"Anatomy of a Financial Crisis"-The Government
Wednesday, October 29, 2008SUSIE GHARIB: How did American government leaders allow the financial crisis to occur? It's a question many people are asking. Tonight as we continue our series "Anatomy of a Financial Crisis," we shift our focus to the nation's capital for some answers. As Stephanie Dhue explains, lax lending standards and a hands-off regulatory approach laid the groundwork for the meltdown.
STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: The problems began when lenders started bundling their mortgage loans into securities and stopped worrying about whether those loans could be paid back. The government let that happen in pursuit of the American dream of home ownership. Ira Peppercorn was at the Federal Housing Administration from 1998 until 2002.
IRA PEPPERCORN, FORMER DEPUTY FEDERAL HOUSING COMMISSIONER: What went wrong is simply the system failed and the system failed in so many different ways and part of that is the regulation of the system is completely fragmented.
DHUE: During the housing boom, sub-prime loans were barely regulated. And it wasn't until last year that the Feds made a serious attempt to crack down.
PEPPERCORN: We have no system as a nation that looks at mortgage products and mortgage foreclosures and defaults holistically. And the challenge is you say, well the government should have. Well, the problem is when the government did step in, it pushes people over into the non- regulated sector.
DHUE: Ironically, Fannie Mae and Freddie Mac were regulated all along and could have been a stabilizing factor in the market, but even they got into the sub-prime game. Their mission to support affordable housing conflicted with the mission to increase shareholder profitability. Both collided in August when the government took over the firms. Analyst Karen Petrou says the quest for profits drove the firms to buy billions of dollars in sub-prime mortgage backed securities.
KAREN PETROU, MANAGING PARTNER, FEDERAL FINANCIAL ANALYTICS: Freddie's CFO said this, we did it because the competition was and we thought we needed to too, to give our shareholders a profit.
DHUE: At the same time home loans were getting riskier, Wall Street was increasing the complexity of packaging and traded mortgage backed securities, selling them around the world. Petrou says regulators had faith the markets were spreading the risk.
PETROU: The regulators had bought into what I call the gee, isn't it cool approach to financial product innovation. They believed that the market had an insight into them. They believed all of these quote innovative products were in fact distributing risk and they did not respect how dependent the entire global financial market had gotten on untested models.
DHUE: Last week former Fed Chairman Alan Greenspan confessed as much to a House committee investigating the financial crisis.
ALAN GREENSPAN, FORMER FEDERAL RESERVE CHAIRMAN: Those of us who have looked to the self interest of lending institutions to protect shareholders' equity, myself especially, are in a state of shocked disbelief.
DHUE: Banks were counting on an innovation called credit default swaps to protect themselves from bad mortgage investments. These instruments are essentially insurance against the potential failure of a company or investment. In this case, Greenspan and other regulators were hands off. Michael Greenberger disagreed with that approach. He headed the trading and markets division at the Commodity Futures Trading Commission in the late 1990s. At that time, he worried credit default swaps were kind of a shell game.
MICHAEL GREENBERGER, FORMER DIR., TRADING & MARKETS, CFTC: The people who held the guarantees were saying, look the worst that can happen to us is we'll collect our insurance, so financial statements seemed very much in order. What nobody understood is that the money guaranteeing the so-called insurance was not there.
DHUE: But against Greenberger's advice, swaps were deregulated further and trading took off. Now there are an estimated $55 trillion in credit default swaps.
GREENBERGER: Had at any point between December 2000 and the onset of this crisis, which really was pretty clear to anybody who was paying attention in the summer of 2007, someone made the judgment to check on the capital reserves of the guarantors on the credit default swap side, this fiasco could have been prevented.
DHUE: Lawmakers are still figuring out what went wrong. What they decide will set the stage for a new regulatory structure aimed at keeping it from happening again. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.
