Thursday, April 29, 2010


I have been following the financial reform bill and the debate via the media as best I can. The shape of the bill appears to be quite comprehensive, with one very fundamentally large exception. The bill appears to focus on absorbing the losses resulting from another financial panic or meltdown so the whole economy is not imperiled to the same degree. Things like "too big to fail", enhanced capital requirements, lower leverage limits, regulation of derivatives, executive compensation, and even the bank tax, are all well and good (perhaps), but they don't address the issue of actually preventing a future crisis.

In fact the one thing that's not covered is the prevention of making bad loans, or least an attempt to so. If the loans were good loans, no amount of leverage, securitization, derivatives, out sized compensation, or other opaque complexities or side bets, would have been a problem.

Why hasn't the emphasis been, as far as reasonably possible, to prevent lenders from making bad loans.

There is a lot of talk about a Consumer Protection Agency when what we really need is a Lender's Protection Agency. I know the optics don't look very good, but that's what's really needed. We need to protect lenders from making bad loans.

You say that sounds silly, well it's not so silly and here is why. I'll start with a story about a piece I saw on 60 Minutes. They interviewed a subprime lender in California (he seemed like a pretty smart guy) and asked how could he make loans to people who not only put no money down, but didn't even go through a credit check (income , job, assets etc-NINJA loans.) These were also known as liars loans. He said that he knew that he should have required all of the basic underwriting stuff , but that if he did so, his customers would just go down the street to another lender who won't require it, and in a few months he would be out of business. He was caught in a trap, even if one of his own doing, and he couldn't stop unless his competitors did as well. The only way to have put a stop to this insanity would be for the government to stop everyone from making these bad loans. That's what they do in Canada; no home loans without putting 20% down and customary credit underwriting.

Not so long ago our banks were "required" under banking regulations to use "safe and sound lending practices" to properly underwrite loans. Clearly the so called NINJA loans won't qualify. Implementing such a rule again would protect the banks from themselves and as a result protect all of us. I don't know when that all went away , but at the very least we should bring it back and apply it to all lenders of any kind. These shaky, some say shady, loans not only hurt the borrowers but in the end hurt the lenders as well; as we have so painfully seen.

So let's add a Lender's Protection Provision to the financial reform bill to protect lenders against making bad loans. Of course, you can't eliminate all bad loans, but we could go a long way in that direction and then we wouldn't have to worry so much about all that other stuff everybody talks about, but was not the root cause of the financial crisis. The root cause was BAD LOANS.

I'll discuss why lenders were allowed to make these bad loans in a subsequent post.


Tuesday, April 27, 2010

The Wall St. Full Employment Act

It seems to me that one of the consequences of the financial reform efforts (unintended, I assume) is the benefits which may redound to Wall St. As I see what could happen, these efforts could be called The Wall St. Full Employment Act.

Let's start with getting our definitions straight. Wall St. refers to investment banks; firms like Goldman Sachs, Morgan Stanley, Merrill Lynch( now owned by Bank of America), Lehman Bros. (gone) and Bear Stearns (now owned by JP Morgan Chase). They all are (or were) headquartered in the Wall St area of New York City; ergo the name.

Big Banks are large commercial financial institutions that used to just basically take deposits and makes loans. They don't even primarily reside in Wall St, but rather are headquartered in Charlotte, San Francisco, Minneapolis, Pittsburgh and Mid-Town Manhattan.

As a result of the financial crisis, investment banks also became commercial banks because it entitled them to many of the government benefits employed to fight the financial panic. It was the smart thing to do, and it was allowed since the repeal of Glass Steagall.

Commercial banks, also as a result of that repeal, have been allowed, for some time, to act as investment banks.

If Glass Steagall is repealed, they will have to choose sides. The true investment banks will just drop their bank charters. They really don't care much about taking deposits and making loans. Have you ever seen a Morgan Stanley branch bank or a Goldman ATM? Me neither.

For the commercial banks, it's not so easy. If they are forced to leave investment banking, the field will be wide open for Wall St. to capture all of that business (very profitable albeit risky) the commercial banks will be required to abandon.

Talk about unintended consequences. In one fell swoop, Wall St. will have eliminated it's strongest competition. They will have to scramble to handle all of the new business.

By the way, I'm not sure allowing the Banks to do just non-proprietary investment banking will solve this problem in the long run.

All in all, getting rid of Glass Steagall may be bad for Banks, but great for Wall St.


Tuesday, April 13, 2010

Time Out --Part II

In David Brook's op-ed "Relax, We'll Be Fine" in the Tuesday, April 6,2010 New York Times, he picks up on the optimism for America's future of my post "Time Out" . Here are a few choice quotes:

"despite all the problems, America's future is bright."

"Over the next 40 years... the US population will surge by an additional 100 million people...The population will be enterprising and relatively young. In 2060, only a quarter will be over 60, compared with China at 31 percent and 41 percent in Japan."

