Paulson & Co. start closing the barn door
I've been reading the 21-page Policy Statement on Financial Market Developments of the Hank-Paulson-led President's Working Group on Financial Markets. It's got a lot of acronyms in it. It's also five years late and a few trillion dollars short, but that's almost always the case with financial regulation. We're very good at designing rules to prevent the last big bad thing that happened from happening again. We're not so good at preventing new bad things from happening.
Anyway, the diagnosis of what went wrong strikes me as largely correct. Here's what the working group (which consists of folks from Treasury, the Fed, the SEC and the Commodity Futures Trading Commission) says were the "principal underlying causes" of our current troubles:
• a breakdown in underwriting standards for subprime mortgages;
• a significant erosion of market discipline by those involved in the securitization
process, including originators, underwriters, credit rating agencies, and global
investors, related in part to failures to provide or obtain adequate risk disclosures;
• flaws in credit rating agencies' assessments of subprime residential mortgage-
backed securities (RMBS) and other complex structured credit products,
especially collateralized debt obligations (CDOs) that held RMBS and other asset-
backed securities (CDOs of ABS);
• risk management weaknesses at some large U.S. and European financial
institutions; and
• regulatory policies, including capital and disclosure requirements, that failed to
mitigate risk management weaknesses.
As for what to do to prevent this from happening in the future, the recommendations around mortgage lending have gotten the most press. For good reason: They're by far the clearest and most forceful of the lot. Paulson & Co. are essentially calling for national mortgage regulations, with all lenders subject to the same licensing, underwriting and disclosure standards. Which wouldn't solve all the world's problems, but would make the kind of regulatory arbitrage that spurred the spectacular and ultimately disastrous rise of nonbank, nonthrift subprime mortgage lenders over the past few years much harder. So that's something.
For the rest, though, the recommendations are all in the line of investors and banks and ratings agencies all need to be more careful, ok? Plus we need lots of studies on how to make regulations work better. I'm sure we do. But it would be nice to see at least hints of bolder ideas like:
1) Slashing regulatory reliance on ratings agencies (this is what my column this week is about; I'll link when it goes up online). The report does say that "Regulators should review the current use of ratings in regulation and supervisory rules," but doesn't go much farther than that.
2) Doing more to shift our financial system away from illiquid, customized securities to commoditized, tradeable ones. Organized financial markets are amazing things. Sure they go crazy sometimes, and get prices wrong a lot of the time. But they're really good at incorporating new information and changing their minds. The big problem right now is that the financial system is clogged with securities for which there are no markets, and no agreed-upon prices. Every couple of months, the uncertainty of it all threatens to shut down the whole process of financial intermediation--forcing the Fed and other central banks to more or less artificially set prices for this stuff by accepting it as collateral for loans. It seems to me that in the future, regulators ought to be pressure financial institutions to transact as much of their business as possible in transparent markets rather than in opaque over-the-counter deals. For example, what if they simply decreed that securities that aren't traded regularly don't count for nearly as much (in terms of capital requirements and such) as those that are--whatever rating Moody's and S&P have slapped on the things. Wouldn't that make sense?
3) Flogging. We need some kind of punitive action to scare the world's bankers straight for a while. So why not public floggings of disgraced bank and securities firm CEOs? It'd be fun for the whole family! Unless you think being interrogated by Henry Waxman is already punishment enough.
Update: Felix Salmon has another bold idea that the Paulson report fails to mention: Doing something about the "alphabet soup" of financial regulation in the U.S., where you have lots of different, sometimes competing regulators and no one really in charge:
If the current system remains in place, does anybody seriously believe that "supervisors of global financial institutions" will be any better at monitoring "risk management weaknesses" than they have been up until now?
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Another thing we can do is require the salemen to refund any commision on any loan that goes into foreclosure or default. Its that incentive thing. If they get the commission for every sale, no matter how they got the sale, there is no reason for them to be... uh not predatory. I mean, didn't we have this very same problem during the dot com bubble? Salesmen pushing stocks they thought were dogs because they wanted the commission. Isn't there some kind of fiduciary point (not to mention, God forbid, ethical) here? After all, the "sophisticated" bankers screw up & we all are paying the cost. How much of this bubble & resulting credit crunch is due to speculating by said "sophisticated" bankers? There is a reason greed is amongst the seven deadly sins.
