Las Vegan on Financial Crisis Inquiry Commission seeks answers from fat cats

By J. Patrick Coolican

Wednesday, Jan. 20, 2010 | 2 a.m.

Nevada has suffered more from this recession than the rest of the country.

Our homes have lost the most value, and more Nevadans have lost their jobs than in other places.

So it is fitting that Nevada should be well represented by the Financial Crisis Inquiry Commission, the federal investigative body examining the causes of the 2008 financial meltdown, which led to the worst recession since the Great Depression.

The commission held its first public hearings last week, calling on the leaders of the nation’s largest financial institutions to testify. It will submit a final report to Congress in December.

Byron Georgiou, one of two Nevadans on the 10-member panel, got to pepper the bankers with questions.

Georgiou, who moved to Las Vegas in 2005, is well-suited to the task: He helped lead a team of 30 lawyers to recover $7.5 billion for investors bilked by Enron, the Houston conglomerate whose tricky accounting practices and failure to manage risk a decade ago presaged the collapse of financial companies in 2008.

The panel heard from executives of Goldman Sachs, JP Morgan Chase, Bank of America and Morgan Stanley, as well as federal and state regulators of securities and mortgages.

Georgiou reflected on the first round of public hearings in an exclusive Sun interview.

What were your impressions of the testimony of the executives of the major financial institutions?

Some of the answers were frank, and some of the answers could have been much clearer. The public’s interest is very significant given the human cost of this financial crisis, particularly here in Nevada. Was I disappointed in some instances in the answers? I’d say yes.

What in particular?

One, recognizing their own responsibility in the financial crisis. And two, acknowledging the extent to which their companies might not have survived, or would have been significantly weaker without an infusion of capital from the taxpayers.

From the preliminary investigation, can you point to causes yet?

There was inadequate accountability for those responsible for the creation of certain financial instruments.

The financial institutions bundled bad mortgages together and sold them to investors, and faced no immediate consequences for their failure, right? So you want to affix financial responsibility on the people who create these financial instruments?

We can use market mechanisms to fix financial responsibility where it belongs, on those who originate the instruments. Right now, no one bears any financial cost for what happens if they fail: Lawyers who write the prospectus, the ratings agencies, the investment bankers who do the underwriting, they all make money no matter what. We might consider the retention of risk on people who originate the securities so they would undertake a greater degree of care.

So their fees would be based, in part, on the success of the securities themselves?

Hopefully that would induce a greater degree of due diligence. This kind of financial innovation moves quickly, and regulators are ill equipped to keep up with it, so you’re better off with market mechanisms that align incentives properly.

One reason the securities backed by bundled mortgages went bad was pure fraud in the mortgage market.

We learned that in 2004 the FBI alerted regulators about a great deal of fraud in the mortgage market, but there was no response. Yes, and bank regulators should have been there in a more significant way.

Then there were the so-called credit default swaps, essentially betting against loan defaults, which brought down AIG and other companies once there were mass defaults in the mortgage market.

These were largely unregulated. There was no centralized market where the extent of the risk was known. There’s a consensus developing among the commission members and witnesses that there should be a central clearinghouse for these instruments.

It seems ironic that the major problem here was that some of these financial institutions were so massive that their failure would threaten to bring down America’s entire economy. And, yet, in the end, we wound up with fewer companies that are even larger. What gives?

That’s a major issue we are called upon to investigate. There need to be mechanisms where any financial institution in America could fail. We would have provisions in place that would permit it to fail in a responsible and disciplined manner, which didn’t create a risk of systemic failure.

Your final take-away?

Everybody has a short memory. I know this having conducted an investigation for a decade — Enron, which collapsed in large part because of off-balance sheet special investment vehicles. And we still see that and that, in part, led to the collapse of these companies.

There were failures at every level of government, but there were also significant failures of many parties in the private sector.