Do you feel, in the end, that we need these big banks? I mean, what social good is there in banks that engage in proprietary trading, for instance?
Look, in my view, banks can do the trading they want, but those kind of institutions shouldn't be backed up by the taxpayers of the United States. And they shouldn't be of a scale where they're too big to fail and systemically important that we have to ride to their rescue.
So it's fine if a financial institution wants to be a trading house. Let them take their risks. And if they win, they win. If they lose, they lose. But when you allow that to happen in the mega-financial institutions, and you couple that with a backing by the taxpayers of the United States, that's a formula for disaster. And unless we break that bond, we're going to have repeated crises.
You know, it's interesting. People on the right who have resisted many of the financial reforms point to Fannie Mae and Freddie Mac as deeply flawed business models. And they were. The profits were privatized; the losses were socialized. But the model of Freddie Mac and Fannie Mae that were so disastrous really ended up being the model for Wall Street, of the big institutions: profits privatized, losses socialized.
So, you know, some would argue that you need mega-financial institutions for us to compete in the global economy. I'm not so sure that's the case. Most big loans are syndicated. And, you know, we competed just fine in the global economy when we had more banks, more regional banks, more diversitye in their financial sector for years and years.
There are a lot of Republicans that will say this was all caused by Freddie and Fannie. Just give me the overview of what you found about Freddie Mac and Fannie Mae.
We looked extensively at Fannie Mae and Freddie Mac and their role in the crisis. And I think one of the most interesting notes is that when it was all done, and we looked at the data, we looked at their role versus Wall Street, and nine of the 10 commissioners -- five Democrats, three Republicans, and one independent -- did not concur with the view that Fannie Mae, Freddie Mac, and government housing policy were the driving forces of this crisis. So this was an area where the facts were on the table. And at the commission, there was bipartisan agreement.
Great, thank you.
Take me to that weekend when they took over Fannie and Freddie. ...
I think it was a Friday morning when I received a call from Dan Mudd, the CEO of Fannie, saying he had been summoned to a meeting with Bernanke, Paulson, and the head of the regulatory agency for the GSEs, the government-sponsored entities, who was Jim Lockhart. ...
We pleaded that Fannie was deserving of better treatment then Freddie, because Fannie had gone out and raised a lot of capital. I'll never forget one of Secretary Paulson's lines; he said, "You may think that and we may even agree, but the Chinese don't know the difference between Fannie and Freddie," because they were both government-sponsored.
So they basically said: Get your board together, because we want you to be placed into conservatorship.
The reason why at that moment they made that decision?
It was principally that Fannie and Freddie were having enormous difficulty funding in the markets and the yield was starting to spike.
The short-term loans again were the problem.
Exactly right. ...
So the white paper comes out, and this launches the Dodd-Frank process. The banks gear up and are busy lobbying at this point. Do they find friends on the Hill? Do they affect that legislation?
They've got a lot of friends on the Hill. They did impact that legislation, absolutely.
This is one of the most powerful lobbies that Washington has ever seen.
It is, and they got too big as part of the market; they got too big as part of the political process.
Gretchen Morgenson's book Reckless Endangerment chronicles what Fannie did, how Fannie got its tentacles everywhere through not just lobbying and campaign contributions and hiring staff and all of that, but also through funded research with academics, with contributions to some community groups.
I think a lot of the big banks took a page from that same playbook. So it wasn't just the PAC contributions which are significant, but it's hiring former members of Congress and staff. It's funding research that supports your position. It kind of comes from you at all directions.
So even in their weakened position with this horrible financial crisis, they still had a lot of influence. And I think also this ideological dogma of self-correcting markets had taken hold and it was very, very difficult to dislodge, even with all these problems that were clearly related to just basic fundamental regulatory shortfalls. ...
If we'd just had higher capital standards for banks and they had mortgage lending standards that applied to everybody, so much of this could have been avoided. ...
Give us a sense of the power of the banking lobby and what it puts you as regulators up against. How does it work? How do they operate?
Well, it is tremendous. First of all, there are these ongoing relationships. Regulators aren't supposed to lobby, and we shouldn't lobby. We provide tactical assistance. We respond when asked our views.
And Congress generally very freely asks for our views, so it gives the opportunity to have a robust dialogue. But there are actual legal restrictions against lobbying by regulatory agencies, so it needs to be weighed into the balance.
Then [there is] also regulatory agency. The only thing we have are the force of our policy arguments. We don't have campaign contributions. We don't have big paying jobs to hire staff and former members of Congress. We don't have any of that.
So if we can't make our policy case -- and that was one of the reasons why I interacted so frequently with the media -- we needed public help on this, because we didn't have money, and we shouldn't, to counter all this lobbying. ... And these lobbying people don't have to disclose their relationships with the banks. …
... The notion out there on the street ... is that the banks have us over a barrel. That the bank lobbyists buy favor in Washington and that regulators like yourself really are at a tremendous disadvantage in terms of making any progress. ...
They have more influence than they should.
The optics are bad, as you would say.
Well, you can't not talk to them. ... And the fact that you meet with them or talk with them doesn't mean that there's something bad going on. You need to get input from a variety of sources to make rules.
