In May, the commission’s executive director was moved aside and succeeded by an economist from the Fed, a decision that drew criticism since the central bank is an object of the investigation because of its leading role in handling the crisis. In addition, five of the commission’s 14 senior staff members have resigned, including Matt Cooper, a journalist who was drafting the report.

Moreover, the commission’s chairman, Phil Angelides, and vice chairman, Bill Thomas, are finding it challenging to maintain support from all eight other commissioners. While squabbling within the panel has not broken into open dissent, several commissioners are divided over how much to blame specific individuals and banks, how and when to release the documents it has gathered and whether to make available testimony of government officials and bank executives it has interviewed privately.

In a joint interview by phone on Tuesday, Mr. Angelides, a Democrat, and Mr. Thomas, a Republican, said that the turnover’s effects had been exaggerated and that they were optimistic about a consensus.

“We’re doing our very best, and we will do our level best,” said Mr. Angelides. He said he had spoken recently with Thomas H. Kean, the former New Jersey governor who led the 9/11 Commission, which produced an acclaimed report that was a surprise best seller. “Several weeks out, they doubted whether they would get any kind of agreement on anything,” Mr. Angelides said.

The FCIC has always been something of a lame duck. It will complete its work months after the financial regulatory reform bill became law, and will have done little to help legislators draft the bill. Moreover, its report will come out after dozens of other books and reports on the financial crisis — long after government, journalism, economics and Wall Street itself got a handle on, if not a perfect understanding of, just what tipped banks into chaos.

That said, the FCIC is performing an enormously important function in demanding answers of the Wall Street titans responsible. It used its subpoena power, for instance, on Warren Buffett. And today, the FCIC is speaking with Dick Fuld, the now-reclusive former head of Lehman Brothers, whose spectacular collapse kicked off the worst of the credit crunch.

But here’s one nugget. Brooksley Born, the former head of the Commodity Futures Trading Commission, which regulates certain kinds of derivatives, used her time to ask Buffett multiple questions about the financial instruments, contracts derived from the price of another asset that will come under new regulation once the financial regulatory reform bill passes. Derivatives trading accounts for up to 40 percent of revenue at some Wall Street banks, and their regulation is the subject of intense lobbying by financial firms that do not want to have to exchange-trade derivatives or put trades through clearinghouses.

Born quoted Buffett’s shareholder letters declaring derivatives “financial weapons of mass destruction, carrying dangers that while now latent are potentially lethal” and “time bombs both for the parties that deal in them and the economic system.”

In response to questions about the instruments, Buffett said that derivatives “accentuated enormously the leverage in the system” and contributed to the financial collapse. He described his acquisition of reinsurance company GenRe, which came with 23,000 derivatives contracts, and how he sold off all of them for $400 million at a loss because he felt he could not understand them. “It was impossible,” he said, noting he had never heard of most of the counterparties and “couldn’t pronounce their names.”

“The only answer was to get out of the business,” he said.

Born asked whether major investment banks, such as J.P. Morgan Chase, have the capacity to understand their derivatives contracts and their risks. Buffet replied, “I think they’re dangerous. I’ll say this: I don’t think I could manage them. … It’s hard for me to imagine a regulatory system that could supervise something like that.”

Finally, Born asked him, “In your view, is the derivatives market still a time bomb ticking away?”

Buffett responded, “I would say so.”

And, lo and behold, Buffett will testify on Wednesday on the subject of ratings agencies. Berkshire Hathaway controls a major stake in Moody’s, one of the three big credit raters.

In his prepared testimony, Paulson cites governmental homeownership policy as the underlying reason for the housing bubble and ensuing credit crunch:

Underlying the crisis was the housing bubble, and it is clear that several policy decisions shaped the home mortgage market. Excesses in that market eventually led to a significant decline in home prices and a surge of loan defaults which caused tremendous losses in the financial system, triggered a contraction of credit, and put many Americans — quite literally — out on the street. These excesses were driven in large part by housing policy. From 1994 to 2006, home ownership soared from an already spectacular 64 percent of U.S. households to a staggering 69 percent due to the combined weight of a number of government policies and programs. Fannie Mae and Freddie Mac, the government sponsored enterprises (GSEs) comprised a central part of U.S. housing policy. The GSEs operated under an inherently flawed model of private profit backed by public support, which encouraged risky revenue seeking and ultimately led to significant taxpayer losses.

