Wall Street and the Financial Crisis
The financial crisis was not an act of nature; it was a man-made economic assault that cost millions of jobs, evaporated billions of dollars in retirement savings, and put our nation in the worst economic tailspin since the Great Depression.
In April 2010, the Permanent Subcommittee on Investigations held a series of hearings in order to examine some of the causes and consequences of the crisis. The goals of the hearings were threefold: to construct a public record of the facts to deepen public understanding of what happened and to try to hold some of the perpetrators accountable; to inform the legislative debate about the need for financial reform; and to provide a foundation for building better defenses to protect Main Street from the excesses of Wall Street.
The hearings were based on an in-depth bipartisan investigation that began in November 2008. The Subcommittee conducted over 100 detailed interviews and depositions, consulted with dozens of experts, and collected and initiated review of millions of pages of documents. Given the extent of the economic damage and the complexity of its root causes, the Subcommittee’s approach has been to develop detailed case studies to examine each stage of the crisis.
The first hearing examined the role of high risk home loans and the mortgage backed securities that those loans produced, using as a case history the policies and practices of Washington Mutual Bank.
The second hearing examined the role of the banking regulators charged with ensuring the safety and soundness of the U.S. banking system, again using Washington Mutual as a case history.
The third hearing focused on the role of the credit rating agencies (CRAs), specifically the two largest CRAs: Moody's and Standard and Poor's.
The final hearing focused on the role of investment banks, using Goldman Sachs as a case study.
Hearing One: The Role of High Risk Home Loans
The first hearing, April 13, 2010, focused on the role of high risk loans, using Washington Mutual Bank as a case history. It showed how the bank originated and sold hundreds of billions of dollars in high risk loans to Wall Street in return for big fees, polluting the financial system with toxic mortgages.
The Subcommittee investigation reached the following findings of fact:
1. High Risk Lending Strategy. Washington Mutual (“WaMu”) executives embarked upon a high risk lending strategy and increased sales of high risk home loans to Wall Street, because they projected that high risk home loans, which generally charged higher rates of interest, would be more profitable for the bank than low risk home loans.
2. Shoddy Lending Practices. WaMu and its affiliate, Long Beach Mortgage Company (“Long Beach”), used shoddy lending practices riddled with credit, compliance, and operational deficiencies to make tens of thousands of high risk home loans that too often contained excessive risk, fraudulent information, or errors.
3. Steering Borrowers to High Risk Loans. WaMu and Long Beach too often steered borrowers into home loans they could not afford, allowing and encouraging them to make low initial payments that would be followed by much higher payments, and presumed that rising home prices would enable those borrowers to refinance their loans or sell their homes before the payments shot up.
4. Polluting the Financial System. WaMu and Long Beach securitized over $77 billion in subprime home loans and billions more in other high risk home loans, used Wall Street firms to sell the securities to investors worldwide, and polluted the financial system with mortgage backed securities which later incurred high rates of delinquency and loss.
5. Securitizing Delinquency-Prone and Fraudulent Loans. At times, WaMu selected and securitized loans that it had identified as likely to go delinquent, without disclosing its analysis to investors who bought the securities, and also securitized loans tainted by fraudulent information, without notifying purchasers of the fraud that was discovered.
6. Destructive Compensation. WaMu’s compensation system rewarded loan officers and loan processors for originating large volumes of high risk loans, paid extra to loan officers who overcharged borrowers or added stiff prepayment penalties, and gave executives millions of dollars even when its high risk lending strategy placed the bank in financial jeopardy.
- Levin-Coburn memo - Wall Street and the Financial Crisis: The Role of High Risk Home Loans [PDF] - April 13, 2010
- Opening Statement - PSI Hearing on Wall Street and the Financial Crisis: The Role of High Risk Home Loans - April 13, 2010
- Exhibits - PSI Hearing on Wall Street and the Financial Crisis: The Role of High Risk Home Loans [PDF 51 MB] -April 13, 2010
- Hearing information - Homeland Security and Governmental Affairs Committee website - April 13, 2010
- Press release - Senate Subcommittee Launches Series of Hearings on Wall Street and Financial Crisis - April 12, 2010
Hearing Two: The Role of Bank Regulators
The second hearing, on April 16, 2010, focused on regulators, using as a case study the role of the Office of Thrift Supervision (OTS), and the Federal Deposit Insurance Corporation (FDIC) in exercising oversight of Washington Mutual Bank.
