Real Estate & Mortgage Insights

Finally, the Real Cause of the Financial Crisis...Or Not

The U.S. government has just released its official report on the causes of the financial crisis. And the culprit was drum roll please lots of people. A little anti-climatic? Perhaps, but that was the conclusion of the 633-page report from the Financial Crisis Inquiry Commission, the congressionally-appointed panel that studied it over the past 18 months.

Here's who's on the short list: global investment banking firm Goldman Sachs, wealth management company Merrill Lynch, and insurance company American Internal Group (AIG), government entities Fannie Mae and Freddie Mac and government regulators like the Federal Reserve.

According to the report Goldman Sachs was responsible for creating too much risk in the market, by pumping out billions of dollars for subprime loans and then repackaging and selling those loans as investments. On top of that, the company had invented some creatively complicated investment options called derivatives that allowed it to bet against its own loans.

"These new instruments would yield substantial profits for investors that held a short position," the report said. "They also would multiply losses when housing prices collapse."

Likewise AIG, although maintaining a AAA rating, had a separate division - its Financial Products unit - that was busy building up an investment portfolio full of risky derivatives which were basically insurance against mortgage-related securities.

Merrill Lynch is accused in the report of lying to investors about it financial situation. The panel reviewed testimonies affirming that Merrill Lynch officials realized their company was facing major risks from the faltering subprime market, as early as the end of 2006 or early 2007. But the company maintained publicly that there would be no ill consequences.

Freddie and Fannie, now in government conservatorship, made a big mistake by investing so heavily in the subprime mortgage market, which the report says was a result of their desires to "meet Wall Street expectations for growth, to regain market share, and to ensure generous compensation for its employees." It also mentions that their actions were partly motivated by directives from policymakers to encourage homeownership among low-income and minority populations.

And then of course there was the Federal Reserve, along with several other regulators who weren't doing their job to protect against such risky situations. The Fed especially was blamed for a "pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards," the report concluded. "The Federal Reserve was the one entity empowered to do so and it did not."

Yet even while this report was supposed to be the definitive authority on what really happened to cause the financial meltdown, there was not even consensus within the panel, with dissent split right down party lines. The minority of Republicans on the panel all dissented with one, Peter J. Wallison, a fellow at the American Enterprise Institute, saying that Freddie and Fannie were really a much larger cause of the crisis than the other institutions because "if the U.S. government had not chosen this policy path - fostering the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high-risk residential mortgages - the great financial crisis of 2008 would never have occurred."

The three other Republicans on the panel dissented saying that the reported conclusions were too broad and it failed to distinguish sufficiently between causes and effects." They offered a list of 10-items that they felt were the true precipitants of the crash, including the massive increase in subprime mortgages, too much risk and leveraging, and the interconnection of many of the nation's largest financial firms.

So after 18 months and 633 pages, the question of what truly caused the financial crisis remains subject to interpretation!



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