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 +