Feeble oversight by regulators, combined with weak regulatory standards and agency infighting, allowed Washington Mutual Bank, a $300 billion thrift and the sixth largest U.S. depository institution, to engage in high-risk and shoddy lending practices and the sale of toxic and sometimes fraudulent mortgages that contributed to both the bank’s demise and the 2008 financial crisis.
The Subcommittee investigation reached the following findings of fact:
1. Largest U.S. Bank Failure. From 2003 to 2008, OTS repeatedly identified significant problems with Washington Mutual’s lending practices, risk management, and asset quality, but failed to force adequate corrective action, resulting in the largest bank failure in U.S. history.
2. Shoddy Lending and Securitization Practices. OTS allowed Washington Mutual and its affiliate Long Beach Mortgage Company to engage year after year in shoddy lending and securitization practices, failing to take enforcement action to stop its origination and sale of loans with fraudulent borrower information, appraisal problems, errors, and notoriously high rates of delinquency and loss.
3. Unsafe Option ARM Loans. OTS allowed Washington Mutual to originate hundreds of billions of dollars in high risk Option Adjustable Rate Mortgages, knowing that the bank used unsafe and unsound teaser rates, qualified borrowers using unrealistically low loan payments, permitted borrowers to make minimum payments resulting in negatively amortizing loans (i.e., loans with increasing principal), relied on rising house prices and refinancing to avoid payment shock and loan defaults, and had no realistic data to calculate loan losses in markets with flat or declining house prices.
4. Short Term Profits Over Long Term Fundamentals. OTS abdicated its responsibility to ensure the long-term safety and soundness of Washington Mutual by concluding that short-term profits obtained by the bank precluded enforcement action to stop the bank’s use of shoddy lending and securitization practices and unsafe and unsound loans.
5. Impeding FDIC Oversight. OTS impeded FDIC oversight of Washington Mutual by blocking its access to bank data, refusing to allow it to participate in bank examinations, rejecting requests to review bank loan files, and resisting FDIC recommendations for stronger enforcement action.
6. FDIC Shortfalls. FDIC, the backup regulator of Washington Mutual, was unable to conduct the analysis it wanted to evaluate the risk posed by the bank to the Deposit Insurance Fund, did not prevail against unreasonable actions taken by OTS to limit its examination authority, and did not initiate its own enforcement action against the bank in light of ongoing opposition by the primary federal bank regulators to FDIC enforcement authority.
7. Recommendations Over Enforceable Requirements. Federal bank regulators undermined efforts to end unsafe and unsound mortgage practices at U.S. banks by issuing guidance instead of enforceable regulations limiting those practices, failing to prohibit many high risk mortgage practices, and failing to set clear deadlines for bank compliance.
8. Failure to Recognize Systemic Risk. OTS and FDIC allowed Washington Mutual and Long Beach to reduce their own risk by selling hundreds of billions of dollars of high risk mortgage backed securities that polluted the financial system with poorly performing loans, undermined investor confidence in the secondary mortgage market, and contributed to massive credit rating downgrades, investor losses, disrupted markets, and the U.S. financial crisis.
9. Ineffective and Demoralized Regulatory Culture. The Washington Mutual case history exposes the regulatory culture at OTS in which bank examiners are frustrated and demoralized by their inability to stop unsafe and unsound practices, in which their supervisors are reluctant to use formal enforcement actions even after years of serious bank deficiencies, and in which regulators treat the banks they oversee as constituents rather than arms-length regulated entities.
- Levin-Coburn memo - Wall Street and the Financial Crisis: The Role of Bank Regulators [PDF] - April 16, 2010
- Opening statement - PSI Hearing on Wall Street and the Financial Crisis: The Role of Bank Regulators - April 16, 2010
- Exhibits - PSI hearing on Wall Street and the Financial Crisis: The Role of Bank Regulators [PDF 25 MB] - April 16, 2010
- Hearing information - Homeland Sercurity and Governmental Affairs Committee website - April 16, 2010
- Press release - Senate Subcommittee Holds Second Hearing on Wall Street and the Financial Crisis: The Role of Bank Regulators - April 15, 2010
Hearing Three: The Role of Credit Rating Agencies.
