U.S. defends against prior financial war;
business once again safe from real regulation
In the great tradition of the conquered, much as the French built the Maginot line to protect themselves from a World War I offensive, the U.S. Government has come out with suggestions for how we can best prepare for the last economic war.
“A mortgage broker would be required by law to act in the borrower’s best interest, not his or her own interest,” suggests Uncle Sam. The only problem with this suggestion is that it would create a fiduciary relationship between the Broker and the prospective Borrower. Such a relationship would be anathema to the mortgage industry.
The brokers make their money as a percentage of the profits made and this change would require them to apply only for products that were in the interests of the borrower and not their real financial interests. Moreover, the only people who have to watch the interests of their customers over their own interests are Attorneys and Physicians, who as a result call those they serve clients and patients.
Thus, physicians are frequently at odds with health insurance companies when they prescribe treatments for their patient that they feel are necessary. They are, in essence, required to bite the hand that feeds them, since doctors are now paid by insurance companies almost exclusively.
Lawyers, as we all know, are only interested in representing the interests of their clients, except that they are Officers of the Court, and must also represent the interests of justice. They can never represent their own interests, financial or otherwise.
These obligations come after the lawyers finish three years of law school and pass the bar exam of their state and the Doctors graduate from medical school and pass their own examinations. They are professionals from the beginning and that colors all of their relations with the public. I really don’t think that will work with mortgage brokers who are only interested in a fast buck. It is childish to think that they can be made into fiduciaries.
The above requirement is the only concrete one contained in the administration’s proposals. There is nothing about requiring banks to act in anyone’s interests but their own, and there is nothing about controlling the credit card industry which is currently charging up to 30% on money borrowed on their cards.
That huge interest is also causing the collapse of the credit markets. No one in the administration is suggesting that these card companies stop targeting everyone and anyone with ads for their hyper expensive cards. There is no requirement that they even consider the credit worthiness of the people whom they offer cards to. Plenty of bankruptcies come from credit card debt.
There is also no requirement that there be a real fiduciary relationship between the members of the legislature and the people they represent. Outside interests are still paying for the elections of our representatives, and as long as that is happening our elected representatives will be dancing to their music and not ours.
Also, as long as the administration of this country continues to believe in a basically pure free-market economy we will continue to get into financial crises. We have seen crisis after crisis since deregulation seriously began under Ronald Reagan’s administration.
Only the super rich have benefited from such policies. This needs to stop. The government needs to look out for all its citizens, not just business interests.
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14. March 2008 at :
Maginot Line: a zone of heavy defensive fortifications erected by France along its eastern border in the years preceding World War II, but outflanked in 1940 when the German army attacked through Belgium.
14. March 2008 at :
Joel,
There are many points of contention in this article. I will focus my rebuttal on your call for more regulation of the credit card industry.
Credit card companies serve a very valuable place in society in extending purchasing power to all socio-economic strata. High interest rates are not arbitrarily decidedly, nor are they targeted at any one band of consumer. Rather, high interest rates reflect an implied risk the credit card company is assuming to provide purchasing power to a customer who provides no collateral. In the course of default (bankruptcy) the credit card company has little, if any, recourse to recoup those losses. Ergo, the high interest rate, which is spread out across a wide swath of risk to defray the potential losses.
The issuing of credit, at a predetermined rate of interest, is agreed upon by both parties for a set amount of credit is extended. Based on a credit check conducted by the credit card companies, it is determined first, if credit should be extended to an applicant and second, at what rate interest is charge on this unsecured line of credit if payment is not made in full by a specific time period.
Thus, your argument is proven wrong. “There is no requirement that they even consider the credit worthiness of the people whom they offer cards to.” The market necessitates an extreme consideration of credit worthiness because of the tremendous amount of risk the credit issuing is assuming. This risk is assumed in two ways. First, through interest rates which discourage permanently carrying a balance and second, through issuing limited amount of credit to the lowest fringes of the economic ladder.
However, you have failed to take any of these factors into consideration. Rather, through implication, you suggest the government is the best agent of regulation and that government regulation must include the following:
• Whom is worthy of credit
• How much credit should be extended
• At what rate of interest they be charged for said credit
• What entity is worthy of issuing credit
Such an onerous regulatory system would have a chilling effect on commerce and ostensibly our economy. In order to protect citizens from themselves, the government would necessitate such a high bar of credit worthiness that only the “super rich” would qualify. Yet, it is the highest reach of the economy that has the least amount of need for the very services credit card companies offer.
