Finally A Call For A Congressional Investigation

Say what you want about US Speaker Nancy Pelosi, but she has just floated a very reasonable idea of having Congress investigate the cause of the financial crisis (presumably somewhat deeper than just noting greed and fraud).  Bloomberg is reporting that House Speaker Nancy Pelosi plans to push for a comprehensive inquiry.  You would think that prior to legislating new laws and regulations Congress would have already called for an investigation into the causes and practices of the financial industry.  Unfortunately, not all in power agree.  In his typical "Barney Knows Best" approach, Barney Frank, chair of the House Financial Services Committee, proposes legislating first and then holding hearings to justify the new laws he proposes.  

It is exactly that type of arrogance that has resulted in the shift of losses from investors to taxpayers and the resulting delay in recovery.  Had Congress held hearings before approving the TARP legislation, it is unlikely that it would ever have been passed.  We now know that the expert panel appointed by Congress to oversee the TARP fund stated that subsidizing financially troubled institutions results in a delayed recovery, but permitting orderly liquidation while painful, results in a quicker recovery and a more robust economy.  (See $4 Trillion and Nothing to Show for It.)  Legislating with prudence after careful consideration of all relevant facts and the likely effects of the proposed regulation results in better law and more workable solutions.  Legislating on the fly only results in a poor and confusing patchwork of red tape that is bound to have unintended consequences that forethought could have avoided.

What is truly unfortunate is that the rush to regulate by this Congress will undoubtedly stifle the free market and substitute Barney Frank's ideas for collective best practices.  Legislation needs to focus on maintaining transparency and punishing deceit rather than substituting the judgment of business folk with that of politicians.  

My hope is that hearings will happen and will ferret out the truth about the extent of the fraudulent and questionable practices occurring on Wall Street (and Main Street), but also explore how greater transparency in this day and age is possible.  Indeed, more frequent and more accurate disclosures may have prevented the crisis in the first place (albeit at the cost of cutting short the recent economic bubbles - which were probably not real in the first place).  

Perhaps the hearings will also force the Treasury and Fed to be more open and transparent with information as well, such as bank ratings.  The Treasury is reluctant to disclose information on banks for fear of causing a run on banks, as happened in the Great Depression.  It is, however, rumor and innuendo that cause runs on banks (and thus runs on the taxpayer funded FDIC fund).  If banks were forced to disclose their assets and liabilities, leverage ratios, loan loss reserves, etc. on a weekly (or even daily) basis to the public, the depositors could make an informed decision as to the safety of their funds.  It won't prevent banks from becoming insolvent or from making bad loans, but it will allow individuals to save more of their deposits at an earlier date.  Maybe the hearings will also result in some other common sense provisions, such as increasing FDIC insurance premiums for banks that assume more risk than conservative banks.  Bad drivers pay more for insurance than good drivers (in most free market states), why shouldn't bad banks pay more for deposit insurance than good banks?

Fraud and Cover Up In the Banking Scandal

The fraud that has brought our economy to the brink of collapse occurred at every level, from the borrowers, to the mortgage lenders, to the investment bankers pooling the loans, to the ratings agencies, to the government regulators themselves.  It is time to ask yourself why after at least fifteen (15) months since the public became aware of the crisis (which started 2 years ago) have there been no fact finding investigations in Congress as to the roots of the crisis?  Sure, Congress called in some of the ratings agencies, but where is the fact finding investigation about the practices, who was involved, who knew what when?The Senate engages in endless debate about political appointees, but passes bailout legislation without even understanding why the money is needed.  Ask why have there been no prosecutions for the fraud yet?  The answer may very well be that our senior elected officials from both parties and the top regulators are involved in covering up the extent of how bad the crisis is.

On April 3, 2009, PBS's Bill Moyers interviewed William K. Black, a professor of law and economics at the University of Missouri-Kansas City School of Law, and author of The Best Way to Rob a Bank Is to Own One .  (Hat tip to Economic Populist and Market Ticker.) Black was a former prosecutor and chief regulator in for the Federal Home Loan Bank Board during the Savings and Loan crisis in the 1980's.  Black understands bank fraud and how it occurs.  He was instrumental in setting up laws that would prevent such crises in the future - laws that are now being ignored.    The interview is about 20 minutes, but it is worth watching if you want to understand the extent of the fraud.  If you don't want to watch, read the transcript here.  

