The Reckoning

The final report of the Financial Crisis Inquiry Commission is meant to be the definitive account of the economic crisis that erupted in 2008. Like the 9/11 Commission Report, it seeks to provide a complete account of the circumstances surrounding a cataclysmic event, in this case the worst recession since the Great Depression. Unfortunately, political disagreements among the commission members combined with the complexity of the narrative threaten to consign the report to obscurity.

If that happens, a crucial opportunity will be missed. Even with the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the regulatory system in place may not be strong enough to prevent another crisis. As the commission members observe, “If we do not learn from history, we are unlikely to fully recover from it.”

While the 9/11 Report was hailed by members of both parties, the Finance Commission faced significant political obstacles from the outset. The causes of the crisis are still much debated on Capitol Hill, and government’s response to the crisis, the Troubled Asset Relief Program, or TARP, is politically poisonous. It is not surprising that none of the Republicans on the commission chose to endorse its findings, deciding instead to issue two lengthy dissents. For one thing, the report offers a stinging indictment of financial deregulation, an article of faith for Republicans—and some Democrats—for the last 30 years.

Already critics are dismissing the commission’s report as a politicized document. In fact, it is grounded in months of research and hundreds of interviews, some facilitated by subpoenas. If not a definitive account of the crisis, it is the most thorough so far and merits serious study. A few of the report’s themes deserve emphasis.

Risky Business. The mortgage industry has been widely pilloried for its unethical lending practices prior to the crisis, and the commission’s report adds depth and detail to that judgment. Yet it is also striking how many American homeowners took advantage of these lax practices, signing on for adjustable-rate mortgages or trying to make a quick profit by “flipping” a second home. Overall, mortgage indebtedness in the United States doubled from 2001 to 2007, from $5.3 trillion to $10.5 trillion. In the wake of the housing market collapse, few parties emerged unscathed.

Irrational Exuberance. Again and again the report cites individuals and institutions who warned of the coming crisis. Beginning in 1999, a nonprofit housing group in California alerted Chairman Alan Greenspan of the Federal Reserve to predatory lending practices. Why were such warnings ignored? With markets surging and retirement and investment accounts following suit, few seemed willing to play spoiler. As one former government official said of the mortgage market: “Everybody was making a great deal of money…and there wasn’t a great deal of oversight going on.”

Markets Unbound. “The financial system we examined bears little resemblance to that of our parents’ generation,” the report’s authors write. And yet the regulatory regime in place during the crisis was created to deal with financial problems that arose generations ago. In some instances, those reforms had been severely weakened. In the case of the Glass-Steagall Act, which sought to regulate the activities of the banking industry, the reform was repealed altogether. The triumph of the gospel of deregulation led to risky decisions that valued short-term profits over long-term investment.

Watching the Watchdogs. Public institutions with the power to rein in questionable practices failed to act, most notably the Federal Reserve. Meanwhile, Moody’s and other ratings agencies charged with assessing the strength of financial instruments repeatedly awarded misleading ratings. In case after case, individuals failed in their professional and ethical responsibilities.

With the Dow Jones Industrial Average hitting 12,000 in January for the first time since 2008, it is tempting to let the financial crisis fade into history. Yet as Wall Street surges, the economy still sputters, in very large part because of the events of two years ago. A final reckoning is necessary both to determine what went wrong and to ensure the system does not fail again. The rise and fall of the housing market is an example of corporate malfeasance not unlike the rush to war in Iraq in 2003, with both individuals and institutions playing a part. Some national soul-searching seems in order.

That examination could well begin with the 633-page report from the Financial Crisis Commission. Though short on analysis and weakened by Republican dissenters, it recognizes the crisis for the fundamental failure of responsibility it was. And for the average reader, the report offers a simple judgment amid an ocean of detail, one that could serve to temper the next wave of market madness: “We conclude this financial crisis was avoidable.”

This article appears in February 14 2011.