Wall Street is on the wrong side of this fight

By Carl Levin, U.S. Senator
Tuesday, April 27, 2010

Today the Senate Permanent Subcommittee on Investigations, which I chair, held the fourth in our series of hearings to explore some of the causes and consequences of the financial crisis. These hearings are the culmination of nearly a year and a half of investigation.

The freezing of financial markets and collapse of financial institutions that sparked our investigation are not just a matter of numbers on a balance sheet. Millions of Americans have lost their jobs, their homes and their businesses in the recession that the crisis sparked, the worst economic decline since the Great Depression. Behind every number we cite are American families who are still suffering the effects of a man-made economic catastrophe.

Our Subcommittee's goal has been to construct a record of the facts in order to deepen public understanding of what went wrong; to inform the ongoing legislative debate about the need for financial reform; and to provide a foundation for building better defenses to protect Main Street from the excesses of Wall Street.

• Our first hearing dealt with the impact of high-risk mortgage lending, and focused on a case study of Washington Mutual Bank. WaMu, as it is known, is a thrift whose leaders embarked on a reckless strategy to pursue higher profits by emphasizing high-risk exotic loans. WaMu didn't just make loans that were likely to fail, creating hardship for borrowers and risk for the bank. It also built a conveyor belt that fed those toxic loans into the financial system like a polluter dumping poison into a river. The poison came packaged in mortgage-backed securities that WaMu sold to get the enormous risk of these loans and their growing default rates off its own books, dumping that risk into the financial system.
• Our second hearing examined how federal regulators saw what was going on but failed to rein in WaMu's reckless behavior. Regulation by the Office of Thrift Supervision that should have been conducted at arm's length was instead done arm in arm with WaMu. OTS failed to act on major shortcomings it observed, and thwarted other agencies from stepping in.
• Our third hearing dealt with credit rating agencies, specifically case studies of Standard & Poor's and Moody's, the nation's two largest credit raters. While WaMu and other lenders dumped their bad loans into the river of commerce and regulators failed to stop their behavior, the credit rating agencies assured everyone that the poisoned water was safe to drink, slapping AAA ratings on bottles of high risk financial products. The credit rating agencies operate with an inherent conflict of interest - their revenue comes from the same firms whose products they are supposed to critically analyze, and those firms exert pressure on rating agencies who too often put market share ahead of analytical rigor.
• Today's hearing explored the role of investment banks in the development of the crisis. We focused on the activities during 2007 of Goldman Sachs, one of the oldest and most successful firms on Wall Street. Those activities contributed to the economic collapse that became full-blown the following year.

Goldman documents make clear that in 2007 it was betting heavily against the housing market while it was selling investments in that market to its clients. It sold those clients high-risk mortgage-backed securities and CDOs that it wanted to get off its books in transactions that created a conflict of interest between Goldman's bottom line and its clients' interests.

These findings are deeply troubling. They show a Wall Street culture that, while it may once have focused on serving clients and promoting commerce, is now all too often simply self-serving. The ultimate harm here is not just to clients poorly served by their investment bank. It's to all of us. The toxic mortgages, and the securities that funded them, that these firms injected into our financial system have done incalculable harm to people who had never heard of complicated mortgage-backed securities, and who have no defenses against the harm such exotic Wall Street creations can cause.

The thread that connects the reckless actions of mortgage brokers at WaMu with market-driven credit rating agencies and the Wall Street executives designing the next synthetic is unbridled greed, and the absence of a cop on the beat to control it.

As I write this, lobbyists fill the halls of Congress, hoping to weaken or kill legislation aimed at reforming these abuses. Wall Street is on the wrong side of this fight. It insists that reining in its excesses would unduly restrict a free market that is the engine of American progress. But this market isn't free of self-dealing or conflict of interest. It is not free of gambling debts that taxpayers end up paying.

I hope the executives who testified before us today, and their colleagues on Wall Street, will recognize the harm that their actions have caused to so many of their fellow citizens. This market cries out for restraint. We need to put an end to Wall Street creating and selling complex securities and then betting against them.

The bill Sen. Dodd produced is a strong beginning. We can strengthen it with provisions that address conflicts of interest and regulate the kind of exotic and reckless financial instruments that helped create the financial crisis. I hope these hearings provide some added strength to the reform effort that will put a cop back on the Wall Street beat.

Sincerely,
Carl Levin