“Our task was first to determine what happened and how it happened so that we could understand why it happened,” writes the Financial Crisis Inquiry Commission in its opening statement. “If we do not learn from history, we are unlikely to fully recover from it,” the inquiry adds in its 662-page report.
The document, released three weeks ago, is a hefty tome of text, tables, graphs and technical analyses. Yet it’s moving reading. “All of us have been deeply affected by what we have learned in the course of our inquiry. We have been at various times fascinated, surprised, and even shocked by what we saw, heard, and read. Ours has been a journey of revelation,” write the authors.
One wouldn’t think that a report released two years after the peak of the crisis would have much to teach. Don’t we know it all? How many hundreds of articles and analyses have been published on the worst financial crisis since 1929? Yet it has plenty to reveal. The report runs deep: More than 100 people spent two years reading millions of documents, interviewing 700 witnesses and holding 19 days of public hearings. The result is the final, official report of the facts, and it casts blame.
Its conclusions were not reached unanimously. The commission was political.
Democrats had the majority. Some of the Republican members reached different conclusions, which were appended to the report. Some, for instance, felt that the outbreak of a similar crisis in Europe’s real estate and financial markets, where regulation was tougher, partly exonerates the American system.
The report’s value lies in this: How it happened to us, and how it could happen to you. It contains lessons for Israel.
1. The crash didn’t have to happen
“We conclude this financial crisis was avoidable,” is the very first conclusion. It wasn’t a natural disaster or “computer models gone haywire” − it was deeds by people in the financial and supervisory systems. It was the cause of sins of commission and omission: “To paraphrase Shakespeare, the fault lies not in the stars, but in us.”
The signs were there. They could have been seen but the people in charge ignored them.
Basically, the crisis was caused by the merry extension of low-quality mortgages (“predatory lending practices”), a bubble in property prices, and the construction of a giant financial system based on these things. The numbers the commission found were known, but it gave a name to the disease: “pervasive permissiveness.”
The U.S. Federal Reserve could have cracked down on mortgage lending terms, stemming the flow of toxic loans. The banks didn’t have to sell subprime mortgages without even checking the quality of the borrowers. The financial systems didn’t have to create monsters of leverage. In the absence of rules, riot reigned. “What else could one expect on a highway where there were neither speed limits nor neatly painted lines?” the commission asks.
The significance for Israel: Leaving acts of God out of it, financial crises are caused by humans and can be avoided. The next time somebody tells you a crisis hit by surprise, that it couldn’t have been foreseen or that it was caused by exogenous factors, check if the speaker wasn’t the very person best positioned to see the red flags and take action.
2. It’s the regulators’ fault
“We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets,” is the second conclusion. The regulators unthinkingly bought into Alan Greenspan’s theories about deregulation and letting the markets correct warps; financial institutions won’t self-destruct, the theory reasoned. That is now known to be utter balderdash.
Three decades of deregulation at the urging of the financial institutions stripped away safeguards, in short. The regulators were cowed. But the regulators had all the tools they needed to avert the crisis.
Worse yet, the banks and financial institutions used their political clout to amend legislation in their favor. From 1999 to 2008, the financial sector spent $2.7 billion on federal lobbying, the commission reports: “What troubled us was the extent to which the nation was deprived of the necessary strength and independence of the oversight necessary to safeguard financial stability.”
The significance for Israel: More lobbyists than Knesset members ply the Knesset’s corridors each day. Interested parties hire armies of machers.
Government officials scurry straight from public service to the tycoons’ embrace. Israel is even more vulnerable than the United States to rule-bending and government paralysis.
Pressure of this sort was most recently evident in the case of the royalties on Israel’s natural gas reserves, but actually it’s everywhere. Interested parties use lobbyists to sway members of the Knesset’s committee on economic concentration, the communications minister, the Antitrust Authority, and every minister and parliamentarian in the land.
That’s exactly what caused the global financial system to crash. Here, so far, the worst damage has been to deny the people their fair share of Israel’s economic growth.
3. The bankers blew it
“We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis,” the commission writes. The bankers ran wild, taking too much risk. They didn’t ensure they had enough capital and relied too heavily on short-term funding. No, their instinct for self-preservation didn’t save them. Icarus-like, flying too close to the sun, they competed to see who could generate more high-risk credit derivatives and drum up the most leverage.
They used mathematical models supposed to predict risk, but used the models to justify risk, not quantify it. The banks gorged on acquisitions, growing aggressively but unwisely. “Too big to fail meant too big to manage,” tut-tuts the commission.
