A 650-page Senate report on the causes of the financial crisis, citing internal documents and private communications of bank executives, regulators, credit ratings agencies and investors, identifies culprits whose business practices were rife with conflicts and deception, according to a New York Times article by Gretchen Morgenson and Louise Story called “Naming Culprits in the Financial Crisis.”
After two years of investigations, the “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse” was released by the Senate Permanent Subcommittee on Investigations, a bipartisan group. The co-chairs are Carl Levin, a Michigan Democrat, and Tom Coburn, an Oklahoma Republican.
The report focuses on institutions with central roles in the mortgage crisis: Washington Mutual, an aggressive mortgage lender that collapsed in 2008; the Office of Thrift Supervision, a regulator; the credit ratings agencies Standard & Poors and Moody’s Investors Service; and the investment banks Goldman Sachs and Deutsche bank.
“The report pulls back the curtain on shoddy, risky, deceptive practices on the part of a lot of major financial institutions,” Sen. Levin was quoted as saying, adding: “The overwhelming evidence is that those institutions deceived their clients and deceived the public, and they were aided and abetted by deferential regulators and credit ratings agencies who had conflicts of interest.”
The report recommends a number of changes to regulatory and industry practices, such as anti-conflict-of-interest policies and higher reserves requirements against risky mortgages. The report also asks federal regulators to consider possible legal actions based on the report’s findings.
According to the article: “The report adds significant new evidence to previously disclosed material showing that a wide swath of the financial industry chose profits over propriety during the mortgage lending spree. It also casts a harsh light on what the report calls regulatory failures, which helped deepen the crisis.”
The Office of Thrift Supervision (“OTS”), which was supposed to oversee lending institutions, viewed aggressive lenders like Countrywide Financial, IndyMac and Washington Mutual as “constituents,” and was reluctant to interfere with “even unsound lending and securitization practices,” instead relying on the lenders to fix their own problems.
One bank executive provided OTS with outdated loss estimates as the mortgage crisis spread. After the risk manager told regulators that the estimates it had received were outdated, he was fired.
OTS staffers identified more than 500 serious deficiencies at Washington Mutual. OTS management did nothing about it. When the Federal Deposit Insurance Corporation (“FDIC”) moved to downgrade the bank’s safety and soundness rating in September 2008, the OTS director wrote an indignant email referring to Sheila Blair, the FDIC chairwoman, saying: “I cannot believe the continuing audacity of this woman.” Washington Mutual failed two weeks later.
The same Senate committee that issued the report conducted an 11-hour hearing last April with Goldman executives and employees of its mortgage unit, who testified about their trading and securities underwriting practices. Goldman asserted that it had not bet against the mortgage market as real estate prices collapsed. But Goldman documents used the phrase “net short” 3,400 times, according to Sen. Levin.
Here is my take on it: Goldman says it was not “net short” the MBS market in general ? i.e., if you net out all the firm’s long and short positions in the mortgage-backed securities market, they claim it’s a wash. But what would that matter to an investor in a particular deal where Goldman had an undisclosed bet against that particular deal? Even if Goldman’s longs and shorts netted out overall (not saying they did), it is undisputed that Goldman was short in a number of specific deals that it recommended and sold to clients. That is the point.
“Why would Goldman deny what was so obvious, that they were engaged in a huge short in the year 2007?” Senator Levin rhetorically asked, answering: “Because they gained at the expense of their clients and they used abusive practices to do it.”
The investigation also uncovered that Goldman engineered a “short squeeze” to drive the shorts to panic sell to Goldman at artificially low prices. Then, in June 2007, when two Bear Stearns hedge funds collapsed because of bad mortgage bets, Goldman reversed its position and became short itself. This is more evidence that Goldman bet against the mortgage-backed securities market and its clients.
Because Goldman was a market maker, it had the power to drive prices in a certain direction. The report quotes from the self-evaluation of Deeb Salem, a mortgage trader, who wrote: “We began to encourage this squeeze, with plans of getting very short again.” He added, “This strategy seemed do-able and brilliant.”
Michael Swenson, head of trading in the structured product group at Goldman and Mr. Salem’s superior, in an e-mail, said that Goldman should “start killing” investors who were betting against mortgages. (In testimony before the committee, he said he was simply trying to add balance to the market.)
The report also exposes how a Duetsch Bank trader named Greg Lippmann described mortgage-backed securities before the crisis as “pigs,” and, when he was asked to buy one such mortgage security, he responded that he “would take it and try to dupe someone,” according to the report.
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