Wednesday, September 24, 2008

A Solution to the Current Financial Meltdown

By Ed Smallwood


We’re hearing a lot of talk about the bail-out of the financial companies on Wall Street. Both parties are weighing in, with most people (more than 70% of those polled) skeptical that giving almost a Billion Dollars of money without oversight to one person to dole out to the companies is a terribly good idea. The President and John McCain seem to be okay with it. Republican Representative Joe Barton from Texas (who voted with the President 96% of the time) called the bill “Dead on Arrival,” and stated that the bill “doesn’t have 40 votes in the House,” so someone is listening.

This is my take on the situation:

We are right to be skeptical. The way the bail-out has been architected, the executives of the companies are likely to keep their jobs and fat bonuses. The government will take a chunk of the shares in the company, diluting the value of the remaining shares and shafting the shareholders if the company recovers. It does nothing for the homeowners whose failing loans are causing the financial debacle in the first place. In short: The heck with your retirement or your home. What’s really important is saving rich people’s butts! Understand?

The really huge problem with this is that we are likely to see as much as (possibly more than) Seven Billion Dollars in losses through the mortgage meltdown. That’s Seven Billion Dollars in lost home equity. To put it another way, that’s more than half of the U.S. Gross Domestic Product. Imagine if your gross salary suddenly got divided in half for a year without changing any of your other obligations. That’s what we’re talking about happening to the economy of the U.S. And that’s not counting the amount of money that people put into their home and lost due to the home being foreclosed on.

Now imagine that the current bail-out doesn’t address any of the problems with the mortgage meltdown. Why imagine? It doesn’t. None of this money, not one single cent, is slated to reduce the damage to homeowners’ pockets. All the legislation does is make sure the mortgage company is still there to foreclose on the homes if need be.

Now, keep in mind that while that’s not good, the current bill also does nothing whatsoever to address the bad mortgage making decisions that got us into this problem. Nope, repealing Phil Gramm’s deregulation of the industry is not currently on the table.

So, here’s the deal: Executives keep their jobs, retirement savings invested in mutual funds get smaller, homeowners are out on the street, and taxpayers are left holding the tab. If that isn’t a Bush/McCain field goal, I don’t know one.

Here’s what we need to really be doing:

First, we need to bring back confidence in our financial institutions. Simply making sure that they continue to exist isn’t that helpful if they aren’t doing their jobs. That means they have to be lending money out to people who can afford it and collecting that money accordingly. In order to make sure they are doing their job we absolutely must at a minimum bring back the old regulations by repealing Phil Gramm’s (architect of McCain’s economic policy) deregulation bill. Creating a few new regulations might be useful as well, as long as they prevent this kind of mindless money grab.

However, that is nowhere near enough. We should also have the FDIC and SEC swoop in on banks and mortgage companies after closing on some Fridays for unscheduled audits that would take the entire weekend. Go over these institutions completely and with a fine-toothed comb. Then on the following Monday morning if the company doesn’t pass the audit, the government takes them over. If they do, then the FDIC or SEC should make a nice, loud public statement that the company is financially sound and ready to continue business.

That helps bring back confidence in our financial institutions, but doesn’t help the real backbone of our economy. In order to fix that, we’re going to have to relieve the homeowners of some of their burden. This is going to be hard and involved. My recommendation is to do something similar to the audit of the banks themselves. We’re going to have to freeze foreclosures for a time. Before foreclosing on a property, a financial institution will have to do the following: Attempt to contact the homeowner and offer to meet with them. This should be first attempted through the mail, followed by phone calls, and then home visits if necessary. The mortgage companies would not be able to foreclose on the property if they couldn’t prove that they had done this. If the homeowner agrees to a meeting, then they would meet at a neutral location with the mortgage company and a neutral mediator.

At the meeting, the mortgage company would have to present an honest assessment of the current value of the property, as well as the amount owed on the property. The homeowner would present documents showing their income as well as their financial liabilities. It is likely in many cases that the homeowner would not be able to pay back the entire amount of the loan. It’s probable that in many areas the home could not be sold for more than the loan amount for a decade or more. The mortgage company is going to have to take a loss in these cases. But, we can mitigate the loss if we’re careful. The loan must be restructured so that the payments are affordable and not for less than the reassessed value of the property, but if the homeowner sells for more than the loan’s restructured value for up to some specified time (I would say up to 10 years after the life of the loan would be reasonable), the mortgage company should be entitled to a portion (not most or all) of the profits up to the original value of the loan. This money going to the mortgage company would be used to offset any bailout funds given to the mortgage company by the government, and buy back shares in the company from the government, helping to keep shareholder equity. Any financial institution unwilling to do this should be excluded from bailout funds.

This idea has the merit of helping to free up funds for the homeowners to spend or invest and keep our economy afloat, while protecting shareholder value. However, in order for this plan to work it will have to be heavily promoted. It will do nothing if people don’t know about it. Is this idea perfect? No, it doesn’t really punish those who were greedy enough to get us in this mess. Is it simple? No, but the simple solution was to prevent this problem in the first place (and it was clearly preventable.) However, it is the best we can probably do at this point, and it would probably be enough to prevent a serious recession.

Anyone in Congress who wants to steal this idea and elaborate on it is very much welcome to do so.

No comments: