The United States has been living a lie.
As a nation, we have been kidding ourselves, repeating myths, hoping that if we say something enough times, it will become reality — no matter how untrue. The credit crisis and now foreclosure debacle has revealed to anyone who cares to look what we have sought to ignore: That the past decade has been based on a set of fundamental beliefs that are intrinsically false.
Its time for an intervention. We need someone to force us to stop hitting the bottle, lose the bimbo, skip the dessert cart, visit the gym. Its time to stop bullshitting ourselves about Financial Engineering, and face both the Truth & Consequences of our legacy financial system.
It is past time we recognize these hard truths:
1) There is no free lunch: The very first rule of economics has been forgotten time and again. Everything has a cost, and that cost is commensurate with value received. This includes making loans to unqualified borrowers to propping up home prices. Banks, regulators and policy makers have to start thinking in terms of collateral costs of free lunches to unintended consequences.
2) Financial Engineering is Not Alchemy: Just as you cannot convert lead to gold, neither can you convert high risk to low risk through a wave save of the spreadsheet. Ongoing attempts at eliminating risk — repackaging, syndicating and securitizing it — have been revealed as misleading nonsense. The risk involved in any directional bet cannot be removed by slicing and dicing and merely selling off various tranches. During crises, all asset classes seem to correlate anyway.
Whether its Greek bonds or Alabama’s sewer financing, changing numbers on a spreadsheet does not magically transform losses into gains, change debt-to-income ratios, or create wealth. All this does is temporarily mask the actual underlying financial condition of the engineered entity. Moving pieces of paper around has time and again been revealed as a scam; why people fall for it over and over is due to a collective failure of memory.
3) Bank Hedging Undermines Lending: At one point in time, banks’ had a collective expertise in evaluating the credit worthiness of borrowers. Whether it was revolving credit, auto loans, mortgages, or small business loans — they knew how to evaluate the likelihood of repayment or default.
In a mad grab for market share and profits, the larger lending institutions experimented with replacing their own experience and business judgment with complex hedging models.
Thus, credit risk of any borrower became far less significant, since it was to be hedged. As the financial sector became less dependent upon their own decision making, credit quality slid towards worthless. Hedging removed the banks’ incentive to quality-of-loans, and replaced it with the motivation of quantity-of-loans. Sliding all the way down the quality scale in credit ALWAYS end badly.
4) The Rule of Law is Sacrosanct: Our system of private property has developed due to the rule of law. The ability to demonstrate ownership, pass clear title, resolve disputes has worked for 100s of years. The recent frauds we have seen from law firms, process servers, bank legal departments, even drive through RE courts has put the nation at risk of becoming a lawless banana republic.
There is only one solution to this threat: For the rule of law to be in force, those people who violate it — previously known as “criminals” — must suffer the painful consequence of their illegal actions.
If you falsified documents that where used in foreclosures, you must be prosecuted for criminal fraud. If your firm’s primary purpose was this illegal activity, it must be put down. This means loss of professional licenses, corporate death penalties and jail time for offender . There is no deterrent to criminality of there are no significant penalties.
5) Campaign Finance Reform: The hijacking of the American financial system was done legally. Over the past 3 decades, the regulatory apparatus was Jiu Jitsued so that rules were made for the benefit of the financial sector — not the public. Thanks to a series of Supreme Court decisions, the corporate takeover of first Congress, then the election process, is now complete.
The only way to reverse this is a national campaign to pass a Campaign Finance reform law — preferably, a Constitutional Amendment — that gets the dirty money out of politics. Full disclosure of all donors, no hidden advantages for corporate cash, public financing of Congressional elections needs to be written into the constitution.
No one likes to face the hard ugly truths about themselves. As a nation, we need an intervention — our closest friends need to sit us down and slap us across the face. The sooner we stop kidding ourselves, the sooner we can move forward with more productive honest economic lives . . .