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Obama Repeats Bush's Worst Market Mistakes
Bad accounting rules are the cause of the banking crisis.
By STEVE FORBES
What is most astounding about President Barack Obama's radical economic recovery program isn't its breadth, but its continuation of the most destructive policies of the Bush administration. These Bush policies were in themselves repudiations of Franklin Delano Roosevelt, Mr. Obama's hero.
The most disastrous Bush policy that Mr. Obama is perpetuating is mark-to-market or "fair value" accounting for banks, insurance companies and other financial institutions. The idea seems harmless: Financial institutions should adjust their balance sheets and their capital accounts when the market value of the financial assets they hold goes up or down.
That works when you have very liquid securities, such as Treasurys, or the common stock of IBM or GE. But when the credit crisis hit in 2007, there was no market for subprime securities and other suspect assets. Yet regulators and auditors kept pressing banks and other financial firms to knock down the book value of this paper, even in cases where these obligations were being fully serviced in the payment of principal and interest. Thus, under mark-to-market, even non-suspect assets are being artificially knocked down in value for regulatory capital (the amount of capital required by regulators for industries like banks and life insurance).
Banks and life insurance companies that have positive cash flows now find themselves in a death spiral. Of the more than $700 billion that financial institutions have written off, almost all of it has been book write-downs, not actual cash losses. When banks or insurers write down the value of their assets they have to get new capital. And the need for new capital is a signal to ratings agencies that these outfits might deserve a credit-rating reduction.
So although banks have twice the amount of cash on hand that they did a year ago, they lend only under duress, or apply onerous conditions that would warm Tony Soprano's heart. This is because they know that every time they make a loan or an investment there is a risk of a book write-down, even if the loan is unimpaired.
If this rigid mark-to-market accounting had been in effect during the banking trouble in the early 1990s, almost every major commercial bank in the U.S. would have collapsed because of shaky Latin American and commercial real estate loans. We would have had a second Great Depression.
But put aside for a moment the absurdity of trying to price assets in a disrupted or non-existent market, of not distinguishing between distress prices and "normal" prices. Regulatory capital by its definition should take the long view when it comes to valuation; day-to-day fluctuations shouldn't matter. Assets should be kept on the books at the price they were obtained, as long as the assets haven't actually been impaired.
Mark-to-market accounting does just the opposite. When times are good, it artificially boosts banks' capital, thereby encouraging more investing and lending. In a downturn it sets off a devastating deflation.
Mark-to-market accounting is the principle reason why our financial system is in a meltdown. The destructiveness of mark-to-market -- which was in force before the Great Depression -- is why FDR suspended it in 1938. It was unnecessarily destroying banks.
But bad ideas never die. Mark-to-market was resurrected by the Financial Accounting Standards Board and became effective in the fall of 2007 (FASB rule 157) to the approval of the Bush administration, its Treasury Department, and the Securities and Exchange Commission. Even as FASB 157 began to take its toll on financial institutions last year, Mr. Bush refused to kill or suspend it. When Congress voiced displeasure last fall, the administration and regulatory authorities made some cosmetic changes, but the poisonous essence remained.
Another horrific Bush policy that Mr. Obama has left untouched concerns short selling. In 1938, the SEC, created by FDR, enacted the so-called uptick rule, which held that investors could not short a stock unless it went up in price. In July 2007, the SEC, whose commissioners were handpicked by the White House, got rid of the rule. Market volatility exploded.
Compounding this lunacy was the SEC's inexplicable failure to enforce the rule against "naked" short selling. Before an investor can short a stock, he is supposed to borrow the shares and pay a broker or stockholder a fee. What sellers soon realized was that the SEC was turning a blind eye to naked short-selling, thus adding even more pressure to beleaguered bank equities. Short sellers quickly saw how mark-to-market made seemingly invincible companies vulnerable to destruction. They picked their targets and relentlessly sold financial stocks short.
If the president really takes Roosevelt's legacy seriously, he should suspend mark-to-market accounting rules, restore the uptick rule, and enforce the prohibition against naked short selling. If he doesn't, historians will look back in utter amazement at Mr. Obama's preservation of Mr. Bush's worst economic policies.
Mr. Forbes is chairman and CEO of Forbes Inc. and editor in chief of Forbes magazine.
I think if mark to market was removed then there would be no downside to asset inflation. And then we could possibly face bubbles that never pop.
