It wasn’t bailout that caused Monday’s market surge — 3 other factors
Since the $700 billion bailout was first proposed, whatever the stock markets did, much of the press took that as a sign that the market wanted more government intervention. The markets sinking on Sept. 29, the day the House voted down the first bailout bill (although much of the sinking was before the bailout was defeated), was a sign that markets needed the bailout. Then, when it went up about 500 points the next day, it was somehow explained as anticipation of Congress passing a new bailout.
The press was somewhat at a loss for words when the market tanked all last week, just after the bailout had been passed. But yesterday, when the Dow Jones Industrial Average zoomed up 900 points, the explanation was that the markets just loved the forthcoming global bailouts and partial nationalizations. Comedy Central’s Stephen Colbert, as he so often does, cleverly mocked this conventional wisdom. On last night’s Colbert Report, he reported on “Henry Paulson’s plan to change his plan to whatever the Europeans are planning is working.”
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The international mark-to-market contagion — sending global markets in a downward
Bailouts. Global interest rate cuts. More bailouts. Global government liquidity injections into banks. Direct government buying of commercial paper. And even more types of bailouts.
But nothing seems to stop the downward spiral of equity and credit markets throughout the world that have been accelerating this week. But there is one intervention the governments of the world haven’t tried yet: Standing up to the high priests of the accounting profession and suspending requirements of mark-to-market accounting for illiquid assets.
Markets are more connected across the world than ever before, but, more importantly, so are accounting rules. Over the past decade or so the U.S. Financial Accounting Standards Board (FASB) and the European International Accounting Standards Board (IASB) — private professional organizations that basically have a monopoly on setting the accounting rules that government agencies adopt for regulations on the private sector — have worked on a project of “convergence” of accounting standards. This wouldn’t be so bad if it just amounted to mutual recognition of each others’ rules. But it often has meant mandating a one-size-fits-all-rule throughout the world. And this has meant a disaster with the flawed mark-to-market rule.
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Market down on bailout — Don’t compound damage with overregulation of ‘Main Street’
Today — five days after a courageous independent vote against Treasury Secretary Hank Paulson’s $700 billion bailout for Wall Street — the U.S. House of Representatives disappointingly approved the same basic measure. Many of the bill’s other “sweeteners”, such as earmarks and a regressive increase in deposit insurance for upper income bank customers –will also cost taxpayer hundreds of billions of dollars.
All this week I and my colleagues have pointed out ways this bailout could, in addition to being costly, be counterproductive for the economy. Wall Street may have been feeling this “buyers’ remorse” today as the Dow Jones Industrial Average pared back ealier gains to end the day down by 150 points. As Yahoo Finance noted, “financial stocks, which had traded sharply higher on the promise the bill would be passed, fell after the House vote on profit-taking and as the market focused on the tough road that still lies ahead for the U.S. economy.”
As I had noted previously, despite the scare tactics from Paulson to Pelosi of economic Armageddon if no bailout was passed, the volatility of the past few weeks was in siginifcant part due to fear about what goverment was going to do as well as fear of market conditions.
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Deregulation Didn’t Cause the Financial Crisis, But It Might Help Solve It
Banking expert Peter Wallison explains why deregulation didn’t cause the financial crisis, while Steven Malanga explains how government regulators foolishly pressured banks to drop prudent lending criteria as “discriminatory,” resulting in risky lending that caused the crisis.
Peter Wallison was one of the few people who warned for years about the risky practices of the government-sponsored mortgage giants, Fannie Mae and Freddie Mac, which helped spawn the mortgage crisis. Liberal Congressional leaders turned a deaf ear to his pleas for reform, blocking reform legislation and claiming that the leadership of the fraud-ridden Fannie Mae was “outstanding,” while Fannie Mae was busy engaged in accounting fraud to enrich its managers (who remain liberal power-brokers), and political bullying. (Congressman Barney Frank’s role in causing the mortgage crisis is chronicled in the Boston Globe).
Yesterday, the SEC reformed mark-to-market accounting rules to make them less rigid. [CORRECTION: THE SEC JUST "CLARIFIED" THE RULES. IT'S NOT CLEAR THAT THE SEC CHANGED THE RULES SUBSTANTIVELY AT ALL. THE NEWS STORY I LINKED TO MADE IT SEEM LIKE A REFORM, BUT IT WASN'T MUCH OF A REFORM]. Those rules have apparently contributed to the financial panic and frozen credit markets. The SEC should also revisit wasteful regulations governing the minutiae of companies’ “internal controls,” which cost the economy $35 billion per year.
Community organizers like the fraud-ridden ACORN used regulations like the Community Reinvestment Act to pressure lenders into making billions of dollars worth of bad loans.
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SEC Loosens Rigid Accounting Rules
Rigid mark-to-market accounting rules may have triggered the current financial crisis by artificially undervaluing mortgages and securities (making financial institutions appear insolvent). Even the very government officials who have advocated those rules now hint that they will disregard them in valuing the government’s own mortgages, in administering any bailout! (This inconsistency undermines arguments for the bailout).
