fcic_final_report_conclusions

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CONCLUSIONS OF THEFINANCIAL CRISIS INQUIRY COMMISSION

The Financial Crisis Inquiry Commission has been called upon to examine the fnan-cial and economic crisis that has gripped our country and explain its causes to theAmerican people. We are keenly aware o the signifcance o our charge, given theeconomic damage that America has su ered in the wake o the greatest fnancial cri-sis since the Great Depression.

Our task was frst to determine what happened and how it happened so that wecould understand why it happened. Here we present our conclusions. We encouragethe American people to join us in making their own assessments based on the evi-dence gathered in our inquiry. I we do not learn rom history, we are unlikely to ully recover rom it. Some on Wall Street and in Washington with a stake in the status quomay be tempted to wipe rom memory the events o this crisis, or to suggest that noone could have oreseen or prevented them. This report endeavors to expose the

acts, identi y responsibility, unravel myths, and help us understand how the crisis

could have been avoided. It is an attempt to record history, not to rewrite it, nor allowit to be rewritten.To help our ellow citizens better understand this crisis and its causes, we also pres-

ent specifc conclusions at the end o chapters in Parts III, IV, and V o this report.The subject o this report is o no small consequence to this nation. The pro ound

events o and were neither bumps in the road nor an accentuated dip inthe fnancial and business cycles we have come to expect in a ree market economicsystem. This was a undamental disruptiona fnancial upheaval, i you willthatwreaked havoc in communities and neighborhoods across this country.

As this report goes to print, there are more than million Americans who areout o work, cannot fnd ull-time work, or have given up looking or work. About

our million amilies have lost their homes to oreclosure and another our and a hal million have slipped into the oreclosure process or are seriously behind on their

mortgage payments. Nearly trillion in household wealth has vanished, with re-tirement accounts and li e savings swept away. Businesses, large and small, have elt

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the sting o a deep recession. There is much anger about what has transpired, and jus-tifably so. Many people who abided by all the rules now fnd themselves out o workand uncertain about their uture prospects. The collateral damage o this crisis hasbeen real people and real communities. The impacts o this crisis are likely to be elt

or a generation. And the nation aces no easy path to renewed economic strength.Like so many Americans, we began our exploration with our own views and some

preliminary knowledge about how the worlds strongest fnancial system came to thebrink o collapse. Even at the time o our appointment to this independent panel,much had already been written and said about the crisis. Yet all o us have beendeeply a ected by what we have learned in the course o our inquiry. We have been at various times ascinated, surprised, and even shocked by what we saw, heard, andread. Ours has been a journey o revelation.

Much attention over the past two years has been ocused on the decisions by theederal government to provide massive fnancial assistance to stabilize the fnancial

system and rescue large fnancial institutions that were deemed too systemically im-portant to ail. Those decisionsand the deep emotions surrounding themwill bedebated long into the uture. But our mission was to ask and answer this central ques-tion: how did it come to pass that in our nation was forced to choose between twostark and painful alternatives either risk the total collapse o our fnancial systemand economy or inject trillions o taxpayer dollars into the fnancial system and anarray o companies, as millions o Americans still lost their jobs, their savings, andtheir homes?

In this report, we detail the events o the crisis. But a simple summary, as we seeit, is use ul at the outset. While the vulnerabilities that created the potential or cri-sis were years in the making, it was the collapse o the housing bubble ueled by low interest rates, easy and available credit, scant regulation, and toxic mortgagesthat was the spark that ignited a string o events, which led to a ull-blown crisis in

the all o . Trillions o dollars in risky mortgages had become embeddedthroughout the inancial system, as mortgage-related securities were packaged,repackaged, and sold to investors around the world. When the bubble burst, hun-dreds o billions o dollars in losses in mortgages and mortgage-related securitiesshook markets as well as inancial institutions that had signi icant exposures tothose mortgages and had borrowed heavily against them. This happened not just inthe United States but around the world. The losses were magni ied by derivativessuch as synthetic securities.

