Portraits in Oversight:
Financial Crisis: Taking on the Big Banks
In 2008, the United States suffered its worst financial crisis since the stock market crash of 1929. Securities backed by home mortgages lost much of their value, stock markets plummeted, storied financial firms went under, and millions of Americans lost their jobs, their homes, and their retirement savings. The financial cost has been estimated at $20 trillion in lost gross domestic product, including costs associated with bankrupt businesses, foreclosures, homelessness, underwater mortgages, unemployment, and lost savings.[1] In response, multiple congressional committees launched investigations into what happened. The most comprehensive, bipartisan effort was a two-year inquiry by the U.S. Senate Permanent Subcommittee on Investigations.
The Permanent Subcommittee on Investigations (PSI) is the premier investigative body in the U.S. Senate, with a history of conducting fact-based, bipartisan investigations into complex issues.[2] In 2008, the PSI chair was Sen. Carl Levin (D-MI), and the ranking minority member was Tom Coburn (R-OK). Both agreed to devote the subcommittee’s entire resources to investigating the key causes of the financial crisis.
The two senators directed their staff to conduct a bipartisan inquiry. The PSI staff accordingly issued joint document requests, conducted joint witness interviews, designed bipartisan hearings, and drafted a joint report. Over the course of two years from 2009 to 2011, the staff reviewed over 50 million pages of documents, including emails, memoranda, Board minutes, audits, Securities and Exchange Commission (SEC) filings, correspondence, personnel records, mortgage transactions, legal pleadings, and more. PSI staff also conducted over 150 interviews with financial experts, federal regulators, mortgage issuers, credit rating analysts, investment bankers, public interest groups, investors, and others.
After three months of research, the PSI investigation identified four key causes of the financial crisis: high risk home lending, regulatory failures, inflated credit ratings, and massive investment bank conflicts of interest which, together, contaminated U.S. markets with toxic mortgages and widespread defaults. The staff developed detailed case studies to illustrate each of the problems uncovered, featuring Washington Mutual, Moody’s, Standard and Poor’s, Goldman Sachs, Deutsche Bank, and the Office of Thrift Supervision.
In April 2010, PSI held four hearings laying out what the investigation had learned. Each hearing included in the hearing record a bipartisan memorandum from Senators Levin and Coburn with joint findings of fact. PSI also included in each hearing record up to 100 documents presenting key information. At each hearing, PSI members took live testimony from senior executives at the firms serving as the case studies.
The first hearing, on April 13, 2010, focused on U.S. banks switching from low-risk to high-risk mortgages and packaging them into mortgage-backed securities that polluted the U.S. mortgage market, using Washington Mutual as the in-depth case study.[3] In 2008, Washington Mutual, a leading issuer of home mortgages, was the largest U.S. thrift with over $300 billion in assets. Documents released at the hearing showed that the primary reason it had switched from low-risk to high-risk mortgages was its analysis that the higher-risk mortgages produced higher profits.
The documents also described the higher-risk mortgages. Some had used initial low teaser interest rates to convince borrowers to take out larger loans. Others offered optional repayment terms – sometimes called “pick a payment” or “option loans” – to persuade borrowers they could meet the loan repayment requirements. Washington Mutual also made increasing use of so-called “stated loans” in which borrowers stated their income and the bank accepted the income claims without verification, a practice later derided as issuing “liar loans.”
At the hearing, the bank’s executives were confronted with evidence of the bank’s risky mortgages, unqualified borrowers, rampant loan fraud, shoddy loan oversight, compensation practices that rewarded loan volume over loan quality, high loan default rates, and aggressive sale of toxic loan pools to Wall Street. The evidence also showed that, as investors began to shun high-risk mortgage pools, Washington Mutual became unable to sell billions of dollars of its high-risk mortgage-backed securities which had quickly lost value. The bank’s stock price plummeted, depositors withdrew billions of dollars from the bank, and in September 2008, Federal Deposit Insurance Corporation (FDIC) took control of Washington Mutual in the largest bank failure in U.S. history. Despite extensive hearing evidence exposing its shoddy lending practices, Washington Mutual executives denied all wrongdoing.
