Page 20 - untitled

CONCLUSIONS OF THE FINANCIAL CRISIS INQUIRY COMMISSION xix

mental change in these institutions, particularly the large investment banks and bank
holding companies, which focused their activities increasingly on risky trading activ-
ities that produced hefty profits. They took on enormous exposures in acquiring and
supporting subprime lenders and creating, packaging, repackaging, and selling tril-
lions of dollars in mortgage-related securities, including synthetic financial products.
Like Icarus, they never feared flying ever closer to the sun.
Many of these institutions grew aggressively through poorly executed acquisition
and integration strategies that made effective management more challenging. The
CEO of Citigroup told the Commission that a  billion position in highly rated
mortgage securities would “not in any way have excited my attention,” and the co-
head of Citigroup’s investment bank said he spent “a small fraction of ” of his time
on those securities. In this instance, too big to fail meant too big to manage.
Financial institutions and credit rating agencies embraced mathematical models
as reliable predictors of risks, replacing judgment in too many instances. Too often,
risk management became risk justification.
Compensation systems—designed in an environment of cheap money, intense
competition, and light regulation—too often rewarded the quick deal, the short-term
gain—without proper consideration of long-term consequences. Often, those systems
encouraged the big bet—where the payoff on the upside could be huge and the down-
side limited. This was the case up and down the line—from the corporate boardroom
to the mortgage broker on the street.
Our examination revealed stunning instances of governance breakdowns and irre-
sponsibility. You will read, among other things, about AIG senior management’s igno-
rance of the terms and risks of the company’s  billion derivatives exposure to
mortgage-related securities; Fannie Mae’s quest for bigger market share, profits, and
bonuses, which led it to ramp up its exposure to risky loans and securities as the hous-
ing market was peaking; and the costly surprise when Merrill Lynch’s top manage-
ment realized that the company held  billion in “super-senior” and supposedly
“super-safe” mortgage-related securities that resulted in billions of dollars in losses.

• We conclude a combination of excessive borrowing, risky investments, and lack
of transparency put the financial system on a collision course with crisis. Clearly,
this vulnerability was related to failures of corporate governance and regulation, but
it is significant enough by itself to warrant our attention here.
In the years leading up to the crisis, too many financial institutions, as well as too
many households, borrowed to the hilt, leaving them vulnerable to financial distress
or ruin if the value of their investments declined even modestly. For example, as of
, the five major investment banks—Bear Stearns, Goldman Sachs, Lehman
Brothers, Merrill Lynch, and Morgan Stanley—were operating with extraordinarily
thin capital. By one measure, their leverage ratios were as high as  to , meaning for
every  in assets, there was only  in capital to cover losses. Less than a  drop in
asset values could wipe out a firm. To make matters worse, much of their borrowing
was short-term, in the overnight market—meaning the borrowing had to be renewed
each and every day. For example, at the end of , Bear Stearns had . billion in