crisis. There is still + +On line 242: + examination + of this crisis. There is still + much to learn, much to + +On line 242: + of this crisis. There + is still much to learn, much to + investigate, and + +On line 244: + There is still much to + learn, much to investigate, + and much to fix. This + +On line 244: + is still much to learn, + much to investigate, and + much to fix. This is + +On line 244: + still much to learn, much + to investigate, and much + to fix. This is our + +On line 244: + is our collective + responsibility. It + falls to us to make + +On line 244: + It falls to us to + make different choices if + we want different + +On line 261: + we want different + results. PART I Crisis on + the Horizon BEFORE + +On line 263: + I Crisis on the + Horizon BEFORE OUR VERY EYES + In examining + +On line 263: + Horizon BEFORE OUR + VERY EYES In examining + the worst financial + +On line 263: + BEFORE OUR VERY EYES + In examining the worst + financial meltdown + +On line 263: + examining the + worst financial meltdown since + the Great Depression, + +On line 263: + financial meltdown + since the Great Depression, the + Financial Crisis + +On line 263: + Great Depression, the + Financial Crisis Inquiry + Commission reviewed + +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: + walks of life—to find + out how and why it happened. + In public hearings + +On line 265: + of life—to find out + how and why it happened. In + public hearings and + +On line 265: + out how and why it + happened. In public hearings + and interviews, many + +On line 265: + public officials + testified that they had been + blindsided by the + +On line 265: + testified that they + had been blindsided by the + crisis, describing + +On line 265: + been blindsided by + the crisis, describing it + as a dramatic + +On line 265: + blindsided by the + crisis, describing it as + a dramatic and + +On line 265: + crisis, describing + it as a dramatic and + mystifying turn + +On line 265: + as a dramatic + and mystifying turn of + events. Even among those who + +On line 265: + of events. Even among those + who worried that the housing + bubble might burst, few—if + +On line 265: + among those who worried + that the housing bubble might + burst, few—if any—foresaw + +On line 265: + those who worried that + the housing bubble might burst, + few—if any—foresaw the + +On line 265: + the housing bubble + might burst, few—if any—foresaw the + magnitude of the + +On line 265: + bubble might burst, few—if + any—foresaw the magnitude + of the crisis that + +On line 267: + few—if any—foresaw the + magnitude of the crisis + that would ensue. Charles + +On line 267: + the magnitude of + the crisis that would ensue. + Charles Prince, the former + +On line 267: + that would ensue. Charles + Prince, the former chairman and + chief executive + +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: + the chairman and chief + executive officer + of Berkshire Hathaway + +On line 267: + of Berkshire Hathaway + Inc., which until was the largest + single shareholder + +On line 267: + which until was the + largest single shareholder of + Moody’s Corporation, + +On line 267: + until was the largest + single shareholder of Moody’s + Corporation, told + +On line 267: + single shareholder + of Moody’s Corporation, told + the Commission that + +On line 267: + Moody’s Corporation, + told the Commission that "very, + very few people could + +On line 267: + told the Commission + that "very, very few people could + appreciate the + +On line 267: + very few people could + appreciate the bubble," + which he called a "mass + +On line 267: + could appreciate + the bubble," which he called a + "mass delusion" shared by + +On line 267: + the bubble," which he + called a "mass delusion" shared by + million Americans."2 + +On line 267: + a "mass delusion" shared + by million Americans."2 Lloyd + Blankfein, the chairman + +On line 267: + million Americans."2 + Lloyd Blankfein, the chairman and + chief executive + +On line 267: + the chairman and chief + executive officer + of Goldman Sachs Group, + +On line 267: + Goldman Sachs Group, Inc., + likened the financial crisis + to a hurricane.3 + +On line 269: + likened the financial + crisis to a hurricane.3 + Regulators echoed + +On line 269: + Regulators echoed + a similar refrain. Ben + Bernanke, the chairman of + +On line 269: + echoed a similar + refrain. Ben Bernanke, the chairman + of the Federal + +On line 269: + similar refrain. + Ben Bernanke, the chairman of the + Federal Reserve + +On line 269: + refrain. Ben Bernanke, the + chairman of the Federal + Reserve Board since told + +On line 269: + the chairman of the + Federal Reserve Board since + told the Commission + +On line 269: + Federal Reserve + Board since told the Commission + a "perfect storm" had + +On line 269: + Reserve Board since told + the Commission a "perfect + storm" had occurred that + +On line 269: + told the Commission + a "perfect storm" had occurred + that regulators + +On line 269: + the Commission a + "perfect storm" had occurred that + regulators could + +On line 269: + storm" had occurred that + regulators could not have + anticipated; + +On line 269: + regulators could + not have anticipated; + but when asked about whether + +On line 269: + when asked about whether the + Fed’s lack of aggressiveness + in regulating + +On line 269: + asked about whether the Fed’s + lack of aggressiveness in + regulating the + +On line 269: + aggressiveness in + regulating the mortgage + market during the + +On line 269: + in regulating + the mortgage market during + the housing boom was + +On line 269: + regulating the + mortgage market during the + housing boom was a + +On line 269: + market during the + housing boom was a failure, + Bernanke responded, "It + +On line 269: + the housing boom was + a failure, Bernanke responded, + "It was, indeed. I + +On line 269: + housing boom was a + failure, Bernanke responded, "It + was, indeed. I think + +On line 269: + was a failure, Bernanke + responded, "It was, indeed. + I think it was the + +On line 269: + responded, "It was, + indeed. I think it was the + most severe failure + +On line 269: + "It was, indeed. I + think it was the most severe + failure of the Fed + +On line 269: + indeed. I think it + was the most severe failure + of the Fed in this + +On line 269: + was the most severe + failure of the Fed in this + particular episode."4 + +On line 269: + this particular + episode."4 Alan Greenspan, the Fed chairman + during the two decades + +On line 269: + episode."4 Alan Greenspan, the Fed + chairman during the two decades + leading up to the + +On line 269: + Greenspan, the Fed chairman + during the two decades leading + up to the crash, told + +On line 269: + during the two decades + leading up to the crash, told + the Commission that + +On line 269: + decades leading up to + the crash, told the Commission + that it was beyond + +On line 269: + leading up to the + crash, told the Commission that + it was beyond the + +On line 269: + Commission that it + was beyond the ability + of regulators + +On line 269: + the ability of + regulators to ever + foresee such a sharp + +On line 269: + regulators to + ever foresee such a sharp + decline. "History + +On line 271: + cannot identify + the timing of a crisis, + or anticipate + +On line 271: + the timing of a + crisis, or anticipate + exactly where it + +On line 271: + or anticipate + exactly where it will be + located or how + +On line 271: + exactly where it + will be located or how + large the losses and + +On line 273: + will be located + or how large the losses and + spillovers will be."5 In fact, + +On