The second hearing, on April 16, 2010, delved into how banking regulators had failed to stop their regulated banks from issuing, packaging, and selling substandard mortgage loans and securities, using the Office of Thrift Supervision (OTS) as the case study.[4] OTS was the primary regulator of thrifts like Washington Mutual with large mortgage portfolios. Documents released at the hearing showed that many OTS examiners had known about the increasingly high-risk mortgages and had requested tougher restrictions on their use but had been rebuffed by OTS executives who downplayed the risk given the quick sale of mortgage pools to Wall Street and the lucrative profits.
At the hearing, PSI members questioned OTS regulators about the agency’s failure to realize that the increasing issuance and sale of substandard, high-risk mortgages was poisoning the U.S. mortgage market as a whole. PSI members grilled regulators about OTS’ failure to take enforcement action against Washington Mutual despite OTS examiners identifying more than 500 deficiencies at the bank over five years. PSI members also pressed OTS about why its regulators had blocked FDIC enforcement efforts and even impeded FDIC oversight of the bank’s operations. In addition, the OTS Director was criticized for using an apologetic tone when informing Washington Mutual of necessary enforcement actions. PSI members also took testimony from the Treasury and FDIC Inspectors General confirming the agencies’ poor supervision of Washington Mutual. Despite the ample evidence of its regulatory failures, OTS officials denied engaging in lax oversight.
The third hearing, on April 23, 2010, focused on how major credit rating agencies had rated substandard mortgage securities as safe investments despite high default risks, focusing on the two largest U.S. credit rating agencies, Moody’s and Standard and Poor’s.[5] Together, those two companies provided the bulk of the credit ratings of mortgage-related securities at the center of the crisis. PSI members grilled the credit rating executives about evidence showing that their supervisors had pressured their analysts to inflate credit ratings for higher-risk mortgage securities and delay downgrading those ratings when the securities began to default, all to secure profits and greater market share from the banks hiring the firms to rate their securities.
The two companies were also asked about their sudden, allegedly independent decisions in July 2007 to issue mass rating downgrades of hundreds of subprime mortgage-backed securities. Those mass downgrades shocked the mortgage market, drove down prices, and triggered mass investor withdrawals. Committee members also asked about evidence showing that over 90% of the AAA ratings given to mortgage-backed securities in 2006 and 2007 were later downgraded to junk status. At the hearing, the credit rating executives defended their firms but also admitted, when faced with incriminating documents, that the investment banks had engaged in high-pressure tactics and ratings shopping to obtain inflated ratings, that the credit rating companies had assigned inadequate staff resources to track mortgage defaults, and that the companies eventually had to downgrade numerous AAA ratings.
The fourth and final hearing, on April 27, 2010, presented evidence on the ways in which investment banks had directly contributed to the financial crisis, using Goldman Sachs as the detailed case study.[6] In 2008, Goldman was a major player in the mortgage market and had a large portfolio of mortgage-related securities including four collateral debt obligations (CDOs) that Goldman designed, formed, and sold to investors: Abacus, Anderson, Hudson, and Timberwolf.
At the hearing, Goldman executives were grilled about including poor quality, high-risk mortgage loans in its CDOs, obtaining AAA ratings for those CDOs despite the risk, and knowingly selling shares in the CDOs to unsuspecting clients worldwide as safe investments. Sen. Levin asked the witnesses, for example, about an internal Goldman email calling the Timberwolf CDO a “shitty deal” at the same time Goldman was selling it to investors worldwide.[7] PSI members also pressed Goldman executives about advising clients to buy shares in CDOs that Goldman was secretly betting against, enabling the firm to reap huge profits at the direct expense of its clients. Sen. Levin asked, for example, about documents showing Goldman had sold $2 billion in Hudson shares to clients, while secretly taking 100% of the short side of the CDO; when Hudson’s value plunged, Goldman secured $1.7 billion in profits from the very clients it had convinced to invest in the CDO.
