What If

The World Economic Forum is going on in Davos again. This time around the world is telling bankers to expect regulation, and lots of it, and soon. The bankers engaged the regulators, and were allowed to provide input, though that is probably meaningless, considering Barney Frank's attitude at the conference.

One of the biggest things guys like Frank would like to do is once again separate commercial and investment banking from each other. In the world according to Barney, the entire financial crisis was created because banks both lend money for housing (commercial enterprise) then package those loans as mortgage backed derivatives (investment banking) and sell them.

What Barney refuses to admit, or see, is that it wasn't the derivatives that brought down the market, it was the mortgages themselves, made easy by the rules he insisted on for mortgage lenders. When you push for regulations that make zero down mortgages, interest only payments, etc. the norm, you end up with a skewed market, that will crash.

What if Barney decided that the same capital reserve standards had to apply to government entities as the Davos crowd is pushing for banks? Would the US government be able to meet that standard considering it has 10 trillion in outstanding debt?

What if the bankers say "Okay", and just jump out of markets considered risky? Will Frank, Obama and the European leaders who are pushing these regulations admit the regulations might be the problem when capital sources start drying up for businesses? We've already seen the start of that, as banks are much less willing to lend right now. When they are told to be even more stringent in their investment standards do regulators really think that suddenly money will flow?

The proposed regulations will help prevent another economic collapse. That's because they'll prevent an economic recovery of any scale, and the folks pushing the regulations will lament they don't understand why.

If you'd like my cynical view of why the current US government and European governments want more, and very heavy handed regulation, it's because they want to be the major sources of capital, not the banks. It's much easier for governments to be the hero's, and pick the winners and losers when they don't have to worry about pesky free markets to make decisions.

Want an example? Green energy products. The markets have been slow to invest in them because they don't pay back the investment quickly, if at all. Solar cells, wind turbines and fuel cells are all great sources of clean energy, the problem; as real investors note; is that you can't sell them at a price that makes a reasonable profit, so they don't invest.

Governments chastise them for not investing in such a worthwhile endeavor, and ignore the fiscal facts of the industry. So then governments get to play king makers in the industry, and use it as a reason to say the markets don't work.

Take your Fusion hybrid as an example, Ford loses money on every unit it sells. But they get credits from the government for selling them, in the form of tax breaks and access to federal money to build the plants.

The markets actually work fine. As soon as someone comes up with a hybrid or all electric car, or fuel cell for the home that is profitable, and priced where it can be successfully marketed, they'll be all over it. Until then all but a few altruistic venture capitalists will opt out.

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Executive Pay Mess

As I was reading through my Wall Street Journal opinion pages yesterday, I came across a great article that explains the executive pay mess that Wall Street, and others are facing. "Washington's Plans May Result in Even Higher Executive Pay " explains how a Congress, in 1992 decided that cash payments to executives were wrong, and didn't tie their compensation to actual company performance. They also thought that boards of directors weren't doing enough to increase shareholder value, and that by tying their compensation to performance it would create an environment that would make us (shareholders) more money, and keep executives from being overpaid for under performing.

Now of course, Congress is ticked off that executives get big stock option bonuses, based on performance guidelines they codified 17 years ago, and want to change the system, because evidently it's unfair again.

There are a few outcomes that are nearly sure anytime congress does anything. One is they won't accurately predict the results. In 1992 it was thought that executive pay would stay fairly stable, while shareholder value went up. But since they wrote a bad law, only one of the two did happen, shareholder value did go up. But executive pay skyrocketed based on the criteria congress laid out.

Now, we are seeing the other end of the spectrum. While the President complains banks won't lend enough, he signs bills that punish the banks, and specifically the boards, for taking risks.

Look over the financials and you see that AAA corporate lending is back to a pretty steady track, where it was in the 2006 and 2007. Small business, venture, and personal lending, the riskiest types are languishing far behind.

This is rightfully so based on the way the TARP program has worked. Now the rules are take out too much risk, and the boys from the Fed will show up with a check you can't refuse, and take control of your bank, either explicitly or implicitly through congressional action.

The worst is yet to come, though. The new pay schemes, if they work at limiting executive pay won't just slash pay, they'll slash talent. The folks at the top of the banking industry aren't rubes, they can work in nearly any industry and be successful. So when the government decides what's "fair" compensation for anyone who took bailout funds, they'll just bail out of the industry.

What we'll be left with is an industry that's full of newly promoted former middle managers, who didn't leave because they were afraid they couldn't succeed elsewhere. The result is going to be less money for anyone to borrow, with you and me still at the bottom of the list to get that money.

And of course, Congress will wonder why this happened.

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Bailing Out The Banks

Congress passed the "mortgage rescue" bill that will help 400,000 home owners, but is really a benefit for banks and Freddie Mac and Fannie Mae.

Unfortunately the President doesn't have the guts to veto it, due to the bad publicity he'd get for it, and that would go to the GOP during an election cycle.

The bill is definitely a contradiction. On one hand 400,000 "at risk" home owners could get bailed out IF their banks are willing to take a loss on their loans and refinance them through FHA. If everyone takes that deal, taxpayers are on the hook for 300 BILLION dollars in new loan guarantees.

However, the bill also gives nearly 4 billion in grants to banks to rehab foreclosed properties to get them ready to sell. In other words, the bank gets two choices, take a loss and refinance, or get a grant after foreclosure to repair the house and resell it; hopefully at less of a loss.

The block grants, opposed by Bush and the GOP are an issue. Banks generally stay out of the real estate business as much as possible. In most cases, when possible, they'd rather work out a short sale, or refinance instead of foreclosing so they don't have to deal with the inevitable problems associated with holding a home. This bill gives them as much an incentive to foreclose as it does to refinance, possibly more since the government is willing to mitigate part of their loss under the block grant program.

Freddie and Fannie also get sweet deals, with the Federal Reserve being able to loan them basically unlimited amounts of money over the next 18 months to help shore up their poor loan portfolios. Yes, they get some extra oversight (finally), and have to pay for some new programs, but on the whole, it's a big wet kiss for getting in over their heads with risky loans.

Who loses in the bill? The tax payers, that's who. We get put on the hook for hundreds of billions in new loans through FHA, and hundreds more by tossing cash at Freddie and Fannie. While Congress sees this as "doing their job" the truth is both the GOP lead congress and the one run by Democrats fell down on their jobs by not having some of the new protections in place previously. They were too busy rolling around in the cash that was coming in from a housing driven economy to look at how wobbly the foundation was.

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