Stephen Foley: The trouble with the FCIC is it agonised too long over who was wrong, rather than why
Saturday 29 January 2011
US Outlook: Since every man and his dog appears to have a dissenting opinion on the Financial Crisis Inquiry Commission report, allow me, too.
The commission has, on its own terms, been a failure. It failed to forge a bipartisan consensus on the causes of the credit crisis. Amusingly, it couldn't even forge two partisan consensuses. While the Democrat majority fingered Alan Greenspan and Wall Street bosses for blame, and the Republican minority mostly went for China and the Arabs, one member split off to write an opinion which blames the crisis entirely on US government housing policy.
This failure should not have come as a surprise to anyone. The fundamental mistake made by its chairman, Phil Angelides, was to adopt a prosecutorial style, subpoenaing documents and cross-examining witnesses as if, by digging hard enough, he would find some smoking gun inside Goldman Sachs or somewhere, or elicit a confession in which Mr Greenspan suddenly agrees: "Yes, all right, I dunnit, and you got me bang to rights, guv'nor."
The desire to find culprits to blame – or, more charitably, the desire to identify mistakes, so that they can be avoided in the future – is natural. What would be the point of the commission if it didn't? What indeed?
Actually, the facts are quite well known – though historians will appreciate the thousands upon thousands of documents from inside government and Wall Street that the FCIC leaves to posterity. The narrative one spins out of them, and the weight given to any contributory cause, is the stuff of the historical debating society. University students now have three neat new essay templates for when the question comes up in exams.
Of course, Alan Greenspan must take a share of the blame commensurate with his enormous power over American and global finance. He was the regulator who didn't believe in regulation. If only the US had had a Federal Reserve chairman who believed in using the central bank's powers to shore up underwriting standards, the flow of money into the black hole of the US mortgage market might have been dramatically slowed. If only unfettered Wall Street had not had such a strong champion in the halls of government. If only people had not believed Alan Greenspan was right. But they did.
My favourite of the three competing narratives is the one set out by the Republicans Keith Hennessey, Douglas Holtz-Eakin and Bill Thomas. It is the only one to put the financial crisis in the wider, global context and to describe it accurately for what it was: the catastrophic bursting of a credit bubble, the size of which we had never before seen.
In the US, the dissenters' main argument is popularly known as "the giant pool of money" narrative (after the name of a National Public Radio programme which was one of the most successful attempts to explain the crisis in layman's terms). It is what economists and politicians mean when they talk about "global imbalances".
China and oil-rich nations generated more money from their exports than they could possible invest or spend at home, so they hunted investment opportunities abroad – mainly in the US. With so much money chasing a home, credit became cheaper and easier to get than ever before. That applied not just to the US housing market, but to housing markets across the developed world (many of which enjoyed their own bubbles) and to all kinds of lending (such as the loans that made private equity buyouts such a feature of the pre-crisis landscape).
The Republicans eschew the naming and shaming of culprits. If the Democrats' report is "The Prosecutor's View", then the Republican minority's is "The Economist's View". They say even mortgage fraud and conflicts of interest on Wall Street pale in comparison to these much bigger forces – and I agree.
But it is not satisfactory to just throw one's hands up and say the whole thing was inevitable and, by the way, another crisis is inevitable, too, because we can never predict these things, so let's all just stop going on about it. (This is the worrying new consensus among people I speak to on Wall Street.)
So, allow me my dissenting opinion.
The FCIC spent far too much time on who was wrong, and far too little on why they were wrong, on the philosophical underpinnings of a financial system that proved unsustainable. The great irony – it should be on page 1 of any history of the credit crisis – is that in 2006, on the brink of calamity, we all thought that global finance was less risky than it had ever been. What were we thinking?
The errors are manifold, but a good few boil down to a misplaced faith in financial modelling, which appears to have been only touched upon by the commission. In 2006, it was as if we had found a secret formula for controlling the world. We had turned uncertainty, an awareness of which ought to make us all sensibly conservative, into something we called "risk". Risk has the illusory properties of being able to be modelled, quantified, priced, and traded away. It is less scary than uncertainty.
And this was the newly dawned information age, too. Even those who know that financial models are only as good as the information you put in had to agree that they were playing with more complete data than ever before. It seemed plausible that markets, approaching complete information, really would be self-correcting.
In this climate, leverage seemed less scary, so banks and other financial players took on oodles more of it than they ever had before. Financial models justified advancing mortgages to whole new classes of people, indulging the American dream. Central bankers could plausibly claim, if not to have abolished boom and bust, at least to be smooth pilots of their economies.
What were we thinking?
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