The crisis reached seismic proportions in September with the ailure o Lehman Brothers and the impending collapse o the insurance giant American Interna-tional Group (AIG). Panic anned by a lack o transparency o the balance sheets o major fnancial institutions, coupled with a tangle o interconnections among institutionsperceived to be too big to ail, caused the credit markets to seize up. Trading ground

to a halt. The stock market plummeted. The economy plunged into a deep recession.The fnancial system we examined bears little resemblance to that o our parentsgeneration. The changes in the past three decades alone have been remarkable. The

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fnancial markets have become increasingly globalized. Technology has trans ormedthe e ciency, speed, and complexity o fnancial instruments and transactions. Thereis broader access to and lower costs o fnancing than ever be ore. And the fnancialsector itsel has become a much more dominant orce in our economy.

From to , the amount o debt held by the fnancial sector soared rom trillion to trillion, more than doubling as a share o gross domestic product.

The very nature o many Wall Street frms changed rom relatively staid privatepartnerships to publicly traded corporations taking greater and more diverse kinds o risks. By , the largest U.S. commercial banks held o the industrys assets,more than double the level held in . On the eve o the crisis in , fnancialsector profts constituted o all corporate profts in the United States, up rom

in . Understanding this trans ormation has been critical to the Commis-sions analysis.

Now to our major fndings and conclusions, which are based on the acts con-tained in this report: they are o ered with the hope that lessons may be learned tohelp avoid uture catastrophe.

We conclude this fnancial crisis was avoidable. The crisis was the result o humanaction and inaction, not o Mother Nature or computer models gone haywire. Thecaptains o fnance and the public stewards o our fnancial system ignored warningsand ailed to question, understand, and manage evolving risks within a system essen-tial to the well-being o the American public. Theirs was a big miss, not a stumble.While the business cycle cannot be repealed, a crisis o this magnitude need not haveoccurred. To paraphrase Shakespeare, the ault lies not in the stars, but in us.

Despite the expressed view o many on Wall Street and in Washington that thecrisis could not have been oreseen or avoided, there were warning signs. The tragedy was that they were ignored or discounted. There was an explosion in risky subprime

lending and securitization, an unsustainable rise in housing prices, widespread re-ports o egregious and predatory lending practices, dramatic increases in householdmortgage debt, and exponential growth in fnancial frms trading activities, unregu-lated derivatives, and short-term repo lending markets, among many other red

ags. Yet there was pervasive permissiveness; little meaning ul action was taken toquell the threats in a timely manner.

The prime example is the Federal Reserves pivotal ailure to stem the ow o toxicmortgages, which it could have done by setting prudent mortgage-lending standards.The Federal Reserve was the one entity empowered to do so and it did not. Therecord o our examination is replete with evidence o other ailures: fnancial institu-tions made, bought, and sold mortgage securities they never examined, did not careto examine, or knew to be de ective; frms depended on tens o billions o dollars o borrowing that had to be renewed each and every night, secured by subprime mort-

gage securities; and major frms and investors blindly relied on credit rating agenciesas their arbiters o risk. What else could one expect on a highway where there wereneither speed limits nor neatly painted lines?

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We conclude widespread ailures in fnancial regulation and supervisionproved devastating to the stability o the nations fnancial markets. The sentrieswere not at their posts, in no small part due to the widely accepted aith in the sel -correcting nature o the markets and the ability o fnancial institutions to e ectively police themselves. More than 30 years o deregulation and reliance on sel -regulationby fnancial institutions, championed by ormer Federal Reserve chairman AlanGreenspan and others, supported by successive administrations and Congresses, andactively pushed by the power ul fnancial industry at every turn, had stripped away key sa eguards, which could have helped avoid catastrophe. This approach hadopened up gaps in oversight o critical areas with trillions o dollars at risk, such asthe shadow banking system and over-the-counter derivatives markets. In addition,the government permitted fnancial frms to pick their pre erred regulators in whatbecame a race to the weakest supervisor.

Yet we do not accept the view that regulators lacked the power to protect the f-nancial system. They had ample power in many arenas and they chose not to use it.To give just three examples: the Securities and Exchange Commission could have re-quired more capital and halted risky practices at the big investment banks. It did not.The Federal Reserve Bank o New York and other regulators could have clampeddown on Citigroups excesses in the run-up to the crisis. They did not. Policy makersand regulators could have stopped the runaway mortgage securitization train. They did not. In case a ter case a ter case, regulators continued to rate the institutions they oversaw as sa e and sound even in the ace o mounting troubles, o ten downgradingthem just be ore their collapse. And where regulators lacked authority, they couldhave sought it. Too o ten, they lacked the political willin a political and ideologicalenvironment that constrained itas well as the ortitude to critically challenge theinstitutions and the entire system they were entrusted to oversee.

