Washington's role in laying the groundwork for financial crisis

Having delved into the minutiae of the financial crisis in your book – providing the names, ranks and serial numbers of those involved -- what surprised you the most about it?
I would say it was the collaboration between the private sector and the regulatory framework and law makers. We’ve always known about public/private partnerships, but this one was much more significant than any before it. You had a government entity being encouraged to help promote home ownership, when they’re really a regulator and should have been more like a ‘cop on the beat’. The degree to which the regulators were co-opted from the outset by the people promoting home ownership was a pretty stunning revelation.

Your book outlines both the sins of omission and the sins of commission that fuelled the crisis.  Which sin of each type bears the greatest responsibility for the outcome?
Certainly, the sin of omission would have to be the ‘dogs that didn’t bark’ -- the regulators who didn’t regulate during the lead up to the crisis. I have often said that new regulations weren’t really necessary in the aftermath of the crisis; there were plenty of regulations on the books that could have been enforced and policed properly, but  were not.

As for sins of commission, I guess that would be the poisonous loans that were underwritten by some of the larger lenders like Countrywide Financial.  These people preyed upon the most unsophisticated of borrowers – first-time home buyers, immigrants, people who really didn’t understand the process – encouraging them to take loans which Countrywide would then sell to investors or to Fannie Mae so it wasn’t on the hook. But in the meantime, the people underwriting those loans -- the mortgage brokers -- were making tremendous amounts of money on them.  These were some of the sins of commission that we are still feeling the impact of.

You have posed the question, “Was it simply too difficult to prosecute these people, or was there something more pernicious at work?” Given what you have learned, what is your answer?
I think at the outset of the crisis, there was a sense that, if these entities and institutions were prosecuted too aggressively, it would destabilize an already-fragile financial system. I believe that was the feeling at the very highest ranks in Washington. There was definitely a lack of appetite to prosecute these cases early on in the crisis, which contributed to where we are today. Not one high-level executive associated with the mortgage crisis has been sentenced or convicted.

Names like Johnson, Mozilo, Geithner and Bernanke get plenty of ink in your book. Is there a single individual without whose actions the crisis would not have occurred to the same extent?
It’s difficult to pinpoint one, because it was such a collaboration.  You could argue that Jim Johnson, the head of Fannie Mae, was the architect of the public/private partnership that proved so disastrous, and I think we make that argument pretty persuasively in the book. But Johnson left the scene in 1999, and others took over and really ramped it up. There were a handful of people who, I believe, are more culpable and should be held accountable, but have not; you certainly named some of them in your question. I think Ben Bernanke came late to the deal and had very little understanding of the regulatory framework around consumer banking. While he is obviously a very intelligent man, he didn’t know much about regulation, so I wouldn’t name him as one of the most culpable. But Timothy Geithner certainly falls into that category, as he was the New York Fed president who oversaw the expansion of Citibank’s balance sheet to include a tremendous number of toxic loans that ended up almost collapsing that company.

You have said there are some areas where a criminal investigation could still ‘bear fruit’.  
I am not a criminal prosecutor, so I don’t know what it takes to make a successful criminal case. But I think many people agree that the situation at Countrywide should have been prosecuted aggressively. The Securities and Exchange Commission even found evidence: at a time when he was making public statements about the strength and solidity of his company, Angelo Mozilo was writing internal e-mails about the toxic loans his people were writing, showing how unsustainable the business was. As an executive, you are not allowed to make statements privately that differ from your public statements. At the same time, of course, he was selling hundreds of millions of dollars worth of Countrywide shares. I can’t say whether it should have been a criminal case, but I think that’s the case people feel would have been the easiest to make.

In your view, should a ‘cap’ be set on executive compensation?  
That would be very difficult to do. I think anytime you put a cap on something, you end up creating a situation where someone will find a way around it. These are very intelligent people with extremely intelligent lawyers and tax attorneys and accountants working for them; if you shut the door, they’ll open the window.  What I would rather do is have a series of drastic improvements made to the boards of directors that run these companies and deliberate on executive compensation. Currently, we don’t have any way to hold directors accountable when they give away so much of shareholders’ money to executives. Even those who fail end up with severance agreements and golden handshakes. We desperately need more accountability in the board room.

How complicit was Washington in the crisis?
I would say Washington was central to this crisis. The government  opened the door to the poisonous lending that hurt so many people. The big paradox is that they thought their actions would improve the lives of people who had not yet been able to become homeowners.  But at the end of the day, they really hurt the very people that they were trying to help. It’s such an upsetting paradox that minorities, immigrants and young home buyers are the ones who got lured into these toxic loans and are now on the road to financial ruin.

What is your take on the ‘Occupy’ movements around the world?  Is this the beginning of class warfare?
I don’t think so, but I do think these movements have brought attention to the notion that there is a deep sense of inequality out there. The government’s response to the crisis was to throw immense amounts of money at the very institutions that drove us into the ditch; yet at the same time, average everyday people got very little or nothing to help them. This really contributed to a feeling that there are two sets of rules. The occupy movements have brought attention to the fact that a few people get a great response from the government and the rest of us are left to fend for ourselves.

In a September 2011 speech, Paul Volcker presented a ‘to-do list’ that included: making capital requirements tough and enforceable; making derivatives more standardized and transparent; and ensuring that auditors are truly independent by rotating them periodically. Which is the most important for our leaders to embrace right away, in your view?
The situation in Europe indicates that we really need to shore up bank balance sheets, so I think the first thing to do is to increase capital requirements.  Derivatives are also very important because they’re such an enormous market and they are very intertwined with the problems in Europe.

In your view, why did greed go so viral at this point in time?
There was this widespread sense that there was very little risk or threat involved in grabbing for all the ‘gusto’ you could, and that those who did so would be rewarded. This sense of ‘getting yours’ while you could became part of the Zeitgeist, at the same time as there was this increasing celebration of great wealth. My alma mater, Forbes magazine, puts out lists of the richest people in the world. There’s a sense that wealth is a scorecard for many people, and that you need to get on the Forbes 400 if you want to be perceived as a mover and a shaker. I think that contributed to the chasing of the almighty dollar.

What is disturbing is that even today, very little punishment is doled out for this behaviour, and morality is rarely discussed. A source of mine told me that he ran into Angelo Mozilo at a philanthropic evening where he was being honoured. It was this big black tie event in a ballroom filled with people honouring Mozilo – the man who caused millions of homeowners to lose their homes. The idea that he’s being honoured by anybody is very peculiar, and it illustrates that we are still stuck in the mindset where, if you’ve got a lot of money, you must be very smart and important.  In my view, allowing these people to ‘slink away’ without any consequences  is a recipe for anarchy and chaos.  

Gretchen Morgenson is a Pulitzer Prize-winning journalist and columnist for The New York Times. She is the co-author, with Joshua Rosner, of Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon (Times Books, 2011).

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]