Demanding Accountability at the Highest Levels

There are very few things upon which I agree with Congressional Democrats and even fewer with Speaker Nancy Pelosi (D-CA). In most instances they have a lot of complaints but few solutions. But this time, at least in concept, I think they are right on the money.

Speaker Pelosi and her Democrat colleagues have stated that as condition of approving federal government bailouts for the country’s financial institutions, the government should have the power to slash salaries, bonuses and severance packages of executives of institutions who accept the bailouts. Frankly, I don’t think the Democrats’ proposal goes far enough and, perhaps, in cannot because of the constitutional guarantees against “ex post facto” laws.

The problems in the financial markets, like the problems in the housing market, did not occur overnight. Many of the people, including advisers to both presidential campaigns, who were instrumental in developing the practices that inevitably led to the problems we are seeing today, have long since been rewarded with extraordinary bonuses and handsome severance packages. They got out before the “s**t hit the fan” and are now living high, wide and handsome on the misery they imposed on others. Justice requires that they too be relieved of their extraordinary bonuses and severance packages.

A quick review of how we arrived at this situation reveals the culpability of the government, the regulators and the corporate executives. More importantly, the underlying element of the problem is so painfully obvious it is hard to believe that intelligent, educated and experienced men and women could advance this notion — lending money to people who cannot afford to pay it back.

In the economic boom occasioned by the fiscal policies of President Ronald Reagan and continued through Clinton years and well into the second Bush administration, the growth in homeownership was explosive.

Most people were able to realize a portion of the American dream of owning their own home — most but not all. The ability to acquire a home continued to allude those just entering the job market and those stuck in the rut of minimum wage and/or seasonal jobs were simply unable to meet the income requirements for conventional financing for home purchases.

For the low income advocates and the minority race hustlers this fact became an open running sore — proof that the system did not work and that the country intended to keep success beyond the reach of their constituents. Their complaints began to resonate with those politicians who owed, in part, their election to those constituencies and they began to use the power of their offices to demand that a means be found to “include” their constituents in the dream of homeownership.

Federal regulators began to demand that a percentage of financial institutions’ portfolios include loans to lower income families. The term “red zoning” which originally applied to racial profiling was made to apply to economic strata.

The financial industry, never shy about finding a new way to make a buck — particularly when its government regulators are giving them the green light — noticed that the increased demand for homes was causing the average price of homes to accelerate beyond the normal rates of inflation thus creating “new equity” for homeowners. Both the financial institutions and the government regulators reasoned that even if a new buyer did not have the traditional ten to twenty percent equity to purchase a home initially, that they would “acquire” that equity within a short period of time because of the rapid escalation of the average price of homes. All of that might be true if you assume that the average price of housing would continue to escalate at a rate greater than inflation forever more. (This is the same type of baseless assumption that fueled the “dot.com” bubble and brought down the market less than a decade ago.)

But even with the new “no equity” loans, many still did not have the revenue stream to qualify for payment of the loans. The financial institutions, ever creative, derived, with the approval of government regulators, a new series of “sub-prime loans” which essentially matched the payment schedules to the available revenue stream of the borrower rather than determining whether there was sufficient revenue stream to amortize the loan over thirty years. In most instances this took the form of reduced payments for an introductory period followed by escalated payments somewhere down the road. In many instances, the borrower’s loan increased annually to account for the difference between his payment and the amount actually needed to amortize the loan. The banks and the government regulators reasoned that so long as the value of the house was increasing annually, the borrower’s equity was growing and was available to be “loaned against” to subsidize the low initial payments. Said more simply, for the initial period, the borrowers were required to borrow more to pay the interest on the amount they borrowed initially.

In both such instances, the whole rationale underlying the loans had nothing to do with the best interests of the borrowers, nothing to do with the long term interest of the financial institutions, and nothing to do with the shareholders in those institutions. In both such instances, introductory courses in finance, economics, and accounting would tell you that this was a license for a disaster. Both the financial institution executives and the regulators knew that the foundation for these loans were shaky at best and catastrophic at worst. But the financial institution executives were being rewarded handsomely and the regulators had the politicians off their backs.

These borrowers could not afford the loans on the day they borrowed, could not afford the loans for the initial period of reduced payments, and more than likely would not be able to afford the loans when payments escalated. But the executives and the regulators didn’t really care because they were both using Other Peoples Money.

Yes, that’s right, neither the executives, the regulators or the politicians urging them on, were at risk. And that is what needs to change. So if Congress is serious about this business then its members should include the following elements in their legislation:

1. Current bonus and severance packages for executives of institutions accepting the government bailout should be forfeited and salaries for officers should be adjusted downwards. The windfall from those forfeitures and reductions should be utilized to offset the cost of the bailouts.
2. The companies accepting a bailout should also commence actions against former executives who participated in the decisions responsible for these catastrophes and all proceeds recovered should be utilized to offset the cost of the bailouts.
3. Additional financial disclosure regulations should be put in place to alert investors of the dangers of policies and practices engaged in by corporate executives. Transparency is always the best means of control in a free market and such transparency did not exist in these instances. In this regard the disclosures should include a risk analysis of particular practices including the assumptions upon which practices was based and the likely outcome if the assumptions prove to be wrong. (In this instance if these financial institutions had disclosed that they were making loans to people who could not pay them back but assumed that the collateral would increase in value at a sufficient rate to cover any default, how many investors do you think would have placed their money with these firms?)
4. New criminal penalties with mandatory prison time should be created for executives engaging in conduct likely to mislead investors — in this instance for failing to make full disclosures regarding the practices, assumptions and risk analysis of the likely outcomes. The loss of money and the prestige of money for these executives is a painful but tolerable event. Jail time is not and it is the only thing they fear.
5. The politicians accepting campaign contributions from institutions or executives who are subsequently determined to have engaged in misconduct should be held personally, financially liable for repayment of all of those contributions to offset the cost of the bailouts.

