Posts Tagged ‘ leadership ’

$700 Billion Spent, But Nothing to Fix Root Cause of Crisis

I’ve been on the same emotional roller coaster as everyone else on “Main Street” over the past weeks, but I was finally able to clarify my anger just as the bailout became a reality. Despite all of the “sweetening” to bring over House Republicans and some Democrats, the bill now signed into law still does absolutely nothing to address the collapse of the real estate market that is the engine of the meltdown. As Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan notes,

Because of the 20% fall in the price of homes since the bursting of the house-price bubble, there are now some 10 million homes with mortgages that exceed the value of the house. Residential mortgages are generally “no recourse” loans, meaning that if the homeowner stops making payments, the creditor can take the property but cannot take other assets or attach income. Individuals with loan-to-value ratios greater than 100% therefore have an incentive to default even if they can afford their monthly payments, and to rent an apartment or other house until house prices stop declining. When individuals default and creditors foreclose, the property is added to the stock of unsold homes. That depresses prices further, increasing the number and magnitude of negative equity houses.

The prospect of a downward spiral of house prices depresses the value of mortgage-backed securities and therefore the capital and liquidity of financial institutions. Experts say that an additional 10% to 15% decline in house prices is needed to get back to the prebubble level. That decline would double the number of homes with negative equity, raising the total to 40% of all homes with mortgages. The mortgages of five million homeowners would then exceed the value of their homes by 30% or more, which could prompt millions of defaults.

Glen Hubbard of Columbia, another former chairman of the Council under President George W. Bush, has a similar assessment. They and others have proposals worth a hard look and prompt action, but I haven’t heard it yet, and certainly it hasn’t been a priority like the insistence on the bailout passed this week. Why is this? Is it because of fear tactics? Is it because we still cling to trickle down concepts even when it’s clear everyone involved is making a best guess at what will bring faith back to the market?

I don’t know. I do know one thing, however. We can’t stop asking questions now, as I’m sure the conspicuously quiet executives on Wall Street hope we will. Where have they been? Aside from Warren Buffett, where was the leadership? Why didn’t executives come forward with gestures of their own? Imagine how powerful a statement by top financial executives would have been along these lines:

Until our firms return to profitability, we will not receive salary or a bonus. Once we have succeeded in putting our houses back in order, we will only accept pay at a level no more than 20 times non-executive pay in our firms. And because we believe so firmly in the American economy and the spirit of opportunity, severance packages for executives will be performance based–no more no-fault golden parachutes.

I am not holding my breath, but it’s exactly what is needed, and our politicians and pundits who travel in the same circles would do well to quietly prod their executive friends to consider it.