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Some Quick Takes On The Financial Crisis Inquiry Report

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The official Financial Crisis Inquiry Report by the Financial Crisis Inquiry Commission (FCIC) has become the subject of many turgid commentaries since its January 27 release date.  The Report itself is 633 pages long.  Nevertheless, if you hope to avoid all that reading by relying on reviews of the document, you could easily end up reading 633 pages of commentary about it.  By that point, you might be left with enough questions or curiosity to give up and actually read the whole, damned thing.  (Here it is.)  If you are content with reading the 14 pages of the Commission’s Conclusions, you can find those here.  What follows is my favorite passage from that section:

We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.  More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed 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 at risk, such as the shadow banking system and over-the-counter derivatives markets.  In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor.

In order to help save you some time and trouble, I will provide you with a brief roadmap to some of the commentary that is readily available:

Gretchen Morgenson of The New York Times introduced her own 1,257-word discourse in this way:

For those who might find the report’s 633 pages a bit daunting for a weekend read, we offer a Cliffs Notes version.

Let’s begin with the Federal Reserve, the most powerful of financial regulators.  The report’s most important public service comes in its recitation of how top Fed officials, both in Washington and in New York, fiddled while the financial system smoldered and then burned.  It is disturbing indeed that this institution, defiantly inert and uninterested in reining in the mortgage mania, received even greater regulatory powers under the Dodd-Frank law that was supposed to reform our system.

(I find it disturbing that Ms. Morgenson is still fixated on “mortgage mania” as a cause of the crisis after having been upbraided by Barry Ritholtztwice – for “pushing the Fannie-Freddie CRA meme”.)

At her Naked Capitalism blog, Yves Smith focused more intently on what the FCIC Report didn’t say, as opposed to what it actually said:

The FCIC has also been unduly close-lipped about their criminal referrals, refusing to say how many they made or giving a high-level description of the type of activities they encouraged prosecutors to investigate.  By contrast, the Valukas report on the Lehman bankruptcy discussed in some detail whether it thought civil or criminal charges could be brought against Lehman CEO Richard Fuld and chief financial officers chiefs Chris O’Meara, Erin Callan and Ian I Lowitt, and accounting firm Ernst & Young.  If a report prepared in a private sector action can discuss liability and name names, why is the public not entitled to at least some general disclosure on possible criminal actions coming out of a taxpayer funded effort?  Or is it that the referrals were merely to burnish the image of the report, and are expected to die a speedy death?

At his Calculated Risk blog, Bill McBride corroborated one of the Report’s Conclusions, by recounting his own experience.  After quoting some of the language supporting the point that the crisis could have been avoided if the warning signs had not been ignored, due to the “pervasive permissiveness” at the Federal Reserve, McBride recalled a specific example:

This is absolutely correct.  In 2005 I was calling regulators and I was told they were very concerned – and several people told me confidentially that the political appointees were blocking all efforts to tighten standards – and one person told me “Greenspan is throwing his body in front of all efforts to tighten standards”.

The dissenting views that discount this willful lack of regulation are absurd and an embarrassment for the authors.

William Black wrote an essay criticizing the dissenters themselves – based on their experience in developing the climate of financial deregulation that facilitated the crisis:

The Commission is correct.  Absent the crisis was avoidable.  The scandal of the Republican commissioners’ apologia for their failed anti-regulatory policies was also avoidable.  The Republican Congressional leadership should have ensured that it did not appoint individuals who would be in the impossible position of judging themselves.  Even if the leadership failed to do so and proposed such appointments, the appointees to the Commission should have recognized the inherent conflict of interest and displayed the integrity to decline appointment.  There were many Republicans available with expertise in, for example, investigating elite white-collar criminals regardless of party affiliation.  That was the most relevant expertise needed on the Commission.

At this point, the important question is whether the efforts of the Financial Crisis Inquiry Commission will result in any changes that could help us avoid another disaster.  I’m not feeling too hopeful.