The United States has always encouraged home ownership, and rightly so. Home ownership builds wealth, stabilizes neighborhoods, creates jobs, and promotes economic growth. But it must be pursued responsibly. The right person must be matched to the right house (and consequently the right home loan), and in the years before the crisis we lost that discipline. The overstimulation of the housing market caused by government policy was exacerbated by other problems in that market.

Geithner, in his prepared remarks, instead focuses on regulation:

Nearly eight decades ago, after a series of banking crises led to the Great Depression, the United States put in place broad protections over the financial system. These reforms — deposit insurance, prudential rules to limit risk-taking by banks, and improved transparency and investor protection in our securities markets — alongside the Federal Reserve’s role as lender of last resort, laid the foundation for a more stable banking industry for several decades.

Over time, however, the financial system outgrew those protections. A large parallel financial system emerged outside of the framework of protections established for traditional banks. A great diversity of financial institutions emerged to provide banking services to individuals and companies, and they were allowed to operate without being subject to the same constraints applied to traditional banks. The shift in mortgage lending away from banks, the growth of the relative importance of non bank financial institutions, the increase in the size of investment banks, and the emergence of a range of specialized financing vehicles are all manifestations of this phenomenon.

Of the two, I think Paulson’s are the more interesting comments. Realistically, I fear there is only so much that the government can do in regulatory terms to stop Wall Street from blowing bubbles in the pursuit of profit — in that Washington can do nothing to shut down Wall Street’s trillion-dollar motive to seek outsize returns. But the Hill can turn off the tap of money and credit at the source of those outsize returns. Rising homeownership combined with and stoked by cheap credit not only put millions of people in homes, but created millions of new funding and securitization streams for Wall Street. If getting rid of Fannie and Freddie removes the government subsidy to that pipeline, in a way, housing market reform could be a bigger deal for the banks than the Dodd bill.

Diane E. Thompson, a lawyer with the National Consumer Law Center, begs to differ. As part of the Federal Reserve’s Consumer Advisory Council, she and other consumer advocates alerted him to the looming crisis in mortgages starting in the early 2000s. We spoke earlier today; the interview transcribed below is lightly edited for length and clarity.

Greenspan’s testimony seemed to contradict even the Fed’s own reports on the housing bubble.

I was surprised to read what he said, because he articulated a view that’s been thoroughly discredited over the past several years. There was no meaningful regulation [in housing by the Fed] between 2000 and 2008. Statements were issued, but they weren’t binding — they were advisory and worked around the edges of the problem. Plus, there weren’t even any such statements during the height of the crisis! When things were gathering steam and hens were coming home to roost, the Fed did nothing. And it did nothing despite the fact that many consumer advocates were warning about loans in the subprime market. He says that he believed the sub-prime market was so small it wouldn’t matter to the broader economy. But obviously it did.

I also found it interesting that he said the problem was the demand for those loans. To some extent I agree with him. There was demand for these loans, of course, but had there been meaningful restrictions in place, this would not have become the crisis it did. The Fed finally put those restrictions into place in 2008.

The other point that struck me was his description of how involved the Fed was. He has cited the Consumer Advisory Council, but it was created by statute. The Consumer Advisory Council doesn’t exist by the good of the Fed’s heart. The years I served on it, it was dominated by industry. The Fed governors would say, “We have all these meetings with the Consumer Advisory Council! We get an interchange of views!” But my experience was that it was difficult to get consumers heard.

And the crisis was easier to see from the end-user, consumer side of it than the banking side?

The problem was obvious to those of us who worked in the communities where the housing bubble originated, particularly the African-American and Latino communities that were just obliterated by subprime lending. I think that there was this understanding that this was a minority-community problem — deplorable, but not exportable to the rest of the economy. That was wrong.

How often and how strongly did the Consumer Advisory Council warn the Fed about the housing bubble?

The council meets three times a year, and I was on it for three years, in 2003, 2004, and 2005. I know that during my time on it, as well as before me and after me, there were consumer advocates who said, “There are problems in the subprime market, and they could impact the entire mortgage market and the entire economy.“

That isn’t to say — I will not claim to have predicted the financial meltdown. To be honest, I was shocked, because I assumed that investment bankers had a better grasp of risk management. But, I know for years before I came on, and for years after I went off, at least from 2001 to 2007, at every meeting, people said, “There are problems in the subprime market. These policies aren’t promoting home ownership. If anything, they’re going to end up doing the opposite.”

I have heard statements from Greenspan in the past two years that seem to me more reflective of the role the Fed played and more cognizant of the fact the Fed missed signs of the crisis, which he did not say here.

