Posted 5/21/2010

WASHINGTON REVIVES "LITTLE MORON" JOKE

The Senate and House Financial Reform bills bring back memories of the "little moron" jokes which were popular 70 years ago.

This one especially:

Walker: "Little Moron, why are you searching under the street lamp?"

Moron: "I dropped my watch."

Walker: "Did you drop it under the street lamp?"

Moron: "No, I dropped it further down the block."

Walker: "Then why don't you look for your watch down there?"

Moron: "Because there's more light here."

Congress is clearing looking in the wrong place for a plan which will prevent future financial crises. There is more light in the controversial toxic, mortgage-backed securities area, but the really big problem occurred upstream in the poorly lit loan origination area.

Foolish lending in the form of subprime mortgages, liars mortgages, no-interest mortgages and adjustable rate mortgages became the raw materials that flowed into a system of indiscriminate securitization, poor regulation, false risk ratings, insensible credit defaults and outright casino-type gambling by major banks and insurance companies.

In any business, it's garbage in, garbage out.

Garbage loans produce garbage securities.

You can't make a silk purse out of a sow's ear.

People with only grammar school educations have grasped this principle.

Why cannot Congress?

If we want a system which does not produce toxic securities, we must not maintain lending practices which produce toxic mortgages and auto loans.

The 1,500-page Financial Reform bills currently in Congress ignore the real issues:

• Preventing the toxic lending practices of mortgage brokers and banks.
• And ending the roles of Fannie Mae and Freddie Mac, which encourage banks to make bad loans by transferring the risk of bad loans from the banks to the taxpayer. At this writing, Washington has bailed out these two failed institutions to the tune of $185 billion, with no end in sight.

A useful Financial Reform Bill need only be ten pages long. It should accomplish three things:

1. Restrict mortgages to "prime" only. Define prime as "20% down" for a buyer whose purchase price is no more than 2.5 times his income.
2. Eliminate the organizations which promote bad loans – Fannie Mae and Freddie Mac.
3. Require issuers of mortgage-backed securities to accurately rate their offerings or suffer criminal penalties for false ratings.

If you think this is poorly thought out, let me refer you to Canada for corroboration.

Maybe you missed it amid all the bad news about bank failures in the USA, Great Britain, Europe and the Middle East, but Canada did not suffer bank failures or bank bailouts. Canada's banks which were too big to fail simply didn't.

When a CNBC reporter asked a Canadian banker why his country did not go through the bank failure-bailout trauma, he laughed. Then exclaimed:

"We didn't make any crazy loans!"

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