Friday, February 20, 2009

The Next Step: Banking, Investment and Credit Reform

How do we secure America's Financial Future?

Apparently, the traditional approach to managing risk in lending has failed. It appears that one of two things has happened. Either a comprehensive background assessment of a borrower's qualifications did not occur during underwriting at certain institutions (and those banks looked the other way in order to secure short term profits, bonuses and commissions); or, it is too costly for the banks to manage risk.

Well, many banks are managing risk effectively; so, apparently the other banks didn't care if borrowers were qualified or not. After all, the bad loans could be mixed in with good loans before they were sold to investors.

No doubt about it, greed contributed significantly to the current financial crisis.

Despite public outrage at being forced at "gun point" to bailout financial institutions, there is no justice to be found. The financial bailout isn't about justice -- it is about survival.

Without government help, there was a good chance our banking system would collapse, and that would result in gut wrenching pain for all of us.

Fact: on September 18, 2008 we had an electronic bank run of $550 billion in just two hours. Congressman Paul Kanjorske told media that the U.S. Treasury Department estimated that if they had not temporarily shut down the system and raised deposit guarantees, $5.5 trillion would have likely been withdrawn from the U.S. money market system by 2 p.m., effectively taking down our financial system.

Yes - apparently, that' s how close we came to a total collapse of the U.S. Financial System.

In the past, NYU banking professor Nouriel Roubini estimated that banking losses could peak at $3.6 trillion, which means the U.S. Banking System is Insolvent.

What happens when a banking system collapses? In 2007, Iceland was tagged by the United Nations as the most developed country in the world. But last October, the nation's banking system collapsed. Consequently, Iceland's currency lost about half of its value. Inflation is at 18.6% and rising. The Central Bank (Iceland nationalized it's banks when they collapsed) is charging 18% interest and unemployment has quadrupled. And all this happened before interest rates skyrocketed.

The worst thing about Government intervention is that it has the ability to distort the market -- and, we are just beginning to see the ripples of adverse economic effects. For example, If the banks earn interest on deposits at the Fed, will they be motivated to lend money to other banks? Where will businesses and citizens obtain credit, if a large portion of America's money is out of circulation?

I understand that a lot of folks, including myself, are outraged by the bank executive bonuses, corporate jets, brand new mega yachts, lavish parties or the consequences of moral hazard. But the most toxic part of the bailout is not the financial industry's in-your-face arrogance, its the distortion of the market.

Now that we know a few investment firms can undermine the entire financial system, we must take steps to protect taxpayers and consumers from this kind of behavior in the future.

There are no influencial lobbyists who will volunteer to do this on our behalf. (But there are plenty of financial industry lobbyists who are taking advantage of bailout money to lobby against us).

If we, (the American people) want to avoid another massive bank bailout in the future, we (the taxpayers) must insist Congress implement the following reforms:

1. First and foremost, enact reforms that prevent another bailout from ever taking place again. (This isn't the first bailout, but it better be the last).

2. Hold banks accountable - require banks and other institutions to account for how they are spending taxpayer funds.

3. Enact stronger consumer protections and new financial regulations to protect consumers from predatory lending practices.

4. Create a Consumer Credit Safety Commission with the authority and to rank and regulate the safety of banking products.

5. Place appropriate restrictions on how the remainder of the bailout funds are spent. For example, bailout funds may not be used to pay executive bonuses, commissions, corporate retreats, or lobbying.

6. When rescuing firms like AIG, require them to stop writing new policies and slowly phase them out. Corporations should not be rewarded for poor business practices. Nor should their competition be placed at a disadvantage because a bankrupt firm was rescued by the taxpayers.

7. Revamp the existing FICO Credit Scoring System and the Fair Credit Act. Too many market decisions are made based on an individuals FICO score. Credit report errors are increasingly difficult to fix and unscrupulous collection firms routinely sell old debts to new companies, (including debts discharged in bankruptcy) in order to make profits. It is estimated that over 50% of America's credit reports contain errors serious enough to prevent a borrower from purchasing a home or car at a competitive interest rate.

Today, many individuals have reduced FICO scores due to the recession. Credit scores are routinely used to determine how much we will pay for car insurance and home owner's insurance. (Apparently, we become crazed the second our score drops below a certain number).

To add insult to injury, many employers pull credit on job applicants. In other words, people who desperately want and need a job may be discriminated against because they have fallen on hard times through no fault of their own. Now there's a catch 22 if I ever saw one!

Finally, a number of states (including Washington) will cancel a person's professional license if they are forced to file for bankruptcy. In hard economic times like this, I can't think of an act that is more punitive than taking away a person's ability to support themselves.

Individuals are not responsible for creating economic recessions and governments should not cancel a person's professional license because they have suffered adverse financial impacts. Especially if the bankruptcy is caused by a medical emergency. 47 million Americans do not have health insurance. In other words, we can look forward to a lot of bankruptcies -- so, rather than punish people for events they have no control of, let's put America back to work.

8. Implement the recommendations of the Special Report on Regulatory reform of the bi-partisan Congressional Oversight Panel chaired by Professor Elizabeth Warren. The full report can be found at

Where did it all begin? Well, there is no simple answer to that question, but, just for grins, check out the article below.

U.S. law-makers reach compromise on banking bill - Oct. 22, 1999
The White House and congressional negotiators agreed early Friday on compromises that clear the way for passage of major legislation overhauling Depression-era banking and ...
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