In my lifetime, I have watched the greed of politicians and corporate executives fuel the savings and loan crises, the dot.com/telecommunications crash and now the housing/financial crises. And it is always the same, those who are the primary cause of the crises proceed, wealthy and unscathed, and those who can least afford it (investors and taxpayers) are left holding the bag. Something has to change.

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  • John in Oregon

    In the news just out is an article that lays out the chapter and verse of the to the current financial crisis.

    *How the Democrats Created the Financial Crisis*
    Sept. 22 (Bloomberg) —

    The article begins by saying things look complicated, then continues;

    – “But really, it isn’t. Enough cards on this table have been turned
    – over that the story is now clear. The economic history books will
    – describe this episode in simple and understandable terms: *Fannie
    – Mae and Freddie Mac exploded,* and many bystanders were
    – injured in the blast, some fatally.”

    – “Fannie and Freddie did this by becoming a key enabler of the
    – mortgage crisis.”

    – “In the times that Fannie and Freddie couldn’t make the market,
    – they became the market.”

    The article now moves to a tipping point in 2005;

    – “Back in 2005, Fannie and Freddie were, after years of dominating
    – Washington, on the ropes. *They were enmeshed in accounting
    – scandals that led to turnover at the top.* At one telling moment in
    – late 2004 … the Securities and Exchange Comiission’s chief
    – accountant told disgraced Fannie Mae chief Franklin Raines that
    – *Fannie’s position on the relevant accounting issue was not even
    – “on the page” of allowable interpretations.”*

    – “Then legislative momentum emerged for an attempt to create a
    – “world-class regulator” that would oversee the pair… Politicians who
    – previously had associated themselves proudly with the two
    – accounting miscreants were less eager to be associated with them.
    – The time was ripe.”

    – “The clear gravity of the situation pushed the legislation forward.
    – Some might say the current mess couldn’t be foreseen, yet in 2005
    – Alan Greenspan told Congress how urgent it was for it to act in the
    – clearest possible terms,,, Greenspan said. *”We are placing the
    – total financial system of the future at a substantial risk.” *

    – “What happened next was extraordinary. For the first time in
    – history, a serious Fannie and Freddie reform bill was passed by the
    – Senate Banking Committee.”

    – “But the bill didn’t become law, for a simple reason: Democrats
    – opposed it on a party-line vote in the committee, signaling that
    – this would be a partisan issue. Republicans, tied in knots by the
    – tight Democratic opposition, couldn’t even get the Senate to vote
    – on the matter.”

    And there you have the bottom line. As a mater of Democrat party policy the choice was made to ignore the Securities and Exchange Commission’s chief accountant, ignore Greenspan, and ignore all reason and logic. And I suspect ignored for reasons of political power and corruption.

    Bold is mine. Read the complete article at https://www.bloomberg.com/apps/news?pid=newsarchive&sid=aSKSoiNbnQY0

  • Bob Clark

    I am a Republican but have to say this most grievious of financial crisises has plenty of contributors, including top Republicans. Alan Greenspan had a big hand in creating the housing bubble by keeping interests rates artificially very low for a few years and then advocating folks take on adjustable rate mortgages in place of conventional 15 or 30 year fixed rate mortgages.

    President Clinton signed into law the repeal of the Glass-Steagall Act of the 1930s, which had served to put a check on the mixing of investment banking with traditional banking, and in doing so, he help speed the financial derivatives market. Then about a year ago somebody at the Securities Exchange Commission removed the “uptick” rule for short sales, which had helped slow “bear” raids by market manipulators.

    If gold and silver prices ever drop back to a more normal range, I advise adopting a personal gold standard to at least a fractional degree because financial crisises seem unavoidable.

  • Tim Lyman

    The executives who ran these companies into the gorund should not just have their salaries cut – they should face criminal investigation and prosecution where warranted – ESPECIALLY the D’s who ran the FNMA gravy train right off the tracks and precipitated this disaster.

    As far as limiting salaries in the future, that’s just silly. If you want to guarantee bad management, refusing to pay market wages is the way to go.

    Finally, we need to face the fact that the heart of the problem was government blackmailing banks into making mortgage loans to people who couldn’t pay them back in the name of “opportunity.”

    There are some people who cannot afford to buy homes, or who simply do not have the financial discipline to make mortgage payments. That is an unfortunate fact, but a fact nonetheless. There’s a reason these people have crappy credit scores – they’re a bad risk!

    If government wants to increase home ownership, the best thing they can do is to encourage economic growth by lowering business taxes.

    • dean

      Tell us Tim…how did the government “blackmail” banks into making mortagage loans to those with dubious means? The government had some sort of gun to the head of bankers here? Please explain.

      • dean

        And to add a question: Whicjhparty has been running “the government” unfettered for the 6 of the the past 8 years that encompased the housing bubble that led to this disaseter?

  • John in Oregon

    > *how did the government “blackmail” banks into making mortagage loans to those with dubious means?*

    A Federal Law known as the Community Reinvestment Act compelled lenders to make the risky loans.

    > *Whicjhparty (sic) has been running “the government” unfettered for the 6 of the the past 8 years that encompased the housing bubble that led to this disaseter?*

    On the issue of regulating Fannie and Freddie, from 1999 to date, the Democratic Party. In 2005 the Democratic Party fought Fannie and Freddie regulation to a standstill.

  • Terry Parker

    It is my understanding that Obama has taken financial contributions either directly or indirectly from the financial institutions and executives now in trouble, maybe as much as $60m. If this is true, shouldn’t he be required to disclose it to the public and return it?

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