What The Financial Crisis Commission Should Really Ask
Today in the New York Times, Andrew Ross Sorkin has a fun column consisting of a list of questions that he would like to hear the Financial Crisis Inquiry Commission ask when it convenes tomorrow. He believes the questions would "help start some lively discussions." He's right, because the questions he lists are virtually all accusatory in nature towards the Wall Street bank CEOs who will be testifying. So while amusing, I think the commission would be prudent to consider more questions that are actually productive to its mission of better understanding "the causes and current state of the crisis." As a result, I thought I'd offer a few suggestions of my own, just in case anyone on the committee happens to be reading.
Before getting into my own, let me give an example of the kind of questions Sorkin poses:
A question for all the executives about bonuses: We keep hearing that you plan to pay out billions in bonuses this year. Given that they come out of profits that, to a large degree, seem to be the result of government programs to prop up and stimulate the banking sector, do you think they are deserved, even if they are in stock? And, while we're on the topic, given the market crisis of 2008, were you all overpaid in 2007?
For starters, bonuses had very little to do with what actually caused the crisis. Even if they were substantially lower in 2007, the bankers would not have behaved differently. They would have still sought the highest profit possible, because that's what bankers do. The CEOs would likely respond that there were some divisions that did not perform well (MBS traders, for example), and their bonuses (and layoffs) will reflect that, but the majority of their employees performed at or better than expectations (M&A, corporate debt underwriters, etc.). Unfortunately, in this case, a few bad apples spoiled the bunch.
So rather than ask questions to purposely put these CEOs on the defensive, and produce no significant answers to actually help the reform effort, I'd suggest the following instead:
Imagine it's 2005. You can change three decisions you made and alter the future. What are those three things that you would have done differently?
What do you believe the Federal Reserve could have done differently to prevent or lessen the severity of the crisis? Did it have the tools necessary at the time to do so, or was it incapable due to a lack of authority?
A popular regulatory goal of Washington is bank regulator consolidation. Would it make your job easier or more difficult to have to answer to one bank regulator, instead of several? Do you think this would harm or benefit the market?
Many have argued that capital and leverage levels weren't prudent enough, which is part of what forced the government to recapitalize your banks with a bailout. How high would your capital levels have needed to be to avoid the crisis? What maximum leverage limit would have accomplished the same result?
One of the most significant regulatory proposals would be the creation of a non-bank resolution authority. The idea would be that, if something like the crisis happened again, a firm like AIG could be more neatly wound down. Do you believe it's actually possible to resolve large, interconnected firms like AIG and your banks without causing economic crises in the process?
It's been suggested that one way of accomplishing neat resolution of complex entities would be to require those firms to submit failure plans to be followed in a default event. If you had to draw up such a plan currently, could you do so with the confidence that the plan could be executed without causing a major economic disturbance?
What are your views on Fannie and Freddie? Is it a good idea from an economic perspective to have an entity with an implicit government guarantee to insure and purchase mortgages? What should the government's role be going forward when it comes to mortgages?
Some believe that option adjustable-rate mortgages are financial instruments of destruction for consumers. Can you explain why dangerous, misleading consumer financial products should remain legal?
If independent financial research firms were to take on the responsibility of evaluating bonds, instead of the rating agencies, how would that change the market? Would investors be able to function without rating agencies? Do you believe during the crisis they were too reliant on the rating agencies without doing enough of their own due diligence?
All of Washington's financial regulation proposals would force securitizers to keep some skin in the game, requiring them to retain a portion of the risk in the pools they create asset-backed bonds out of to sell to investors. How would that change the securitization market as we know it? How would that, in turn, affect consumer lending?
Explain the role that derivatives played in the crisis. What might have helped prevent the problems they created?