[Senate Hearing 112-100]
[From the U.S. Government Publishing Office]





                                                        S. Hrg. 112-100


    REVIEWING THE FINANCIAL CRISIS INQUIRY COMMISSION'S FINAL REPORT

=======================================================================

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

    REVIEWING THE FINANCIAL CRISIS INQUIRY COMMISSION'S FINAL REPORT

                               __________

                              MAY 10, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs









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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Charles Yi, Chief Counsel

                   Glen Sears, Senior Policy Advisor

                   Lisa Frumin, Legislative Assistant

                 Andrew Olmem, Republican Chief Counsel

               Mike Piwowar, Republican Senior Economist

            Chad Davis, Republican Professional Staff Member

                       Dawn Ratliff, Chief Clerk

                     William Fields, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)











                            C O N T E N T S

                              ----------                              

                         TUESDAY, MAY 10, 2011

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                                WITNESS

Phil Angelides, Chairman, Financial Crisis Inquiry Commission....     3
    Prepared statement...........................................    27
    Responses to written questions of:
        Senator Shelby...........................................    29
        Senator Reed.............................................    31

              Additional Material Supplied for the Record

Statement submitted by Peter J. Wallison, Arthur F. Burns Fellow 
  in Financial Policy Studies, American Enterprise Institute.....    32
JPMorgan Study ``Eye on the Market''.............................    43
Financial Crisis Inquiry Commission archived Web site list.......    48
Financial Crisis Inquiry Commission preliminary staff report 
  ``The Mortgage Crisis''........................................    49
Financial Crisis Inquiry Commission memorandum ``Analysis of 
  Housing Data''.................................................    77

                                 (iii)

 
    REVIEWING THE FINANCIAL CRISIS INQUIRY COMMISSION'S FINAL REPORT

                              ----------                              


                         TUESDAY, MAY 10, 2011

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I would like to call this hearing to 
order.
    The Financial Crisis Inquiry Commission was created with 
the enactment of the Fraud Enforcement and Recovery Act in May 
2009. During the debate on the bill, a partisan group of 
Senators, led by Senator Isakson, offered an amendment to 
establish a commission to examine the causes of the current 
financial and economic crisis in the U.S. The amendment was 
approved by a 92-4 vote.
    The law creating the FCIC explicitly requires that the 
Chairperson of the Commission shall appear before the Committee 
on Banking, Housing, and Urban Affairs of the Senate regarding 
such reports and the findings of the Commission.
    After culling through the thousands of documents, 
interviewing hundreds of key individuals, and holding over a 
dozen public hearings, the FCIC in January put forward a 
thorough and credible account of what went wrong. The factual 
findings of the final report echo what many other independent 
sources as well as the Committee have identified as key causes 
of this crisis, such as the widespread breakdown of basic 
protections for consumers, investors, and taxpayers.
    Congress enacted the Dodd-Frank Wall Street Reform and 
Consumer Protection Act to address these problems, and it must 
be fully and properly implemented. The FCIC report shows that 
repealing or undermining Dodd-Frank, as some have proposed, 
would take us back to the same weak financial system that 
ushered in the worst economic crisis in generations and whose 
painful costs are still being felt.
    Systemic risks would remain unsupervised; there would be no 
focused consumer watchdog; investors would be exposed to more 
Ponzi schemes; reckless financial firms would undermine those 
who played by the rules; taxpayers would be on the hook for 
more bailouts.
    We cannot allow Dodd-Frank to be dismantled. As costly as 
the great recession has been, we simply cannot afford to go 
back to the old financial system that destroyed millions of 
jobs and cost the economy trillions of dollars. To do so would 
be dangerous and irresponsible.
    I look forward to hearing from Mr. Angelides about the 
findings of the Commission so we can continue our work to make 
sure history does not repeat itself. I want to thank Mr. 
Angelides, all the Commissioners, and the staff for their hard 
work on this report.
    I now recognize Ranking Member Shelby for any opening 
statement he may have. Senator Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Today, as you indicated, we will hear from Phil Angelides, 
Chairman of the Financial Crisis Inquiry Commission. The 
Commission's statutory mission was, and I will quote, ``to 
examine the causes, domestic and global, of the current 
financial and economic crisis in the United States.'' The final 
report of the Commission was delivered to Congress in January. 
For some, the Commission's report represents a comprehensive 
record of the crisis. For me, it represents a missed 
opportunity.
    Before the Commission was created, I called for this 
Committee to conduct a comprehensive investigation into the 
causes of the financial crisis. I believe that the American 
people deserve a full accounting of what happened. I also 
believe that such an accounting would lay a foundation for 
financial reform legislation.
    As I have said many times, before Congress considered how 
to reform our financial regulatory structure, we should have 
first determined the underlying causes of the crisis. Without a 
comprehensive understanding of what went wrong, Congress would 
not be able to determine how our regulatory structure failed 
and what reforms were needed.
    I noted that this Committee responded to the Great 
Depression by launching the so-called Pecora investigation. 
That investigation went on for more than 2 years and laid the 
foundation for ground-breaking legislation, including the 
Banking Act of 1933, which created the FDIC; the Securities Act 
of 1933; and the Securities and Exchange Act of 1934, which 
created the Securities and Exchange Commission.
    Ultimately the Democratic majority refused to undertake 
such a Committee-led investigation. Instead, it created an 
independent Commission to examine the origins of the crisis and 
make recommendations on how to reform our financial system.
    In the absence of a Committee effort, I reluctantly 
supported the creation of the Commission. If the Committee was 
not going to do this work, I believed at least someone should. 
Unfortunately, while the Commission worked, the Administration 
and the majority moved forward with financial reform 
legislation. Rather than help inform Congress, the Commission's 
findings were largely ignored as the Democratic majority 
drafted and passed over 2,300 pages of new law without a firm 
grasp of the facts behind the financial crisis.
    Predictably, without a clear record to justify specific 
provisions, the Dodd-Frank legislation merely became a wish 
list of reforms long sought by liberal activists, special 
interests, and Federal bureaucrats. Today the costs and 
unintended consequences of Dodd-Frank continue to mount while 
the benefits of the legislation remain unclear.
    Mr. Chairman, I believe that this Committee squandered a 
historic opportunity when it chose not to conduct its own 
inquiry. It only exacerbated that mistake when it decided to 
legislate before the Commission even had a chance to begin its 
work, let alone finish its report. And while it is unfortunate 
that the Commission was unable to reach a bipartisan consensus 
on its final report, it is more unfortunate that in the end it 
did not matter.
    Thank you, Mr. Chairman.
    Chairman Johnson. Are there any other Members who would 
like to be recognized for a brief statement? If not, I will 
remind my colleagues that we will keep the record open for 7 
days for statements, questions, and any other material you 
would like to submit.
    I will now introduce our witness for today's hearing. Mr. 
Phil Angelides served as the Chairman of the Financial Crisis 
Inquiry Commission. He was previously elected as California's 
State Treasurer and served from 1999 to 2007. As early as 2002, 
he warned of the excesses and abuses in the Nation's financial 
markets, mobilizing pension funds and investors across the 
country to push for reforms, fight fraud, and improve corporate 
governance.
    Mr. Angelides, you are now recognized for 5 minutes to give 
your opening statement. Please proceed.