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Everyone Knew About Lehman Brothers

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March 19, 2010

A March 18 report by Henny Sender at the Financial Times revealed that former officials from Merrill Lynch had contacted the Securities and Exchange Commission as well as the Federal Reserve of New York to complain that Lehman Brothers had been incorrectly calculating a key measure of its financial health.  The regulators received this warning several months before Lehman filed for bankruptcy in September of 2008.  Apparently Lehman’s reports of robust financial health were making Merrill look bad:

Former Merrill Lynch officials said they contacted regulators about the way Lehman measured its liquidity position for competitive reasons.  The Merrill officials said they were coming under pressure from their trading partners and investors, who feared that Merrill was less liquid than Lehman.

*   *   *

In the account given by the Merrill officials, the SEC, the lead regulator, and the New York Federal Reserve were given warnings about Lehman’s balance sheet calculations as far back as March 2008.

*   *   *

The former Merrill officials said they contacted the regulators after Lehman released an estimate of its liquidity position in the first quarter of 2008.  Lehman touted its results to its counterparties and its investors as proof that it was sounder than some of its rivals, including Merrill, these people said.

*   *   *

“We started getting calls from our counterparties and investors in our debt.  Since we didn’t believe the Lehman numbers and thought their calculations were aggressive, we called the regulators,” says one former Merrill banker, now at another big bank.

Could the people at Merrill Lynch have expected the New York Fed to intervene and prevent the accounting chicanery at Lehman?  After all, Lehman’s CEO, Richard Fuld, was also a class B director of the New York Fed.  Would any FRBNY investigator really want to make trouble for one of the directors of his or her employer?  This type of conflict of interest is endemic to the self-regulatory milieu presided over by the Federal Reserve.  When people talk about protecting “Fed independence”, I guess this is what they mean.

The Financial Times report inspired Yves Smith of Naked Capitalism to emphasize that the New York Fed’s failure to do its job, having been given this additional information from Merrill officials, underscores the ineptitude of the New York Fed’s president at the time — Tim Geithner:

The fact that Merrill, with a little digging, could see that Lehman’s assertions about its financial health were bogus says other firms were likely to figure it out sooner rather than later.  That in turn meant that the Lehman was extremely vulnerable to a run.  Bear was brought down in a mere ten days.  Having just been through the Bear implosion, the warning should have put the authorities in emergency preparedness overdrive.  Instead, they went into “Mission Accomplished” mode.

This Financial Times story provides yet more confirmation that Geithner is not fit to serve as a regulator and should resign as Treasury Secretary.  But it may take Congress forcing a release of the Lehman-related e-mails and other correspondence by the New York Fed to bring about that outcome.

Those “Lehman-related e-mails” should be really interesting.  If Richard Fuld was a party to any of those, it will be interesting to note whether his e-mail address was “@LehmanBros”, “@FRBNY” or both.

The Lehman scandal has come to light at precisely the time when Ben Bernanke is struggling to maintain as much power for the Federal Reserve as he can — in addition to getting control over the proposed Consumer Financial Protection Agency.  One would think that Bernanke is pursuing a lost cause, given the circumstances and the timing.  Nevertheless, as Jesse of Jesse’s Cafe Americain points out — Bernanke may win this fight:

The Fed is the last place that should receive additional power over the banking system, showing itself to be a bureaucracy incapable of exercising the kind of occasionally stern judgment, the tough love, that wayward bankers require.  And the mere thought of putting Consumer Protection under their purview makes one’s skin crawl with fear and the gall of injustice.

They may get it, this more power, not because it is deserved, but because politicians themselves wish to have more power and money, and this is one way to obtain it.

The next time the financial system crashes, the torches and pitchforks will come out of the barns and there will be a serious reform, and some tar and feathering in congressional committees, and a few virtual lynchings.  The damage to the people of the middle class will be an American tragedy.  But this too shall pass.

It’s beginning to appear as though it really will require another financial crisis before our graft-hungry politicians will make any serious effort at financial reform.  If economist Randall Wray is correct, that day may be coming sooner than most people expect:

Another financial crisis is nearly certain to hit in coming months — probably before summer.  The belief that together Geithner and Bernanke have resolved the crisis and that they have put the economy on a path to recovery will be exposed as wishful thinking.

Although that may sound a bit scary, we have to look at the bright side:  at least we will finally be on a path toward serious financial reform.



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