Our Financial Future
Assemblymember Pedro Nava
September 29, 2008
As Congress debates the possible expenditure of $700 billion to shore up our financial markets the American economy sets on a precipice overlooking the future possibilities and potential pitfalls that could occur. After years of disregard for risk management and the increasing reliance on obscure financial products the American people are now being offered a choice. Spend up to $700 billion of taxpayer money to wash away the mistakes of Wall Street, or fail to act and risk more job loss and a collapse of the financial system where car loans, mortgages and student loans could become a thing of the past. Both choices could bring grim consequences.
The roots of this crisis have now become clear. An over-exuberance and over investment in subprime loans that had little or no possibility of reaching full maturity. Unlike a good investment advisor who recommends portfolio diversification our markets were dumping billions into mortgage backed securities creating investment vehicles so arcane and risky that often their true value was unknown. This is a crisis built on the backs of our middle class and now our middle class, having already been victimized by these schemes, is being asked to foot the bill for this bail out. A number of conservatives have had the audacity to lay this blame on the Community Reinvestment Act and its mandate to invest in underserved communities. They dismiss the issuance of thousands of mortgages that were not properly underwritten as the only way that many Americans could afford a home, when the data is clear that responsible subprime lending is sustainable and good for communities. Underlying that premise is the faulty logic that the only way to provide distressed communities with financial empowerment is through financial mismanagement. The roots of this problem have nothing to do with assisting the middle class or underserved communities; the roots of this crisis arose from poor decision making and outright greed by some on Wall Street. It was a systematic failure of a system that created collaterized debt obligations and the selling of bonds on debt. A system that rewarded executives with multi-million dollar compensation packages even when their companies failed.
For better or worse it appears that we are well on our way to bailing out the financial industry. Let´s call it what it really is, a subsidy at the taxpayer´s expense to mitigate the risky behavior of investors and managers. We need to discuss this issue with honesty and clarity. If, as some have pondered, the assistance of homeowners facing foreclosures creates a moral hazard, then this bailout is clearly a signal to Wall Street that risky behavior is not only tolerated but encouraged. The plan currently under consideration is purely voluntary on the part of the institutions. The problem is that those institutions with the most outstanding debt will be most likely to participate. This situation could give way to prolonging the inevitable as companies that have no chance of surviving are able to operate for a few more months with gobs of government money. The main factor compounding the actual amounts of money that will be spent is the lack of certainty regarding the true value of the assets that would be purchased. Even at this moment financial experts are debating whether they are worth 20 cents on the dollar or much more. Where ever these prices break is vital to determine who will participate. If the assets are determined to have more value than is possible in reality, then the Treasury will have over injected liquidity into a market with no underlying value. It is vital to get a true and honest measure of what the assets may be worth in the short and long term. With this possible risk in mind it is more appropriate that the government get guaranteed equity stakes in the companies being assisted, or the option to acquire preferred stock in the institutions. We have already seen this more systematic approach with the assistance to Fannie Mae and Freddie Mac. It is somewhat odd that what began as a case by case review has now become a shotgun approach.
It is also possible that in order to make this plan work the Treasury and Federal Reserve will have to work with private financial managers to make these deals work who will inevitably charge a commission or fee for this service. This plan must cap any fees that may be charged for arranging these deals. A small commission on the bailout of some bad mortgage debt could amount to millions of dollars.
This bailout also must not reward executives with golden parachutes amounting to millions of dollars of what will be taxpayer money. We have already seen that Wall Street rewards failure when former CEO of Citigroup, Charles Prince, got a severance package of $68 million plus bonuses after Citigroup had to write down over $17 billion in subprime mortgages. Former CEO of Merrill Lynch, Stan O´Neal walked away with more than $160 million after his firm took a $2 billion loss on subprime mortgages. We cannot condone any practice that leads to a soon to be out of work CEO's enrich himself or herself at taxpayer expense. Can anyone imagine the average worker underperforming, or failing at his or her job and then getting a raise? What currently prohibits a CEO should they somehow foresee a turn for the worse to not provide their top executives massive bonuses, stock options, and on top of that a hefty severance package? Although we are considering borrowing $700 billion from the American people, these companies are still able to compensate their CEO's with more money than one person sees in their lifetime. Does this make sense? During the recent bailout discussions, Congressional Members potentially negotiated into the plan a cap on executive compensation, including a prohibition on golden parachute payments for two years. Considering the severity of this situation and the exorbitant amount of money being discussed CEO's need to feel as much of a burden as the ordinary taxpayer should this bailout plan become a part of our life; felt by generations to come.
Lastly, this deal must address two key and fundamental concepts. One, it must address the needs of homeowners facing foreclosure. If handing over money to irresponsible financial institutions is now ok, then assisting those homeowners who are not speculators must be a priority. This will encourage the stabilization of neighborhoods and reveal the true value of the mortgage securities that the treasury will be buying. Two, this plan must jumpstart a regulatory overhaul of the financial markets. We have lived through several decades of the free market ideology that the markets can correct themselves and that Wall Street needs free reign to invent new products and models. This current crisis teaches us that unbridled freedom from government oversight is not only irresponsible but dangerous to our way of life. When junk paper is getting triple A ratings on Wall Street, the signal is clear that regulation needs to be ramped up.
