It's tough to head off the next disaster if you don't understand why the last one happened -- an insight that's apparently lost on Wall Street.
Instead, as I watch banker after banker grilled on how the mortgage mess happened, they seem to repeat a lot of the excuses I've heard for more than a year. Such as "No one knew." Or "It was everyone else's fault."
There's a little truth in each excuse, but none is completely honest. "If we're going to avoid these mistakes, it really starts with an honest assessment of what's happened," says Phil Angelides, the head of the Financial Crisis Inquiry Commission, an investigative panel charged with identifying to causes of the credit crisis.
The excuses also muddy the waters at a critical time. The nation is just starting to recover from the meltdown. Financial reform has finally taken center stage in Washington. We need to know what truly went wrong to keep this from happening again.
So here are five big lies we need to stop hearing from Wall Street:
Big lie No. 1: No one could have known
Consider this scenario: You work at the top of a key bank on Wall Street. You hire the smartest guys from the best schools. You get paid big bucks to know your business better than anyone else. And warning signs are everywhere. When it goes bad, can you really say you didn't know?Yet time and again, we've heard something similar to this from top bankers.
Former Citigroup (C, news, msgs) CEO Charles Prince and former senior board member Robert Rubin told the commission earlier this month that they're really sorry but didn't know what was coming. "There isn't a way in an institution that has hundreds of thousands of transactions a day that you're going to know what's in those position books," testified Rubin, a former Treasury secretary.
Dick Fuld, who was head of the failed Lehman Brothers, has said he had no idea his company was using accounting gimmicks to cover up exposure to risky debt instruments.
Now, I can't tell you which executive knew what or when, or what they believed they were seeing. But their institutions spotted trouble early on:
- At Citigroup, a former executive, Richard Bowen, says he warned top managers as early as 2006 about problems with bad mortgages. "I witnessed business risk practices which made a mockery of Citigroup credit policy," Bowen told the commission this month.
- E-mails disclosed last weekend reveal Blankfein gloating, "We lost money, then made more than we lost because of shorts," in November 2007 -- when the banks' problem had just started to surface. With the crisis looming, the bank had placed big bets against, or shorted, the mortgage-backed securities it was selling to customers, a maneuver Angelides says is akin to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars."
- Another e-mail has a Goldman bond trader telling his girlfriend in March 2007 that the subprime business "is totally dead, and the poor little subprime borrowers will not last so long!!!" (Goldman Sachs responded that the Senate Permanent Subcommittee on Investigations, which released the e-mails, had "cherry-picked" them from millions of pages of documents and that the bank lost money on residential-mortgage-related products during 2007 and 2008.)
- At Lehman Brothers, former executive Matthew Lee says he was fired in May 2008 after raising concerns about accounting practices.
A lot of people outside the banks saw something coming, too. In September 2004, the FBI publicly warned that a potential epidemic of rampant mortgage fraud could cause "the next S&L crisis," referring to the huge savings-and-loan meltdown of the 1980s. In early 2005, The Wall Street Journal and The New York Times began running articles warning that relaxed lending standards and a speculative housing market bubble were dangerous.
Directors have little excuse for missing such signs because they have a legal obligation to understand the risks inside companies, says Michael Garland of CtW Investment Group, which lobbies companies on shareholder issues for union pension funds. "They didn't have to know that the mortgage market was going to collapse to know that the risk equation in the mortgage market had changed dramatically," he says.
And the CEOs? Well, it's possible some of them really didn't recognize the risk early on, but there were enough warnings to say they could have and, given the size of their paychecks, to think they should have.
Continued: It's someone else's fault