Changes in the regulatory system occurred in many instances as fnancial mar-

kets evolved. But as the report will show, the fnancial industry itsel played a key role in weakening regulatory constraints on institutions, markets, and products. Itdid not surprise the Commission that an industry o such wealth and power wouldexert pressure on policy makers and regulators. From to , the fnancialsector expended . billion in reported ederal lobbying expenses; individuals andpolitical action committees in the sector made more than billion in campaigncontributions. What troubled us was the extent to which the nation was deprived o the necessary strength and independence o the oversight necessary to sa eguardfnancial stability.

We conclude dramatic ailures o corporate governance and risk managementat many systemically important fnancial institutions were a key cause o this cri-sis. There was a view that instincts or sel -preservation inside major fnancial frms

would shield them rom atal risk-taking without the need or a steady regulatory hand, which, the frms argued, would sti e innovation. Too many o these institu-tions acted recklessly, taking on too much risk, with too little capital, and with toomuch dependence on short-term unding. In many respects, this re ected a unda-

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mental change in these institutions, particularly the large investment banks and bankholding companies, which ocused their activities increasingly on risky trading activ-ities that produced he ty profts. They took on enormous exposures in acquiring andsupporting subprime lenders and creating, packaging, repackaging, and selling tril-lions o dollars in mortgage-related securities, including synthetic fnancial products.Like Icarus, they never eared ying ever closer to the sun.

Many o these institutions grew aggressively through poorly executed acquisitionand integration strategies that made e ective management more challenging. TheCEO o Citigroup told the Commission that a billion position in highly ratedmortgage securities would not in any way have excited my attention, and the co-head o Citigroups investment bank said he spent a small raction o o his timeon those securities. In this instance, too big to ail meant too big to manage.

Financial institutions and credit rating agencies embraced mathematical modelsas reliable predictors o risks, replacing judgment in too many instances. Too o ten,risk management became risk justifcation.

Compensation systemsdesigned in an environment o cheap money, intensecompetition, and light regulationtoo o ten rewarded the quick deal, the short-termgainwithout proper consideration o long-term consequences. O ten, those systemsencouraged the big betwhere the payo on the upside could be huge and the down-side limited. This was the case up and down the line rom the corporate boardroomto the mortgage broker on the street.

Our examination revealed stunning instances o governance breakdowns and irre-sponsibility. You will read, among other things, about AIG senior managements igno-rance o the terms and risks o the companys billion derivatives exposure tomortgage-related securities; Fannie Maes quest or bigger market share, profts, andbonuses, which led it to ramp up its exposure to risky loans and securities as the hous-ing market was peaking; and the costly surprise when Merrill Lynchs top manage-

ment realized that the company held billion in super-senior and supposedly super-sa e mortgage-related securities that resulted in billions o dollars in losses.

We conclude a combination o excessive borrowing, risky investments, and lack o transparency put the fnancial system on a collision course with crisis. Clearly,this vulnerability was related to ailures o corporate governance and regulation, butit is signifcant enough by itsel to warrant our attention here.

In the years leading up to the crisis, too many fnancial institutions, as well as toomany households, borrowed to the hilt, leaving them vulnerable to fnancial distressor ruin i the value o their investments declined even modestly. For example, as o

, the fve major investment banksBear Stearns, Goldman Sachs, LehmanBrothers, Merrill Lynch, and Morgan Stanleywere operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as to , meaning or

every in assets, there was only in capital to cover losses. Less than a drop inasset values could wipe out a frm. To make matters worse, much o their borrowingwas short-term, in the overnight marketmeaning the borrowing had to be renewedeach and every day. For example, at the end o , Bear Stearns had . billion in

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equity and . billion in liabilities and was borrowing as much as billion inthe overnight market. It was the equivalent o a small business with , in equity borrowing . million, with , o that due each and every day. One cantreally ask What were they thinking? when it seems that too many o them werethinking alike.

And the leverage was o ten hiddenin derivatives positions, in o -balance-sheetentities, and through window dressing o fnancial reports available to the investingpublic.