The third hearing, on April 23, 2010, focused on the role of the credit ratings agencies (CRAs). Moody’s and Standard and Poor’s, the two largest credit ratings agencies, rated tens of thousands of residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) that were based on high-risk home loans.
While making record profits from 2004 to 2007, CRAs –which are paid by the issuers of the securities they rate—gave the highest possible ratings to securities underpinned by high-risk home loans. In 2007, after delinquencies rose and the subprime market began to collapse, the CRAs had to massively downgrade many of these securities, resulting in major shocks to the financial system.
The Subcommittee reached the following findings of fact:
1. Inaccurate Rating Models. From 2004 to2007, Moody’s and Standard & Poor’s used credit rating models with data that was inadequate to predict how high risk residential mortgages, such as subprime, interest only, and option adjustable rate mortgages, would perform.
2. Competitive Pressures. Competitive pressures, including the drive for market share and need to accommodate investment bankers bringing in business, affected the credit ratings issued by Moody’s and Standard & Poor’s.
3. Failure to Re-evaluate. By 2006, Moody’s and Standard & Poor’s knew their ratings of residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs) were inaccurate, revised their rating models to produce more accurate ratings, but then failed to use the revised model to re-evaluate existing RMBS and CDO securities, delaying thousands of rating downgrades and allowing those securities to carry inflated ratings that could mislead investors.
4. Failure to Factor In Fraud, Laxity, or Housing Bubble. From 2004 to 2008, Moody’s and Standard & Poor’s knew of increased credit risks due to mortgage fraud, lax underwriting standards, and unsustainable housing price appreciation, but failed adequately to incorporate those factors into their credit rating models.
5. Inadequate Resources. Despite record profits from 2004 to 2008, Moody’s and Standard & Poor’s failed to assign sufficient resources to adequately rate new products and test the accuracy of existing ratings.
6. Mass Downgrades Shocked Market. Mass downgrades by Moody’s and Standard & Poor’s, including downgrades of hundreds of subprime RMBS over a few days in July 2007, downgrades by Moody’s of CDOs in October 2007, and downgrades by Standard & Poor’s of over 6,300 RMBS and 1,900 CDOs on one day in January 2008, shocked the financial markets, helped cause the collapse of the subprime secondary market, triggered sales of assets that had lost investment grade status, and damaged holdings of financial firms worldwide, contributing to the financial crisis.
7. Failed Ratings. Of [12,000] RMBS that, from 2006 to 2007, received AAA ratings from Moody’s or Standard & Poor’s, about [one-third] have since received a rating downgrade, some within 6 months of their initial rating.
8. Statutory Bar. The U.S. Securities and Exchange Commission is barred by statute from conducting needed oversight into the substance, procedures, and methodologies of the credit rating models.
- Levin-Coburn memo - Wall Street and the Financial Crisis: The Role of Credit Rating Agencies [PDF] - April 23, 2010
- Opening statement - PSI Hearing on Wall Street and the Financial Crisis: The Role of Credit Rating Agencies - April 23, 2010
- Exhibits - PSI Hearing on Wall Street and the Financial Crisis: The Role of Credit Rating Agencies [PDF 23 MB] - April 23, 1010
- Hearing information - Homeland Security and Governmental Affairs Committee website - April 23, 2010
- Press release - Senate Subcommittee Holds Third Hearing on Wall Street and the Financial Crisis: The Role of Credit Rating Agencies - April 22, 2010
Hearing Four: The Role of Investment Banks.
The final hearing, held on April 27, 2010, focused on the role of investment banks, using Goldman Sachs as a case study. Goldman Sachs and other investment banks played a crucial role in building and running the conveyor belt that fed toxic mortgages and mortgage-backed securities into the financial system.
For Goldman Sachs, this role included underwriting securities backed by or related to mortgages from some of the most notorious subprime mortgage lenders, including Long Beach. Goldman Sachs also designed and sold billions of dollars of collateralized debt obligations (CDOs) that further spread the risks associated with toxic mortgages, and issued derivative financial products, such as synthetic collateralized debt obligations (CDOs), which had no underlying assets and were merely bets that referenced mortgage-backed securities. In several cases, Goldman was marketing deals to its clients as good investment opportunities while simultaneously betting that these very same deals would fail.
