Analysis and Commentary
Established by Congress in 2009 with an $8 million budget, the Financial Crisis Inquiry Commission consisted of 10 members-six Democrats and four Republicans-who were appointed to investigate the causes underlying the 2007-2009 financial crisis. Recommendations for reform fall under the jurisdiction of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed by Congress in July 2010. The commission focused on several topics underlying the crisis, holding 19 hearings and interviewing 700 witnesses. In January 2011, it produced a majority report signed by the Democrats and two dissenting minority reports, the first from three Republicans, the second from one Republican. The term "report" is used below to refer to the entire set of three reports unless one of the individual reports is specified.
The financial crisis can be distilled into the following scenario: Unsound loans were made and then securitized into investments that were improperly rated by the credit rating agencies. Thereafter, those investments "backed" by troubled mortgages were sold to the public. The majority report concluded that the crisis should have been stopped in its tracks, placing significant blame on governmental agencies, especially the Federal Reserve Board, its recent chairs Ben Bernanke and Alan Greenspan, and the SEC-not to mention the large banks that were deemed too big to fail. The majority report contends that inconsistent treatment of, for example, American International Group (AIG), which was allowed to stay in business, and Lehman Brothers, which was allowed to collapse, sent confusing signals to the market on the role of the government in winding down bankrupt financial companies. Blind to their risks, Citigroup and AIG, among others, issued securities that they did not understand. In fact, AIG never even hedged against those securities. Indeed, one has to wonder, in view of all the wrongdoing in this crisis and its impact on unemployment and housing foreclosures, why there have been so few criminal cases brought to trial, let alone adjudicated. The answer is that in many instances it is difficult to prove fraudulent intent. Interestingly enough, the report does not attempt to pin any of the blame on the accounting community.
According to the majority report, the financial crisis was a "perfect storm" fueled by a distinct lack of prudent risk management and corporate governance in finance, with regulators failing to act in a timely fashion. Too many banks and financial companies were excessively leveraged, and thus open to significant risk, using exotic, unregulated financial instruments and off-balance sheet financing. The Federal Reserve, in particular, did not exercise due diligence in its monetary policies. While it had many opportunities to extinguish the crisis, the Fed took no discernible action to end the toxic mortgage market, which could have been accomplished by issuing strict mortgage lending standards. According to Bernanke, 12 of the 13 largest financial institutions were in dire financial straits near the end of 2008. Bernanke further observed that this was the "worst financial crisis in global history including the Great Depression" (report, p. 354). Fannie Mae and Freddie Mac pursued the conflicting goals of maintaining a viable market for mortgages while increasing their profit margins and market shares.
The first minority report views the crisis as unavoidable and global in scope, stemming from too much available cash, inadequate capital maintenance, and errors in security credit ratings. The second minority report stresses government policies to encourage home ownership as the principal factor underlying the crisis.
Reading between the lines in the report, it appears to the author that the following factors were underlying causes of the crisis: above all ethics, but also enterprise risk management, moral hazard, deregulation, fair valuation, capital maintenance, variable interest entities, and credit rating agencies. …