The American population is aging fast, and more and more people will soon be living largely off the proceeds of their 401K plans and what is left of fixed-rate pensions. These current and future retirees count on drawing a steady stream of cash from high-rate yields of what they believe to be secure, reliable investments in those plans. They believe this because it's what theyve been led to believe. But if the financial crisis of the past week is any indication, they may be in for a rude confrontation with reality. What the subprime meltdown reveals is how much of the income for the middle classes' Golden Years has been resting on a foundation of bad debtand in some cases, on the exploitation of low-income homeowners.
"The global investment community wanted to believe that Wall Street and other centers of financial engineering could manufacture investment-grade, long-term debt to meet the huge demand of insurance companies, pension funds and central governments for predictable, long-lived and safe interest-paying investments," says Jim Jubak, whose recent column on MSN Money offers a concise history of "how Wall Street got into this mess." While common sense would tell you that this wasn't likely to workthat there simply couldn't be that large a pool of genuinely secure, high-quality investments with the kinds of yields people had gotten used to in the 1990sthe global economy bought it, nonetheless. "Because, you see," continues Jubak, "it's the only way out for an aging world that's running a huge shortage of the real stuff. So investors were all too willing to buy fake investment-grade paper—at prices commanded by the real investment-grade stuff—until finally the con was revealed as assets were marked to market at 50% or less of their assumed value." That's exactly where the crackup has taken place, in the credit market for assets based on corporate junk bonds and especially on subprime mortgagesspeculative-grade credits that were bundled together (which would purportedly limit the risk) and passed off as safe places for Americans to grow their future livelihoods.
The meltdown in the subprime business is setting off declines elsewhere in the market and throughout the world, and the suffering of the mostly low-income homebuyers targeted by subprime lenders is now likely to be shared by a huge swath of investors and especially retirees as the assets they depend upon lose value. And it remains very much to be seen whether the Federal Reserve and other central banks and private money can fend off a recession.
So far the three main Democratic presidential CandidatesClinton, Obama, and Edwardshave made proposals for modest reform, including setting up funds to help homeowners fend off foreclosure and providing them with counseling, along with laws to ban predatory policies. But these are too little, too late. Achieving the kind of dramatic change that would both protect consumers and discourage the gross overvaluing and fraud that threatens the investments of millions of Americans is something no mainstream presidential candidate nor the Democratic Congress has contemplated: direct government intervention in the form of regulated interest rates, along with prosecution of collusion among banks and the securities industry to set terms and rates.
Short of this, a few steps could be taken in the near term to ease the crisis and reduce the number of foreclosures.
- Stop conning people into borrowing money. Make it illegal to sell mortgages to buyers who clearly can't repay them, and prosecute violators.
- Hold lenders responsible for their brokers' actions with civil and criminal penalties.
- Elimate repayment penalties on subprime loans.
- Place a cap on fees, including kickbacks from lenders to brokers.
Some similar measures were included in two new Minnesota state laws against predatory lending practices passed this spring and may be the strongest in the country.
Even before the latest financial crisis, groups such as ACORN and the NAACP were calling for a temporary moratorium on subprime foreclosuresanother short-term step that could be taken immediately. (ACORN was also the group that negotiated with subprime lenders on behalf of Katrina victims, who had been given only one month after the storm to catch up on their mortgage payments or lose their homes.)
If action to stop foreclosures is not taken at the federal or state level, county sheriffs and courts couldand in some places well mighttake matters into their own hands, refusing to conduct foreclosure sales or auctions.
In fact, some kind of government action, however tame, now seems far more likely than it did a few weeks ago. This is because the travesty that previously affected mostly the poor has finally worked its way into the retirement accounts of the middle class and the investment portfolios of the rich, who until recently had actually been profiting from subprimes' inflated yields. In this sense, there's a kind of grim justice to what happened on Wall Street last week.