STATEMENT OF PHIL ANGELIDES, CHAIRMAN, FINANCIAL CRISIS INQUIRY 
                           COMMISSION

    Mr. Angelides. Thank you, Chairman Johnson, Ranking Member 
Shelby, and Members of the Committee. Thank you for your 
invitation to discuss the report of the Financial Crisis 
Inquiry Commission. It was my honor to chair the panel, which 
officially disbanded on February 13th of this year. I want to 
thank my fellow Commissioners and our staff for their service 
to our country.
    Let me begin by noting that the financial crisis has been 
of no small consequence to our Nation. There are more than 24 
million Americans who are out of work, cannot find full-time 
work, or have given up looking for work. About 4 million 
families have lost their homes to foreclosure, and millions 
more have slipped into the foreclosure process or are seriously 
behind on their mortgage payments. Nearly $9 trillion in 
household wealth has vanished. The budgets of the Federal 
Government and of State and local governments across the 
country have been battered by the economic tailspin 
precipitated by the financial meltdown. And the impacts of the 
crisis are likely to be felt for a generation, with our Nation 
facing no easy path to renewed economic strength.
    In 2009, Congress tasked the Commission to examine ``the 
causes of the current financial and economic crisis in the 
United States'' and to probe the collapse of major financial 
institutions that failed or would have failed if not for 
exceptional assistance from the Government. We were true to our 
charge and we fulfilled our mandates.
    Our task was to determine what happened and how it happened 
so we could understand why it happened. In doing so, we sought 
to answer this central question: How did it come to pass that 
in 2008 our Nation was forced to choose between two stark and 
painful alternatives: either risk the total collapse of our 
financial system and economy, or inject trillions of taxpayer 
money into the system and into private companies, even as 
millions of Americans still lost their jobs, their savings, and 
their homes?
    In the course of our investigation, we reviewed millions of 
pages of documents, interviewed more than 700 witnesses, and 
held 19 days of public hearings. The Commission also drew from 
a large body of existing work developed by congressional 
committees, Government agencies, academics, and others.
    The Commission's report contains six major conclusions:
    First and foremost, we concluded that this financial crisis 
was avoidable. The crisis was the result of human action, 
inaction, and misjudgment, not Mother Nature. Financial 
executives and the public stewards of our financial system 
ignored warnings and failed to question, understand, and manage 
evolving risks within a system so essential to the well-being 
of the American people.
    Second, we found widespread failures in financial 
regulation that proved devastating to the stability of our 
Nation's financial markets.
    Third, our report describes dramatic breakdowns in 
corporate governance and risk management at many systemically 
important financial institutions.
    Fourth, we detail the excessive borrowing, risky 
investments, and lack of transparency that combined to put our 
financial system on a collision course with catastrophe.
    Fifth, we concluded that key policy makers were ill 
prepared for the crisis and that their inconsistent responses 
added to uncertainty and panic.
    And, finally, we documented how breaches in accountability 
and ethics became widespread at all levels during the run-up to 
the crisis.
    Our report, as well as the two dissents, can be found at 
our Web site, www.FCIC.gov. That Web site also contains 
approximately 2,000 documents; public testimony at our 
hearings; audio, transcripts, and summaries of more than 300 
witness interviews; and additional information to create an 
enduring historical record of the crisis.
    Conclusions aside, our report contains a valuable and 
accurate historical accounting of the events leading up to the 
crisis and the crisis itself. While Commissioners were not 
unanimous on all issues or on the emphasis placed on causes of 
the crisis, there was notable common ground among nine of ten 
Commissioners on a number of matters such as flaws in the 
mortgage securitization process, the presence of serious 
mortgage fraud, appallingly poor risk management at some large 
financial institutions, and failures of the credit rating 
agencies. Indeed, Mr. Thomas, Mr. Holtz-Eakin, and Mr. 
Hennessey stated in their dissent that they found areas of 
agreement with our conclusions. As just one example, nine of 
ten Commissioners determined that the Community Reinvestment 
Act was not a significant factor in the crisis.
    Finally, you have asked me to comment on the Dodd-Frank 
financial reform law. With our inquiry and report completed and 
the facts in evidence, I believe that it is important speak to 
this matter. I believe that the law's financial reforms are 
strong and needed and that the law directly and forcefully 
addresses issues and conclusions identified in our report.
    In the wake of this crisis, it is critical that the Dodd-
Frank law be fully implemented, with sufficient resources for 
proper oversight and enforcement, to help prevent a future 
crisis. It is important for regulators and prosecutors to 
vigorously investigate and pursue any violations of law that 
have occurred to ensure that justice is served and to deter 
future wrongdoing. And it is essential that we focus our 
efforts anew on rebuilding an economy that provides good jobs 
for Americans and sustained value for our society--in place of 
an economy that in the years before the crisis was inordinately 
driven by financial engineering, risk, and speculation.
    In conclusion, it is my hope that our report will serve as 
a guidepost in the years to come as policy makers and 
regulators endeavor to spare our country from another 
catastrophe of this magnitude.
    Thank you. I look forward to your questions.
    Chairman Johnson. Thank you for your testimony.
    As we begin questioning the witness, I will ask the clerk 
to put 5 minutes on the clock for each Member's questions.
    Mr. Angelides, would you briefly tell us what you found to 
be the most compelling finding in the report? Also, the 
Commission included a vast array of facts surrounding the 
crisis in their final report. Has anyone on or off the 
Commission disputed any of those facts?
    Mr. Angelides. Thank you, Mr. Chairman. Let me start with 
the second part of that question.
    It has now been more than 3 months since the release of 
this report, and while clearly there was disagreement among 
Commissioners on certain aspects of the conclusions, I will say 
that one of the things that I think the Commission should be 
proud of is that, as to our factual accounting of the events 
leading up to the crisis and the crisis itself, this report--
the facts of this report have stood. There have not been 
challenges to the factual accuracy of this report.
    In fact, Mr. Holtz-Eakin, one of our members, said after 
the release of the report, he said, ``What we will leave behind 
and what the staff in particular is to be congratulated for is 
an archive of extraordinary information of the testimony and 
the hearings, of the subpoenas and the documents we acquired. I 
believe that is the lasting legacy of this Commission.''
    So if you look at our report, I believe about 410 pages of 
the report is really the results of our investigation, the 
factual accounting of what occurred from the 1970s on, and 
particularly with emphasis on the 2007-08 time period. And it 
is a factual, accurate, historical accounting that has gone, to 
my knowledge, unchallenged in terms of that accuracy.
    With respect to the most compelling findings, I think I 
would offer this: The report very strongly articulated the view 
that this was not, as some on Wall Street would have us 
believe, a perfect storm. This was not, as Mr. Blankfein said, 
an ill wind or a hurricane that blew from offshore. This crisis 
really was the result of human action, inaction, and 
misjudgment, and what was most striking to me is the number of 
warning signs that appeared along the road to disaster: the 
unsustainable rise in housing prices; the widespread reports of 
predatory and egregious lending practices, in fact, that 
appeared in the 1990s in Cleveland, Ohio, and many other 
communities across this country; the creation of $13 trillion 
of mortgage securities, many of which turned out to be wholly 
defective; the doubling of mortgage debt in this country; and 
the dramatic change in the risk profile of many of the large 
financial institutions that ultimately were deemed systemically 
important.
    So I think for me the most compelling finding of this 
report was the avoidability of this crisis, and what 
accompanied it was a widespread breakdown in regulation, both 
gaps that existed as well as the failure of regulators to use 
their statutory authority, coupled with the reckless behavior 
of some of the largest financial institutions in this country.
    Chairman Johnson. I am disappointed that there are some who 
seek to repeal or undermine the implementation of the Dodd-
Frank Act, which was designed to fix what was broken in the 
financial system. Wouldn't repealing the Dodd-Frank Act 
increase our chances of having the same financial crisis that 
is described in your final report? Would you also explain why 
full Dodd-Frank implementation is important to fix the problems 
the report identifies?
    Mr. Angelides. Let me first say that the Commission itself 
was assiduous, as we undertook our investigation and as we did 
our research leading up to the release of our report in 
January, in a sense to focus on our work and our factual 
inquiry and not on the legislative debates occurring in this 
building. We knew we were given a job to do, and we focused on 
doing that job.
    It was really only after the issuance of our report--and 
obviously after Dodd-Frank was signed into law--that I looked 
at essentially how our report matched up with Dodd-Frank. And 
let me just suggest to you that we identified a number of 
failures which the legislation addresses very directly and very 
forcefully.
    Clearly, one of the items that we indicated--let me just 
give you a couple of examples in the area of supervision and 
regulation. One of the areas that we identified as a weakness 
were some of the gaps that had grown in the regulatory 
framework as our financial system had evolved over the 30 years 
from the late 1970s, early 1980s, to the time of the crisis, 
2007-08. By the beginning of 2008, the shadow banking system, 
that system of lightly if regulated at all nonbank financial 
institutions, that that system now had about $13 trillion in 
assets; the regulated bank and thrift system had about $11 
trillion in assets.
    One of the things the Dodd-Frank bill does by creating the 
Financial Stability Oversight Council and providing it with the 
ability to monitor systemic risk and also to impose greater 
scrutiny and greater requirements on systemically important 
institutions, is it helps close up that gap in our regulatory 
framework that existed before the crisis.
    Another example, I think, of where Dodd-Frank is important 
and responsive to the conclusions and the facts we laid out was 
that it empowered the Financial Stability Oversight Council, in 
fact, to act where it saw risk in individual institutions that 
could jeopardize the system as a whole.
    Yet another example is the imposition of a new regulatory 
regime on credit rating agencies, and, of course, what I think 
is a seminal decision, to regulate the massive over-the-counter 
derivatives market that did play a role in the crisis of 2007-
08. And with respect to that matter, what we found in our 
report was that credit derivatives themselves, the over-the-
counter credit derivatives, did help fuel the mortgage 
securitization boom. We found that by virtue of the creation of 
synthetic CDOs, it helped amplify the effect of the housing 
bubble collapse. And at the end, as panic set into the markets 
and market participants had very little knowledge of what 
counterparty positions were, the general absence of information 
on over-the-counter derivatives fed the panic in the fall of 
2008.
    So those are just a couple of examples. I could go on, but 
just briefly I would say I certainly believe the reforms in the 
consumer protection area are important. Our report documents 
many, many instances where lenders made loans to borrowers who 
clearly did not have the ability to pay. We recount instances, 
for example, where mortgage brokers deliberately steer lenders 
into loans that are the most expensive for the borrower, not 
the best for the borrower. And so that is another aspect of the 
Dodd-Frank bill that is very responsive to our findings.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Chairman, the Commission's report concludes that the 
GSEs ``followed rather than led'' the private sector into 
subprime. But earlier this month, a prominent industry analyst, 
Michael Cembalest, who once shared that same view, issued a 
report in which he changed his opinion, and I would like to 
submit that for the record at this time. I will read just a few 
sentences, if I could put it in the record.
    Quoting Mr. Cembalest, the analyst, ``In January 2009, I 
wrote that the housing crisis was mostly a consequence of the 
private sector. However . . . what emerges from new research is 
something quite different: Government agencies now look to have 
guaranteed, originated, or underwritten 60 percent of all 
`nontraditional' mortgages, which totaled $4.6 trillion in June 
2008. What's more, this research asserts that housing policies 
instituted in the early 1990s were explicitly designed to 
require U.S. Agencies to make much riskier loans, with the 
ultimate goal of pushing private sector banks to adopt the same 
standards.''
    Senator Shelby. Mr. Chairman, because this analyst was 
presented with the same research available to you--I hope it 
was the same--and found it credible enough to change his 
position, why have you not changed your position--or have 
you?--on the GSEs' role here? Did they follow or did they lead?
    Mr. Angelides. They followed, and I would like to speak 
about that for a few minutes.
    Senator Shelby. OK.
    Mr. Angelides. And let me say, Senator Shelby, that we 
spent an enormous amount of time on this issue, and I will just 
tell you, as someone who had come from the private sector 
immediately before my appointment and spent more than half my 
career in the private sector, I did not come into this inquiry 
with a preconceived notion of the extent of Fannie and 
Freddie's involvement in this crisis. So----
    Senator Shelby. Well, obviously this gentleman did not 
either because he agreed with you, and then with more data he 
changed his mind. I am just----
    Mr. Angelides. Maybe I could re-persuade him. So let me 
start by saying this was an area in which at least there was 
some agreement--not total agreement--between nine of ten 
Commissioners. The dissent filed by Mr. Holtz-Eakin, Mr. 
Thomas, and Mr. Hennessey said Fannie Mae and Freddie Mac did 
not by themselves cause the crisis, but they contributed 
significantly.
    What we found is we found that they were not a primary 
cause but they did contribute, so let me talk for a few minutes 
about what we found and how we did our analysis because I think 
this is important.
    We took a deep-dive look at the GSEs, and the way we 
conducted our inquiry because of our budget and time, we 
selected 10 institutions for in-depth investigations, 
institutions like Merrill Lynch, Countrywide, Goldman Sachs, 
and we looked very intensely at Fannie Mae, even though we also 
looked a good deal at Freddie Mac. And let me start by saying 
that there is no question that the GSEs were a disaster. To 
date, they have cost the taxpayers more than $151 billion, so 
let us get that off the table.
    Senator Shelby. Thus far.
    Mr. Angelides. This did not go well. They had a flawed 
business model, which, I might add, in some ways was eventually 
emulated by firms on Wall Street, the privatizing of gain and 
the socializing of loss. They were of significant scale in the 
marketplace so they mattered. They used their political power 
to ward off effective regulation. They clearly ramped up their 
purchasing and guarantee of the riskiest loans in 2005, 2006, 
and 2007 as the market was peaking, and they did have corporate 
governance failures of a magnitude of other major Wall Street 
firms. But here I think are some very important points.
    First of all, the GSE mortgage-backed securities, because 
the marketplace believed there was this implicit, which became 
explicit, Government guarantee, if you look at their valuations 
starting in about January 2007 all the way up to the day before 
they are put into conservancy, the value of mortgage-backed 
securities purchased or guarantees by the GSEs did not decline 
during that period. You know, they were around 98, 99, 100, 
102.
    The reason I mention that--and I think this is a technical 
but important point--is these securities did not cause the 
losses that manifested themselves on Wall Street in 2007 and 
2008, the big losses at Merrill and Citi that were brought 
about by the market value declination of subprime securities 
those institutions were holding. So I think that is important 
to keep in mind. They did not begin the stampede of losses on 
Wall Street. Those were caused by the private label securities.
    With respect to whether they followed or led, here is what 
we found. They clearly participated in the expansion of 
subprime and other risky lending, but when they purchased 
private label securities, they purchased the highest rated 
portions of those securities, and they never represented a 
majority of the purchases. In 2001, they were 10.5 percent of 
the purchases of subprime private label securities. By 2004, 
they were up to 40 percent. But by 2008, they fell back to 28 
percent.
    We reviewed thousands of documents, and what we found is 
that they upped their investments in subprime and risky loans 
in the 2005 to 2007 period to regain market share that they had 
lost to Wall Street, to respond to the expectations of 
analysts, and, frankly, to ensure generous compensation for 
their executives.
    But most importantly, here is something we did that we 
hope--again, conclusions aside--will lead to, I think, good 
analysis of what occurred.
    We took a look at about 25 million loans that had been 
securitized in the marketplace by Wall Street and other non- 
Fannie, Freddie firms, by Fannie and Freddie, and by FHA, and 
what we found is that those loans that were securitized by 
Fannie and Freddie did perform significantly better than the 
private label securities. Now, because there were a lot of 
them, it clearly had an impact. But just to put this on the 
record, apples-to-apples, the Fannie and Freddie 
securitizations performed exceptionally better than the private 
label Wall Street securities.
    For example, if you take borrowers who have credit scores 
below 660, by the end of 2008, the private label securities 
packaged by Wall Street had default rates of 28 percent. For a 
similar set of borrowers with the same credit scores, the 
default rate of Fannie and Freddie loans were about a little 
over 6 percent, I believe, 6.3 percent. So the worst of the 
loans, the most toxic loans, in fact, were done by the non-GSE 
entities first, and then the magnitude, or the lack of quality 
was most striking.
    So, again, we believe they contributed, but they did not 
lead this charge.
    Senator Shelby. Mr. Chairman, I have one question, then I 
have others----
    Mr. Angelides. Sure.
    Senator Shelby. ----I will submit for the record, if I 
could. The Commission's Vice Chairman, former Congressman Bill 
Thomas, raised several concerns about the partisan nature of 
the Commission, and I would like you to address some of them. 
How many days' notice, for example, did Commissioners get prior 
to votes on motions, and was this different for Republican 
Commissioners versus Democratic Commissioners? We have been 
told that it was. How many days' notice did Commissioners get 
