Inquiry into financial crisis finds no shortage of parties to blame
The Age
Saturday February 5, 2011
The seeds of the worldwide crisis were sown in the US as much as three decades ago, writes Eric Johnston. A DOCUMENT the size of a telephone book is doing the rounds of the boardrooms and being passed between executives of Australia's banks.Senior regulators have also been thumbing through the report, which dissects the origins of the financial crisis that is still sending shock waves through the global economy after three years.The 576-page report, published a little more than a week ago by the US government's Financial Crisis Inquiry Commission, has already started climbing best-seller lists.The 10-member commission was created by Congress to investigate and explain the causes of the 2008 meltdown.It sifted through millions of documents many subpoenaed from banks and held hundreds of interviews, and its assessment provides one of the most forensic accounts of how a seemingly stable system fell apart.With Australia no stranger to heated housing markets, institutions that could be considered too big to fail, and with one of the most active securitisation markets in the world, are there lessons to be drawn from the US disaster that could add to the fireproofing of our financial system?"The same sorts of seeds were in evidence around here, and maybe some germinated," says Access Economics director Ian Harper, who was a member of the Wallis inquiry that in the late 1990s set out the blueprint for financial market reform in Australia."But we weren't anywhere near as far down the track as the United States because of the way our regulatory system operates, economic circumstances we were in and things like rules around lending."The US commission's nine conclusions paint a picture of commercial banks, retail banks, mortgage brokers, investors and credit ratings agencies furiously pumping a mortgage market while light regulation put the financial system on a course for disaster."What else could one expect on a highway where there were neither speed limits nor neatly painted lines?" the report asks.The committee traces the US crisis back to the housing market, where lax regulation was mixed with hubris and the tendency of those in the finance industry to look the other way.The committee found that home owners pulled cash out of their homes to send their kids to expensive schools, install designer kitchens, take holidays or launch businesses.Financial institutions bought and sold mortgage securities they either never examined or knew to be defective. Companies depended on tens of billions of dollars of ultra-short-term borrowing that had to be renewed daily, and major investors put blind faith in credit ratings agencies for their risk assessment.Veteran bankers knew that age-old rules of prudent lending had been cast aside. Arnold Cattani, chairman of California-based Mission Bank, told the commission he had been disturbed by the "pure lunacy" he saw in the local home-building market, fuelled by "voracious" Wall Street investment banks. His bank had opted out of certain kinds of investments by 2005.The commission points to "housing bubbles" in Britain, Spain, Australia, France and Ireland, "some more pronounced than in the United States".But the default and foreclosure experience of the US market has been far worse than in other countries. The rate of serious defaults in the US reached4.6 per cent, while in all other countries it remains less than3 per cent and in Australia is less than 1 per cent.Australian home loans are "full recourse", unlike the NINJA loans in the US market where borrowers with "no income, no job or assets" had little hope of repaying debts.The securitisation boom in the US led to other risky loans with strange names: Alt-A, I-O (interest-only), no-doc, liar loans; piggyback second mortgages and pick-a-pay adjustable rate mortgages.Soon there was a multitude of different mortgages available on the market, confounding consumers who didn't examine the fine print baffling conscientious borrowers.But it appears not all were blind to the strains in the system.Paul McCulley, managing director of Pimco, told the commission that he and his colleagues began to worry about "serious signs of bubbles" in 2005. They sent out credit analysts to 20 cities to do "old-fashioned shoe-leather research", talking to real estate brokers, mortgage brokers, and local investors about the housing and mortgage markets.They witnessed what he called "the outright degradation of underwriting standards". From then on, every time Pimco was offered a fresh batch of mortgage securities it kept a wide berth.Australian banks are vulnerable to the whims of global funding markets. Years of free-flowing credit had allowed their borrowing profiles to become alarmingly short term in the period leading up to 2008.John Laker, chairman of the Australian Prudential Regulation Authority, revealed recently that the regulator had been uncomfortable with early signs of a drop in lending standards by the banks as the Australian housing market heated up in 2003.There were signs of pressure within the banking industry to meet the desires of the customer by finessing, overriding or changing strong credit standards, Laker recently told a Senate hearing into competition in the Australian banking system.Still, the consensus among regulators and industry is that Australia owes its escape from the crisis mainly to strong regulation, helped by the good luck of having trading links with the giant Chinese economy.Bankers also point out that Australia's banking crisis came early, with events in the early 1990s having been critical in shaping a deeply conservative culture among Australian regulators and some senior bankers.At the time, the state banks of New South Wales, South Australia and Victoria, and two of the big four ANZ and Westpac were tottering under heavy losses from soured commercial property loans and wayward subsidiaries. This threatened to paralyse an economy already in the throes of recession.One of the simplest conclusions of the US financial crisis inquiry that there was a systemic breakdown in accountability and ethics is a reminder of one of the pillars of modern economics."In our economy, we expect businesses and individuals to pursue profits, at the same time that they produce products and services of quality and conduct themselves well," the commission says.But it concludes that the US housing boom led to an erosion of standards that exacerbated the financial crisis.This stretched from the "ground level to the corporate suites"."Adam Smith wrote the Wealth of Nations on the back of the theory of moral sentiments," Professor Harper said. "So the father of laissez-faire economics also had a moral framework in mind."Today people tend to sever those two things, but when the market separates from the moral foundation is when you get into strife."The US commission reserves some of its toughest criticism for regulators, accusingsome of the biggest names,such as Federal Reserve chairman Ben Bernanke and former Fed chairman Alan Greenspan of being asleep at the wheel.It also called for a strengthening of institutions.It says that more than three decades of deregulation and reliance on self-regulation by financial institutions, championed by Greenspan and others, supported by successive governments and actively pushed by the financial industry, had "stripped away key safeguards".Governments had also permitted financial entities to pick their preferred regulators in what became "a race to the weakest supervisor".The commission's essential message is that the financial crisis was avoidable, which suggests Australia can avoid any future crisis."The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire."The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the . . . public."Theirs was a big miss, not a stumble."THE FINANCIERS Wall Street: Overexposed to short-term money markets and toxic assets. Main Street banks and other lenders: Cut lending standards. Ratings agencies: Offered generous ratings for mortgage securities. Derivatives markets: Fuelled the mortgage boom and amplified losses. AIG (insurer): Underestimated the risk in the derivatives markets Fund managers, investors: Blindly relied on credit rating agencies.THE REGULATORS US Federal Reserve chairman Ben Bernanke: Failed to heed red flags in the mortgage market.Did not recognise that the bursting of the housing bubble could harm the entire financial system. Former US Treasury secretary Henry Paulson: His inconsistent response to the crisis undermined confidence. Former Federal Reserve chairman Alan Greenspan: Put too much faith in deregulated financial markets. Failed to recognise clear signs of a housing bubble.THE POLITICIANS Presidents Bill Clinton and George W Bush: Set aggressive goals to increase home ownership.THE HOME OWNER Became reckless in excessive borrowing.
© 2011 The Age