line 273: + be located or + how large the losses and spillovers + will be."5 In fact, there + +On line 273: + located or how + large the losses and spillovers will + be."5 In fact, there were + +On line 273: + how large the losses + and spillovers will be."5 In fact, there + were warning signs. In + +On line 273: + large the losses and + spillovers will be."5 In fact, there were + warning signs. In the + +On line 273: + and spillovers will be."5 In + fact, there were warning signs. In + the decade preceding + +On line 273: + spillovers will be."5 In fact, + there were warning signs. In the + decade preceding the + +On line 273: + fact, there were warning + signs. In the decade preceding + the collapse, there were + +On line 273: + there were warning signs. + In the decade preceding the + collapse, there were many + +On line 273: + warning signs. In the + decade preceding the collapse, + there were many signs that + +On line 273: + there were many signs that + house prices were inflated, that + lending practices had + +On line 273: + many signs that house prices + were inflated, that lending + practices had spun out + +On line 273: + prices were inflated, + that lending practices had spun + out of control, that + +On line 273: + were inflated, that + lending practices had spun out + of control, that too + +On line 273: + that lending practices + had spun out of control, that + too many homeowners + +On line 273: + lending practices had + spun out of control, that too + many homeowners were + +On line 273: + spun out of control, + that too many homeowners were + taking on mortgages + +On line 273: + of control, that too + many homeowners were taking + on mortgages and debt + +On line 273: + control, that too many + homeowners were taking on + mortgages and debt they + +On line 273: + many homeowners were + taking on mortgages and debt + they could ill afford, + +On line 273: + taking on mortgages + and debt they could ill afford, + and that risks to the + +On line 273: + mortgages and debt they + could ill afford, and that risks + to the financial + +On line 273: + and debt they could ill + afford, and that risks to the + financial system + +On line 273: + could ill afford, and + that risks to the financial + system were growing + +On line 273: + afford, and that risks + to the financial system + were growing unchecked. Alarm + +On line 273: + were clanging inside + financial institutions, + regulatory + +On line 273: + organizations, + state law enforcement agencies, + and corporations + +On line 273: + state law enforcement + agencies, and corporations + throughout America, + +On line 273: + enforcement agencies, + and corporations throughout + America, as well + +On line 273: + and corporations + throughout America, as well + as in neighborhoods + +On line 273: + throughout America, + as well as in neighborhoods + across the country. Many + +On line 273: + in neighborhoods across + the country. Many knowledgeable + executives saw + +On line 273: + to avoid the train wreck. + While countless Americans joined + in the financial + +On line 273: + Americans joined in + the financial euphoria + that seized the nation, + +On line 273: + others were shouting + to government officials + in Washington and + +On line 273: + in Washington and + within state legislatures, + pointing to what would + +On line 273: + to what would become + a human disaster, not + just an economic + +On line 275: + disaster, not just + an economic debacle. + "Everybody in the + +On line 275: + just an economic + debacle. "Everybody in + the whole world knew that + +On line 275: + "Everybody in the + whole world knew that the mortgage + bubble was there," said + +On line 275: + in the whole world knew + that the mortgage bubble was + there," said Richard Breeden, + +On line 275: + the whole world knew that + the mortgage bubble was there," + said Richard Breeden, the + +On line 275: + the mortgage bubble + was there," said Richard Breeden, the + former chairman of + +On line 275: + there," said Richard Breeden, + the former chairman of the + Securities and + +On line 275: + the former chairman + of the Securities and + Exchange Commission + +On line 275: + Exchange Commission + appointed by President + George H. W. Bush. "I + +On line 275: + President George H. + W. Bush. "I mean, it wasn’t + hidden. You cannot + +On line 275: + George H. W. Bush. "I + mean, it wasn’t hidden. You + cannot look at any + +On line 275: + W. Bush. "I mean, it + wasn’t hidden. You cannot + look at any of this + +On line 275: + "I mean, it wasn’t + hidden. You cannot look at + any of this and say + +On line 275: + it wasn’t hidden. + You cannot look at any of + this and say that the + +On line 275: + You cannot look at + any of this and say that the + regulators did + +On line 275: + at any of this and + say that the regulators + did their job. This was + +On line 275: + any of this and say + that the regulators did + their job. This was not + +On line 275: + of this and say that + the regulators did their + job. This was not some + +On line 275: + the regulators + did their job. This was not some + hidden problem. It + +On line 275: + did their job. This was + not some hidden problem. It + wasn’t out on Mars + +On line 275: + was not some hidden + problem. It wasn’t out on + Mars or Pluto or + +On line 275: + some hidden problem. + It wasn’t out on Mars or + Pluto or somewhere. + +On line 275: + problem. It wasn’t + out on Mars or Pluto or + somewhere. It was right + +On line 275: + It wasn’t out on + Mars or Pluto or somewhere. + It was right here. You + +On line 275: + wasn’t out on Mars + or Pluto or somewhere. It + was right here. You can’t + +On line 275: + on Mars or Pluto + or somewhere. It was right here. + You can’t make trillions + +On line 275: + Mars or Pluto or + somewhere. It was right here. You + can’t make trillions of + +On line 275: + Pluto or somewhere. + It was right here. You can’t make + trillions of dollars’ + +On line 275: + or somewhere. It was + right here. You can’t make trillions + of dollars’ worth of + +On line 275: + It was right here. You + can’t make trillions of dollars’ + worth of mortgages and + +On line 275: + was right here. You can’t + make trillions of dollars’ worth + of mortgages and not + +On line 275: + right here. You can’t make + trillions of dollars’ worth of + mortgages and not have + +On line 275: + You can’t make trillions + of dollars’ worth of mortgages + and not have people + +On line 277: + trillions of dollars’ + worth of mortgages and not have + people notice."6 Paul + +On line 277: + of dollars’ worth of + mortgages and not have people + notice."6 Paul McCulley, a + +On line 277: + worth of mortgages and + not have people notice."6 Paul + McCulley, a managing + +On line 277: + notice."6 Paul McCulley, a + managing director at + PIMCO, one of the + +On line 277: + McCulley, a managing + director at PIMCO, one + of the nation’s largest + +On line 277: + one of the nation’s + largest money management firms, + told the Commission + +On line 277: + of the nation’s largest + money management firms, told + the Commission that + +On line 277: + money management + firms, told the Commission that + he and his colleagues + +On line 277: + management firms, told + the Commission that he and + his colleagues began + +On line 277: + the Commission that + he and his colleagues began + to get worried about + +On line 277: + he and his colleagues + began to get worried about + "serious signs of + +On line 277: + colleagues began to + get worried about "serious + signs of bubbles" in + +On line 277: + to get worried about + "serious signs of bubbles" + in they