prior to the final vote on findings and conclusions, and was 
this different for Republican Commissioners versus Democratic 
Commissioners? And why were the minority views excluded by a 
partisan six-to-four vote from the report and restricted in the 
commercial book? I think those are important, because, Mr. 
Chairman, we are looking for a bipartisan deal here, as you 
well know.
    Mr. Angelides. Good. Good questions. So let me start off 
and talk just about process for a few minutes, and let me say, 
again, at the end of the day, the bulk of this report is, I 
believe, a historical accounting which I hope and believe will 
be of extraordinary use to your Committee as well as the 
American public, and I hope, frankly, regulators----
    Senator Shelby. We hope so, too.
    Mr. Angelides. ----regulators, and I will say, also, I hope 
prosecutors read this book and take a look at it, because we 
had a limited budget, limited time----
    Senator Shelby. A close look, right?
    Mr. Angelides. Hmm?
    Senator Shelby. Prosecutors ought to take a close look.
    Mr. Angelides. They should, and the fact is we had limited 
time, limited resources. We could open a number of doors. We 
opened those doors and I hope the prosecutors and regulators 
walk through those doors.
    But I want to talk about process because this is important. 
First of all, I want to answer very specific questions that you 
asked. We had a--for most of our tenure, we had a 7-day notice 
rule for all agendas and the process would be that I would 
propose an agenda and the Vice Chairman would have a chance to 
look at it and amend that and then it was sent to 
Commissioners.
    Now, near the end of the process, Mr. Ranking Member 
Senator Shelby, we shortened that, and I do not believe the 
vote was a split vote, I believe to a 48-hour notice because of 
all the kind of hurdles we had to go over to get to production 
of that report. And so the fact is we did have agendas that 
were available and materials were made available to 
Commissioners at the same time.
    Now, during the course of this, there were a couple of 
instances where members made proposals the day before or during 
Commission meetings consistent with the agenda, and I might say 
that that happened both ways, where--and I am sure this happens 
in this Committee, where Members will say, I want to offer this 
or I want to offer that. But it was equal opportunity in terms 
of process, and I just want to say flatly that is the case. 
We----
    Senator Shelby. You referenced the Committee, so I want 
to----
    Mr. Angelides. OK.
    Senator Shelby. I have been on the Committee 25 years and I 
can say under both Democrats and Republican chairmen that my 
recollection is that it has been one of fairness both ways on 
this Committee, and I believe it will always be.
    Mr. Angelides. Well, and I want to say this. Every member 
had the full opportunity to attend and participate in every 
meeting and to raise issues that they wanted pursued, and some 
members were--some were more aggressive than others. For 
example, Mr. Wallison always had ideas about things we should 
pursue, and obviously we had to balance matters, but we did our 
best to balance every member's desire to probe areas. Every 
member had the opportunity to attend hearings.
    All materials were made available at the same time to all 
members, and in fact, for example, we had an interview grid 
that was available--we had a Commissioner work space. Any 
Commissioner could look at that. They could tell the staff 
people they thought ought to be interviewed, interviews they 
wanted to participate in.
    All drafts of the report, every single one was made 
available to every member at the same time. We started to roll 
out Commission chapter drafts in about July and in earnest in 
about September and every Commissioner got those. Some took 
advantage of commenting; others did not.
    And I might add that all staff per the statute, really, I 
think, that came out of the Senate, all staff had to be 
approved by the Chairman and the Vice Chairman. So with respect 
to kind of equality of opportunity, fairness of the process, I 
do not think there is any question that this was an extremely 
open and fair process while there are ultimately some policy 
disagreements.
    Now, with respect to the matter of dissents, we accorded 
every member, all 10 members, the ability to file a dissenting 
or additional view. In fact, those who signed the report, you 
know, for example, had they not been fully satisfied with the 
conclusions, had that opportunity, also. And just as a rule of 
reason, we accorded every Commissioner--we looked, by the way, 
at the whole history of what other commissions had done. We 
accorded every Commissioner nine pages in the commercially 
printed version and we allowed members to combine them so they 
chose. In addition, I shall say, we placed no limit on what 
could be placed on our electronic version on the Web and no 
limit in what could be put in the GPO version.
    Now, Mr. Thomas, Mr. Holtz-Eakin, and Mr. Hennessey chose 
not to use any additional space on the Web or in the Government 
Printing Office edition. Mr. Wallison did take advantage of 
that extra opportunity.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Chairman Johnson, and 
Chairman Angelides, thank you and your colleagues for, I think, 
an extraordinary bit of work. And the more I have the 
opportunity to listen to you, I think a lot of it is a tribute 
to your mastery of detail and your extraordinary efforts over 
the course of these many months, so thank you for your personal 
contribution.
    Mr. Angelides. Thank you, sir.
    Senator Reed. Lately, other reports have come online, and I 
am just wondering if you have been aware of them and if you 
agree. For example, Senators Levin and Coburn, their Permanent 
Subcommittee on Investigations has just released a report about 
``The Anatomy of the Financial Collapse: Wall Street and the 
Financial Crisis.'' Have you been--are you aware of that? Some 
of their conclusions suggest that there were market 
participants that anticipated the crisis, were, in fact, 
shorting some of these products at the same time they were 
selling the products to the public, and it also raises issues 
that you raised with respect to whether some of these large 
institutions actually understand the risks they are 
undertaking. So if you could just generally comment on your 
reaction to the Levin-Coburn report and on anything else, Mr. 
Chairman.
    Mr. Angelides. Absolutely. Let me start with my 
observations about the Levin-Coburn report. I believe that they 
did an excellent job. I must admit, I have not read the 
totality of it, but I am well into it. I look forward to the 
day when I can start reading nonfinancial documents, but the 
minute they put that out, I was back--they sucked me back in.
    The first thing I want to say is because, again, we had 
limited time, limited resources, we looked forward to the 
report of the Permanent Subcommittee because what we wanted to 
be able to do was build on the work of other entities, and as 
you know, while the final report came out this year, a lot of 
their information was available during the year. And, in fact, 
strategically, we also decided to the extent that the 
subcommittee was producing information, we would use their 
information in our analysis rather than reinvent the wheel. So, 
in a sense, it was an effective tag team.
    By way of example, while we both looked at the activities 
of Goldman Sachs, they focused a lot of their efforts on 
Washington Mutual. Therefore, we focused one of our in-depth 
investigations on Countrywide. Where in the matter of the 
credit rating agencies they spent a lot of time with Standard 
and Poors, we decided, because they had built a lot of 
information in that regard, we would focus more of our 
attention on Moody's to kind of complete the picture.
    So first and foremost, if you look at our report, you will 
see a lot of references to Senate documents produced by that 
investigation.
    I do think that if you look at the two reports, they are 
very complementary, not of each other, but complementary in the 
sense that the conclusions reinforce each other. We, too, 
found, obviously, practices of market participants where on one 
hand they were selling securities into the marketplace very 
aggressively, often without proper disclosures, at the same 
time that they were shorting those same instruments. Now, they 
would take the position that they were being simply market 
makers, but what our investigation revealed, and I believe the 
investigation of the Senate subcommittee revealed, is that in 
many respects they were more than marketmakers. They were 
shorting on their own account.
    What we found, and I believe what the Senate investigation 
also indicated, is while they were selling securities in the 
marketplace, they were not making the kind of disclosures about 
what they knew and about what their activities were. So that is 
one area, clearly, where there was some symmetry and some 
synergy.
    I also ought to say that both reports catalogued the 
extraordinarily risky practices that were undertaken by some 
institutions. In the course of our investigation, we catalog 
how Countrywide makes riskier and riskier loans. We cataloged 
in our investigation how they lower their lending standards. We 
catalog how they buildup their portfolio of option ARM loans to 
a really extraordinary level, by the way, at the same time that 
the number of option ARM loans that Countrywide is making, I 
think 1 percent of them are negatively amortizing in 2004. I 
think something like 53 percent are negatively amortizing by 
2006, and 90 percent by 2007. But as they undertake these 
activities, Mr. Mozilo and other executives are warning that 
these very practices, and I believe these are their words, have 
the possibility of bringing on financial and reputational 
catastrophe for the company, but they keep on going.
    And I believe if you look at the Senate subcommittee's 
investigation of Washington Mutual, you see the same pattern, 
extraordinary risk going on while the executives at some level 
understand or at least recognize the level of risk and they do 
nothing to stop it.
    Senator Reed. Well, my time has expired, Chairman, but 
again, let me thank you. And also, I think what you underscore 
is at least the question about whether markets are so efficient 
that they always self-correct and always self-regulate. I think 
we have an example here where very successful, apparently, 
business leaders were powerless, really, to stop because of 
many motivations, even things they thought were reckless, and 
there were no regulators to stop them, either, so it just 
continued to deteriorate. So I think it underscores the need 
for balanced regulation.
    Mr. Angelides. Well, and I just want to--I know your time 
has expired, but Mr. Chairman, if I might, just one brief 
comment, and that is that----
    Chairman Johnson. Proceed.
    Mr. Angelides. As I said, I have spent the majority of my 
career now in the private sector, and so I think one of the 
greatest engines is the private enterprise system and the 
ability to take risk and to succeed and to fail. Where I think 
there is difference here is that the financial system is so 
elemental to the stability of the overall economy and 
particularly the large systemically important institutions have 
such a ripple effect on the financial system and the economy as 
a whole, I do think this is one area where we have to have the 
kind of adequate oversight to ensure stability. This is one 
place where we do want to curb excess risk because of the 
systemic implications, both to the system and to the economy as 
a whole.
    Senator Reed. Thank you, Mr. Chairman. Thank you.
    Mr. Angelides. Thank you, Senator.
    Chairman Johnson. Senator Wicker.
    Senator Wicker. Thank you, Mr. Chairman, and thank you, Mr. 
Angelides. I appreciate you being with us today.
    I am a bit struck by your testimony about Dodd-Frank being 
responsive to the findings of your Commission in several 
respects. As a matter of fact, your Commission reported on 
January 27, 2011, and Dodd-Frank was enacted in 2010, so the 
authors of Dodd-Frank would have to have been clairvoyant to be 
responsive to those findings.
    But I would like to ask about one area in which perhaps 
Dodd-Frank failed to look into the future very well and divine 
what your findings would be, and I quote from page Roman 
numeral XXV of the conclusions, where your Commission states, 
``We conclude the failures of credit rating agencies were 
essential cogs in the wheel of the financial destruction. The 
three credit rating agencies were key enablers of the financial 
meltdown. The mortgage-related securities at the heart of the 
crisis could not have been marketed and sold without their seal 
of approval. Investors relied on them, often blindly. In some 
cases, they were obligated to use them.'' And then continuing 
on, the Commission states flatly, ``this crisis could not have 
happened without the rating agencies.''
    And so let me ask you, in light of this finding, are you 
disappointed in the very tepid treatment that Dodd-Frank gave 
to the rating agencies?
    Mr. Angelides. By the way, and let me thank you, Senator. 
Let me also say this is one area where at least the three 
Republican members who filed their dissent agreed with us that 
the rating agencies substantially contributed to the creation 
of toxic financial assets.
    I believe this is an area where we can do more, and I will 
say I believe, and correct me if I am wrong, that Dodd-Frank 
does have a study in it with respect to the selection of rating 
agencies by issuers. I believe it is one of the study items in 
the legislation.
    Senator Wicker. Indeed, yes. That was substituted in place 
of the Franken-Wicker Amendment----
    Mr. Angelides. Correct. Oh, was that your amendment?
    Senator Wicker. ----which would have been much stronger.
    Mr. Angelides. Oh, along with Senator Franken? Well, I will 
just say this, and now I speak personally. I am an advocate of 
trying to break the issuer rating relationship, which I believe 
is fundamentally at the heart of many of the conflicts we saw. 
And so I am glad that the legislation has the study. I would 
urge this Committee and I would urge others to take the next 
step, and as that study is completed, take whatever action is 
necessary legislatively or regulatory to break that link----
    Senator Wicker. Well, I----
    Mr. Angelides. ----between issuers and ratings. So----
    Senator Wicker. OK. Well, thank you for that----
    Mr. Angelides. ----and one thing, Senator, just on--I guess 
it is your time, so I will say it after.
    Senator Wicker. No, go ahead. It is just that we only have 
the 5 minutes, so----
    Mr. Angelides. All right. Well, and that is I would also--
--
    Senator Wicker. You have a right to complete your answer.
    Mr. Angelides. Well, I would hope, also, that one of the 
things that could be looked at is the model used to be of 
credit rating agencies that you had essentially subscriber 
pays. And at the end of the day, somehow, we have got to move, 
in my view, toward a model where the investors themselves are 
paying because those are the folks for whom the ratings are 
supposedly to benefit.
    Senator Wicker. Well, I think you and I are in bipartisan 
agreement that a lot needs to be--a lot more needs to be done 
on the issue of the rating agencies.
    Briefly, in the time we have, what do you think about the 
fact that there are no real standards, no real working 
structure to classify mortgage instruments into basic 
categories, such as prime or subprime or the more intermediate 
alt-A category? Do you think there is some benefit to be gained 
from establishing such classifications and categories?
    Mr. Angelides. I believe it is hard to do legislatively. I 
think it can be done regulatorily. And if my memory serves me, 
Dodd-Frank does have some provisions about--I cannot remember 
the exact term, whether it is high-quality mortgages are 
specified in the legislation, but some categorization, I think, 
is sensible. I think it has to be done at the regulatory level 
and it ought to be done by one single entity.
    Senator Wicker. OK. Thank you.
    Chairman Johnson. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman, and Chairman 
Angelides, thank you for joining us.
    Thank you for the part of your report that described the 
growth of risky and subprime mortgages in Cleveland and the 
work of then-Treasurer Jim Rokakis in alerting the public and 
others to that and the incredible devastation it caused, and I 
appreciate your discussion of it and analysis of it.
    A section of the report is devoted to financial sector 
growth, and you allude to this problem in other chapters. As my 
fellow Members of the Committee know, we have seen a huge 
change in our economy in the last 30 years. Manufacturing some 
30 years ago made up about 25 percent of our GDP. It now makes 
up about 11 percent. Financial services made up about 11 or 12 
percent 30 years ago and now makes up 21.5 percent. So we have 
seen really a flip in position of financial services and 
manufacturing, and we know in terms of a ticket to the middle 
class what manufacturing has meant. We know what has happened 
with financial services.
    President Bush's Treasury Secretary John Snow told the 
Commission, ``We have a lot more debt than we used to have, 
which means we have a much bigger financial sector. I think we 
overdid finance versus the real economy and got a little 
lopsided as a result.'' But it does not appear during the 
process of your hearings and since the report that much has 
changed. And prior to that, in 2006, finance companies made 27 
percent of the corporate profits in this country. The fourth 
quarter of last year, the financial industry accounted for 
about 30 percent of corporate profits.
    What are the implications ongoing, Chairman Angelides, what 
are the implications between this imbalance between finance and 
manufacturing, but more precisely between finance and just the 
rest of the economy?
    Mr. Angelides. Well, thank you very much for asking that 
question, because I will tell you that the further I get away 
from the issuance of our report, I believe this is one of the 
most fundamental issues. And, in fact, you just cited from page 
66 of our report this phenomenal growth, 15 percent of 
corporate profits coming from the financial sector in 1980, 
growing to over 30 percent in the 2000s. The amount of debt 
being taken on by financial companies versus nonfinancial 
companies, it goes from, I think in 1978, $13 in debt for 
financial companies for every $100 for nonfinancial companies, 
companies producing services and goods, to $51 for financial 
companies for every $100 for nonfinancial companies by 2007, 
increasing the amount of debt emanating out of the financial 
sector.
    And let me be blunt, Senator. I think this is a problem. I 
think in many respects, the financial sector became the master, 
not the servant, of the economy.
    I came into this position after some 20 years in the 
private sector with this quaint notion that the financial 
system was there to deploy capital to build enterprises, create 
jobs in the United States. I was shocked at the extent at which 
it had become a gambling parlor. And unlike Claude Raines, I 
was truly shocked at the level of gambling going on on Wall 
Street. And I do think postcrisis that our policy emphasis has 
to be back on how you build a real economy of sustainable 
wealth.
    We had a very robust debate in our Commission about the 
effect of the credit bubble. But I will say this. The greatest 
tragedy of the last decade and a half is that we used all that 
foreign investment, all that cheap money, to create $13 
trillion of phony mortgage securities, not to create jobs and 
enterprise in this country, and I do think at the heart that is 
our most enduring challenge today.
    And when you talk about the deficit, you cannot ignore the 
fact that between the mid-2000s and postcrisis, the Federal 
deficit ballooned by about a trillion dollars annually. When 
you take diminution in revenues and the measures that have been 
