FCIC Report

The Majority


The Financial Crisis Inquiry Commission has been called upon to examine the financial and economic crisis that has gripped our country and explain its causes to the American people.


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The Dissent


We find areas of agreement with the majority’s conclusions, but unfortunately the areas of disagreement are significant enough that we dissent and present our views in this report.


Note:  A vote of the Commission on December 6, 2010, limited dissenters to nine pages each in the approximately 550-page commercially published book. No limits apply to the official version submitted to the President and the Congress.  Page 438

Our task was first to determine what happened and how it happened so that we could understand why it happened. Here we present our conclusions. We encourage the American people to join us in making their own assessments based on the evidence gathered in our inquiry. If we do not learn from history, we are unlikely to fully recover from it.  Page xv


…our mission was to ask and 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 financial system and an array of companies, as millions of Americans still lost their jobs, their savings, and their homes?  Page xvi


While the vulnerabilities that created the potential for crisis were years in the making, it was the collapse of the housing bubble—fueled by low interest rates, easy and available credit, scant regulation, and toxic mortgages— that was the spark that ignited a string of events, which led to a full-blown crisis in the fall of 2008. Trillions of dollars in risky mortgages had become embedded throughout the financial system, as mortgage-related securities were packaged, repackaged, and sold to investors around the world. When the bubble burst, hundreds of billions of dollars in losses in mortgages and mortgage-related securities shook markets as well as financial institutions that had significant exposures to those mortgages and had borrowed heavily against them. This happened not just in the United States but around the world. The losses were magnified by derivatives such as synthetic securities.


To be continued…Still working on this section

The Dissent of
Keith Hennessey
Commissioner Commissioner


Douglad Holtz-Eakin


Vice Chairman
Bill Thomas


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Page 413

The majority says the crisis was avoidable if only the United States had adopted across-the-board more restrictive regulations, in conjunction with more aggressive regulators and supervisors. This conclusion by the majority largely ignores the global nature of the crisis.  For example:

A credit bubble appeared in both the United States and Europe. This tells us that our primary explanation for the credit bubble should focus on factors common to both regions.

The report largely ignores the credit bubble beyond housing. Credit spreads declined not just for housing, but also for other asset classes like commercial real estate. This tells us to look to the credit bubble as an essential cause of the U.S. housing bubble.  It also tells us that problems with U.S. housing policy or markets do not by themselves explain the U.S. housing bubble.

There were housing bubbles in the United Kingdom, Spain, Australia, France and Ireland, some more pronounced than in the United States. Some nations with housing bubbles relied little on American-style mortgage securitization. A good explanation of the U.S. housing bubble should also take into account its parallels in other nations. This leads us to explanations broader than just U.S. housing policy, regulation, or supervision. It also tells us that while failures in U.S. securitization markets may be an essential cause, we must look for other things that went wrong as well.

Large financial firms failed in Iceland, Spain, Germany, and the United Kingdom, among others. Not all of these firms bet solely on U.S. housing assets, and they operated in different regulatory and supervisory regimes than U.S. commercial and investment banks. In many cases these European systems have stricter regulation than the United States, and still they faced financial firm failures similar to those in the United States.  Pages 414-416

The Commission’s statutory mission is “to examine the causes, domestic and global, of the current financial and economic crisis in the United States.”  By focusing too narrowly on U.S. regulatory policy and supervision, ignoring international parallels, emphasizing only arguments for greater regulation, failing to prioritize the causes, and failing to distinguish sufficiently between causes and effects, the majority’s report is unbalanced and leads to incorrect conclusions about
what caused the crisis.  Page 416

Conventional wisdom is that the failure of Lehman Brothers triggered the financial panic. This is because Lehman’s failure was unexpected and because the debate about whether government officials could have saved Lehman is so intense. The focus on Lehman’s failure is too narrow. The events of September 2008 were a chain of one firm failure after another:  Page 435

The following ten causes, global and domestic, are essential to explaining the financial and economic crisis.


I. Credit bubble. Starting in the late 1990s, China, other large developing countries, and the big oil-producing nations built up large capital surpluses. They loaned these savings to the United States and Europe, causing interest rates to fall. Credit spreads narrowed, meaning that the cost of borrowing to finance risky investments declined. A credit bubble formed in the United States and Europe, the most notable manifestation of which was increased investment in high-risk mortgages. U.S. monetary policy may have contributed to the credit bubble but did not cause it.

II. Housing bubble. Beginning in the late 1990s and accelerating in the 2000s, there was a large and sustained housing bubble in the United States.  The bubble was characterized both by national increases in house prices well above the historical trend and by rapid regional boom-and-bust cycles in California, Nevada, Arizona, and Florida. Many factors contributed to the housing bubble, the bursting of which created enormous losses for home- owners and investors.

