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Chairman Johnson, Ranking Member Shelby and members of the Senate Banking Committee:

Thank you for the opportunity to submit written testimony in connection with today's hearing on the work of the Financial Crisis Inquiry Commission. I regret that a prior commitment prevents me from appearing in person. I was a member of this 10-member commission, and dissented from the Commission majority's report. In this testimony, I will outline the substance of my dissent and explain why I believe a dissent was necessary.

Before turning to the substance of my dissent, however, I would like to comment on how the Commission was organized and run.

The Commission's Process

The financial crisis was an unprecedented event, possibly the worst financial breakdown in U.S. history, and will be studied for years by historians, economists and other scholars in the hope of understanding what caused it and how similar events can be avoided. From the beginning of the Commission's substantive operations, however, it was not run as the serious, objective investigation that it should have been. Instead, it focused only on a narrow set of issues, and never succeeded in providing the data and the perspectives that might have been helpful to future scholars and policymakers. It is all too common that the reports of special government investigative commissions like the FCIC are shelved and never seen again. But this Commission's work, I'm sorry to say, fully deserves that treatment.

I have had some limited experience with government commissions, including the 1976 Rockefeller commission study of the CIA's activities in the United States, but I have never seen a Commission as badly organized and run as this one. Since there has always been great uncertainty about what caused the financial crisis, I expected that, at the outset of the Commission's work, the members would have had an opportunity to discuss what they thought were the most important issues for the staff to investigate. If I had made a list at that time, it would have included many of the ideas--hypotheses, I would have called them--that were widely discussed in public debates and for that reason alone deserved to be looked into in detail. These included the possibility that the crisis was caused by (i) easy Fed monetary policy in the early 2000s; (ii) a flood of funds from abroad looking for high returns; (iii) the repeal of a portion of the Glass-Steagall Act; (iv) mark-to-market accounting; (v) government housing policies and the role of the government-sponsored enterprises; (vi) the growth and collapse of an unprecedented housing bubble; (vii) lack of or insufficient regulation, (viii) interconnections among financial institutions, and many others. My initial view was that many of these hypotheses were not factors in the crisis, but I thought they should be investigated so that the Commission could provide to Congress, scholars and the American people the best answers that a thorough and objective investigation could reveal.

As it turned out, the members of the Commission never had an opportunity to discuss these issues, or to have any influence at all on the direction the Commission took in its inquiry and ultimately in its report. According to my records, in the 18 months the Commission was in operation, there were only 12 meetings at which the members of the Commission could exchange views on the causes of the financial crisis. Of these meetings, only six were day-long sessions. The only time that the Commission members sat around a table to discuss the causes of the crisis occurred during three days in early September, well after the discussion could have had any effect on the direction of the investigation.

The members were appointed in July 2009 and the first few months of the Commission's existence were spent in hiring the staff and establishing the basic rules for how the Commission would operate. By the late fall of 2009, we were ready to begin the substantive portion of the Commission's work. This would have been the point at which several-days of discussion among the members about the causes of the financial crisis would have turned up agreements and disagreements that might have shaped and broadened the subsequent investigation. However, there was never a time during this period when the members were invited to sit around a table and consider what issues the Commission would actually investigate.

Instead, in early December, we were given a list of monthly public hearings that the Commission would conduct virtually through the end of its tenure. The list included hearings on subprime lending, securitization and the GSEs, the shadow banking system, credit rating agencies, complex financial derivatives, excessive risk and financial speculation, too big to fail, and macroeconomic factors. Many of the items in this list qualified as important issues, but to schedule them as public hearings in advance made no sense. The hearings should have been shaped by what was turned up in the investigation, not function as the drivers of what the Commission would study. There was a pervasive sense that a serious investigation was being sacrificed to the publicity that could be wrung from public hearings. Moreover, since the work of the staff was inevitably going to be devoted to preparing for the hearings, establishing a list of hearings in advance threatened to reduce both the amount and the scope of the Commission's investigative work.

In practice, this meant that a large number of important issues were not to be addressed in any detail by the Commission. There was just no time for the staff to prepare for the hearings and also do a thorough investigation. As a result, the Commission majority's report shows the superficiality of its work in many important areas. For example, the discussions of the role of monetary policy and the flow of investment funds from abroad--two possible causes of the financial crisis that have drawn a lot of attention from scholars--are no more detailed than newspaper or magazine articles; no new data is provided and no conclusions are presented. Instead, the Commission majority reserved their conclusions for the issues that were the focus of the hearings: that that the financial crisis was caused by insufficient regulation--particularly a failure to "rein in excesses in the mortgage and financial markets"--weak risk management, unregulated over-the-counter derivatives, and excessive risk-taking" It's not that many other causes were considered and dismissed; in many cases, they were not considered at all.

