Posts Tagged ‘Government Sponsored Enterprise’

Each New Year begins with a look back and a toast to the future. I suspect the look back on 2009 was more brief than usual given all that transpired in the global capital markets in the past year. Further, the toast to 2010 may be longer than normal, given all that must be accomplished to eliminate the causes of the global capital market meltdown which began in December 2007.

Never one to complain, but often one to contemplate and take action, following are pragmatic solutions for regulators and policy makers to act on today:

1.   There’s been a lot of talk (mainly politicians) about regulating the amount of compensation paid by financial institutions. A practical and effective way to curtail the ‘excessive risk-taking mindset’, for which they are paid oversized awards, is to change the timeline over which they get paid. Forget about quarterly or annual awards; focus on long-term measures of contribution to profitability, measures of customer satisfaction, worker job satisfaction, amount paid out to shareholders and above all, the consistency of achievement of all these goals. The concept of ‘out earning the previous quarter’ is counter-productive and destructive of wealth (well, for many, but clearly not the short-sighted managers making their short-term bets). The short-sightedness of too many financial institutions results from their ‘trader mentality’ and loss of ‘investor mentality’. There must be claw backs for failure to achieve stated goals and lack of consistency. There must be a direct link between shareholder payouts and wealth accumulation, over time, and managers’ compensation – after all, who owns the company, and who do the employees ultimately work for – customers first, then the owners; management should come last, by default. Novel concepts like long-term financial stability and consistency of profitability come to mind as appropriate priorities. Longevity of the board and management’s career risk should be secondary concerns, and would in fact become secondary concerns if they were held accountable for long-term accomplishments and not quarter-over-quarter minutiae. Put a far greater share of the annual compensation at ‘risk-of-return’ if results beyond one year don’t meet objectives. Put more compensation at risk for mistakes, fraud, incompetence, malfeasance, etc. The no brainer among these suggestions is to extend the payout period, including ‘golden parachutes’ and ‘buyout bonuses’ and the sort. Provide less cash payout and in forms (i.e. – stock) which accrue value as the value to the shareholders grows, over time.

2.    Don’t’ fix it if it isn’t broke. Why not re-enable the Glass-Steagall Act? It worked fine for 66 years, enforcement didn’t carry a large price tag and it prevented risk mongers from getting out of control as they did in 2000 – 2009. Do you think the fact the return from investing in the U.S. stock market is – 1 % for this decade may be related to the short-sighted repeal of this Act? This Act was established in 1933 to control speculation and excessive risk-taking by banks. The repeal of this act in 1999 is believed by some to have contributed to the global financial crises of 2000-2002 and 2008-09. The original law created deposit insurance and to limit the risk to the U.S. Treasury, it forbade a bank holding company from owning other financial companies or engaging in certain high-risk financial activities. This firewall between a commercial bank and an investment bank was critical and the repeal spawned reckless lending practices which contributed to the meltdown of the financial markets. Let banks be banks, taking deposits for checking and savings accounts and prudently loaning money. Investment banks should be just as they are named, a place for investment. There is talk on Capitol Hill that Senator John McCain and former Federal Reserve Chairman Paul Volcker will be pushing this idea in 2010.

3.   Again, if it’s not broke, don’t fix it. In the case of Credit Default Swaps (CDS), this insurance concept was never implemented or regulated properly. You know the old saw about ‘out of sight, out of mind’? With a majority of global CDS done off-market (i.e.-unlisted), absolutely nobody had any idea of the total notional value of these liabilities (so-called insurance policies) or the extent of counter-party risk. Pure and simple, CDS should be exchange traded (i.e. – listed) for investors’ protection. Instead of investment banks and others (remember AIG?) playing matchmaker between parties, a public exchange would do this with standardized guidelines for risk management and transparency.

4.   Another simple, easily implementable fix is to set a higher standard for stronger capital structure in the financial industry by increasing equity capital or reserve requirements for depository and lending institutions, regardless of their size. We now know that ‘too big to fail’ means too big to save (Bear, Stearns, Lehman Brothers, Washington Mutual and on and on). The current leverage ratio of 8 percent tangible equity per dollar of assets should be increased to 10 to 12 percent. Why not double the reserves requirement all the way up to 10% from the obviously inadequate 5%? This includes banks, insurance companies and brokers as well as every government sponsored enterprise (GSE). This protects the workers’ job security and the American taxpayer by reducing the risk that the burden of failure among financial institutions will be dropped on our heads, again.

5.   Speaking of GSEs (GNMA, SLMA, FNMA, FHLMC, FHLB), there is absolutely no economic reason to not dismantle and restructure Fannie Mae, Freddie Mac and maybe FHLB. The latter two relinquished their independence on September 7, 2008, when the U.S. Government took control of both Fannie Mae and Freddie Mac and committed up to $1.5 trillion to keep them afloat. Both were once publicly-traded corporations and issued billions of debt on top of the equity. Both government-sponsored entities have over-evolved since inception. Both purchase single-family mortgages, originated by other companies, guarantee the mortgages and pool them to sell to institutional investors or keep them in their respective portfolios. Over the years these two entities have become identical twins and both abandoned their original charter which was to purchase prime mortgages (people who could actually make a monthly payment and had a substantial down payment to begin with). Management of both companies failed as they ignored their charters in hopes of earning outsized compensation. This was done with higher risk Alt-A and Sub-prime mortgages. Restructuring should involve limitations on the amount of guarantees that may be covered, market segmentation and likely geographic separation. Subdividing the portfolios of these two into possibly four or more entities also has merit. This will create jobs and a more vibrant, competitive residential lending environment versus the current monopolistic version.

Each of these ideas will reduce corporate welfare (i.e. – decrease the need for government bailout), reduce the financial burden on today’s taxpayers and give future generations a chance to enjoy the same standard of living that we enjoy today.

George Vitta, President of Asset Strategies Portfolio Services, Auburn Hills, MI.   For more information, visit our web site www.assetstrategie.com