therefore sent + +On line 279: + signs of bubbles" in + they therefore sent out credit + analysts to cities + +On line 279: + in they therefore sent + out credit analysts to + cities to do what he + +On line 279: + they therefore sent out + credit analysts to cities + to do what he called + +On line 279: + cities to do what he + called "old-fashioned shoe-leather research," + talking to real + +On line 279: + shoe-leather research," talking + to real estate brokers, + mortgage brokers, and + +On line 279: + to real estate + brokers, mortgage brokers, and + local investors about + +On line 279: + brokers, and local + investors about the housing and + mortgage markets. They + +On line 279: + and local investors + about the housing and mortgage + markets. They witnessed + +On line 279: + and mortgage markets. + They witnessed what he called "the + outright degradation + +On line 279: + They witnessed what he + called "the outright degradation + of underwriting + +On line 279: + outright degradation + of underwriting standards," + McCulley asserted, and + +On line 279: + of underwriting + standards," McCulley asserted, and + they shared what they had + +On line 279: + McCulley asserted, and + they shared what they had learned when + they got back home to + +On line 279: + asserted, and they + shared what they had learned when they + got back home to the + +On line 279: + and they shared what they + had learned when they got back home + to the company’s + +On line 279: + shared what they had learned + when they got back home to the + company’s Newport + +On line 279: + when they got back home + to the company’s Newport + Beach, California, + +On line 279: + to the company’s + Newport Beach, California, + headquarters. "And when + +On line 279: + when our group came back, + they reported what they saw, + and we adjusted + +On line 279: + our group came back, they + reported what they saw, and + we adjusted our + +On line 279: + reported what they + saw, and we adjusted our + risk accordingly," + +On line 279: + and we adjusted + our risk accordingly," McCulley + told the Commission. + +On line 279: + we adjusted our + risk accordingly," McCulley told + the Commission. The + +On line 281: + those who remembered + the savings and loan crisis, + knew that age-old rules of + +On line 281: + the savings and loan + crisis, knew that age-old rules of + prudent lending had + +On line 281: + loan crisis, knew that + age-old rules of prudent lending + had been cast aside. Arnold + +On line 281: + knew that age-old rules of + prudent lending had been cast + aside. Arnold Cattani, the + +On line 281: + age-old rules of prudent + lending had been cast aside. Arnold + Cattani, the chairman + +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: + Commission that he + grew uncomfortable with the + "pure lunacy" he + +On line 281: + grew uncomfortable + with the "pure lunacy" he + saw in the local + +On line 281: + lunacy" he saw + in the local home-building + market, fueled by + +On line 281: + saw in the local + home-building market, fueled + by "voracious" Wall + +On line 281: + home-building market, + fueled by "voracious" Wall + Street investment banks; + +On line 281: + investment banks; he + thus opted out of certain + kinds of investments + +On line 283: + thus opted out of + certain kinds of investments + by William Martin, the + +On line 283: + of certain kinds of + investments by William Martin, + the vice chairman and + +On line 283: + investments by William + Martin, the vice chairman and + chief executive + +On line 283: + vice chairman and chief + executive officer + of Service 1st Bank + +On line 283: + chief executive + officer of Service 1st + Bank of Nevada, told + +On line 283: + of Service 1st Bank + of Nevada, told the FCIC that + the desire for a + +On line 283: + Service 1st Bank of + Nevada, told the FCIC that the + desire for a "high + +On line 283: + 1st Bank of Nevada, + told the FCIC that the desire + for a "high and quick + +On line 283: + of Nevada, told the + FCIC that the desire for a + "high and quick return" + +On line 283: + FCIC that the desire + for a "high and quick return" + blinded people to + +On line 283: + the desire for a + "high and quick return" blinded + people to fiscal + +On line 283: + "high and quick return" + blinded people to fiscal + realities. "You + +On line 283: + blinded people to + fiscal realities. "You + may recall Tommy + +On line 283: + realities. "You + may recall Tommy Lee Jones + in Men in Black, where + +On line 283: + may recall Tommy + Lee Jones in Men in Black, where + he holds a device + +On line 283: + recall Tommy Lee + Jones in Men in Black, where he + holds a device in + +On line 283: + Tommy Lee Jones in + Men in Black, where he holds a + device in the air, + +On line 283: + Lee Jones in Men in + Black, where he holds a device + in the air, and with + +On line 283: + Jones in Men in Black, + where he holds a device in + the air, and with a + +On line 283: + in Men in Black, where + he holds a device in the + air, and with a bright + +On line 283: + Men in Black, where he + holds a device in the air, + and with a bright flash + +On line 283: + in Black, where he holds + a device in the air, and + with a bright flash wipes + +On line 283: + Black, where he holds a + device in the air, and with + a bright flash wipes clean + +On line 283: + a device in the + air, and with a bright flash wipes + clean the memories + +On line 283: + device in the air, + and with a bright flash wipes clean + the memories of + +On line 283: + air, and with a bright + flash wipes clean the memories + of everyone who + +On line 283: + and with a bright flash + wipes clean the memories of + everyone who has + +On line 283: + bright flash wipes clean the + memories of everyone + who has witnessed an + +On line 283: + the memories of + everyone who has witnessed + an alien event," he said.9 + +On line 285: + of everyone who + has witnessed an alien event," he + said.9 Unlike so many + +On line 285: + who has witnessed an + alien event," he said.9 Unlike so + many other bubbles—tulip + +On line 285: + has witnessed an alien + event," he said.9 Unlike so many + other bubbles—tulip bulbs + +On line 285: + event," he said.9 Unlike + so many other bubbles—tulip bulbs + in Holland in the + +On line 285: + he said.9 Unlike so + many other bubbles—tulip bulbs in + Holland in the 1600s, + +On line 285: + many other bubbles—tulip + bulbs in Holland in the 1600s, + South Sea stocks in the + +On line 285: + other bubbles—tulip bulbs + in Holland in the 1600s, South + Sea stocks in the 1700s, + +On line 285: + bulbs in Holland in + the 1600s, South Sea stocks in the + 1700s, Internet stocks + +On line 285: + in Holland in the + 1600s, South Sea stocks in the 1700s, + Internet stocks in + +On line 285: + in the 1600s, South Sea + stocks in the 1700s, Internet + stocks in the late 1990s—this + +On line 285: + the 1600s, South Sea stocks + in the 1700s, Internet stocks + in the late 1990s—this one + +On line 285: + South Sea stocks in the + 1700s, Internet stocks in the + late 1990s—this one involved + +On line 285: + Sea stocks in the 1700s, + Internet stocks in the late + 1990s—this one involved not + +On line 285: + 1700s, Internet stocks + in the late 1990s—this one involved + not just another + +On line 285: + in the late 1990s—this one + involved not just another + commodity but + +On line 285: + one involved not just + another commodity + but a building block + +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: + Children usually + go to schools linked to their home + addresses; local + +On line 285: + go to schools linked