The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
Friday, June 4, 2010
2nd Day – Commission Retreat
Commissioners Present: Phil Angelides, Bill Thomas, Peter Wallison,
Brooksley Born, Heather Murren, Bob Graham, Doug Holtz‐Eakin, Byron
Georgiou, Keith Hennessey
Commissioners Absent: John W. Thompson
Staff Present: Wendy Edelberg, Beneva Schulte, Gary Cohen, Scott Ganz,
Gretchen Newsom, Courtney Mayo, Rob Bachmann
Phil: Scheduling Re‐cap – hold days on Commission calendar. Derivatives working
group will see if it can be squeezed down to a day. The TBTF fail hearing will be a
single day. The remaining hearings are off. Lock in October/November dates (See
Book production schedule!) Target November 15th for our deadline.
Forums in our hometowns – simple – no bells and whistles.
By next Friday – process memo on the book.
Bill Heather’s importance on chapeters
Heather: yesterday’s discussion on process – difficult to do without first coming up
with the structure of the report – chapters/groupings.
Bill: silence isn’t acquiescence.
Phil: by 1:00pm today – expressed views from Commission on the strong candidates
for potential causes – then Bill/Phil/staff prepare an outline form for working
framework of the report.
Byron: where does our conversation on securitization fit into this outline?
Overriding theme?
Bill: Try to find a home for it in the structure we got.
Doesn’t think we can talk about baskets – but go through each number and have
person that presented it – add names in terms of weight behind each point.
Bob: talk about causes and accelerators. Timing important. Propagating
mechanisms/accelerating element.
PA: he looks to go through the list and determine what was a leading candidate for
the trigger.
Bob: this topic will be assigned to a staff member for a development of fleshing out
these themes.
PA: something that ought to be studied or determined as a leading potential cause.
1
Pass 1: who thinks its worthy of examination
Pass 2: who thinks it’s a underlying cause, trigger, accelerate, thematic
Staff is preparing a list of institutions that would be covered for TBTF for debate by the
Commission
1. Too much liquidity chasing higher returns {PA: in the system} (No – no’s)
Money flowing into the system
Caused “irrational” behavior
Cheap money – huge bets and new higher levels of risk taking
Interest rates (particularly long‐term)
{where international capital flows would be considered}
2. Great Moderation (Doug) {DHE: underlying condition – across the board
there was a perception the world had changed – business cycles not like past,
lower market risk, different mind from regulators, landscape, setting} (NOT
worthy of consideration: Keith and Peter)
Failure of pricing risk
Greenspan put
The ultimate moral hazard
2
Contributed to regulatory environment
Bad business cycles became a distant memory
3. Why were warning signals ignored/not noticed/overlooked? (Bob)
[Bob: accelerate.] {All: Thematic}
No entities focusing on signals (not rating agencies)
Key players want to ignore
Early warning entities not capable (accounting, profession, rating
agencies…)
Example of signal: FBI warning in 2004
4. Failure of corporate financial risk management and governance in the
financial sector (John) [underlying condition] (No: Peter) (Phil thinks its
underlying and trigger)
Outsized compensation packages – tied to equity markets that were
soaring
Outdated models with new risk
Long‐term consequences not collaborated to short‐term risks
3
5. Loss of consequences for behavior (Byron ) (Thematic)
Lack of capital and leverage
No “skin in the game”
Individuals borrowed too much
6. Capital and Leverage (Heather) [accelerate, underlying condition]
At every level: household, corporate, systemic
7. Hyper‐sensitive short‐term liquidity model (Keith) [underlying condition
and accelerant ]
8. Housing and commercial real estate bubble (Doug) [a/the trigger]
Should check other assets to see if there is parallel behavior
Broadly defined
Explosion of subprime lending
o Including predatory lending and fraud
9. Securitization [Byron] [accelerant }
10. GSEs (Keith) (yes – big)
4
11. Failure of regulation/regulatory reform/policy (Brooksley) [underlying
condition]
Government failed to prevent excesses
Failure to regulate derivates and other products
Failure to regulate shadow banking/markets
Regulations were insufficient
Ineffective oversight of markets and institutions
Regulations
Implementation
Markets
X
X
E.g. Glass‐Steagall
Regulatory arbitrage
Products
X
X
Institutions
X
X
12. Mark‐to‐Market Accounting (Peter) [ (staff requested memos from …. –
Commission wants to see) {Brooksley thinks the institution, not the action].
