When the Financial Crisis Inquiry Commission opened for business on September 17, it was a nonevent for the media. Leading newspapers brushed aside chairman Phil Angelides, the former California state treasurer, and his declaration of purpose–“uncovering the facts and providing an unbiased historical accounting of what brought our financial system and our economy to its knees.” As Angelides put it, “The fuses for that cataclysm were undoubtedly lit years before. It is our job to diligently and doggedly follow those fuses to their origins.”

The press has moved on. Financial crisis was last year’s story. Didn’t the Treasury and Federal Reserve announce they have already turned things around? Hasn’t the president proposed a bunch of complicated reforms (boring!) for Congress to enact? Yes, but that is the problem. How can Washington reform the financial system when we still don’t know what happened?

We may know the broad outlines, but the landscape remains littered with unanswered questions and informed suspicions about who did what to produce the breakdown. The relevant facts are still buried in the files of Wall Street firms and the regulatory agencies that utterly failed as watchdogs. The Angelides commission has the subpoena power to dig out secrets–from e-mails and private memos, and through testimony under oath–that can disclose political deal-making and ruinous financial strategies. Given the rush of events, the commission may be the public’s last, best chance to get at the truth of the matter.

Congress created the ten-member commission (six Democrats, four Republicans) to identify the root causes of the financial crisis. It listed more than twenty areas for inquiry, from the collapse of individual institutions to the complex financial instruments now known as toxic assets. It is a gigantic task fraught with explosive implications for government and finance.

The commission has chosen an executive director with an impressive twenty-five-year history of uncovering corporate fraud and malfeasance. Thomas Greene, chief assistant attorney general from California endorsed as a nonpartisan straight shooter by the Republican and Democratic attorneys general he served, has led complex investigations into anti-trust, price-fixing and deceptive accounting gimmicks on cases involving big names like Enron, Microsoft and El Paso Natural Gas. The financial crisis has all those elements and more.

“If we do this right,” Angelides said, “our work can serve as an antidote–much as the Pecora hearings did in the 1930s–to the kinds of financial market practices that none of us would want to see be repeated ever again.”

In the New Deal years, the Congressional investigation led by Ferdinand Pecora helped build the case for landmark regulatory reforms–legislation establishing the Securities and Exchange Commission and the Glass-Steagall Act, which separated commercial banks from risk-taking investment banks. Like Pecora, Angelides does not intend to propose policy solutions but simply to discover what really happened.

“I’m very serious on this point,” Angelides told me in an informal conversation. “If we stick to the hard facts, we might turn up some perpetrators, but our job is to accomplish something more than that. If we pursue all the facts, we can give the American people a clear understanding of what occurred during the last twenty years or so. What forces lit the fire that led to this explosion? What exactly happened with those financial firms that failed? What happened in regulation or at the Federal Reserve? What happened in the economy to fuel the fire? Where were the firefighters? Who was asleep? Who was awake? Who sounded the alarm and was ignored? It could be a very disturbing story.”

Washington cynics have low expectations for Angelides. Too many important people just want the whole thing to go away. The Obama administration had hoped to pass its reform package quickly and then move on. But the White House plan, which rearranges the boxes among regulatory agencies and puts the Fed in charge, is stalled by rising skepticism in Congress and doubts expressed by establishment figures like former Federal Reserve chairman Paul Volcker, who is particularly wary of making the “too big to fail” doctrine into a permanent assumption. In a statement to the House Banking and Financial Services Committee on September 24, Volcker asked, “Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?” Volcker wants commercial banks restored to their narrower purpose–taking deposits and lending to borrowers, instead of playing in high-risk financial markets. He does not say so directly, but that would restore some protections enacted seventy years ago by Glass-Steagall and repealed by the Clinton administration.

Even if Congress manages to act this fall, the debate will not end. Obama’s plan does not begin to get at the rot in the financial system. Wall Street’s most notorious practices continue to flourish, and if unemployment rates keep rising through 2010, the public will not set aside its anger. The Angelides investigators could put the story back on the front page.

The good news is, there are not one but two major investigations exploring this ground. The House Committee on Oversight and Government Reform, chaired by Edolphus Towns of Brooklyn, New York, broke a hoary taboo this summer–unprecedented in modern times–by issuing two subpoenas to the Federal Reserve, demanding e-mails and other documents on its role in Bank of America’s subsidized takeover of Merrill Lynch. The Fed tried to duck and dodge, but given its tarnished reputation, it complied rather than provoke a fight it was bound to lose.

