The Truth About the Financial Crisis, Part I

Jennifer S. Taub is a Lecturer and Coordinator of the Business Law Program at the Isenberg School of Management, University of Massachusetts, Amherst. Her research interests include corporate governance, financial regulation, investor protection, mutual fund governance, shareholders rights and sustainable business. Previously, Professor Taub was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds. She graduated cum laude from Harvard Law School and earned her undergraduate degree, cum laude, with distinction in the English major from Yale College. Professor Taub is currently writing a book on the financial crisis for Yale University Press.

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After reading much of the final report identifying the causes of the Financial Crisis in the United States, released last Thursday December 27, by the Financial Crisis Inquiry Commission, I have one suggestion.  But before I get to it, allow me to explain.

Awe-inspiring labor and thought went into this document including interviews with 700 people, numerous hearings, millions of pages of information reviewed and synthesized.  Those who have followed the hearings or even read popular books or other accounts of the Crisis will find little new with the framework and conclusions.   What makes the Report uniquely useful, though, is the level of detail (with nearly 100 pages in footnotes and untold amounts of exhibits and supporting materials) organized so well in one document. Undoubtedly, this effort will provide tremendous value for the long term.

However, an important near-term measure of success is whether the conclusions are both credible and also can be communicated quickly and clearly to the general public.  Can the report as delivered succeed in educating millions of Americans about the causes of the Crisis?  And, will the result of such education be encouragement of and support in 2012 for those political candidates who plan to facilitate, not impede, the legislative and regulatory reforms necessary to hold people accountable and avoid such a disaster in the future? Without an appreciation of the truth, the public will be too easily swayed by the misleading refrain propagated by the US Chamber of Commerce, that existing reform and certainly any future measures will be “job-killing” regulation.

Communicating the true causes of the Financial Crisis is a tough challenge for our times. Back in the day of the investigation led by Ferdinand Pecora into the causes of the Great Crash, there were few other media distractions. Folks were riveted by the hearings that spanned 1932 through 1934. Testimony of “banksters,” worked to show how “extravagant incentive salary arrangements” had “encouraged bank officers to engaged in unsound security-selling and unsound banking practices.” The populist anger propelled a significant overall of the financial system, including passage of the first federal laws regulating the sale of securities to the public and the creation of the FDIC.

In our era, there is much competition for our attention.  And, there are interests skilled at directing populist anger away from those who are to blame and onto those who are trying to hold the culprits accountable. In terms of competition for our attention, even regarding the Financial Crisis, there have already been numerous Congressional hearings, and investigatory bodies that delved into the same topics, interviewed some of the same witnesses, and issued reports touching on similar topics. Moreover, because the Commission report has appeared more than six months after the financial reform legislation (the Dodd-Frank Wall Street Reform and Consumer Protection Act) was signed it to law, special care should be paid to explaining why the work is indeed still relevant. On page xv, the Commission makes its ambition and relevance clear:

“Some on Wall Street and in Washington with a stake in the status quo may be tempted to wipe from memory the events of this crisis, or to suggest that no one could have foreseen or prevented them. This report endeavors to expose the facts, identify responsibility, unravel myths, and help us understand how the crisis could have been avoided. It is an attempt to record history, not to rewrite it, nor allow it to be rewritten.”

So, back to the suggestion.  In line with this agenda to “unravel myths,” perhaps, after the Commission winds up operations in February, a few staffers (or mere Commission-watchers) could create a program similar to the Discovery Channel’s popular MythBusters.  For those unfamiliar with MythBusters, it is an hour -long cable television show hosted by two former Hollywood special-effects experts and three charismatic and knowledgeable co-stars. Each episode typically includes three separate investigations into whether certain “urban myths” can be substantiated. If after testing out the myth, it proves untrue, it is “busted.” If it is accurate it is categorized as “fact.”  And, occasionally, a third category is invoked where the myth is not refuted, but where a high level of certainty is unattainable, “plausible.” By way of example, one urban myth is that drinking diet coke while consuming Mentos candy will make one’s stomach explode. This myth was busted. However the theory that playing dead will help a person survive a shark attack was confirmed as fact. What makes the show additionally useful is that viewers can send in urban myths they have encountered, for testing.

So why and how to mash-up a myth-busting television format with the Commission report? From the nonprime mortgage crisis of 2007, through the moment the credit markets nearly froze up in September 2008 up to the present, it has been difficult to become educated about what happened and why.  Some of this relates to the complexity of the subject for those unfamiliar with finance, accounting or regulation. However, even beyond that, the truth is often hard to find.  There is a mixture of truth competing with mal-intentioned-lobbyist-backed misinformation.  In this muddle, I have noticed many myths worthy of examination.  Also, I suspect that many Americans concerned about the Financial Crisis struggle not just with the truth about the broader financial system, but the reality of their own financial problems in the current challenging economy and therefore have a few myths of their own for testing.

What motivates our inquiry? Consider first, the extraordinary measures begun under the Bush Administration to commit Trillions of dollars to prop up giant failing financial firms. Add to that anger about the audacity of the chief executives of those same failed firms doling out more than $18 billion in bonuses for 2008.  Share the pain of millions of foreclosures and double digit unemployment. Then, top that with the lobbyists campaign to undo and undermine the regulatory implementation of even anemic reforms enacted under Dodd-Frank.  All of this is bewildering and infuriating.

Thus, the public is eager to understand why this happened. We wish to know whether the blameworthy will be punished (or at the least have to return their ill-gotten gains). We wonder whether those injured will be made whole. And, we fear for the future of this nation, for the prospects of equality and democracy for our grandchildren. Finally, we hope against hope that we have the courage to ensure that this type of catastrophe can be prevented or mitigated.

The prospects of getting to that place of confidence depends upon important changes to the current banking and shadow banking system. However without first clearing away the misconceptions, busting the myths, we cannot see what has happened and what is merely a smoke-screen.

Toward that end, parts ii and iii of this series shall present and debunk the top ten urban myths about the crisis.