The kings o leverage were Fannie Mae and Freddie Mac, the two behemoth gov-ernment-sponsored enterprises (GSEs). For example, by the end o , Fanniesand Freddies combined leverage ratio, including loans they owned and guaranteed,stood at to .

But fnancial frms were not alone in the borrowing spree: rom to , na-tional mortgage debt almost doubled, and the amount o mortgage debt per house-hold rose more than rom , to , , even while wages wereessentially stagnant. When the housing downturn hit, heavily indebted fnancialfrms and amilies alike were walloped.

The heavy debt taken on by some fnancial institutions was exacerbated by therisky assets they were acquiring with that debt. As the mortgage and real estate mar-kets churned out riskier and riskier loans and securities, many fnancial institutionsloaded up on them. By the end o , Lehman had amassed billion in com-mercial and residential real estate holdings and securities, which was almost twicewhat it held just two years be ore, and more than our times its total equity. Andagain, the risk wasnt being taken on just by the big fnancial frms, but by amilies,too. Nearly one in mortgage borrowers in and took out option ARMloans, which meant they could choose to make payments so low that their mortgagebalances rose every month.

Within the fnancial system, the dangers o this debt were magnifed becausetransparency was not required or desired. Massive, short-term borrowing, combinedwith obligations unseen by others in the market, heightened the chances the systemcould rapidly unravel. In the early part o the th century, we erected a series o pro-tectionsthe Federal Reserve as a lender o last resort, ederal deposit insurance, am-ple regulationsto provide a bulwark against the panics that had regularly plaguedAmericas banking system in the th century. Yet, over the past -plus years, wepermitted the growth o a shadow banking systemopaque and laden with short-term debtthat rivaled the size o the traditional banking system. Key componentso the market or example, the multitrillion-dollar repo lending market, o -bal-ance-sheet entities, and the use o over-the-counter derivativeswere hidden rom view, without the protections we had constructed to prevent fnancial meltdowns. Wehad a st-century fnancial system with th-century sa eguards.

When the housing and mortgage markets cratered, the lack o transparency, theextraordinary debt loads, the short-term loans, and the risky assets all came home toroost. What resulted was panic. We had reaped what we had sown.

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We conclude the government was ill prepared or the crisis, and its inconsistentresponse added to the uncertainty and panic in the fnancial markets. As part o our charge, it was appropriate to review government actions taken in response to thedeveloping crisis, not just those policies or actions that preceded it, to determine i any o those responses contributed to or exacerbated the crisis.

As our report shows, key policy makersthe Treasury Department, the FederalReserve Board, and the Federal Reserve Bank o New Yorkwho were best posi-tioned to watch over our markets were ill prepared or the events o and .Other agencies were also behind the curve. They were hampered because they didnot have a clear grasp o the fnancial system they were charged with overseeing, par-ticularly as it had evolved in the years leading up to the crisis. This was in no smallmeasure due to the lack o transparency in key markets. They thought risk had beendiversifed when, in act, it had been concentrated. Time and again, rom the springo on, policy makers and regulators were caught o guard as the contagionspread, responding on an ad hoc basis with specifc programs to put fngers in thedike. There was no comprehensive and strategic plan or containment, because they lacked a ull understanding o the risks and interconnections in the fnancial mar-kets. Some regulators have conceded this error. We had allowed the system to raceahead o our ability to protect it.

While there was some awareness o , or at least a debate about, the housing bubble,the record re ects that senior public o cials did not recognize that a bursting o thebubble could threaten the entire fnancial system. Throughout the summer o ,both Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paul-son o ered public assurances that the turmoil in the subprime mortgage marketswould be contained. When Bear Stearnss hedge unds, which were heavily investedin mortgage-related securities, imploded in June , the Federal Reserve discussedthe implications o the collapse. Despite the act that so many other unds were ex-

posed to the same risks as those hedge unds, the Bear Stearns unds were thought tobe relatively unique. Days be ore the collapse o Bear Stearns in March , SECChairman Christopher Cox expressed com ort about the capital cushions at the biginvestment banks. It was not until August , just weeks be ore the governmenttakeover o Fannie Mae and Freddie Mac, that the Treasury Department understoodthe ull measure o the dire fnancial conditions o those two institutions. And just amonth be ore Lehmans collapse, the Federal Reserve Bank o New York was stillseeking in ormation on the exposures created by Lehmans more than , deriv-atives contracts.

