Don’t ever say that I failed to explain things.
I came upon a Bob Schieffer interview of Bill Clinton on NPR radio yesterday. In general terms, the program dealt with our economic meltdown and specifically, they discussed the culpability of Goldman Sucks (GS) in that near collapse. Listening to our 42nd President was like a light bulb going off in my head. Beside the fact that Clinton is an enormously smart person, he also has the gift to translate that intellectual capacity into language that all of us can understand. This is called communication. Thus, let me enlighten you a bit on the financial subterfuge that is eating our economy alive. Here is what Clinton taught me.
Oh wait. First let me tell you what Clinton did NOT say. This bubble composed of sub-prime mortgages had its starting point with unscrupulous lenders and stupid, greedy lien holders, i.e. individual home owners. The mortgage lenders never qualified their customers in a thorough and accountable way. Additionally, those seeking the loans knew damn well that they would never qualify for the size of the loan they were seeking, much less with no down payment. So they agreed to adjustable rate mortgages. These loans enabled them to afford the monthly payments at a lower rate for a few years. Then, the APR would soar to a ridiculous amount which in no way, shape or form could be covered by the earning power of these home owners. And this was in good times. God forbid, their financial situation deteriorate ever so slightly, and they would face certain foreclosure. So right from the get-go, these aspiring homeowners had no more qualifications for these loans than did a rock, but the lenders approved them, including in that agreement a huge increase in their interest rate that would kick in about five years down the road. Unscrupulous lenders and stupid borrowers. Clinton left this first step out of his analysis, so I felt you should know what Square A was.
Let us move on to Square B. What Clinton did say on the program was that futures and hedges were devised to protect producers, whether they be farmers wanting protection for their from bad weather or manufacturers who want protection against currency fluctuations. These intentions were founded on real economic purpose, which is the key concept here. Clinton admitted that GS probably did nothing illegal; but their hedge funds and derivatives had no underlying, intrinsic value. Their investment packages were composed of bets upon bets upon bets, with no economic purpose other than to generate fees for the investment banking firm. Clinton said this was their greatest sin, peddling worthless securities from the beginning. Absolutely no economic purpose. This is the point where, as a last resort, morality enters the picture. However, morality cannot be legislated, so new regulations must be undertaken to try and short-circuit the lack of ethical behavior.
His antidote? Regulation that would require banking houses to back up their offerings with a much higher down payment. These highly leveraged deals must not be supported with just thin air, but with real assets behind them. Kind of like the solution for those individual home owners who mortgaged away their lives without any collateral behind their loans. Clinton also said that the banking houses must provide much more accountability and disclosure on the instruments they offer for sale. Specific information on the make-up, quality and viability of those items grouped together in an investment “package” must be included.
This reminds me of my call yesterday for re-vamping the blue sky pre-offering period into a much more aggressive interval for real exploration, discovery and fact-finding about the issue about to be publicly offered. Here is the formal definition of blue sky laws:
State securities laws designed to protect investors which require sellers of new stock issues to register their offerings and provide financial details on each offering. The term is said to have originated from a judge who claimed a that a new stock offering had as much value as a patch of blue sky.
Hell: the blue sky period should not be a time of serene quietude. No way. It should be a down-and-dirty series of days for getting the real dope on what is being offered, who stands behind it and the ethical history of the underwriter.
Such are the remedies that Clinton suggested. They make a lot of sense to me: a higher dollar-value of collateral to back up these dubious investments coupled with additional regulation that requires complete disclosure on what those investments actually are.
It goes without saying that these principles of sound investing should also be applied to the individual who attempts to partake in our financial markets. From individual levels to the very pinnacle of institutional levels, total disclosure, transparency and due diligence must be the pre-requisites for involvement. If these standards are not adhered to right from the beginning, all the crying later on of “No fair”, “I was robbed” or “Save me” will be meaningless and laughable.
They say our economy is looking up: jobs are somewhat rebounding, corporate earnings are posting excellent gains and consumer optimism is enjoying a rebirth. Faith in the economy is picking up. Don’t kid yourselves. If the bedrock of our economy, its financial institutions, cannot or will not clean house, that house will come tumbling down. It will not matter if this structural flaw is real or just perceived. The perception of danger will be quite enough to take our breath away.
Tags: adjustable rate mortgages, Bill Clinton on financial reform, more collateral required for leveraged investments, specific and total disclosure on financial products, violations of financial solvency