Towns used the evidence from private communications to grill officials with provocative questions. Did Fed chairman Ben Bernanke bully BofA into doing a bad deal? Did BofA CEO Ken Lewis mislead his shareholders on the losses and the outrageous midnight bonuses the bank paid to Merrill Lynch executives? After the hearings, Towns sent a tart letter to Lewis, mocking his double talk and demanding more documents. On September 30 Lewis threw in the towel and announced his retirement. (BofA remains in the cross hairs.)

Bite by bite, Towns is trying to keep alive the aggressive style he inherited from former Oversight Committee chair Henry Waxman. Next he is going after Moody’s and other credit-rating agencies that issued triple-A ratings for rotten mortgage securities. The tough-guy approach can produce results, as the example of BofA shows, but also can carry political risks. Right-wing Republicans have blasted back at Towns, accusing him of getting sweetheart mortgages from Countrywide Financial (now owned by BofA). “Congressman Towns did not receive, nor did he seek, any special mortgage benefits,” his office responded.

Towns has one crucial advantage over Angelides–the power to issue subpoenas single-handedly. Angelides is required by law to get approval from at least one of the commission Republicans, who are led by former California Congressman Bill Thomas, a brainy and formidable figure. This rule means GOP members (or Democrats, for that matter) could stall or stymie the investigation. If that occurs, Angelides should go public and call them on their tactics.

“We have started off on the right footing,” Angelides insists. “Bill Thomas and I are working together. I have reason to believe both Republicans and Democrats on the commission want to and should have an interest in getting to the truth.” The chairman, in any case, promises to “pull no punches.” Meanwhile, he could develop useful relationships with Towns and with aggressive state attorneys general like Andrew Cuomo of New York, who also targeted Lewis, and Jerry Brown of California. There is plenty of scandal to go around.

Digging deep can begin with uncovering shocking revelations about the bailouts. That would redirect the reform debate toward more fundamental issues. Here are some promising targets for investigators:

Collusion in High Places

. Some Wall Street players suspect that certain bailouts engineered by the Treasury and the Federal Reserve (including Treasury Secretary Timothy Geithner, former head of the New York Fed) were motivated by a logic never revealed to the public. The suspicion goes like this: the strange and costly rescue of AIG, an insurance company facing bankruptcy, was really intended to save Goldman Sachs, the premier investment house. If AIG went down, it would threaten Goldman and other big holders of AIG’s collapsing derivative contracts. Goldman CEO Lloyd Blankfein participated in the pre-bailout discussions, an oddity revealed by Gretchen Morgenson of the New York Times. Afterward, Goldman got paid off in full with the public’s money–$12.9 billion to erase its exposure.

Something similar is suspected about the Bear Stearns bailout. The intention may have been to protect JPMorgan Chase, the commercial bank with the largest holdings of vulnerable derivatives. Morgan Chase demanded and got full federal financing for any losses it might suffer by taking over Bear Stearns (in effect, the bank was reimbursed for its own rescue). Did Washington decline to rescue Lehman Brothers because the firm was not sponsored by an important club member that felt threatened by Lehman’s demise?

Answering these questions can illuminate the overbearing influence on government exercised by the two dozen or so firms at the pinnacle of financial power. Both the Bush and Obama administrations were committed to saving the big boys first, demanding little or nothing in return. The favoritism raises other unexplored questions. Why, for instance, hasn’t the Treasury bought up rotten assets from the troubled banks after demanding Congress put up $700 billion for that purpose? One possibility is that officials may have devised a back-door way to clean up bank balance sheets without provoking more anger in Congress. It appears that toxic assets are gradually being offloaded through three discreet channels the government now controls–AIG, Fannie Mae and the Federal Reserve. Look, no hands. If people can’t see it happening, they can’t get mad.

Unprosecuted Crimes

. Beyond Ponzi schemes and deceitful mortgage lending, a far larger crime may lurk at the center of the crisis–wholesale securities fraud. “Risk models” reassured unwitting investors who bought millions of bundled mortgage securities and derivatives like credit-default swaps. But as Christopher Whalen of Institutional Risk Analytics has testified, many of the models lacked real-life markets where they could be tested and verified. “Clearly, we have now many examples where a model or the pretense of a model was used as a vehicle for creating risk and hiding it,” Whalen said. “More important, however, is the role of financial models for creating opportunities for deliberate acts of securities fraud.” That’s what investigators can examine. What did the Wall Street firms know about the reliability of these models when they sold the securities? And what did they tell the buyers?

