A Plea for Financial Sanity

Dear Honorable Member of Congress:

Are we in a financial crisis yet? As recently as 2 weeks ago, conservatives like Larry Kudlow on CNBC were inexplicably saying no. Robert Reich even asked for a pair of Larry's rose colored glasses. We didn't suddenly get into a crisis last week and we will not be able to "fix" our economy in a short time, if at all.

What has been presented of the Paulsen plan is unacceptable. Huge dollars. No strings. No accountability. No safeguards. No regulatory changes. No punishment. No restitution. We should not be giving taxpayer money for any of this financial mess unless MAJOR strings are attached and it keeps more people in the homes they bought. The resolution of this crisis must punish the perpetrators and reduce the chance that this mess will happen again, at least during our lifetimes. The RTC did not work in the 1980s. If it had, we would not be here. It appears that the only lesson learned from the RTC process was: the American taxpayers will bail out the banking system from its mistakes.

It seems that now everyone, even Senator "our fundamentals are strong" McCain agrees we are in a financial crisis. There are many proposals being thrown about to spend unbelievable sums of money "saving" financial institutions. That is wrong. That will neither solve our problems nor keep us out of trouble next time. If we want to try to "fix" our economy, if that is even possible, we need a closer look at the causes of the problems and undo the causes. "Fixing" the symptoms of our crisis will not repair the deep, underlying damage.

While it seems perfectly fine with our leadership that the American taxpayer should be paying for this "fix", I have heard nothing about how those connected to the crisis will pay their greater portion. The suggestions which follow are only politically unappealing if you work in the financial industry. To the American taxpayer, perhaps they are a reasonable consequence of inappropriate behaviors. Without real consequences, ones that actually hurt, rules have no meaning. Now that we are talking "real money" in the range of $1 TRILLION ($1,000,000,000,000), can we please invoke some sanity and responsibility? Please forward this to anyone who might listen. I was pleased to hear that some of these suggestions are actually being considered by Congress. If you can promote even one suggestion that may be of value in minimizing the cost to the American taxpayer and reduce the chance of recurrence, Thank You.

My view of the biggest causes of our problems:

1. Mortgage brokers who violated their fiduciary responsibility to borrowers, encouraging them to take loans that were not in their interest, including ones where the borrower clearly could not afford the mortgage
2. Inadequate oversight of individual brokers by the banks who lent the money
3. Lack of transparency - Inadequate ratings of mortgage security quality, which now leaves us with securitized mortgage products that we cannot value
4. Greed - Everyone was "doing it" and making money. Like 1929 or 1999, it appeared housing values could only go up
5. Poorly constructed bonus plans that put short term financial gains ahead of pretty much everything else, including legality and ethics
6. Corporations allowed to get "too big to fail"

Solution Part 1 - Assign responsibility and accountability

There is a lot of culpability to go around. When there is no punishment, there is no learning. Lack of consequences for bad choices guarantees that bad choices will be made again. Regardless of how much money we ultimately spend, we must spend around $1 billion for enough investigators, prosecutors, prisons and associated government services to ensure that those responsible are found and punished. Every individual who participated in loan originations should be investigated. It is likely that most are innocent. However, if they encouraged borrowers to lie about income, guilty. If they lied about a borrower, guilty. If a borrower was sold a loan the broker should have known they could not afford based on the income information provided, guilty. Investigate. Speak to borrowers who have lost or are losing their homes. Prosecute. Assess fines, with all of the money collected going toward this huge bailout budget. Jail. If the problem extends up the chain of command, keep going. If we do not do this critical first step, there are no disincentives for this out-of-control cancer to recur. The extent of the malfeasance should not be a protection for the guilty.

Solution Part 2 - Enforce or expand banking oversight requirements

Require every bank making a loan to perform due diligence. They cannot simply rely on what they receive from the loan originator. If the numbers don't add up, don't make the loan. If it is "too expensive" to verify every piece of data submitted by the loan originator, verify every piece of data for every thrid, fifth or tenth application. This process can be different for each bank to permit competition, but the necessity that each bank have such a process should be part of regulations. If these regulations exist and are not being enforced, then enforcement activities must increase and the penalties for non-compliance need to be much tougher, including fines to both corporations and individuals who fail to comply. For those complaining about the dire consequences of credit being too tight, too bad. It is a rational response to credit being too loose for too long.

