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The Financial Crisis Report's Wakeup Call

NEW YORK ( TheStreet) -- There's been a lot going on lately. Between the shootings in Tucson, massive winter storms across the U.S., and protests in Egypt that threaten to destabilize the entire Middle East, we've had a great many crises to engage our attention.

That may be why last week's release of the long-awaited report of the Financial Crisis Inquiry Commission has received relatively little coverage. (After all, what's more compelling -- riots in the streets, or a report that's almost 700 single-spaced pages long?) However, the commission's report deserves more attention than it's been getting, because it pinpoints some critical flaws in our financial system that must be corrected if we're going to avoid another major financial meltdown like the one that rocked the world economy only two years ago.

The commission very kindly provided a 14-page summary of the majority's conclusions for readers who lack the interest or stamina to read the full report. For those of us who've been actively following analysis of the meltdown, the conclusions are hardly surprising.

In a nutshell, the commission found that the financial crisis was avoidable, had the "captains of finance" and regulators recognized and heeded the warning signs. The commission observed that the Federal Reserve Bank of New York, the Securities and Exchange Commission Office of the Comptroller of the Currency and Office of Thrift Supervision all failed adequately to oversee and regulate their respective sectors of the nation's financial system, creating a laissez-faire foundation for questionable financial industry practices.

The commission blasted investment banks and bank holding companies for failures of governance and ethics. It observed that the firms focused increasingly on risky trading activities, especially those involving subprime mortgages, in order to pursue hefty profits. Some of the firms reportedly grew too quickly to be effectively managed. Compensation systems were designed to reward risk-taking rather than prudent investment. Both financial institutions and credit rating agencies relied on computerized mathematical models, rather than professional judgment, to predict risk; according to the commission, "risk management became risk justification."

The commission further concluded that risky investments, excessive borrowing both in financial institutions and private households, and lack of transparency drove the financial system into crisis. In particular, the commission focused on leverage, often hidden in derivatives positions, off-the-balance-sheet entities and "window dressing" of financial reports available to investors eroded the stability of the financial system.
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