How Congress Can Fix the Crisis

It's the question of the hour: How can Congress fix the housing and credit crisis? And where are we in this crisis? We've been talking about this issue on our morning show Money for Breakfast.

I don't make it a habit of trying to call the end of the world and I don't think we're headed for the abyss. I also fully support a moonshot to Mars so we can pack all those recession fanatics on it so they can annoy each other into oblivion. It's true, if you call a recession long enough, you can call yourself a seer, as someone once said--a stopped clock is right twice a day. Global growth is here to stay. 

Same for the market's "bottom callers," in full regalia now, telling us to expect an upswing, though beats me why if they're that good, they're even sticking around and not hitting the beaches on the Riviera.

The market hasn't hit the bottom yet because housing hasn't found its bottom yet. Do the math and we're still in at best inning three. Congress is going to hold hearings next month on the crisis. There is a way for elected officials to get us out of this crisis and avoid future disasters.

First the parade of horribles. Foreclosed properties held by lenders accounted for 493,000 of all homes on the market in January. Again, that's held by lenders, and that's out of an estimated 3.3 million home-mortgage defaults in 2007 and 2008, with about two-thirds of those homeowners losing their homes, says Moody's.com.

Western banks have taken about $180b in writedowns to date out of the projected $300b-$400b. And that's only for subprime, it doesn't include other credit problems like leveraged loans and other consumer installment credit. Credit problems are the reason why GDP growth rates will slow and return to trend at the earliest in 2010. Analysts estimate the economic cost to clean up the current crisis is $1.1T, or 9% of GDP--the bailout of Argentina cost 55% of GDP to fix, the S&L crisis here in the US cost 3% of GDP.

What to do now? Set aside the government bailouts--yes it's unfortunate that traders, investors and borrowers like to be Milton Friedman, free-market types on the way up, but John Keynesian, "run to Uncle Sam" ninnies on the way down. Yes we privatize the gains and socialize the pain, hearing that now is like chewing tin foil. Yes we want as much homeownership as possible--but this is one heck of a grossly expensive, upside down way to get there.

Here's a rundown of how Congress can fix the mess--and how it could save us grief in the future:

DON'T GET LOST IN THE WEEDS. Take heart in this broad-zoom perspective. The world is still in the early innings of globalization. Already, China, India, Indonesia, South America, places a generation ago considered dirt-poor, are now seeing explosive growth in the middle class. Some 1.8b new entrants are expected to join the middle class over the next 12 years. By 2010 the world's middle class will make up 52% of the total world population, up from 30% now. As the middle class grows, that means burgeoning demand for things like healthier diets, better, more fuel efficient cars and gadgets. Global growth, in fits and starts, is here to stay.

BOOST IMMIGRATION. Ballooning housing inventory is now at a record levels, with foreclosure signs popping up like crabgrass in Nevada, Arizona, California, Florida--which is why the volume about government bailouts has turned up in these key swing states in this presidential election year. Strengthen the borders, absolutely, but boost LEGAL immigration. It's good that teachers, firemen, policemen can now afford first-time homes. Hardworking immigrants can help pick up the slack, too (and let's face it, can they help Social Security? Watch that debate in coming months as well). 

SUPPORT BUZZSAW BEN. Time to turn down the volume in Congress on the criticism of Federal Reserve Chairman Ben Bernanke--much of it is self-serving, arm-chair quarterbacking. Dramatic cuts in interest rates help homeowners facing some $350b in ARMs resetting, as the cuts lower the hikes in their monthly payments to an increase of about 10% from 25%. And Bernanke's creative moves such as broadening the discount window and auction facilities to reliquefy bank balance sheets could cement his place in the history books as helping to soften a cataclysm set in motion by his predecessor Alan Greenspan, who kept rates too low for too long and disregarded growing subprime excesses while telling borrowers to take out riskier ARMs vs traditional fixed rate loans. "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage," Greenspan once said.