What else surprised you in the testimony?

I was surprised at the attack on the GSEs [government-sponsored enterprises, Fannie Mae and Freddie Mac]. I was particularly surprised that he said that the banks weren’t the problem, but that the GSEs were. They got into the subprime boom late — and they aren’t what is driving the current foreclosure crisis. They contributed to the volume for some bad loans, but so did the large banks.

And so ultimately, as a consumer advocate…

There’s an assumption that runs throughout his testimony that these toxic products were in fact affordable products that increased home ownership. That continues to be a popular view among bankers. If you get rid of these toxic products you will reduce homeownership; these products help increase homeownership. That is contrary to all of my experience. There is just a weird tautology in saying there wasn’t a problem in the origination of the loans, but the demand for them.

There’s tremendous demand for cocaine — it would be like saying the issue isn’t the sale of cocaine, but the fact that there’s tremendous demand for cocaine. It is just bizarre. Can you imagine our drug enforcement focusing exclusively on drug users rather than drug dealers?

Prince opened his remarks with regrets. “I’m sorry,” he said. “I’m sorry the financial crisis has had such a devastating impact for our country. I’m sorry about the millions of people, average Americans, who lost their homes. And I’m sorry that our management team, starting with me, like so many others could not see the unprecedented market collapse that lay before us.” (The apologia deviated from Prince’s prepared statement, which read: “I can only say that I am deeply sorry that our management, starting with me, was not more prescient and that we did not foresee what lay before us.”)

Such candor was unexpected and, at least judging the faces of the commissioners, welcome. But hours of rationalization, blame shifting, and evasion followed during questioning that at times became heated. Indeed, while Rubin and Prince expressed regret in general, they refused to classify their own or any of Citigroup’s actions as anything other than mistakes made in the run-up to an unforeseeable bust.

The commissioners’ questions focused on mortgage-backed securities, the housing bubble, derivatives regulation, Citigroup’s losses and the problem of too big to fail. “I personally do not think Citi was too big to manage,” Prince said, a sentiment Rubin echoed. Prince said the “broad, multifaceted and diversified nature” of Citigroup’s investments and liabilities did not “materially contribut[e] to our losses.”

That statement jarred with Rubin’s testimony; he cited the interconnectedness of financial firms and financial products, which undercut diversification, as particularly destructive during the financial crisis. Asked why he did not recognize the extent of Citigroup’s liabilities until too late, the former Treasury Secretary defensively noted that Citigroup managed “trillions” of dollars every day and the best risk management the company could perform was to put the “right people” in place. He also called Citigroup’s risk management “robust and proactive.”

FCIC Chair Phil Angelides later pointedly asked Rubin, “Do you bear central responsibility for the near-collapse, but for the government, of Citigroup?” He replied that Citigroup’s board, which he led, was not “a substantive part of the decision-making process” at the firm. “All of us in the industry failed to see the potential for this serious crisis. We failed to see the multiple factors at work.”

“In the process of selling them to institutional investors, however, your firm lobbied ratings agencies to assign them high ratings as solid bets — even as your firm planned on shorting them,” Sorkin wrote as mock questioner. “Could you explain how Goldman bet against these [mortgage bundles] while simultaneously trying to persuade ratings agencies and investors that they were good investments?”

Today, during the first gathering of the commission, Chairman Phil Angelides took Sorkin’s advice.

“How do you persuade [rating agencies] to give many of the tranches the highest ratings — triple A — at the same time that you have credit information that leads you to believe that, in fact, those securities may fail?” Angelides, former California state treasurer, asked Blankfein. “It sounds to me a little bit like selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars.”

The resulting exchange between Blankfein and Angelides lends a good deal of insight into the thinking of Wall Street power brokers.

Blankfein: Every purchaser, is an institution — probably professional-only investors — dedicated, in most cases, to this business.”

Angelides: Representing pension funds which have the life savings of police officers, teachers…

Blankfein: These are the professional investors who want this exposure.

To translate, what Blankfein is saying here is that Wall Street brokers really don’t have any greater responsibility than used car salesmen, and if they can convince someone — a professional, he clarifies — to buy a lemon, well, joke’s on them, and the seller wins that round. This is just a game to these guys. Trouble is, they all played so badly that the entire country — even those with no interest in Wall Street investing — suffered the fall.

If nothing else, this is perhaps a warning to those police officers and teachers that their money is much safer under the mattress.

By the end of October, Angelides said at this morning’s first FCIC meeting, the panel will “be sending letters to companies referenced in the statute to make sure records are preserved.”

