After you've read the blog below, we want to hear from you. What questions do you think the Financial Crisis Commission should ask Wall Street's CEOs? We'll be compiling the best questions from our readers and featuring them prominently in the next few days. Leave your questions in the comments section below, and we'll select the best responses. Click here to submit your question now.
The Financial Crisis Inquiry Commission (FCIC) is holding its first public hearings and will hear testimony from the CEOs of some of the largest financial institutions. This is not the hearing at which experienced investigators would produce fireworks. The FCIC has not used subpoena authority or voluntary requests for information to obtain the background information essential in order to hold a real investigative hearing. In particular, it has not obtained AIG (and Fannie and Freddie's) emails and other critical internal documents such as their financial models, internal accounting records, and loss reserve data that are readily available and vital to understand what caused the crisis. Any aircraft crash investigator knows how critical it is to find the "black box" that records the information that is typically essential to finding the cause. In the financial context, these AIG, Fannie & Freddie emails and internal accounting and risk records are the "black box" that any competent investigator would demand to review.
FCIC should use this first public hearing for two quiet purposes. The primary goal should be to develop information. The subsidiary goal is to put the CEOs on record as to what went catastrophically wrong, which will allow the FCIC to judge their candor as the facts are developed. The FCIC, and the nation, need the utmost candor. The CEOs must testify under oath, as is the norm now for witnesses testifying before the House Financial Services Committee. Precisely because it is the norm it does not impute any wrongdoing to any witness.
The primary goal is gathering information because that is what the FCIC needs and that is what the CEOs can provide at the hearing and, more importantly, in response to requests for information that the FCIC should make at the hearing. The CEOs have expertise, access to all information on the facts critical to understanding the crisis, the analyses their firms' have conducted or received on the causes of the Great Recession, and the steps their officers, firms, and other entities took (or failed to take) in response to those analyses. Those analyses are critical both for what they will reveal directly (what did they know and when did they know it?) but perhaps more importantly what they will reveal that the largest (surviving) financial institutions did not know or understand as the crisis was developing. For example, if the financial institutions did not conduct urgent analyses in response to the FBI's September 2004 warning that an "epidemic" of mortgage fraud was developing that would cause a financial "crisis" if it were not contained and/or did not act on those analyses to change their operations that non-action would be one of the primary contributors to the Great Recession.
We suggest specific questions below, but our overall recommendation to FCIC for this initial hearing can be stated succinctly: the FCIC should enlist the financial industry as its research assistants. The industry should jump at the chance. Now, we are not naÏve and the FCIC must not be naÏve. The industry is self-interested. It has performed abysmally, sometimes criminally. It rightly fears that exposure of its emails, data, analyses, and actions (and failures to act) to the public will expose it to criminal prosecutions, administrative enforcement actions, civil suits, and well-deserved ridicule. The CEOs' most salient fears are that disclosure of the information will demonstrate that the massive bonuses paid to them and their officers were paid improperly (because they were based on phony accounting) and should be "clawed back" and that many senior officials should be fired. Tough. The only way to reduce the frequency and damage of future crises is to find out what caused this one. So FCIC must insist on total disclosures by these firms - no selective release of analyses that make the senior officers look good or were written to try to justify bonuses or help the lawyers defend the officers. It all must come out - and it must do so promptly. FCIC, and the nation, need to know now whether the firms are unwilling to provide all the analyses and underlying facts that FCIC needs to fulfill its statutory duty. If they are not willing to do so then the nation needs to know whether FCIC has the guts and integrity to use its subpoena authority immediately to obtain the information.
For the sake of brevity in the questions below we have not repeated each time the critical specific details (who, when, how?) any competent investigator would need to ask in the formal request for information in order to learn the specifics and identify the essential documents.
Here are our top ten questions:
1. AIG: What was your firm's relationship with AIG? How much exposure did you have to AIG? What information did you publicly disclose about that exposure? Did you think AIG's CDS strategy was "good business"? Do you think we still would have needed to rescue AIG if its derivatives had been centrally cleared, as some in Congress have proposed?
