Mortgage debacle the result of criminal action, not mistakes
Kai-Alexander Schlevogt, Singapore
thejakartapost.com
Here is the ploy: Banks rapidly grow their loan books by granting mortgages even to borrowers who cannot afford them. They swiftly sell these risky loans to other financial intermediaries and thus clean their balance sheets. Those repackage them as "collateralized debt obligations" (CDOs), adorn the securities with high credit ratings, and thus hide the junky nature of the underlying assets.
Then, they sell myriad slices of what essentially is a black box to investors around the globe, who are lured by high interest rates and put blind faith both in the sellers' brands and credit ratings. Central banks look the other way.
In a pyramid scheme, a steady flow of new CDOs helps financing the interest payments to the investors. The Pandora's Box is opened when the mortgage holders start to default and the equivalent of a run on banks is triggered. Liquidity is drained from the system, since banks refuse to lend and investors scramble to escape from the trap. Market insiders again profit, this time from well-informed bets against the junk loans.
Financial institutions at the brink of collapse are rescued with taxpayers' money. Central banks succumb to pressures to cut interest rates, which fuels inflation. The financial problems spread into the real economy and unleash a vicious circle: The credit squeeze dampens investment in the housing sector and results in layoffs. Distressed consumers spend less and default on other loans, prompting banks to tighten credit further.
Governments around the world should implement a "3 R"-framework of retribution, regulation and reengineering to deal with the crisis and prevent similar developments.
In the short-term, authorities must stop talking about unfortunate "mistakes" and use the term "crime" instead. The masterminds of the financial time bombs and their accomplices should be prosecuted mercilessly. Destroying the life savings of pensioners and other investors is a serious offense, especially in countries with ageing populations and insufficient retirement provisions.
Like drug trafficking, it undermines the fundament of society and thus deserves the harshest sentences that courts have at their disposal. Those criminals and their employers, rather than taxpayers, should pay for the damage using the cash they horded. Criminal convictions and significant compensation payouts will help deter similar crimes.
In the medium-term, governments must tighten regulation in certain financial arenas. As for other legal subjects, compliance must be mandatory, not just voluntary. Mortgage features, such as low down-payments and deferred debt-service, should be scrutinized to protect financially naove consumers. Hedge funds must be closely supervised, too.
Besides, the authorities must lift the veil hiding the dubious practices of credit-rating agencies and regulate them, too. To eliminate their monopoly power, which leads to abuse, national governments should consider setting up their own credit rating agencies.
The authorities also need to regulate securities more tightly and keep a watchful eye on financial "innovations", which often are old tricks in new disguises. A stricter penal code needs to be introduced to deal with financial high crime.
In the long-term, the financial system must be changed fundamentally to decrease the likelihood of collapse. Most importantly, countries around the world should move from a market-driven system to a bank-centered financial architecture, which puts firm limits on "securitization".
In the past,... |