He makes the argument that the market functioned fine without m-t-m but through the 80s and 90s and 00s we had multiple asset bubbles. I think if they had mark to market pricing that behavior would have been curbed; if the market is built on inflationary actions then no doubt m-t-m will have a severe impact on the balance sheets. But a place I lack understanding is if it [mark to market] leads to price volatility or not.
The uptick rule is good IMO, keeps vultures out as is the Naked short selling rule. I agree with Forbes on both of those... but feel free to correct me!
Last edited by Motormouth; 03-06-2009 at 10:48 AM.
I also thing uptick needs to come back, it will help shed some of the volatility. But the big problem right now is that no one can figure out what P/E is, which means people are just guessing at the price.
why can't people figure out P/E? in certain sectors I guess I can understand, but as a whole it seems the formula would still work.
in relation to the financials, of course I agree that P/E is impossible for many reasons (off balance sheet asset losses, revaluation of paper assets, economic hardship...) but hopefully the stress testing accomplishes what it is supposed to as well as is transparent... though it seems it won't turn out that way.
Last edited by Motormouth; 03-06-2009 at 11:05 AM.
"President Obama’s proposed budget would tax a “carried interest,” currently treated as capital gains, as ordinary income. While media reports often only link carried interest compensation with Wall Street hedge fund managers, this proposal would have a broad devastating impact on the commercial real estate development industry.
At a time when the real estate industry is struggling, this would increase taxes on entrepreneurs from the current level of 15 percent to as high as 39.6 percent. This would be a severe blow to entrepreneurs wanting to undertake new deals, which are the source for much of the industry’s job creation. Straightforwardly, many development projects will not be undertaken if this becomes law. Proposals to tax carried interest at ordinary income rates, without regard or differentiation as to the nature of the underlying investment, would adversely impact the flow of capital to real estate deals.
The Obama administration recently undertook efforts to alleviate the severe credit crisis now affecting commercial real estate by expanding the activities of the Term Asset Backed Lending Facility (TALF) to include commercial real estate debt — an action NAIOP applauded. This most recent proposal by the Obama administration to increase taxes on the industry is totally at odds with their prior actions, which was recognition of the difficulties currently affecting the credit and capital markets in commercial real estate.
A healthy real estate economy is vital to a prosperous U.S. economy and produces an immense ripple effect with job creation and personal earnings that quickly roll over into increased consumer spending. The most recent data available cites total real estate construction spending of $1.16 trillion — approximately 8.5 percent of the nation's Gross Domestic Product. Commercial development supports 4.89 million full-time equivalent jobs in the United States and generates personal earnings of $170.1 billion."
Huh. Domestic fiscal policy does not seem to be a strong suit of our new President.
I am encouraged only because of the seeming rabid risk prevalent throughout all
of the markets which I choose to follow. It is that same indefinable risk which has
created marketplaces filled with gunshy investors. Aggression is my only ally.
why can't people figure out P/E? in certain sectors I guess I can understand, but as a whole it seems the formula would still work.
in relation to the financials, of course I agree that P/E is impossible for many reasons (off balance sheet asset losses, revaluation of paper assets, economic hardship...) but hopefully the stress testing accomplishes what it is supposed to as well as is transparent... though it seems it won't turn out that way.
i see what you mean...peopel just get scared about the nationalization talk...so doing it in a way that isnt full nationalization is actually costing more, all just for the BAC and City chareholders....i guess its the political game, if he nationalizes then it will be harder to bargain with the right...but IMO the right are just simply not going to do try to work anything out anyways.
I still havent heard yet of revamping regulation, SEC....i imagine its going to happen still(he better), given how much damage "shadow banks" created
Quote:
Originally Posted by Motormouth
aren't they still planning on raising capital gains anyway also to around 20-25%?
and also: good. on both counts in my opinion. they should both be treated as income IMO.
yeah, that argument that low taxes on capital gains would translate to moe construction was used when they reduced capital gains taxes, but in fact it was the expansionary monetary policy of deregulation along with the low interest rates, stupid risk management decitions by "shadow bank" executives, etc. are what resulted in the 1.6trillion invested in realstate(is # @ peak) construction...the bubble.
Quote:
Originally Posted by T.Berg
..those who benefit the most of the 15% tax on capital gains are individuals with fat portfolios that use it as their primary income, as while everybody else pays 25-30% on primary income.
I know it helped "luxury" economy tremendously, but you cannot sustain a whole economy just on that premise.
Taxing more on capital gains, I do not see how that will help our economy. When you tell someone, the more you make the more you will be taxed. Go figure.
Obama Repeats Bush's Worst Market Mistakes