The people shut out of access to credit in your brave new world are the very people who need the services of credit card agencies the most. Government regulation is not the answer to preventing bankruptcies.
14. March 2008 at :
I never suggested that rates were arbitrarily determined, what I said was that they were too high. In fact, in any other context they would be usurious. They are specifically excluded from the usury statutes and that is based upon a governmental decision to support the banks. This decision is not a fair one because millions of consumers are caught in a web of debt that increases exponentially. Not only are they charged interest on the amount owed, they are charged late fees, which exacerbate the situation. Thus, the consumer who suddenly cannot pay his bill for one reason or another, usually the loss of a job or a change in their economic situation, is faced with a drastic increase in the amount that they owe, ON A MONTHLY BASIS. This continues for as long as they don’t pay. Thus they have interest piled upon late fees, etc. In no other area of the economy does a debt increase in this way. It is a foolish capitulation by the legislatures to the banks. If you owe money directly for the purchase of an item you only owe interest on what you pay, not on late fees. If I owe you $100 for an item I don’t have an increase of $30-35 each month on top of that plus interest. It is simply absurd.
Your second argument that there is some agreement between the parties is also wrong. The parties are not in an arms length contractual agreement. There is no agreement between the parties. The agreement the banks present is an adhesion contract; the consumer either takes it or leaves it. Now that may sound fair, but consumers are not as sophisticated a group as you imply in your argument. The American consumer is buffeted on all sides by appeals to “Master the Possibilities,” to buy on credit, and to spend what they don’t have now to satisfy their unnecessary desires. Buy, buy, buy has been the mantra of the market. Under such pressure many people sign on for credit cards that they don’t need. This is exacerbated by the presence of internet purchasing, which requires that they have such cards to do business. What I suggest, and what the country needs is the government to step in and reduce the rates and the insane late charges and administrative fees so that the consumer isn’t buried in debt for money that he did not borrow. What the banks are getting is Unjust Enrichment. Any bank can monitor the use of a credit card, and if that card use is not promptly paid for, they can cut it off. They have the ability to do that. The banks do not have the right to usury if no one else in the economy has. Moreover, if you study the amounts that are typically owed after late charges are added, the rates can exceed 50 or 60% interest. This is absurd.
The argument that I love best is that regulation is going to have a chilling effect on the market. That is simply untrue. The profits that are being made by the banks are extraordinary. They are actually mind boggling, and they are made on the backs of working people. If regulation sounds paternalistic, well that is simply too bad. The card companies have no right to protections and rights that are denied to others who operate in a commercial context. They have no right to special status, except that they have paid off the legislatures, both the Senate and the House of Representatives for so many years that they have made amnesiacs of our elected representatives. Free meals, free trips, election money, etc., can do that to an elected official.
Finally, no one needs access to credit if they can’t pay for it, and if they can’t pay for it they should only owe money on the amount that they borrowed and not on late fees piled upon that amount month after month. If only the rich should have credit cards than only the rich should have them. In fact, Congress recently changed the Bankruptcy Code to prevent people from discharging their debts to Credit Card companies. That is another Perk that has been given to business by the Republican Congress.
We are in the situation economically, probably on the verge of not the R condition, but perhaps the D condition, because we have had our regulatory structure eviscerated since the reign of “Saint Ronald Reagan.” It is time to put our system back under control so that the fruits of the people work goes more equitably to all of the people and not just to the class with clout in Congress. We now live in a country where the distribution of income is more like a banana republic than a democratic republic, and certainly not like a first world power.
The fact is, social mobility in America is not what it once was and many other places in the world are far more mobile then we are. The Horatio Alger story isn’t possible here any longer.
15. March 2008 at :
Joel,
Thank you for your response.
This country cannot set up a paternalistic society by which profits are capped simply because you, and other equally unqualified citizens, determine they are “too much.” Corporate profits in this country fuel innovation, they fuel job growth, they fuel economic opportunity, they fuel an expansion of wealth across all economic strata. Where do you think teacher union pension money is invested? Corporate stocks and bonds, the gains from which keeps these pension plans solvent. Workers today are able to save for their future, tax free, through 401(k) plans, and where are those assets invested? Again, corporate stocks and bonds. The gains from which will provide for retirement of the next generation after social security, which is invested only in government debt, goes into insolvency. Does not life insurance play a crucial role in helping the elderly with the loss of a spouse? Yes, but under your system of capping profits, insurance companies would be hamstrung to offer the most innovative products to the widest group of people. These are but three examples of the ways in which financial services profits help all classes, I can provide others if necessary.
Thus, contrary to your statements, corporate profits do not get siphoned off by some ruling class of elitist in this country. The richer getting richer is a myth perpetuated by todays political left because it speaks to an ignorance of society. Yet, you have stepped upon this platform and proclaimed to the world that the government should step in to divert money from a group you don’t deem worthy of the product of their labor: “the rich.” If a bank has its profits capped, because King Friedlander and his Merry Band of Liberals say they are too much, what incentive is there for product innovation and growth? What incentive is there to reinvest corporate profits into the development of new products and businesses which in turn create jobs?
The answer is there are no incentives. Financial institutions would move various profits centers to other parts of the world with more relaxed regulations. If you want “the D” word, you got it through such a ridiculous idea of capping corporate profits.
So I ask, openly, what are the “extraordinary…actually mind boggling” profits being made by the banks? How much profit does a bank have to make to reach this line you have drawn? And why do you posit these profits are made on the back of the “working people?” Such an idea betrays fundament ignorance to the revenue sources of today’s financial institutions and plays to class warfare talking points perpetuated, but not substantiated, by today’s left.
Yes, credit cards are a lucrative source of revenue for banking institutions, but they are by no means the largest source of revenue. Banks, by and large, make the majority of their revenue through investment banking. This includes such activities as bond issuance, equity issuance, financial product structuring, etc. There is little to be made on the backs of the “working people” there. Also away from the “working people” backs are corporate banking services, cash management, treasury, retail drop boxes and the like which are set up specifically for corporate and institutional clients.
Then there are other banks, such as the Bank of New York Mellon, State Street and Brown Brothers Harriman. These banks make their money on securities services. In other words, services such as accounting and recordkeeping they provide for pension funds, mutual fund companies and hedge funds. They make their money on the backs of asset managers.
But see you have group all financial institutions into the broad banking umbrella, thus, all of them should have their profits capped, and the excess diverted to “working people,” for some arbitrary reason.
Chilling effect on the economy? Absolutely.
The government should create more incentives, not less, for the pursuit of corporate profits and create a system by which these profits are more easily shared with all economic strata through investment. Putting caps on profits, or adding layers of regulation make it more difficult for companies to maximize this potential and only sees to it that accountants and lawyers get a larger share. What happens under such a system you outline is the mass exodus of these profits from the US to other financial centers in the world. The backs of the working people will be broken because there will be no capital to buy the fruit of their labor.
15. March 2008 at :
1. Profits are not capped when usury rules are applied to all transactions. Bank credit card operations have been allowed to operate outside the realm of ordinary business endeavors. This came about because of the control that the business lobby has over the congress. If any of the editors of this publication loaned money to anyone, or had money owed to them on a debt, regardless of the circumstances of how it came about, you would be subject to the usury laws. Those laws arbitrarily do not apply to credit cards. This results in massive profits by the card companies and the untold misery of the debtors. I don’t care what the risks they face are, the banks are not entitled to unfettered profits when those profits could not possibly be made in other equally legitimate business enterprises. It is not a case of profits being too much as you suggest, it is a question of those profits being unfairly secured, or their being unfair advantage being given to one economic enterprise as opposed to another. As the last Bush president with a brain said, there ought to be a level playing field. That applies to business as well as other endeavors.
2. Your defense of the system of perks available to certain favored business enterprises in opposition to others which must play by the rules is not strengthened by reference to pension plans. Millions of people, governments, and business entities have lost extensive parts of their pension funds through their investments in the uncontrolled products sold by the banking system. Those products, favorably endorsed by the rating agencies, were created without a thought to their viability or the actual risk involved in compiling them. The reason why such risk was passed on to every player in the market, and that all of them have been cursed with such products, is that there was no regulation of what the banks were doing. And, there was no effective control of what the accountants were doing, what the assessors and appraisers of the products were doing, what the law firms were doing, or what the marketers were doing. Those controls were effectively eliminated during and after the Reagan administration. The result of this has been the Savings and Loan Crisis, the Pension Fund Crisis, the current housing crisis, the current credit crisis, and other crises in the past.
