Inside Scoop on the Financial Crisis Inquiry Commission

Nobel prize winning economists George Akerloff and Joseph Stiglitz, former Fed chairman Alan Greenspan, leading economists such as Robert Shiller, Anna Schwartz, James Galbraith, former lead S & L regulator William K. Black, former Tarp overseer Elizabeth Warren and many other leading financial experts say that criminal fraud was the primary cause of the financial crisis.

They also say that failing to prosecute that fraud will prolong the crisis, interfere with the ability to stabilize the economy, and cause future crises. And see this.

They make it clear that the most fraud destructive fraud starts at the top: with the heads of the biggest banks, biggest accounting firms, and biggest corporations.

Experts in fraud as a cause of economic crises have developed a set of terms to describe this process, including “looting“, “control fraud“, “accounting fraud” and “regulatory capture“. However, none of these terms appear in the Financial Crisis Inquiry Commission Report.

Why not?

As Josh Rosner of of Graham-Fisher told me:

If one looks closely at the document behind the investigation, it appears the FCIC failed to highlight perhaps the most central issue in the crisis – warehouse lending. Documents in the FCIC archives demonstrate that at least one of the rating agencies was aware, before they began to downgrade securities en masse, that the Wall Street banks were aggressively cleaning out their inventory of securities and selling them to investors. Other documents demonstrate that at least one large firm was aggressively seeking to offload risks they had intended to retain by moving them to sales traders and arming sales-traders with information to use to move those risks, even going so far as to choose specific firms to target. Clearly, they believed in the greater fool theory, the question is did they make honest representations to those they sought to fool. Culpability seems clear, and I would think legal action should follow, but as is the case with most “gold panel” commissions, those who control the game make sure they can skate away.

And in a series of 3 investigative reports, Yves Smith shares insights gained from insiders on the Commission.

Yesterday, Smith noted:

From the very outset, the Financial Crisis Inquiry Commission was set up to fail.

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The investigations were further hampered by the requirement that subpoenas have bi-partisan approval along with Its decision to hold hearings with high profile individuals, including top Wall Street executives, before much in the way of lower-level investigation had been completed. The usual way to get meaningful disclosure from a top executive is to confront him with hard-to-defend material or actions; interrogations under bright lights, while a fun bit of theater, generally yield little in the absence of adequate prep.

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Recent reports that the panel urged various prosecutors to launch criminal probes were a hopeful sign that the commission might nevertheless come out with some important findings. But correspondence from insiders in the last few days suggests otherwise. One, for instance, wrote, “I’m still in the process of getting the stink out of my clothes.”

These ideologically-neutral sources close to the investigation depict the commissioners as having pre-conceived narratives and of fitting various tidbits unearthed during the investigation into these frameworks, with the majority focusing more on the problems caused by deregulation and the failure of the authorities to use even the powers they had, while the minority assigns blame to government meddling, particularly housing-friendly policies.

These insiders see both sides as wrong, and want to encourage investigative reporters to challenge both the majority and dissenting accounts. They contend that both versions help perpetuate the myth that Wall Street was as much a victim of the crisis as anyone else.

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From a source close to the investigation:

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When it comes to the three reports (one report and two dissents) to be released the Financial Crisis Inquiry Commission later this week[,] the reports start out with how many documents were reviewed and how many people interviewed. This sets us up to believe that the Commissioners relied on facts garnered from the documents and interviews in coming to their conclusions.

It would do Americans a lot of good to put this to the test. Did the Commissioners really use the facts to arrive at their conclusions or did they arrive at the conclusions first and are simply citing a selection of the facts to support their previously arrived at positions?

In fact, the majority will provide a history of financial crisis anecdotes and then try to fit the facts into its theory that the crisis was avoidable if only the financial sector took fewer risks and government was more competent. The dissents will do the same to support their theory that it was all government’s fault.