On the list – Keith with two questions – is it a cause and what
5
recommendations do you have for fixing it – send to SEC, FASB, all Peter’s
institutions. PA: not causal but ) No, cause at all: Brooksley, Byron, Bill, Bob,
etc. – have others look into the matter.
Writing down mortgage–related assets to current market prices made
institutions appear weak
Spreads the mortgage crisis
13. Over‐the‐Counter derivatives (Brooksley) (accelerant in most respects
(trigger when AIG collapses) (graphics needed) (Peter – should look at it but
doesn’t think it is a cause or accelerant)
Lack of federal regulations
Role of CDS with respect to securitization (by AIG and others on AAA
tranches)
Use in synthetic CDOs
o Including CDS
Equally relevant: role of OTC derivatives (millions of contracts with
trillions national value)
6
o Counterparty risk
o Leverage
o Lack of transparency
Added to panic and freezing of markets
14. Complex and exotic products (Phil) (Bill – was it the products or the use of
the products that was bad?) Peter: naked short selling – fails. Demand for
exposure to these risks.
In housing
In financial markets
Opacity and leverage
Betting and amplification
15. Rating Agencies (Bill) (accelerant)
Gatekeepers
How did this system evolve?
16. Lack of Transparency (Peter) (stress test memo – Wendy to provide)
(accelerant)
7
Too big to fail and lack of resolution authority (Keith) (underlying
condition? Trigger?) Keith – correlated risk. what will happen? Probability?
Moral hazard) (Peter thinks this item should not be examined) Byron thinks
Bear should have been able to fail; Peter: should have been able to fail if
market was stable. Policy makers are very risk adverse. Brooksley thinks
Lehman/Bear should have been saved b/c of interconnections) (Byron’s
Enron’s example and market condition. CIT failure. Large institution could
not fail in an unhealthy market.
Policy makers believed they had to step in
Moral hazard
System not robust
17. Effectiveness of policy in face of globalization of financial system (Bob)
(Bob: fold into #1 – essential question is the degree of the liquidity – drop it
and assume as sub‐issue in #1, but put regulatory arbitrage under
regulation) (Brooksley: everyone does not fully recognize the globalization of
8
the financial system – this is a basic theme) (Be surgical – Phil) (not
eliminated/subsumed)
Large international institutions in certain countries buying toxic vs.
assets
International regulatory arbitrage
Coordination of global financial policy
International contagion
Global financial markets
Comparative analysis
18. Scale, size and power of financial sector (Phil) (keith: large financial
sector could distort policy or distribution; or create problems to economy as
whole – tease 2 apart. )(Phil – policies/actions of significance that were
causes) Keith: GSE’s. look through the list on where. Piece 1: influence of
financial sector on policy. Separate size and scale. Heather: one is regulatory
capture of political influence, 2 would be the size the financial sector
represents in the overall economy which would go under TBTF. Phil: how
9
much was borrowed and by whom? – no reasonable research on “why”
expended. Phil: find certain facts – very helpful – how much we borrowed, by
what means, and for what purpose (to the extent the data is available).
By force and design?
Outsized effect of financial crisis on economy
Stop things? Make things happen? Change over time?
Not a monolith
Influence of GSEs
Influence of biggest i‐banks and biggest BHCs
o Look at pivot points
Byron: statute says we need to look at tax structure
Bob: Question – what is the timeframe of our inquiry? Germany collapse after our
collapse‐ effectiveness of our responses to the collapse? Current stage of the crisis?
(is the crisis over or ongoing?) Brooksley – global and domestic causes in the US.
10
PA: our statute is to look at the causes of the crisis – only comment on a response if
it was causal or accelerated the crisis.
Byron: staff – go back to the outline you prepared and try to identify such issues we
haven’t discussed – re‐review and potentially include in the book.
PA: work plan – take a look at it – update accordingly; staff – identify things we
didn’t talk about today – things in the final report? Do a new outline for this report
and incorporate the discussion in today/ contextual items? Coherent way – QUICK.
Peter: wanted to put priorities on these things – worried we won’t get to everything.
Bill: receive revised outline, individuals rank things,
Staff: based on today – give us the definition of the crisis.
11
@FedFRASER