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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

This new system threatened the once-dominant traditional commercial banks, and
they took their grievances to their regulators and to Congress, which slowly but
steadily removed long-standing restrictions and helped banks break out of their tra-
ditional mold and join the feverish growth. As a result, two parallel financial sys-
tems of enormous scale emerged. This new competition not only benefited Wall
Street but also seemed to help all Americans, lowering the costs of their
mortgages and boosting the returns on their (k)s. Shadow banks and commer-
cial banks were codependent competitors. Their new activities were very prof-
itable—and, it turned out, very risky.
Second, we look at the evolution of financial regulation. To the Federal Reserve
and other regulators, the new dual system that granted greater license to market par-
ticipants appeared to provide a safer and more dynamic alternative to the era of tradi-
tional banking. More and more, regulators looked to financial institutions to police
themselves—“deregulation” was the label. Former Fed chairman Alan Greenspan put
it this way: “The market-stabilizing private regulatory forces should gradually dis-

place many cumbersome, increasingly ineffective government structures.” In the
Fed’s view, if problems emerged in the shadow banking system, the large commercial
banks—which were believed to be well-run, well-capitalized, and well-regulated de-
spite the loosening of their restraints—could provide vital support. And if problems
outstripped the market’s ability to right itself, the Federal Reserve would take on the
responsibility to restore financial stability. It did so again and again in the decades
leading up to the recent crisis. And, understandably, much of the country came to as-
sume that the Fed could always and would always save the day.
Third, we follow the profound changes in the mortgage industry, from the sleepy
days when local lenders took full responsibility for making and servicing -year
loans to a new era in which the idea was to sell the loans off as soon as possible, so
that they could be packaged and sold to investors around the world. New mortgage
products proliferated, and so did new borrowers. Inevitably, this became a market in
which the participants—mortgage brokers, lenders, and Wall Street firms—had a
greater stake in the quantity of mortgages signed up and sold than in their quality.
We also trace the history of Fannie Mae and Freddie Mac, publicly traded corpora-
tions established by Congress that became dominant forces in providing financing to
support the mortgage market while also seeking to maximize returns for investors.
Fourth, we introduce some of the most arcane subjects in our report: securitiza-
tion, structured finance, and derivatives—words that entered the national vocabu-
lary as the financial markets unraveled through  and . Put simply and most
pertinently, structured finance was the mechanism by which subprime and other
mortgages were turned into complex investments often accorded triple-A ratings by
credit rating agencies whose own motives were conflicted. This entire market de-
pended on finely honed computer models—which turned out to be divorced from
reality—and on ever-rising housing prices. When that bubble burst, the complexity
bubble also burst: the securities almost no one understood, backed by mortgages no
lender would have signed  years earlier, were the first dominoes to fall in the finan-
cial sector.