Are Financial Markets a Source of Terror?

Why is requiring consumers to repay in full the loans they agreed to take for first and second mortgages, home equity loans and all the variations thereof, any different than suggesting that banks and financial institutions repay their debts in full?

Why has over one Trillion dollars (that's Trillions with a big "T" folks!) already been committed to "too big to fail" financial, industrial and insurance companies, with potentially Trillions more at risk from Taxpayers? A Trillion is equal to $3,000+ for every man, woman and child in the U.S. Family of four? About thirteen thousand dollars (usdebtclock.org/), lots of interesting information there. Check the totals for each taxpayer and household.

Because greedy-for-big-paycheck executives designed financial products with "leveraged-to-the-hilt-with-borrowed-money" structures, and with little or no regard or calculation of the "what if" scenarios, occurred. Simple prudent investing by limiting capital risk through leveraged borrowing would have prevented the crisis.

So, where are we today?

Banks still have hundreds of Billions (that's Billions with a big "B" folks!) if not Trillions (that's Trillions with a big "T" folks!) of losses not yet taken on toxic assets on their books. Same with other financial institution owners of similar assets, purchased by them in hopes of high(er) rates of return from security and bond designers, packagers, underwriters and issuers ranging from AIG, to Citibank, to Fannie and Freddie, to GM, Merrill Lynch and more. If all such assets were "marked to market"-valued at current market values,-the U.S. financial system could collapse overnight.

Treasury printing presses already run 24/7 and they can't keep up. The federal reserve created Trillions of dollars overnight by buying existing and newly-issued U.S. Government obligations. The U.S. Treasury has also invested, unwisely some might say, to help ease liquidity in the financial system, which had become
" locked up" and unable to generate buyers or sellers for all kinds of securities, from Overnight Funds for banks, to Money Market funds for everyday investors, all because the underlying assets had no marketplace to call on that could generate the cash needed to satisfy obligations as they mature. So the government stepped in to rescue the worst banking crisis since the Great Depression.
So, here we are.

What's next?

Legislation is pending In the Senate which calls for the formation of a new Consumer Finance Protection Agency, whose responsibility would be to oversee financial institutions and the products and services they provide to consumers, and to business. Other legislation seeks to punish the banking industry primarily, but the financial industry as a whole, as well as major segments of the U.S. economy by allowing government takeover of companies and commercial enterprises of any sort, according market circumstances and problems as determined by a government committee of bureaucrats and "experts."

This must not happen; it would be the slow death of free enterprise, of capitalism and a free market economy. While I might agree that the policies and practices of excess have led to this backlash, the cure is not indiscriminate punishment of industry and institutions, but recognition of government's responsibilities in facilitating the encouraging open markets and competition that benefits all. Government and business should have closely-aligned goals, their mutual success through meeting and satisfying Citizen needs through support of the free enterprise system.

How can we accomplish that when liberal and conservative ideologies support neither government, business or free society in meeting the needs of Citizens within the free market system?

Financial institutions have to accept that in exchange for their licenses to operate in a capitalist system,to be afforded the opportunity to make money, they must agree to limitations which allow any risk-taking enterprise they desire, but only to the extent that in the event of failure, the owners and shareholders are the only ones at risk for such losses. This means owner equity levels must constantly improve to meet reserve levels sufficient to cover the obligations of the institutions as they come due-"mature"- in financial parlance.

Not only that, but all debts and obligations of the bank, investment and of other financial institutions must be reported or registered as appropriate with responsible government financial management authorities like the SEC, primarily, but others like the FDIC, Federal Reserve, and Treasury Department as well, each according to their authority, each according to their needs.. And Transparency Regulations must be coordinated so that financial institutions can't "shop" for the least restrictive authority under which to operate. The legislation being considered must provide a unified framework for managing our financial marketplace and economy, regardless of the hue and cry and lobbying of those who seek to avoid such oversight.

What about equity capital, the owner's/shareholder's capital at risk in the new legislation?
A review of the current statistics regarding U.S. banking shows a total of 6839 FDIC Insured banks (almost all banks that accept deposits are required to be FDIC insured), only 510 of which have assets over One Billion Dollars, which means that 6325 have assets less than One Billion.

In fact, 3800 have assets from one hundred million to a Billion, and 2525 have less than one hundred million in assets. But, those numbers are misleading; the top ten banks have over $3.3 Trillion in assets; the top 25 have $6.09 Trillion in assets, some thirty-seven percent of all FDIC listed bank assets. This means that the other 6,814 banks have sixty-three percent of FDIC bank assets.

Why all the numbers? Because over 90% of the realized and projected losses are in the top fifty financial institutions in the U.S.. This includes government guaranteed entities like Fannie and Freddie, the FHA, insurers like AIG, and Investment Banks, even industrial companies like GM and Chrysler.the vast majority of insured financial institutions have little or no losses to realize.

That almost all the taxpayer exposure and projected losses are in the largest financial institutions argues forcefully for limitations which require only their own capital , the "owner's equity" to be at risk of loss. This may also insure that Executives and managers have "skin in the game" by forcing self-interest to the top of their priority list. It has the further benefit of allowing the evaluation of management over an extended period of measuring their skills in maintaining and improving ROI, and therefore capital with which to generate more assets. The best managers will generate the most capital by managing risk to achieve the best ROI.

How to accomplish this vital goal?