adopted on a bipartisan basis, take away the stimulus on which 
there has been debate, two-thirds of that $1 trillion annual 
deficit is due to this financial crisis. So I think, at this 
point, it is the heart of the question.
    Senator Brown. Thank you. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman, and Mr. Angelides, 
I really do appreciate you being here and I appreciate the hard 
work you did on this Commission. It was----
    Mr. Angelides. Thank you, Senator.
    Senator Hagan. I do appreciate that. One of the conclusions 
that the Commission reached, as you were saying, sort of, that 
was the key policy makers were ill-prepared for the crisis and 
that their inconsistent responses added to the uncertainty and 
panic during the crisis. And it would seem to me that this 
conclusion would support strong leadership at the heads of our 
banking regulators. When you look at the range of financial 
regulators, we have a number of key posts today that are 
unfilled or are filled with temporary appointments. This is 
despite the fact that a number of qualified candidates have 
been put forward. Can you comment on how you think having these 
vacancies and temporary appointments might impact our ability 
to successfully implement the Dodd-Frank bill and our ability 
to manage through a financial market downturn?
    Mr. Angelides. Well, let me just say, first of all, about 
our finding. I think in many respects, this is one of our most 
significant findings, and I would also say one of our most 
disturbing findings, because what it really said was that as 
the crisis begins to unravel in 2007 and 2008, we have a 
situation where Treasury, then headed by Mr. Paulson, the 
Federal Reserve, then headed by Mr. Bernanke, and the Federal 
Reserve Board of New York, headed by Mr. Geithner, in many 
respects did not have the knowledge, had not asked the 
questions, had not kept up with the evolution in the financial 
system that allowed them to see the nature of the crisis that 
was unfolding. And so a lot of the response was a finger in the 
dike response because of the lack of information that even the 
public stewards of our system had.
    In that context, having leaders who are in place who are 
knowledgeable, combined with a level of data and information 
and, frankly, constant questioning by policy makers and 
regulators is fundamentally important. And I will say that both 
gaps in knowledge and gaps in leadership could be fatal. In 
this instance, it was near-fatal. Now, at the end of the day, 
these leaders, to their credit, were able to scramble, and at a 
tremendous cost to the American taxpayers were able to 
stabilize the system. But what was most striking is the extent 
to which those in charge did not have the knowledge. That can 
only be exacerbated by the lack of people in positions to carry 
out the mandates.
    Senator Hagan. Both the Commission's report and the 
dissenting views cite the mortgage market as a source of 
systemic failures that led to the crisis. However, you reached 
the conclusions that the Government housing policies were not a 
significant factor in the crisis. How do you reconcile these 
two conclusions, which appears at the time to be at odds with 
one another?
    Mr. Angelides. All right. So let me take these--I mean, 
when we talk about Government housing policies, we were very, I 
think, very specific. Rather than just saying ideologically, do 
you think they do or they did not, we looked at each specific 
policy. Our conclusion, I think, with the mortgage interest 
deduction, it had been around for decades. That is not 
something that had changed, even though it is a legitimate 
policy driver for consumption of housing, and some would argue 
over-consumption of home ownership.
    We looked very specifically at the Community Reinvestment 
Act, and you will note that we looked at a number of studies. 
We also made document requests and follow up of several major 
institutions. And in the end of the day, it appeared that only 
about 6 percent of the high-cost loans, which would be a proxy 
for subprime loans, were made--were related in any way to the 
CRA. And when you looked--and, of course, many of the biggest 
subprime lenders--Ameriquest, New Century--were not even 
subject to the CRA. So we did not find a correlation there and 
that was supported by nine of ten Commissioners.
    We looked in great depth at the affordable housing goals of 
Fannie and Freddie and we interviewed, I believe, about 50 
folks. Only two of the people--and by the way, those are people 
at Fannie, Freddie, HUD, FHFA, OFHEO, and also other market 
participants--and I believe in the end of the day, only two of 
those individuals thought that those affordable housing goals 
were primary drivers.
    But we also did analysis of the losses at Fannie and 
Freddie, and they were by no means the predominant locus of the 
losses. In fact, at those institutions, while the goals were 50 
percent or below, which I believe is from 2004 and before, 
everyone pretty much said Fannie and Freddie could meet those 
goals in their ordinary course of business. When the goals got 
above 50 percent in 2005, it did put pressure on them and they 
did start making targeted loans for affordability which did 
have an impact.
    But by no means, if you look at the numbers which are in 
our report, I believe pages 185 to 187--I know this is bad that 
I know all these numbers, but I have read it a lot--you will 
see actual data about how much of the losses are attributable 
to those affordable housing loans. They were not the drivers. 
They were at the margin.
    The one thing I would say, though, in the end, is that the 
public rhetoric around home ownership in some aspects ended up 
providing cover for activities that were pernicious. And, I 
mean, one of the real tragedies of this crisis is that in the 
end, it was not even about adding more home owners to our 
Nation. One of the most striking facts I came across in our 
investigation, which was right out there and obvious, is the 
home ownership rate in this country actually peaked in the 
spring of 2004. So all that terrible lending in the end of 
2004, 2005, 2006, and 2007 did not even add home owners in this 
country. It was, in a sense, ground cover for what became very 
pernicious activities.
    Senator Hagan. I am sorry. How does it not add to----
    Mr. Angelides. From 2004 on, our home ownership rate peaked 
in the spring of 2004. The worst lending really happened in the 
end of 2004, 2005, 2006, 2007. So the notion that all this 
mortgage lending was adding to home ownership was false. It 
just was not. It was feeding speculators. It was helping people 
refinance their homes. It was not, in the end, adding to new 
home ownership in this country. I mean, that is one of the real 
tragedies of this crisis. There was not even a good, in the 
end, public policy driver or rationale for what occurred.
    Senator Hagan. Recently, the Treasury Department, the 
Center for American Progress, the American Enterprise 
Institute, and others, they have all released proposals on 
housing finance reform. Could you give us your thoughts on 
these proposals and what do you see as the important features 
of housing finance reform that will ensure that housing does 
not contribute to a future crisis?
    Mr. Angelides. I cannot say that I have seen--I have had a 
chance to read the Treasury report. Are you talking about on 
the future of Fannie and Freddie?
    Senator Hagan. Yes.
    Mr. Angelides. I cannot tell you that I have seen the 
Center for American Progress report. And, you know, I will just 
make a short observation on this. I would not posit myself as 
the expert. I do think there is a legitimate but well-defined 
and focused role for governmental support for the housing 
finance sector. But I think it has to be finite, specific, well 
defined, constrained. And I just want to say what I believe 
everyone--not everyone, but we should certainly understand this 
model of a publicly traded, profit-driven institution carrying 
out public policy that we had in Fannie and Freddie, with the 
implicit and then explicit guarantee of the Federal Government 
along with all the subsidies that went with it--that model 
should never be replicated. But for decades, we had a 
relatively steady State model where we did provide ballast for 
the housing finance sector, and it worked relatively well.
    There is just one quick note. During the course of our 
testimony--and the Committee may want to look at this--
Professor Dwight Jaffee of the University of California, 
Berkeley, told us that one of his research students had 
uncovered papers at the Johnson Library in Austin in which 
there was a very robust debate back in 1968 where, when Lyndon 
Johnson wanted to spin Fannie Mae out of the U.S. Government 
because of the balance sheet of the Government--we were running 
a deficit at the time, and he did not want that, and the 
proposal was to create a private entity, a Government-sponsored 
enterprise. The folks who were asked to look at it said, you 
know, this could be very risky because at the end of the day 
they will have all the ability to take the upside and the 
taxpayers will be left with the downside, and that should never 
be replicated.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much for your testimony and 
for your hard work on this Commission. I wanted to ask you to 
expand a little bit on the issue of State preemption and how 
that kind of was interwoven into this.
    When I was a State legislator, I was pursuing trying to 
take on some practices in the last decade related to prepayment 
penalties, steering payments, undocumented loans, and largely 
preemption, as it was applied to the States, prevented us from 
being able to do more than regulate State banks, which created 
kind of an unlevel playing field issue that was difficult to 
overcome.
    I believe that the OCC has played a significant role in 
pushing these issue of preempting States from being able to 
regulate on a variety of issues, and could you kind of explore 
this a little bit for us?
    Mr. Angelides. Yes, I can. And, in fact, this is a matter, 
Senator, with which our report deals in some detail. And 
essentially, as we know in the 2003-04 time period, the Office 
of the Comptroller of the Currency as well as the Office of 
Thrift Supervision moved very aggressively to preempt State 
efforts to regulate unfair lending practices of national banks 
and thrifts, and it had a very significant effect.
    We received a lot of testimony on this matter. I think what 
is quite striking is between 2000 and 2003 States were very 
active in this arena in trying to curb abusive predatory 
lending, and they were doing so really because of the absence 
of action by the Federal Reserve.
    There was a legitimate policy argument for Federal 
preemption with respect to national banks and thrifts, but what 
really should have happened in my view at that time is instead 
of the Feds just moving in to preempt States, they should have 
entered into essentially joint action with the States so 
collectively they were going after both the national thrifts 
who were engaged in unfair and predatory lending, while the 
States joined with them in going after State-regulated 
institutions. And a significant portion of the problem loans 
were, in fact, being initiated by national banks and thrifts, 
and at least by our review, after the preemption, I think it is 
fair to say the OCC and the OTS tied the hands of the States 
and then sat on their own hands.
    It would have been different had they preempted and then 
aggressively pursued, which they did not do.
    Senator Merkley. So one piece of this certainly was in 
mortgage lending, but there were also these unmargined 
derivatives essentially that related to risks ranging from the 
up and down of oil futures to other complex financial 
derivatives in the credit default swap world.
    Do you see the issue as mainly the impact mainly happening 
around mortgages or also in this other area?
    Mr. Angelides. Well, a significant impact in the mortgage 
arena. There is just no question about that.
    By the way, can I add one other thing on the mortgage 
arena? This was made worse by the fact that the Federal Reserve 
that was the one entity that had the full authority to write 
rules that applied to every mortgage lender, whether they were 
State charter or federally chartered, did nothing. In 2001, in 
the wake of information about growing predatory lending 
practices, the Fed did adopt some rules under HOEPA, which was 
a law passed by the Congress in 1994. Those rules, at the time 
it was projected they would cover 38 percent of subprime 
lending. They were so weak that they covered 1 percent.
    When we questioned Mr. Greenspan about this, he said, well, 
the solution is--and, by the way, it was not until 2006 that 
the Fed actually issued voluntary guidance to national banks 
and thrifts about subprime lending, and it was not until July 
2008 when the system was collapsing on itself that they finally 
adopted a rule to say you cannot lend to people who cannot 
afford to take the loan.
    Now, Mr. Greenspan at the time said, well, the solution was 
not more regulation; it was law enforcement. And when we looked 
at the records, the Federal Reserve referred only three unfair 
lending cases to the Department of Justice from 2000 to 2006: a 
small bank in Carpentersville, Illinois; a small bank in 
Victorville, California; and the New York branch of Societe 
Generale. So they stopped the States, and then they did 
nothing.
    With respect to derivatives, the 2000 law was pretty clear 
that it forbade regulation of over-the-counter derivative 
instruments by both the Federal and the State governments. I 
cannot remember what year it was--I think it was 2000 or 2001--
that the New York Department of Insurance issued a ruling that, 
in fact, confirms their inability to regulate naked credit 
default swaps as insurance instruments. And certainly with 
respect to AIG, that ends up being a very significant 
phenomenon.
    Senator Merkley. Thank you.
    Chairman Johnson. We will proceed to a short second round.
    In your report, the Commission wrote, ``The Federal 
Reserve's pivotal failure was to stem the flow of toxic 
mortgages 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.''
    Would you please discuss how consumer protection was an 
afterthought for Bank regulators and why an independent agency 
focused solely on consumer protection would help prevent 
another crisis?
    Mr. Angelides. Just on this matter--and I addressed it in 
my remarks to Senator Merkley, and that is that I do believe 
this was a pivotal failure. The Federal Reserve had substantial 
information about the nature of loans that were being made. In 
fact, it was not just the information they had in the late 
1990s and early 2000s, but in 2005, they commissioned their 
staff to take a look at what was happening in the marketplace, 
and they took a look at the practices of large lenders--the 
largest mortgage lenders. And I remember, I believe at the 
time, that the results in terms of what they were finding was 
quite astounding. If you would give me just 1 second, Senator.
    I believe they found in 2005, page 105, they found that--
well, I am not finding it right now, and I do not want to take 
your time. But they found of the largest mortgage lenders, they 
found, for example, I believe, that 59 percent of Countrywide's 
loan originations were nontraditional loans. They took a look 
at the biggest lenders, and it was stunning, the extent to 
which they had moved away from prudent lending. And they had a 
lot of information. They never acted. As I said, it took about 
a year from that study in 2005 for them even to get the 
voluntary guidance out the door. And then it took Mr. Bernanke 
coming in and issuing the new rules in July of 2008.
    It was on their screen, and they just did not act, and I do 
think that part of the reason was the nature of the Federal 
Reserve is they did not--that really was not their focus. That 
really was not what they were built to do. And so I do think 
there was an absence of attention to consumer protection. And I 
do believe an independent consumer protection entity within the 
Federal Reserve can be very helpful in at least focusing 
attention on abuses in the marketplace and the rising problems 
in that marketplace.
    Chairman Johnson. Senator Shelby.
    Senator Hatch. Thank you.
    It seems to me from what we have learned from your report 
and what we have learned from hearings and other investigations 
that the Federal Reserve and the other regulators--not just the 
Federal Reserve as regulators--basically failed the American 
people. Is that fair, Mr. Chairman?
    Mr. Angelides. Yes, and I want to say something very 
directly. We found there were gaps, Senator.
    Senator Shelby. That is right.
    Mr. Angelides. And so I want to say this: We found there 
were gaps, and there is no question that there were large 
regulatory gaps. But also where regulators had the authority, 
they did not use it.
    Senator Shelby. They had it but they did not use it, right.
    Mr. Angelides. Yes. The SEC could have reduced risk and 
increased capital and liquidity at the investment banks. They 
did not do it. The Federal Reserve Bank of New York could have 
reined in the excesses of Citigroup. They did not do it. So, 
yes, I think it was a dual phenomenon of regulators not 
exercising the power they had as well as very specific gaps 
that did exist that precluded both oversight as well as the 
ability to stabilize the situation.
    Senator Shelby. So while the bank crisis grew underneath 
their feet, they continued to sleep in a sense or look the 
other way, however you want to describe it.
    Mr. Angelides. I think our report is very clear on that, 
yes.
    Senator Shelby. And you agree with that.
    Mr. Angelides. Yes, sir.
    Senator Shelby. Let me get into another area of loans, down 
payments, and so forth. Did you in your investigation or the 
Commission's get into the area of where loans were made with, 
say, nothing down, for example, or a concoction of borrowing 
the down payment, you know, some way, with a second mortgage, 
or 3 percent down as opposed to 5 percent down, 10 percent 
down, 20 percent down, and the rate of foreclosures in these 
categories?
    For example--I do not know this. This is just anecdotal, 
but perhaps you do. But if someone paid 20 percent down, real 
equity in a bona fide transaction, the chances, it would seem 
to me, of a foreclosure would be much smaller than 3 percent 
down or 0 percent down and so forth. Did you get into this 
area? And if you did not, why did you not?
    Mr. Angelides. So, yes, here is----
    Senator Shelby. Do you see where I am going?
    Mr. Angelides. Yes. Well, here is how we did it, and I will 
have to refresh my memory on all the various places throughout 
this report.
    Senator Shelby. Would you furnish, share some of this for 
the record of the Committee?
    Mr. Angelides. I certainly could.
    Senator Shelby. But go ahead.
    Mr. Angelides. If you would give me the chance----
    Senator Shelby. Absolutely.
    Mr. Angelides. ----on the plane home tonight to course 
through this.
    Senator Shelby. Yes, sir.
    Mr. Angelides. But there are a couple of things we did. 
Throughout the report we catalogued the frankly grotesque 
deterioration of mortgage lending standards in terms of what 
kinds of loans were being made over a period of time. And, in 
fact, just on that point, I am going to just give you one 
little section.
    You know, for example, on page 107, we talk about 
Countrywide's option ARM business. You know, those are the 
loans where you did not even have to pay enough to cover the 
interest. Those loans that began to grow up----
    Senator Shelby. It is like those kinds of loans were a 
recipe for a disaster.
    Mr. Angelides. Yes.
    Senator Shelby. And the regulators should have realized 
that.
    Mr. Angelides. Well, yes, and, you know, in fact, one of 
the reasons they went from the OCC as a regulator to the OTS as 
a regulator--which Dodd-Frank does deal with, got rid of that 
regulatory shopping opportunity. But, you know, the OCC was 
beginning to have concerns; the OTS was not. But as an example, 
Senator, by the second quarter of 2005, 25 percent of all its 