The FCIC was given a $5 million budget as well as 22 separate financial issues and products to investigate as possible causes of the economic meltdown. (A list of all 22 is available after the jump.) Angelides said the panel soon would “boil those [22] down” and give the public a sense of in what order they would tackle.

As it moves forward — potentially striking fear in the hearts of any bank executive who’s considered turning on the shredder — the FCIC plans to open a full-time Washington office and hire more staff members. The panel’s senior aide has already started work: Thomas Greene, a 25-year veteran of the California attorney general’s office and leader of the civil prosecution team that took on Enron.

The FCIC’s 22 areas of focus cover the horizon of financial practices that have come under fire for helping to encourage unsustainable risk, subprime mortgage lending, and the securitization of just about everything under the sun. Indeed, its biggest obstacle in leaving no stone unturned may not be the political ties of its members or Congress’ uncertain regulatory reform effort, but rather the rules for issuing subpoenas.

The law that created the FCIC, which is split 6 to 4 in favor of Democratic-named members, specifies that subpoenas must be approved by at least one GOP-appointed member in order to be valid. Thus, Republicans could theoretically stave off a summons to a former Bush administration official by withholding their votes and pressing for private discussions rather than public testimony.

The bipartisan 9/11 Commission, which was evenly matched between Democrats and Republicans, accepted private, time-constrained interviews with former President George W. Bush and Vice President Dick Cheney, while former President Clinton and Vice President Al Gore agreed to take questions in public without a time limit.

The FCIC’s mission, according to the statute that created it, is “to examine the causes of the current financial and economic crisis in the United States, specifically the role of”:

(A) fraud and abuse in the financial sector, including fraud and abuse towards consumers in the mortgage sector;
(B) Federal and State financial regulators, including the extent to which they enforced, or failed to enforce statutory, regulatory, or supervisory requirements;
(C) the global imbalance of savings, international capital flows, and fiscal imbalances of various governments;
(D) monetary policy and the availability and terms of credit;
(E) accounting practices, including, mark-to-market and fair value rules, and treatment of off-balance sheet vehicles;
(F) tax treatment of financial products and investments;
(G) capital requirements and regulations on leverage and liquidity, including the capital structures of regulated and non-regulated financial entities;
(H) credit rating agencies in the financial system, including, reliance on credit ratings by financial institutions and Federal financial regulators, the use of credit ratings in financial regulation, and the use of credit ratings in the securitization markets;
(I) lending practices and securitization, including the originate-to-distribute model for extending credit and transferring risk;
(J) affiliations between insured depository institutions and securities, insurance, and other types of nonbanking companies;
(K) the concept that certain institutions are `too-big-to-fail’ and its impact on market expectations;
(L) corporate governance, including the impact of company conversions from partnerships to corporations;
(M) compensation structures;
(N) changes in compensation for employees of financial companies, as compared to compensation for others with similar skill sets in the labor market;
(O) the legal and regulatory structure of the United States housing market;
(P) derivatives and unregulated financial products and practices, including credit default swaps;
(Q) short-selling;
(R) financial institution reliance on numerical models, including risk models and credit ratings;
(S) the legal and regulatory structure governing financial institutions, including the extent to which the structure creates the opportunity for financial institutions to engage in regulatory arbitrage;
(T) the legal and regulatory structure governing investor and mortgagor protection;
(U) financial institutions and government-sponsored enterprises; and
(V) the quality of due diligence undertaken by financial institutions

Brooksley Born, who fought unsuccessfully to regulate derivatives during her years at the helm of the Commodity Futures Trading Commission (CFTC), singled out “the failure of government to oversee the financial markets” as a central cause of the meltdown that began last year. “Experience has now clearly shown that financial markets cannot self-regulate,” Born said, urging her colleagues on the panel to “identify and examine regulatory gaps and failures so that they may be eliminated.”

But while Born urged Congress and the Obama administration to press ahead with strong new rules of the road for Wall Street, fellow commissioner Keith Hennessey declared that reform legislation has a slim chance of passing this year.

Still, Hennessey added, the panel’s deadline of December 2010 to release its final report risks making its conclusions irrelevant.

“We cannot predict when Congress will act, but we’ve been given a job to do and part of that job is to be as useful to lawmakers as possible,” said Phil Angelides, the panel’s Democratic-appointed chairman. Members of the Financial Crisis Inquiry Commission, as the panel is formally known, will “structure our work with knowledge of the congressional calendar,” Angelides added.

