“There have been times when I have tried very hard to forget the Financial Crisis Inquiry Commission. After all, taken at face value, it utterly failed in its mission to provide the American public a clear consensus explanation for what caused the crisis…

…One lesson for me was how not to run a commission. I think (fellow commissioner and R Street panelist) Peter Wallison will agree with me that this was demonstrated by the days when 10 commissioners sat in a room for literally a full day while chair, Phil Angelides, encouraged us to come to a consensus – even as he refused to budge on his interpretation of the crisis….It is simply no way to run a commission and very painful…The second thing I learned in the past five years…we knew it at the time but it has become increasingly clear…is that the commission was a political entity. It’s ostensible task was to write an understandable report to the American people detailing the causes of the financial crisis and helping to ameliorate the chances of one happening again. That wasn’t really its purpose. What became the Dodd-Frank legislation was already moving; the administration had made its proposals before we even began to work. So the notion that some of this was informing some sort of legislative and/or regulatory response was never on the agenda. The real agenda was to deal with the politics of the financial crisis. The Democrats wanted the narrative for the cause of the financial crisis to be that greedy bankers rigged the game in Washington and imposed this crisis on the American people for their own benefit. It remains the prevailing view to this day. It is completely wrong, but it still has a phenomenal amount of resonance with the American people.”, Excerpts from “A Political Commission”, Douglas Holtz-Eakin, President of the American Action Forum and commissioner of the Financial Crisis Inquiry Commission, R Street Policy Study No. 56: Sizing Up The FCIC Report Five Years Later, R Street, March 17, 2016

R Street Policy Study No. 56: Sizing Up The 
FCIC Report Five Years Later
March 17, 2016
A POLITICAL COMMISSION
Douglas Holtz-Eakin,
President of the American Action Forum and
Commissioner of the Financial Crisis Inquiry Commission

There have been times when I have tried very hard to forget the Financial Crisis Inquiry Commission. After all, taken at face value, it utterly failed in its mission to provide the American public a clear consensus explanation for what caused the crisis. Today’s event makes it impossible to forget. Instead, I’m going to work through my post-traumatic stress disorder and talk a little bit about what we have learned in the past five years.

One lesson for me was how not to run a commission. I think Peter Wallison will agree with me that this was demonstrated by the days when the 10 commissioners sat in a room for literally a full day while the chair, Phil Angelides, encouraged us to come to a consensus – even as he refused to budge on his interpretation of the crisis. He also envisioned the group of 10 actually writing as a group a report detailing the causes of the financial crisis in the United States. It is simply no way to run a commission and it is very painful. For those of you who may end up in a similar position in the future, here is the lesson: get a chief of staff for your commission who is qualified to actually be a member of the commission. Tell him or her to write a report and then take that report to each commissioner and see what they agree and disagree with until you arrive at a consensus, if there is one.

The second thing I learned in the past five years – we knew it at the time but it is becoming increasingly clear – is that the commission was a political entity. Its ostensible task was to write an understandable report to the American people detailing the causes of the financial crisis and helping to ameliorate the chances of one happening again. That wasn’t really its purpose. What became the Dodd-Frank legislation was already moving; the administration had made its proposals before we even began to work. So the notion that some of this was informing some sort of legislative and/or regulatory response was never the agenda.

The real agenda was to deal with the politics of the financial crisis. The Democrats wanted the narrative for the cause of the financial crisis to be that greedy bankers rigged the game in Washington and imposed this crisis on the American people for their own benefit. It remains the prevailing view to this day. It is completely wrong, but it still has a phenomenal amount of resonance with the American people.

So in terms of politics, I learned a lot about how important it is to have a clean message. The dissent I wrote with Commissioners Keith Hennessey and Bill Thomas discussed 10 causes of the financial crisis. That is not a clean message. It is not something easily communicated to the American people.

On the politics of setting the agenda for a sensible response, I do not think we were very successful.

Then there is the substance of the response, which I and the American Action Forum’s Meghan Milloy addressed in a paper on the good, the bad and the ugly of the policies.

If you look at what the government has done since the commission, there are some things that make sense to me. It is good to see better-capitalized large financial institutions. Holding more capital covers a lot of sins. As banks hold their own capital, their own money is at risk and they will do better due diligence. Moreover, when mistakes are made, you will be able to absorb those loses. So that has been a step in the right direction.

I also think there was a modest step in the right direction with the credit rating agencies. Those agencies were one of the big surprises to me during my time on the FCIC, one of the big things I changed my mind about during the course of the deliberations. I went into the FCIC with a strong bias that the participants in these transitions – large, sophisticated institutions like Goldman Sachs and J.P. Morgan – were easily able to do their own due diligence on the securities, the underlying mortgages and their likely financial performance. The rating agencies would be irrelevant and it would not matter what label agencies put on a security, because the participants would know the truth. That turned out to not be the case. They did not do their due diligence; they just took the ratings. The ratings turned out to be more important than I thought. So closer scrutiny of the rating agencies is a beneficial thing going forward.

There have been some bad responses, as well. The narrative that fancy derivative transactions caused the financial crisis is all wrong. There was only one derivative involved in the crisis, and that was the American International Group credit default swaps. But on the basis of the false narrative, the United States undertook vast regulation of derivatives. The same observation is true for the Volcker Rule. There is no evidence that proprietary trading contributed to the financial crisis. It was not a trading crisis; it was fundamentally a lending crisis, with bad underwriting. The Volcker Rule is one of the most complex rules, expensive to comply with and serves no real purpose as a response to the crisis. The other bad response is a lot of the new disclosure requirements. The poster child for overreach on disclosures is the conflict mineral rule, which has decimated the Congo and done very little else. It is hard to defend those kinds of policies.

Finally, there are the ugly responses. Begin with orderly liquidation authority, which memorializes in statute the government’s capacity to continue to prop up large financial institutions. As a result, it takes the basic bailout instinct of all regulators and now gives them more legal rope. It’s important to remember that the notion of “too big to fail” is not a flaw of the private sector. It is the policymakers who are so risk-averse that they step in and do not allow institutions to fail. This makes it easier for them to do that, and it is a big step in the wrong direction.

The other proactively bad development is creation of the Financial Stability Oversight Council (FSOC). While a bad idea to begin with, its actual operation is almost like a Stalinist court system. Non-bank systemically important financial institutions (SIFIs) have no idea why they are SIFIs, and the court of appeals is simply the FSOC itself. I will go to my grave confused by the MetLife and Prudential SIFI designations, except as purely politicized actions. The FSOC is something I think we are going to wrestle with for a long time.

Lastly, I guess I remain naïve, because I would never have bet that I would be attending a forum on the fifth anniversary of the FCIC and there would have been no substantial reforms (or closure) for Fannie Mae and Freddie Mac. They made no sense in 2003 when I was at the Congressional Budget Office. They were living financial dynamite during the crisis. I thought, surely, that common sense would prevail and there would be no more housing government-sponsored enterprises. It is a real lesson in just how hard it is to get an obvious reform done in Washington.

Posted on April 27, 2016, in Postings. Bookmark the permalink. Leave a comment.

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