to + their home addresses; local + governments decide + +On line 285: + their home addresses; + local governments decide + how much money they + +On line 285: + addresses; local + governments decide how much + money they can spend + +On line 285: + governments decide + how much money they can spend + on roads, firehouses, + +On line 285: + how much money they + can spend on roads, firehouses, + and public safety + +On line 285: + much money they can + spend on roads, firehouses, and + public safety based + +On line 285: + on roads, firehouses, + and public safety based on + how much property + +On line 285: + roads, firehouses, and + public safety based on how + much property tax + +On line 285: + and public safety + based on how much property + tax revenue they have; + +On line 285: + public safety based + on how much property tax + revenue they have; house + +On line 285: + safety based on how + much property tax revenue + they have; house prices are + +On line 285: + how much property + tax revenue they have; house prices + are tied to consumer + +On line 285: + tax revenue they have; + house prices are tied to consumer + spending. Downturns in + +On line 285: + spending. Downturns in + the housing industry can + cause ripple effects + +On line 289: + cause ripple effects + almost everywhere. When the + Federal Reserve + +On line 289: + almost everywhere. + When the Federal Reserve + cut interest rates + +On line 289: + When the Federal + Reserve cut interest rates + early in the new + +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 + +On line 289: + withdraw equity + built up over previous decades + and to consume more, + +On line 289: + equity built up + over previous decades and to + consume more, despite + +On line 289: + over previous decades + and to consume more, despite + stagnant wages. Home sales + +On line 289: + decades and to consume + more, despite stagnant wages. Home + sales volume started + +On line 289: + and to consume more, + despite stagnant wages. Home sales + volume started to + +On line 289: + consume more, despite + stagnant wages. Home sales volume + started to increase, + +On line 289: + stagnant wages. Home sales + volume started to increase, + and average home + +On line 289: + sales volume started + to increase, and average + home prices nationwide + +On line 289: + volume started to + increase, and average home + prices nationwide climbed, + +On line 289: + and average home + prices nationwide climbed, rising + in eight years by one + +On line 289: + prices nationwide climbed, + rising in eight years by one + measure and hitting + +On line 289: + rising in eight years + by one measure and hitting + a national high + +On line 289: + years by one measure + and hitting a national + high of in early + +On line 289: + by one measure and + hitting a national high + of in early Home + +On line 289: + measure and hitting + a national high of in + early Home prices in + +On line 289: + early Home prices in + many areas skyrocketed: + prices increased nearly + +On line 289: + prices in many areas + skyrocketed: prices increased + nearly two and one-half + +On line 289: + skyrocketed: prices + increased nearly two and one-half + times in Sacramento, + +On line 289: + increased nearly two + and one-half times in Sacramento, + for example, in + +On line 289: + two and one-half times in + Sacramento, for example, + in just five years,12 and + +On line 289: + times in Sacramento, + for example, in just five + years,12 and shot up by + +On line 289: + in Sacramento, for + example, in just five years,12 + and shot up by about + +On line 289: + example, in just + five years,12 and shot up by about + the same percentage + +On line 289: + up by about the same + percentage in Bakersfield, + Miami, and Key + +On line 289: + the same percentage + in Bakersfield, Miami, + and Key West. Prices about + +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 289: + San Diego, and West Palm + Beach.13 Housing starts nationwide + climbed from million in + +On line 289: + Diego, and West Palm Beach.13 + Housing starts nationwide climbed + from million in to + +On line 291: + reached a record in the + spring of although it wouldn’t + rise an inch further + +On line 291: + a record in the spring + of although it wouldn’t rise + an inch further even + +On line 291: + record in the spring of + although it wouldn’t rise an + inch further even as + +On line 291: + spring of although it + wouldn’t rise an inch further + even as the mortgage + +On line 291: + although it wouldn’t + rise an inch further even as + the mortgage machine + +On line 291: + wouldn’t rise an inch + further even as the mortgage + machine kept churning + +On line 291: + further even as the + mortgage machine kept churning + for another three + +On line 291: + machine kept churning + for another three years. By + refinancing their + +On line 293: + their homes, Americans + extracted trillion in home + equity between + +On line 293: + equity between + and including billion in + alone, more than seven + +On line 293: + including billion + in alone, more than seven times + the amount they took out + +On line 293: + billion in alone, more + than seven times the amount they + took out in Real + +On line 293: + speculators and + potential homeowners stood + in line outside new + +On line 293: + stood in line outside + new subdivisions for a + chance to buy houses + +On line 293: + new subdivisions + for a chance to buy houses + before the ground had + +On line 293: + for a chance to buy + houses before the ground had + even been broken. By + +On line 293: + chance to buy houses + before the ground had even been + broken. By the first + +On line 293: + buy houses before + the ground had even been broken. + By the first half of + +On line 293: + houses before the + ground had even been broken. By + the first half of more + +On line 293: + before the ground had + even been broken. By the first + half of more than one + +On line 293: + the ground had even been + broken. By the first half of + more than one out of + +On line 293: + had even been broken. + By the first half of more than + one out of every + +On line 293: + even been broken. By + the first half of more than one + out of every ten + +On line 293: + been broken. By the + first half of more than one out + of every ten home + +On line 293: + broken. By the first + half of more than one out of + every ten home sales + +On line 293: + By the first half of + more than one out of every + ten home sales was to + +On line 293: + the first half of more + than one out of every ten + home sales was to an + +On line 293: + half of more than one + out of every ten home sales + was to an investor, + +On line 293: + out of every ten + home sales was to an investor, + speculator, or + +On line 293: + ten home sales was to + an investor, speculator, + or someone buying + +On line 293: + home sales was to an + investor, speculator, or + someone buying a + +On line 293: + was to an investor, + speculator, or someone + buying a second + +On line 293: + or someone buying + a second home.15 Bigger was + better, and even the + +On line 293: + Bigger was better, + and even the structures themselves + ballooned in size; the + +On line 293: + was better, and even + the structures themselves ballooned + in size; the floor area + +On line 293: + better, and even the + structures themselves ballooned in + size; the floor area of + +On line 293: + the structures themselves + ballooned in size; the floor area + of an average + +On line 293: + ballooned in size; the + floor area of an average + new home grew by to + +On line 293: + in size; the floor