3. There is a point that must be recognized here, and that is that the market is not only exuberant, vital, productive, and absolutely essential to the running of our economy, but it is also irrational, erratic, herd like, under regulated. The reason Bear Sterns went down yesterday was not due to its actual financial position but to the fact that the investors became fearful about it. If there had been regulations in place to assure the investors that everything was under control in the markets, Bear Sterns, after 85 years of profit and liquidity would not have fallen. And let me add to this, Bear Sterns was rescued by PUBLIC MONEY. Why are we rescuing them if so many mortgagors are being allowed to see their properties go into foreclosure? Is that one house so special? Is the financial condition of those people to be favored over the well being of the great unwashed multitude of Americans. I will not allow an argument that they were saved so that America would not go into the R word. They were saved by their friends, who operate in an unfair economic environment.
4. Unfair, you might say; how naïve I must be. Well, for thirty years now I have done my best to protect the public against the predatory behavior of the powerful, and since the Reagan years, one after another of the rights of the public to gain redress against the improper and illegal behavior of the banks and businesses that currently control the government, have been removed. It is almost impossible to seek legal redress against boards of directors and CEO’s under the law today, however egregious and illegal their behavior might be. With the end of effective legal redress the public is at the mercy of people that they can’t sue. There is no effective way to seek redress against the perpetrators of fraud, the grossly, or merely negligent, and the intentionally criminal. The public is left helpless. Moreover, where the law allows the government agencies which have some regulatory power to act, the administration of George W. Bush places people in control who refuse to act for the public good, or even to act at all. This is true in some cases even where the courts have stated that they have the right to act. Unfettered capitalism leads to illegal behavior because the profit motive is stronger than any sense of ethics or morality (and you well know what the morality of the market place is caveat emptor).
5. The truth about pension funds, especially those of the various States of the United States is that they are often insolvent. Thousands of municipalities which invested in the uncontrolled and unregulated and certainly hyper risky products of the banks in the past few years are now on the verge of insolvency. This is also true of other countries which invested in these products. The faith that other countries had in the safety of our economic system has been undermined by the outrageous behavior of the investment banks in the past few years. The banks were able to help create this crisis because they could do whatever they wanted to do. You speak of the value of innovation and free enterprise. There is no value in the financial destruction of the economy. You also say that the money of the public is not at risk in what was being done by the banks and businesses. That is not correct because the only money that they have is public money, unless they are printing it themselves. Money invested by States, municipalities, and individuals are the public’s money. Even if the pension money is invested by investor groups on behalf of public entities, it is still public money. There must be regulation by the government to prevent excessive behavior by the banks and other investment groups. In the absence of regulation there is chaos, and that is what we are seeing now.
6. Ah yes, before I forget. You seem to like personal attacks, and that is a fault which is attributable to both conservatives, moderates, and liberals. This is supposed to be an abstract intellectual discussion. I am not in the government and I do not make policy, but if I did I would not be terribly impressed by arguments that were supported by personal attacks
7. The very basis of this nation is the market economy, but it is not effective without reasonable regulation. There has been no effective regulation in the past few years unless there has been a scandal of epic proportions to force the government to act (for example: the pension fund scandal) . The absence of oversight will only make our markets unreliable over time. We survive on the investment of other countries as well as internal investment. If other countries, which previously had faith in the efficacy of our financial system, lose that faith, they will cease to invest. If we lose the economic respect of the world we will become a second-rate country. This must not be allowed to happen. I never said to cap profits, but if usury laws apply to all business entities except credit card banks, that is just plain wrong. Why are my profits in business loans capped if theirs aren’t? I am not for capping profits, merely for reasonable regulation.
8. Now stop making personal attacks and leave your argument in the intellectual sphere. Crafting responses to intellectual attacks on a position requires a person to evaluate their position to defend it and that is very productive. Arguing with an adversary is useful both for policy and intellectual development. Personal attacks are not.
15. March 2008 at :
Joel,
You make many sound arguments. I will not be able to address each of them in this reply. The arguments on pension plans I shall handle separately. I’d like to first respond to the charge of personal attacks and address credit card business practices.
