We need real reform in the financial markets. This reform should include how we regulate and how we audit and enforce these regulations.
Reform will not prevent another crisis that we have just witnessed or the S&L/Mutual Savings Bank crisis some three plus decades ago or frauds such as Madoff’s. But reform can catch these problems before they get out of hand, which will reduce the impact on our economy.
- First, we must restore confidence to the secondary mortgage market. Liquidity in mortgages provided by the secondary market is essential to our economy. Banks and S&Ls should not be holding mortgages for long periods of time and should have a market to which they can sell.
Require escrow for real estate taxes and homeowners insurance for all homes where the home buyer does not have a 20-percent down payment. - Require that the buyer have a 20-percentcash down payment or that another entity, such as a mortgage insurer, the VA, FHA or Farmers Home Loan Agency, is covering the 20-percent difference between appraisal and mortgage.
- Forbid financial institutions from lending borrowers their 20-percent down payments.
- Ensure that income and assets listed are verified.
- Ensure that appraisals are realistic
- License all appraisers and mortgage brokers nationally, or at the very least, create a standardized system for appraisers and mortgage brokers, including the personnel of any firm issuing paper to be sold on the secondary market.
- Strictly regulate mortgage insurance companies. There have been too many incidents where these firms have had conflicts of interest (using subsidiaries as collateral) or have made risky business decisions that affect their contingent liability funds.
- Require that all use the standardized underwriting and forms issued by Fannie Mae and Freddie Mac.
Make full disclosure and other paperwork simple to understand. Reduce this paperwork to one or two pages that are understandable. - Where possible, require that homeowners with less than a 20-percent down payment receive counseling so that they have a budget and so the mortgages they receive are fair, that charges required of them are reasonable and that the property they are buying is worth what they are paying.
- Restrict such practices as "interest only mortgages," balloon mortgages or variable mortgages with teaser rates.
In regards to regulation of the financial industry, it is important to separate the audit and enforcement functions from the influence of politics and business as much as is possible. Politics influences enforcement.
A recent example was the firing of Gary Aguirre, an Securities & Exchange Commission (SEC) attorney lauded for his excellent work. He was fired because he wanted to interview John Mack for allegedly giving inside information to Pequot, a hedge fund. (I could have used examples from both Democratic and Republican administrations).
The New York Stock Exchange, the Nasdaq, the Federal Reserve Bank and the SEC did little to go after abuses on Wall Street. For years, Eliot Spitzer was a lonely crusader against Wall Street abuses.
"Self-regulation" by the industries themselves has been not been successful. The Federal Reserve failed to stop abuses in the banking industry through its audits. Their "objective" is to protect banking, but too often this means avoiding confrontation by the few banks that control most of the country’s assets.
My suggestion is to create an independent agency that has many features of an inspector general or the General Accounting Office. Fund their budget for seven years at a time. Give a single 10 or 12-year year term to its leadership. Forbid its civil servants from becoming lobbyists or working in the industries they have regulated for five years.
This will not be perfect, but it will go a long way in isolating political influence on the agency.
Furthermore, I suggest that we separate regulation and oversight by an industry’s function. Credit, life, health and property-casualty insurance companies manage risk; banks, S&Ls and mutual savings banks lend money. Mutual funds and annuities deal in collective investments. Money managers, hedge funds, financial advisors and stock brokers manage money or offer advice.
Multiple and contradictory regulations need to be reduced, but there should continue to be competition in enforcement. National tests, continuing education and licensing should be national. Licensing by states based on the national model should continue.
Bob Chernow is a futurist who predicted the S&L/mutual savings bank crisis, the future of mortgage backed bonds and the recent sub-prime crisis. He works in the financial industry. His opinions are his own.