The bankers often had no idea what they were really doing; the commission lists “stunning examples” of bad governance, from insurance giant AIG to Fannie Mae to Merrill Lynch. The systems encouraged the brokers and bankers to make massive bets worth billions and billions, thinking the downside was limited: “This was the case up and down the line − from the corporate boardroom to the mortgage broker on the street.”
The significance for Israel: Israeli managers are no better than American ones − not in skill, not in accountability and not in greed. We’ve had any number of studies showing no correlation between pay and performance.
There are differences, of course. In America, pay tends to be linked to short-term performance, while here pay is a function of the executive’s loyalty to the company’s owner and to what degree he is prepared to allow that owner’s interests to supersede those of the shareholders and public.
If naked greed brought down Wall Street, it could certainly bring down Rothschild Boulevard in Tel Aviv, or lower living standards in Mitzpeh Ramon.
4. The regulators were not prepared
“We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets.” Key policy makers, from the Treasury Department to the Federal Reserve Board to the Federal Reserve Bank of New York had no clue what was going on and flapped like headless chickens when the crisis erupted.
They had no contingency plans for a meltdown of the financial system. They had no strategy. When they saw red flags, such as soaring housing prices, they miscalculated the damage the bursting bubble could cause to the financial system.
They knew that some financial institutions were in trouble, a few hedge funds belonging to Bear Stearns, but thought those were the exception.
A month before Lehman Brothers collapsed, the Fed was busy gathering information on the exposure created by the more than 900,000 derivatives contracts that Lehman had issued.
When the regulators did intervene, they shoved a finger into the cracking dam, but were hopelessly inconsistent. They saved Bear and AIG but not Lehman, causing total collapse of faith in the system. They caused panic.
The significance for Israel: We haven’t had a crisis quite like this, but unpreparedness for the evil day is a very familiar story to us. The U.S. government’s cardinal sin was its failure to understand the situation in the subprime mortgage market and derivatives market on these mortgages. We surely have the same disease. Our authorities are surprised by each passing crisis − fire on the Carmel, transportation breakdowns, you name it. Yet everything could easily have been foreseen.
The Finance Ministry and Bank of Israel must be prepared for developments that could imperil Israel’s financial stability, even if the risks seem remote.
They must have contingency plans, even if populists accuse them of over-conservatism, inflexibility or, as they say in these parts, “inconsideration of the poor and weak.”
5. It’s everyone’s fault
Finally, “We conclude there was a systemic breakdown in
accountability and ethics,” the commission wrote. Quite. “The soundness and the sustained prosperity of the financial system and our economy rely on the notions of fair dealing, responsibility, and transparency.” Ah yes, and the kicker: Unfortunately, says the panel, standards of responsibility and ethics eroded, making a bad situation worse.
Take the simplest example, of merrily showering mortgages onto people who couldn’t possibly repay them. These practices deteriorated into the criminal realm: The number of “suspicious activity reports” in the U.S. mortgage market grew 20-fold from 1996 to 2005. One study, says the commission, puts the losses resulting from mortgage fraud between 2005 and 2007 at $112 billion.
What was the crisis? Blame it on human nature, blame it on mortal flaws like greed and hubris − but no, that would be simplistic, says the commission. “It was the failure to account for human weakness that is relevant to this crisis.” It was the regulator’s job to protect the system from itself. Nobody said no.
But don’t blame Wall Street alone. The nation as a whole must accept responsibility for what it allowed to occur, the commission sums up. Collectively, if not unanimously, America acquiesced to or embraced a system that gave rise to the predicament.
The significance for Israel: Much of the 662-page report is technical, discussing the mechanics of meltdown. Those are less relevant to us on the other side of the planet. We don’t have subprime mortgages as such, let alone fantastically concocted derivatives based on them.
Over here, the problem is economic concentration. We have a handful of people with tremendous economic power. They control groups of companies that issue shares and bonds and they manage other people’s money invested in or through their companies.
Everything the report relates about the craven capitulation of the authorities and regulators before the rich and powerful, everything they write about personal responsibility and accountability, applies to us.
Just as profound for us is that last sentence, about our collective responsibility for allowing this situation to arise. We have allowed our education system to deteriorate. We have allowed business interests to quash competition. We have allowed governance to thrash about. We have permitted healthcare, infrastructure and transport systems and so much else to crumble. It’s our collective fault as well.
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