I apologize for previous personal attacks. But I do not believe I have acted out of the reasoned realm of this debate . The positions you present are personal opinions you express and I attack the opinion. I am not way insulting your person. I’m sure you are a lovely man. However, I will refrain for remarks which can be construed as personal in nature.
That said, it is unfair to say I have not made arguments in the intellectual sphere (point #8). I have evaluated and defended my positions extremely well. Many of the points I have earlier raised have not yet been addressed. Fair enough, this argument has meandered, and I’m as much as fault as the other participant of the debate. But please spare what readers are following this thread the construction of a straw man of intellectual debate versus personal attack.
So I begin with your counterpoint #1. To simply state your lack of understanding, or unwillingness to understand, financial risk, does not make the argument that a credit card company’s risk irrelevant. This is not directed as a personal attack, because you previously stated “I don’t care what the risks they face are.” One must consider the financial risk a credit card company undertakes in order to understand the realm in which they operate. Credit card companies provide unsecured lines of credit. This is different than an auto loan operation, or a mortgage broker. The recent changes to the bankruptcy laws not withstanding, credit card companies have little recourse to recoup losses on unsecured credit lines. Thus, the rates they charge are in various multiples to rates charged for other extensions of credit. As I previously stated, these rates are not determined arbitrarily, the market dictates a ceiling consumers will accept, while the issuers determine the floor, based on the number of credit applicants in the pool, their propensity toward default, and thousands of other actuarial assumptions.
The playing field is plenty level between the credit card company and the consumer. (As an aside, through proxy insinuating the current President Bush lacks a brain is a bit immature and has no place in reasoned discourse). Contrary to your earlier assertion “The agreement the banks present is an adhesion contract; the consumer either takes it or leaves it,” is incorrect. Consumer have the choice to switch credit card companies at will, and can even move balances from one card which may have a rate the consumer believes to be unfair. Also, the rates and fees are negotiable. Consumers can call an 800 number, speak with a representative and argue for a lower rate. If a late fee is assessed, a consumer can argue for its repeal. Credit card companies do not seek to punish random behavior, they seek to curtail habitual malfeasance. Consumers enter into a contract knowing the risks they will incur if they are late and fail to confront this behavior. If a personal problem develops, consumers can call the credit card company and negotiate a separate term for repayment. This involves the suspension of late fees, and a reduced interest rate, with an agreed upon reduced minimum payment.
Profits are thus gained fairly, and on a leveled playing field. Credit card companies merely provide a financial intermediary service. They do not force consumers to spend beyond their means. Thus, I do not believe regulations on credit card company profits would have any impact on the underlying problem: consumer spend more money than they make.
Why is this? I don’t know, if I did I would be able to charge a lot more per hour in the form of consultancy. However, the question in the sphere of this debate is whether or not the government is the best entity for regulating consumer spending behavior. I argue against such a position. The government has no place dictating what is a fair, versus unfair, consumer purchase.
More to come at an undetermined point in the future (most likely tomorrow). My wife wishes to excerise her right as a consumer to spend her money as she sees fit, and I’d like to accompany her.
15. March 2008 at :
Thank you for your response. I will craft a response to your arguments. I must go to a Shiva house with my Dad. A cousin of his died a couple of days ago. I think that the last time I saw this fellow was at my wedding and he danced all night. My Dad and he were very close in their youth and I heard the hurt in his voice when I had to tell him. Anyway, we will go over there to pay our respects and remember the past.
THE MIDDLE
When I remember bygone days
I think how evening follows morn;
So many I loved were not yet dead,
So many I love were not yet born.
Ogden Nash, from VERSUS
and
OLD MEN
People expect old men to die,
They do not really mourn old men.
Old men are different. People look
At them with eyes that wonder when …
People watch with unshocked eyes;
But the old men know when an old man dies.
Ogden Nash, HARD LINES
16. March 2008 at :
My condolences for your loss.
Wilshire Associates, a pension consulting firm, issued a report earlier this month in which it found most of the public pension plans is canvassed to be 95% fully funded. Pensions & Investments provides an analysis of the report for those interested here:
http://www.pionline.com/apps/pbcs.dll/article?AID=/20080305/REG/850946644/1003
Now a pessimist could examine these results and see a funding gap of 5% between what the plan owes participants in retirement benefits (liabilities) and what it has to fund said benefits with (assets). Pensions & Investments takes this pessimistic view.
