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November 25, 2017

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Financial crisis was avoidable, Las Vegan on inquiry panel says

Two Las Vegans served on Financial Crisis Inquiry Commission

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Byron Georgiou, a prominent Las Vegas attorney, is a member of the commission investigating causes of the U.S. financial meltdown. It is to submit a final report to Congress in December.

Heather Murren

Heather Murren

Perhaps no city has suffered more from the 2008 financial crisis and its causes than Las Vegas.

While the suffering continues, Las Vegas can at least have a measure of satisfaction from the release Thursday of a 600-page government report that offers a blistering critique of government fecklessness, and incompetent — and potentially criminal — conduct at the highest levels of Wall Street.

The 18-month investigation by the Financial Crisis Inquiry Commission, which was created by Congress to investigate the causes of the economic collapse, led to disagreement among its 10 members. The majority report argues that loose mortgage lending standards and a culture of reckless betting on Wall Street combined to bring the world financial system to its knees, causing massive job losses and foreclosures, especially in Nevada.

The commission featured two Nevadans: philanthropist and former Wall Street analyst Heather Murren; and Byron Georgiou, a securities lawyer, entrepreneur and former counselor to California Gov. Jerry Brown.

“The most important conclusion is that the crisis was avoidable,” Georgiou said in a phone interview.

The broad outlines of the crisis are by now fairly well-known: Financial institutions offered high-risk mortgages to many homebuyers who could not afford the loans, including many in Las Vegas; the mortgages were bundled together by Wall Street firms into supposedly safe securities; once the mortgages went bad, the securities went bad; some financial firms, including AIG, had sold insurance on the mortgage securities, meaning that once the securities went bad, AIG had to pay out tens of billions of dollars in obligations it could not meet.

The Wall Street firms were so large and tightly connected that the government had to intervene, fearing the loss of these firms would lead to even greater panic, with money going under mattresses and the economy effectively shutting down.

Although this story has been told by investigative journalists and government and Wall Street whistle-blowers, the commission’s report is the most comprehensive account, including 700 interviews and millions of pages of documents.

Among the key conclusions:

• “The financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire.” That conclusion is meant as a direct counterattack on the oft-heard claim in the past two years that the crisis was an act of God and could not have been predicted or prevented.

In fact, the report concludes, the warning signs were everywhere, including a sharp rise in risky subprime mortgages, mortgage fraud and predatory lending, all of which were pushing up real estate prices to unsustainable levels. At the same time, Wall Street was borrowing huge sums to make risky, out-of-sight bets that few people understood.

• “Widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets.”

A key villain: Legendary former chairman of the Federal Reserve, Alan Greenspan, whose reputation has been tarnished by the crisis and who has acknowledged flaws in his markets-know-best worldview.

“The Federal Reserve was the one entity empowered” to set prudent mortgage standards. “And it did not.”

The report cites other regulatory failures, including by current Treasury Secretary Timothy Geithner when he was head of the Federal Reserve Bank of New York.

• Wall Street firms were ignorant of their exploding exposure to great risk. “By one measure, the leverage ratios (of major investment banks) were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses.” This means a small turn in the market put them at great risk of insolvency, which is exactly how it played out.

• The government was ill-prepared for the crisis and then made matters worse with its inconsistent response, bailing out Bear Stearns and AIG while allowing Lehman Bros. to fail, for instance.

The report also cites the rating agencies that were paid by financial firms to rate securities, and often rated them the highest possible “AAA” when they were anything but; a decision by the Clinton administration to let financial instruments known as derivatives go unregulated, which contributed to their boom and bust; and a general breakdown of accountability and ethics in business, as evidenced by the profusion of predatory lending, for instance.

The 10 members of the commission were unable to reach consensus, with the four members appointed by Republicans publishing two dissents. One places blame on federal policies that encouraged homeownership, as well as reckless behavior of the quasi-governmental home lenders Fannie Mae and Freddie Mac, whose collapse worsened the crisis.

The other three Republican appointees blame massive amounts of capital flowing into the U.S. and Europe from China and the big oil exporting countries, which they say created the housing and securities bubble. They do not agree with the report’s conclusion that a tighter regulatory environment would have prevented the crisis.

Georgiou said some of what he learned was breathtaking. “The most shocking thing I found was the amazing testimony that the top people at several institutions literally didn’t know this enormous amount of risk” they had taken on, he said.

Top executives at AIG, Merrill Lynch and Citibank were left unaware of the huge bets their companies had made on securities and insurance contracts that were rapidly failing. They were like a casino bettor not knowing how large his marker is.

The commission, as required by the statute that created it, has forwarded some evidence it collected to federal authorities for potential prosecution, according to The New York Times.

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