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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

Indeed, the regulators, including the Fed, would fail to identify excessive risks and
unsound practices building up in nonbank subsidiaries of financial holding compa-
nies such as Citigroup and Wachovia. 
The convergence of banks and securities firms also undermined the supportive
relationship between banking and securities markets that Fed Chairman Greenspan
had considered a source of stability. He compared it to a “spare tire”: if large commer-
cial banks ran into trouble, their large customers could borrow from investment
banks and others in the capital markets; if those markets froze, banks could lend us-
ing their deposits. After , securitized mortgage lending provided another source
of credit to home buyers and other borrowers that softened a steep decline in lending
by thrifts and banks. The system’s resilience following the crisis in Asian financial
markets in the late s further proved his point, Greenspan said. 
The new regime encouraged growth and consolidation within and across bank-
ing, securities, and insurance. The bank-centered financial holding companies such
as Citigroup, JP Morgan, and Bank of America could compete directly with the “big
five” investment banks—Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman
Brothers, and Bear Stearns—in securitization, stock and bond underwriting, loan
syndication, and trading in over-the-counter (OTC) derivatives. The biggest bank
holding companies became major players in investment banking. The strategies of
the largest commercial banks and their holding companies came to more closely re-
semble the strategies of investment banks. Each had advantages: commercial banks
enjoyed greater access to insured deposits, and the investment banks enjoyed less
regulation. Both prospered from the late s until the outbreak of the financial cri-
sis in . However, Greenspan’s “spare tire” that had helped make the system less
vulnerable would be gone when the financial crisis emerged—all the wheels of the
system would be spinning on the same axle.

LONGTERM CAPITAL MANAGEMENT:
“THAT’S WHAT HISTORY HAD PROVED TO THEM”
In August , Russia defaulted on part of its national debt, panicking markets. Rus-
sia announced it would restructure its debt and postpone some payments. In the af-
termath, investors dumped higher-risk securities, including those having nothing to
do with Russia, and fled to the safety of U.S. Treasury bills and FDIC-insured de-
posits. In response, the Federal Reserve cut short-term interest rates three times in

seven weeks. With the commercial paper market in turmoil, it was up to the com-
mercial banks to take up the slack by lending to corporations that could not roll over
their short-term paper. Banks loaned  billion in September and October of

—about . times the usual amount —and helped prevent a serious disruption
from becoming much worse. The economy avoided a slump.
Not so for Long-Term Capital Management, a large U.S. hedge fund. LTCM had
devastating losses on its  billion portfolio of high-risk debt securities, including

the junk bonds and emerging market debt that investors were dumping. To buy

these securities, the firm had borrowed  for every  of investors’ equity; lenders