Lawmakers originally hoped that the House would act on regulatory reform before the fall, but the House Financial Services Committee postponed its vote on the White House’s proposed Consumer Financial Protection Agency, likely until next month. The decision of Senate Banking Committee Chairman Chris Dodd (D-Conn.) to retain his gavel has been seen as a boost for financial reform’s prospects in the upper chamber, but FCIC members stressed the importance of keeping their work connected to — and independent from — the action on Capitol Hill.

“There’s no question that this commission had a political birth,” quipped former House Ways and Means Committee Chairman Bill Thomas (R-Calif.), now the FCIC vice chairman. But, he noted, one can stay defined by one’s birth or “get on with your life.”

Speaking to reporters after the FCIC’s first meeting, Thomas offered his own prediction that Congress would ultimately come down harder on a financial industry that is still weighing how much systemic risk to embrace. “It isn’t whether there will be regulation or not,” Thomas said. “It’s whether it’ll be regulation for the sake of regulation.”

One possible obstacle to moving quickly: many members of the commission have close ties to the elite financial institutions that played a central role in the crisis, and several are known as dogged supporters of the political party that named them to the panel. Will the inquiry truly turn over every rock and question every tight-lipped bank executive? We could begin to see the  answer today. In the meantime, let’s meet the investigators.

Phil Angelides: The commission’s chairman was most recently in public view as the Democrats’ 2006 nominee for California governor, but he has vowed to use famed 1930s financial investigator Ferdinand Pecora as a model and pursue a non-partisan, just-the-facts approach. Angelides’ first test may be the reluctance of White House or Wall Street officials to abide by subpoenas for testimony; such refusals became a problem for the 9/11 Commission in its early days.

Bill Thomas: During his years as GOP chairman of the influential House Ways and Means Committee, Thomas earned a reputation as a brilliant and fierce combatant in the fight for broad deregulation of industry. He voted for the Gramm-Leach-Bliley Act that allowed banks to amass unprecedented amounts of risk, and he raised $1.8 million from the financial industry during his political career.

Brooksley Born: This former chairwoman of the Commodity Futures Trading Commission became a folk hero of sorts after the economy began its free fall, when her struggle to regulate the shadowy world of derivatives trading burst into public view. Born lost the battle she waged in the late 1990s with then-Fed chairman Alan Greenspan and Larry Summers, then and now a senior White House economics adviser. But she could well be the most vocal commission member when it comes to unmasking the government’s failure to guard against financial risk – because she had a front-row seat.

John W. Thompson: Formerly chairman of the high-tech company Symantec, Thompson was singled out by the Center for Responsive Politics as the commission’s most prolific political campaign donor. During the 2008 cycle alone, he and his wife gave more than $405,000 to Democratic candidates.

Sen. Bob Graham (D-Fla.): This former chairman of the intelligence committee is no stranger to bank-industry cash, raising $2.1 million from financial firms during his career.

Keith Hennessey: This former economic adviser to President George W. Bush could be a witness for the panel, were he not a member. Hennessey joined the White House in late 2007, and he told Foreign Policy magazine last month that few on the president’s team saw the financial crisis coming until it hit in mid-2008.

Byron Georgiou: Based in Las Vegas, Georgiou is an attorney whose firm represents shareholders in several lawsuits filed against bailed-out banks, including Morgan Stanley and Bear Stearns.

Douglas Holtz-Eakin: After heading the non-partisan Congressional Budget Office during the GOP’s years in control of Congress, Holtz-Eakin left to start his own private consulting firm and serve as a senior economic adviser to Sen. John McCain’s (R-Ariz.) presidential campaign last year. Whether the CBO-era Holtz-Eakin or the more partisan McCain-era Holtz-Eakin will emerge should be interesting to watch as the commission digs deeper into the crisis.

Peter Wallison: This GOP appointee, a longtime fellow at the American Enterprise Institute, has already claimed to have uncovered the cause of the financial crisis – Fannie Mae and Freddie Mac’s role in helping low-income homeowners obtain mortgages. While Fannie and Freddie were certainly not blameless, Wallison’s narrative is shared almost exclusively by other conservatives.

Heather Murren: Named to the commission by Senate Majority Leader Harry Reid (D-Nev.), Murren is a veteran managing director at Merrill Lynch, the firm that paid out $3.6 billion in bonuses in the final days before its shotgun wedding with Bank of America.

With the commission stacked with so many of its friends, the financial industry is likely breathing a little easier than it was when the panel was proposed in April.