The financial crisis – too big to manage

The financial crisis Inquiry report have been published and it though reading. For many of us the biggest question about the crisis has been WHY did this happen? And as it actually did the second question is HOW could it be avoided?

The financial Crisis commission has worked since 2009 and has come up with a series of answers to some of these essential questions. The report itself is about 660 pages so I have just taken some of the conclusions and comments that they have come up with.

We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public.

Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. The tragedy was that they were ignored or discounted.”

There were plenty of signs and I do not think that anybody thought that the crisis was avoidable the real question was who would “blink” first? As the money kept pouring in and stocks rocketed, we all knew that at some point it would all cave in and the ones that were left behind would be the ones who sat with the bill. Most people in government and the finance are reasonable intelligent people, but they were caught up in their own arrogance and willingness to gamble with big money, like the people at Citygroup and others.

“The CEO of Citigroup told the Commission that a $40 billion position in highly rated mortgage securities would “not in any way have excited my attention,” and the co-head of Citigroup’s investment bank said he spent “a small fraction of 1%” of his time on those securities. In this instance, too big to fail meant too big to manage.

We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.

Yet we do not accept the view that regulators lacked the power to protect the financial system. They had ample power in many arenas and they chose not to use it.

And where regulators lacked authority, they could have sought it. Too often, they lacked the political will—in a political and ideological environment that constrained it—as well as the fortitude to critically challenge the institutions and the entire system they were entrusted to oversee.”

We have come to expect that we to some degree are protected from the full force of capitalism. But apparently this is not the case actually is both the government and financial institutions littered with free-market ideologues that rather see millions of people lose their jobs and leave their home than admit that they were wrong. I do not consider myself a socialist, not by fare, but there seem that in 2007 and 2008 there were no middle ground. The motto of the neo-liberals was “Either you are with us or you are against us” it would seem.    

We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. There was a view that instincts for self-preservation inside major financial firms would shield them from fatal risk-taking without the need for a steady regulatory hand, which, the firms argued, would stifle innovation. Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding.

Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences.”

Reminds me of the dear mister Gordon Gekko from the movie Wall Street and the famous quote “Greed, for lack of a better word, is good”, well maybe he was wrong after all. The captains of corporate finance have turned out to be greedy, willing to gamble with other people lives and money and to certain extend can be categorized as just plain evil.

 “We conclude a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis.

In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly.”

By the end of 2007, Lehman had amassed $111 billion in commercial and residential real estate holdings and securities, which was almost twice what it held just two years before, and more than four times its total equity.”

We conclude the government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial markets.

…key policy makers—the Treasury Department, the Federal Reserve Board, and the Federal Reserve Bank of New York—who were best positioned to watch over our markets were ill prepared for the events of 2007 and 2008.

While there was some awareness of, or at least a debate about, the housing bubble, the record reflects that senior public officials did not recognize that a bursting of the bubble could threaten the entire financial system.”

We conclude there was a systemic breakdown in accountability and ethics. The integrity of our financial markets and the public’s trust in those markets are essential to the economic well-being of our nation. The soundness and the sustained prosperity of the financial system and our economy rely on the notions of fair dealing, responsibility, and transparency. In our economy, we expect businesses and individuals to pursue profits, at the same time that they produce products and services of quality and conduct themselves well.”

I think that this point pretty much covers my whole perception about the background of the financial crisis. The systematic and disregard of common sense, when people live in a world where nothing is hard, where every mistake can be covered up in packaged systems of your own design, that you yourself do not understand then you lose your grip of reality.

“We conclude the failures of credit rating agencies were essential cogs in the wheel of financial destruction. The three credit rating agencies were key enablers of the financial meltdown. The mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval. Investors relied on them, often blindly.”  

The partners in crime and the body we thought we could trust as a third party that could validate our investment strategies. But they did not understand the system that they were meant to give the rest of us advice on and the consequence was that we all too some degree suffered.

I have only taken a snapshot of all the conclusions in the inquiry report and you will properly find more interesting details buried in there somewhere. I would be the first to admit that I to ignored the signs and did not understand the complexity and risk that globalised finance have brought along with it. I’m a firm believer in free markets etc. but I’m also deeply committed to transparency and accountability two things that have been absent in the world of business and not least the financial sector before 2009.

It saddens me to see that some of the people in this report are still very much active in there nice of the world and that that they have not learned any other lesson other than trying not to get caught next time. They continue to believe it is a game and are now designing ever more elaborate systems that can bypass the barriers we try to put up as we speak. The US has and still has the most elaborate financial reporting system (Sarbanes-Oxley) and it could still not stop the crisis from shaking the world so why would new systems even more complex do any better.

You can read the whole thing here


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