A Bank Crisis Whodunit, With Laughs and Tears

By GRETCHEN MORGENSON for the New York Times

TRULY startling revelations were few in the voluminous report, published last Thursday by the Financial Crisis Inquiry Commission on the origins of the financial panic. This is hardly a shock, given the flood-the-zone coverage and analysis of the crisis since it erupted four years ago.

Yet the report still makes for compelling reading because so little has changed as a result of the debacle, in both banking and in its regulation. Providing chapter and verse, for example, on the bumbling and siloed management at the nation’s largest banks is enlightening, in that many of these institutions are even bigger than they were before. With too-big-to-fail institutions now larger than ever, we are almost certain to go through another episode like 2008 in the not-too-distant future.

For those who might find the report’s 633 pages a bit daunting for a weekend read, we offer a Cliffs Notes version.

Let’s begin with the Federal Reserve, the most powerful of financial regulators. The report’s most important public service comes in its recitation of how top Fed officials, both in Washington and in New York, fiddled while the financial system smoldered and then burned. It is disturbing indeed that this institution, defiantly inert and uninterested in reining in the mortgage mania, received even greater regulatory powers under the Dodd-Frank law that was supposed to reform our system.

The report shows how the Fed refused to exert its authority on predatory lending. On Page 94, we learn that from 2000 to 2006, it referred a grand total of three institutions to prosecutors for possible fair-lending violations in mortgages.

The Fed “succumbed to the climate of the times,” its general counsel, Scott G. Alvarez, told commission investigators. It is hard for a supervisor to challenge banks when they are highly profitable, other officials said. Richard Spillenkothen, head of supervision at the Fed until 2006, attributed its reluctance to “a desire not to inject an element of contentiousness into what was felt to be a constructive or equable relationship with management.”

Is it any shock, then, that neither the Federal Reserve Bank of New York nor the Office of the Comptroller of the Currency, a partner in regulatory inadequacy, saw that the S.S. Citigroup was headed for the shoals? This depressing case is chronicled in depth in the report.

In testimony last September, Ben S. Bernanke, the chairman of the Federal Reserve Board, said that his organization “has moved vigorously to address identified problems.”

BUT back a few years, as regulators were coddling bank managers, some executives were busily telling their investors that everything was just dandy. On Page 248, we learn about dire events at Countrywide Financial, the subprime lender.

On Aug. 2, 2007, Countrywide’s access to crucial market financing dried up; commercial paper investors would not buy its obligations, the report quoted Angelo R. Mozilo, the company chief executive, as saying. But Eric P. Sieracki, the company’s chief financial officer, said in a statement that day that Countrywide had plenty of liquidity and had experienced “no disruption in financing its ongoing daily operations, including placement of commercial paper.”

This rather interesting take on reality prompted Moody’s to reaffirm the company’s A3 debt rating. Two weeks later, Countrywide drew down all of its $11.5 billion in credit lines, signaling extreme distress to the markets. The stock plunged; a few months later the lender was taken over in distress by Bank of America.

Mr. Sieracki declined to comment, but his lawyer said on Friday that the Aug. 2 statement was accurate at the time Mr. Sieracki made it.

On Page 264, the report lays out Citigroup’s silence about the ticking time bombs it had shoved off its balance sheet but that would soon have to be repatriated, generating enormous losses. A spokeswoman for Citigroup said that it was a different company today, and that it had overhauled its risk management and bolstered its financial strength.

We already know, of course, that our government moved mountains to help the banks during the crisis. But the report adds to our understanding of events by describing how the Treasury Department changed the tax code to benefit banks acquiring weaker institutions. Never mind that the Constitution allows only Congress to write tax rules.

I.R.S. Notice 2008-83 came out of nowhere on Sept. 30, 2008, the report noted on Page 371. It removed existing limits on the use of tax losses that could be taken by a bank when it acquired a troubled institution. The change appeared just as Citigroup was mounting its $1-a-share bid for Wachovia. (The beleaguered bank was headed by Robert K. Steel, a former under secretary of domestic finance at Treasury who had left his post two months earlier. “Secretary Paulson had recused himself from the decision because of his ties to Steel,” the report said, “but other members of Treasury had ‘vigorously advocated’ saving Wachovia.”)

Two days after the tax change, Wells Fargo topped Citi’s proposal by offering $7 a share. The change in the code had made such a deal more economical for Wells because it could reduce its taxable income by $3 billion in the first year after acquiring Wachovia. Previously, Wells could have reduced its income by just $1 billion in Year 1.

“They were changing the rules on the fly to the apparent advantage of banks who wanted to get something for nothing out of this crisis,” said Janet Tavakoli, president of Tavakoli Structured Finance in Chicago. “Why aren’t people being questioned and held accountable for that?”

As it turned out, Wells did not benefit from the code change because it had no taxable income to offset, the report said. I.R.S. Notice 2008-83 was repealed in 2009.

For those of you who’ve wondered why there have been so few prosecutions of mortgage fraud during this epidemic, your answer is on Page 164. “The terrible thing that happened,” said William K. Black, a former fraud investigator in the savings-and-loan crisis who is a professor at the University of Missouri-Kansas City School of Law, “was that the F.B.I. got virtually no assistance from the regulators, the banking regulators and the thrift regulators.”

Finally, if it’s comic relief you’re after, turn to Page 105 for an interview with Angelo R. Mozilo, former chief executive of Countrywide Financial, a lender that profited by roping unsuspecting borrowers into poisonous loans.

Mr. Mozilo, the commission said, described his company as having “prevented social unrest” by providing loans to 25 million borrowers, many of them members of minority groups. Never mind that throngs of these loans have resulted in foreclosures and evictions. “Countrywide was one of the greatest companies in the history of this country,” Mr. Mozilo maintained, “and probably made more difference to society, to the integrity of our society, than any company in the history of America.”

You cannot make this stuff up.

Do further bailouts lie ahead? Neil Barofsky, special inspector general for the Troubled Asset Relief Program, seems to think so. When the government stepped in to save Citigroup in 2008, “it did more than reassure troubled markets — it encouraged high-risk behavior by insulating risk-takers from the consequences of failure,” he said in his report to Congress last week.

“Unless and until an institution such as Citigroup is either broken up, so that it is no longer a threat to the financial system, or a structure is put in place to assure that it will be left to suffer the full consequences of its own folly,” he said, “the prospect of more bailouts will potentially fuel more bad behavior with potentially disastrous results.”


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