By changing the required levels of capital, transparency of reporting and regulation, along with registration of securities and trading ONLY on Authorized Exchanges, like the NYSE.

How much capital?

The Prudent Man/Investor "Rule" has been around for a long time, since first created in 1830 in a Massachusetts Court Ruling. It states:

"All that is required of a trustee to invest is, that he shall conduct himself faithfully and exercise sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested." That rule obviously wasn't followed.

The Prudent Man Rule should be modified in legislation to provide for equity capital levels that backstop financial institution decisions about the investment products in which they invest depositor's and shareholder's money. This includes limiting the potential for loss by reserving all investments using an asset- based formula, which is relatively simple.

Financial Institutions Equity Capital Requirements: (Financial being defined as any enterprise which collects cash as deposits, payments for premiums, provides financing as a product or service-for any propose-GMAC, FANNIE, AIG, Prudential Insurance, Goldman-Sachs, Citibank, BoA, S&L's - all would be included - and invests those deposits or payments on behalf of Clients and stockholders).

*Up to 100 Million in assets; Minimum Ten Percent in Shareholder Equity Capital (more is OK, and would allow increasing the investment base up to the limits specified): No more than 10% of assets in any one security or class of securities, meaning bonds, or equities, or even loans; no more than ten percent from any one issuer or issuer's class of securities, meaning that if a company issues one hundred million in bonds the bank or financial institution could only buy one million of that issue. There would be required equity capital of a minimum of ten percent of total assets, and assets would be permitted to exceed allowed totals and equity reserves only when additional equity is provided, either through re-invested earnings or additional investment.

The result is that financial institutions would be limited to total leverage (borrowing to support investing) of five-ten times their equity capital, depending on the types of investments Considering the diversification of investment opportunities, risk management and selective investing would insure both good Return on Investment (ROI) and prudent management.

Considering the variety and types of loans available to banks and financial institutions, this is good policy. The ten percent limit would not apply to mortgages, which could be generated up to fifty percent of assets, providing that a maximum of twenty percent of mortgages were in any one class, as in A-rated, B-rated, Sub Prime, and so on, and reselling of mortgages for servicing by others would still require reserves according to a Rating Scale; 10 percent-A, 20 percent B, 25-30 percent C.

While this might limit some opportunities, it has the benefit of mostly localizing mortgage origination and servicing, promoting competition in Rates and fees, and establishes a more citizen-friendly banking system, while still offering many profit opportunities to financial institution who do not lack for creativity, nor motivation.

*One Hundred Million to One Billion of assets: Fifteen percent Equity Capital, as above.
*One Billion up to Twenty-five Billion: Sixteen percent Equity Capital, as above.
*Twenty-Six to Fifty Billion: Seventeen percent
*Fifty-One to One Hundred Billion: Eighteen percent
*One Hundred and One to Two Hundred and Fifty Billion: Nineteen percent
*Two Hundred and Fifty-One to 500 Billion: Twenty percent
*Five Hundred Billion and up: Twenty-Five percent Equity Capital

Once required capital levels have been reached and managed for three years, a proper review and analysis of financial markets by the Federal Reserve should occur, with U.S. markets compared to European and Asian markets for purposes of adjustment to required capital or leverage, as necessary and prudent.

Why different levels for different size institutions? Because, while the type of risk may not change according to size, the absolute amounts of risk, capital at risk, do go up as size goes up.

The new legislation proposes additional fees on banks to provide what, in some economist's and businessman's point of view, amounts to a license to try the same financial legerdemain all over again, because the fees would be collected in service of a fund with which future failing institutions would be "bailed out."

We don't want that exposure again. Better that the legislation would impose the increased capital requirements, transparency through registration and regulation; that creates a whole new path for U.S. financial institutions to once again seize the lead in financing world commerce.

While the financial community might find these equity capital levels limiting their earnings and leveraging of assets to a degree in the short term, anyone who works with the numbers will see that such limitations do not impose undue restrictions, and have the substantial benefit of making as sure as possible that taxpayers are not exposed again to "too big to fail." It's worth noting that some of the banks in the 6,800 ""Under a Billion in assets" category, already practice "safe capital" in that they prudently manage their asset portfolio to reduce risk, recognizing that depositor and shareholder equity is, indeed, valuable, and to be protected.

Obviously, Foreign banks wishing to pursue opportunities in the U.S. through being Licensed to do business would have to meet the same qualifications, and so foreign bank home countries would benefit as well.

The whole point of any attempt to promote banking and financial institution capital and transparency requirements is to re-orient the financial industry towards it's proper place in a free-market economy; not to punish, not to micro manage, but to establish a framework for financial enterprise that allows for their importance, their vital part in financing U.S. business-small and large- and promoting savings as an important element of each Citizens' future, while their license to operate is predicated on a greater understanding of their need for judiciously developing, planning and managing investments on behalf of stakeholders.

The real key is all of this is requiring enough equity capital through stockholders so that "too big to fail" becomes an impossibility, as least so far as taxpayers involvement, because the imposition of borrowing restrictions would insure that if and when a financial enterprise fails, investor shareholder's would be the ones losing, not taxpayers.

The public interest is well-served by a vibrant, competitive financial marketplace. This legislation should be aimed at restoring balance in the marketplace, and as a result, the enduring achievement of capitalism, continuing America as the world leader it has become.