The implosion of the housing market and the cascading crises in the credit markets are the direct consequence of a 30-year experiment of trying to create a deregulated, low wage economy where high consumer spending is propped up by easy credit and asset bubbles. Real solutions must be based on restoring the economic health of the American middle class through good jobs, health care, retirement security and a voice at work for all. And an important part of the solution must be the thoughtful, comprehensive re-regulation of the financial markets.
The AFL-CIO has long favored greater investor protections and regulatory oversight of participants in the U.S. financial markets. As we meet, much of the mortgage market, the municipal bond market, the market for riskier corporate debt, and in the last week the student loan market, are frozen—the result of speculative excess and a massive loss of confidence in the information available to investors. Only thoughtful re-regulation can restore that confidence and the ability of the markets to properly function.
The damage to working families is real, and growing. Working people are losing their homes at an alarmingly rate. Jobs in residential construction, one of the largest construction industry markets, are disappearing. Perfectly good companies are unable to finance their businesses. And workers’ pension funds have suffered tens of billions of dollars in losses from their investments in financial services companies and housing-sector companies battered by subprime losses.
Reining in financial intermediaries after a 30-year free-for-all will be a complex task requiring coordinated action involving Congress and regulators at the state, federal international levels. Given the irresponsible attitude of many in the Bush administration, we must assume that at best only the first steps will be possible while that administration remains in office.
Effective regulation must be implemented to ensure the transparency and accountability of mortgage lenders, investment banks, credit-rating agencies, hedge funds, private equity funds, off-balance-sheet lending vehicles and other structured credit products, as well as Sovereign Wealth Funds. The AFL-CIO has called repeatedly for transparency and clear fiduciary duties to investors by all pools of private capital and capital market intermediaries. The reasons for such transparency have never been clearer.
The AFL-CIO also has warned repeatedly of the danger of market accounting in contexts where there are no functioning markets or where such accounting can contribute to a downward economic spiral unrelated to the actual business activity of companies. We are now living through a bubble followed by a downward spiral in the credit markets, made worse by applying mark to market accounting where markets have frozen.
As a first step, policymakers must revisit the inherent conflict that exists when fee-based investment banking is combined with the business of taking and investing insured deposits. The repeal of the Glass-Steagall Act by the Gramm-Leach-Bliley Act left this dangerous conflict without any effective oversight. In particular, Congress and the regulators must address compensation structures that reward the taking of excessive risk with federally insured deposits. Furthermore, regulators here and around the world must deal with the fundamental problem that if a lender can pass off bad loans to an unsuspecting public, keep none of the risk and collect large fees, that institution has no incentive not to make the bad loan in the first place. The AFL-CIO supports the effort of House Banking Committee Chairman Barney Frank to work on these issues on an international basis with the European Parliament.
Credit-rating agencies that gave securitized subprime loans triple A ratings are one of the major causes of this debacle. Congress needs to increase the Securities and Exchange Commission’s power to regulate these agencies, possibly through an independent body like the Public Company Accounting Oversight Board created by the Sarbanes-Oxley Act.
Like all investors that rely heavily on borrowing to finance their investments, hedge funds and private equity funds will suffer as lenders tighten their standards. The high-profile failures of leveraged buyouts led by prominent private equity firms including Blackstone and J.C. Flowers are indicative of the difficulties ahead. As we have said in the past, Congress should act (1) to give the regulators power in this area to protect investors and (2) to ensure that our tax system is fair by taxing hedge fund and private equity fees at ordinary income rates.
As a result of nearly three decades of self-destructive trade and energy policies, our trade deficit has given birth to the Sovereign Wealth Funds. Our flagship financial institutions, crippled by their catastrophic involvement in the subprime markets, have recently turned to these funds, who have gained significant levels of ownership in these important institutions. As a result of our trade deficit, our economy has come to depend on flows of foreign capital, and we cannot look to exclude such funds from our markets or take away their rights as investors. Nonetheless, we strongly support the efforts of Sens. Jim Webb, Charles Schumer and Evan Bayh to address the challenges posed by the rise of Sovereign Wealth Funds.
Specifically, Sovereign Wealth Funds should be required to comply with all of the disclosure requirements that apply to domestic investors. In addition, Congress should strengthen the process for U.S. government review when foreign governments invest in U.S. companies by (1) removing provisions that allow foreign investors to escape government review when shares are non-voting, and (2) lowering the ownership level that triggers optional governmental review from 10 percent to 5 percent.
However, not all Sovereign Wealth Funds are the same. Norway’s Government Pension Fund provides retirement security for all Norwegians and is a leader in efforts at transparency in the global capital markets. The Norwegian fund should be looked to as a model of the transparency and accountability we should expect from all Sovereign Wealth Funds.
Financial re-regulation will not by itself restore our economy to health. That will require middle class restoration. But thoughtful re-regulation of financial markets is part of what must be done. We urge Congress and the regulators to act without delay to address the conflicts within financial institutions, bring transparency to opaque pools of capital, and protect consumers and the public interest in the capital markets.