Today the Financial Crisis Inquiry Commission released its long-awaited report ( The Financial Crisis Inquiry Report: Financial Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States). The Report of the ten-member, bipartisan Commission, consists of the official report adopted by a majority (six) of the commissioners, including the chairman Phil Angelides (408 pages plus 13 pages of summary, referred to here as “the Report”), a dissenting statement by Republican members, Bill Thomas (vice chairman), Keith Hennessey and Douglas Holtz-Eakin (limited per Commission rules to 26 pages, referred to as the “Thomas dissent”), and a separate dissenting statement by Peter J. Wallison, also limited in length (referred to as the “Wallison dissent”). Mr. Wallison has supplemented his statement with a much longer version separately available.
Obviously a report of this length covers many complicated issues. It is going to be ensnared in adversary politics. Nevertheless, it is very high quality. Together with the thoughtful Thomas dissent, the overall report provides us much considered insight and lessons for the future. It represents two different and not incompatible ways to understand the Crisis. In another time, these views could have been blended into one truly outstanding analysis, but such is the atmosphere in America today, even after the Arizona shootings, that we may be expecting too much to hope for unanimity. Indeed, juxtaposed as they are, the majority and dissenting views provide a case study in themselves on the perplexity of financial crises and how to think about them.
But first let me say a few words about the Wallison dissent.
Mr. Wallison believes that the Commission never seriously tried to understand the real cause of the crisis, that members of the commission were essentially railroaded by closed-door determinations as to what questions would be asked, which hearings to hold and who would be interviewed, and that the interviews were sometimes themselves held behind closed doors. He says that the question he has most frequently been asked is “why Congress bothered to authorize [the Commission] at all” because Congress went ahead anyway and enacted the Dodd-Frank Act without waiting for the report. In Mr. Wallison’s view the real cause of the crisis was the Clinton-Bush-promoted government housing policy from 1997 – 2007. The chief miscreants were the GSEs, Fannie Mae and Freddy Mac, the Community Reinvestment Act (CRA), and subprime lending “best practices.” In this climate, he argues, the GSEs and insured banks facing a CRA gun to their heads were “compelled to compete for mortgage borrowers who were at or below the median income in the areas in which they lived.”
The Report debunks this tired old shibboleth by correctly noting that CRA requirements were minuscule in proportion to the scale of lending involved, and by noting the fact that private financial institution securitization in the area led to a far, far higher rate of default than that done by the GSEs (which was bad enough itself). Mr. Wallison asserts that “deregulation” in the form of the repeal of the Glass-Steagall Act in 1999 had nothing to do with the crisis. One cannot help but get the feeling that he does not fully appreciate how financial entities mutually interact and interconnect in many complex ways (this is one of the reasons sociologists call the industry “tightly coupled”). And to excuse reckless lending by suggesting that banks were under coercion, when most of the toxic lending was in fact originated not by banks but by financial entities that were not even subject to the constraints Mr. Wallison offers as the excuse, reflects a basic misunderstanding about how the CRA applies and is implemented by banks.
The Wallison dissent also says that AIG was the “only company known to have failed because of its CDS obligations . . . and that firm appears to have been an outlier.” Hence it rejects the claim that credit default swaps had anything to do with the crisis. The fact that AIG was the principal player in the field, that almost all, if not all, the major investment and commercial banks were dependent on AIG being able to honor its commitments, and that the government and taxpayers ultimately had to provide more than $180 billion in support for AIG in order to prevent all the others from failing, is totally lost on Mr. Wallison. Hints at the reason for Mr. Wallison’s almost obsessive focus on the Fannie/Freddy alleged cause of the crisis are to be found in a litany of complaints in the latter part of his dissent about being excluded from interviews, his friend’s American Enterprise Institute paper not being circulated by the Commission. and having only 8 days to read the draft report and decide whether to join it. (Has Mr. Wallison ever worked in a busy law firm or company? The Commission was mandated by Congress to get its work done by a deadline, and was not able to meet the deadline as it was.)
