Thursday, April 29, 2010

Financial Reform Moves Forward - What Must Be Fixed to Make it Real?


Now that the Senate Republicans have agreed to debate the financial reform bill we will finally get to see the real intent of Congress to tackle the Wall Street problems. Missing from the Democrat bill the media claims the GOP was blocking, when in fact the GOP wants it just as bad as the Democrats, are a number of critical elements that better be addressed in the floor debate.

First, the major cause of the economic collapse was the housing element in which sub-prime mortgages were forced on the public by the drop in mortgage standards by our monstrous housing agencies Fannie Mae and Freddie Mac. These federally funded agencies who insure most of the mortgages in America reduced down payments from 20% to zero and allowed a technique called the Stated Income loan, or NIV for "No Income Verification". Most fraud on mortgage applications resulted from use of this technique in which applicants would just state how much income they earned without offering proof. This opened the floodgates to fraud.

Now a second feature of the extent of fraud and deception came in the repackaging of the loans into pools, called collateralized debt obligations, CDO, which was how Wall Street intended to cash in on the trillions of dollars in the mortgage market and the astounding increase in home values in the decade before 2006. Of course the demand for CDOs continued long after the housing market became stagnant and it became obvious certain markets were far overpriced.

To keep the housing market moving the Federal Reserve steps in and buys mortgage backed securities from the two housing agencies and banks. By March 31, 2010, the Federal Reserve had purchased $1.2 trillion of mortgage-backed securities from banks and $200 billion of direct obligation debt of Fannie Mae and Freddie Mac, for total purchases of $1.4 trillion. As a result of these actions, the Federal Reserve now owns almost 25% of the stock of mortgage-backed bonds. Assuming that banks turned these excess reserves into loans at a typical 10:1 ratio, the increase in money supply would be $12 trillion. That's more than the current amount of outstanding mortgages in the United States!

Finally, the Treasury Department has estimated the total additional US spending to prop up the two federal agencies will be $188 billion dollars. This is above and beyond the Fed money. Treasury says $85 billion will be lost along with $49 billion in foreclosure activity by Treasury, a total of $237 billion in taxpayer exposure with a total loss expected of at least $134 billion. That means we will have about $1.5 trillion at risk in supporting the housing market.

Nothing in Senate financial reform bill addresses the issues concerning housing including the CDO issue, relaxed down payments, the stated income loans, Treasury aid, foreclosure aid and Federal Reserve aid, all of which is still at risk. That means the predator mortgages, fraudulent mortgages, even foreclosures saved by the government will cost the government at least $134 billion. That sounds like an incredible windfall for all the thieves who ripped off the government. A reason for the omission may be that the changes in federal rules and policy that led to the actions were approved late in the Clinton administration, a move Clinton already acknowledged was a failure of his to stop his people from changing the rules.

The Senate bill also fails to address the conflict of interest of the credit reporting agencies who gave the CDO packages triple A ratings to help sell them even though many were defaulting within months after issue. Since the brokerage houses selling the packages were paying the millions of dollars in lucrative fees made by the credit agencies, there was intense competition to approve them regardless of the real value of the mortgage pool. Some contained as much as 90% stated income mortgages. Nothing is in the Senate bill to stop the conflict of interest nor punish credit agencies for fraudulent ratings.

Also there is nothing in the bill to review the actions by the government that opened the floodgates to bank control over the economy. Once again the absence of this area may well be inspired by the fact it was the Clinton people who made the changes. In the '90s Wall Street took over Clinton's Treasury Department and all of the regulatory agencies (Clinton's Treasury Secretary Robert Rubin came from Goldman Sachs). In 1998 Rubin, his deputy Larry Summers, Allen Greenspan (Fed Chairman) and Arthur Levitt (SEC Chairman) gave Wall Street a major victory -- defeating a modest proposal to regulate the then nascent, exploding derivatives market (e.g., mortgage backed securities). In 1999 Glass-Steagall was repealed. From 1995 to 2009 the six biggest banks (Morgan Stanley, Goldman Sachs, Wells Fargo, Citigroup, JP Morgan Chase and Bank of America) grew from 20 percent to 62 percent of GDP. These Wall Street victories gave us the Great Recession of 2008.

Finally there is the Consumer Protection Agency offered by Obama. For some odd reason he places it under the Federal Reserve which operates autonomous from the government and whose actions also played a role in the financial collapse. That is a big mistake. If anything, we should be auditing the Federal Reserve to find out what they are doing with America's currency, not adding to their powers.

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