First came the financial meltdown – now here comes the regulation. That’s not a bad thing, but almost none of the players that created this large problem are willing to accept any responsibility: the Federal Reserve, Congress or any of the banks. I’m a firm believer that in order to fix a problem, we first need to understand how it happened. Then I’ve got a few prescriptions.
Problem 1: The federal government encouraged and still encourages banks and other financial intermediaries to make mortgage loans to anyone with a pulse and even agreed to insure these banks against potential losses. Whether the borrower could ever hope to pay back the loan was not important. And, oh, by the way, many lawmakers and regulators have argued that responsible citizens should bail out the irresponsible borrowers, eyes closed, no questions asked.
Problem 2: Throughout the past 10 years, the bank regulators knew that the largest institutions – banks, car loan companies, insurance companies, then and now branded with a cattle iron as “too big to fail” – had continued to pile extremely risky derivatives into their systems. However, probably because these regulators had no clue how to evaluate these complex instruments, these institutions were permitted to keep this junk off their balance sheets so their regulators did not have to worry about how to deal with the problem. Note that I did not say that the regulations did not exist; they did, but no one would enforce them. When U.S. buyers ran out of cash for this junk created, the investment banks that created the stuff sold it to as many foreign governments and financial institutions as possible. Moreover, it turns out that the insurance and bank regulators were completely unaware that many of the derivatives traded on the backs of envelopes. As if this weren’t bad enough, in early 2009 the regulators and Congress threw fuel on the fire and forced an accounting change on the system that allowed banks not to place a real value on problem assets that ARE on their balance sheets.
Problem 3: Too-big-to-fail financial institutions (and car companies, for that matter) are a problem. Here the government du jour gets to pick and choose which institutions it likes and which it does not, saving the big ones that get into trouble and sinking the others when the economy goes bad. What this means for the rest of us: either these institutions will never be shut down or, looking at current solutions on the table, even if they are, it will cost all taxpayers an enormous amount. Banks don’t want a real solution. They can continue to pay their executives enormous compensation packages at taxpayers’ bailout expense. National lawmakers do not want to fix this problem effectively because they receive such large contributions from these same people, and they can force these now “quasi-public” institutions to implement social policies to their liking.
Problem 4: Total U.S. government and private debt is huge and must be reduced. Depending on how the numbers are counted, during this near meltdown the U.S. government has added up to an additional $26 trillion to our national debt. And a large number of municipalities cannot pay their current bills. Birmingham, Ala., and Harrisburg, Pa., are virtually bankrupt. California and New York (much like irresponsible mortgage borrowers) have asked the federal government and hence other taxpayers to consider bailing them out. Yet, putting aside how to reduce this debt for a minute, the Federal Reserve and the current administration have not only avoided the debt reduction process, both also continue to encourage U.S. consumers and states to spend more, even though it means that more debt.
Problem 5: The world relied on rating agencies to provide them with a religious blessing to justify much of this – sort of like a blessing from the imam, rabbi, pope or anyone else you could think of that would give you permission to sleep at night no matter what. The rating agencies had to evaluate all of this environmentally toxic stuff before the investment banks could package it and anyone would buy it, and guess what? They were paid to ignore the fact that taking a bite of so much of this would cause cancer – the really aggressive kind.
Now I’m not just a complainer. Here are my simple fixes (yeah, right), or at least a simple statement of our solution:
Solution 1: Shut down Fannie Mae and Freddie Mac now, and require that all new mortgage borrowers put down at least 20 percent and have real, verifiable income.
Solution 2: Bring all derivatives onto a recognized market exchange. This concept is included in the bill being debated in Congress. But let’s go one more: Force financial institutions of any kind to account for all investments – derivatives or otherwise – on their balance sheets, and put real values to these securities, just like the rest of us do. And do not allow bank regulators to grant selected exemptions.
Solution 3: Break up all too-big-to-fail institutions – commercial and investment banks, insurance companies, GMAC and their Ally Bank (and, yes, industrial companies) – into pieces so small that failure of any one piece will cause no major disruptions to our financial system and taxpayer-funded fixes will be close to nonexistent. Going back to Glass-Steagall divisions between commercial and investment banks presumes that if Goldman Sachs goes back to life as purely an investment bank but stays the behemoth that it is, the Fed and the federal government would not bail them out if they start to fail – obviously this is not true. The current solution proposed in Congress would not change anything. It would create a bailout fund of $50 billion to $250 billion, once again funded by the rest of us taxpayers.
Solution 4: Have the Fed and the administration announce that the time to stop spending at all levels of society is right now, not next year or whenever they think is best. This means that the Fed will no longer buy any debt issued by banks, insurance companies or car companies. After this pronouncement, try to reduce the current debt choking all of us.
Solution 5: Change how the rating agencies are paid, and make them liable for the problems that they helped create.
Craig Forbes is a co-founder of Alpha Omega Wealth Management, LLC, a registered Investment Advisory Firm in Richmond Virginia (www.aowealthmanagement.com). You can contact Craig at aowm@aowealth.com.
Exactly. What amazes me is that congress is getting set to ‘regulate’ the banks and financial industries and has yet to spend even a moment to identify and understand what the problem is. How can congress add yet more regulation to the financial industry when they do not understand the industry, the problem and its underlying causes? They’ve spent more time in the congressional cafeteria picking out their lunch entre than they have in consideration of these issues. And, in my mind, more amazing, but all too common, they have yet to recognize or acknowledge their major role in helping to create this problem. So, okay. Congress is going to generate more regulation to control an industry that it does not understand and to solve a problem that they have not taken the time to identify. Fine. Congress is going to regulate. That’s what they do. But who will regulate them?
We need a few new Amendments to the Constitution that further limits the powers of Congress and the President. While they can start with a balanced budget, I’d suggest the following:
“Healthy free trade and commerce being the life blood every nation’s economy, Congress shall not involve itself in the operations or insert itself into the management of private enterprise.”
Let those who understand the financial industry and banking oversee finance and banking. For too long we’ve handed control and oversight over to a government that has no understanding of these industries. As a result, the people, government and the industry has become complacent. Why worry? The government is lifeguarding the pool. This has been the major fault in regulation. The government can’t swim!