However, one must remember that funding ratios, as analyzed by Wilshire present-dates all assets and liabilities to today’s ratios. This is an inaccurate reporting of the nature of pension fund liabilities. Why? Because pension funds are not required to pay out all of their liabilities today. Rather, these liabilities are paid out over the retirement life of their beneficiaries. A useful example is in a home mortgage. One could have a mortgage balance of $100,000 and a home value of $100,000. Thus, the home is funded 0%. However, the mortgage is scheduled for repayment over a 30 year term. The mortgage note is not structured for immediate pay-off. So once the balance of the mortgage drops to $20,000, the owner now has funded balance of 80% (assuming no appreciation in real estate).
An ordinary citizen would see this as a good position to be in with a very low debt to equity ratio. So why isn’t the same applied to the analysis of pension fund ratios? After all, pension plans are not structured to immediately pay off their retirees. One, retirees have a defined benefit once they leave employ. That benefit is an annuitized payment from point X until the retiree shuffles off this mortal coil.
Meanwhile, the pension plan continues cash funding from the underlying government entity (state, city, county, etc) with tax payer dollars AND realizes market gains through the plan’s investments. As investments grow, the plan accumulates compounded interest, making money on previously realized gains.
One reason I attribute to the mix match is a populist media. Putting in 20 pt type “All’s Fine In Your Pension” does not sell papers nearly as well as “Your Pension Is Underfunded.” While this latter is technically true, the accounting betrays the fallaciousness of the overzealous reporting.
Thus, pension fund crises are born.
The latest one occurred in 2002 following a “perfect storm” of equity investment looses, low long-term bond returns and present dating of pension liabilities, during the 2002 and 2003 period, no public plans went into insolvency and are once again flush with cash.
So my question: what good does unnecessary regulation do?
Quite simply, the pension fund industry does not need to be regulated any more than it already is. Pension fund administrators and investment committees act as fiduciaries to the plan participants. They make investment decisions based on what is in the best interest of the plan. Yet, after the latest “crisis” there were calls for a reduction in stock investments, less exposure to “dangerous” hedge funds, etc. This was a short-term reaction to a long-term investment horizon, and quite frankly the breeding ground for bad policy. It is easy for a politician to grab the spotlight during a financial “crisis,” claim to do what is best for the “working man,” and pass a flurry of regulation governing investment principals, lending guidelines or responsibilities to citizens. But such regulation becomes burdensome, creates another layer of unnecessary bureaucracy and ultimately serve to benefit only accountants and lawyers who must be hired at exorbitant rates to ensure compliance.
I say allow the market to regulate itself, and again I hold the pension fund industry as an example of how this system is balanced and guards against malfeasance. Pension funds are some of the largest holders of corporate stock and have significant sway in the behavior of corporate boards. Following the accounting scandals of 2000 and 2001 (which revealed accounting shenanigans the Clinton administration allowed to propagate while the goings were good in the late ‘90s), pension funds turned to an activities role to ensure better corporate governance of their investments. Many funds moved, and passed, motions onto corporate boards related to such run-away corporate policies of executive compensation and the separation of chairman and CEO responsibilities. Further, those executives who acted beyond the law (Bernard Ebbers of Worldcom, Jefffery Skilling and Ken Lay of Enron and others I could look up if I were so inclined) were prosecuted to the full extent of the existing law to ensure they paid for the crimes. Leading this prosecution were pension funds seeking redress for the financial crimes committed.
Coincidently, the result of the Clinton’s financial excesses of the 1990s, when enforcement of existing financial laws was non-existent, was the passage of the Sarbanes-Oxley Act of 2002. SOX as it is referred to in common parlance, was passed by a Republican Congress and signed into law by a Republican President. It requires all manner of corporate responsibility for financial reporting and lays out stiff penalties for failure in compliance. (I do not agree that SOX was necessary and argue it has had a detrimental effect on investment in the US, but that is a story for another day).
The market as it stands today is well regulated, robust and full of safeguards against malfeasance. You argue we are under regulated, I argue we are overregulated. I say let the investors continue to police their investments. It creates the best opportunities for all.