The SEC today made federal accounting rules a bit less rigid by allowing methods other than mark-to-market accounting in appropriate conditions. Thus, when mortgages have not defaulted, financial institutions need no longer treat them as worthless, even when no active market exists for the security based on those mortgages.
Hopefully, Congress will leave the SEC’s decision to reform accounting rules intact, or, better yet, push for further reform. The Congress’s Republican Study Committee has advocated a similar, but more far-reaching, reform. Similarly, Senator McCain welcomed the SEC’s decision, and apparently has advocated the reform it adopted since March.
Others supporting reform of mark-to-market accounting rules include former FDIC Chairman William Isaac, the Wall Street Journal, Jeff Miller, Holman Jenkins, and Newt Gingrich, to name just a few supporters.
Ideally, the SEC would also consider reforming other accounting rules that are burdening the economy without benefiting investors or financial institutions, such as regulations that dramatically expanded the reach of the Sarbanes-Oxley Act. A prime example would be the economically-devastating PCAOB rules on company’s “internal controls,” which cost the economy $35 billion per year, while focusing managers’ attention on trivia like which employee has access to which computer password. Those regulations were used by subprime mortgage lender Countrywide Financial to divert attention from its risky lending practices, earning it a reputation as a paragon of regulatory compliance despite its financial recklessness.
Speaking of the SEC, John McCain recently proposed appointing Andrew Cuomo to be chairman of the SEC. What an unbelievably bad choice! Earlier, we wrote about how Cuomo, as Clinton’s HUD secretary, helped cause the mortgage crisis by imposing “affordable housing” mandates that artificially created markets for risky mortgage loans to people with low incomes and little savings.
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Republican Study Commitee plan now best viable alternative
The stunning defeat of the Hank Paulson’s socialism-for-Wall Street bailout on Monday has just made planks of a pro-free market alternative much more viable. As Open Market has noted before, The Republican Study Comittee, a caucus of pro-market members of the GOP Congress, has presented such a plan that would be much more effective at stopping the contagion than the Paulson bailout, and many of its provisions would not cost taxpayers a dime.
The RSC plan is chock-full of measures to remove barriers to economic growth and market-distorting subsidies. It would suspend capital gains taxes to put trillions of dollars of capital in the economy, and set Fannie Mae and Freddie Mac, which as CEI has documented were at the root of this crisis, on the road to full privatization.
Most importantly for the crisis at hand, the RSC plan would make regulatory agencies suspend the mark-to-market accounting rules that a range of experts agree are spreading the contagion by forcing solvent banks’ to “write down” their assets, based on the last fire sale of a highly leveraged bank. As Gary Gorton, finance professor at Yale and member of the National Bureau of Economic Research has written, “With no liquidity and no market prices, the accounting practice of ‘marking-to-market’ became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates.”
You can read more about mark-to-market regulations in my op-ed in the Wall Street Journal last weekend. My Open Market post early last week, as well as CEI’s new podcast, explains how the Paulson bailout may make things worse by forcing more paper losses that threaten healthy banks with “regulatory insolvency.”
The problem with the Paulson buy-up plan or some new variant of it is if the government pays pennies on the dollar, mark-to-market rules would make every other bank take this paper loss on its books. So there will be a tension between getting the best deal for the taxpayer and not spreading further systemic risk from massive writedown the government purchase could force. Even Ben Bernanke acknowledged this tension in his Congressional testimony last Tuesday.
All the more reason to go with the RSC plan instead of a reformulated Paulson plan, which would throw $700 billion and the free market out the window and still not solve the crisis at hand.
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Bailout fails — Move on to Mark-to-Market Reform
Oh, Happy Day! And it certainly is for all those who value freedom, responsibility and the true free market in which individuals are free to profit from their risks on the condition that they don’t stick the rest of us with their losses.
It’s not hyperbole to say the Republican and Democratic backbenchers who defied both parties’ leadership to defeat this $700 billion package of Wall Street socialism literally saved America. Whatever their reasons, this defeat (or rather victory for freedom), means that America is much less likely to turn into France, Venezuela, or the old Soviet Union, as this bailout/nationalization package would have set us on the road to becoming.
Several great speeches on the Right and Left were given. Democrats Brad Sherman of California and Earl Blumenauer of Oregon gave powerful speeches against corporate giveaways. And conservative leaders of the Republican Study Committee — such as Jeb Hensarling, Jeff Flake, Mike Pence, and of course Ron Paul — spoke about how government intervention was largely the cause of this predicament, but the bailout would doom arguments for the free market form here on out. The idea of the government making this kind of outlay to high-flying risk takers just didn’t jibe with members, and certainly not with the American people.
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$700 billion to worsen economy? — Berlau in American Spectator
Here are excerpts from my story in today’s American Spectator Online on how the $700 billion bailout could actually make things worse — in terms of resulting inflation and even a further contraction in credit due to the government purchases’ interaction with the mark-to-market accounting rules. To read the piece in its entirety, click here.
