Financial crisis was 'avoidable', says official US report

Bankers, regulators, government – even homeowners – all to blame for credit crunch, says Financial Crisis Inquiry Commission

guardian.co.uk, Dominic Rushe in New York, Thursday 27 January 2011 15.45 GMT

The 2008 financial was 'avoidable', says the report of the US Financial Crisis Inquiry
Commission. Above, former Federal Reserve chairman Alan Greenspan testifies
before the commission in April 2010. Photograph: J. Scott Applewhite/Associated Press

Wall Street bankers, regulators, government officials and even homeowners all share part of the blame for the 2008 financial crisis, according to a scathing US official investigation into the meltdown published today.

The 545-page Financial Crisis Inquiry Commission (FCIC) report reads like a financial thriller in which there are very few heroes. One chapter on the boom and bust fiasco is entitled "The Madness".

The commission concludes that the crisis was avoidable and was caused by:

• Widespread failures in financial regulation, including the Federal Reserve's failure to stem the "tide of toxic mortgages".
  
  
• Dramatic breakdowns in corporate governance, with too many firms acting recklessly and taking on too much risk.
  
  
• An explosive mix of excessive borrowing and risk by households and Wall Street.
  
  
• Policymakers who were ill-prepared for the crisis and lacked a "full understanding of the financial system they oversaw".
  
  
• Systemic breaches of accountability and ethics at all levels. Mortgage-holders took out loans they never intended to pay; lenders made loans they knew the borrowers could not afford.

"As this report goes to print, there are 26 million Americans who are out of work ... Nearly $11tn in household wealth has vanished ... The collateral damage of this crisis has been real people and real communities. The impacts of this crisis are likely to be felt for a generation," the report says.

So far, the 2008 financial crisis has led to few prosecutions. The authors interviewed more than 700 witnesses to compile the report and said they had referred potential violations to the appropriate authorities.

While the crisis was years in the making, it was the collapse of the housing bubble that triggered the 2008 collapse. Trillions of dollars in risky, sub-prime mortgages had been embedded in the system. When the housing bubble burst, the impact was magnified by complex financial derivatives based on those loans, whose risks had been woefully underestimated.

Behind the collapse was the rewiring of Wall Street. From 1987 to 2007, the amount of debt held by financial sector soared from $3tn to $36tn (£1.88tn to £22.5tn). Subprime mortgage loans went from 5% of loans in 1994 to 20% in 2006. At the same time, financial services firms constituted an increasingly disproportionate part of the US economy – 27% of all corporate profits in the US compared with 15% in 1980.

The crisis itself was avoidable – the result of "human action and inaction, not of Mother Nature or computer models gone haywire". And in large part it was led by government mismanagement.

The Federal Reserve played a central role in enabling the crisis. It failed in its duty to set more prudent limits. Financial firms "made, bought and sold mortgage securities they never examined". They invested blindly and did not care if the investments were defective. Compensation "too often rewarded the quick deal, the short-term gain" and "encouraged the big bet", the report concludes.

Aggressive expansion left banks unable to manage their own assets – and few escaped blame.

For Citigroup, singled out for heavy criticism, "too big to fail meant too big to manage". Goldman Sachs multiplied the effects of the collapse of sub-prime loans by funding and creating billions of dollars of bets based on the back of the loans. AIG's senior management was ignorant of the terms and risks of the insurer's $79bn derivatives exposure. It was a "costly surprise" to Merrill Lynch's top managers that their $55bn investment in "super-safe" mortgage securities had resulted in billions of dollars in losses.

Top officials, including Alan Greenspan, the former Federal Reserve chairman, were also blamed. The FCIC said the drive towards deregulation over the past 30 years helped to create the conditions for disaster. "What else could one expect on a highway where there were neither speed limits nor painted lines?" asks the report.

Minority report

The FCIC panel failed to reach a majority agreement, with the major report signed off only by its Democrat members.

In a dissenting opinion, Republican members questioned many of the report's conclusions. "The commission's majority used its extensive statutory investigative authority to seek only the facts that supported its initial assumptions – that the crisis was caused by 'deregulation' or lax regulation, greed and recklessness on Wall Street, predatory lending in the mortgage market, unregulated derivatives and a financial system addicted to excessive risk-taking."

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