The Report itself and the main, Thomas dissent, however, are both worthy of careful study. Using multiple detailed, factual case studies, the Report works its way through the many factors that led up to the Crisis and it concludes that the Crisis could have been avoided were it not for clear human mistakes. Readers will be familiar with all of the suggested reasons for the Crisis, from the orgy of borrowing and lending to the fraud, self-dealing and denial on the part of many players in the industry. The Report correctly places blame on all of us: borrowers who were out of their depth, lenders who lacked discipline and sometimes honesty, corrupt and mismanaged GSEs (Fannie and Freddy), securitizers and distributors who had neither skin in the game nor any incentive to act in the long term interest of investors, shareholders and taxpayers, weak corporate governance, and a Congress and regulators who had the ability but not the fortitude to take preventive action. Paraphrasing Shakespeare, the Report declares that “the fault lies not in the stars, but in us.”
And so this must be with something as systemic as a financial crisis. It is naive to try to pin blame on any one group, though it is even more naive to try to argue, as does Mr. Wallison, that some of the principal players were somehow innocent or helpless victims! Of course our housing policy was based on unrealistic goals, and the GSE system is badly in need of reform. The Report acknowledges this by describing extensively why these policies have failed. But, as Simon Johnson has recently explained, trying to blame the poor for the crisis is simply absurd.
The Report also rightly notes that despite Dodd-Frank we have a lot left to fix:
Our financial system is, in many respects, still unchanged from what existed on the eve of the crisis. Indeed, in the wake of the crisis, the U.S. financial sector is now more concentrated than ever in the hands of a few large, systemically significant institutions.
As Neil Barofsky, the TARP Special Inspector General, said yesterday in his testimony to the House Committee on Oversight and Government Reform (hat tip Jennifer Taub),
In other words, unless and until institutions currently viewed as “too big to fail” are either broken up so that they are no longer perceived to be a threat to the financial system, or a structure is put in place that gives adequate assurance to the market that they will be left to suffer the full consequences of their own recklessness, the prospect of more bailouts will continue to fuel more bad behavior with potentially disastrous results. Thus far, the Dodd-Frank Act appears not to have solved the perception problem.
Whether we have the fortitude to do so remains to be seen.
The Thomas dissent adds more interest to the overall publication. While chiding the main Report for focusing on some aspects that, in the dissenters view were only minor contributors to the crisis (e.g., CRA and the repeal of Glass-Steagall) or are simplistic diagnoses (e.g., “deregulation”), the dissenters ask a number of very valid questions as they try to isolate the “essential” causes (many of which concur with the views expressed in the Report). The dissent rightly notes widely differing conditions–political, institutional, cultural and regulatory–in Europe, where the financial institutions also wrought havoc. One might dispute that these differences were really significant in an increasingly “Americanizing” and tightly coupled world of finance. Nevertheless, it is important to continue exploring these questions. We still don’t have enough answers. The dissent accuses the majority of wanting to give
more an account of bad events than a focused explanation of what happened and why. When everything is important, nothing is.
The problem is that to understand systemic crises everything is important and it is very hard to isolate single causes. Even the list of ten “essential causes” enumerated by the Thomas dissent, none of which is disputed in the Report, is inadequate. One has to understand the dynamic story, and indeed the Thomas dissent itself resorts to the same approach when explaining the “Stages of the Crisis.” While not really explaining why a full dissent was necessary (what about a qualified concurrence?), the dissenters nevertheless make interesting and helpful distinctions between types of systemic risk (“contagion” and “common shock”–actually there are more), and they also rightly observe that, until the major financial plunge,
even larger past wealth losses did not bring the global financial system to its knees. The key differences in this case were leverage and risk concentration. Highly correlated housing risk was concentrated in large and highly leveraged institutions in the United States and much of Europe.
The Commission was charged only with investigating the causes of the Crisis, not coming up with policy solutions. We still have much work to do for the future.
Perhaps the Commission is unduly optimistic to make the general assumption that “this financial crisis was avoidable” (majority) and that we can “avoid the next financial crisis” (Wallison). As with oil drilling disasters, it is doubtful that we can ever completely avoid future problems. What we can do is substantially mitigate them and make them manageable. This means reducing potential shocks to the financial system by reducing the scale of the players that operate within it.
On this reform there is implicit and sometimes even explicit agreement among at least nine members of the Commission.