We know what caused the housing crash: Reckless banks, shoddy regulation, rampant greed. Let’s lay out the truth.
The news cameras kept recording after the power failed. Complete darkness. Then a heavy red curtain was swept aside, allowing a bit of sunlight to stream into the woodpaneled hearing room. This natural illumination had a strange effect on Alan Greenspan, the day’s first witness. He was seated before the Financial Crisis Inquiry Commission (FCIC), a ten-member panel of private citizens appointed by Congress to examine the causes of the financial and economic crisis. By that day, in April 2010, the FCIC had already conducted several hearings and public meetings. Greenspan had spent much of the morning before the power outage in a defensive mode, denying that, as chairman of the Fed for nearly two decades, he had the tools to predict or prevent the subprime mortgage meltdown and the connected global financial crisis.
Yet he had admitted to the panel: “I was right 70 percent of the time, but I was wrong 30 percent of the time. And there are an awful lot of mistakes” over the years. Now, in the semidarkness, Greenspan retreated a bit. He responded to a question about whether he believed there still was excessive debt in the banking system with a nod, a gesture not captured on the official record. The commissioner who posed the question remarked that he saw Greenspan nod. An audience member said he had not nodded. Greenspan sat silently, not offering to clarify. Minutes later, the hearing adjourned and the witness departed.
That was classic Greenspan: bright moments of clarity followed by obfuscation and retreat. Eighteen months earlier in October 2008, in his most candid moment, he told a congressional subcommittee that he had found “a flaw” in his entire system of thought. He had adhered for decades to a particular view of how markets operated, only to discover several decades later he’d been very wrong. Yet the question for the panel that April morning was whether the crisis could have been avoided.
At the hearing, Greenspan explained that the origination of subprime mortgages had posed no problems between 1990 and 2002. In that early era, he said, it was a contained market, but then things changed. It was the expansive sale of adjustable rate subprime mortgages, followed by the securitization of these mortgages, and the transformation of those securities into collateralized debt obligations (CDOs) that caused problems. There was a huge demand from Europe for CDOs backed by such mortgages, thus fueling increasingly higher-risk originations. Greenspan also made it clear that without “adequate capital and liquidity,” the “system will fail to function.” He called for additional equity capital (less borrowing relative to assets held). He said he now realized that our banking system had been undercapitalized for forty to fifty years. But in 2011, when it came time to require banks to have greater equity capital, he publicly denounced “an excess of buffers” in an op-ed in the Financial Times. Seeming to forget the savings and loan (S&L) crisis of just twenty years earlier, he asked: “How much of its ongoing output should a society wish to devote to fending off once-in-50 or 100-year crises?” This was Greenspan, light and dark.
While he admitted in the abstract to being wrong 30 percent of the time, the FCIC found it impossible to pin him down on particular acts or omissions. Instead, he pointed toward many others who contributed to the problem. His view was supported by the evidence but was nevertheless incomplete. He asserted that effective markets depended on enforcement against fraud and misrepresentation. When asked by FCIC chairman Phil Angelides what the Fed had done to combat fraud, Greenspan admitted that between 2000 and 2006, it had made only two criminal referrals to the Justice Department. In contrast, in 2005, the Federal Bureau of Investigation (FBI) had 22,000 cases of mortgage fraud under investigation. Greenspan dismissed this figure, contending that out of 55 million outstanding residential mortgages, 22,000 did not indicate a systemic problem. Angelides then asked him to explain why the Fed had made only two referrals. Greenspan explained that in all other cases of concern, they had been able to achieve compliance without the need for criminal enforcement. He said, “[a] goodly part of supervision and regulation is to get things solved so that if somebody is in violation of something and you can get them to adjust so that the regulators are satisfied, it never gets to the point where it’s a referral for enforcement in some form or another.” This non-enforcement policy created an incentive for misbehavior. Cracking down both through criminal and civil enforcement is not just about compliance, but also a vital part of deterrence.
Brooksley Born, Again
One of the appointees to the FCIC was Brooksley Born, who had resigned from her position as commissioner of the Commodity Futures Trading Commission (CFTC) in 1999. It was appropriate for her to at last face Alan Greenspan, who with others in the Clinton administration had deregulated derivatives and helped create the conditions for the meltdown.
While Angelides questioned Greenspan about his record on combating fraud, perhaps on Born’s mind was a lunchtime conversation she’d had with him in 1996. She had just become chairman of the CFTC but was not new to Washington. She had been a partner at the Arnold & Porter law firm for many years and, before her appointment to lead the agency, had briefly served as a commissioner. In her new leadership role, Born was already concerned about risks associated with derivatives, a key area of the CFTC’s jurisdiction.
Over lunch, Greenspan had shared with Born his view of market fraud. As she later recalled: “He explained there wasn’t a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him.” Born challenged him on this view, contending that as an attorney, she believed that prohibitions on fraud were essential. At Arnold & Porter, for instance, she had represented clients entangled in the Hunt brothers’ conspiracy to manipulate the price of silver and defraud investors. After hearing her out, Greenspan replied: “Well, Brooksley, I guess you and I will never agree about fraud.” The exchange was so unsettling that she shared the conversation with her top aides, Michael Greenberger and Daniel Waldman, who confirmed her account of the discussion. This encounter was particularly disturbing given Greenspan’s influence, not just over the economy but over President Clinton and the other banking regulators. This conversation would not be the last or the most contentious of their encounters.
Today, she asked him this question: “In your view, did credit default swaps, which are a type of over-the-counter derivatives contract, play any role in causing or exacerbating the financial crisis?” Greenspan did not answer directly, although he knew what she was getting at. He said that to his knowledge, they had not been discussed at the President’s Working Group; they were “not on the agenda” at the time. That may have been his recollection, but the report that he signed in 1999 did include “credit swaps.” Born reminded him that in 1996, the Fed had issued supervisory guidance on them.
Next, Born asked him about his libertarian views and whether he thought the Fed was to blame for the crisis. Specifically she asked whether the Fed had
fail[ed] to carry out its mandates, . . . [in that] . . . the Fed and the banking regulators failed to prevent the housing bubble; they failed to prevent the predatory lending scandal; they failed to prevent our biggest banks and bank holding companies from engaging in activities that would bring them to the verge of collapse without massive taxpayer bailouts; they failed to recognize the systemic risk posed by an unregulated over- the- counter derivatives market; and they permitted the financial system and the economy to reach the brink of disaster.
Greenspan never answered that question. But he did deny that his “views on regulation” interfered with his performance: “I took an oath of office to support the laws of the land,” he said, and he insisted that he had enforced the laws, including those he “would not have constructed in the way they were constructed,” as “that was my job.” Born had a limited amount of time to ask her questions and Greenspan to answer. It was the next commissioner’s turn. Greenspan concluded by informing her: “So I know my time has run out, but I really fundamentally disagree with your point of view.”
After the long day, as after many others at the FCIC, it was difficult to fully understand the truth about the crisis. When a single witness can equivocate over a period of hours and then over a period of years, it is easy to think there is no there, there.