Pedro Nava represents the 35th District in the California State Assembly. He serves as Chair of the Assembly Committee on Banking & Finance.
The roots of this crisis have now become clear. An over-exuberance and over investment in subprime loans that had little or no possibility of reaching full maturity. Unlike a good investment advisor who recommends portfolio diversification our markets were dumping billions into mortgage backed securities creating investment vehicles so arcane and risky that often their true value was unknown. This is a crisis built on the backs of our middle class and now our middle class, having already been victimized by these schemes, is being asked to foot the bill for this bail out. A number of conservatives have had the audacity to lay this blame on the Community Reinvestment Act and its mandate to invest in underserved communities. They dismiss the issuance of thousands of mortgages that were not properly underwritten as the only way that many Americans could afford a home, when the data is clear that responsible subprime lending is sustainable and good for communities. Underlying that premise is the faulty logic that the only way to provide distressed communities with financial empowerment is through financial mismanagement. The roots of this problem have nothing to do with assisting the middle class or underserved communities; the roots of this crisis arose from poor decision making and outright greed by some on Wall Street. It was a systematic failure of a system that created collaterized debt obligations and the selling of bonds on debt. A system that rewarded executives with multi-million dollar compensation packages even when their companies failed.
For better or worse it appears that we are well on our way to bailing out the financial industry. Let´s call it what it really is, a subsidy at the taxpayer´s expense to mitigate the risky behavior of investors and managers. We need to discuss this issue with honesty and clarity. If, as some have pondered, the assistance of homeowners facing foreclosures creates a moral hazard, then this bailout is clearly a signal to Wall Street that risky behavior is not only tolerated but encouraged. The plan currently under consideration is purely voluntary on the part of the institutions. The problem is that those institutions with the most outstanding debt will be most likely to participate. This situation could give way to prolonging the inevitable as companies that have no chance of surviving are able to operate for a few more months with gobs of government money. The main factor compounding the actual amounts of money that will be spent is the lack of certainty regarding the true value of the assets that would be purchased. Even at this moment financial experts are debating whether they are worth 20 cents on the dollar or much more. Where ever these prices break is vital to determine who will participate. If the assets are determined to have more value than is possible in reality, then the Treasury will have over injected liquidity into a market with no underlying value. It is vital to get a true and honest measure of what the assets may be worth in the short and long term. With this possible risk in mind it is more appropriate that the government get guaranteed equity stakes in the companies being assisted, or the option to acquire preferred stock in the institutions. We have already seen this more systematic approach with the assistance to Fannie Mae and Freddie Mac. It is somewhat odd that what began as a case by case review has now become a shotgun approach.
It is also possible that in order to make this plan work the Treasury and Federal Reserve will have to work with private financial managers to make these deals work who will inevitably charge a commission or fee for this service. This plan must cap any fees that may be charged for arranging these deals. A small commission on the bailout of some bad mortgage debt could amount to millions of dollars.
This bailout also must not reward executives with golden parachutes amounting to millions of dollars of what will be taxpayer money. We have already seen that Wall Street rewards failure when former CEO of Citigroup, Charles Prince, got a severance package of $68 million plus bonuses after Citigroup had to write down over $17 billion in subprime mortgages. Former CEO of Merrill Lynch, Stan O´Neal walked away with more than $160 million after his firm took a $2 billion loss on subprime mortgages. We cannot condone any practice that leads to a soon to be out of work CEO's enrich himself or herself at taxpayer expense. Can anyone imagine the average worker underperforming, or failing at his or her job and then getting a raise? What currently prohibits a CEO should they somehow foresee a turn for the worse to not provide their top executives massive bonuses, stock options, and on top of that a hefty severance package? Although we are considering borrowing $700 billion from the American people, these companies are still able to compensate their CEO's with more money than one person sees in their lifetime. Does this make sense? During the recent bailout discussions, Congressional Members potentially negotiated into the plan a cap on executive compensation, including a prohibition on golden parachute payments for two years. Considering the severity of this situation and the exorbitant amount of money being discussed CEO's need to feel as much of a burden as the ordinary taxpayer should this bailout plan become a part of our life; felt by generations to come.
Lastly, this deal must address two key and fundamental concepts. One, it must address the needs of homeowners facing foreclosure. If handing over money to irresponsible financial institutions is now ok, then assisting those homeowners who are not speculators must be a priority. This will encourage the stabilization of neighborhoods and reveal the true value of the mortgage securities that the treasury will be buying. Two, this plan must jumpstart a regulatory overhaul of the financial markets. We have lived through several decades of the free market ideology that the markets can correct themselves and that Wall Street needs free reign to invent new products and models. This current crisis teaches us that unbridled freedom from government oversight is not only irresponsible but dangerous to our way of life. When junk paper is getting triple A ratings on Wall Street, the signal is clear that regulation needs to be ramped up.
Pedro Nava represents the 35th District in the California State Assembly. He serves as Chair of the Assembly Committee on Banking & Finance.
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