"The demographic growth is driven partly by fertility. The American fertility rate is 50 percent higher than Russia, Germany or Japan, and much higher than China."

"In addition , the US remains a magnet for immigrants. Global attitudes about immigration are diverging , and the US is among the best at assimilating them (while China is exceptionally poor). As a result, half of the word's skilled immigrants come to the U.S."

" between 1990 and 2005, immigrants started a quarter of the new venture- backed public companies"

"the US leads the world in scientific and technological development. The US now accounts for a third of the world's research and development spending ... The average American worker is nearly 10 times more productive than the average Chinese worker, a gap that will close but not go away in our lifetimes."

There is a lot more to his column and I urge you to find it. I particularly liked his conclusion that " In sum , the US is on the verge of a demographic, economic and social revival, built on its historical strengths".

It's also very interesting to note, in light of some of the anti-immigration hysteria, how critical immigration is to our future economic success.


Tuesday, April 6, 2010

O Canada-Why Not?

I have been following the efforts in the Congress to enact financial reform. I agree with strengthening regulations regarding increased capital requirements and less leverage.

I definitely agree that the so called "shadow banking" sector must be included in the regulatory scheme.

Frankly, I think credit default swaps should be banned, unless you also hold the underlying asset(the so called naked swaps) or treated as insurance, with reserves set aside like any other insurance. But I'm sure there are decent arguments on the other side of that one.

I'm not sure why we need a separate Consumer Protection Agency other than to make sure bankers do what they should always do which is to make loans based on "safe and sound" underwriting principles.

Of course it's just silly to levy a tax on banks which can only cost consumers and create additional moral hazard ( whatever that really is). I really don't get why you tax banks for TARP losses arising from making loans to car companies and an insurance holding company. They better pass that tax quick before GM,Chrysler and AIG pay back the money they got, maybe even with a profit to the taxpayer.

However, what we really need is a ban, as exists in Canada, on subprime lending of the kind that got us into this mess in the first place.

Why is it that no one talks about eradicating the root cause of the financial meltdown-- abusive subprime loans. How in the world did the government allow subprime lending, especially the kind made with no money down and no proof of income, assets or even a job. The so called "no docs" loans that were made to anyone with a pulse.

As Paul Krugman pointed out it is against the law in Canada to make home loans with less than 20% down. Even with low interest rates and too big to fail banks, Canada didn't have much of a housing bubble problem. The reason was no subprime lending. The same was true of NYC where co-op boards certainly didn't allow subprime financing.

Why can't we just do that in the US? I really don't understand why no one talks about that. Everything else deals with how best to absorb the consequences of future problems. I think we also should do something to actually help prevent future problems. Securitization didn't cause the loans to go bad. Even credit default swaps didn't create those scandalously poorly underwritten loans. What's the old computer cliche "Garbage In , Garbage Out". The subprime loans were mostly garbage and no Volker Rule or other regulatory reform would change that.

All the other catastrophic problems followed from having made crappy loans in the first place. What am I missing here? All the other reforms do not address eliminating this root cause of the meltdown. Who is against eliminating subprime lending and why?


Friday, April 2, 2010

Pol Taxes

I have read and heard various numbers that anywhere from 35% to 60% of eligible taxpayers pay NO Federal Income Tax. When I discussed this with one of my more progressive friends and queried why the Republicans weren't making a big deal out of this, he said something that "blew my mind" ( sorry for the '60s jargon). The Republicans don't want to bring this issue up because so many of their constituents ( i.e. Tea Party type people) are among those who pay no,or very little, Federal Income Tax.

They think they are overburdened with Federal Income Taxes, but in reality they are not . If it were brought to their attention that they don't really pay very much Federal Income Taxes, Republicans might lose a lot of their most active and vocal base. The top 5% percent pay 60% of the Federal Income Taxes, but I'm guessing that a whole lot of those folks at Tea Party rallies are not in that top 5%.

Now let's be clear about this. I'm only talking about Federal Income Taxes; not Social Security Taxes ( which hopefully people will get back at least the money they paid) or Medicare Taxes ( which most people will use in the future to pay medical costs).

Of those who pay Federal Income Taxes, the top 10% of income earners pay over 72% of the taxes and the bottom 50% pay less than 3% of taxes paid.

Both parties really don't want people to hear too much about these figures. You almost never see articles or prominent stories about this in the mainstream or fringe media.

The Democrats, of course, believe the rich are under taxed and the middle class is overburdened, and facts like this are very inconvenient. Why is it , according to the Democrats apparently ,that only people making less than $250,000 come from hard working, tax paying, families? Are the rest just free loaders? The numbers don't bear that out; but those higher earners don't have as many votes.

The Republicans want to keep as many people as they can "riled up" about how they are overtaxed, so they can get elected. Whipping up the top 5% just won't bring out much of a crowd. Therefore it helps the Republicans to perpetuate the illusion that we are all overburdened with Federal Income Taxes.

Neither party care much about the facts.