Solution Part 3 - Rate mortgage related securities

All mortgage related securities (CDOs or otherwise) must be rated by one of the ratings organizations. Clear criteria must be used and these criteria, developed by the ratings agencies, must be published to enhance transparency. If the ratings criteria are inadequate to enable valuation of a mortgage related security, they must be expanded. The SEC shall be the arbiter of whether the ratings are adequate based upon input from the market, both buyers and sellers of mortgage related securities. If the ratings agencies cannot develop adequate criteria, then Congress shall determine a mechanism to direct this to occur. If a mortgage related product cannot be rated or does not achieve a minimum level of rating, it may not be sold. Thus, the security creator will perform due diligence before selling it to the market. Once it is sold in the market, this security should have a readily determined value on a periodic basis, perhaps monthly to correlate with the receipt of monthly mortgage payments. Higher risk securities will command lower prices and the market will, in the future, adjust price according to risk as it does for high risk corporate bonds. This would eliminate the crisis of confidence we have had and continue to have where no one really knows the value of the mortgage related securities that they hold. DO NOT bundle the securities together and resell them until and unless this procedure has occurred.

Solution Part 4 - Moderate Greed

There is no cure for greed. It is as human as love. However, when greed causes significant financial harm to others, as it has in this crisis, there needs to be a mitigating force. Key factors of greed at play in creating this crisis:

1. mortgage broker compensation
2. corporate compensation

On the one hand, we are a capitalist democracy wherein individuals should be able to charge what the market will bear. On the other hand, we should consider whether some of our incentives, which clearly motivate personal choices, are harmful. Mortgage broker compensation must be independent of the type of loan funded, so that they are not motivated by their potential earnings to direct borrowers to bad loans. Any mortgage broker found to have directed a borrower to a harmful loan, for any reason, will repay their commission on that loan to the bailout fund. This applies to all loans funded back to 2000, the approximate beginning of the recent boom.

Corporate executives have been overly incentivized to do whatever is necessary to continually increase the bottom line. This has led us down the path of finding the newest financial product, generally unregulated because it is new. It is long past time to recognize that the obscene salaries paid to many corporate executives are long overdue for a correction. The increasing number of angry shareholders wanting some say over corporate pay makes that abundantly clear. In answer to the executives request for this huge financial bailout, for which many have partial if not total responsibility, their pay must be reduced. All bonuses retroactive to 2000 must be repaid (including stock or options) to the bailout fund by all named corporate executives in every affected financial institution. In addition, all salaries shall be retroactively cut to a multiple of the median employee wage at their company, no greater than 10. It may be variable from 4 (at 100 employees) to 10 (at 100,000) depending on the size of the corporation. All money must be paid within 12 months regardless of any losses the executive may suffer in the process. If they have inadequate personal resources, their debt shall fall to their family for both future generations and distant relatives, including any former spouses. The American taxpayer should only pay after culpable individuals and their families have first repaid.

Does this sound like retribution? It is partial restitution. Is there a reason the American taxpayer should not be upset that while these executives were laying the groundwork for our current crisis they were being well compensated for their terrible long term choices? Is there a reason the American taxpayer has greater responsibility to pay for the errors of corporate greed than those who benefited?

Solution Part 5 - "Fix" the mortgages

Once we implement effective ratings, identify the problem mortgages and "fix" them. Don't buy CDOs as part of the bailout, they are a derivative. Pay down mortgages or decrease interest rates or extend terms so that people can stay in the homes they bought and the value of the collateralized mortgages increase, increasing the value of the derivatives. Best to decrease interest rates as that reduces bank profits but costs the taxpayer ZERO. Putting money anywhere else in the system both lets the homeowner lose and the American taxpayer lose. Who wants a lose-lose proposition? Resetting mortgage terms to where banks make less money, still allows for some level of profit and real live people benefit by staying in their homes. The real estate market will improve from reduction of foreclosures and given enough time, prices will eventually rise again. While enabling bankruptcy judges to do this will help, that should not be a necessary condition. Clear criteria could be established where banks are simply required to make the change for qualified borrowers. Those criteria should only apply to owner-occupied homes and would be considered to be recommendations to bankruptcy judges. Speculators, as part of the problem, would not qualify for a "fix".

Solution Part 6 - Ensure that there is no company "too big to fail"

If there is the perception that any company can become "too big to fail", then once a company reaches a certain size, it can increase the risks it takes without consequences knowing the American taxpayers will bail them out. We must either specifically and explicitly state that "no company is too big to fail" to counter all the statements made by our leaders, or we regulate away this possibility. Existing companies that are deemed "too big to fail" must shrink by spinning off a few divisions as new companies. Regulations would have to prohibit mergers beyond a certain "too big to fail" size and require companies that grow too big through prudent choices to spin off one or more divisions.

If you support anything in this message, please forward it to everyone you know in the hopes that it ultimately reaches every member of Congress before Friday. While it would be better to fix the system right, it appears that they are going to try to fix it fast. Of course, a very good argument could be made that Congress should only implement reforms which do not require any taxpayer dollars and allow our otherwise effective capitalist system to run its course to resolve this crisis.