Is it me or does it feel more and more like we should be brushing up on the Romance languages of Europe? Why do I ask that? Because America right now feels a helluva lot like Turkey – intent on implementing policies that will ease our admission into the European Union. Maybe I missed the press release but I didn’t realize Americans had voted in the current administration or the rest of our so called “representatives” in Washington to turn America into a paternalistic, entrepreneurial bashing, risk averse, socialist leaning country. Sure, I understand that we are in the midst of one of the worst financial crises we have faced since the “Great Depression” (how’s that for an oxymoron), but we have never reacted in a way that so greatly challenged the fundamentals of our capitalistic society as we are now.
Do I believe that improvements can be made in our regulatory structure, our financial systems, and the way we manage systemic risk? Absolutely.
Do I believe that in order to address those challenges we should embrace an EU type model that favors higher taxes, more government intervention in private enterprise, and a spate of social programs financed by high taxes leading to a dependence on the state rather than self-reliance? Absolutely not!
Based on where this country has been headed this year, I have a target rich environment of gripes to pursue. However I’m going to limit my kvetching to three topics that will affect our financial providers in Gonzo land. So I will now surmount my soap box for a brief diatribe on what’s bugging me.
The Perceived Problem: Bankers want to make money; they’re greedy, and in order to make more money they engage in excessive risk taking, which puts the whole financial system at risk. In the end, taxpayers will end up paying to bail out the financial institutions guilty of this.
The Proposed Solution: Punish the entire banking industry. On Aug. 1 the House passed legislation to allow federal regulators to restrict “inappropriate or imprudently risky” pay packages at financial companies with over $1 billion in assets and to give shareholders a greater say over executive compensation at both financial and non-financial companies alike. The legislation would require federal regulators to implement rules aimed at preventing financial firms from adopting compensation systems that encourage excessive risk-taking.
The Problem with the Solution: First, the solution is overbroad based on a vernacular issue we face. The country has learned to associate excessive compensation and the recession with “greedy bankers.” The issue as you loyal GonzoBanker readers know is that average “bankers” aren’t earning outsize pay packages; those are being rewarded to investment bankers and traders who engage in activities our mid-size and community banks typically don’t engage in. When is the last time you heard of a commercial lender, branch manager, EVP of retail, or small business banker being awarded a 7-figure bonus? There’s currently a big brouhaha over whether Andrew Hall at Citigroup should be paid his $100 million bonus for the smart bets he made on oil prices. The issue, however, isn’t Mr. Hall’s “compensation” but whether Citi should even be allowed to engage in this type of trading activity in the first place when it is funded, in large part, by taxpayer insured deposits. When you have a system that blends corporate reward with socialized risk you’re bound to encounter conflict.
Second, I haven’t come across “hard evidence” that establishes a solid link between pay packages and the current financial debacle. The last time I checked, government policies predisposed toward home ownership that were implemented through Fannie and Freddie, led to an “accommodative” monetary policy with cheap credit, which led to consumers taking excessive risk in buying real estate they couldn’t afford, which led to a housing bubble, which led to a financial meltdown because of the financial instruments tied to all of those mortgages. Executive compensation had little or nothing to do with the housing bubble, which is really the root of our current problems.Third, this is America, damn it! Does the federal government really think that it somehow is in a superior position to dictate compensation schemes to our nation’s financial industry? If so, that frightens me. As Representative Spencer Bachus of Alabama said about the House legislation, “Government bureaucrats don’t know what’s best for America.” Hear, hear Mr. Bachus.
The Perceived Problem: Americans across the country are defaulting on their mortgages. This is setting off a wave of foreclosures, which is further exacerbating the free fall in home values.
The Proposed Solution: If you’re in the House, enact cram down legislation allowing bankruptcy judges to rewrite mortgage contracts when homeowners file for bankruptcy. [Thankfully the Senate hasn’t approved this measure.] Combine this legislation with the loan modification program being urged by the Obama administration so that the government can really lean on the large banks and servicers to change the terms of the loans homeowns signed on for.
The Problem with the Solution: While I do agree with proponents that there should be a mechanism for dealing with problem mortgages short of going through costly and time consuming bankruptcy proceedings and that stemming foreclosure rates would be good for all of us, my gripe with the proposed solution is twofold. First, the message it sends to consumers is plain wrong. The underpinnings of our political system and economy are built on personal responsibility and a person being as good as his/her word. When the government steps in to change a written agreement because a gardener in California making $42,000 a year suddenly can’t afford the $650,000 house he bought (true story), then a message is being sent to Americans that you don’t have to take personal responsibility for your commitments because we’ll be there to change them.
Second, this is America, damn it! A contract is a contract and we shouldn’t rewrite a mortgage because millions of Americans either bought homes they knew they couldn’t afford or bought home speculating on an endless uptick in property values. When you start to mess with the sanctity of contracts in a capitalist society in the name of social or economic policies of the day, you quickly head down a slippery slope from which there is no return. One only need look at our good friend and ally Mr. Chavez to understand the value a contract holds in Venezuela before he starts nationalizing industries he is displeased with.
THE CONSUMER FINANCIAL PROTECTION AGENCY
The Perceived Problem: Americans have burdened themselves with too much debt, whether in the form of credit cards, mortgages, auto loans, or simple overdraft fees. The reason they have done so is because they can’t understand the products they are buying from those nasty financial institutions who wrap everything in 10 page disclosures with 8-point type that no one can understand.
The Proposed Solution: Enact the Consumer Financial Protection Agency Act of 2009. The proposed agency would have regulatory authority over retail products like credit cards and mortgages with the goal of ensuring that consumers “have, understand, and can use the information they need to make responsible decisions.” However, the agency will do more than provide information. It will also design “standard” consumer financial products that will contain whatever “features or terms [are] defined by the Agency for the product or service.”
FIs will be forced to offer the “plain vanilla product,” and the agency can even forbid the FI from offering its own product if it would “cause substantial injury to consumers” that “is not reasonably avoidable by consumers and… is not outweighed by countervailing benefits to consumers or to competition.”
The Problem with the Solution: Yikes, where does one begin on the problems with this solution? Three quick observations.
First, the FIs that sell the plain vanilla “agency version” of a given product will be given safe harbor from lawsuits. It doesn’t take a genius to figure out that soon the only products being offered will be the government-sanctioned ones. Talk about a way to stifle innovation, creativity and entrepreneurialism in one fell swoop – well this is it.
Second, we’re again punishing an entire industry for the misdeeds of a select few. Our current regulatory structure is well equipped to deal with FIs that sell deceptive or misleading products. A regulator can determine when a bank is overloading on 5-year ARMs made to non-qualified homebuyers. Banks themselves are paying the price of putting credit cards in the hands of consumers who are now defaulting in droves. Whether the regulators have been effective in ferreting out deceptive product marketing is a different topic altogether, but we shouldn’t scrap a system that has served us well for decades because of a few unsavory characters.Third, I hearken back to an observation made above – where is our sense of personal responsibility and self reliance? If I want to buy a 5 year adjustable rate mortgage, this is America, damn it, and I should be allowed to do so. My father taught me a very valuable lesson about credit cards before I went off to college and was given my first one (only to be used in the event of a true emergency, violation of which was punishable by death): if you can’t pay off the balance at the end of every month, you’re spending too much and living beyond your means. Do we really need to create an agency to act as a substitute for common sense? In my opinion, a better way to go would be to require all high-schoolers to take and pass a basic financial literacy course.
Don’t get me started. Besides, I said I would only pick on three things that bugged me. I now step down from my boîte de savon (that’s “soap box” for you non-EU members).
All for now.
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