Waiting for a subprime perp walk
Punishing companies isn't as satisfying as punishing the people who made the bad decisions. But how do you make sure they feel the pain?
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| Pat Regnier's column "The Bottom line," appears monthly in Money Magazine. Email him at pregnier@moneymail.com |
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| Type | Overnight avgs |
|---|---|
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| 30 yr fixed mtg | 6.16% |
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| 30 yr fixed jumbo mtg | 7.52% |
| 5/1 ARM | 5.93% |
| 5/1 jumbo ARM | 6.17% |
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(Money Magazine) -- Admit it. you want to see some justice handed out on Wall Street. Thanks to the Great Mortgage Panic of 2008, your home value is tumbling, credit is harder to get and the job market may turn a lot tougher. And let's not even talk about your 401(k) balance.
It's natural to be angry when forces beyond your control mess with your life. So we're looking for villains. Some people - especially Wall Street people - blame feckless, house-hungry borrowers. Then there were regulators who didn't bother to regulate. But the heart of the matter is that Wall Street went nuts. Again.
The banks dreamed up ever more creative ways to give anybody a loan. They pushed mortgages with optional payments and "liar loans" that required little proof of income. All this inflated home prices, which nudged even sane people into bigger, variable-rate loans just to land a house.
Those mortgages were then bundled into investment securities, jumbled up with other kinds of debt and chopped into pieces again to be bought up by institutional investors hungry for yield. And like flippers of Miami condos, many borrowed to get in on the action.
Of course, such manias are not unusual. But this is different from, say, the Internet bubble because the financial industry needs our help (taxpayers' help, that is). As homeowners miss payments, overexposed Wall Streeters are having a crisis of confidence.
The Fed has already lent out public money, based on stinky collateral, to stop investment bank Bear Stearns (BSC, Fortune 500) from collapsing. Congress may even have the government guarantee mortgages, taking on the risk if they turn bad. It's not fair, but it beats the possible alternative: a freeze-up of the financial system.
Still, it's important that people pay for dumb decisions. Firms that get help should have to take steep losses. They could even, as former labor secretary Robert Reich suggests, hand some equity to the government so taxpayers profit from a recovery. (It happened in the 2001 airline bailout.)
But punishing companies isn't as satisfying as punishing people. How do you ensure that the decision makers, who pocketed stratospheric sums when the bets were paying off, feel pain?
Count on some big lawsuits and perhaps even prosecutions. (All it may take, says Chapman University law professor Kurt Eggert, is an e-mail in which some banker or trader or analyst admits, "Dudes, this stuff is garbage....")
When companies get rescued, the government should demand transparency in return so we know who did what and how. Forcing firms into the bankruptcy process, for example, would let in sunlight, says Temple University bankruptcy expert Jonathan Lipson.
The main problem here isn't fraud, just imprudence. But a CEO who hurts his shareholders badly enough should feel a sharp penalty. That's hardly standard operating procedure in corporate America: Last year Citigroup's (C, Fortune 500) Charles Prince retired with a $10 million cash bonus even as investors reeled from mortgage losses.
"We're locking the barn door after the horse, and its bank account, has disappeared," quips Nell Minow of the Corporate Library, which tracks executive pay. Minow would like to see firms promise to take back past compensation in some cases. To get there, lawmakers could give shareholders more real power in proxy voting to make the boards who set pay accountable.
Smart regulation would make costs and pitfalls obvious to borrowers - not only in mortgages but in credit cards. (Iffy plastic debt is sloshing around Wall Street too.) Perhaps lenders should have to illustrate how far underwater a loan would go if home prices fell 10%.
Harvard Law's Elizabeth Warren has proposed creating a "financial product safety commission" that could declare certain loans too dangerous to market at all. Yes, more rules would make credit flow a little less easily. Does anyone still think that's the worst problem we could have? 