2. Disclosure: Were your financial statements during 2005-08 accurate? What did your officers disclose to your board about your bank's exposure to the nonprime mortgage markets before 2008? What specific information did you publicly disclose about your exposure to derivatives and nonprime mortgages? When did officers or employees of your firm recognize that there was a serious risk of a housing bubble? What did they recommend, and what changes did the firm implement, in response to the identification of this risk? Why?
3. Pay: What was your bank's total compensation for officers for each year from 2001 to the present? What were the components of that compensation? Identify and explain where compensation created perverse incentives in the following contexts: your bank, other banks, executive compensation advisory firms, audit firms, appraisers, rating agencies, loan brokers, loan officers? What aspects of compensation produced these perverse incentives? When did employees of your bank become aware of the literature in economics, criminology, and compensation warning of these perverse incentives? What specific actions did the bank take in response? Which elements of your bank's compensation system create perverse incentives?
4. Ratings: Why do you think the rating agencies gave AAA ratings to toxic CDOs? Did you think CDO credit ratings accurately reflected their credit worthiness? Did employees of your bank ever express concerns internally/publicly about the judgment of the ratings agencies? If so, when was the first time?
5. Moral hazard: What incentives at your institution helped lead to the financial crisis? What conversations did you have with the Fed regarding your exposure to CDS and other derivatives? What monetary value would you place on the government guarantee of your deposits?
6. Mortgage fraud: Name the three nonprime specialty lenders with the worst reputations for originating fraudulent mortgages. Name the three nonprime specialty lenders with the worst reputations for originating predatory loans. Is there any legitimate business reason why a secured lender would seek to induce appraisers to inflate the value of the secured property? When did employees of your bank become aware that coercion of appraisers to inflate appraised values was becoming common? What action did they take or recommend when they became aware?
7. Warnings: What were the three most significant specific steps your banks took in response to the FBI's September 2004 warning that the developing "epidemic" of mortgage fraud would produce a crisis if it were not stemmed? Why do you think the spread on nonprime mortgages fell after this warning, and other warnings? Why did bank loss reserves also fall during this time? What were your bank's analyses of these risks and the adequacy of loss reserves (industry-wide and at your bank) and how did they change as the markets exhibited these perverse patterns? What did your bank's officers recommend that the bank do in response to these perverse market conditions and what actions did the bank actually take? Were the industry reactions, and your bank's reactions, to the warnings adequate?
8. Lobbying: How much has your bank spent on lobbying over the last five years? This year? How many additional personnel has your bank hired full-time or as consultants to lobby the federal government?
9. Crimes: How many criminal referrals has your bank made for mortgage-related frauds in each year beginning in 2002? How many named your own officers or employees? Does the FBI have adequate resources to investigate such frauds? Explain how an epidemic of mortgage fraud must lead to widespread accounting and securities fraud if the mortgage paper is to be resold.
10. Regulation: Did the passage of the Commodities Futures Modernization Act of 2000 contribute to the crisis? Did the federal regulators' efforts to preempt state regulation of predatory mortgage lenders contribute to the crisis? Should the Federal Reserve have used its authority under HOEPA to regulate nonprime lending during the financial bubble? Provide any contemporaneous analyses of the role of regulation, deregulation, and desupervision in contributing to the crisis. Did your bank lobby (directly or indirectly through trade associations) in support of deregulatory efforts that contributed to the crisis?
Eliot Spitzer is a former attorney general and governor of New York. Frank Partnoy is a professor of law at the University of San Diego and the best-selling author of The Match King: Ivar Kreuger, The Financial Genius Behind a Century of Wall Street Scandals, about the 1920s markets and Ivar Kreuger, who many consider the father of modern financial schemes. William Black is a former investigator of the S&L crisis and a professor of economics and law at the University of Missouri-Kansas City and the author of The Best Way to Rob a Bank is to Own One.
This post originally appeared on New Deal 2.0.
— Ask a Banker 
Just a figure head, not much substance, or real power.
Both parties are the same, elections are just a ruse to keep the peasants from revolting.
“We have to cover our potential losses”… the excessive interest charged creates an “insurance pool” so if one person defaults… the excessive interest charged to all high risk borrowers will cover the loss. Spread the potential loss over the entire class of “high risk” borrowers. Like insurance. The higher rate allows the lenders to “self-insure”.