area + of an average new home + grew by to square feet, + +On line 293: + size; the floor area of + an average new home grew + by to square feet, in + +On line 293: + the floor area of an + average new home grew by + to square feet, in the + +On line 293: + of an average + new home grew by to square feet, + in the decade from to + +On line 295: + average new home + grew by to square feet, in the + decade from to Money + +On line 295: + new home grew by to + square feet, in the decade from to + Money washed through the + +On line 295: + by to square feet, in + the decade from to Money washed + through the economy + +On line 295: + to square feet, in the + decade from to Money washed through + the economy like + +On line 295: + decade from to Money + washed through the economy like + water rushing through + +On line 297: + through a broken dam. + Low interest rates and then + foreign capital + +On line 297: + Low interest rates + and then foreign capital + helped fuel the boom. + +On line 297: + helped fuel the boom. + Construction workers, landscape + architects, real + +On line 297: + the boom. Construction + workers, landscape architects, + real estate agents, + +On line 297: + real estate agents, + loan brokers, and appraisers + profited on Main + +On line 297: + profited on Main + Street, while investment bankers and + traders on Wall Street moved + +On line 297: + Street, while investment + bankers and traders on Wall Street moved + even higher on the + +On line 297: + bankers and traders on Wall + Street moved even higher on the + American earnings + +On line 297: + on Wall Street moved even + higher on the American + earnings pyramid and + +On line 297: + Street moved even higher + on the American earnings + pyramid and the share + +On line 297: + even higher on the + American earnings pyramid + and the share prices of + +On line 297: + American earnings + pyramid and the share prices of + the most aggressive + +On line 297: + pyramid and the share + prices of the most aggressive + financial service + +On line 297: + firms reached all-time + highs.16 Homeowners pulled cash out + of their homes to send + +On line 297: + reached all-time highs.16 + Homeowners pulled cash out of + their homes to send their + +On line 297: + highs.16 Homeowners pulled + cash out of their homes to send + their kids to college, + +On line 297: + Homeowners pulled cash + out of their homes to send their + kids to college, pay + +On line 297: + cash out of their homes + to send their kids to college, + pay medical bills, + +On line 297: + to send their kids to + college, pay medical bills, + install designer + +On line 297: + their kids to college, + pay medical bills, install + designer kitchens with + +On line 297: + pay medical bills, + install designer kitchens with + granite counters, take + +On line 297: + install designer + kitchens with granite counters, take + vacations, or launch + +On line 297: + vacations, or launch + new businesses. They also + paid off credit cards, + +On line 297: + new businesses. They + also paid off credit cards, + even as personal + +On line 297: + as personal debt + rose nationally. Survey + evidence shows that + +On line 297: + rose nationally. + Survey evidence shows that + about of homeowners + +On line 297: + Survey evidence + shows that about of homeowners + pulled out cash to buy + +On line 297: + homeowners pulled out + cash to buy a vehicle + and over spent the cash + +On line 297: + pulled out cash to buy + a vehicle and over spent + the cash on a catch-all + +On line 297: + buy a vehicle + and over spent the cash on a + catch-all category + +On line 297: + the cash on a catch-all + category including + tax payments, clothing, + +On line 297: + tax payments, clothing, + gifts, and living expenses.17 + Renters used new forms of + +On line 297: + payments, clothing, gifts, + and living expenses.17 Renters + used new forms of loans + +On line 297: + living expenses.17 + Renters used new forms of loans to + buy homes and to move + +On line 297: + homes and to move to + suburban subdivisions, + erect-ing swing sets in + +On line 297: + move to suburban + subdivisions, erect-ing swing + sets in their backyards + +On line 297: + erect-ing swing sets in + their backyards and enrolling their + children in local + +On line 299: + sets in their backyards + and enrolling their children in + local schools. In an + +On line 299: + backyards and enrolling + their children in local schools. + In an interview + +On line 299: + an interview with + the Commission, Angelo + Mozilo, the longtime + +On line 299: + the longtime CEO of + Countrywide Financial—a lender + brought down by its risky + +On line 299: + CEO of Countrywide + Financial—a lender brought down by + its risky mortgages—said + +On line 301: + lender brought down by its + risky mortgages—said that a "gold + rush" mentality + +On line 301: + risky mortgages—said that + a "gold rush" mentality + overtook the country + +On line 301: + rush" mentality + overtook the country during + these years, and that he + +On line 301: + overtook the country + during these years, and that he + was swept up in it + +On line 301: + the country during + these years, and that he was swept + up in it as well: + +On line 301: + during these years, and + that he was swept up in it + as well: "Housing prices + +On line 301: + and that he was swept + up in it as well: "Housing + prices were rising so + +On line 301: + he was swept up in + it as well: "Housing prices were + rising so rapidly—at + +On line 301: + swept up in it as + well: "Housing prices were rising + so rapidly—at a rate + +On line 301: + up in it as well: + "Housing prices were rising so + rapidly—at a rate that + +On line 301: + as well: "Housing prices + were rising so rapidly—at a + rate that I’d never + +On line 301: + well: "Housing prices were + rising so rapidly—at a rate + that I’d never seen + +On line 301: + rising so rapidly—at + a rate that I’d never seen + in my years in the + +On line 301: + so rapidly—at a rate + that I’d never seen in my + years in the business—that + +On line 301: + that I’d never seen + in my years in the business—that + people, regular + +On line 301: + never seen in my + years in the business—that people, + regular people, + +On line 301: + in my years in the + business—that people, regular + people, average + +On line 301: + years in the business—that + people, regular people, + average people + +On line 301: + people, regular + people, average people + got caught up in the + +On line 301: + regular people, + average people got caught + up in the mania + +On line 301: + people, average + people got caught up in the + mania of buying + +On line 301: + average people + got caught up in the mania + of buying a house, + +On line 301: + people got caught up + in the mania of buying + a house, and flipping + +On line 301: + in the mania of + buying a house, and flipping + it, making money. + +On line 301: + buying a house, and + flipping it, making money. + It was happening. + +On line 303: + a house, and flipping + it, making money. It was + happening. They buy + +On line 303: + flipping it, making + money. It was happening. + They buy a house, make + +On line 303: + it, making money. + It was happening. They buy + a house, make and talk + +On line 303: + making money. It + was happening. They buy a + house, make and talk at + +On line 303: + was happening. They + buy a house, make and talk at + a cocktail party + +On line 303: + happening. They buy + a house, make and talk at a + cocktail party about + +On line 303: + house, make and talk at + a cocktail party about it. + Housing suddenly + +On line 