loans, Countrywide's loans, were option ARM by the second 
quarter of 2005.
    Senator Shelby. By option ARM, just for the record, explain 
that because you are talking to the American people here.
    Mr. Angelides. Yes. That is a loan where the borrower does 
not even--can decide to pay less than--it is not even an 
interest-only loan. You can pay less than the interest, so your 
balance is growing. They are the most dangerous kinds of loans.
    Senator Shelby. And that is a time bomb, is it not?
    Mr. Angelides. It is kind of like a time bomb.
    Senator Shelby. A financial time bomb.
    Mr. Angelides. But, for example, they decided in July 2004 
they would lend up to 90 percent of homes' appraised value, up 
from 80 percent. They reduced minimum credit scores to as low 
as 620. In early 2005----
    Senator Shelby. Who approved or looked the other way as 
this was going on? Who approved these kind of loans?
    Mr. Angelides. Well, first of all, the Fed looked the other 
way. They had a lot of this information, and they did not act. 
And the two bank regulators, OCC and OTS, did not act. And in 
particular in this case, Countrywide moved from the OCC/Fed to 
the OTS----
    Senator Shelby. Looking for the weak regulator.
    Mr. Angelides. Well, yes. And, in fact, very specifically 
they make the move because internal e-mails say: You know what? 
OCC and Fed are beginning to get concerned. Let us move over to 
the OTS because OCC is being too tough now on appraisals and it 
could, quote-unquote, kill the business; and the OCC and the 
Fed are beginning to get uncomfortable with these option ARM 
loans.
    So in this instance, it was the Fed, the OCC, and the OTS.
    Senator Shelby. Can I go back to a question I asked a 
minute ago?
    Mr. Angelides. Oh, I apologize. Yes.
    Senator Shelby. For example, if there is nothing down, in 
some of the stuff you describe, we know that is a financial 
disaster waiting to happen. What about if it is 3 percent down? 
Can you furnish this for the record, if you could? What are the 
percentage of foreclosures there as opposed to 5 percent down 
or 10 percent down or 20 percent down? I think this would be 
interesting. In other words, the less people have in the game, 
the less skin or money they have in the game, the chances are 
toward a default?
    Mr. Angelides. So let me say, as I said--and I got a little 
specific there. Throughout the book we do catalogue the 
deterioration in lending standards, and I will have to look at 
how we then correlate that to default rates. I mentioned 
earlier to you in the context of Fannie and Freddie how we had 
looked at a basket of 25 million loans. What I am aware of is 
we also took that data and sliced it into, I think, about 500-
some buckets of different kinds of loans--one that had lower 
down payments, ones that had high loan-to-value ratios.
    What I will have to look at, Senator, is how finely we 
broke down what kinds of loans had what kinds of default rates, 
and so if I could swing back to you on that. I know that we did 
look at those big buckets I told you, which----
    Senator Shelby. That is forensic financial accounting, but 
that is good.
    Mr. Angelides. Let me see what we did on that, how far we 
broke it down. [Ed.: Please see, http://www.gpoaccess.gov/fcic/
fcic.pdf to refer to the Committee's request for further 
information: (1) ``Page 110 re: delinquencies among borrowers 
with `piggyback' loans''; (2) ``Pages 111, 222, and 402 re: the 
performance of mortgage loans included within our case study 
mortgage-backed security CMLTI 2006-NC2''; (3) ``The first 
subchapter of Chapter 11 of the report, entitled 
`Delinquencies: The Turn of the Housing Market' commencing on 
page 214, with specific reference to Figure 11.2 on page 
217.'']
    Senator Shelby. You mentioned President Johnson's concern 
way back where we create a hybrid where you socialize the 
risk--that is, it sits in the taxpayer's lap, like it is today, 
Fannie and Freddie--and privatize the profits. That is a 
dangerous situation, is it not?
    Mr. Angelides. Yes.
    Senator Shelby. So that is what we have in Fannie Mae and 
Freddie Mac except now we do not have an implicit guarantee, we 
have an explicit, because Fannie and Freddie are sitting in the 
taxpayer's lap right now. Is that correct?
    Mr. Angelides. Correct.
    Senator Shelby. OK. Thank you.
    Mr. Angelides. Except the profit motive part of that has 
been wiped out because of the conservancy.
    Senator Shelby. Thank you.
    Chairman Johnson. Senator Hagan, do you have a quick 
question?
    Senator Hagan. Thank you, Mr. Chairman.
    Mr. Angelides, as you know, the Dodd-Frank left a number of 
rules and regulations to implement, and when you think about 
the work that is being done right now by the regulators, what 
areas, just for example, do you think would require the most 
monitoring and attention by Members of this Committee in our 
oversight role?
    Mr. Angelides. OK. Let me make one broad statement, then 
maybe a couple specific comments.
    One broad statement, and I do think it is a significant 
issue, again, as someone who has been in both the private and 
the public sector, I think having sufficient resources and 
talent in your regulatory entities to oversee this very fast 
moving, very quickly evolving industry is important. I have 
said--and I do not mean this disrespectfully, but Wall Street 
is a little bit like a greased pig. They move fast, they are 
hard to catch. And this is a conversation I had with Chairman 
Bernanke. Making sure sufficient resources are available at 
these regulatory entities I think is fundamentally important. 
But also making sure pay scales, career opportunities are such 
that we can attract talent to those regulatory entities is one 
of the biggest challenges, and I think one that has not yet 
been fully met. So I would focus on the resource issue 
generally.
    With respect to very specific areas that require attention, 
I would think that particularly the derivatives area, because 
we are talking about taking a massive market that grew to $600 
trillion in notional value, the over-the-counter derivatives 
market, and now the CFTC, the Commodity Futures Trading 
Commission, has the Herculean task of moving that market to 
publicly traded exchanges. And that will be a large job, and it 
is one that requires, I think, very significant attention. And 
I would hope that the nature of oversight is not obviously to 
constrain regulators but to push them along, make sure they are 
meeting deadlines and making sure they have the resources to do 
their job.
    The other area, I think, that is worth focusing on is, you 
know, as you know--and you probably hear this in your districts 
often or your States--people have a level of frustration about 
why have there been no prosecutions, where has the justice 
been. And obviously we do not want hangman justice in the 
United States, we do not want vengeance, but we do want people 
to know that the justice system is for all, that there is not a 
dual system of justice, one for people of wealth and power and 
one for everyone else. And we want to make sure deterrence is 
in place.
    So another area, I think, of oversight is on the 
enforcement side. One of the things that happened in the S&L 
crisis was that regulators were very active partners with 
prosecutors in identifying potential wrongdoing, in a sense 
being their sherpas. And I do think it is an appropriate role 
for this Committee to have oversight on enforcement efforts to 
make sure that justice is being done and deterrence is in 
place. And when you look at actions that are being taken and 
the nature of settlements that often are pennies on the dollar 
with no admission of wrongdoing, I think that is a legitimate 
area for oversight as to whether you are satisfied as elected 
representatives of various States in this country that 
enforcement is as a fulsome as it needs to be.
    Senator Hagan. Thank you.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair.
    I want to explore a little bit what you term in your report 
``the CDO machine,'' and certainly throughout the 2 years I 
have served on this Committee, CDOs have come under a lot of 
discussion, and kind of a piece of the puzzle that I was not 
familiar with was the retention of the higher AAA portions of 
the CDOs by banks because of their lower capital charges.
    Indeed, there has been a lot of discussion of the fact that 
an investment bank would buy the lower tiers, combine them, 
reissue the mortgage securities into CDOs, and then CDOs 
squared, if you will, because doing so would transform and 
create a whole new set of AAA-rated securities that produced a 
tremendous amount of profit. Certainly the main fundamental 
justification of this was geographic diversity. However, there 
has been a lot of discussion of the credit rating agencies not 
really having the information to recognize they all suffered 
from the same critical flaw, which was 2-year teaser rates.
    But the broader issue that I want to ask you to comment on 
is the role of buying one's own securities in terms of creating 
artificial demand to drive the market or kind of creating 
certain conflicts of interest along the way. And this is 
relevant as we look down the road here because there is a 
discussion of kind of how to treat securities under the issue 
of proprietary trading under Dodd-Frank. And on one level, it 
sounds like a very, very complicated, troublesome machine, 
which elements could be re-created that cause all sorts of 
trouble. On another level, it is, like, hey, here are 
securities that are often AAA rated, what is the issue? So just 
your thoughts.
    Mr. Angelides. Oh, boy. Well, first of all, what did happen 
during this crisis is, you know, the whole notion of 
securitization was it was supposed to spread the risk. It was 
supposed to create diversification in a number of ways. First 
of all, in the instruments themselves, as you said, they were 
supposed not to be correlated, and the original CDOs that came 
in the marketplace actually were instruments that were composed 
of different kinds of assets: auto loans, airplane leases, 
mortgages. So, in fact, they were supposed to be uncorrelated. 
If one went bad, it was not likely that another would go bad.
    When the mortgage securities started to be created, they 
were assumed to be not highly correlated, and, of course, they 
end up being extraordinarily correlated, both geographically 
and in the type of mortgages that were contained within. And 
what you also had a phenomenon--so, you know, risk was supposed 
to be dispersed in that way.
    The other way risk was supposed to be dispersed was that 
the large financial institutions would securitize these, sell 
them to investors across the world. Well, what starts happening 
in 2006 and 2007 is institutions like Citigroup and Merrill 
Lynch cannot sell the most super senior tranches of these CDOs 
because the yields are too low, and they certainly cannot sell 
them at par, which is interesting because they booked them at 
par even though they could not sell them at that. And I think 
that is another whole issue. They were in a sense booking their 
profits and earnings as if they were worth $100 when they were 
worth less.
    But they end up retaining these on their books as they are 
trying to offload, frankly, the riskier stuff. They cannot 
offload the, quote-unquote, super senior super safe, and they 
thought it is OK, we will keep these because they do not have 
much risk. Well, in fact, when the whole market came apart, I 
believe Citigroup had built up an exposure of some $50-plus 
billion, as had Merrill Lynch, and when the market value of 
subprime securities plummet, they take enormous losses. In 
2007, each institution takes more than $20 billion in losses.
    So it is a legitimate area of inquiry to examine what these 
major money centers, systemically important institutions are 
holding on their books and what the real risks associated with 
them are.
    Is that responsive?
    Senator Merkley. Yes. It is kind of the beginning of a much 
more in-depth conversation. Thank you.
    Mr. Angelides. But for me that was one of the more--I mean, 
I think for us in the Commission, I think it is one of the most 
significant pieces of information here, is how those 
institutions ended up in a sense holding onto those and, you 
are right, with very little capital standards because they 
were, quote-unquote, super senior and super safe. But their 
market valuations were dramatically hit, and, you know, they 
took enormous losses, which really are the losses that began 
the ripple effect, the unraveling of the financial crisis in 
2007 and early 2008.
    Senator Merkley. Thank you.
    Chairman Johnson. I hope today's hearing equips us with a 
better understanding of the financial crisis so that we can 
work together to make sure history does not repeat itself. As 
costly as the great recession has been, we simply cannot afford 
to go back to the old financial system that destroyed millions 
of jobs and cost the economy trillions of dollars.
    Thanks again to my colleagues and our panelist for being 
here today. This hearing is adjourned.
    Mr. Angelides. Thank you, Senator Johnson, and thank you, 
Members of the Committee.
    [Whereupon, at 11:32 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                  PREPARED STATEMENT OF PHIL ANGELIDES
             Chairman, Financial Crisis Inquiry Commission
                              May 10, 2011
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, thank you for the invitation to discuss the report of the 
Financial Crisis Inquiry Commission. It was my honor to chair the 
panel, which officially disbanded on February 13 of this year. I want 
to thank my fellow Commissioners and our staff for their service to our 
country.
    Let me begin by noting that the financial crisis has been of no 
small consequence to our Nation. There are more than 24 million 
Americans who are out of work, cannot find full time work, or have 
given up looking for work. About 4 million families have lost their 
homes to foreclosure and millions more have slipped into the 
foreclosure process or are seriously behind on their mortgage payments. 
Nearly $9 trillion in household wealth has vanished. The budgets of the 
Federal Government and of State and local governments across the 
country have been battered by the economic tailspin precipitated by the 
financial meltdown. And, the impacts of the crisis are likely to be 
felt for a generation, with our Nation facing no easy path to renewed 
economic strength.
    In 2009, Congress tasked the Commission to examine ``the causes of 
the current financial and economic crisis in the United States,'' and 
to probe the collapse of major financial institutions that failed or 
would have failed if not for exceptional assistance from the 
Government. We were true to our charge and we fulfilled our mandates.
    Our task was to determine what happened and how it happened so we 
could understand why it happened. In doing so, we sought to answer this 
central question: How did it come to pass that in 2008 our Nation was 
forced to choose between two stark and painful alternatives--either 
risk the total collapse of our financial system and economy--or inject 
trillions of taxpayer dollars into the system and into private 
companies--even as millions of Americans still lost their jobs, their 
savings, and their homes?
    In the course of the Commission's exhaustive investigation, we 
reviewed millions of pages of documents, interviewed more than 700 
witnesses, and held 19 days of public hearings in New York, Washington, 
DC, and in communities across the country. The Commission also drew 
from a large body of existing work developed by congressional 
committees, Government agencies, academics, and others.
    The Commission's report contains six major conclusions:
    First and foremost, we concluded that this financial crisis was 
avoidable. The crisis was the result of human action, inaction, and 
misjudgment, not Mother Nature. Financial executives and the public 
stewards of our financial system ignored warnings and failed to 
question, understand, and manage evolving risks within a system so 
essential to the well-being of the American public.
    Second, we found widespread failures in financial regulation that 
proved devastating to the stability of the Nation's financial markets.
    Third, our report describes dramatic breakdowns in corporate 
governance and risk management at many systemically important financial 
institutions.
    Fourth, we detail the excessive borrowing, risky investments, and 
lack of transparency that combined to put our financial system on a 
collision course with catastrophe.
    Fifth, we concluded that key policy makers were ill prepared for 
the crisis, and that their inconsistent responses added to uncertainty 
and panic.
    And finally, we documented how breaches in accountability and 
ethics became widespread at all levels during the run-up to the crisis.
    Our report, as well as the two dissents, can be found at our Web 
site, www.FCIC.gov. That Web site also contains approximately 2,000 
documents; public testimony at our hearings; audio, transcripts, and 
summaries of more than 300 witness interviews; and additional 
information to create an enduring historical record of the crisis.
    In addition to the major causes we identified, the Commission 
determined that collapsing mortgage-lending standards, the flawed 
mortgage securitization pipeline, over-the-counter derivatives, and the 
actions of the credit rating agencies contributed significantly to the 
financial meltdown.
    The Commission also investigated, among other things, whether the 
crisis was caused by excess capital availability and liquidity; the 
activities of Fannie Mae and Freddie Mac; and Government housing 
policies. We concluded that excess liquidity, by itself, did not need 
to cause a crisis, and that Fannie Mae and Freddie Mac contributed to 
the crisis but were not a primary cause. We determined that Government 
housing policies were not a significant factor in the crisis.
    Conclusions aside, our report contains a valuable and accurate 
historical account of the events leading up to the crisis and the 
crisis itself. While commissioners were not unanimous on all issues or 
on the emphasis placed on causes of the crisis, there was notable 
common ground among nine of ten commissioners on a number of matters 
such as flaws in the mortgage securitization process, the presence of 
serious mortgage fraud, appallingly poor risk management at some large 
financial institutions, and failures of the credit rating agencies. 
Indeed, Mr. Thomas, Mr. Holtz-Eakin, and Mr. Hennessey stated in their 
dissent that they found areas of agreement with our conclusions. As 
just one example, nine of ten commissioners determined that the 
Community Reinvestment Act was not a significant factor in the crisis.
    Finally, you have asked me to comment on the Dodd-Frank financial 
reform law. With our inquiry and report completed and the facts in 
evidence, I believe that it is important speak to this matter. I 
believe that the law's financial reforms are strong and needed, and 
that the law directly and forcefully addresses issues and conclusions 
identified in our report.
    In the wake of this crisis, it is critical that the Dodd-Frank law 
be fully implemented, with sufficient resources for proper oversight 
and enforcement, to help prevent a future crisis. It is important for 
regulators and prosecutors to vigorously investigate and pursue any 
violations of law that have occurred to ensure that justice is served 
and to deter future wrongdoing. And, it is essential that we focus our 
efforts anew on rebuilding an economy that provides good jobs for 
Americans and sustained value for our society--in place of an economy 
that in the years before the crisis was inordinately driven by 
financial engineering, risk, and speculation.
    In conclusion, it is my hope that our report will serve as a 
guidepost in the years to come as policy makers and regulators endeavor 
to spare our country from another catastrophe of this magnitude.
    Thank you. I look forward to your questions.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM PHIL ANGELIDES

