I’m currently reading the Financial Crisis Inquiry Commission Final Report after having skimmed it, and so far it’s an excellent guide through the financial markets and how they’ve changed over the past 30 years, as well as the lead-up to the financial crisis.
The Republicans and conservatives did a great job trying to hatch-job and politicize the reception of this volume by breaking away and writing a dissenting opinion, since the FCIC’s opinion has virtually all the honest conservative thoughts expressed in there.
Two items in particular jumped out at me in the first skim. First, the role of regulator’s 2001 Recourse Rule has been blamed by conservatives (and others) for increasing the demand for securitization and, more specifically, placing the Ratings Agencies in the drivers seat for bank capital stocks. This claim has been made by by Jeffrey Friedman, Editor, Critical Review here, John Carney, CNBC here, Arnold Kling at AEI here. I think it is fair to say that these are strong libertarians, maybe even a kind of anarchist in some cases – they are to the right of most of the discussion on the financial sector.
Here’s the FCIC report which features the same argument:
In October 2001, they introduced the “Recourse Rule” governing how much capital a bank needed to hold against securitized assets. If a bank retained an interest in a residual tranche of a mortgage security, as Keystone, Superior, and others had done, it would have to keep a dollar in capital for every dollar of residual interest. That seemed to make sense, since the bank, in this instance, would be the first to take losses on the loans in the pool….The Recourse Rule also imposed a new framework for asset-backed securities.
The capital requirement would be directly linked to the rating agencies’ assessment of the tranches. Holding securities rated AAA or AA required far less capital than holding lower-rated investments….
The new requirements put the rating agencies in the driver’s seat….
And they spend a lot of the report blasting the ratings agencies too: “We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction.”
There’s a debate about when the concept of Too Big To Fail enters the financial elites minds. I don’t have the book near me, but I remember the Manhattan Institute’s Nicole Gelinas making the case that the failure of Continental Illinois was the introduction of Too Big To Fail mentality into the regulatory apparatus in her book After the Fall.
So does the FCIC report. FCIC:
In 1984, federal regulators rescued Continental Illinois, the nation’s 7th-largest bank…These banks had relied heavily on uninsured short-term inancing to aggressively expand into high-risk lending, leaving them vulnerable to abrupt withdrawals once conidence in their solvency evaporated. Deposits covered by the FDIC were protected from loss, but regulators felt obliged to protect the uninsured depositors—those whose balances exceeded the statutorily protected limits—to prevent potential runs on even larger banks that reportedly may have lacked sufficient assets to satisfy their obligations, such as First Chicago, Bank of America, and Manufacturers Hanover….
This was a new regulatory principle, and within moments it had a catchy name. Representative Stewart McKinney of Connecticut responded, “We have a new kind of bank. It is called ‘too big to fail’—TBTF—and it is a wonderful bank.”
The report spends a lot of time analyzing how the GSEs failed, and what the CRA’s role in the crisis was, and handles the topics in a fair, critical and investigative manner. I haven’t gone through the full dissent by the three Republican members yet, but on the first glance it look like an aesthetic critique at best. Their narratives are virtually identical, except that the Republicans don’t actually call out Wall Street in any serious manner.
I think David Dayen gets it right here: “My sense is that somebody told the Republicans on the commission that they’d better not assent to the final report, or else there would be some kind of consensus for action.”
Peter Wallison Does It His Way
(Boo. I can’t embed the Gary Oldman version of the song.)
The Wallison dissent is almost Sid Vicious punk rock; the other GOPers kick him out of the band, and he just goes ahead and does it his way. For the Wallison solo dissent, I predicted: “I can’t respond to this argument because there are no numbers or citations. It is likely that Wallison is using Edward Pinto’s idiosyncratic definition of what constitutes a subprime mortgage, renaming prime loans with FICO < 660 as subprime, and not industry standard, as James Kwak has taken apart elsewhere.”
I should have also noted that it was almost 100% likely that Wallison’s report was going to be exactly what he and a handful of other true-believers at the conservative think tank AEI believed before the FCIC panel. Sure enough, first four footnotes of the Wallison dissent:
1 See, e.g., Peter J. Wallison, “Deregulation and the Financial Crisis: Another Urban Myth,” Financial Services Outlook, American Enterprise Institute, October 2009
2 Edward Pinto, “Triggers of the Financial Crisis” (Triggers memo), http://www.aei.org/paper/100174.
3 Edward Pinto, “Government Housing Policies in the Lead-up to the Financial Crisis: A Forensic Study,” http//ww.aei.org/docLib/Government-Housing-Policies-Financial-Crisis-Pinto-102110.pdf.
4 …Much of this work is posted on both my and Pinto’s scholar pages at AEI as follows…
This report is exactly what he believed in 2009. Think about this. We paid this guy at a level IV of the Executive Schedule, which is a juicy six-figure salary, for the days he worked. He had a staff, subpenoa power, researchers, documents, access, interviewers. And he ultimately had a responsibility to be an investigator. And his final product is a handful of AEI white papers from 2009 stapled together. If there is new evidence from his investigations I didn’t see it on the first pass. He could have not been on the FCIC, we could have put in a conservative who was serious about getting to the bottom of what’s broken with our financial system, and Wallison could have written the same exact thing on his own.
Wallison doesn’t call his special case subprime anymore but NTM – nontraditional mortgages. He had to change the word because of what James Kwak found when he was writing his book 13 Bankers:
Looks pretty compelling, right? Well, only until you realize that Pinto’s definition of subprime is one he made up himself. (See the words “by his criteria” in the quotation above.) In his December 2008 Congressional testimony,* he said there were 25 million high-risk loans. In that analysis, he said there were 17 million subprime loans, of which Fannie/Freddie held 5.7 million, or 34 percent. But drop down to PDF page 56 and you see that this 5.7 million is made up of:
- 0.8 million are “subprime private label mortgage backed securities”
- 4.9 million are “‘prime’ loans < 660 FICO”
In other words, Fannie and Freddie held zero subprime whole loans by the conventional definition (loans denominated as subprime by the issuer, which is the definition used by LoanPerformance). They held 4.9 million loans that Pinto, in his wisdom, decided to call subprime, and subprime-backed MBS that are equivalent to 0.8 million loans.
Now, Pinto knows more about mortgages than I do. Maybe loans with a FICO below 660 should have been counted as subprime all along, and maybe they should have gone into the LoanPerformance subprime database. But they weren’t. The fact remains that Fannie and Freddie had standards, and there were some loans they would not buy. Maybe those standards were too low; I would probably agree with Pinto on that one. But that’s a different issue. Pinto’s “data” don’t contradict the fact — pointed out by many people more knowledgeable than I — that Fannie and Freddie simply could not legally buy or guarantee the worst of the subprime loans.
I’ll have more thoughts on the FCIC, over the next week, including trying to get a theoretical handle on the concept of capture.