303: + a cocktail party + about it. Housing suddenly + went from being part + +On line 303: + cocktail party about + it. Housing suddenly went + from being part of + +On line 303: + Housing suddenly + went from being part of the + American dream to + +On line 303: + went from being part + of the American dream to + house my family + +On line 303: + from being part of + the American dream to house + my family to + +On line 303: + of the American + dream to house my family + to settle down—it + +On line 303: + house my family + to settle down—it became + a commodity. + +On line 303: + my family to + settle down—it became a + commodity. That + +On line 303: + to settle down—it + became a commodity. + That was a change in + +On line 303: + down—it became a + commodity. That was a + change in the culture. + +On line 305: + That was a change in + the culture. It was sudden, + unexpected."18 On + +On line 305: + in the culture. It + was sudden, unexpected."18 + On the surface, it + +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 + +On line 305: + called securities, + which kept cash flowing from Wall + Street into the U.S. + +On line 305: + which kept cash flowing + from Wall Street into the U.S. + housing market—were tools + +On line 305: + cash flowing from Wall + Street into the U.S. housing + market—were tools that had + +On line 305: + from Wall Street into + the U.S. housing market—were tools + that had worked well for + +On line 305: + Wall Street into the + U.S. housing market—were tools that + had worked well for many + +On line 305: + Street into the U.S. + housing market—were tools that had + worked well for many years. + +On line 307: + U.S. housing market—were + tools that had worked well for many + years. But underneath, + +On line 307: + tools that had worked well + for many years. But underneath, + something was going + +On line 307: + had worked well for many + years. But underneath, something + was going wrong. Like + +On line 307: + worked well for many years. + But underneath, something was + going wrong. Like a + +On line 307: + years. But underneath, + something was going wrong. Like + a science fiction + +On line 307: + going wrong. Like a + science fiction movie in which + ordinary household + +On line 307: + science fiction movie + in which ordinary household + objects turn hostile, + +On line 307: + in which ordinary + household objects turn hostile, + familiar market + +On line 307: + were being transformed. + The time-tested 30-year fixed-rate mortgage, + with a down payment, + +On line 307: + being transformed. The + time-tested 30-year fixed-rate mortgage, with + a down payment, went + +On line 307: + transformed. The time-tested + 30-year fixed-rate mortgage, with a down + payment, went out of + +On line 307: + The time-tested 30-year fixed-rate + mortgage, with a down payment, + went out of style. There + +On line 307: + mortgage, with a down + payment, went out of style. There + was a burgeoning + +On line 307: + with a down payment, + went out of style. There was a + burgeoning global + +On line 307: + payment, went out of + style. There was a burgeoning + global demand for + +On line 307: + of style. There was a + burgeoning global demand + for residential + +On line 307: + global demand for + residential mortgage–backed + securities that + +On line 307: + securities that + offered seemingly solid + and secure returns. + +On line 307: + offered seemingly + solid and secure returns. + Investors around the world + +On line 307: + seemingly solid + and secure returns. Investors + around the world clamored + +On line 307: + solid and secure + returns. Investors around the world + clamored to purchase + +On line 307: + returns. Investors around + the world clamored to purchase + securities built + +On line 307: + around the world clamored + to purchase securities + built on American + +On line 307: + built on American + real estate, seemingly + one of the safest bets + +On line 307: + American real + estate, seemingly one of + the safest bets in the + +On line 309: + estate, seemingly + one of the safest bets in the + world. Wall Street labored + +On line 309: + one of the safest bets + in the world. Wall Street labored + mightily to meet + +On line 309: + safest bets in the world. + Wall Street labored mightily + to meet that demand. + +On line 309: + bets in the world. Wall + Street labored mightily to + meet that demand. Bond + +On line 309: + demand. Bond salesmen + earned multi-million-dollar + bonuses packaging + +On line 309: + bonuses packaging + and selling new kinds of loans, + offered by new kinds + +On line 309: + and selling new kinds + of loans, offered by new kinds + of lenders, into new + +On line 309: + selling new kinds of + loans, offered by new kinds of + lenders, into new kinds + +On line 309: + of loans, offered by + new kinds of lenders, into new + kinds of investment + +On line 309: + offered by new kinds + of lenders, into new kinds of + investment products + +On line 309: + of lenders, into new + kinds of investment products + that were deemed safe but + +On line 309: + into new kinds of + investment products that were + deemed safe but possessed + +On line 309: + kinds of investment + products that were deemed safe but + possessed complex and + +On line 309: + investment products + that were deemed safe but possessed + complex and hidden + +On line 309: + but possessed complex + and hidden risks. Federal + officials praised the + +On line 309: + changes—these financial + innovations, they said, had + lowered borrowing + +On line 309: + innovations, they + said, had lowered borrowing + costs for consumers and + +On line 309: + they said, had lowered + borrowing costs for consumers + and moved risks away from + +On line 309: + lowered borrowing + costs for consumers and moved risks + away from the biggest + +On line 309: + borrowing costs for + consumers and moved risks away from + the biggest and most + +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: + either the captains + of finance or the system’s + public stewards. In + +On line 309: + of finance or the + system’s public stewards. In + fact, some of the largest + +On line 309: + the system’s public + stewards. In fact, some of the + largest institutions + +On line 309: + stewards. In fact, some + of the largest institutions + had taken on what + +On line 309: + fact, some of the largest + institutions had taken + on what would prove to + +On line 309: + on what would prove to + be debilitating risks. + Trillions of dollars + +On line 309: + debilitating + risks. Trillions of dollars had + been wagered on the + +On line 309: + had been wagered on + the belief that housing prices + would always rise and + +On line 309: + been wagered on the + belief that housing prices would + always rise and that + +On line 309: + on the belief that + housing prices would always rise + and that borrowers + +On line 309: + would always rise and + that borrowers would seldom + default on mortgages, + +On line 309: + that borrowers would + seldom default on mortgages, + even as their debt grew. + +On line 309: + would seldom default + on mortgages, even as their debt + grew. Shaky loans had been + +On line 309: + as their debt grew. Shaky + loans had been bundled into + investment products + +On line 309: + grew. Shaky loans had been + bundled into investment + products in ways that + +On line 309: + loans had been bundled + into investment products + in ways that seemed to + +On line 309: + into investment + products in ways that seemed to + give investors the best + +On line 309: + products in ways that + seemed to give investors the best + of