III. Nontraditional mortgages. Tightening credit spreads, overly optimistic assumptions about U.S. housing prices, and flaws in primary and secondary mortgage markets led to poor origination practices and combined to increase the flow of credit to U.S. housing finance. Fueled by cheap credit, firms like Countrywide, Washington Mutual, Ameriquest, and HSBC Finance originated vast numbers of high-risk, nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers’ ability to repay. At the same time, many homebuyers and homeowners did not live up to their responsibilities to understand the terms of their mortgages and to make prudent financial decisions. These factors further amplified the housing bubble.

IV. Credit ratings and securitization. Failures in credit rating and securitizationtransformed bad mortgages into toxic financial assets. Securitizers lowered the credit quality of the mortgages they securitized. Credit rating agencies erroneously rated mortgage-backed securities and their derivatives as safe investments. Buyers failed to look behind the credit ratings and do their own due diligence. These factors fueled the creation of more bad mortgages.

V. Financial institutions concentrated correlated risk. Managers of many large and midsize financial institutions in the United States amassed enormous concentrations of highly correlated housing risk.  Some did this knowingly by betting on rising housing prices, while others paid insufficient attention to the potential risk of carrying large amounts of housing risk on their balance sheets.  This enabled large but seemingly manageable mortgage losses to precipitate the collapse of large financial institutions.

VI. Leverage and liquidity risk. Managers of these financial firms amplified this concentrated housing risk by holding too little capital relative to the risks they were carrying on their balance sheets. Many placed their firms on a hair trigger by relying heavily on short-term financing in repo and commercial paper markets for their day-to-day liquidity. They placed solvency bets (sometimes unknowingly) that their housing investments were solid, and liquidity bets that overnight money would always be available. Both turned out to be bad bets. In several cases, failed solvency bets triggered liquidity crises, causing some of the largest financial firms to fail or nearly fail.  Firms were insufficiently transparent about their housing risk, creating uncertainty in markets that made it difficult for some to access additional capital and liquidity
when needed.

VII. Risk of contagion. The risk of contagion was an essential cause of the crisis.  In some cases, the financial system was vulnerable because policymakers were afraid of a large firm’s sudden and disorderly failure triggering balance-sheet losses in its counterparties. These institutions were deemed too big and interconnected to other firms through counterparty credit risk for policy- makers to be willing to allow them to fail suddenly.

VIII. Common shock. In other cases, unrelated financial institutions failed because of a common shock: they made similar failed bets on housing. Unconnected financial firms failed for the same reason and at roughly the same time because they had the same problem: large housing losses. This common shock meant that the problem was broader than a single failed bank–key large financial institutions were undercapitalized because of this common shock.

IX. Financial shock and panic. In quick succession in September 2008, the failures, near-failures, and restructurings of ten firms triggered a global financial panic. Confidence and trust in the financial system began to evaporate as the health of almost every large and midsize financial institution in the United States and Europe was questioned.

X. Financial crisis causes economic crisis. The financial shock and panic caused a severe contraction in the real economy. The shock and panic ended in early 2009. Harm to the real economy continues through today.  Pages 417-419



















The Dissent of

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The question I have been most frequently asked about the Financial Crisis Inquiry Commission (the “FCIC” or the “Commission”) is why Congress bothered to authorize it at all. Without waiting for the Commission’s insights into the causes of the financial crisis, Congress passed and the President signed the Dodd-Frank Act (DFA), far reaching and highly consequential regulatory legislation.  Congress and the President acted without seeking to understand the true causes of the wrenching events of 2008, perhaps following the precept of the President’s chief of staff —“Never let a good crisis go to waste.” Although the FCIC’s work was not the full investigation to which the American people were entitled, it has served a useful purpose by focusing attention again on the financial crisis and whether—with some distance from it—we can draw a more accurate assessment than the media did with what is oft en called the “first draft  of history.”

To avoid the next financial crisis, we must understand what caused the one from which we are now slowly emerging, and take action to avoid the same mistakes in the future. If there is doubt that these lessons are important, consider the ongoing efforts to amend the Community Reinvestment Act of 1977 (CRA).