PSI members also pushed Goldman executives to admit that the firm had made billions of dollars from betting that U.S. mortgage-related securities would fall in value, enabling the firm to profit from the mortgage market downturn. Numerous documents were placed in the hearing record laying out the facts, including Goldman actions to bet against – to short – mortgage securities. For example, an email sent by Goldman CEO Lloyd Blankfein to other Goldman executives stated: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts.”[8] Goldman’s chief financial officer stated in another email that the firm had netted $50 million from betting against certain mortgage-related securities, while observing, “Tells you what might be happening to people who don’t have the big short.”[9]
Still another set of Goldman documents featured at the hearing were internal “brag sheets” – self-reviews written by Goldman executives competing for year-end bonuses. Several Goldman mortgage bankers used them to boast of designing shorts that netted large profits for the firm from mortgage-related securities losing value or from investors who’d taken Goldman investment advice and purchased mortgage-related securities that later cratered in price.[10] Despite the evidence, throughout the hearing, Goldman denied that it had knowingly sold poor-quality CDOs, engaged in conflicts of interest that hurt its clients, or profited from shorting the mortgage market.
At the hearing, both Democratic and Republican subcommittee members condemned Goldman’s conduct and denial of responsibility. Their bipartisan concerns received widespread media coverage.[11] The day after the Goldman hearing, the Senate ended a filibuster of a House-passed bill with financial reforms and allowed debate to begin on a companion Senate bill.[12] On May 20, 2010, the Senate approved its bill by a vote of 59-39. One month later, on June 29, 2010, the two chambers reached agreement on a common text. The House voted 237-192 in favor of the final bill on June 30; the Senate followed suit 60-39 on July 15. President Barack Obama signed the bill into law on July 21, 2010, just three months after the last PSI hearing.[13]
The Dodd-Frank Wall Street Reform and Consumer Protection Act led to the most significant U.S. financial reforms in a generation.[14] They included:
- New restrictions on issuing high-risk mortgages;
- A new requirement that banks verify the borrower’s ability to repay a mortgage;
- A new conflict of interest prohibition on banks betting against their clients;
- The “Volcker Rule” which prohibited banks, with narrow exceptions, from trading for their own profit rather than on behalf of their clients;
- Abolishment of OTS and the transfer of its functions to other federal agencies;
- Establishment of an SEC office to police the conduct of credit rating agencies;
- Formation of the Financial Stability Oversight Council, bringing federal financial regulators together to detect and curb risks in the financial system; and
- Creation of the Consumer Financial Protection Bureau to safeguard American families against predatory lenders.
Enactment of the new law did not, however, end the PSI investigation of the financial crisis. The subcommittee continued to collect information and began to draft a comprehensive report. The next year, on April 13, 2011, PSI released a 750-page Levin-Coburn staff report entitled, “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse.”[15] It is the only bipartisan report on the financial crisis.
The report provided a detailed explanation of what PSI learned during its year-long investigation, describing the nature and state of the U.S. mortgage market, the four key causes of the financial crisis, and the four case studies it had developed while also adding a second investment bank case study involving Deutsche Bank. The report provided nearly three dozen, bipartisan findings of fact and numerous recommendations for financial reforms. In addition, the report released over 700 new documents supporting its analysis. In 2011, PSI published a comprehensive, five-volume hearing record on the financial crisis, comprised of the four PSI hearings, the report, and extensive supporting documentation.[16]
In a press release accompanying the report, Sen. Coburn stated:
The free market has helped make America great, but it only functions when people deal with each other honestly and transparently. At the heart of the financial crisis were unresolved, and often undisclosed, conflicts of interest. 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.[17]
In the aftermath of the PSI investigation into the financial crisis, the entities that served as PSI case studies were subjected to lengthy civil enforcement proceedings that held them accountable for their misconduct. In 2008, the FDIC shuttered Washington Mutual and sold it to JPMorgan Chase; in 2013, JPMorgan Chase paid $13 billion to the U.S. Department of Justice (DOJ) to settle civil charges related to issuing defective mortgages and mortgage-backed securities, including by Washington Mutual.[18] In 2015, Standard & Poor’s paid over $1.37 billion to DOJ to settle civil charges that it defrauded investors in the lead up to the financial crisis.[19] In 2017, Moody’s paid nearly $864 million to settle similar charges.[20]
In 2016, Goldman Sachs paid over $5 billion to DOJ to settle civil charges of misconduct in its packaging, securitization, marketing, sales, and issuance of mortgage- related securities from 2005 to 2007.[21] Earlier, it had paid $550 million to the SEC to settle civil charges of misleading investors who purchased shares in the Goldman CDO known as Abacus.[22] In 2017, Deutsche Bank paid $7.2 billion to DOJ to settle civil charges that it had misled investors in the packaging, marketing, securitization, sale, and issuance of mortgage-related securities during the financial crisis.[23] Other financial firms also paid fines, although virtually no bank or bank executive was criminally prosecuted.
