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 DISSENTING STATEMENT

In effect, many of the largest financial institutions in the world, along with hun-
dreds of smaller ones, bet the survival of their institutions on housing prices. Some
did this knowingly; others not.
Many investors made three bad assumptions about U.S. housing prices. They
assumed:
• A low probability that housing prices would decline significantly;
• Prices were largely uncorrelated across different regions, so that a local housing
bubble bursting in Nevada would not happen at the same time as one bursting
in Florida; and
• A relatively low level of strategic defaults, in which an underwater homeowner
voluntarily defaults on a non-recourse mortgage.

When housing prices declined nationally and quite severely in certain areas, these
flawed assumptions, magnified by other problems described in previous steps, cre-
ated enormous financial losses for firms exposed to housing investments.
An essential cause of the financial and economic crisis was appallingly bad risk
management by the leaders of some of the largest financial institutions in the United
States and Europe. Each failed firm that the Commission examined failed in part be-
cause its leaders poorly managed risk.
Based on testimony from the executives of several of the largest failed firms and
the Commission staff’s investigative work, we can group common risk management
failures into several classes:

• Concentration of highly correlated (housing) risk. Firm managers bet mas-
sively on one type of asset, counting on high rates of return while comforting
themselves that their competitors were doing the same.
• Insufficient capital. Some of the failed institutions were levered : or higher.
This meant that every  of assets was financed with  of equity capital and
 of debt. This made these firms enormously profitable when things were go-
ing well, but incredibly sensitive to even a small loss, as a  percent decline in
the market value of these assets would leave them technically insolvent. In
some cases, this increased leverage was direct and transparent. In other cases,
firms used Structured Investment Vehicles, asset-backed commercial paper
conduits, and other off-balance-sheet entities to try to have it both ways: fur-
ther increasing their leverage while appearing not to do so. Highly concen-
trated, highly correlated risk combined with high leverage makes a fragile
financial sector and creates a financial accident waiting to happen. These firms
should have had much larger capital cushions and/or mechanisms for contin-
gent capital upon which to draw in a crisis.
• Overdependence on short-term liquidity from repo and commercial paper
markets. Just as each lacked sufficient capital cushions, in each case the failing
firm’s liquidity cushion ran out within days. The failed firms appear to have
based their liquidity strategies on the flawed assumption that both the firm and