Like Congress and the Administration, the Commission’s majority erred in assuming that it knew the causes of the financial crisis. Instead of pursuing a thorough study, the Commission’s majority used its extensive statutory investigative authority to seek only the facts that supported its initial assumptions—that the crisis was caused by “deregulation” or lax regulation, greed and recklessness on Wall Street, predatory lending in the mortgage market, unregulated derivatives and a financial system addicted to excessive risk-taking. Th e Commission did not seriously investigate any other cause, and did not effectively connect the factors it investigated to the financial crisis. Th e majority’s report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally failed to show how practices that had gone on for many years suddenly caused a world-wide financial crisis. In the end, the majority’s report turned out to be a just so story about the financial crisis, rather than a report on what caused the financial crisis.  Pages 443-444

If the Commission’s investigation had been an objective and thorough investigation, many of the points I raise in this dissent would have been known to the other commissioners before reading this dissent, and perhaps would have been influential with them.  Similarly, I might have found facts that changed my own view.  But the Commission’s investigation was not structured or carried out in a way that could ever have garnered my support or, I believe, the support of the other Republican members. 

One glaring example will illustrate the Commission’s lack of objectivity.

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 staff  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).  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.

This research raised important questions about the role of government housing policy in promoting the 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, taken Pinto’s testimony, and tested the accuracy of Pinto’s research. But the Commission took none of these steps. Pinto’s 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. Accordingly, the Commission majority’s report ignores hypotheses about the causes of the financial crisis that any objective investigation would have considered, while focusing solely on theories that have political currency but far less plausibility.

This is not the way a serious and objective inquiry should have been carried out, but that is how the Commission used its resources and its mandate.  Page 447

Three specific government programs were primarily responsible for the growth of subprime and Alt-A mortgages in the U.S. economy between 1992 and 2008, and for the decline in mortgage underwriting standards that ensued. 

1.  The GSEs’ Affordable Housing Mission. 

In 1992, Congress enacted Title XIII of the Housing and Community Development Act of 19926 (the GSE Act), legislation intended to give low and moderate income7 borrowers better access to mortgage credit through Fannie Mae and Freddie Mac. Th is effort, probably stimulated by a desire to increase home ownership, ultimately became a set of regulations that required Fannie and Freddie to reduce the mortgage underwriting standards they used when acquiring loans from originators.  Pages 452-453

2.  The Community Reinvestment Act. 

In 1995, the regulations under the Community Reinvestment Act (CRA)10 were tightened. As initially adopted in 1977, the CRA and its associated regulations required only that insured banks and Savings & Loans reach out to low-income borrowers in communities they served.  The new regulations, made effective in 1995, for the first time required insured banks and S&Ls to demonstrate that they were actually making loans in low-income
communities and to low-income borrowers.  

In 2007, the National Community Reinvestment Coalition (NCRC), an umbrella organization for community activist organizations, reported that between 1997 and 2007 banks that were seeking regulatory approval for mergers committed in agreements with community groups to make over $4.5 trillion in CRA loans.  A substantial portion of these commitments appear to have been converted into mortgage loans, and thus would have contributed substantially to the number of subprime and other high risk loans outstanding in 2008. For this reason, they deserved Commission investigation and analysis. Unfortunately, as outlined in Part III, this was not done.

Accordingly, the GSE Act put Fannie and Freddie, FHA, and the banks that were seeking CRA loans into competition for the same mortgages—loans to borrowers at or below the applicable AMI.  Page 454

3.  Housing and Urban Development’s (HUD) Best Practices Initiative. 

In 1994, HUD added another group to this list
when it set up a “Best Practices Initiative,”…  As shown later, this program was explicitly intended to encourage a reduction in underwriting standards so as to increase access by low income borrowers to mortgage credit.

It also created ideal conditions for a decline in underwriting standards, since every one of these competing entities
was seeking NTMs not for purposes of profit but in order to meet an obligation imposed by the government.  The obvious way to meet this obligation was simply to reduce the underwriting standards that impeded compliance with the government’s requirements.

Indeed, by the early 1990s, traditional underwriting standards had come to be seen as an obstacle to home ownership by LMI families. In a 1991 Senate Banking Committee hearing, Gail Cincotta, a highly respected supporter of low-income lending, observed that “Lenders will respond to the most conservative standards unless [Fannie Mae and Freddie Mac] are aggressive and convincing in their efforts to expand historically narrow underwriting.”

In this light, it appears that Congress set out deliberately in the GSE Act not only to change the culture of the GSEs, but also to set up a mechanism that would reduce traditional underwriting standards over time, so that home ownership would be more accessible to LMI borrowers. For example, the legislation directed the GSEs to study “The implications of implementing underwriting standards that—

(A) establish a downpayment requirement for mortgagors of 5 percent or less;

(B) allow the use of cash on hand as a source of downpayments; and

(C) approve borrowers who have a credit history of delinquencies if the borrower can demonstrate a satisfactory credit history for at least the 12-month period ending on
the date of the application for the mortgage.”  None of these elements was part of traditional mortgage underwriting standards as understood at the time.  Page 455

By 2008, the result of these government programs was an unprecedented number of subprime and other high risk mortgages in the U.S. financial system.  Page 456

As Table 1 makes clear, government agencies, or private institutions acting under government direction, either held or had guaranteed 19.2 million of the Non-traditional mortgage (NMT) loans that were outstanding at this point. By contrast, about 7.8 million NTMs had been distributed to investors through the issuance of private mortgage-backed securities, or private-mortgage-backed securities (PMBS), primarily by private issuers such as Countrywide and other subprime lenders.

