I’m guessing a few of you may have heard that phrase before, usually uttered in disgust “There outta be a law!”
Well friends, that’s pure horse hockey. In fact, we don’t enforce the laws we have on the books – what makes anyone think a new law is going to make a difference? Those of you who read this blog frequently will ask, “I wonder what’s set him off this time?” The answer is of course, the sub-prime mortgage crisis and specifically the Bear Stearns collapse. What is the response to this crisis? Let’s write some laws to prevent this from ever happening again and along the way, let’s save those poor people who are caught in the middle of this mess with public funds.
Let’s take a trip to the way-back machine to the beginning of this decade shall we? OK, I guess it’s not that far back, but you get the point. California was in the throes of an “energy crisis” resulting in rotating blackouts, Enron’s stock was climbing through the roof on the back of nefarious “round trip” energy transactions, and their independent auditor, the venerable Arthur Anderson is too busy counting “money” to notice that the entire company is, in fact, a ponzi scheme designed to take advantage of the poorly executed deregulation of the energy market in California and elsewhere. We all know what happened, Enron went boom and took Anderson with them (though not before the consulting arm escaped morphing into Accenture.)
On the heels of this robbery writ large, our noble law makers launch themselves into action to enact Sarbanes-Oxley (SOX,) laws so strong, criminals won’t ever try to hide their activities behind the facade of corporate America ever again. Laws so strong, they require deodorant to simply stand in the same room with them. Laws so strong, they distort the basic truism that if you sell something for $1, it cost you $0.50 to make it, $0.10 to sell it, and another $0.10 in supporting corporate functions that you no longer have a net income before taxes of $0.30, it must go through the GAAP rules and that net income may be any number GAAP dictates! Now all public corporations report earnings in two ways, on a “real cash” and GAAP basis and then gamely attempt to connect the two methods. All hail the new transparency!
Is it surprising that companies are now earning less due to the army of accountants and attorneys they’ve hired to ensure they’re complying with SOX? If SOX were effective and transparent, wouldn’t company’s need only report the SOX inspired GAAP number? And, more to the point, wouldn’t the shareholders of Bear Stearns seen through the magic transparency of SOX reporting that the company had taken on a huge amount of risk in the subprime market and could be vulnerable to liquidity concerns? And if that were the case, wouldn’t you have expected investors to run from the stock well in advance of it’s collapse to $2 a share?
This subprime mess bothers me greatly. It starts with the individuals who take subprime loans – there’s nothing particularly wrong with subprime loans as an instrument, and when used appropriately, they provide great leverage for an individual borrower. But my sympathy for these individuals is very limited. Why? Have you signed loan documents? I have. There are summaries, disclosures, payment schedules, amortization schedules, and untold pages of legal disclaimer. All of which must be signed and initialed by the borrower.
Perhaps I’m weird, but I actually read those documents before I sign them and if I don’t understand them, I ask for clarification and/or correction. That a borrower finds trouble down the road tells me that they took a risk and suffered the negative outcome of that risk. And no one could ever say that a borrower was coerced or didn’t have access to the information to judge the situation into which they were entering. No, these borrowers took a calculated risk. Now, do I believe that these folks should lose their homes, nope. Read what I wrote about that a few weeks ago. It’s in everyone’s best interest for the institution who holds the paper to find a payment scheme that works provided that the book value of the asset and the outstanding value of the financial instrument are reasonably close.
Now, let’s go to the mortgage companies. Sure, subprime loans were a hot product and of course you would want to get in on the gravy train of processing fees and interest that was going to roll in. But these are businesses who also know about risk. In fact, their entire business is predicated on judgment of good risks and escalating compensation for taking on higher risks. Were the mortgage and lending companies ability to judge risk impaired by some sort of institutional mickey? With all the transparency provided by SOX, didn’t these risks stand out prominently in public reporting?
Now, what about the financial institutions that purchased groups of these loans from the mortgage brokers and lenders? Did their judgment go south too? It’s pretty standard to package these things with a mixture of risk and market them that way. The higher risk instruments have higher reward typically. Why did these institutions (like Bear) fall for high risk packages?
Well, the answer is simple: GREED. The old saying goes, “Bears make money. Bulls make money. Pigs get slaughtered.” That my friends is what we’re seeing today coupled with complete lack of common sense comparing asset value to book value and if possible, working out some reasonable compromise such that the mortgage doesn’t default, the bank still has income, and people stay in their homes.
Now, getting back to the core thesis of this post, with all due respect to our Congress, the Bush Administration, and the Candidates on both sides of the aisle. Don’t you dare bail these people and companies out. Don’t you dare go write a bunch of new laws that add to the complexity and cost of our society and fail to prevent the core behavior. Here’s news: you can’t legislate greed and judgment. It’s impossible. The borrowers were greedy extending themselves beyond what they, and the lenders knew, was reasonable risk. The mortage brokers and lenders were greedy trying to cash in on low interest rates and high fees boosted by high volume enabling borrowers to take unreasonable risk. The core institutional banks were greedy believing that what the mortgage brokers were selling them was legit, they have smart people who know risk and know when something sounds too good to be true it usually is. Laws aren’t going to fix that behavior.
In fact, let’s do everyone a favor and simplify the legal framework of the country. Let’s reset and have a more permissive, but more accountable society. Accountability means you understand the possible outcomes of your decisions and that you are ready to stand by the negative as well as the positive potential outcomes. Our society is degrading and it’s not because of TV, violent video games, and the breakdown of the nuclear family, it’s because we, as a society are tolerant of bad behavior of our leaders, our celebrities, and ourselves. Rarely do you hear someone stand up and say “Yes, I made that decision. The reasons I made the decision were … Now, in retrospect, I was wrong and I accept responsibility for my decision. Here’s what I’ll do to learn from the decision, share with others what I can to help them benefit from the bad decision, and here’s why I won’t repeat that mistake.”
It starts with us and no law is going to fix our problem.
