The Financial Crisis Inquiry Commission Final Report

……came out yesterday. Klein gives the crux of the findings:

The Financial Crisis Inquiry Commission has released its final report, which looks to “determine what happened and how it happened so that we could understand why it happened.” The full document — including the dissents from four of the Republicans on the panel — can be downloaded here. The transcripts of the hearings the committee conducted can be found here. If the thousands of pages in those two links seem like a bit much to you, the FCIC’s conclusions are here (pdf). This, I think, is the key takeaway:

We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble. While the business cycle cannot be repealed, a crisis of this magnitude need not have occurred. To paraphrase Shakespeare, the fault lies not in the stars, but in us.

Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The tragedy was that they were ignored or discounted. There was an explosion in risky subprime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red flags. Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner.

The prime example is the Federal Reserve’s pivotal failure to stem the low of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not. The record of our examination is replete with evidence of other failures: Financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. What else could one expect on a highway where there were neither speed limits nor neatly painted lines?

We have the full doc up on Scribd. Unfortunately, Tumblr is jacked up right now, we can’t do direct coding and put it on the post as we usually do. Once it’s back to normal, we’ll add. It’s a beast. 700+ pgs. But they 19 days of hearings, thousands of pages of subpoena’d docs. Remarkable effort. Worth your time to at least glance over.

#GREATMOMENTSINBANKINGHISTORY #theyarewhowethoughttheywere #50hotones #godswork

Financial Crisis Inquiry Commission Final Report

The Leverage Debate Revisited, aka GREAT MOMENTS IN BANKING HISTORY

This being Christmas (at least for those who didn’t get coal in their stockings), it seemed like a fine time to revisit the leverage debate. We here at The Scrambler thought this was just the moment to return to our occasional series/tongue in cheek hashtag, GREAT MOMENTS IN BANKING HISTORY.

The Baseline Scenario had a great piece a little while back by Anat Admati (she teaches Finance I, among other things at the Stanford GSB). She responds to a long NYTMag article on Jamie Dimon and his assertion that JPMorgan should continue to grow. She also dismantles the larger issue of the cost of capital for the street. It’s riveting. Basically, her argument is that debt financing has made it too cheap for the banks to operate (ie, they don’t fully internalize their costs to society and risk to investors alike due to their heavy reliance on leverage/debt financing). If they moved more towards equity, we’d all be better off (or at least, less likely to suffer another cataclysmic meltdown). Excerpt from the piece below. Click the link here for the full Baseline Scenario. Her article is based on a longer working paper put out last October (the full paper is Scribd below). Print this one out and enjoy with your lunch. If you took a low blow (or some long-dated shares) last week, you could use it to wipe away your tears. But it’s really fascinating. Read it before turning it into Kleenex…

What Jamie Dimon Won’t Tell You: His Big Bank Would Be Dangerously Leveraged

By Anat Admati, Professor of Finance and Economics at Stanford Graduate School of Business.  To see her explain these issues in person, watch this Bloomberg interview.  This is a long post, about 3,500 words.

The debate is raging about banks and their size, financial regulation, and the international capital standards known as “Basel”.  Jamie Dimon of JP Morgan Chase, in his New York Times magazine profile, expresses admiration for the Basel committee and says,

“… they are asking the questions that, in theory, bankers ask of themselves: how much capital do banks need to withstand the inevitable downturn, and what is an acceptable level of risk?”

There is one problem, however. Basel may have asked the right question, but it did not come up with the right answers, mainly because it allows banks to remain dangerously leveraged, setting equity requirements way too low. This fact is not understood because the debate on capital regulation has been mired with a cloud of confusion, and filled with un-substantiated assertions by bankers and others. As a result, the issues appear much more mysterious and complicated than they actually are.

After a massive and incredibly costly financial crisis, we seem to have financial system that is a more consolidated, more powerful, more profitable and, yes, as fragile and dangerous as we had before the crisis. How did this happen and what can we do?

Here are some questions on which the confusion is staggering.

(i) Is “too big” the same as “too big to fail?”

(ii) Do capital requirements force banks to “set capital aside for a rainy day” and not use it to help the economy grow?

(iii) Are banks different than non-banks in that high leverage is essential to banks’ ability to function?

(iv) Would terrible things happen if capital requirements were to increase dramatically?  

The first order of business is to clear the fog and focus on the right things. I will try to explain. With the basics in place, answers will begin to emerge, or at least the right questions to ask.

By the way, I answer an emphatic NO to each of the above questions.

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