In addition, the governments inconsistent handling o major fnancial institutionsduring the crisisthe decision to rescue Bear Stearns and then to place Fannie Maeand Freddie Mac into conservatorship, ollowed by its decision not to save LehmanBrothers and then to save AIGincreased uncertainty and panic in the market.

In making these observations, we deeply respect and appreciate the e orts madeby Secretary Paulson, Chairman Bernanke, and Timothy Geithner, ormerly presi-dent o the Federal Reserve Bank o New York and now treasury secretary, and so

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many others who labored to stabilize our fnancial system and our economy in themost chaotic and challenging o circumstances.

We conclude there was a systemic breakdown in accountability and ethics. Theintegrity o our fnancial markets and the publics trust in those markets are essentialto the economic well-being o our nation. The soundness and the sustained prosper-ity o the fnancial system and our economy rely on the notions o air dealing, re-sponsibility, and transparency. In our economy, we expect businesses and individualsto pursue profts, at the same time that they produce products and services o quality and conduct themselves well.

Un ortunatelyas has been the case in past speculative booms and bustswewitnessed an erosion o standards o responsibility and ethics that exacerbated the f-nancial crisis. This was not universal, but these breaches stretched rom the groundlevel to the corporate suites. They resulted not only in signifcant fnancial conse-quences but also in damage to the trust o investors, businesses, and the public in thefnancial system.

For example, our examination ound, according to one measure, that the percent-age o borrowers who de aulted on their mortgages within just a matter o monthsa ter taking a loan nearly doubled rom the summer o to late . This dataindicates they likely took out mortgages that they never had the capacity or intentionto pay. You will read about mortgage brokers who were paid yield spread premiumsby lenders to put borrowers into higher-cost loans so they would get bigger ees, o -ten never disclosed to borrowers. The report catalogues the rising incidence o mort-gage raud, which ourished in an environment o collapsing lending standards andlax regulation. The number o suspicious activity reportsreports o possible fnan-cial crimes fled by depository banks and their a liatesrelated to mortgage raudgrew - old between and and then more than doubled again between

and . One study places the losses resulting rom raud on mortgage loansmade between and at billion.Lenders made loans that they knew borrowers could not a ord and that could

cause massive losses to investors in mortgage securities. As early as September ,Countrywide executives recognized that many o the loans they were originatingcould result in catastrophic consequences. Less than a year later, they noted thatcertain high-risk loans they were making could result not only in oreclosures butalso in fnancial and reputational catastrophe or the frm. But they did not stop.

And the report documents that major fnancial institutions ine ectively sampledloans they were purchasing to package and sell to investors. They knew a signifcantpercentage o the sampled loans did not meet their own underwriting standards orthose o the originators. Nonetheless, they sold those securities to investors. TheCommissions review o many prospectuses provided to investors ound that this crit-

ical in ormation was not disclosed.

THESE CONCLUSIONS must be viewed in the context o human nature and individualand societal responsibility. First, to pin this crisis on mortal aws like greed and

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hubris would be simplistic. It was the ailure to account or human weakness that isrelevant to this crisis.

Second, we clearly believe the crisis was a result o human mistakes, misjudg-ments, and misdeeds that resulted in systemic ailures or which our nation has paiddearly. As you read this report, you will see that specifc frms and individuals actedirresponsibly. Yet a crisis o this magnitude cannot be the work o a ew bad actors,and such was not the case here. At the same time, the breadth o this crisis does notmean that everyone is at ault; many frms and individuals did not participate in theexcesses that spawned disaster.

We do place special responsibility with the public leaders charged with protectingour fnancial system, those entrusted to run our regulatory agencies, and the chie ex-ecutives o companies whose ailures drove us to crisis. These individuals sought andaccepted positions o signifcant responsibility and obligation. Tone at the top doesmatter and, in this instance, we were let down. No one said no.

But as a nation, we must also accept responsibility or what we permitted to occur .Collectively, but certainly not unanimously, we acquiesced to or embraced a system,a set o policies and actions, that gave rise to our present predicament.