“”The government has to do something to keep markets from falling and the economy from getting worse.” How many times have you heard that mantra this past week from President Bush, Treasury Secretary Hank Paulson, Democrat leaders, the news media, and even some ostensibly conservative periodicals?
But what if the bailout, as originally proposed and in its latest incarnation, would spend $700 billion of taxpayers’ money and actually make the economy worse? Believe it or not, there is good evidence this may happen. The inflationary prospects of the bailout price tag may lead to spikes in oil and crop prices that could hit ordinary Americans in their cars and on their kitchen tables. And government purchases of financial assets could ironically further constrain credit through causing write-downs on even the balance sheets of financial firms not participating in the bailout by worsening the effects of mark-to-market accounting rules.
All last week, the stock market’s plunging downward was pointed to as a sign that Washington must step up to the plate — as quickly as possible. Yet ironically last Friday — the day after the bailout talks broke down at the wild White House meeting with the presidential candidates — the Dow Jones industrial average actually went up by 120 points! This doesn’t mean that the market is opposed to the bailout, but it does show that the market volatility is probably as much due to the potential effects of a bailout as it is to a lack of one.”
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Kudos to Republican Study Committee for bailout alternative
Those of us (and CEI is among the “us”!) who oppose Treasury Secretary Henry Paulson’s $700 billion bailout of Wall Street have been challenged to come up with an alternative to stop the credit contagion. The Republican Study Comittee, a caucus of pro-market members of the GOP Congress, has just answered this challenge. They have presented such an alternative that would be much more effective at stopping the contagion than the Paulson bailout, and it would not cost taxpayers a dime.
The RSC plan is chock-full of measures to remove barriers to economic growth and market-distorting subsidies. It would suspend capital gains taxes to put trillions of dollars of capital in the economy, and set Fannie Mae and Freddie Mac, which as CEI has documented were at the root of this crisis, on the road to full privatization.
Most importantly for the crisis at hand, the RSC plan would make regulatory agencies suspend the mark-to-market accounting rules that a range of experts agree are spreading the contagion by forcing solvent banks’ to “write down” their assets, based on the last fire sale of a highly leveraged bank. As Gary Gorton, finance professor at Yale and member of the National Bureau of Economic Research has written, “With no liquidity and no market prices, the accounting practice of ‘marking-to-market’ became highly problematic and resulted in massive write-downs based on fire-sale prices and estimates.”
You can read more about mark-to-market regulations in my op-ed in the Wall Street Journal this weekend. My Open Market post early this week, as well as CEI’s new podcast, explains how the Paulson bailout may make things worse by forcing more paper losses that threaten healthy banks with “regulatory insolvency.” The problem is if the government pays pennies on the dollar, mark-to-market rules would make every other bank take this paper loss on its books. So there will be a tension between getting the best deal for the taxpayer and not spreading further systemic risk from massive writedown the government purchase could force. Even Ben Bernanke acknowledged this tension in his Congressional testimony Tuesday.
All the more reason to go with the RSC plan instead of the Paulson plan, which would throw $700 billion and the free market out the window and still not solve the crisis at hand.
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Cost of Bailout Gets Bigger; SEC Regulation Backfires
The financial bailout bill is not just “dangerous, inflationary, unnecessary, and unconstitutional.” It’s also a lot more costly than the government admits, judging from the hypocritical arguments made by government officials. The Treasury Secretary in the past has resisted calls to loosen federal accounting rules, so-called “mark-to-market” rules that require mortgages to be assessed at their current fire-sale prices, rather than their estimated value if held to maturity. These rules can result in banks being declared insolvent even if few of their loans have defaulted.
Now, however, the government hypocritically plans to ignore its own mark-to-market regulations when buying up mortgage loans as part of the bailout, saying that instead of buying assets at their current “fire-sale prices,” the bailout will ”have taxpayers buy the assets and hold them at close to their maturity value.” If “mark-to-market” accounting is really as accurate as the government claims, then the government is going to grossly overpay for the worthless mortgages it buys, and taxpayers are going to lose tons of money in the bailout — far more than the government is admitting. On the other hand, if this accounting method is not accurate enough to be used by the government for its own purchases, then the government should stop forcing private banks to use it, since doing so jeopardizes their solvency, and the financial system as a whole.
Many commentators are now calling for relaxation of federal regulations mandating “mark-to-market” accounting (which requires assets to be valued at current fire-sale prices), in order to stem the financial crisis, including former FDIC Chairman William Isaac, the Wall Street Journal, John Berlau, Jeff Miller, Holman Jenkins, Newt Gingrich, and the Republican Study Committee
The SEC’s foolish ban on short-selling, a classic example of shooting the messenger, has now backfired, with people worried about the market falling investing in commodities like gold rather than the stock market, as investment manager Peter Schiff has observed. Investor confidence took a dive after the details of the bailout became public — not surprising when you consider the role that government incompetence played in spawning the mortgage crisis, especially by the very lawmakers and officials who are pushing the bailout (such as mandating risky loans to promote “affordable housing“).
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