The Real Culprits of the Financial Crisis


NEW YORK (MainStreet) — Some three years after the collapse of the financial industry, a bipartisan report from the Senate’s Permanent Subcommittee on Investigations has determined that banks, regulators and credit agencies all share the blame for the subprime mortgage crisis that facilitated this collapse and eventually led the country into a recession.

Washington Mutual Bank is singled out in the report for shady lending practices, while other financial institutions like Goldman Sachs and Deutsche Bank are criticized for dubious investment tactics. Major credit rating agencies like Moody’s and S&P are faulted for their failure to appropriately assess the risk posed by a number of investments and the government’s Office of Thrift Supervision, charged with the all-important task of regulating savings banks, is bashed for failing to do its job.

“Using emails, memos and other internal documents, this report tells the inside story of an economic assault that cost millions of Americans their jobs and homes, while wiping out investors, good businesses, and markets,” said Sen. Carl Levin (D-Mich.), who chairs the subcommittee and who co-sponsored the report along with Sen. Tom Coburn (R-Okla.).  “High risk lending, regulatory failures, inflated credit ratings, and Wall Street firms engaging in massive conflicts of interest, contaminated the U.S. financial system with toxic mortgages and undermined public trust in U.S. markets.”

The story of the collapse, as told in the report, essentially begins several years before the recession when Washington Mutual decided in 2005 to initiate a high-risk mortgage-lending strategy, underwriting loans to middle and lower class Americans who were traditionally turned down. Within one year, many of those loans began to default; within two years the bank suffered major financial losses from this strategy and by 2008, the company faced a liquidity crisis and was seized by government regulators and eventually sold off to Chase.

The bank’s strategy had several impacts on the market. For starters, it led to a surge in demand for housing as more consumers were able to secure mortgage loans, causing a housing boom that of course ended up going bust when millions of Americans fell behind on their payments. Washington Mutual also proved to be the largest bank failure in history, which unsettled the markets, and before it collapsed, the bank began selling off some of its risky loans to Fannie Mae and Freddie Mac, contributing to their downfall as well.

While Washington Mutual may have helped kick-start the subprime mortgage crisis, other financial institutions played off of it to market investments, only to make the inevitable collapse that much worse.

Goldman, which was grilled very publicly by Congress last year for its role in the meltdown, once again comes off as the leading culprit in this saga. The investment bank bundled these mortgages into larger investment packages and sold them to clients for a nice profit. But when Goldman realized the mortgage market was a taking a turn for the worse, it deliberately bet against the market even while continuing to push these mortgage-backed securities to its clients.

In one exchange, Goldman reportedly promised investors that their interests were completely “aligned,” when the bank had in fact shorted its own investment in order to ensure profits when those mortgage-backed securities flopped.

Goldman saw the subprime mortgage crisis coming well ahead of most analysts and reduced its own risk by effectively pushing clients - and the market as a whole - off a cliff. Yet, it was not the only banking institution to apply this cutthroat strategy, even if it was the most successful at it.

Deutsche Bank also recognized the coming crisis in the mortgage market and desperately maneuvered to limit its losses by selling off mortgage-backed securities that it knew to be a terrible investment.

In one particularly contentious exchange, newly revealed in this report, Greg Lippmann, the company’s top global trader in these securities, referred to these assets as “crap” and “pigs,” but conceded that he “would take it and try to dupe someone” into purchasing them. Deutsche Bank still ended up losing $4.5 billion as a result of the mortgage crisis, but according to the report, that number would have been much higher had they not duped others into buying up the assets they held.

Ultimately though, the organizations that come off the worst in the report may be the credit rating agencies and the Office of Thrift Supervision, a public agency. One might cynically expect a few banks to work in their best interest, even if that meant employing some dubious tactics, but the oversight groups are held to a different standard.

The report indicts the OTS specifically for its failure to monitor the lending practices of Washington Mutual by taking a broader look at the bank’s balance sheets and the risks associated with its lending strategy, a failing that the senators chalk up to a mix of a narrow focus at the agency as well as “deference to management, weak standards, and demoralized examiners.”

According to the report, “Because it mishandled its responsibilities, OTS gave the illusion to investors, economists, policy makers, and others that the bank was sound, when in reality, it was just the opposite. Unfortunately, the truth of the matter was not revealed until it was too late, and the bank collapsed.”

On the other hand, credit rating agencies like Moody’s and S&P are criticized for having a conflict of interest, as these agencies received much of their business from the same Wall Street companies they were supposed to rate. As a result, the report claims that these agencies were prone to offer more favorable credit ratings, which masked the true financial health of these companies and their operations.

Moody’s, for example, was found to have given AAA ratings (the highest possible) to hundreds of new securities investments as late as the first half of 2007, even as news reports began to surface about looming issues facing the subprime mortgage market, in part because they received generous fees from companies to rate these investments. Then, in the second half of the year, it did an about face and along with S&P, downgraded ratings en masse, severely jolting the market and pushing it that much closer to collapse.

—For a comprehensive credit report, visit the Credit Center.

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