Q.1. For each of the following individuals, please state 
whether the Commission or staff conducted interviews with them. 
If so, please explain why the audio files, transcripts, and/or 
notes for these interviews are not posted on the Commission's 
Web site. If not, please explain why the Commission did not 
conduct an interview with each of those individuals.

  a.  James A. Johnson (Fannie Mae CEO, 1991-1998)

  b.  Franklin Raines (Fannie Mae CEO, 1999-2004)

  c.  Leland Brendsel (Freddie Mac CEO 1987-2003)

  d.  Gregory Parseghian (Freddie Mac CEO 2003-2003)

  e.  Mark Kinsey (Acting Director OFHEO 1997-1999)

  f.  Brian Montgomery (FHA Commissioner 2005-2009)

  g.  John C. Weicher (FHA Commissioner 2001-2005)

  h.  William Apgar (FHA Commissioner 1998-2001)

A.1. Response not provided.

Q.2. The Commission's statutory mission is ``to examine the 
causes, domestic and global, of the current financial economic 
crisis in the United States.'' However, the Financial Times 
notes that the final report ``suffered from lack of global 
context.'' How do you respond to this criticism?

A.2. Response not provided.

Q.3. Commissioners Keith Hennessey, Doug Holtz-Eakin, and Bill 
Thomas ask four important questions in their dissenting 
statement. Please respond to each of them.

  a.  If the political influence of the financial sector in 
        Washington was an essential cause of the crisis, how 
        does that explain similar financial institution 
        failures in the United Kingdom, Germany, Iceland, 
        Belgium, the Netherlands, France, Spain, Switzerland, 
        Ireland, and Denmark?

  b.  How can the ``runaway mortgage securitization train'' 
        detailed in the majority's report explain housing 
        bubbles in Spain, Australia, and the United Kingdom, 
        countries with mortgage finance systems vastly 
        different than that in the United States?

  c.  How can the corporate and regulatory structures of 
        investment banks explain the decisions of many U.S. 
        commercial banks, several large American university 
        endowments, and some State public employee pension 
        funds, not to mention a number of large and midsize 
        German banks, to take on too much U.S. housing risk?

  d.  How did former Fed Chairman Alan Greenspan's 
        ``deregulatory ideology'' also precipitate bank 
        regulatory failures across Europe?

A.3. Response not provided.

Q.4. According to a recent Financial Times article, 
Commissioner Douglas Holtz-Eakin said that the absence of a 
bipartisan consensus in the final report was ``a great 
failure.'' What specific facts and conclusions did the 
Commissioners disagree on?

A.4. Response not provided.

Q.5. According to the Financial Times, a big problem with the 
final report is ``a high level of inconsistency.'' The report 
concludes that the crisis was ``avoidable.'' However, report 
spreads the blame across a laundry list of factors, such as 
widespread failures in financial regulation, failures of 
corporate governance and risk management at financial 
institutions, excessive borrowing, lack of transparency, 
inconsistent Government responses to the crisis, and an erosion 
of standards of responsibility and ethics. Was the crisis 
``avoidable?'' Or, was it caused by a wide-ranging set of 
disparate factors?

A.5. Response not provided.

Q.6. One of the Commission's statutory functions is ``to refer 
to the Attorney General of the United States and any 
appropriate State attorney general any person that the 
Commission finds may have violated the laws of the United 
States in relation to such crisis.'' Did you refer any person 
to any Federal or State law enforcement agency? If so, did any 
of those referrals result in any enforcement actions?

A.6. Response not provided.

Q.7. Many people have argued that the repeal of Glass-Steagall 
was a major cause of the financial crisis. The final report 
discussed the repeal of Glass-Steagall, but it did not draw any 
conclusions. How did you determine that the final report should 
be silent on whether the repeal of Glass-Steagall was a major 
cause of the crisis?

A.7. Response not provided.

Q.8. The Commission's Vice-Chairman, Congressman Bill Thomas, 
raised several concerns about the partisan nature of the 
Commission. I would like you to address some of them. Please 
respond to the following.

  a.  How many days notice did Commissioners get prior to votes 
        on motions? Was this different for Republican 
        Commissioners versus Democrat Commissioners?

  b.  How many days notice did Commissioners get prior to the 
        final vote on findings and conclusions? Was this 
        different for Republican Commissioners versus Democrat 
        Commissioners.

  c.  Why were minority views excluded by a partisan 6-4 vote 
        from the report and restricted in the commercial book?

A.8. Response not provided.

Q.9. In previous Congressional testimony, you said that Dodd-
Frank's ``financial reforms are strong and needed, and the law 
directly and forcefully addresses issues and conclusions 
identified in our report.'' What is the single most important 
conclusion in your report? How does Dodd-Frank specifically 
address that single most important conclusion?

A.9. Response not provided.

Q.10. The Commission's Vice-Chairman Bill Thomas said in 
Congressional testimony ``Regarding the Dodd-Frank Act, I do 
believe that our work has shed light on a number of problems in 
our financial markets that have not been sufficiently 
addressed, as well as cases of regulatory overreach where the 
financial and economic crisis was used as cover to regulate 
activities that had little to do with the financial crisis.'' 
What is the most important problem identified in your report 
that was not addressed by Dodd-Frank? What is the most 
prominent case of regulatory overreach in Dodd-Frank?

A.10. Response not provided.

Q.11. The Commission has been criticized for conflicts of 
interest on the part of Commission staff. For example, multiple 
staff members, including the executive director, were detailed 
from the Federal Reserve and have since returned to the Fed. 
Since the Commission investigated the Fed's role in the crisis, 
it appears that these employees had a conflict of interest. 
Were any Commission staff detailees or former employees of any 
banks that the Commission investigated? If not, why did you 
ignore the same type of conflicts of interest by allowing Fed 
employees to serve on the Commission's staff?

A.11. Response not provided.
                                ------                                


         RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
                      FROM PHIL ANGELIDES

Q.1. On April 29, 2011, the Department of the Treasury 
announced its intention to exempt foreign exchange swaps and 
forwards from the scope of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act. Do you have an opinion on this 
intended action?
    If so, please explain.

A.1. Response not provided.

Q.2. The FCIC's Report referred to certain accounting and 
reporting practices as ``window dressing.'' Do you believe that 
the regulators and accounting profession have sufficiently 
dealt with this practice? Why or why not?

A.2. Response not provided.

Q.3. Do you believe that auditors could have provided advanced 
warning to investors or others of issues or practices that were 
the subject of the FCIC's report?
    Why or why not? If you believe they could or should have, 
but did not, what policy changes would you recommend?