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Which of the multitude of anecdotes were critical? If they can’t identify one or two critical factors, ask them specifically (anecdote by anecdote) whether the crisis would have occurred even if the anecdote in question didn’t occur. If they can’t tell you either, then really what they are saying is the crisis was a “perfect storm” of just the right mix of private sector greed and public sector incompetence coming together at the same time. In other words, what happened could not have been predicted and the crisis was not avoidable.

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Catastrophic financial system collapse is not the result of largely unrelated anecdotes. There are too many firewalls in the system to allow it to happen. It has to be the result of one or more firewalls failing or something really big in the system going bad. What was there about the system that was big enough to cause systemic failure so quickly? What connects the two: the failure of the housing and securities markets?

Based on further discussions with individuals familiar with how the report was developed, the following shortcomings are evident:

The Commission was able to do comparatively little in the way of forensic work; the bulk of its effort was devoted to the hearings, which delivered relatively little in the way of new insight

As indicated above, the FCIC report is guilty of “drunk under the streetlight” behavior, of trying to fit its story to already known or easily found information. Even though the report makes extensive use of salacious extracts from e-mails, the insiders content that none of these information in these e-mails illuminates information critical to the crisis trajectory.

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The sad thing isn’t that the FCIC did not do its job. As we indicated earlier, that failure was by design. No one in the officialdom wants the mechanisms of the crisis to be exposed in full. It would compromise too many influential people and restoke well warranted public ire about the bailout of a miscreant financial services industry and its ongoing extractive behavior. Ironically, this core element of the dissent’s criticism is spot on, even if their own narrative suffers from precisely the same flaws. As FCIC commissioner Peter Walliston observes:

Like Congress and the Obama administration, the Commission’s majority erred in assuming that it knew the causes of the financial crisis…The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority’s report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority’s report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis…..

From the beginning, the Commission’s investigation was limited to validating the standard narrative about the financial crisis—that it was caused by deregulation or lack of regulation, weak risk management, predatory lending, unregulated derivatives, and greed on Wall Street. Other hypotheses were either never considered or were treated only superficially. In criticizing the Commission, this statement is not intended to criticize the staff, who worked diligently and effectively under difficult circumstances and did extraordinarily fine work in the limited areas they were directed to cover. The Commission’s failures were failures of management.

By having the FCIC validate widely accepted, superficial, and ultimately inadequate explanations of the crisis, the Obama administration continues in its policy of looking forward rather than back, when looking back is the foundation of any serious scientific, investigative, or prosecutorial process. The odds are high that the media and the public at large will mistake the extensive use of anecdote in the FCIC report for accuracy and completeness. As with so many accounts of the crisis, the artful use of detail will yet again have the effect of diverting attention from the true drivers of the crisis and thus leave Wall Street free to devise new ways to wreck the economy for fun and profit.

Today, Smith writes:

What is troubling about the report is the manner in which it hews to conventional wisdom. Its ten major findings are hardly controversial, yet they are still insufficient to explain why the financial system seized up and appeared close to failure. And telling a familiar-sounding story assures that the status quo will remain unchallenged, and serves to validate the inadequate reforms now underway. After all, they are premised on the very same superficial beliefs.

I participated in a blogger conference call with FCIC commissioners Phil Angelides and Brooksley Born. I’m clearly not cut out for public life. It was disconcerting to hear them thumping their talking points. For instance, Angelides began by saying that the purpose of the report was to explain why we faced the choice in 2008 of spending billions of dollars to bail out the financial system or let it fail.

That’s a false dichotomy that serves to justify the unprecedented rescues. It implies that the only way the crisis could have been addressed was the course of action taken. We pointed out as the crisis was unfolding that some of the early interventions made matters worse. Even at the peak of the crisis, a range of other actions were possible but were not taken. The bias throughout the crisis was to throw money at the problem with virtually no strings attached, and even in the cold light of day, to take far too little in the way of corrective and punitive measures.

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Another problem area was the difficulty in getting subpoenas issued. The process was made difficult by design; it took sign off by commissioners of both parties. As a result, nearly all the document production was voluntary.