YANK THE LIQUIDITY PUNCH BOWL. To avoid inflation and repair the weak-dollar damage, Congress must fingerwag Bernanke by telling him to avoid tipping the economy into the bottomless liquidity punch bowl. He has to be ready to hike rates when the economy returns to trend in 2010 and 2011, as the Fed expects. The dollar is at its weakest since the era of floating exchange rates began in 1973, and inflation is coming a cropper. Central bankers would do well to heed the advice of Richard Fisher at the Federal Reserve Bank of Dallas: "Easy money is like truly tasty tequila, it's tasty--but dangerous."

BRING BACK SOME VERSION OF GLASS-STEAGALL. Originally enacted in 1933 after the crisis of the Great Depression, it took another crisis--the 1987 crash--to get bankers to start lobbying for its repeal, which took 12 years to do. The act separated the barbarians of Wall Street from the mahogany-lined board rooms of white shoe bankers. Since its repeal in 1999, which let banks compete for the first time in the securities industry, the free market banking system has turned into a disastrous free-for-all.

Banks lobbied hard to repeal this act soon after the 1987 crash as foreign competition from Japan bore down on them--Japan, whose banks did not face the same strict rules on maintaining capital reserves and whose calamitous lending helped foster the lost decade of zero growth in that country in the ‘90s.

Congress should ignore mindless, self-serving entreaties from the bankers now. Listen to what Dennis Weatherstone, president of J.P. Morgan, said in the late ‘80s: "I don't think the repeal of Glass-Steagall should be seen as a way of providing relief for the banks," adding, "rather, I think it should be seen as a way of making capital markets more efficient." Abolishing Glass-Steagall let Citigroup make disastrous bets underwriting and trading mortgage-backed securities and collateralized debt obligations. Citi now faces potentially another $15b in write-downs on top of the $22b it's already taken due to the housing and credit crisis. 

Footnote: Talking to top executives on Wall Street about the crisis, a number of them now brazenly finger the act's repeal as the reason behind their woes, proving with age comes no maturity.

PUT UP THE GUARDRAILS. I've noted in prior blogs how deregulation shoved 3/4ths of Wall Street borrowing into the shadow lands, away from the prying eyes of regulators. If the investment houses want access to taxpayer-backed financing from the Federal Reserve, a historic move the central bankers have made, then these investment houses must meet commensurate capital reserve requirements that are forced on the big banks, which means new regulation forcing them to hold more capital on their balance sheets. Watch the securities industry lobbyists fight this one hard. They want all of the upside of taxpayer-backed funding with none of the downside.  

KEEP TABS ON LOANS. It's been suggested that lenders should be forced under new regulation to keep the riskiest parts of securitized loans on their balance sheets, and I agree. Banks broke the last vestige of oversight of derelict borrowers when they sold these loans off the balance sheets and into the ether.

MORE HEDGE FUND DISCLOSURES. Congress should enact laws that would get the Securities & Exchange Commission to force hedge funds at minimum to publish their balance sheets so the brokerage houses can truly see how leveraged they are before risking their house money in loans to these funds. It's what got Bear Stearns in trouble. Investment banks and hedge funds tend to blow out their leverage in boom periods, then dry out in bumpy times, spreading their hangover to the rest of us. With debt that amounts to half of all leverage outstanding, expect more collapses and shotgun weddings at these shops.

BRING CREDIT DERIVATIVES INTO THE LIGHT. Bring credit derivatives onto one of the major exchanges. Yes it'll be costly, but transparency is better at catching future problems then wasting tax dollars fighting a financial nuclear winter.

REPORT CARD FOR THE RATINGS AGENCIES. Congress should force Moody's Investors Service, Standard & Poor's, Fitch Ratings, Egan Jones, all the ratings agencies to publish a report card on their prior ratings calls from now on. They've got a virtual monopoly on this business, time their feet are held to the fire.

STOP THE AFTER-THE-FACT REFEREEING. Congress, regulators, the government has found it a lot simpler to more or less let things happen. With bureaucratic apathy comes wasted tax dollars. Enough is enough.