Who Let the Dogs Out?

The question of political blame is explosive but not partisan. Both parties collaborated in stripping away the safeguards against greed and recklessness, authorizing the culture of permissiveness that led to ruin. The invitation to irresponsibility originated on the right with the naïve ideology of Milton Friedman. Republicans were the most zealous advocates for gutting New Deal regulations that had produced financial stability for three generations, but Democrats started the game when they repealed the federal law against usury and the legal ceilings on interest rates in 1980 (before Ronald Reagan came to Washington).

Both parties championed the creation of all-purpose mega-banks with the 1999 repeal of the Glass-Steagall Act. The Federal Reserve permitted Citibank to ignore the law even before it was repealed. Indeed, nearly every offense attributed to reckless bankers was authorized by Congress and presidents–over-borrowing against bank capital, hiding debt with accounting tricks, evading regulatory laws by interacting with hedge funds and other nonbanks. The political culprits have not shown much remorse or offered apologies. That’s what makes the prospective investigations so important.

The Failure of the Fed.

The Federal Reserve’s dereliction as the regulator of the banking system is by now widely understood. But far more grave was the central bank’s failure to conduct responsible monetary policy. Driven by Friedmanite ideology, Fed governors tipped the normal balance in favor of capital over labor, the financial sector over the productive economy. The result was numerous disorders, including the triumph of the financiers and swelling income inequality. Monetary policy became unreliable as “bubbles” inflated, followed by recession. Instead of moderating, Fed policy swung between extremes and ultimately destabilized the entire economy.

One reason for the Fed’s failure is that deregulation undermined the central bank’s ability to manage the supply of credit. As rules and prudential limits were abandoned or unenforced, the Fed’s policy mechanisms were steadily weakened, and it lost control of its core function–countering the real economy’s excesses both on the upside and the downside. Debt exploded, accumulating far faster than economic growth. Instead of candidly addressing the central bank’s weakness, though, Alan Greenspan led cheers for the new order–right up to the day it collapsed. If nothing significant is changed about monetary policy, more bubbles and crashes will surely follow.

Dysfunctional Democracy

. Surely the political system itself is a root cause of the financial crisis. The swollen influence of financial interests pushed Congress and presidents to repeal regulation and look the other way as reckless excesses developed. Efforts to restore a more reliable representative democracy can start with Congress. The power of money could be curbed by new rules prohibiting members of key committees from accepting contributions from the sectors they oversee. Regulatory agencies, likewise, need internal designs to protect them from capture by the industries they regulate.

The Federal Reserve, having failed in its obligations so profoundly, should be reconstituted as an accountable federal agency, shorn of the excessive secrecy and insider privileges accorded to bankers. The Constitution gives Congress, not the executive branch, the responsibility for managing money and credit. Congress must reassert this responsibility and learn how to provide adequate oversight and policy critique. [See “Dismantling the Temple,” Aug. 3/10.]

Reforming the financial system, in other words, can be the prelude to reviving representative democracy.

Origins of the Debtor Nation

. Congress instructed the Angelides commission to examine lopsided financial flows in the global economy and the global imbalance of savings. How did China wind up with a mountain of surplus capital while the US economy has had to borrow more heavily from abroad each year just to stay afloat? One obvious explanation is the unbalanced trading system in which the United States has been steadily weakened by serving as “buyer of last resort” for other nations’ exports. During the past two decades, the United States piled up something like $15 trillion in debt from trade deficits, as value-added production and jobs were relocated overseas. Simply put, we import a lot more than we export, goods we buy from abroad that used to be manufactured in the United States.

Political debate usually avoids the links between negative US trade and our weakened condition as a debtor nation, but the consequences are visible through several channels. The out-migration of production and jobs drives the long-running stagnation of industrial wages, roughly stuck at the same level as in 1973. The annual trade deficits, recently as high as 6 percent of GDP, subtract directly from domestic economic growth. These ill effects and others have created a permanent shortfall in aggregate demand–not enough consumers with the money to buy the stuff they need or want. So households rely on borrowing to pay the bills and hang on to their faltering living standards.

The financial crisis crisply marks an end to that era of false prosperity. The illusion of living well on borrowed money cannot be revived by repairing the banking system. The restoration of prosperity will require wrenching economic changes, including a very different US approach to the global trading system. No one expects the commission to solve the trade problem, of course. But the investigation can restart the debate on more honest terms. Asking deeper questions about the true sources of the calamity is a first step toward developing authentic answers to the nation’s predicament.