But you do need to make sure that it's balanced input, that you're hearing from everybody, not just big banks, and that your decision is based on what's good public policy, not what some big bank lobbyist wants.
So do the big banks have too much influence? Yes. Is it as bad as people think with the regulators? No, I don't think it is. ...
Some people have put a lot of blame on the compensation and incentives that were driving people to develop ever more sophisticated and complex financial instruments.
A lot of it goes back to the government. Between the Community Redevelopment Act, requiring banks to make what I would call very weak loans, and specific quotas that the Congress imposed on Fannie Mae and Freddie Mac, that created the market demand that really led to the subprime phenomenon.
But that doesn't explain the spread of this window dressing of balance sheets and whatnot. It doesn't address how it spread to Europe. Fannie and Freddie don't apply there. There's something larger it seems, just to me as an outsider, going on here.
I think the reason it became an export product is people rely, just as they relied too much on models, too much on rating agencies from a capital requirement point of view.
The way that they solved these allegedly AAA pieces of papers was to say this is AAA-certified by a couple of rating agencies, although they wouldn't like the word certified, and it yields 10 basis points more, it yields 20 basis points more, but it's the same risk.
So there became a very willing suspension of disbelief inspired by making a little extra spread.
The part I could never understand was this: How can the simple fact of slicing and dicing a package of securities make it worth 102 percent of its original face amount? Because that was what was really happening. ...
Was there a time when you sat down with a banker and asked for an explanation of that?
My job is not to grade the bankers or anybody else. My job is to deal with what's going on. ...
Since we did fairly well [to] visualize it coming, we were looking at what should we get ready to be buying when the bad thing occurs? Because that what our job is. Our job is not to be the policemen of the rating agencies. …
... What was it that you were seeing in 2007 that gave you the idea that there was an opportunity here, that there was going to be a collapse?
It was a lot of the models had a series of assumptions, and the most critical assumption with which we disagreed was they were trying to figure out what would be the annual rate of household appreciation. HPA, they were calling it: household price appreciation.
We thought you can't build a model on the theory that housing prices are always going to go up. That's not a rational model. And it's particularly not a rational model when you have now introduced much more leverage, because these are high loan-to-value ratio loans.
You had Fannie and Freddie, while they themselves felt they were only committing 70 percent or 80 percent loan-to-value, they were in fact writing 90 percent and 95 percent and even 100 percent in buying private sector mortgage insurance. But the primary risk was theirs.
They were in effect reinsuring with the PMI companies. We felt that that was clearly inflating the price of houses to have both subprime and normal loans be based on more or less 100 percent loan-to-value, whereas in the old days, people thought about 70 percent, 75 percent loan-to-value. Introducing the leverage had to mean more people were buying more expensive houses.
So when you say, "We caused this crisis," you're in a sense standing shoulder to shoulder with other bankers across the financial industry. So there's a view that you bear therefore, whether it was Wells or not, you bear collectively some responsibility for the crisis. But on the other hand, you're saying that it was Washington; it was regulators at fault here for failing to listen to people like yourself. So where is the blame here? Is it equal parts banks and Washington? Where do you lay it?
I'd state it this way. There has always been abhorrent behavior by financial institutions. We can go back centuries, we can go back decades, whatever it is, by some financial institutions. There always will be, and regulators seem to be incapable of stopping it. In fact, it even leads to bank failures. So I'm just assuming that's always going to be the case.
What happened here, no question, is why did it get so big? It's management. You know, you may have a few problems and issues, but it doesn't turn into the worst and longest recession we've had since the Depression. Why did that occur? That's the question.
Well, the first statement is that yes, it occurred, but primarily with 20 institutions who were investment banks and S&Ls mostly, not commercial banks. And then why did it get so big if it was only between 20 institutions?
Because of the failures of regulators is your view.
Well, five institutions. Rating agencies is not a regulator.
But they're part of the checks and balances.
Right. The SEC who regulated the investment banks did nothing about their liquidity and leverage, the federal banking regulators who had all the authority they needed to reign in, say, Citicorp. Congress -- this crisis could never have occurred [if it] hadn't been for Fannie [Mae] and Freddie [Mac]. Seventy percent of all subprime mortgages, all pay mortgages and other risky mortgages, were guaranteed by Fannie, Freddie or some other government agency. For 20 years -- I'm not exaggerating; look in the record -- I've been warning members of Congress that the portfolios and the risk at Fannie and Freddie were to such an extent that one day they were going to blow up and cost taxpayers $100 billion or more.
To date, it's cost $150 billion. I believe it's going to at least double. Three hundred billion dollars of taxpayers [money] is more than all the costs of banks, automobile companies and insurance companies by a factor of 10.
The taxpayer costs of $300 billion, the estimate of TARP is about $30, so it's going to cost 10 times more. Where's the outrage with Congress? Every administration for the last 20 years has told Congress that Fannie and Freddie are risky. Every regulator has told them.
I think people have given up on Congress.
So why aren't we occupying Washington, D.C.?
"The FRONTLINE Interviews" tell the story of history in the making. Produced in collaboration with Duke University’s Rutherfurd Living History Program. Learn more...