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Lessons From an "Avoidable" Crisis

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Earlier this week, the congressionally appointed Financial Crisis Inquiry Commission (FCIC) released reports detailing the ugly, complex factors that led up to the 2008 financial crisis. With the disaster past, too many people who once panicked over these issues would now rather dismiss them as yesterday's problems. But the painful moments documented in the FCIC's 500-plus-page tome, and the lessons they can teach us about the importance of good corporate governance, shouldn't be forgotten or ignored.

The blame game
The reports reveal that in 2009, Federal Reserve Chairman Ben Bernanke privately dubbed the crisis "the worst financial crisis in global history, including the Great Depression." He also contended that 12 out of 13 of the most important U.S. financial institutions were on the brink of collapse at the time, apparently excluding JPMorgan Chase (NYSE: JPM  ) .

The commission's research also reminds us how much the government bailout of AIG (NYSE: AIG  ) benefitted Goldman Sachs (NYSE: GS  ) . Goldman collected $2.9 billion in taxpayer money from that deal, plus an additional $14 billion from AIG, which Goldman then doled out to other counterparties.

In their report, the Democratic majority on the FCIC largely blames the crisis on deregulation and greedy, high-rolling financiers. But in fairness, it misses several other significant factors.

Republicans' report notes that the Democrats' findings largely gloss over the culpability of Fannie Mae and Freddie Mac. In their efforts to provide "affordable housing," both of these agencies eventually started offering mortgages to people who, under more sensible rules, simply couldn't afford them.

Furthermore, there's one group that Republicans and Democrats alike might hesitate to blame, despite its share of culpability. The American public loved the idea that "home prices always go up." Too many people started purchasing residential real estate as an increasingly speculative "investment," doing their part to further inflate the housing bubble.

Back to the future
Deconstructing what went wrong is all well and good, but has anybody actually learned anything going forward? As financial executives jump ship with massive golden parachutes, and financial companies that would have otherwise failed enjoy taxpayer-funded bailouts, the folks who likely bear most of the blame for this mess don't seem to have taken any lessons to heart. Failure is often the best (if also the harshest) lesson and remedy for incompenent corporate management. Alas, in the years since the crisis, many Wall Street folks have demonstrated a shocking lack of shame or culpability.

Other pockets of corporate America have similarly seemed reluctant to change the practices they relished during the bubble years. Last year, the Institute for Policy Studies called out companies including Schering-Plough, Johnson & Johnson (NYSE: JNJ  ) , and Hewlett-Packard (NYSE: HPQ  ) for their "Layoff Leader CEOs." These execs pocketed millions in 2009 compensation, even as they cut tens of thousands of U.S. jobs over the same time frame.

Moving forward after looking back
Getting beyond political finger-pointing, and admitting that so many parties shared blame, might be a step in the right direction. It doesn't take rocket science to realize that the 2008 debacle required a lot of different people to all do exactly the wrong, risky things at the same time, in some nearly psychotic confederacy of greed and stupidity.

Let's try to move forward without forgetting the lessons of the past. Major failures in corporate governance lay at the heart of these systemic breakdowns. Fixing those flaws could help prevent future disasters.

Good corporate governance demands that corporate managements and boards embrace accountability for their own performance, and listen to all stakeholders when making decisions. Both such qualities have seemed dramatically lacking lately.

Shareholder-friendly policies like say-on-pay, financial clawback provisions, and independent boards help establish corporate checks and balances, keeping risky, imprudent behavior at a minimum. If we can just give the folks in the boardroom a dash of humility, and encourage more long-term strategic thinking, we could create strong foundations for the companies in which we invest.

What do you think of the FCIC report? Who's to blame for the financial crisis? Have any real lessons been learned, or is another "avoidable" calamity in the works? Air your thoughts in the comments box below.

Check back at every Wednesday and Friday for Alyce Lomax's columns on corporate governance.