And in her hardest-hitting post on the issue, Smith reports:

The Financial Crisis Inquiry Commission report increasingly looks like a whitewash. Even though the commission has made referrals for criminal prosecution, you’d never know that reading its end product. The references to “fraud” and “crime” are sparing, and ex mention of the SEC’s fraud investigation of Goldman, consist almost entirely of mortgage fraud, which is the FBI’s notion of “fraud for profit” or “fraud for housing”, meaning borrower fraud. The book also acknowledges the fraudulent lending by firms that were prosecuted like Ameriquest. In other words, the notion that the TBTF firms might have engaged in less than savory activity is remarkably absent from the report.

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?

Matt Stoller [financial writer and former chief policy aide for Congressman Alan Grayson] provides further support for the cynical take. Via e-mail:

I was on a conference call today with Phil Angelides and Brooksley Born, two commisioners of the Financial Crisis Inquiry Commission. During their unveiling of the FCIC report, they used words like deregulation, leverage, imprudent risk-taking, reckless behavior, failures at credit agencies, and failed regulators. Left out were words like crime, fraud, looting, or a specialized form of looting known as control fraud. At every point reporters asked about their referrals of criminal cases, which someone leaked before the report came out, they demurred. “We are not prosecutors”, said Angelides.

I asked about the criminal nature of the crisis. I said I didn’t want to know about any specific case, but whether they thought that fraud or crime was a core cause of the crisis. This is an important distinction, because the real question at hand is whether you trust the system to correct itself, or whether you believe that the people running the system are the problem and must be removed before we can fix the system. It’s obvious, as you’ll see, that Born and Angelides believe the former.

Neither Born nor Angelides would answer whether accounting fraud or crime was a primal cause of the crisis. The gist of the response was “it’s all in the report,” along with an attempt to pretend like they had discovered the systemic mortgage origination fraud that the FBI discussed in 2004. Born also repeated that they wouldn’t disclose specific cases of criminal referrals, even though I had specifically said that I was not interested in such disclosures. It was a filibuster, and an obvious one at that. I kept pressing, and asked them repeatedly to answer my question, and after the third follow-up Angelides finally said they had to go.

With that, the FCIC has completed the final act of oversight for the last Democratic Congress, and it held true to what Democrats in the last Congress believed. Everyone was at fault for the crisis, but no one is to blame. This was Bush’s line in 2008, that “Wall Street got drunk”, and Obama’s line throughout the Dodd-Frank mark-up. The Republicans went after the GSEs and “regulation”, and the Democrats sadly lamented the tragedy of the crisis. Again, everyone’s at fault, and no one is to blame. I saw high-ranking Democrat Carolyn Maloney brag yesterday about her vote for TARP in the hearing on foreclosures, noting that the Dow busted through 12,000 as a sign of prosperity. This is what they believe, in their bones. There was no theft, only tragedy. The American economy lives on the crack of financialization, not the production of valuable services and goods that solve real problems.

You can even read Obama’s Cooper Union speech from 2008, and with a few additions, it’s basically that narrative. Deregulation bad, regulation good. New Deal “outmoded”, excessive pay a problem. (I do find it amusing that Obama in 2008 brought up how other banks spread rumors about Bear Stearns so it would collapse, and then stressed how the SEC “should investigate and punish this kind of market manipulation.” But that’s kind of an exception, an adorable one that suggested there were rhetorical remnants of outrage among elites)

The FCIC report is destined for the same dustbin of history as that speech. It is a document of and by well-meaning insiders that just can’t deal with the corruption they were supposed to investigate. It’s a psychological crutch maybe, or perhaps a denial mechanism, but it doesn’t really matter. This report is just a cover-up, the same kind of cover-up that is allowing the thieves to escape with their loot.

Nothing will come from the generation in power who created this mess. They just don’t have it in them. The bad guys will steal again. I mean, crime pays. Besides, who’s going to call it crime, anyway?

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