THE BLOG
03/18/2010 05:12 am ET Updated May 25, 2011

To Bankers and Regulators: Why the Risky Business?

The Angelides Commission should focus on why the financial institutions represented took excessive risk. The questions should be designed to enable Americans to understand how this occurred. Here is what we should know.

To the bankers and regulators:

Many of your commercial and investment banks had their own mortgage-originating subsidiaries -- their own Countrywides and New Centurys, in other words. Citigroup, for example, was almost as active as Countrywide in writing subprime mortgages through its subsidiaries. Merrill bought a big originator as late as 2007. Did you and your executives know that your mortgage origination subsidiaries were writing adjustable rate mortgages that depended on an ever rising housing market to be sustainable? Many home owners had to refinance at the higher equity in order to fund the reset rate on the ARM. Did you simply believe that home prices would rise indefinitely, even given the unprecedentedly rapid rise in the early 2000s?

Did you realize your subsidiaries were engaging in predatory lending by writing mortgages for those who could not afford future payments or denying them refinancing options?

If your company's subsidiaries did not originate such subprime mortgages, did you know that your mortgage trading desk and hedge funds were buying or packaging them as parts of mortgage-backed securities? Did you know that by securitizing these mortgages, you were encouraging predatory lending?

Defaults on these mortgages started rising in 2006. Did you understand the defaults would inevitably reduce the value of the mortgage-backed assets you had on your books or were selling to clients like pension funds? When did you come to understand that? If you or a responsible executive did not understand this, do you think it was a violation of your legal obligation to shareholders?

Did you understand that your collateralized debt obligations were often largely backed by subprime mortgages? Did you keep selling them to investment clients anyway?

In the second half of 2007, there was basically a run on SIVs and bank conduits that invested in mortgage-baked securities. The asset-backed commercial paper market essentially revolted. Did you begin to reduce your exposure? If you did not, do you think it was a violation of your legal obligation to shareholders? Did you keep selling mortgage backed securities to clients? If you did, do you think it was a violation of your legal obligation to clients?

Do you believe trading houses like your own have an inherent advantage in making money because of access to information about trading flows? Do you believe trading houses like your own can bluff and persuade traders at other firms to take positions and then sell against them? Has this ever happened to your knowledge? Does it happen regularly? Should traders be paid enormous bonuses if that is how they make their money?

Did anyone warn you about the excessive risks of mortgage backed securities or leverage in your firm? When did they do so? Was his or her advice heeded?

Once banks and investment firms went public in the 1980s and 1990s, traders and bank executives were not longer liable for losses? In fact, bonuses were paid out paper profits-markets to market. It was a system of heads I win, tails you lose. Didn't this encourage excessive risk-taking? Should this be reformed? How?

For regulators at the Fed and the New York Fed, why was it not clear in early 2007 that high defaults in subprime mortgages would affect the entire credit system? There were publications, even by Fitch, the rating services, suggesting the close link between subprime mortgages and the value of mortgage backed securities (MBS) and collateralized debt obligations (CDOs).

For regulators, were you ever disturbed that private credit ratings agencies rated MBSs and CDOs without access to the loan files-to the actual mortgages that comprised the securities?

For regulators, were you ever aware that there was so little public information about the composition of CDOs or the market value of credit default swaps? When did you start to seek more information about them? Do you think it would help to standardize both CDOs and CDSs and have them listed or traded through a clearing house?

Why should we trust the Fed to be vigilant in the future, when conditions change unpredictably? Why did it fail to be vigilant in the past?

This post originally appeared on New Deal 2.0