Paulson is Right: The System Needs Fixing

House MoneyTreasury Secretary Hank Paulson, in a speech this month, gave some prescriptions for fixing components of the financial system which are worthy of consideration, including changing flawed executive compensation plans and rectifying failed regulatory systems.

As we have seen, the root of the crisis is the widely held assumption that housing prices would continue to rise year after year, even though it was obvious to some that we were in an unsustainable bubble.

The blind belief in a continually rising housing market was behind the sales pitches for all kinds of securities, from mortgage-backed securities, credit default swaps and retail mortgages to unqualified borrowers.

Now Wall Street has sustained a body blow of unparalleled and unreal proportions that erased trillions of dollars in stock and bond values, inflated national deficits by trillions of dollars, causing dozens of banks and financial firms to implode and erased hundreds of thousands of jobs.

So why did financial executives nearly destroy the system that pays their lavish salaries and bonuses? For just that reason – the pursuit of lavish salaries and bonuses in a get-while-the-gettins-good mentality, risks be damned.

These bank executives and traders were like Yertle the Turtle, the Dr. Suess character who built an ever-rising tower to the sky for sheer ego gratification (on the backs of other turtles) only to have it collapse miserably.

“All across the banking business, easy profits and a booming housing market led many prominent financiers to overlook the dangers they courted,” the New York Times reported on Nov. 23 in an excellent front-page story about the Citigroup collapse.

I don’t want to point fingers, because there are many who are responsible for the blind and heedless rush to profit. But Paulson is right that Wall Street compensation practices that drove this recklessness needs an overhaul.

“Given their role in supporting and sustaining U.S. economic activity, financial institutions’ compensation practices should not encourage unsafe and unsound risk-taking or reward failure,” said Paulson.

Of course, it is always a tough call to balance reward against risk in any market. But the huge bonuses paid to executives at institutions such as AIG, Citigroup and many others apparently made those risks far too easy to ignore.

Top executives at many institutions made tens of millions of dollars each while their institutions were piling up unsustainable risks – again, on the assumption that housing prices would continue rising.

Where were the boards of directors in these institutions? Weren’t they supposed to be asking questions and demanding answers about how much risk management was taking on? Did they even understand these risks? Or did they simply ignore their fiduciary duties, leading to colossal losses?

Now the government is being forced into an unprecedented bailout to the tune of trillions of dollars. Unfortunately, we have no choice but to keep the financial system afloat.

Where were boards of directors when the unregulated credit default swaps market ballooned to an estimated $55 trillion? Why weren’t they questioning the managements about the risks their companies were taking on?

I agree with Paulson who said we must never again be deluded into thinking that the market can self-regulate, particularly in risky over-the-counter securities like swaps and other derivatives.

“Any financial product whose market size represents a systemic issue should be subject to regulatory oversight,” said Paulson. Better late than never, I suppose. But this financial meltdown should have never happened in the first place.

And it would not have happened if proper corporate boards were in place, doing the job of evaluating risk and keeping management accountable.

In my opinion the best protection for the corporations and our economy is for shareholders, the owners of public companies, to resume their proper role in corporate governance – a role that has been taken from them by managements who, driven by their own avarice and with the assistance of compliant state governments and armies of lawyers, have put into place a self perpetuating system for their own benefit, the results of which we now see before us.

This is why I initiated United Shareholders of America – to better empower shareholders – the true owners of companies – to be able to exercise their power. But it is only when we get large numbers of people involved will we take back the power. Join USA by signing up on my blog, Icahn Report. It will cost you nothing but our financial futures may depend on it.

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About Carl Icahn 29 Articles

Carl Icahn is an American billionaire financier, corporate raider, and private equity investor.

Mr. Icahn is the Chairman of Icahn Enterprises, a diversified holding company engaged in a variety of businesses, including investment management, metals, real estate, and consumer goods. He has been the Chairman of American Railcar Industries since 1994 and a Director of Blockbuster since May 2005. He became Chairman of ImClone Systems in 2006. In January 2008, he became the Chairman of Federal-Mogul.

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