Black points out that the roots of the fraud extend back to the Clinton administration, and were exacerbated by the Bush administration diversion of regulatory attention from white collar crime to homeland security.  What is worse is that current Treasury Secretary Timothy Geitner was the chief regulator of the New York banks while he was President of the New York Federal Reserve District.  In recent testimony before Congress, Geitner denied that he had regulatory authority.  In September 2004 the FBI warned that this crisis was occurring and the fraud was building.  The FBI warning was ignored on every level.  

It is time that we insist that our Government Hold Those Responsible Accountable.  If the Department of Justice will not prosecute those involved, then Congress needs to pass a law allowing private rights of action to enable individuals to prosecute fraud actions on behalf of the government.  We have laws dating back to the Civil War, called Qui Tam actions, that permit private citizens to sue and recover on behalf of the Government when there is fraud against the government - typically a whistle blower actions involving misuse of government funds.  It is time that we expand those laws to allow private individuals to act on behalf of the government to pursue those who were involved in the fraud.

More Regulation?

The G-20 meetings that were held in London this past week resulted in President Obama agreeing to follow France's President, Nicolas Sarcozy, plan to regulate more tightly the once free markets.  Obama also pledged to repudiate U.S. policies towards freeing markets from excessive government interference.  The President's promises at the G-20 essentially reversed 25 years of free market policy spanning Presidents from both parties that ushered in  the largest growth in American wealth in history. 

The problem we are in today has little to do with lack of regulation and has everything to do with a) failing to enforce the regulations we have on the books; and b) sheltering risk takers from the consequences of their actions.  Many of the problems we have could have been prevented simply by enforcing the laws on our books.  If we don't enforce our laws, including punishing people for acts of fraud, we encourage people and entities to push the boundaries of what is acceptable.  Indeed, all laws, customs, mores, and social conventions are fluid concepts that derive from expansion of boundaries of what was once acceptable.  Laws and regulations are in place to put absolute limits on the extent to which these social conventions may be pushed.  Regulations as to capital ratios, executive compensation, and other minutiae on the day to day runnings of business have no place in our society.  The world is complex; businesses are complex.  One government solution does not fit all, nor should it.  No one wants a policy wonk sitting in a government building in Washington DC telling businesses in New York, San Francisco, Boston or elsewhere what ratios, salaries, employees they should have.  What is important is transparency and uniform standards of disclosure, not how the task is accomplished.  Essentially, we want transactions to be free from fraud and the best way to accomplish that is through transparency and mandatory disclosure.  In this day and age with modern communications and powerful computers, there is no reason that we can't have monthly reporting (or even weekly) rather than relying on quarterly disclosures.

The flip side of transparency, however, is another key area that we seemed to have forgotten.  That is, allowing the consequences of risk to fall upon the party assuming the risk.  Risk is a 4-letter word after all.  Not only is there an upside reward if the risk pays off, but there has to be a downside consequence when the risk doesn't pay off.  Spreading the risk among innocent parties (taxpayers in the case of the recent government bailouts) encourages riskier conduct than would normally be taken.  If risk is taken knowing that 100% of the upside is yours, but there is little  penalty on the downside, undisciplined risk will be assumed.  Bankruptcy has to be a viable option for every entity.  There can be no such thing as too big to fail.  The only role of government should be the orderly winding down of large institutions that have failed.    If we choose to insure bank deposits, the risk premiums paid by banks to the FDIC need to be set based on the risk undertaken by the bank, not a uniform premium across all banks.  Conservative banks that make solid loans in accordance with well established underwriting guidelines should be rewarded with lower premium and the ability to pass savings onto their constituencies.  Conversely, banks that take excessive risk need to pay a higher price because it will be more likely that taxpayer dollars will be needed to pay off depositors.  

Bankruptcy needs to be a viable option.  In many instances, it helps restructure loans.  It clears dead weight off the necks of individuals and businesses and allows them to once again become productive.  A few years ago we  changed our bankruptcy laws to make it more difficult for individuals to discharge credit card and other consumer debts in bankruptcy.   We need to revisit the wisdom of making it more difficult to restructure individual debt while at the same time allowing corporations to avoid bankruptcy.  While I have little sympathy for the individual that incurred debt beyond their means, the risk of that loss must be shared with the counter party lender that took the risk to allow the person to incur debt that couldn't be repaid. Without risk, the same practices that brought our economy to the brink of collapse will repeat and collapse will be inevitable.  

Choking the businesses with excessive regulation will not bring us out of this great depression 2.0, but enforcing laws to bring transparency to transactions and allow the consequences of risk to fall upon the risk taker will be a start to righting the ship.