The Subcommittee reached the following findings of fact:
1. Securitizing High Risk Mortgages. From 2004 to 2007, in exchange for lucrative fees, Goldman Sachs helped lenders like Long Beach, Fremont, and New Century, securitize high risk, poor quality loans, obtain favorable credit ratings for the resulting residential mortgage backed securities (RMBS), and sell the RMBS securities to investors, pushing billions of dollars of risky mortgages into the financial system.
2. Magnifying Risk. Goldman Sachs magnified the impact of toxic mortgages on financial markets by re-securitizing RMBS securities in collateralized debt obligations (CDOs), referencing them in synthetic CDOs, selling the CDO securities to investors, and using credit default swaps and index trading to profit from the failure of the same RMBS and CDO securities it sold.
3. Shorting the Mortgage Market. As high risk mortgage delinquencies increased, and RMBS and CDO securities began to lose value, Goldman Sachs took a net short position on the mortgage market, remaining net short throughout 2007, and cashed in very large short positions, generating billions of dollars in gain.
4. Conflict Between Client and Proprietary Trading. In 2007, Goldman Sachs went beyond its role as market maker for clients seeking to buy or sell mortgage related securities, traded billions of dollars in mortgage related assets for the benefit of the firm without disclosing its proprietary positions to clients, and instructed its sales force to sell mortgage related assets, including high risk RMBS and CDO securities that Goldman Sachs wanted to get off its books, creating a conflict between the firm’s proprietary interests and the interests of its clients.
5. Abacus Transaction. Goldman Sachs structured, underwrote, and sold a synthetic CDO called Abacus 2007-AC1, did not disclose to the Moody’s analyst overseeing the rating of the CDO that a hedge fund client taking a short position in the CDO had helped to select the referenced assets, and also did not disclose that fact to other investors.
6. Using Naked Credit Default Swaps. Goldman Sachs used credit default swaps (CDS) on assets it did not own to bet against the mortgage market through single name and index CDS transactions, generating substantial revenues in the process.
- Levin-Coburn memo - Wall Street and the Financial Crisis: The Role of Investment Banks [PDF] - April 26, 2010
- Opening Statement - PSI Hearing on Wall Street and the Financial Crisis: The Role of Investment Banks - April 27, 2010
- Exhibits - PSI Hearing on Wall Street and the Financial Crisis: The Role of Investment Banks [PDF 43 MB] - April 27, 2010
- Hearing information - Homeland Security and Governmental Affairs Committee website - April 27, 2010
- Press release - Senate Subcommittee Holds Fourth Hearing on Wall Street and the Financial Crisis: The Role of Investment Banks - April 26, 2010
Senator Levin’s Record on Wall Street and the Financial Crisis
- April 13, 2012 – Sen. Levin fights oil speculation, high gas prices
Sen. Levin is one of 19 U.S. senators who file an amicus brief in federal court to support commodities regulators in establishing trading limits on speculators who contribute to the volatility in oil and gas prices.
- March 26, 2012 – Sen. Levin speaks out against oil speculation
In a Senate floor speech based on information developed by the Permanent Subcommittee on Investigations, Sen. Levin cites evidence that speculators are overwhelming the market for oil, gas and other commodities, calls for the establishment of trading limits on speculators as required in the Dodd-Frank Wall Street reform legislation, and calls for stronger actions to protect consumers and businesses from the impact of speculation on oil prices.
- March 22, 2012 – Sen. Levin opposes misnamed 'jobs' bill
Sen. Levin speaks out against legislation that has been sold as a job-creation bill, but that eliminates important protections for investors and threatens to reduce, rather than grow, investment in job creation. Earlier, Sen. Levin had joined with Sens. Mary Landrieu and Jack Reed to offer an alternative that would boost investment in job creation while maintaining investor protections.
- Dec. 13, 2011 – Levin calls for tougher action against failed bank’s executives
Sen. Levin calls for tougher action, including possible civil monetary penalties, against the executives of Washington Mutual Bank after an announcement of a settlement of FDIC claims against the bank’s executives. Leaders at Washington Mutual, the largest bank failure in U.S. history and a subject of scrutiny by Levin’s Permanent Subcommittee on Investigations for its role in helping spark the financial crisis, escaped with light penalties by the FDIC.
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