The fact that the credit risk of two-thirds of all the NTMs in the financial system was held by the government or by entities acting under government control demonstrates the central role of the government’s policies in the development of the 1997-2007 housing bubble, the mortgage meltdown that occurred when the bubble deflated, and the financial crisis and recession that ensued.  Page 456

The Commission majority’s report focuses almost entirely on the 7.8 million PMBS, and is thus an example of its determination to ignore the government’s role in the financial crisis.

One of the many myths about the financial crisis is that Wall Street banks led the way into subprime lending and the Government Sponsored Enterprises (GSE’s Fannie Mae and Freddie Mac) followed.  The Commission majority’s report adopts this idea as a way of explaining why Fannie and Freddie acquired so many non-traditional mortgages (NTMs).  This notion simply does not align with the facts. Not only were Wall Street institutions small factors in the subprime private mortgage backed securities (PMBS) market, but well before 2002 Fannie and Freddie were much bigger players than the entire PMBS market in the business of acquiring NTM and other subprime loans.  Table 7, page 504, shows that Fannie and Freddie had already acquired at least $701 billion in NTMs by 2001. Obviously, the GSEs did not have to follow anyone into NTM or subprime lending; they were already the dominant players in that market before 2002.  Table 7 also shows that in 2002, when the entire PMBS market was $134 billion, Fannie and Freddie acquired $206 billion in whole subprime mortgages and $368 billion in other NTMs, demonstrating again that the GSEs were no strangers to risky lending well before the PMBS market began to develop.  Page 463

Even today, there are few references in the media to the number of NTMs that had accumulated in the U.S. financial system before the meltdown began. Yet this is by far the most important fact about the financial crisis. None of the other factors offered by the Commission majority to explain the crisis—lack of regulation, poor regulatory and risk management foresight, Wall Street greed and compensation policies, systemic risk caused by credit default swaps, excessive liquidity and easy credit—do so as plausibly as the failure of a large percentage of the 27 million NTMs that existed in the financial system in 2007.   Page 465

The Commission never attempted a serious study of what was known about the composition of the mortgage market in 2007, apparently satisfied simply to blame market participants for failing to understand the risks that lay before them, without trying to understand what information was actually available…Until Fannie and Freddie were required to meet HUD’s AH goals, they rarely acquired subprime or other low quality mortgages.  Indeed, the very definition of a traditional prime mortgage was a loan that Fannie and Freddie would buy. Lesser loans were rejected, and were ultimately insured by FHA or made by a relatively small group of subprime originators and investors.

Although anyone who followed HUD’s AH regulations, and thought through their implications, would have realized that Fannie and Freddie must have been shifting their buying activities to low quality loans, few people had incentives to
uncover the new buying pattern.  Investors believed that there was no significant risk in MBS backed by Fannie and Freddie, since they were thought (correctly, as it turns out) to be implicitly backed by the federal government.  In addition, the
GSEs were exempted by law from having to file information with the Securities and Exchange Commission (SEC)–they agreed to file voluntarily in 2002–leaving them free from disclosure obligations and questions from analysts about the quality of
their mortgages.  Page 466

Indeed, the Commission’s entire investigation seemed to be directed at minimizing the role of NTMs and the role of government housing policy.  Page 469

Parenthetically, it should be noted that the Commission’s staff  focused on Bear because the Commission’s majority apparently believed that the business model of investment banks, which relied on relatively high leverage and repo or other short
term financing, was inherently unstable. Th e need to rescue Bear was thought to be evidence of this fact. Clearly, the five independent investment banks—Bear, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs—were badly damaged in the financial crisis. Only two of them remain independent firms, and those two are now regulated as bank holding companies by the Federal Reserve. Nevertheless, it is not clear that the investment banks fared any worse than the much more heavily regulated commercial banks—or Fannie and Freddie which were also regulated more stringently than the investment banks but not as stringently as banks.  Page 478

The Commission majority did not discuss the significance of mark-to-market accounting in its report. This was a serious lapse, given the views of many that accounting policies played an important role in the financial crisis. Page 480