The $700 billion bailout of our country’s financial system may be necessary, but it ultimately will prove useless unless real change is enacted to prevent a repeat performance of this fiasco.
What the American people should be demanding is for
someone to give them a clear explanation of what really happened to create the financial mess. Remember, after the market crash of 2000, the Wall Street research scandal (where nearly every Wall Street firm admitted to lying to clients through their research departments) and 9/11, virtually all Wall Street investment banking ceased.
Shortly thereafter, profits and bonuses on Wall Street broke all records. Now we know why, and we’re all still paying the price for Wall Street’s greed and arrogance.
Like all problems, there is a definite beginning to this one. Let’s start with John Q. Public, who decides he wants to buy a $100,000 house. John Q. has reasonably good credit. For a long time, many entities were interested in giving John Q. a loan for 80 percent of the value of his new home. The investors made money and John Q. got his home.
The evaluation process banks used to determine the actual dollar amount of a loan for borrowers like John Q. was
straightforward and based on common sense. Two components came into play: a borrower’s creditworthiness and the value of the asset. It was that simple, and it worked for all parties involved.
A similar model was used by commercial banks and Wall Street investment firms, with one key exception: The loans commercial banks got from Wall Street investment firms and other investors (including me and you, whether we liked it or not) were based on a loan equal to 10 times the value of their assets. Meanwhile, Wall Street investment banks were getting loans from foreign countries, institutional investors and other Wall Street banks at 20 times the value of their assets.
In other words, John Q. gets 80 cents on the dollar, while commercial banks and Wall Street investment banks get 10 and 20 times the dollar.
The process seemed to work for a while, that is, until the greed was out of control and Wall Street’s actions became even more reckless.
If the house John Q. said was worth $100,000 was actually worth only $50,000, then John Q. is a crook. If John Q. takes the bank’s $80,000 loan, puts $50,000 into his house, pockets the remaining $30,000 and gets caught, he will go to jail.
Now, consider that commercial banks and Wall Street investment banks have repeatedly told the public and regulators alike that the value of the dollar they were getting 10 to 20 times in loans against was a dollar. A significant portion of the assets
they were borrowing against were in bad mortgages. They may have told everyone the assets were worth the original amount, but they clearly knew otherwise.
Just like our dishonest John Q., they, too, committed fraud. Our dishonest John Q. goes to jail, but where do retired commercial bankers and forced-out Wall Street executives go? Generally, Boca.
Now we reach 2008, and economic conditions are worsening. Lenders are getting nervous, and investors (that’s me, you, our retirement accounts, charities, pension plans, universities, endowments and foundations) are destined to take the hit. Some will argue it’s our own fault: We trusted Wall Street yet again, after knowing its track record of fraud and deceit. And now the government is bailing out those investment banks with our money.
It’s long past time for America to get tough on those who commit fraud, those who arrogantly violate state and federal securities laws. Get the criminals out of Boca and throw them in jail for lying about the asset valuations. Fire any and all dummies behind these incredibly foolish loans and replace them with smart, honest people who are guided by reasonable regulations. And the leadership at the federal Securities & Exchange Commission, which was not up to the challenge, needs to be completely replaced.
It’s that simple.
Maddox is a former Indiana securities commissioner and a securities lawyer at Maddox Hargett & Caruso PC.