* * *TH IS R EP ORT D ES CR IB ES T HE E VE NT S and the system that propelled our nation to-ward crisis. The complex machinery o our fnancial markets has many essentialgearssome o which played a critical role as the crisis developed and deepened.Here we render our conclusions about specifc components o the system that we be-lieve contributed signifcantly to the fnancial meltdown.

We conclude collapsing mortgage-lending standards and the mortgage securi-tization pipeline lit and spread the ame o contagion and crisis. When housing

prices ell and mortgage borrowers de aulted, the lights began to dim on Wall Street.This report catalogues the corrosion o mortgage-lending standards and the securiti-zation pipeline that transported toxic mortgages rom neighborhoods across Amer-ica to investors around the globe.

Many mortgage lenders set the bar so low that lenders simply took eager borrow-ers qualifcations on aith, o ten with a will ul disregard or a borrowers ability topay. Nearly one-quarter o all mortgages made in the frst hal o were interest-only loans. During the same year, o option ARM loans originated by Coun-trywide and Washington Mutual had low- or no-documentation requirements.

These trends were not secret. As irresponsible lending, including predatory andraudulent practices, became more prevalent, the Federal Reserve and other regula-

tors and authorities heard warnings rom many quarters. Yet the Federal Reserveneglected its mission to ensure the sa ety and soundness o the nations banking and

fnancial system and to protect the credit rights o consumers. It ailed to build theretaining wall be ore it was too late. And the O ce o the Comptroller o the Cur-rency and the O ce o Thri t Supervision, caught up in tur wars, preempted stateregulators rom reining in abuses.

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While many o these mortgages were kept on banks books, the bigger money camerom global investors who clamored to put their cash into newly created mortgage-re-

lated securities. It appeared to fnancial institutions, investors, and regulators alike thatrisk had been conquered: the investors held highly rated securities they thought weresure to per orm; the banks thought they had taken the riskiest loans o their books;and regulators saw frms making profts and borrowing costs reduced. But each step inthe mortgage securitization pipeline depended on the next step to keep demand go-ing. From the speculators who ipped houses to the mortgage brokers who scoutedthe loans, to the lenders who issued the mortgages, to the fnancial frms that createdthe mortgage-backed securities, collateralized debt obligations (CDOs), CDOssquared, and synthetic CDOs: no one in this pipeline o toxic mortgages had enoughskin in the game. They all believed they could o -load their risks on a moments no-tice to the next person in line. They were wrong. When borrowers stopped makingmortgage payments, the lossesamplifed by derivativesrushed through thepipeline. As it turned out, these losses were concentrated in a set o systemically im-portant fnancial institutions.

In the end, the system that created millions o mortgages so e ciently has provento be di cult to unwind. Its complexity has erected barriers to modi ying mortgagesso amilies can stay in their homes and has created urther uncertainty about thehealth o the housing market and fnancial institutions.

We conclude over-the-counter derivatives contributed signifcantly to thiscrisis. The enactment o legislation in 2000 to ban the regulation by both the ederaland state governments o over-the-counter (OTC) derivatives was a key turningpoint in the march toward the fnancial crisis.

From fnancial frms to corporations, to armers, and to investors, derivativeshave been used to hedge against, or speculate on, changes in prices, rates, or indices

or even on events such as the potential de aults on debts. Yet, without any oversight,OTC derivatives rapidly spiraled out o control and out o sight, growing to tril-lion in notional amount. This report explains the uncontrolled leverage; lack o transparency, capital, and collateral requirements; speculation; interconnectionsamong frms; and concentrations o risk in this market.

OTC derivatives contributed to the crisis in three signifcant ways. First, one typeo derivativecredit de ault swaps (CDS) ueled the mortgage securitizationpipeline. CDS were sold to investors to protect against the de ault or decline in valueo mortgage-related securities backed by risky loans. Companies sold protectiontothe tune o billion, in AIGs caseto investors in these new angled mortgage se-curities, helping to launch and expand the market and, in turn, to urther uel thehousing bubble.