both worlds—high-yield, + +On line 309: + in ways that seemed to + give investors the best of both + worlds—high-yield, risk-free—but + +On line 309: + seemed to give investors + the best of both worlds—high-yield, + risk-free—but instead, in + +On line 309: + worlds—high-yield, risk-free—but + instead, in many cases, would + prove to be high-risk + +On line 309: + risk-free—but instead, in + many cases, would prove to be + high-risk and yield-free. + +On line 311: + many cases, would prove + to be high-risk and yield-free. + All this financial + +On line 311: + to be high-risk and + yield-free. All this financial + creativity was + +On line 311: + and yield-free. All this + financial creativity + was a lot "like cheap + +On line 311: + All this financial + creativity was a lot + "like cheap sangria," said + +On line 311: + Mayo, a managing + director and financial + services analyst + +On line 311: + financial services + analyst at Calyon + Securities (USA) + +On line 311: + repackaged to sell at + a premium," he told the + Commission. "It might + +On line 311: + at a premium," + he told the Commission. "It + might taste good for a + +On line 311: + a premium," he + told the Commission. "It might + taste good for a while, + +On line 311: + premium," he told + the Commission. "It might taste + good for a while, but + +On line 311: + told the Commission. + "It might taste good for a while, + but then you get headaches + +On line 311: + Commission. "It might + taste good for a while, but then + you get headaches later + +On line 311: + "It might taste good for + a while, but then you get headaches + later and you have + +On line 311: + taste good for a while, + but then you get headaches later + and you have no idea + +On line 311: + good for a while, but + then you get headaches later and + you have no idea what’s + +On line 311: + while, but then you get + headaches later and you have no + idea what’s really + +On line 313: + really inside."19 + The securitization + machine began to + +On line 313: + began to guzzle + these once-rare mortgage products + with their strange-sounding + +On line 313: + these once-rare mortgage + products with their strange-sounding + names: Alt-A, subprime, I-O + +On line 313: + strange-sounding names: Alt-A, + subprime, I-O (interest-only), + low-doc, no-doc, or + +On line 313: + I-O (interest-only), + low-doc, no-doc, or ninja + (no income, no job, + +On line 313: + low-doc, no-doc, or + ninja (no income, no job, + no assets) loans; 2–28s + +On line 313: + (no income, no job, + no assets) loans; 2–28s and 3–27s; + liar loans; piggyback + +On line 313: + 2–28s and 3–27s; liar loans; + piggyback second mortgages; + payment-option or + +On line 313: + piggyback second + mortgages; payment-option or + pick-a-pay adjustable + +On line 313: + pick-a-pay adjustable + rate mortgages. New variants on + adjustable-rate mortgages, called + +On line 313: + variants on adjustable-rate + mortgages, called "exploding" ARMs, + featured low monthly + +On line 313: + on adjustable-rate mortgages, + called "exploding" ARMs, featured + low monthly costs at + +On line 313: + adjustable-rate mortgages, called + "exploding" ARMs, featured low + monthly costs at first, + +On line 313: + called "exploding" ARMs, + featured low monthly costs at + first, but payments could + +On line 313: + featured low monthly + costs at first, but payments could + suddenly double + +On line 313: + monthly costs at first, + but payments could suddenly + double or triple, if + +On line 313: + at first, but payments + could suddenly double or + triple, if borrowers + +On line 313: + first, but payments could + suddenly double or triple, + if borrowers were + +On line 313: + double or triple, if + borrowers were unable to + refinance. Loans with + +On line 313: + triple, if borrowers + were unable to refinance. + Loans with negative + +On line 313: + of different kinds + of mortgages available on the + market, confounding + +On line 313: + of mortgages available + on the market, confounding + consumers who didn’t + +On line 313: + examine the fine + print, baffling conscientious + borrowers who tried + +On line 313: + the fine print, baffling + conscientious borrowers + who tried to puzzle + +On line 313: + who tried to puzzle + out their implications, and + opening the door for + +On line 313: + to puzzle out their + implications, and opening + the door for those who + +On line 313: + their implications, + and opening the door for those + who wanted in on + +On line 313: + implications, and + opening the door for those who + wanted in on the + +On line 315: + opening the door for + those who wanted in on the + action. Many people + +On line 315: + who wanted in on + the action. Many people chose + poorly. Some people + +On line 315: + in on the action. + Many people chose poorly. Some + people wanted to + +On line 315: + people chose poorly. + Some people wanted to live + beyond their means, and + +On line 315: + people wanted to + live beyond their means, and by + mid-2005, nearly one-quarter + +On line 315: + live beyond their means, + and by mid-2005, nearly one-quarter + of all borrowers + +On line 315: + of all borrowers + nationwide were taking out + interest-only loans + +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: + because that was the + only way they could get a + foothold in areas such + +On line 315: + that was the only + way they could get a foothold in + areas such as the + +On line 315: + way they could get a + foothold in areas such as the + sky-high California + +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: + Georgia became a + particular target for + investors who used these + +On line 315: + a particular + target for investors who used + these loans to acquire + +On line 315: + target for investors + who used these loans to acquire + real estate.22 Some + +On line 315: + to acquire real + estate.22 Some were misled by + salespeople who came + +On line 315: + real estate.22 Some + were misled by salespeople + who came to their homes + +On line 315: + Some were misled by + salespeople who came to their + homes and persuaded + +On line 315: + who came to their homes + and persuaded them to sign + loan documents on + +On line 315: + came to their homes and + persuaded them to sign loan + documents on their + +On line 315: + homes and persuaded + them to sign loan documents + on their kitchen tables. + +On line 315: + and persuaded them + to sign loan documents on + their kitchen tables. Some + +On line 315: + their kitchen tables. Some + borrowers naively trusted + mortgage brokers who + +On line 315: + mortgage brokers who + earned more money placing them + in risky loans than in + +On line 315: + brokers who earned more + money placing them in risky + loans than in safe ones.23 + +On line 315: + who earned more money + placing them in risky loans than + in safe ones.23 With these + +On line 315: + money placing them + in risky loans than in safe ones.23 + With these loans, buyers + +On line 315: + placing them in risky + loans than in safe ones.23 With these + loans, buyers were able + +On line 315: + in risky loans than in + safe ones.23 With these loans, buyers + were able to bid up + +On line 315: + risky loans than in safe + ones.23 With these loans, buyers were + able to bid up the + +On line 315: + loans than in safe ones.23 + With these loans, buyers were able + to bid up the prices + +On line 315: + than in safe ones.23 With + these loans, buyers were able to + bid up the prices of + +On line 315: + safe ones.23 With these loans, + buyers were able to bid up + the prices of houses + +On line 315: + With these