Our financial system is a tapestry of interwoven banks, investment houses, brokerage firms and insurance companies.
When it all started to come unraveled in late 2008, there was no one agency or person to tie it off. The daunting task of preventing the entire system from ruination fell to dozens of policymakers and regulators in countless agencies from statehouses to the White House.
In the end, top officials did the only thing they could do, punt.
Overnight, ad hoc groups were formed to address the crisis and to stop the bleeding. Federal officials like then-Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke turned to the folks that they thought could get a quicker read on the calamity, Wall Street.
If we believe what we are now hearing; it was myopic being led by the visually-impaired. In other words, everyone, including Wall Street’s best and brightest, was in the dark.
For the past several days, the Financial Crisis Inquiry Commission, headed by former California State Treasurer Phil Angelides, has been taking testimony from key figures in this financial docudrama.
Wednesday, the Commission heard from former Fed Chair Alan (Denial Is Not Just a River in Egypt)Greenspan. Yesterday, the panel took testimony from former Citigroup CEO Charles (Chuck) Prince and former Treasury Secretary Robert Rubin, who headed the bank’s executive committee. Their collective account of their bank’s bumbling was like listening to the comic adventures of Captain Clueless and his trusty sidekick Bongo.
Who Knew?
According to Prince, nobody could have predicted that the bank’s highest-rated collateralized debt obligations — created by repackaging mortgage bonds into new securities — would lose so much money. Prince told the panel that the Citi’s chief risk officer didn’t understand the risks, nor did the bank’s senior traders and bankers. “Everyone, including our risk managers, other banks and CDO structurers, all believed that these securities held virtually no risk.”
In his testimony, Rubin said that he spotted “market excesses” prior to the financial crisis and predicted they would lead to a “cyclical downturn” at “some unpredictable point.” Stating the obvious, Rubin further pontificated that “the overriding lesson of the financial crisis was that the financial system is subject to more severe downside risk than almost anyone had foreseen.”
This morning, testimony by former executives from failed lender Fannie Mae largely attributed their company's demise to an “impossible” balancing act to satisfy private shareholders and a public mission to promote greater home ownership. Ex-Fannie Chief Executive Daniel Mudd allowed that credit standards may have been lowered “too much,” but he then blamed Congress for promoting policies that encouraged a dramatic upswing in home ownership.
Between Fannie and her kissing cousin Freddie Mac, they own or back nearly half of the nation’s $11 trillion in home mortgages. Mudd conceded that company losses would have been less severe if Fannie hadn't made a big foray into riskier loans as home prices peaked, but said the companies were ultimately doomed by their flawed setup.
In the near future, the panel will hear from failed insurer AIG along with executives from Goldman Sachs, JP Morgan Chase and Bank of America.
Understanding the failure of AIG will be akin to dissecting an enigma wrapped in a riddle.
Where Was the Wider Perspective?
At the height of its power, AIG owned 71 U.S.-based insurance companies and 176 related financial entities. Each of these companies, including the parent firm, was regulated separately in all 50 states, and by a host of additional federal agencies. There were thousands of regulatory eyes on AIG, but no one saw the big picture.
The deposition offered by former AIG executives will be heard in the context of testimony that ultimately will be presented by executives from the nation’s three largest banks – Goldman, Chase and B of A.
Lloyd Blankfein, Goldman’s CEO, is already laying the groundwork for his appearance. In a spin letter to shareholders released today, Blankfein refuted allegations that Goldman profited improperly from the rescue of insurance giant AIG and that it took positions against clients to whom it had sold high-risk property assets.
Instead of acknowledging the backroom deals made with the U.S. Treasury – then headed by former Goldman CEO Hank Paulson – and the New York Fed under the direction of now-Treasury Secretary Tim Geithner, Blankfein twirled a different baton. He told Goldman shareholders that “we limited our overall credit exposure to AIG through a combination of collateral and market hedges in order to protect ourselves against the potential inability of AIG to make good on all its commitments.”
Put another way, Blankfein made sure his firm was covered both ways to Sunday, and that the government backed his play. No one ever said these guys weren’t smart.
The Commission’s charge is to sift through the economic wreckage to find not just the black box that caused the crash but to make recommendations to Congress and White House in their efforts to overhaul and reform our convoluted financial system. Their preliminary findings are supposed to be made available during the summer.
On a positive note, at least it’s not as complicated as healthcare. John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
