10 Questions for Finance Reformers
By Barry Ritholtz - March 30th, 2010, 8:26AM
The current series of proposals for reforming Wall Street and bankers are toothless facades of what real regulation should look like.
It seems that each new proposal for reforming Banking and Wall Street is more banker friendly – and ineffective – than the previous one. They are milquetoast, meaningless, appeasing nonsense. The reformers are in a race to see who can offer up legislation that is least offensive to bankers.
In order to legislate reform that will prevent the next meltdown from occurring, I suggest that anyone who introduces new reform legislation must answer the following questions about their proposals:
1. Ratings Agencies: The Nationally Recognized Statistical Rating Organization (“NRSRO”) such as Moody’s, S&P, and Fitch slapped triple AAA ratings on paper that was actually high yielding junk. The investment banks paid them for these ratings. The ratings agencies were the prime enablers of the credit collapse.
What does your proposal do about this business model? Does it maintain this unique privileged status? Does it introduce any competition to the ratings business?
2. Derivatives: The Commodity Futures Modernization Act of 2000 (CFMA) exempted derivatives such as CDOs and CDSs from all regulatory oversight, reserve requirements, capital minimums, exchange listings, transparent open interest reporting, and counter-party disclosures.
What does your proposal do to fix this?
3. Leverage: Prior to 2004, Investment Houses were limited to 12-to-1 leverage by the SEC’s net capitalization rule. In 2004, the Bear Stearns exemption was granted by the SEC, giving the five largest investment firms a waiver of this leverage limit. These five promptly allowed their leverage to go up to 25, 30 even 40 to 1.
What does your proposal do about this excess leverage?
4. Insulating Main Street from Wall Street: Glass Steagall separated FDIC insured depository banks from the more risk embracing investment houses. Prior to the repeal of Glass Steagall in 1998, the market had regular crashes that did not spill over into the real economy: 1966, 1970, 1974, and most telling of all, 1987. These market crashes did not freeze credit for the real economy.
How does your proposal prevent the inevitable future market crashes from spilling over to the real economy – especially as applied to real credit availability?
5. NonBank Lenders: Most of the sub-prime mortgages were made by unregulated non-bank lenders. These firms abdicated all lending standards. They pushed the option arms, the interest only loans, and the negative amortization mortgages that defaulted in huge numbers.
How does your legislation deal with these (or similar firms) in the future?
6. Compensation: The banks and investment houses paid many of their senior employees huge bonuses. This encouraged employees to take tremendous risks to generate what we now know were phony profits.
What does your proposal do to address this? Does it allow for clawbacks of stock options, bonuses, and cash payouts for fake profits or future losses?
7. States Rights: Prior to the 2004, many States had Anti-Predatory Lending (APL) laws on their books. These states had lower default and foreclosure rates than the states that did not.
In 2004, the Office of the Comptroller of the Currency (OCC) preempted national banks from state laws regulating mortgage credit, including state anti-predatory lending laws. New subprime mortgages were sold in states that previously didn’t allow them. Subsequently, these states saw their foreclosure rates spike.
Does your legislation return to the States the right to oversee and regulate fraud and predatory lending?
8. Whistle blowers: The SEC had numerous whistleblowers identify funny accounting, malfeasance and even outright fraud. Yet they failed to thoroughly investigate most of these problems, including Bernie Madoff’s ponzi scheme.
What does your proposal do to put a strong police force back on Wall Street ? How does it encourage and reward whistle blowers?
9. Corporate Structure: None of the major Wall Street partnerships got into trouble, as they have full personal liability for their losses. Only the publicly traded Wall Street firms did. This strongly implies that personal liability of senior management prevents them from acting recklessly.
How does your proposal address the issue of personal liability for massive losses by senior management?
10. Fraud: Many families ended up obtaining mortgages they either did not understand or were materially misrepresented.
Does your proposal address consumer education or lender fraud?
If Congress can adequately answer these questions in reform legislation, they can prevent the next meltdown. Otherwise, we should expect the next collapse to be even more severe, and recovery more painful . . .
The Emergency Banking Act was introduced on March 9, 1933, to a joint session of Congress and was passed the same evening amid an atmosphere of chaos and uncertainty as over 100 new Democratic members of Congress swept into power determined to take radical steps to address banking failures and other economic malaise. The sense of urgency was such that the act was passed with only a single copy available on the floor and most legislators voted on it without reading it.[1]
ReplyDeleteAccording to William L. Silber[2] "The Emergency Banking Act of 1933, passed by Congress on March 9, 1933, four days after FDR declared a nationwide bank holiday, combined with the Federal Reserve’s commitment to supply unlimited amounts of currency to reopened banks, created de facto 100 percent deposit insurance. Much to everyone’s relief, when the institutions reopened for business on March 13, 1933 depositors stood in line to return their hoarded cash to neighborhood banks. Within two weeks, Americans had redeposited more than half of the currency that they had squirreled away before the bank suspension.The stock market registered its approval as well. On March 15, 1933, the first day of trading after the extended closure, the New York Stock Exchange recorded the largest one-day percentage price increase ever. With the benefit of hindsight, the nationwide Bank Holiday and the Emergency Banking Act of March, 1933, ended the bank runs that had plagued the Great Depression."
This act was a temporary response to a major problem. The 1933 Banking Act passed later that year presented elements of longer-term response, including formation of the Federal Deposit Insurance Corporation (FDIC).