loans, buyers + were able to bid up the prices + of houses even if + +On line 315: + these loans, buyers were + able to bid up the prices of + houses even if they + +On line 315: + buyers were able to + bid up the prices of houses + even if they didn’t + +On line 315: + were able to bid up + the prices of houses even if + they didn’t have enough + +On line 315: + bid up the prices of + houses even if they didn’t + have enough income to + +On line 315: + of houses even if + they didn’t have enough income + to qualify for + +On line 315: + if they didn’t have + enough income to qualify + for traditional + +On line 315: + they didn’t have enough + income to qualify for + traditional loans. + +On line 317: + to qualify for + traditional loans. Some of + these exotic loans + +On line 317: + for traditional + loans. Some of these exotic + loans had existed + +On line 317: + traditional loans. + Some of these exotic loans + had existed in + +On line 317: + these exotic loans + had existed in the past, + used by high-income, + +On line 317: + in the past, used by + high-income, financially + secure people as + +On line 317: + secure people as + a cash-management tool. Some + had been targeted + +On line 317: + a cash-management + tool. Some had been targeted + to borrowers with + +On line 317: + had been targeted + to borrowers with impaired + credit, offering + +On line 317: + they refinanced. But + the instruments began to + deluge the larger + +On line 317: + larger market in + and The changed occurred "almost + overnight," Faith Schwartz, then an + +On line 317: + and The changed occurred + "almost overnight," Faith Schwartz, then an + executive at + +On line 317: + an executive + at the subprime lender Option + One and later the + +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 317: + most every lender in + the country is in it, one + way or another."24 + +On line 319: + every lender in the + country is in it, one way + or another."24 At + +On line 319: + the country is in + it, one way or another."24 + At first not a lot + +On line 319: + country is in it, + one way or another."24 At + first not a lot of + +On line 319: + is in it, one way + or another."24 At first not + a lot of people + +On line 319: + a lot of people + really understood the + potential hazards + +On line 319: + people really + understood the potential + hazards of these new + +On line 319: + potential hazards + of these new loans. They were new, + they were different, + +On line 319: + of these new loans. They + were new, they were different, + and the consequences + +On line 319: + these new loans. They were + new, they were different, and + the consequences were + +On line 319: + different, and the + consequences were uncertain. + But it soon became + +On line 319: + and the consequences + were uncertain. But it soon + became apparent + +On line 319: + were uncertain. But + it soon became apparent + that what had looked like + +On line 319: + But it soon became + apparent that what had looked + like newfound wealth was + +On line 319: + became apparent + that what had looked like newfound + wealth was a mirage + +On line 319: + apparent that what + had looked like newfound wealth was + a mirage based on + +On line 319: + the United States climbed + from trillion in to trillion + in The mortgage debt + +On line 319: + United States climbed from + trillion in to trillion in + The mortgage debt of + +On line 319: + climbed from trillion in + to trillion in The mortgage + debt of American + +On line 319: + to trillion in The + mortgage debt of American + households rose almost + +On line 319: + in The mortgage debt + of American households rose + almost as much in + +On line 319: + debt of American + households rose almost as much + in the six years from + +On line 319: + American households + rose almost as much in the + six years from to as + +On line 319: + households rose almost + as much in the six years from + to as it had over + +On line 319: + rose almost as much + in the six years from to as + it had over the course + +On line 319: + almost as much in + the six years from to as it + had over the course of + +On line 319: + much in the six years + from to as it had over the + course of the country’s + +On line 319: + in the six years from + to as it had over the course + of the country’s more + +On line 319: + the six years from to + as it had over the course of + the country’s more than + +On line 319: + six years from to as + it had over the course of the + country’s more than 200-year + +On line 319: + to as it had over + the course of the country’s more + than 200-year history. + +On line 319: + as it had over the + course of the country’s more than + 200-year history. The + +On line 319: + it had over the course + of the country’s more than 200-year + history. The amount + +On line 319: + course of the country’s + more than 200-year history. The + amount of mortgage debt + +On line 319: + of the country’s more + than 200-year history. The amount + of mortgage debt per + +On line 319: + than 200-year history. + The amount of mortgage debt per + household rose from in + +On line 319: + history. The amount + of mortgage debt per household + rose from in to in + +On line 319: + amount of mortgage debt + per household rose from in to + in With a simple + +On line 319: + per household rose from + in to in With a simple + flourish of a pen + +On line 319: + rose from in to in + With a simple flourish of + a pen on paper, + +On line 319: + in to in With a + simple flourish of a pen + on paper, millions + +On line 319: + on paper, millions + of Americans traded away + decades of equity + +On line 319: + paper, millions of + Americans traded away decades + of equity tucked + +On line 321: + traded away decades of + equity tucked away in their + homes. Under the radar, + +On line 321: + decades of equity + tucked away in their homes. Under + the radar, the lending + +On line 321: + of equity tucked + away in their homes. Under the + radar, the lending and + +On line 321: + equity tucked away + in their homes. Under the radar, + the lending and the + +On line 321: + tucked away in their homes. + Under the radar, the lending + and the financial + +On line 321: + in their homes. Under + the radar, the lending and the + financial services + +On line 321: + Under the radar, the + lending and the financial + services industry + +On line 321: + financial services + industry had mutated. + In the past, lenders had + +On line 321: + mutated. In the + past, lenders had avoided making + unsound loans because + +On line 321: + In the past, lenders had + avoided making unsound loans + because they would be + +On line 321: + past, lenders had avoided + making unsound loans because + they would be stuck with + +On line 321: + had avoided making + unsound loans because they would + be stuck with them in + +On line 321: + unsound loans because + they would be stuck with them in + their loan portfolios. + +On line 321: + they would be stuck with + them in their loan portfolios. + But because of the + +On line 321: + would be stuck with them + in their loan portfolios. But + because of the growth + +On line 321: + because of the growth + of securitization, + it wasn’t even clear + +On line 321: + clear anymore who the + lender was. The mortgages would be + packaged, sliced, repackaged, + +On line 321: + who the lender was. The + mortgages would be packaged, sliced, + repackaged, insured, and + +On line 321: + lender was. The mortgages + would be packaged, sliced, repackaged, + insured, and sold as + +On line 321: + securities to + an assortment of hungry + investors. Now even the + +On line 321: +