While everyone watches the AIG spectacle unfold in the House, the Government Accountability Office (GAO) is laying some shocking truths on the Senate Banking Committee in a little-noticed report.
The GAO, Congress’ independent investigative bureau, spent three months probing the performance of government financial regulators in advance of a hearing today on “lessons learned in risk management oversight.” What investigators found — summarized in a 35-page report that’s not yet available on its website — was a system held captive by the banking industry.
The GAO’s report concluded that “regulators had identified numerous weaknesses in the institutions’ risk management systems before the financial crisis” — but did nothing “until the crisis occurred because the institutions had strong financial positions and senior management had presented the regulators with plans for change.”
Here are some of the distressing conclusions uncovered by the investigation (emphasis mine):
Some regulators found that institutions’ senior management oversight of risk management systems had significant shortcomings, such as a lack of a comprehensive means to review enterprise-wide risks, yet some regulators gave the institutions satisfactory assessments until the financial crisis occurred. …
[S]ome regulators found that institutions had not tested the assumptions in models used to evaluate risks — such as the likelihood of a borrower to default — but, for at least one institution, examiners did not prohibit the institutions from using untested models nor did they change their overall assessment of the institutions’ risk management program based on these findings.
In a 2006 review, the Federal Reserve found that none of the large, complex banking institutions it reviewed had an integrated stress testing program that incorporated all major financial risks enterprise-wide, nor did they test for scenarios that would render them insolvent. …
Even when regulators perform horizontal examinations across institutions in areas such as stress testing, credit risk practices, and the risks of structured mortgage products, they do not consistently use the results to identify potential systemic risks.
In addition, in 2005, when the Federal Reserve implemented an internal process to evaluate financial stability issues related to certain large financial institutions, it did not consider risks on an integrated basis and, with hindsight, we note that it did not identify in a timely manner the severity of the risks that ultimately led to the failure or near failure of some of these institutions and created severe instability in the overall financial system.
The GAO’s study examined regulatory behavior at the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Securities and Exchange Commission.