Motley Fool Options has recommended a diagonal call position on Johnson & Johnson, which is a Motley Fool Inside Value choice and a Motley Fool Income Investor selection. The Fool owns shares of JPMorgan Chase and Johnson & Johnson. Motley Fool Alpha owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 28, 2011, at 5:58 PM, xetn wrote:

    "The commission's research also reminds us how much the government bailout of AIG (NYSE: AIG) benefitted Goldman Sachs (NYSE: GS). Goldman collected $2.9 billion in taxpayer money from that deal, plus an additional $14 billion from AIG, which Goldman then doled out to other counterparties."

    Eh, I believe the other $14 billion also came from the taxpayers, it just got funneled through AIG first.

    It certainly is a great benefit to have all of those ex GS execs in the treasury dept. when the s*** hits the fan.

  • Report this Comment On January 28, 2011, at 6:05 PM, CMFStan8331 wrote:

    I think all the factors you cite here played significant roles in formation of the crisis. Basically, we were ALL culpable in allowing finance to balloon into such a greatly exaggerated position within our economy. Unfortunately, I'm afraid that reforms enacted to date do very little to lower the possibility of a similar crisis in the future.

    The big banks have only gotten bigger - it's inconceivable that anyone with knowledge of the situation actually believes there would be an orderly resolution if one or more of them were to fail. In a future crisis we would face exactly the same choice we recently encountered - allow the banks to fail and suffer horrific economic catastrophe as a result, or pay the money to bail them out.

    The only ways to mitigate that risk are to directly restrict the size any one bank will be allowed to reach, and/or drastically limit the investment options we allow the very large banks to utilize in their pursuit of profits. To date, we've done nothing on the former and come up with only a bit of flimsy window dressing for the latter.

    It seems that by narrowly averting another Depression, we lost all the requisite will to do what's necessary to avoid repeating the same scenario in the future.

  • Report this Comment On January 28, 2011, at 6:38 PM, mountain8 wrote:

    It also shows we can expect little solid changes from congress as even the blame committee was split by parties.

  • Report this Comment On January 29, 2011, at 1:41 AM, ET69 wrote:

    Asking the US Gov. to regulate big business is like asking the fox to guard the hen house. Just who do you think OWNS this company...errrrh country?!

    When one looks and sees these many problems or mistakes being made then the problem is systemic. One has to admit that the problem is ...CAPITALISM... itself. Don't waist your time pointing at one player or another to "reform"the system.

    The whole damn capitalist system has evolved from its progressive role in the middle ages of throwing off the monarchies of the world to where it is today. ie; the biggest roadblock to the advancement of humanity.

    What don't like Socialism? Well show me a Capitalist system that doesn't lay off millions of working people at the drop of a hat and turn around and give BILLIONS to the wealthy capitalist class that sucks every dime out of the poor and the working class!

    Yesterday Egypt....tomorrow America?

  • Report this Comment On January 29, 2011, at 9:09 AM, RRGGBB wrote:

    Greed Greed Greed - what do these people do with all that money - NOTHING - their grandchildren can not even spend it - pay people more on the lower end of the ladder - then the economy will rebound and be less fragile - rebalancing - Corruption is destroying the United States - people of the nation need to unite and put their foot down or they will continue to fall into the ibis - How does someone sleep at night when thousands of people are laid off while they collect millions of dollars in bonuses or golden parachutes? Long live democracy - it certainly is not in the United States.

  • Report this Comment On January 29, 2011, at 7:18 PM, rfaramir wrote:

    The solution is private property. The problem was the Federal Reserve.

    The Fed was allowed to go off the gold standard, repudiating its commitment to exchange gold for Federal Reserve Notes returned to it. The dollar used to be "as good as gold" because of that exchange policy. No longer.

    The Fed also practiced fractional reserve banking, which is taking in a deposit (one's private property) and then, without taking away his 'ownership' of it (he can still, on demand, withdraw the amount deposited) loan it out (or 90% of it). Two parties at this point claim ownership of the deposited money, this is fraud.

    End the Fed to end fraudulent money printing, and re-institute private ownership laws from which banks are specially exempted, thus ending the fraud of fractional reserve banking.

  • Report this Comment On January 31, 2011, at 11:49 AM, lctycoon wrote:

    "An economy built on debt is not an economy built to last."

    Who encouraged the American people to take on debt? Who encouraged corporations to do that? Who encouraged the government to take on debt?

