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xx FINANCIAL CRISIS INQUIRY COMMISSION REPORT

equity and . billion in liabilities and was borrowing as much as  billion in
the overnight market. It was the equivalent of a small business with , in equity
borrowing . million, with , of that due each and every day. One can’t
really ask “What were they thinking?” when it seems that too many of them were
thinking alike.
And the leverage was often hidden—in derivatives positions, in off-balance-sheet
entities, and through “window dressing” of financial reports available to the investing
public.
The kings of leverage were Fannie Mae and Freddie Mac, the two behemoth gov-
ernment-sponsored enterprises (GSEs). For example, by the end of , Fannie’s
and Freddie’s combined leverage ratio, including loans they owned and guaranteed,
stood at  to .
But financial firms were not alone in the borrowing spree: from  to , na-
tional mortgage debt almost doubled, and the amount of mortgage debt per house-
hold rose more than  from , to ,, even while wages were
essentially stagnant. When the housing downturn hit, heavily indebted financial
firms and families alike were walloped.
The heavy debt taken on by some financial institutions was exacerbated by the
risky assets they were acquiring with that debt. As the mortgage and real estate mar-
kets churned out riskier and riskier loans and securities, many financial institutions
loaded up on them. By the end of , Lehman had amassed  billion in com-
mercial and residential real estate holdings and securities, which was almost twice
what it held just two years before, and more than four times its total equity. And
again, the risk wasn’t being taken on just by the big financial firms, but by families,
too. Nearly one in  mortgage borrowers in  and  took out “option ARM”
loans, which meant they could choose to make payments so low that their mortgage
balances rose every month.
Within the financial system, the dangers of this debt were magnified because
transparency was not required or desired. Massive, short-term borrowing, combined
with obligations unseen by others in the market, heightened the chances the system
could rapidly unravel. In the early part of the th century, we erected a series of pro-
tections—the Federal Reserve as a lender of last resort, federal deposit insurance, am-
ple regulations—to provide a bulwark against the panics that had regularly plagued
America’s banking system in the th century. Yet, over the past -plus years, we
permitted the growth of a shadow banking system—opaque and laden with short-
term debt—that rivaled the size of the traditional banking system. Key components
of the market—for example, the multitrillion-dollar repo lending market, off-bal-
ance-sheet entities, and the use of over-the-counter derivatives—were hidden from
view, without the protections we had constructed to prevent financial meltdowns. We
had a st-century financial system with th-century safeguards.
When the housing and mortgage markets cratered, the lack of transparency, the
extraordinary debt loads, the short-term loans, and the risky assets all came home to
roost. What resulted was panic. We had reaped what we had sown.