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Flogging! lol - i missed that somehow first time around.
@timbo - you're talking about 30 year (and 40 year!) mortgages...you going to keep the money in escrow for 30 years? I know I'm not taking that job, especially if you are over 30-40 years old...If not, how you going to get the money back when sales guy goes - whoops i spent that money already?
Probably the better incentive (besides flogging!) is to only allow syndication of of part of the loan so originator is still holding a small piece of each one and possibly to make it illegal to buy insurance/hedge for that part being held...
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I agree with timbo that sales predators have aggravated the problem, but I still think the bulk of bad loans could have been prevented with a more rigorous approval system.
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Flogging! lol - i missed that somehow first time around.
@timbo - you're talking about 30 year (and 40 year!) mortgages...you going to keep the money in escrow for 30 years? I know I'm not taking that job, oyunlarespecially if you are over 30-40 years old...If not, how you going to get the money back when sales guy goes - whoops i spent that money already?
Probably the better incentive (besides flogging!) is to only allow syndication of of part of the loan so originator is still holding a small piece of each one and possibly to make it illegal to buy insurance/hedge for that part being held...
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It goes on and on like that for pages of recommendations. regulators this, supervisors that, with no names named and no indication that these regulators and supervisors have clearly failed at all this and that there might be something broken which needs fixing on the regulatory side of things Digital Frames.And yeah, Yeah, sales predators have aggravated the problem,
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It is about time. Securitization of mortgages has been great for market liquidity but. But without regulation greed will come into play. There is just too much money involved. Cheap Bowling Balls Although i do not care for regulation as a general rule. But, there has to be some general oversight to make sure people's greed do not get to them. Predatory Mortgage brokers were a big part of the problem but so were their supervisors and the underwriters. Its the Supervisors and Underwriters that should be flogged.
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Frankly I think they should all be put in jail. Every last one of them including regulators. you can't tell me that they had no clue what was going on. If the market hadn't over heated and gone bust, they would still be using the same loan practices. They all knew what ws going on but everyone one was making money so nobody said any thing.
You are right we are good at correcting past mistakes with new regulations. But, over time some smart guy lobbies for the regulations to be removed. Once they are gone interprising people will find loopholes to make more money.
This seems to be a cycle we go through in our financial markets. Scandal - Regualtion - Deregualtion - Scandal. we never seem to learn that people are people and they are fundamentally flawed and need oversight.
We should send a loud and clear message. Crime doesn't pay....put them in jail. so, the next time the rascals will think twice.
Jenny
Discount Soy Candles -
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I just reread my last post. i did not mean for that to sound so law and order. I think what happened in the mortgage industry is criminal. There should be more done.
Jenny
Discount Soy Candles -
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You would think that we would have learned by now. removing regulation and oversight of financial markets is a recipe for disaster. When it comes to money, it is rediculious to think that people are honest and can be trusted to self police. I think there needs to be heavy penalties for people that try to rook the system. Good long sentences for financial fraud should be handed down. Thwn maybe these people will think twice before doing it again.
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Flogging. We need some kind of punitive action to scare the world's bankers straight for a while. So why not public floggings of disgraced bank and securities firm CEOs? It'd be fun for the whole family!
Yup public flogging would be acceptable. Why not. They should be publicly embarassed. They should be disgraced in front of their families. I just don't understan why white collar crime has less severe punishment than blue collar crime. White collar crime has just as much of an impact on victims as does blue collar crime.
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To prevent anymore disorder we definitely need some kind of threat to keep everyone in order. From the other comments, flogging might be a bit extreme but it obviously works in other countries. Public flogging would be entertaining at the same time. However, some people don't really care about being disgraced in public.
Dave
best acne treatment -
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Great stuff.. They should continue with the progress done.
Discount Yarn -
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I think there needs to be heavy penalties for people that try to rook the system. Financial frauds are a big menace for any society.
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Yet another scam that sees the innocent investors trapped and guilty bigwigs escaping out of the back doors. Seems a rather common phenomenon now.
Zara Clothing -
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Someone should take up initiative against these kind of petty scams.
Furniture -
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And look how it has turned out know. paulson an Co are struggling to keep the economy going and are really at wits end with their dwindling opportunities. How ironic the situation.
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