Second, CDS were essential to the creation o synthetic CDOs. These synthetic

CDOs were merely bets on the per ormance o real mortgage-related securities. They amplifed the losses rom the collapse o the housing bubble by allowing multiple betson the same securities and helped spread them throughout the fnancial system.Goldman Sachs alone packaged and sold billion in synthetic CDOs rom July ,

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, to May , . Synthetic CDOs created by Goldman re erenced more than, mortgage securities, and o them were re erenced at least twice. This is

apart rom how many times these securities may have been re erenced in syntheticCDOs created by other frms.

Finally, when the housing bubble popped and crisis ollowed, derivatives were inthe center o the storm. AIG, which had not been required to put aside capital re-serves as a cushion or the protection it was selling, was bailed out when it could notmeet its obligations. The government ultimately committed more than billionbecause o concerns that AIGs collapse would trigger cascading losses throughoutthe global fnancial system. In addition, the existence o millions o derivatives con-tracts o all types between systemically important fnancial institutionsunseen andunknown in this unregulated marketadded to uncertainty and escalated panic,helping to precipitate government assistance to those institutions.

We conclude the ailures o credit rating agencies were essential cogs in thewheel o fnancial destruction. The three credit rating agencies were key enablers o the fnancial meltdown. The mortgage-related securities at the heart o the crisiscould not have been marketed and sold without their seal o approval. Investors re-lied on them, o ten blindly. In some cases, they were obligated to use them, or regula-tory capital standards were hinged on them. This crisis could not have happenedwithout the rating agencies. Their ratings helped the market soar and their down-grades through 2007 and 2008 wreaked havoc across markets and frms.

In our report, you will read about the breakdowns at Moodys, examined by theCommission as a case study. From to , Moodys rated nearly ,mortgage-related securities as triple-A. This compares with six private-sector com-panies in the United States that carried this coveted rating in early . In alone, Moodys put its triple-A stamp o approval on mortgage-related securities

every working day. The results were disastrous: o the mortgage securities ratedtriple-A that year ultimately were downgraded.You will also read about the orces at work behind the breakdowns at Moodys, in-

cluding the awed computer models, the pressure rom fnancial frms that paid orthe ratings, the relentless drive or market share, the lack o resources to do the jobdespite record profts, and the absence o meaning ul public oversight. And you willsee that without the active participation o the rating agencies, the market or mort-gage-related securities could not have been what it became.

* * *THERE ARE MANY COMPETING VIEWS as to the causes o this crisis. In this regard, theCommission has endeavored to address key questions posed to us. Here we discussthree: capital availability and excess liquidity, the role o Fannie Mae and Freddie Mac

(the GSEs), and government housing policy.First, as to the matter o excess liquidity: in our report, we outline monetary poli-cies and capital ows during the years leading up to the crisis. Low interest rates,widely available capital, and international investors seeking to put their money in real

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estate assets in the United States were prerequisites or the creation o a credit bubble.Those conditions created increased risks, which should have been recognized by market participants, policy makers, and regulators. However, it is the Commissionsconclusion that excess liquidity did not need to cause a crisis. It was the ailures out-lined aboveincluding the ailure to e ectively rein in excesses in the mortgage andfnancial marketsthat were the principal causes o this crisis. Indeed, the availabil-ity o well-priced capitalboth oreign and domesticis an opportunity or eco-nomic expansion and growth i encouraged to ow in productive directions.

Second, we examined the role o the GSEs, with Fannie Mae serving as the Com-missions case study in this area. These government-sponsored enterprises had adeeply awed business model as publicly traded corporations with the implicit back-ing o and subsidies rom the ederal government and with a public mission. Their

trillion mortgage exposure and market position were signifcant. In and, they decided to ramp up their purchase and guarantee o risky mortgages, just

as the housing market was peaking. They used their political power or decades toward o e ective regulation and oversightspending million on lobbying rom

to . They su ered rom many o the same ailures o corporate governanceand risk management as the Commission discovered in other fnancial frms.Through the third quarter o , the Treasury Department had provided bil-lion in fnancial support to keep them a oat.

We conclude that these two entities contributed to the crisis, but were not a pri-mary cause. Importantly, GSE mortgage securities essentially maintained their valuethroughout the crisis and did not contribute to the signifcant fnancial frm lossesthat were central to the fnancial crisis.