Conclusion
The 2008 financial crisis had a devastating impact on American families, communities, businesses, and financial markets. Holding powerful financial firms accountable for their actions is always difficult, especially when complex financial products are involved, and no one wants to admit wrongdoing. The Levin-Coburn investigation was remarkable for delving deeply into the details of the U.S. mortgage market, obtaining key documentation, and clarifying what happened. The two senators also produced public hearings and a final report that were both hard-hitting and bipartisan. PSI’s explosive investigation not only exposed misconduct by leading financial firms, it also helped create the momentum needed to enact once-in-a-generation financial reforms to repair the U.S. mortgage market, reduce systemic financial risk, and strengthen consumer protections against predatory lenders. The PSI investigation continued the proud history of Congress – from the 1929 stock market crash to the 2001 Enron financial collapse – of standing up to the U.S. financial industry and holding powerful firms publicly accountable for their wrongdoing.
Learn More
- A guide to the financial crisis – 10 years later
- Video of PSI hearings on the financial crisis
- Video of Levin-Coburn press conference on the 2011 PSI report
- Financial Exposure: Carl Levin’s Senate Investigations into Finance and Tax Abuse, Chapter 9 on the Financial Crisis
[1] Government Accountability Office. (2013, January). Financial Regulatory Reform: Financial Crisis Losses and Potential Impacts of the Dodd-Frank Act. Report No. GAO-13-180. http://www.gao.gov/assets/660/651322.pdf; Better Markets. (2015, July). The cost of the crisis: $20 trillion and counting. [Report]. https://bettermarkets.org/sites/default/files/Better%20Markets%20-%20Cost%20of%20the%20Crisis.pdf
[2] Bean, E. Financial Exposure: Carl Levin’s Senate Investigations into Finance and Tax Abuse. (Palgrave MacMillan 2018), pp. 28-35.
[3] Wall Street and the financial crisis: The role of high risk home loans: Hearing before the Permanent Subcommittee on Investigations, Senate, 111th Cong. (2010). https://www.govinfo.gov/content/pkg/CHRG-111shrg57319/pdf/CHRG-111shrg57319.pdf
[4] Wall Street and the financial crisis: The role of bank regulators: Hearing before the Permanent Subcommittee on Investigations, Senate, 111th Cong. (2010). https://www.govinfo.gov/content/pkg/CHRG-111shrg57320/pdf/CHRG-111shrg57320.pdf
[5] Wall Street and the financial crisis: The role of credit rating agencies: Hearing before the U.S. Permanent Subcommittee on Investigations, Senate, 111th Cong. (2010). https://www.govinfo.gov/content/pkg/CHRG-111shrg57321/pdf/CHRG-111shrg57321.pdf
[6] Wall Street and the financial crisis: The role of investment banks: Hearing before the Permanent Subcommittee on Investigations, Senate, 111th Cong. (2010). https://www.govinfo.gov/content/pkg/CHRG-111shrg57322/pdf/CHRG-111shrg57322.pdf
[7] Wall Street and the financial crisis: The role of investment banks, Exhibit 105, p. 674 (2010).
[8] Wall Street and the financial crisis: The role of investment banks, Exhibit 52, p. 403 (2010).
[9] Wall Street and the financial crisis: The role of investment banks, Exhibit 26, p. 306 (2010).
[10] Wall Street and the financial crisis: The role of investment banks, Exhibit 55, pp. 435-454 (2010).