If the real reason for charging more is to cover the high risk… to “self-insure”… what’s their problem? They made a lot of bad bets - too bad for them.
We should cover their bad bets?
Apparently… bankers perceive that their profit is fixed… their compensation is fixed. Isn’t that a rather unique business plan? Isn’t it the case that when a business takes a loss… that loss is absorbed through lowered profits… reduced bonuses… and cutbacks?
They run the numbers… they evaluate the risk… they determine the rate… supposedly… to cover the potential loss. And when they lose the bet… what happen to all that additional money they charged… an amount based on their assessment of risk?
Something is not right here. Clearly… the higher rates the lenders charge is not to cover their bet. The excessive interest goes into their profits... and stays there.
Don’t the Banks have a fiduciary duty to ensure the hard earned money from pensioners, municipalities, etc., are not adversely affected by excessive fees; salaries; and bonuses?
Such an instrument cares less than zero about the health of the horse (our economy).
Switching horse metaphors in midstream, let us call them sheep.
If our economy is herd of sheep and derivatives are the wool....... Why not have a shearing?
We must save the banking function (deal clearing) but not the money center banks.
When the press focused our attention on the $1.3 trillion sub prime market, it distracted us from the
$60 trillion derivative market that was so toxic the banks refused to trade with themselves.
Bankers can bet against change, just as King Knut can ordain the sea not to change with the tides. So what? As long as they do it with their own bonuses. Why not tax their bonuses in one to one proportion with the bank's Credit Default Swap exposure?
Just don't bet my retirement.
Our government clearly has new priorities. It appears to represent corporations on the international scene more than most US citizens & companies.
Have you damaged our economy for the future revenues of international corporations that banks finance and profit from ?
Many corporations have wanted to get at our resources w/out the bother of fair competition, living wages, representative government or costly environmental laws.
Are we headed for a future with the IMF, World Bank & their corporate buddies? The US does have sway in these organizations, but if our government represents corporations, then the IMF & World Bank do, too?
Does it go like this?:
-Large interests took hold of the US government as it headed for global competition & economic decline, to bubble-extract the wealth workers had built (invested in homes, savings and 401k) & to open the door to exploitation.
-When we crash, IMF/World Bank comes to the "rescue"? (same IMF & Bank that rush loans to some compliant dictatorships & withdraws aid from non-compliant representative governments)
-World Bank says "we'll help you subsist, if you trash all notions of representation & fair competition, etc.” (same bank that nixes policies that lead to self-sufficiency & opportunity in struggling countries)
-Will int'l corps soon swoop in to plunder our resources? Will people of emerging states like India have the wealth they build extracted after their economies have peaked?
Last Question: If true, could you inform us of when you plan to finish us off & where you'll
I voted for Obama and he has done NOTHING he campaigned on. NOTHING.
Candidate Obama is the TOTAL oppisite of President Obama.
It's like we still have Bush, but a better speaking package.
He is pro-Big Banks.
He is Pro Insurance Companies.
He is Pro Big Pharma.
He is Pro protecting the wealthiest Americans.
Basically, he is a Corporate shill.
He is ANTI helping small business
He is ANTI helping the poor and middle class.
All you Obama cult supporters probably have a great, high paying job and you don't realize what the people living paycheck to paycheck deal with.
Get use to it.
If Spitzer had remained in office, the blow up may not have happened.
Spitzer is so well educated on the inner workings of Wall Steet/Banking, all of us should listen.
What have you done for us lately?
I voted for Obama and he has done NOTHING he campaigned on. NOTHING.
Candidate Obama is the TOTAL oppisite of President Obama.
It's like we still have Bush, but a better speaking package.
He is pro-Big Banks.
He is Pro Insurance Companies.
He is Pro Big Pharma.
He is Pro protecting the wealthiest Americans.
Basically, he is a Corporate shill.
He is ANTI helping small business
He is ANTI helping the poor and middle class.
All you Obama cult supporters probably have a great, high paying job and you don't realize what the people living paycheck to paycheck deal with.
Get use to it.
Banker: What's a conscience?