WASHINGTON — Sens. Carl Levin, D-Mich., and Tom Coburn, R-Okla., released a bipartisan report late Wednesday that called for 19 changes to rectify banker, regulator and rating agency errors that led to financial crisis.
After a two-year investigation, the Senate Permanent Subcommittee on Investigations released a 635-page report based on evidence from four hearings held last year, as well as tens of millions of documents from court pleadings, filings with the Securities and Exchange Commission, corporate board meetings, memorandums, emails and more than 150 interviews and depositions.
In a joint news conference Wednesday, Levin and Coburn said that, unlike the Financial Crisis Inquiry Commission, which splintered along party lines, the senators were able to agree on the causes of the financial crisis and remedies to prevent a recurrence.
"It is a bipartisan product of a bipartisan investigation that was bipartisan every step of the way," Levin said. "Threads that run through all of the chapters of this story are conflicts of interest and extreme greed."
In the report investigators detailed at length how Washington Mutual, a $300 billion-asset thrift company, took on high levels of risk by selling and securitizing mortgages as regulators stood by, while credit rating agencies labeled the securities as safe investments and investment banks continued to bet on the failure of such exotic instruments.
"At the heart of the financial crisis were unresolved, and often disclosed, conflicts of interests," Coburn said. "Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild and members of Congress who failed to provide oversight."
Recommendations made by the lawmakers focused on four areas: high-risk mortgage lending, regulatory failure, inflated credit ratings and investment banks and structured finance.
Regulators should use their authority to ensure that all mortgages deemed a "qualified residential mortgage" would have a low risk of delinquency or default, the report said. It said they should also issue a strong risk-retention requirement to ensure institutions do not hold less than 5% of the credit risk sold to a securitization.
In the case of Wamu, fixed-rate mortgage originations fell from 64% of its loan originations in 2003 to 25% in 2006, while subprime, option adjustable-rate mortgages and home equity originations jumped from 19% of the originations to 55%.
Emails obtained by the committee showed there had been growing concern over the criteria for the loans driving delinquencies in the option ARM portfolio.
"The performance of newly minted option ARM loans is causing us problems," wrote David Beck, head of Wamu's Capital Markets Division. "We should address selling 1Q as soon as we can before we lose the [opportunity]. We should figure out how to get this feedback to underwriting and fulfillment."
Additionally, banks that have high-risk structured finance products should meet conservative liquidity and capital requirement while regulators must impose reasonable limits on the amount of high-risk products in a bank's portfolio, the report said.
Lawmakers also offered corrective measures to regulators who in the past stood by while institutions engaged in high-risk practices.
The first recommendation is the termination — already under way as a result of Dodd-Frank — of the Office of Thrift Supervision, which had been Wamu's primary regulator.
"The OTS was abolished by Dodd-Frank with good reason," said Levin, who noted that investigators found hundreds of deficiencies in ongoing practices between 2003 and 2008 by the OTS.
According to the report, the OTS did not adequately supervise Wamu and even impeded Federal Deposit Insurance Corp. oversight of the company, blocking access to bank data and refusing to let the FDIC participate in exams.
Second, regulators should be required to conduct a review of major financial institutions to identify any significant problems and review enforcement approaches to avoid any policies that put short-term profits ahead of concerns about high-risk activities.
The Financial Stability Oversight Council, an interagency body headed by the Treasury Department, should also undertake a study to identify high-risk lending practices, the lawmakers said.
On the matter of inflated credit ratings, lawmakers recommended that the SEC rank rating organizations by performance, especially in the area of ratings accuracy.
Investors, they said, should also be backed by the SEC to hold credit rating agencies accountable in civil lawsuits when the agency fails to examine the rated security. There should also be lesser reliance by federal regulators on privately issued credit ratings, the report said. (The Dodd-Frank Act requires the banking agencies to remove reliance on credit rating agencies in regulatory matters.)
Turning to Goldman Sachs, lawmakers recommended that regulators consider the conflicts of interest at investment banks. Levin and Coburn said that any exceptions to a Dodd-Frank ban on proprietary trading should be confined to activities that serve clients or reduce risk.