    Frankly, if you want to know who is to blame for the Great Recession, look in a mirror. If you see an American there... then you share part of the blame.

  • Report this Comment On January 31, 2011, at 4:09 PM, YoungFool37 wrote:

    I do not even know where to begin with rfaramir up there, except to suggest that you learn a bit more about floating currencies, inflation, and, especially, the importance of fractional reserve banking in, well, every major economic development since Renaissance Italy. I frequently worry about what is taught in American schools.

    Socialism will fail every time. Greed is natural, and fairness and equality are simply not a part of real life. You may establish it for a short period, but it will always crumble. The best, the brightest, and the most economically productive in any socialist country will look for a place where their talents can generate more for them.

    As for paying the people at the bottom more, the CEOs are not paying the workers. The company is paying its workers. The company will always care more about its owners than its employees because that is its purpose. They pay you so that you will do things to make them more money than they paid you. You are, more or less, an investment to them. If you do not like this situation, then you should find a different way to make money other than working for a company. I do not understand the American attitude towards employment. This is (supposedly) a free country. No one owes you a job. No one owes you a paycheck. No one owes you their level of compensation, wealth, or any derivative thereof. No one owes you financial stability. No one owes you equality. You are free to do what you can do. That is all.

    I do not understand how your complaint has anything to do with democracy, but I would like to point out that the U.S.A. has never been a democracy anyway. We were established as a Republic by our founders, many of whom agreed with Aristotle in that democracy is quite possibly the worst form of government.

    As for who is culpable in the financial crisis: everyone was greedy and totally self-interested, and we all acted like idiots when we smelled money- exactly as was expected under a capitalist system. However, the agencies in charge of reigning in that rampant self-interest failed miserably in their duties. The federal reserve essentially looked the American public and every major lending institution in the eye and said, "Everything is fine; there is no need to worry here, so we are going to keep the prime rate and reserve requirements low." In doing so, they handed the banks more and more money to loan out to lower and lower rated consumers. More than anything else, this spurred the free and irresponsible flow of far too much credit to far too many people.

    Perhaps secondarily, the people became enthralled of the idea that anyone could get a home, a car, etc. and demanded that the government ensure they got loans for it. The government interfered by guaranteeing loans through freddie and fannie, taking the risk away from banks. When you offer the big bad banks no downside with a great return, they are going to take it. Wouldn't you?

  • Report this Comment On January 31, 2011, at 4:13 PM, BleuSail wrote:

    Yes everyone wants to blame one particular group or another. We the people ARE America! We the people carry debt that is beyond any reason. Who runs this country? We the people and the Americans who we VOTE into office is us. They carry debt and like to spend and control just like we all do. It is human nature nothing more. But WE CAN learn and must learn from our history and take pride in who we are. Socialism is bad overall. Capitalism with no checks and balances with no responsibility or recourse for those involved is just as bad. A working American people with a healthy economy is a STRONG and PROUD America. May we never forget. Understand YOUR FINANCES and know YOUR CONSTITUTION.

  • Report this Comment On January 31, 2011, at 4:15 PM, FutureMonkey wrote:

    I rather liked both the majority and the minority reports. I didn't perceive much difference between the two except for the key quote at the beginning "involving the word "avoidable." All accidents and boom/bust cycles are avoidable with knowledge of hindsight.

    What I liked about the majority report was that is has a lot more pot-boiler plot twists and direct quotes and stories by the people involved; it will serve as an excellent reference to future historians, much the same way we enjoy reading stories about the Dutch Tulip Crisis. The minority report was a more focused 26 pages without much embellishment, but I don't really see stark contrasts in philosophy or theory. Really just two views of the same event from different personality types. The whole us vs them, blame game, finger pointing is more the product of the media's narrative of how dems and republicans are expected to behave rather than how the committee conducted and concluded it's business.

  • Report this Comment On February 01, 2011, at 9:29 AM, BleuSail wrote:

    One other comment. The credit unions never needed a "bail out" because they don't loan any money unless you meet meet certain income to debt ratios, they offer slightly better interest and loan rates and guess who they are mainly run by or who the bank managers have to answer to? Its members. This is a slap in the face to us all as this is actually being run the way it should and you can see it working every day.

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