A.3. Response not provided.
              Additional Material Supplied for the Record
  STATEMENT SUBMITTED BY PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN 
        FINANCIAL POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE
    Chairman Johnson, Ranking Member Shelby, and Members of the Senate 
Banking Committee:
    Thank you for the opportunity to submit written testimony in 
connection with today's hearing on the work of the Financial Crisis 
Inquiry Commission. I regret that a prior commitment prevents me from 
appearing in person. I was a member of this 10-member commission, and 
dissented from the Commission majority's report. In this testimony, I 
will outline the substance of my dissent and explain why I believe a 
dissent was necessary.
    Before turning to the substance of my dissent, however, I would 
like to comment on how the Commission was organized and run.
The Commission's Process
    The financial crisis was an unprecedented event, possibly the worst 
financial breakdown in U.S. history, and will be studied for years by 
historians, economists and other scholars in the hope of understanding 
what caused it and how similar events can be avoided. From the 
beginning of the Commission's substantive operations, however, it was 
not run as the serious, objective investigation that it should have 
been. Instead, it focused only on a narrow set of issues, and never 
succeeded in providing the data and the perspectives that might have 
been helpful to future scholars and policy makers. It is all too common 
that the reports of special Government investigative commissions like 
the FCIC are shelved and never seen again. But this Commission's work, 
I'm sorry to say, fully deserves that treatment.
    I have had some limited experience with Government commissions, 
including the 1976 Rockefeller commission study of the CIA's activities 
in the United States, but I have never seen a Commission as badly 
organized and run as this one. Since there has always been great 
uncertainty about what caused the financial crisis, I expected that, at 
the outset of the Commission's work, the members would have had an 
opportunity to discuss what they thought were the most important issues 
for the staff to investigate. If I had made a list at that time, it 
would have included many of the ideas--hypotheses, I would have called 
them--that were widely discussed in public debates and for that reason 
alone deserved to be looked into in detail. These included the 
possibility that the crisis was caused by (i) easy Fed monetary policy 
in the early 2000s; (ii) a flood of funds from abroad looking for high 
returns; (iii) the repeal of a portion of the Glass-Steagall Act; (iv) 
mark-to-market accounting; (v) Government housing policies and the role 
of the Government-sponsored enterprises; (vi) the growth and collapse 
of an unprecedented housing bubble; (vii) lack of or insufficient 
regulation, (viii) interconnections among financial institutions, and 
many others. My initial view was that many of these hypotheses were not 
factors in the crisis, but I thought they should be investigated so 
that the Commission could provide to Congress, scholars and the 
American people the best answers that a thorough and objective 
investigation could reveal.
    As it turned out, the members of the Commission never had an 
opportunity to discuss these issues, or to have any influence at all on 
the direction the Commission took in its inquiry and ultimately in its 
report. According to my records, in the 18 months the Commission was in 
operation, there were only 12 meetings at which the members of the 
Commission could exchange views on the causes of the financial crisis. 
Of these meetings, only six were day-long sessions. The only time that 
the Commission members sat around a table to discuss the causes of the 
crisis occurred during 3 days in early September, well after the 
discussion could have had any effect on the direction of the 
investigation.
    The members were appointed in July 2009 and the first few months of 
the Commission's existence were spent in hiring the staff and 
establishing the basic rules for how the Commission would operate. By 
the late fall of 2009, we were ready to begin the substantive portion 
of the Commission's work. This would have been the point at which 
several days of discussion among the members about the causes of the 
financial crisis would have turned up agreements and disagreements that 
might have shaped and broadened the subsequent investigation. However, 
there was never a time during this period when the members were invited 
to sit around a table and consider what issues the Commission would 
actually investigate.
    Instead, in early December, we were given a list of monthly public 
hearings that the Commission would conduct virtually through the end of 
its tenure. The list included hearings on subprime lending, 
securitization and the GSEs, the shadow banking system, credit rating 
agencies, complex financial derivatives, excessive risk and financial 
speculation, too big to fail, and macroeconomic factors. Many of the 
items in this list qualified as important issues, but to schedule them 
as public hearings in advance made no sense. The hearings should have 
been shaped by what was turned up in the investigation, not function as 
the drivers of what the Commission would study. There was a pervasive 
sense that a serious investigation was being sacrificed to the 
publicity that could be wrung from public hearings. Moreover, since the 
work of the staff was inevitably going to be devoted to preparing for 
the hearings, establishing a list of hearings in advance threatened to 
reduce both the amount and the scope of the Commission's investigative 
work.
    In practice, this meant that a large number of important issues 
were not to be addressed in any detail by the Commission. There was 
just no time for the staff to prepare for the hearings and also do a 
thorough investigation. As a result, the Commission majority's report 
shows the superficiality of its work in many important areas. For 
example, the discussions of the role of monetary policy and the flow of 
investment funds from abroad--two possible causes of the financial 
crisis that have drawn a lot of attention from scholars--are no more 
detailed than newspaper or magazine articles; no new data is provided 
and no conclusions are presented. Instead, the Commission majority 
reserved their conclusions for the issues that were the focus of the 
hearings: that that the financial crisis was caused by insufficient 
regulation--particularly a failure to ``rein in excesses in the 
mortgage and financial markets''--weak risk management, unregulated 
over-the-counter derivatives, and excessive risk-taking. \1\ It's not 
that many other causes were considered and dismissed; in many cases, 
they were not considered at all.
---------------------------------------------------------------------------
     \1\ Commission Majority Report, pp. xviii-xxvi.
---------------------------------------------------------------------------
    In January, I told vice chair Bill Thomas that I was thinking of 
resigning. It was clear to me that we were not going to be doing a 
thorough or objective investigation. Thomas promised changes, but none 
of any significance was ever made. The direction things were taking was 
also clear to others. The Commission's principal investigators 
protested the idea that the subjects of the public hearings were set in 
advance, before any investigation had been done. They were ignored. 
They drafted a memo to chairman Angelides and vice chair Thomas, 
explaining their position. I was told by one investigator that Thomas 
``begged'' them not to send it, promising that things would change. 
They didn't send the memo, but nothing changed. Their view, and mine, 
was that the hearings should come out of the investigation--when things 
had been found that warranted a public hearing. Confirming the fear 
that the hearings were scheduled for publicity rather than substantive 
purposes, the first hearing was a fiasco. Without any preparation for 
this hearing, the Commission summoned the CEOs of four of the largest 
U.S. financial institutions, seemingly just so they could be 
photographed being sworn in. The New York Times and the Wall Street 
Journal were in rare agreement about this hearing, with the Times 
heading its editorial ``The Show Must Not Go On.'' Eventually, one of 
the investigators, Martin Biegelman, resigned. He reportedly gave the 
chair and vice chair a memo describing the reasons for his resignation. 
This memorandum was not shared with the other commissioners and has 
never been made public.
    The most disappointing fact about the Commission's management was 
its lack of objectivity. One particular example stands out. In March 
2010, Edward Pinto, a resident fellow at the American Enterprise 
Institute (AEI) who had served as chief credit officer at Fannie Mae, 
provided to the Commission a 70-page, fully sourced memorandum on the 
number of subprime and other high risk mortgages in the financial 
system immediately before the financial crisis. In that memorandum, 
Pinto recorded that he had found over 25 million such mortgages (his 
later work showed that there were approximately 27 million). \2\ Since 
there are about 55 million mortgages in the U.S., Pinto's research 
indicated that, as the financial crisis began, half of all U.S. 
mortgages were of inferior quality and liable to default when housing 
prices were no longer rising. In August, Pinto supplemented his initial 
research with a paper documenting the efforts of the Department of 
Housing and Urban Development (HUD), over two decades and through two 
Administrations, to increase home ownership by reducing mortgage 
underwriting standards. \3\
---------------------------------------------------------------------------
     \2\ Edward Pinto, ``Triggers of the Financial Crisis'' (Triggers 
memo). http://www.aei.org/paper/100174.
     \3\ Edward Pinto, ``Government Housing Policies in the Lead-up to 
the Financial Crisis: A Forensic Study'', http//www.aei.org/docLib/
Government-Housing-Policies-Financial-Crisis-Pinto-102110.pdf.
---------------------------------------------------------------------------
    Pinto's work has been cited with approval by many scholars and 
experts in mortgage finance. His research raised important questions 
about the role of Government housing policy in fostering the growth of 
the subprime and other high risk mortgages that played such a key role 
in both the mortgage meltdown and the financial panic that followed. 
Any objective investigation of the causes of the financial crisis would 
have looked carefully at this research, exposed it to the members of 
the Commission, and taken Pinto's testimony in an open or closed 
hearing. But the Commission took none of these steps. Although Pinto 
met several times with the staff, his research was never made available 
to the other members of the FCIC, or even to the commissioners who were 
members of the subcommittee charged with considering the role of 
housing policy in the financial crisis. In early April, the Commission 
held 3 days of hearings on securitization, subprime mortgages, and the 
GSEs. There were numerous witnesses, but despite my requests Pinto was 
not among them. In the end, the Commission never seriously challenged 
Pinto's work or developed any data of its own on the number of subprime 
and Alt-A loans outstanding. Instead, it makes numerous statements 
about the housing market and the role of the GSEs that have no basis in 
fact. Some of these are discussed in later sections of this testimony.
    There were many other more technical deficiencies. The Commission's 
report claimed that it interviewed hundreds of witnesses, and the 
majority's report is full of statements such as ``Smith told the FCIC 
that . . . .'' However, unless the meeting was public, the 
commissioners were not told that an interview would occur, did not know 
who was being interviewed, and of course did not have an opportunity to 
question the interviewees or understand the contexts in which the 
statements quoted in the report were made. Thus, the extensive use of 
interviews--instead of references to documents--raises a question 
whether there was bias in the witnesses chosen for interviews and the 
particular statements chosen for the report, and whether their 
statements were challenged in any way, with documentation or otherwise, 
during the interviews. A review of a sample of the transcripts and 
interview memoranda suggests that this did not happen. The Commission 
majority's report uses these unchallenged statements of fact and 
opinion by interviewees as substitutes for hard data, which is notably 
lacking in their report; opinions in general are not worth much as 
evidence, especially in hindsight and when given without opportunity 
for challenge. The Commission claims that it reviewed millions of pages 
of documents. It probably received millions of pages of documents, but 
whether they were actually reviewed is doubtful. Very little in the 
report quotes from documents the Commission received, rather than from 
people it interviewed.
    The Commission's authorizing statute required that the Commission 
report on or before December 15, 2010. The original plan was for us to 
start seeing drafts of the report in April. We didn't get any drafts 
until November, when we started to receive drafts of chapters in no 
particular order. We were given an opportunity to submit written 
comments on these chapters, but never had an opportunity to go over the 
chapters as a group or to know whether our comments were accepted. We 
received a complete copy of the majority's report, for the first time, 
on December 15, the date on which the Commission's authorizing statute 
required that the report be completed. The draft was almost 900 double-
spaced pages and was to be approved 8 days later, on December 23. 
Again, we never sat around a table and reviewed the final draft section 
by section. This is not the way to achieve a bipartisan report, or the 
full agreement of any group that takes the issues or its assignment 
seriously. But, somehow, the Commission majority managed to approve 
this report, although it seems to have been almost entirely the work of 
the chairman and the staff.
    In summary, the overall direction of the Commission majority's 
report was determined before the Commission started its work. 
Throughout its 18-month life, the Commission focused only on issues 
that the chairman wanted to cover, was more interested in publicity 
than in a thorough investigation, and never paid serious attention to 
other views. It was not in any sense an objective or thorough study, 
did not produce any facts or data that could aid scholars in the future 
(although its disclosure of documents might assist scholarly research), 
and in my view was a waste of the taxpayers' money. Most important, 
considering the purpose of the Commission, was its failure to shed any 
light on the validity of the many theories that have been advanced to 
explain the financial crisis. Policy makers, scholars, and the American 
people deserved a reasoned analysis of these ideas. In the end, what 
they got was a just so story about the financial crisis, rather than a 
report on what caused the financial crisis.
    I will now turn to the substantive reasons for my dissent. In my 
view, if we are to avoid another financial crisis in the future, it is 
necessary to understand the causes of the crisis that the Commission 
was impaneled to investigate. I decided to write a dissent when it 
became apparent to me that the Commission would not even attempt to 
meet this standard. In my view, there were two elements of the 
financial crisis that were truly unique--the size of the housing bubble 
that developed between 1997 and 2007 and the number of subprime and 
Alt-A mortgages that were present in the financial system when that 
bubble began to deflate. The Commission's management seemed determined 
to avoid any serious investigation of the underlying causes of either 
of these phenomena, and it seemed to me that a failure to consider 
their role in the financial crisis would give a distorted and biased 
picture to policy makers, scholars, and the American public.
What Caused the Financial Crisis?
    George Santayana is often quoted for the aphorism that ``Those who 
cannot remember the past are condemned to repeat it.'' This is not as 
easy as it sounds. There are always many factors that could have caused 
an historical event; the difficult task is to discern which, among a 
welter of possible causes, were the significant ones--the ones without 
which history would have been different. Using this standard, I believe 
that the sine qua non of the financial crisis was U.S. Government 
housing policy, which fostered the creation of 27 million subprime and 
other risky loans--half of all mortgages in the United States. These 
were ready to default in unprecedented numbers as soon as the massive 
1997-2007 housing bubble began to deflate, and as I will show these 
defaults ultimately caused the weakness and failure among the world's 
largest financial institutions that we now recognize as the financial 
crisis.
    With this background, I would like to outline for the Committee the 
logical process that I followed in coming to the conclusion that it was 
the U.S. Government's housing policies--and nothing else--that was the 
underlying cause of the 2008 financial crisis.
    This position has been dismissed as simplistic. It is certainly 
true that many major events have multiple causes that are difficult to 
untangle. But some events can be traced back to a single cause, which--
with sufficient attention--can be separated from surrounding events. A 
child playing with matches can burn down a house. The fact that the 
child was left alone in the house, that house did not have a security 
system that reported the fire, and that the fire department's truck 
broke down on the way to the fire are not other causes. If the child 
had not been playing with matches, the house wouldn't have burned down. 
In the same way, although there are many factors surrounding the 
financial crisis, I believe it is possible to show that if there had 
not been a housing bubble of unprecedented in size and duration, and if 
that bubble had not contained an unprecedented number of subprime and 
Alt-A mortgages, there might never have been a financial crisis.
The Key Questions
    The inquiry must begin with what everyone agrees was the trigger 
for the crisis--the so-called mortgage meltdown that occurred in 2007. 
That was the relatively sudden outbreak of delinquencies and defaults 
among mortgages, primarily in a few States--California, Arizona, 
Nevada, and Florida--but to a lesser degree everywhere in the country. 
No one disputes that the losses on these mortgages, the mortgage-backed 
securities (MBS) they supported, and the decline in housing values that 
resulted from the ensuing foreclosures were the precipitating cause of 
the crisis. These mortgage losses weakened, and caused a loss of market 
confidence in, Bear Stearns, Lehman, WaMu, and Wachovia. The Fed 
thought it had to rescue AIG because the firm had written credit 
default swaps on portfolios of private MBS backed by subprime 
mortgages.
    Since we know that the triggering event for the financial crisis 
was the mortgage meltdown, it is necessary to draw the causal 
connections between this event and the Government's housing policies. 
These connections become clear when we ask three questions.
    1. Why was an international financial crisis triggered by the 
collapse of a housing bubble in the U.S.? The U.S. has had housing 
bubbles in the past. Since the Second World War, there have been two--
beginning in 1979 and 1989--but when these bubbles deflated they had 
triggered only local losses. Part of the answer is that the bubble that 
developed between 1997 and 2007 was far larger and of far longer 
duration than any previous housing bubble. Figure 1 is derived from 
Robert Shiller's calculation of real home prices since 1890 and shows 
the extraordinary size and duration of the 1997-2007 bubble in 
comparison to prior booms or bubbles.



    2. Why was the deflation of the housing bubble in 2007 so 
destructive? The number of subprime and Alt-A loans in the 1997-2007 
bubble was unprecedented. In prior housing bubbles, the number of low-
quality nonprime loans never exceeded a few percent. As noted earlier, 
and as the Commission never acknowledged or disputed, by 2008, half all 
mortgages in the U.S.--27 million--were subprime or otherwise risky 
loans.
    Table 1, below, shows that in early 2008 the credit risk of more 
than two-thirds of these low-quality loans--19.2 million mortgages--was 
held by various Government agencies or by firms the Government 
regulated or could otherwise influence. This makes clear that the 
Government's housing policies were directly responsible for creating 
the demand for these mortgages. The remaining number in Table 1, 7.8 
million loans, were privately securitized by Wall Street firms and 
others. As I will show, the development of a market for securitized 
subprime loans was also attributable to the same Government housing 
policies.
    When the bubble began to deflate, the overwhelming number of 
delinquencies and defaults among these low-quality loans drove down 
housing values, caused the collapse of the market for MBS, and weakened 
financial institutions in the U.S. and around the world.



    3. Why were there so many weak and risky loans in this bubble? What 
had happened to mortgage underwriting standards in the preceding years 
that caused such a serious deterioration in mortgage quality? This is 
perhaps the most fundamental question, and it was completely ignored by 
the Commission majority's in its report. However, the answer lay in 
plain sight; beginning in 1992, U.S. housing policy sought to increase 
home ownership in the United States by reducing mortgage underwriting 
standards in order to make mortgage credit more readily available to 
low income borrowers.
    Although there might be some question about whether this was 
actually Government policy, HUD made no effort to hide its purposes. In 
statements over several years, and through two Administrations, the 
department made clear its intent to reduce mortgage underwriting 
standards. Many of these statements are included in my dissent; three 
are set out below. The first was made in 2000 when HUD was increasing 
the affordable-housing goals for Fannie and Freddie. (The term, ``more 
flexible mortgage underwriting,'' as used in this declaration, has 
always been code for avoiding traditional underwriting standards.)

        Lower-income and minority families have made major gains in 
        access to the mortgage market in the 1990s. A variety of 
        reasons have accounted for these gains, including improved 
        housing affordability, enhanced enforcement of the Community 
        Reinvestment Act, more flexible mortgage underwriting, and 
        stepped-up enforcement of the Fair Housing Act. But most 
        industry observers believe that one factor behind these gains 
        has been the improved performance of Fannie Mae and Freddie Mac 
        under HUD's affordable lending goals. HUD's recent increases in 
        the goals for 2001-03 will encourage the GSEs to further step 
        up their support for affordable lending. \4\ [emphasis mine.]
---------------------------------------------------------------------------
     \4\ U.S. Department of Housing and Urban Development, ``HUD's 
Affordable Housing Goals for Fannie Mae and Freddie Mac'', Issue Brief 
No. V (Washington, DC, January 2011), 5, www.huduser.org/Publications/
PDF/gse.pdf (accessed February 4, 2011).

    Similarly, in 2004, when HUD was again increasing the affordable-
---------------------------------------------------------------------------
housing goals for Fannie and Freddie, the department stated:

        Millions of Americans with less than perfect credit or who 
        cannot meet some of the tougher underwriting requirements of 
        the prime market for reasons such as inadequate income 
        documentation, limited down payment or cash reserves, or the 
        desire to take more cash out in a refinancing than conventional 
        loans allow, rely on subprime lenders for access to mortgage 
        financing. If the GSEs reach deeper into the subprime market, 
        more borrowers will benefit from the advantages that greater 
        stability and standardization create. \5\ [emphasis mine.]
---------------------------------------------------------------------------
     \5\ Final Rule, http://fdsys.gpo.gov/fdsys/pkg/FR-2004-11-02/pdf/
04-24101.pdf.

    Finally, the following statement appeared in a 2005 report 
---------------------------------------------------------------------------
commissioned by HUD:

        More liberal mortgage financing has contributed to the increase 
        in demand for housing. During the 1990s, lenders have been 
        encouraged by HUD and banking regulators to increase lending to 
        low-income and minority households. The Community Reinvestment 
        Act (CRA), Home Mortgage Disclosure Act (HMDA), Government-
        sponsored enterprises (GSE) housing goals and fair lending laws 
        have strongly encouraged mortgage brokers and lenders to market 
        to low-income and minority borrowers. Sometimes these borrowers 
        are higher risk, with blemished credit histories and high debt 
        or simply little savings for a down payment. Lenders have 
        responded with low down payment loan products and automated 
        underwriting, which has allowed them to more carefully 
        determine the risk of the loan. \6\ [emphasis mine.]
---------------------------------------------------------------------------
     \6\ U.S. Department of Housing and Urban Development, Office of 
Policy Development and Resesarch, ``Recent House Price Trends and 
Homeownership Affordability (Washington, DC, May 2005), 85, 
www.huduser.org/Publications/pdf/RecentHousePrice.pdf (accessed 
February 4, 2011).