[11] Gordon, M. and Raum, T. (2010, April 27). Goldman hearing turns into daylong showdown. Associated Press. https://www.nbcnews.com/id/wbna36795143
[12] Herszenhorn, D. and Wyatt, E. “Republicans Allow Debate on Financial Overhaul,” New York Times (2010, April 28). https://www.nytimes.com/2010/04/29/business/29regulate.html?action=click&module=RelatedCoverage&pgtype=Article®ion=Footer
[13] Actions taken by Congress on H.R. 4173, Dodd-Frank Wall Street Reform and Consumer Protection Act (2009-2010). https://www.congress.gov/bill/111th-congress/house-bill/4173/all-actions
[14] Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203 124 Stat. 1376 (2010, July 21). https://www.congress.gov/bill/111th-congress/house-bill/4173/text
[15] Wall Street and the financial crisis: Anatomy of a financial collapse, report and appendix. Permanent Subcommittee on Investigations, reprinted in S. Hrg. 112-675 (2011). Part I (report and documents supporting the Washington Mutual, OTS, and credit rating agency sections of the report), https://www.gpo.gov/fdsys/pkg/CHRG-112shrg57323/pdf/CHRG-112shrg57323.pdf; Part II (documents supporting the Deutsche Bank section of the report), https://www.gpo.gov/fdsys/pkg/CHRG-112shrg66050/pdf/CHRG-112shrg66050.pdf; Part III (documents supporting the Goldman Sachs section of the report), https://www.gpo.gov/fdsys/pkg/CHRG-112shrg66051/pdf/CHRG-112shrg66051.pdf; and Part IV (additional documents supporting the Goldman Sachs section of the report), https://www.gpo.gov/fdsys/pkg/CHRG-112shrg66052/pdf/CHRG-112shrg66052.pdf.
[16] Wall Street and the financial crisis: Anatomy of a financial collapse: Hearing before the Permanent Subcommittee on Investigations, Senate, S. Hrg. 112-675 (2011) (includes four hearings comprising volumes 1-4, see Footnotes 3-6; and a report and appendix comprising volume 5, parts I-IV, see Footnote 15).
[17] Office of Sen. Levin. (2011, April 13). Senate Investigations Subcommittee Releases Levin-Coburn Report on the Financial Crisis. [Press Release]. https://people.ucsc.edu/~hutch/Econ130/Levin%20news%20annoucment%20on%20reprot%20Aoril%202011.pdf
[18] Department of Justice (2013, November 19). Justice Department, federal and state partners secure record $13 billion global settlement with JPMorgan for misleading investors about securities containing toxic mortgages. [Press release.] https://www.justice.gov/opa/pr/justice-department-federal-and-state-partners-secure-record-13-billion-global-settlement
[19] Department of Justice (2015, February 3). Justice Department and state partners secure $1.375 billion settlement with S&P for defrauding investors in the lead up to the financial crisis. [Press Release.] https://www.justice.gov/opa/pr/justice-department-and-state-partners-secure-1375-billion-settlement-sp-defrauding-investors
[20] Department of Justice (2017, January 13). Justice Department and state partners secure nearly $864 million settlement with Moody’s arising from conduct in the lead up to the financial crisis. [Press Release.] https://www.justice.gov/opa/pr/justice-department-and-state-partners-secure-nearly-864-million-settlement-moody-s-arising
[21] Department of Justice (2016, April 11). Goldman Sachs agrees to pay more than $5 billion in connection with its sale of residential mortgage backed securities. [Press Release.] https://www.justice.gov/opa/pr/goldman-sachs-agrees-pay-more-5-billion-connection-its-sale-residential-mortgage-backed
[22] SEC. (2010, July 15). Goldman Sachs to pay record $550 million to settle SEC charges related to subprime mortgage CDO. [Press Release.] https://www.sec.gov/enforcement-litigation/litigation-releases/lr-21592
[23] Department of Justice. (2017, January 17). Deutsche Bank agrees to pay $7.2 billion for misleading investors in its sale of residential mortgage-backed securities. [Press Release.] https://www.justice.gov/opa/pr/deutsche-bank-agrees-pay-72-billion-misleading-investors-its-sale-residential-mortgage-backed