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Over the past decade,
lenders dramatically loosened underwriting standards and aggressively
marketed an assortment of exotic mortgage products designed to make home
ownership more “affordable.” In the end, they helped to create a
now-bursting real estate bubble that increased the costs of shelter for
most Americans and left many of those who shouldn’t have taken the
plunge in the first place unable to afford rising mortgage payments—or
anything else.
By
communicating more openly and adopting a measured pace of interest rate
rises in the two-year period that began in June 2004, the Federal
Reserve sought to restore a measure of economic equilibrium while
reducing market uncertainty. In reality, their approach helped bolster a
quantum leap in risk-taking on Wall Street and elsewhere and added to
ever-growing imbalances that have destabilized the U.S. economy and made
the outlook as uncertain as ever.
Designed
to facilitate risk-sharing and mitigate the cyclical downside of
traditional banking practices, the widespread use of securitization in
recent years has been seen as a boon. Instead, it has transformed
plain-vanilla credit exposure into a dangerous concoction of credit,
interest rate, prepayment, counterparty, timing, and operational risk.
The gold rush of modern financial alchemy virtually ensures that all
facets of the economy will be adversely affected when circumstances take
a turn for the worse.
Historically,
policymakers have viewed over-the-counter derivatives as the province of
sophisticated financial operators who are capable of looking after their
own interests. Yet by seemingly encouraging those who are actively
involved with these often highly-leveraged securities to focus on
profitability without any real oversight or incentives to take stock of
the bigger picture, it is likely that the eventual violent unraveling
will be in no one’s interests.
Similarly,
by allowing hedge funds relatively free rein, regulatory overseers in
Washington and elsewhere have essentially facilitated the spectacular
growth of an industry with a voracious appetite for taking on risk. With
limited liability and an asymmetric compensation structure that
encourages many such operators to go for broke, regulatory arbitrage and
intense competitive pressures means it won’t just be sophisticated
investors who feel the pain.
To
help investors stay better informed and to minimize the potential for
Enron-like chicanery, policymakers introduced measures like the
Sarbanes-Oxley Act of 2002, which mandated a host of costly accounting
and reporting requirements, and Regulation Full Disclosure, which
limited when and how executives could discuss business prospects. Many
companies are now delisting from U.S. exchanges or shifting activities
to more lightly regulated regimes, while most people seem to know less
about what is going on in corporate America than before.
In
theory, incentive compensation stock options ensure that the interests
of investors and managers of publicly-traded companies are aligned. In
practice, inadequate accounting rules, poor regulatory oversight, a
distorted tax code, and the lopsidedly pro-business government policy
orientation of recent years has meant otherwise. One result has been a
growing scandal involving executives at more than 150 companies who
allegedly manipulated options prices for personal gain, while another
has been a ramp-up in borrowing to fund stock buybacks at inflated
prices.
“Sooner
or later,” as Robert Louis Stevenson once remarked, “everyone sits
down to a banquet of consequences.” Unfortunately, the cumulative
effect of a wide range of unintended consequences such as these means
that Americans as a group will be forced to take the Scottish author’s
words to heart in the not too distant future. It will not be a pretty
sight.
© 2006 Michael J. Panzner
Editorial Archive
Michael
Panzner is author of The New Laws of the Stock Market Jungle: An
Insider’s Guide to Successful Investing in a Changing World
and a 25-year veteran of the stock, bond and currency markets. His
next book, Financial Armageddon: Protecting Your Future from Four
Impending Catastrophes is set to be published by Kaplan Business
in February.
Contact
Information
Michael
J. Panzner
P.O. Box 115
Manhasset, NY 11030
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