I am reading this draft. Also of interest is this interview with President Obama.Early on, the draft white paper says,

Gaps and weaknesses in the supervision and regulation of financial firms presented challenges to out government’s ability to monitor, prevent, or address risks as they built up in the system. No regulator saw its job as protecting the economy and financial system as a whole.

I have to disagree with the last sentence. The Fed has always seen this as its job. It did when I worked there, and it did both before and during the crisis.

I also disagree with the tone of the first sentence, which makes it sound as though the problems were caused by unregulated firms. In my view, the problems were poor mortgage underwriting standards and too much credit risk held by institutions with too little capital. The holders of credit risk were regulated institutions, especially Freddie Mac, Fannie Mae, and the banks. They took on excessive risks right under the noses of their regulators. The regulators approved the use of AAA and AA ratings of mortgage securities to reduce bank capital. They approved the banks’ use of off-balance sheet entities to reduce capital even further. They approved the entry of Freddie Mac and Fannie Mae into the business of purchasing subprime mortgage securities.

In football terms, the problem is not that regulators were in the wrong formation or fell for trick plays. The problem is that they did not tackle.

The white paper says,

First, capital and liquidity requirements were simply too low. Regulators did not require firms to hold sufficient capital to cover trading assets, high-risk loans, and off-balance sheet commitments, or to hold increased capital during good times to prepare for bad times. Regulators did not require firms to plan for a scenario in which the availability of liquidity was sharply curtailed.

From the perspective of many insiders, including key officials as well as economist Gary Gorton, there was a liquidity crisis last year. AIG and other companies suffered from what amounted to bank runs. In my view, the real issue was more one of solvency. Banks and other firms genuinely lost enough money on bad mortgage loans to wipe out their capital. You can say that capital requirements were too low. But to me it looks more as though banks found ways to game the system of capital requirements, using techniques approved by regulators.

Two gaping holes in the white paper are housing policy and tax policy. On housing policy, a wide range of interest groups promotes leveraged purchases of houses. The net effects of this are the opposite of good public policy–private benefits for people in the real estate and mortgage industries with social costs in the form of paying for subsidies and cleaning up the mess.

In the interview, President Obama says,

I think you’ve got a broader structural problem in our economy in which our last two recoveries had been based on bubbles, and a massively overleveraged consumer, a massively overleveraged corporate sector, and a financial system that didn’t have much restraint.

Both the President and the white paper blame this excess leverage on greed and faulty compensation structures. What about taxes and subsidies? Our high corporate tax rate, along with the deductibility of interest for corporations, encourages corporations to look for ways to minimize equity financing. For individuals, government-subsidized mortgages and the tax deductibility of mortgage interest help to encourage over-leveraging.

Overall, the white paper offers a highly skewed narrative of the financial crisis. All of the misbehavior took place in the private sector. No mention is made of government policies that contributed. Instead, the story is one of government that needed a better regulatory structure and more powers.

Intellectually, this is a very disappointing piece of work. But given political considerations, I cannot say that I am surprised.