Tuesday, May 4, 2010
The Record

IT SEEMS PEOPLE always seek to identify a single source on which to blame their problems. Time and again we have sought the quick and easy solution when issues have multiple facets and require thoughtful and comprehensive debate.

Last week, the U.S. Senate Subcommittee on Investigations held hearings to examine the role of investment banks in the recent recession, calling seven executives from Goldman Sachs Inc. as witnesses. I doubt the public good was served much by the discussion, which saw snide remarks and extreme accusations from senators on both sides of the aisle and less than forthright answers from the executives.

Let’s face it – Goldman Sachs makes an easy and convenient target. The average American does not understand the difference between being a market maker and a fiduciary, and the subcommittee members revealed that they likewise struggle with the distinction.

There are certainly issues in the private sector that need airing and areas of the financial industry that need to be subject to further oversight. But the hearings and the financial reform package currently being debated in Congress miss two key questions: Where was the SEC and what was Congress doing in the midst of the crisis, and, more importantly, before it?

As Bethany McLean wrote in The New York Times last week:

“Congress … sat by idly as consumer advocates warned that people were getting loans they’d never be able to pay back. It was Congress that refused to regulate derivatives, despite ample evidence dating back to 1994 of the dangers they posed. It was Congress that repealed the Glass-Steagall Act, which separated investment and commercial banking, yet failed to update the fraying regulatory system.”


And let’s not forget one of the key drivers of the housing bubble – the lowering of lending standards to encourage homeownership, regardless of the borrower’s ability to repay their mortgage.

In November 2003, the chairman of President Bush’s Council of Economic Advisers called for stronger regulation of Fannie Mae and Freddie Mac (so-called Government Sponsored Enterprises that back most of the mortgages in the United States) out of concern that “even a small mistake” in managing their risks “could have ripple effects throughout the financial system.”

Rep. Barney Frank, the then-ranking Democrat on the House Financial Services Committee, said the administration’s position was driven by concerns about the financial safety and soundness of the companies “to the exclusion of concern about housing.” Indeed, he repeatedly prevented additional oversight for Fannie Mae and Freddie Mac, and even pushed for them to make more loans to people who couldn’t afford traditional bank financing.

His response now that the financial crisis has occurred, partly due to those very moves at the GSEs, has largely focused on increasing regulation of the financial sector and curbing Wall Street pay.

I do not mean to unfairly single out Frank, but his failure to regulate prior to the crisis, and his insistence that investment banks are the primary entities that need regulating, is emblematic of the larger denial in Washington.

Every minute that Congress and regulators spend attacking Goldman Sachs or other Wall Street firms is a minute they don’t have to spend defending their own actions – or taking responsibility for the role that government played in the financial crisis.

In this matter, I have tremendous respect for Sen. Tom Coburn, R-Oklahoma, who boldly went on the record towards the end of the Goldman hearings to say that 90 percent of the responsibility for the crisis lies with Congress.

There is no doubt that Wall Street firms played a role in the downturn, as Goldman CEO Lloyd Blankfein noted in his testimony before the subcommittee on Tuesday. But we would be foolish to think Wall Street caused the whole problem, or that regulating only Wall Street would prevent another crisis in the future.

Spreading the blame

The economic downturn was caused by people at all levels and in all sectors spending money they didn’t have. Individuals and families bought homes and goods on credit they could not afford to repay. Wall Street was overleveraged, extending credit to those who were making risky bets and failing to see the bubble reaching a bursting point. And, let’s not forget, governments local and national were deeply engaged in deficit spending.

This matter should not be about finding someone to blame – it should be about figuring out what changes need to be made to fix the system.

We need an honest examination of the causes of the financial downturn so that we can make adjustments to prevent another crisis in the future. We cannot afford to get this wrong.