Report Details Wall Street Crisis

Twelve of the 13 largest U.S. financial institutions "were at risk of failure" at the depth of the 2008 financial crisis, while at least 50 hedge funds tried to capitalize on it, according to a report released Thursday by a U.S. panel investigating how the financial system unraveled.

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Phil Angelides, chairman of the Financial Crisis Inquiry Commission, displays a copy of the report Thursday.

The report quantifies a huge run on the bank at Morgan Stanley, describes the alleged trading practices of a secretive hedge fund and tallies the number of such funds betting against U.S. homeowners.

The 545-page document paints a picture of a financial system let loose by lax regulation and careening out of control. Regulators now are hammering out a financial-regulatory overhaul, though some analysts say not enough has been done since to prevent a recurrence.

The Financial Crisis Inquiry Commission didn't produce new culprits or scandals in a crisis already analyzed at length by the news media, a U.S. Senate investigation, a congressional oversight committee, an inspector general and financial regulators.

Partisan divisions that emerged in the report's drafting could also detract from its impact, with Republican members saying they couldn't support the majority's conclusions.

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The report described a shadow banking system that helped trigger a more than tenfold surge in financial-sector debt, to $36 trillion in 2007 from $3 trillion in 1978.

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Partisan Rancor Undercuts Probe

See selections from the FCIC report referenced in this story.

Then it crumbled, Federal Reserve Chairman Ben Bernanke told the commission in a November 2009 interview.

"As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression," Mr. Bernanke said, according to the commission's report.

Of the 13 most important U.S. financial institutions, "12 were at risk of failure within a period of a week or two," the report quoted Mr. Bernanke as saying.

Mr. Bernanke declined to comment through a spokeswoman.

The list of potential failures included Goldman Sachs Group Inc., people familiar with the report said. The only major financial institution not at risk at the time was J.P. Morgan Chase.

Spokesmen for J.P. Morgan Chase and Goldman Sachs declined to comment on the report.

After regulators let Lehman Brothers Holdings Inc. collapse in September 2008, one of the most vulnerable banks was Morgan Stanley, the report notes.

Hedge funds pulled $86 billion in assets from the investment bank in the week following the Sept. 15 Lehman bankruptcy filing, stemming from concerns about Morgan Stanley's viability, according to a Morgan Stanley email at the time to the New York Federal Reserve titled "Liquidity Landscape."

"Many of our sophisticated clients started to liquefy," Morgan Stanley Treasurer David Wong told the commission in October. A Morgan Stanley spokeswoman declined to comment.

The report also provided clarity about the number of hedge funds gambling homeowners couldn't pay their mortgages.

In an interview with the commission, former Deutsche Bank AG trader Greg Lippmann—who played a key role in facilitating short bets—told the commission that in 2006 and 2007 he handled trades for at least 50 hedge funds and "maybe as many as 100" betting that mortgage-backed securities would fall.

An FCIC survey of some hedge funds found they had a total of $45 billion of short bets, which easily outweighed roughly $25 billion of bullish positions they had on mortgages.

The panel also scrutinized the conflicts of interest—involving Wall Street banks, hedge funds and investors—created by the pools of mortgage debt known as collateralized debt obligations.

The crisis panel cited a $1.5 billion CDO called "Norma," underwritten by Merrill Lynch & Co. in 2007. The assets backing the CDOs were to be selected and overseen by a third-party "collateral" manager called NIR Capital Management.

As Norma's value crumbled, some investors and others complained that Magnetar Capital—a hedge fund that had placed bearish and bullish bets on the Norma CDO—played an active role in helping to select Norma's assets.

This would potentially have created a conflict because Magnetar, a Merrill client, would have had an incentive to select poor-performing assets and benefit from short bets it made against the CDO.

The crisis panel said Magnetar had "executed approximately $600 million in trades for Norma" and that Merrill failed to disclose that Magnetar "was selecting collateral when it also had a short position that would benefit from losses."

On Thursday, a Magnetar spokesman said the hedge fund "did not control the selection or acquisition of assets in any CDO, including Norma."

A spokesman for Bank of America, Merrill's current owner, said: "While most of these matters have been closely scrutinized and addressed, the work of the commission is important and we'll review their reports carefully."

Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com, Aaron Lucchetti at aaron.lucchetti@wsj.com and Serena Ng at serena.ng@wsj.com

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