In January, I told vice chair Bill Thomas that I was thinking of resigning. It was clear to me that we were not going to be doing a thorough or objective investigation. Thomas promised changes, but none of any significance was ever made. The direction things were taking was also clear to others. The Commission's principal investigators protested the idea that the subjects of the public hearings were set in advance, before any investigation had been done. They were ignored. They drafted a memo to chairman Angelides and vice chair Thomas, explaining their position. I was told by one investigator that Thomas "begged" them not to send it, promising that things would change. They didn't send the memo, but nothing changed. Their view, and mine, was that the hearings should come out of the investigation--when things had been found that warranted a public hearing. Confirming the fear that the hearings were scheduled for publicity rather than substantive purposes, the first hearing was a fiasco. Without any preparation for this hearing, the Commission summoned the CEOs of four of the largest U.S. financial institutions, seemingly just so they could be photographed being sworn in. The New York Times and the The Wall Street Journal were in rare agreement about this hearing, with the Times heading its editorial "The Show Must Not Go On." Eventually, one of the investigators, Martin Biegelman, resigned. He reportedly gave the chair and vice chair a memo describing the reasons for his resignation. This memorandum was not shared with the other commissioners and has never been made public.

The most disappointing fact about the Commission's management was its lack of objectivity. One particular example stands out. In March 2010, Edward Pinto, a resident fellow at the American Enterprise Institute (AEI) who had served as chief credit officer at Fannie Mae, provided to the Commission a 70-page, fully sourced memorandum on the number of subprime and other high risk mortgages in the financial system immediately before the financial crisis. In that memorandum, Pinto recorded that he had found over 25 million such mortgages (his later work showed that there were approximately 27 million). Since there are about 55 million mortgages in the U.S., Pinto's research indicated that, as the financial crisis began, half of all U.S. mortgages were of inferior quality and liable to default when housing prices were no longer rising. In August, Pinto supplemented his initial research with a paper documenting the efforts of the Department of Housing and Urban Development (HUD), over two decades and through two administrations, to increase home ownership by reducing mortgage underwriting standards.

Pinto's work has been cited with approval by many scholars and experts in mortgage finance. His research raised important questions about the role of government housing policy in fostering the growth of the subprime and other high risk mortgages that played such a key role in both the mortgage meltdown and the financial panic that followed. Any objective investigation of the causes of the financial crisis would have looked carefully at this research, exposed it to the members of the Commission, and taken Pinto's testimony in an open or closed hearing. But the Commission took none of these steps. Although Pinto met several times with the staff, his research was never made available to the other members of the FCIC, or even to the commissioners who were members of the subcommittee charged with considering the role of housing policy in the financial crisis. In early April, the Commission held three days of hearings on securitization, subprime mortgages, and the GSEs. There were numerous witnesses, but despite my requests Pinto was not among them. In the end, the Commission never seriously challenged Pinto's work or developed any data of its own on the number of subprime and Alt-A loans outstanding. Instead, it makes numerous statements about the housing market and the role of the GSEs that have no basis in fact. Some of these are discussed in later sections of this testimony.

There were many other more technical deficiencies. The Commission's report claimed that it interviewed hundreds of witnesses, and the majority's report is full of statements such as "Smith told the FCIC that...." However, unless the meeting was public, the commissioners were not told that an interview would occur, did not know who was being interviewed, and of course did not have an opportunity to question the interviewees or understand the contexts in which the statements quoted in the report were made. Thus, the extensive use of interviews--instead of references to documents--raises a question whether there was bias in the witnesses chosen for interviews and the particular statements chosen for the report, and whether their statements were challenged in any way, with documentation or otherwise, during the interviews. A review of a sample of the transcripts and interview memoranda suggests that this did not happen. The Commission majority's report uses these unchallenged statements of fact and opinion by interviewees as substitutes for hard data, which is notably lacking in their report; opinions in general are not worth much as evidence, especially in hindsight and when given without opportunity for challenge. The Commission claims that it reviewed millions of pages of documents. It probably received millions of pages of documents, but whether they were actually reviewed is doubtful. Very little in the report quotes from documents the Commission received, rather than from people it interviewed.

The Commission's authorizing statute required that the Commission report on or before December 15, 2010. The original plan was for us to start seeing drafts of the report in April. We didn't get any drafts until November, when we started to receive drafts of chapters in no particular order. We were given an opportunity to submit written comments on these chapters, but never had an opportunity to go over the chapters as a group or to know whether our comments were accepted. We received a complete copy of the majority's report, for the first time, on December 15, the date on which the Commission's authorizing statute required that the report be completed. The draft was almost 900 double-spaced pages and was to be approved eight days later, on December 23. Again, we never sat around a table and reviewed the final draft section by section. This is not the way to achieve a bipartisan report, or the full agreement of any group that takes the issues or its assignment seriously. But, somehow, the Commission majority managed to approve this report, although it seems to have been almost entirely the work of the chairman and the staff.

In summary, the overall direction of the Commission majority's report was determined before the Commission started its work. Throughout its 18 month life, the Commission focused only on issues that the chairman wanted to cover, was more interested in publicity than in a thorough investigation, and never paid serious attention to other views. It was not in any sense an objective or thorough study, did not produce any facts or data that could aid scholars in the future (although its disclosure of documents might assist scholarly research), and in my view was a waste of the taxpayers' money. Most important, considering the purpose of the Commission, was its failure to shed any light on the validity of the many theories that have been advanced to explain the financial crisis. Policymakers, scholars and the American people deserved a reasoned analysis of these ideas. In the end, what they got was a just so story about the financial crisis, rather than a report on what caused the financial crisis.

Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.