    These statements are strong evidence that the decline in mortgage 
underwriting standards between 1992 and 2007 did not just happen; nor 
was it the result of low interest rates, flows of funds from abroad, or 
any of the other events or conditions suggested by the Commission 
majority and the other dissenters. The process by which HUD gradually 
reduced underwriting standards is described fully in my dissent.
The Affordable Housing Goals and the Deterioration in Underwriting 
        Standards
    The turning point came in 1992, with the enactment by Congress of 
what were called ``affordable housing goals'' for Fannie Mae and 
Freddie Mac. As the Committee knows, Fannie and Freddie are Government-
sponsored enterprises (GSEs) which were chartered by Congress more than 
40 years ago to operate a secondary market in mortgages. Although they 
were shareholder-owned at all times relevant to this testimony, the 
Government placed them in a Government-controlled conservatorship in 
2008 when they became insolvent. The original mission of Fannie and 
Freddie was to operate a secondary mortgage market by purchasing 
mortgages from originators, providing originating banks and others with 
the cash to make more mortgages.
    As originally chartered by Congress, Fannie and Freddie were 
required to buy only mortgages that would be acceptable to 
institutional investors--in other words, prime mortgages. At the time 
they were chartered, a prime mortgage was a loan with a 10-20 percent 
down payment, made to a borrower with a good credit record who had 
sufficient income to meet his or her debt obligations after the loan 
was made. Fannie and Freddie operated under these standards until 1992.
    The 1992 affordable housing goals required that at least 30 percent 
of all the mortgages that Fannie and Freddie bought in any year had to 
be loans made to borrowers who were at or below the median income in 
the places where they lived. These were considered low-to-moderate 
income (LMI) borrowers. Over succeeding years, the Department of 
Housing and Urban Development (HUD) increased this requirement--to 42 
percent in 1996, 50 percent in 2000, and finally to 56 percent in 2008. 
Table 2, below, prepared by the Federal Housing Finance Agency, shows 
the gradually increasing affordable housing goals after 1992, and the 
success of Fannie and Freddie in meeting them. \7\ The table also shows 
the subgoals. In the case of the Special Affordable goal, it is 
noteworthy that this goal--which required the GSEs to purchase loans to 
very low income borrowers (60 percent and 80 percent of area median 
income)--rose much faster than the general LMI goal.
---------------------------------------------------------------------------
     \7\ The table shows the years in which the requirements went into 
effect, rather than the year in which they were imposed. For example, 
the 50 percent affordable housing goal was imposed by HUD in October 
2000 and went into effect in 2001.
---------------------------------------------------------------------------
    When the goals reached 50 percent, simple arithmetic required 
Fannie and Freddie to acquire at least one goals-eligible loan for 
every prime loan that they acquired, and since not all subprime loans 
were goals-eligible Fannie and Freddie were in effect required to buy 
many more subprime loans than prime loans to meet the goals. As a 
result of this process, by 2008, as shown in Table 1 above, Fannie and 
Freddie held the credit risk of 12 million subprime or otherwise risky 
loans.



    But this was not by any means the full extent of HUD's efforts. The 
agency apparently viewed Congress' enactment of the affordable housing 
goals as an expression of a congressional policy to reduce underwriting 
standards so that low income borrowers would have greater access to 
mortgage credit. As outlined fully in my dissent, by tightening the 
affordable housing goals, HUD put Fannie and Freddie into competition 
with FHA--which had an explicit mission to provide credit to low-income 
borrowers--and with subprime lenders, such as Countrywide, that had 
signed up for a HUD program called the Best Practices Initiative, in 
which adherents were expected to take affirmative steps to reduce 
underwriting standards.
    Moreover, these organizations were joined by insured banks and 
S&Ls, which were required under the Community Reinvestment Act to make 
mortgage credit available to borrowers who are at or below 80 percent 
of the median income in the areas where they live.
    It was this Government-induced competition that created substantial 
demand for subprime and Alt-A loans, which had previously been a niche 
market. By 2008, as noted in Table 1, 19.2 million out of the total of 
27 million subprime and other weak loans in the U.S. financial system 
could be traced directly to U.S. Government housing policies.
    Of course, it is possible to find borrowers who meet prime loan 
standards among LMI families, but it is far more difficult to do this 
than among middle income groups. Among the more obvious problems, LMI 
borrowers don't generally have substantial down payments, their FICO 
credit scores are often below average, and their debt to income ratios 
are often very high. When Fannie, Freddie, FHA, subprime lenders and 
insured banks and S&Ls are all competing to find loans to borrowers in 
the LMI category, they had to reduce their underwriting standards in 
order to find the mortgages they were required to make. So underwriting 
standards deteriorated as the affordable housing goals rose. For 
example, in 1990, only one in 200 mortgages involved a down payment of 
3 percent or less; but by 2007 40 percent of all mortgages had a down 
payment of 3 percent or less.
    These policies were successful in raising home ownership rates. 
These rates had fluctuated around 64 percent for 30 years, but between 
1995 and 2004 they rose to 69 percent. These results were very pleasing 
to policy makers at the time. Only later, as the enormous number of 
delinquencies and defaults rolled in, did HUD begin to deny its role in 
the policies that caused the mortgage debacle, and along with others to 
point fingers at the GSEs and Wall Street.
The Private Securitization of Subprime Loans
    What about the additional 7.8 million low-quality mortgages, shown 
in Table 1, that were securitized by Wall Street and others as private 
label securities (PLS) or private mortgage-backed securities (PMBS)? 
These were also subprime and Alt-A mortgages that were bought and held 
as investments by financial institutions around the world. Although 
they were less than one-third of the total number of subprime and other 
Alt-A loans outstanding, private MBS are the reason that banks and loan 
originators generally have been blamed for the financial crisis in the 
media, in most books about the financial crisis, and of course by the 
Government, which was seeking to avoid its own culpability.
    How were these mortgages related to U.S. Government housing policy?
    The securitization of subprime and other risky loans developed 
during the latter stages of the 1997-2007 housing bubble and was also a 
new phenomenon in the housing finance market. Indeed, it was a direct 
result of the extraordinary growth of the bubble itself. Most bubbles 
in the past had lasted 3 or 4 years. See Figure 1, above. This is 
because in that time delinquencies begin to appear and the inflow of 
the necessary speculative funds begins to dry up.
    The bubble that deflated in 2007, however, had an unprecedentedly 
long 10 year life. This is because the money flowing into the bubble 
was not from private speculators looking for profit and alert to risk, 
but primarily from the Government pursuing a social policy by directing 
the investments of companies it regulated. The Government, unlike 
private speculators, was not concerned about risk, but only about 
increasing home ownership.
    The mechanism here is important to understand: housing bubbles tend 
to suppress delinquencies and defaults. As housing prices rise, people 
who can't meet their obligations can sell the house for more than they 
paid, or can refinance, so defaults are lower than one might expect. By 
2002, five years into the bubble that began in 1997, investors were 
noticing that subprime and other risky loans--which usually carried 
higher than normal interest rates because of their risk--were not 
showing a commensurate number of defaults. In other words, the data 
suggested that these mortgages and the private MBS they backed were 
offering unusually high risk-adjusted yields.
    This stimulated the development of the private market in PLS, 
beginning in the early 2000s. The first year that this market was 
larger than $100 billion was 2002, when it reached $130 billion--about 
4 percent of all mortgages made that year. For comparison, by 2002, 
Fannie and Freddie had already acquired almost $1.2 trillion in 
subprime and other risky loans, including $206 billion in 2002 alone. 
Thus, the 7.8 million subprime and other risky loans that were 
securitized by the private sector during the 2000s, and still 
outstanding in 2008, were an indirect result of U.S. Government housing 
policies, which had built an unprecedented bubble in the late 1990s. 
The bubble created the necessary conditions--a long run of subprime 
loans without the expected losses--for the growth of a huge 
securitization market in subprime and other risky loans in the mid-
2000s. It remains to be discussed, then, how the buildup of subprime 
and Alt-A loans--now shown to be both the direct and indirect result of 
Government housing policies--caused the financial crisis.
    Before leaving this subject, I'd like to deal with an issue that 
comes up again and again--whether Fannie and Freddie followed Wall 
Street into subprime lending or Wall Street followed Fannie and 
Freddie. From what I've just said it should be obvious that Fannie and 
Freddie led Wall Street.
    Still, those who want to protect the Government won't give up. The 
FCIC, without any evidence at all, said in its report that Fannie and 
Freddie followed Wall Street into subprime loans for market share or 
for profit--that the affordable housing goals were not responsible. The 
Commission majority's report said: ``[The GSEs'] relaxed their 
underwriting standards to purchase or guarantee riskier loans and 
related securities in order to meet stock market analysts' and 
investors' expectations for growth, to regain market share, and to 
ensure generous compensation for their executives and employees--
justifying their activities on the broad and sustained public policy 
support for home ownership.'' \8\
---------------------------------------------------------------------------
     \8\ Commission majority report, p. xxvi.
---------------------------------------------------------------------------
    I am no defender of the GSEs, but this is simply a fantasy. Here's 
a quote from Fannie's 2006 10-K:

        [W]e have made, and continue to make, significant adjustments 
        to our mortgage loan sourcing and purchase strategies in an 
        effort to meet HUD's increased housing goals and new subgoals. 
        These strategies include entering into some purchase and 
        securitization transactions with lower expected economic 
        returns than our typical transactions. We have also relaxed 
        some of our underwriting criteria to obtain goals-qualifying 
        mortgage loans and increased our investments in higher-risk 
        mortgage loan products that are more likely to serve the 
        borrowers targeted by HUD's goals and subgoals, which could 
        increase our credit losses. [emphasis supplied.]

    This language, which confirms that Fannie bought subprime and other 
risky loans to comply with the affordable housing goals, and not for 
market share or for profit, somehow never made it into the Commission's 
report.
Subprime and Other Risky Loans Cause the Financial Crisis
    The private MBS market kept growing through 2005 and 2006, but 
completely collapsed in 2007, when the Government-created 10 year 
bubble finally topped out and began to deflate. Figure 2, below, shows 
the extraordinary decline in this market, beginning in 2007. Alarmed by 
the unexpected and unprecedented numbers of delinquencies and defaults, 
investors fled the multitrillion dollar market for mortgage-backed 
securities (MBS) and other asset-backed securities, dropping MBS 
values--and especially those MBS backed by subprime and other risky 
loans--to fractions of their former prices.



    The collapse of the MBS market had an almost immediate and highly 
adverse effect on the apparent financial condition of major financial 
institutions in the U.S. and around the world. Under the accounting 
rules applicable to most financial institutions, securities must be 
valued on a mark-to-market basis unless they are being held to 
maturity. Without an existing liquid market, roughly $2 trillion in MBS 
simply could not be sold except at distress prices, and thus financial 
institutions were compelled to report significant capital writedowns as 
they marked substantial portions of their private MBS holdings to 
market.
    In addition, the inability to sell private MBS at any but fire sale 
prices also had a major adverse effect on the liquidity positions of 
firms such as Bear Stearns and Lehman Brothers, which used AAA-rated 
MBS as a source of financing through repurchase agreements, or repose 
When AAA-rated MBS became unmarketable because of the collapse of the 
MBS market, these securities also became useless for liquidity 
purposes. Whether or not Bear and Lehman were actually insolvent, the 
market lost confidence in their ability to meet their obligations as 
they came due--primarily because they did not have the liquidity 
resources that they had counted on to reassure counterparties.
    The capital writedowns and liquidity effects of the collapse of the 
MBS market were a major contributor to the financial crisis. At the 
very least, they induced an investor anxiety about the solvency and 
stability of financial institutions that became an outright panic when 
Lehman filed for bankruptcy. Nevertheless, although the Commission 
reported that accounting losses seemed to exceed real losses, it never 
attempted to assess the effect of accounting requirements on the 
financial crisis--to determine, in other words, what the world would 
have looked like if mark-to-market accounting had not been required. 
This is another major lapse in the Commission's work, and leaves policy 
makers without a clear idea whether financial institutions should or 
should not be required in the future to mark their securities assets to 
market.
    With half of all mortgages weak and low quality by late 2007, the 
financial crisis was a foregone conclusion. No financial system could 
withstand the huge losses that occurred when the delinquencies and 
defaults associated with 27 million subprime and other risky loans 
began to appear. Mark-to-market accounting then required financial 
institutions to write down the value of their assets--reducing their 
capital and liquidity positions and causing great investor and creditor 
unease. In this environment, the Government's rescue of Bear Stearns in 
March of 2008 temporarily calmed investor fears but created a 
significant moral hazard; investors and other market participants 
reasonably believed after the rescue of Bear that all large financial 
institutions would also be rescued if they encountered financial 
difficulties.
    However, when Lehman Brothers--an investment bank even larger than 
Bear--was allowed to fail, market participants were shocked; suddenly, 
they were forced to consider the financial health of their 
counterparties, many of which appeared weakened by losses and the 
capital write downs required by mark-to-market accounting. This caused 
a halt to lending and a hoarding of cash--a virtually unprecedented 
period of market paralysis and panic that we know as the financial 
crisis of 2008.
    In summary, then, this is the causal connection between the housing 
policies of the U.S. Government and the financial crisis:

    The Government's housing policies--by creating demand for 
        subprime and Alt-A loans--fostered the growth of an 
        unprecedented housing bubble and the creation of 19.2 million 
        subprime and Alt-A loans.

    The size and duration of the bubble permitted the 
        development of a securitization market in subprime and Alt-A 
        loans, adding an additional 7.8 million weak and low-quality 
        loans to the financial system.

    When the bubble deflated, these mortgages--then totaling 
        almost half of all U.S. mortgages outstanding--defaulted in 
        large numbers, causing losses (or anticipated losses) among 
        private MBS and the collapse of the private MBS market.

    Without a market for private MBS, financial institutions 
        were required by mark-to-market accounting to write down the 
        value of their assets, making them appear weak and possibly 
        insolvent.

    The absence of a market for private MBS also eliminated 
        these securities as a source of liquidity for financial 
        institutions, causing a loss of confidence among market 
        participants in their ability to meet their cash obligations as 
        they came due.

    The rescue of Bear Stearns, the first of the institutions 
        to lose market confidence, temporarily calmed the investors and 
        market participants, but when Lehman Brothers filed for 
        bankruptcy a full-scale panic ensued in which market 
        participants hoarded cash and refused to lend to one another. 
        This is what we know as the financial crisis.
Conclusion
    In brief, my dissent shows that the financial crisis was not caused 
by lack of regulation or by private sector greed but by misguided 
Government housing policy. The policy implication of this fact is that 
the Dodd-Frank Act--which has imposed tight and costly regulation on 
all aspects of the financial system--was not an appropriate response to 
the financial crisis. For this reason, Dodd-Frank should be repealed.
    Those who want to protect the Government and the policies it 
followed will continue to assert that the failure to regulate the 
private sector caused the financial crisis. This was certainly the 
motive of the Commission majority in issuing its wholly deficient 
report. As my dissent suggest, however, they do not have the facts on 
their side.
                  JPMORGAN STUDY ``EYE ON THE MARKET''




       FINANCIAL CRISIS INQUIRY COMMISSION ARCHIVED WEB SITE LIST



      FINANCIAL CRISIS INQUIRY COMMISSION PRELIMINARY STAFF REPORT
                        ``THE MORTGAGE CRISIS''




             FINANCIAL CRISIS INQUIRY COMMISSION MEMORANDUM
                      ``ANALYSIS OF HOUSING DATA''



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