The GSEs participated in the expansion o subprime and other risky mortgages,but they ollowed rather than led Wall Street and other lenders in the rush or oolsgold. They purchased the highest rated non-GSE mortgage-backed securities and

their participation in this market added helium to the housing balloon, but their pur-chases never represented a majority o the market. Those purchases represented .o non-GSE subprime mortgage-backed securities in , with the share rising to

in , and alling back to by . They relaxed their underwriting stan-dards to purchase or guarantee riskier loans and related securities in order to meetstock market analysts and investors expectations or growth, to regain market share,and to ensure generous compensation or their executives and employeesjusti yingtheir activities on the broad and sustained public policy support or homeownership.

The Commission also probed the per ormance o the loans purchased or guaran-teed by Fannie and Freddie. While they generated substantial losses, delinquency rates or GSE loans were substantially lower than loans securitized by other fnancialfrms. For example, data compiled by the Commission or a subset o borrowers withsimilar credit scoresscores below show that by the end o , GSE mort-

gages were ar less likely to be seriously delinquent than were non-GSE securitizedmortgages: . versus . .We also studied at length how the Department o Housing and Urban Develop-

ments (HUDs) a ordable housing goals or the GSEs a ected their investment in

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risky mortgages. Based on the evidence and interviews with dozens o individuals in- volved in this subject area, we determined these goals only contributed marginally toFannies and Freddies participation in those mortgages.

Finally, as to the matter o whether government housing policies were a primary cause o the crisis: or decades, government policy has encouraged homeownershipthrough a set o incentives, assistance programs, and mandates. These policies wereput in place and promoted by several administrations and Congressesindeed, bothPresidents Bill Clinton and George W. Bush set aggressive goals to increase home-ownership.

In conducting our inquiry, we took a care ul look at HUDs a ordable housinggoals, as noted above, and the Community Reinvestment Act (CRA). The CRA wasenacted in to combat redlining by banksthe practice o denying credit to in-dividuals and businesses in certain neighborhoods without regard to their creditwor-thiness. The CRA requires banks and savings and loans to lend, invest, and provideservices to the communities rom which they take deposits, consistent with banksa ety and soundness.

The Commission concludes the CRA was not a signifcant actor in subprime lend-ing or the crisis. Many subprime lenders were not subject to the CRA. Research indi-cates only o high-cost loansa proxy or subprime loanshad any connection tothe law. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were hal as likely to de ault as similar loans made in the sameneighborhoods by independent mortgage originators not subject to the law.

Nonetheless, we make the ollowing observation about government housing poli-ciesthey ailed in this respect: As a nation, we set aggressive homeownership goalswith the desire to extend credit to amilies previously denied access to the fnancialmarkets. Yet the government ailed to ensure that the philosophy o opportunity wasbeing matched by the practical realities on the ground. Witness again the ailure o

the Federal Reserve and other regulators to rein in irresponsible lending. Homeown-ership peaked in the spring o and then began to decline. From that point on,the talk o opportunity was tragically at odds with the reality o a fnancial disaster inthe making.

* * *

WH EN T HI S COMMISSION began its work months ago, some imagined that theevents o and their consequences would be well behind us by the time we issuedthis report. Yet more than two years a ter the ederal government intervened in anunprecedented manner in our fnancial markets, our country fnds itsel still grap-pling with the a tere ects o the calamity. Our fnancial system is, in many respects,still unchanged rom what existed on the eve o the crisis. Indeed, in the wake o thecrisis, the U.S. fnancial sector is now more concentrated than ever in the hands o a

ew large, systemically signifcant institutions.While we have not been charged with making policy recommendations, the very purpose o our report has been to take stock o what happened so we can plot a newcourse. In our inquiry, we ound dramatic breakdowns o corporate governance,

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pro ound lapses in regulatory oversight, and near atal aws in our fnancial system.We also ound that a series o choices and actions led us toward a catastrophe orwhich we were ill prepared. These are serious matters that must be addressed andresolved to restore aith in our fnancial markets, to avoid the next crisis, and to re-build a system o capital that provides the oundation or a new era o broadly shared prosperity.

The greatest tragedy would be to accept the re rain that no one could have seenthis coming and thus nothing could have been done. I we accept this notion, it willhappen again.

This report should not be viewed as the end o the nations examination o thiscrisis. There is still much to learn, much to investigate, and much to fx.

This is our collective responsibility. It alls to us to make di erent choices i wewant di erent results.

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