Posts filed under “Bailouts”
The 110-page "Emergency Economic Stabilization Act of 2008" has been written, and is going to Congress today.
Market reaction has not been favorable. As of 5:53am, Dow Futures are off 200, and Europe is trading 3% lower.
All of this points to an issue that I have yet to hear addressed directly: Targeting of asset prices, such as houses and stocks, rather than credit markets and systemic risks. It began under Greenspan (recall the "Put"), but under Fed Chair Bernanke started in January 2008.
Throughout this crisis, there has been chatter and attempts to stop the freefall in Housing prices — something that is counter-productive. Unless we want a Japan like decade of recession, we need to allow the various bad assets to seek their own levels via the open market.
Over the past few years, all the Fed has accomplished with this asset price targeting has been to prevent any capitulatory washout from taking place.
A classic example of this misguided asset price focus is in the Bailout’s suspension of mark-to-market pricing:
SEC. 132. AUTHORITY TO SUSPEND MARK-TO-MARKET ACCOUNTING.
(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under the securities laws (as such term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.*
That seems to be pulled straight from the Bank of Japan’s playbook: Take the right downs later rather than sooner, once the market returns to normalcy. That’s a deeply flawed philosophy.
Former SEC Chair Arthur Levitt lectures the Congress on why mark-to-market is so important.
"That’s why it’s both dismaying and puzzling that as Washington debates the Treasury’s bailout proposal, some of the largest banking and financial services trade groups are aggressively lobbying the SEC to suspend the mark-to-market, or fair-value, accounting standard currently in place, and to oppose any expansion of it.
To ask for a suspension in fair-value accounting is to ask the market to suspend its judgment. These trade groups claim that the fair-value accounting standard has distorted banks’ balance sheets, and has contributed significantly to the market’s volatility.
On the contrary, that gets things backward. It is accounting sleights-of-hand that hid the true risk of assets and liabilities these firms were carrying, distorted the markets, and have caused investors to lose the confidence necessary for our markets to function properly."
What the Fed, Treasury and SEC seems to fail to understand is that you CANNOT get a return to normalcy after a bubble — not until prices are allowed to fall to levels that bring in aggressive buyers. That is true for stocks, houses, and even financial institutions.
The plan as it is currently constructed fails to recognize that Housing prices still remain elevated, more foreclosures are likely, and that another 10-20% downside in real estate is quite likely.
Instead of focusing on asset prices, we should be looking at recapitalizing the banking institutions, providing liquidity to those that need it, and managing insolvency via FDIC.
Its time to fix what’s broken, and leave the assets pricing to the markets.
Futures Update: Dow futures down further at 7:02 am, with fair value approaching minus 237 on the Dow . . .
* The EESA also calls for a study of mark-to-market: "SEC shall conduct a study on mark-to-market accounting
standards as provided in Statement Number 157 of the Financial
Accounting Standards Board" SEC. 133. STUDY ON MARK-TO-MARKET ACCOUNTING.
Fed’s Folly: Fooled by Flawed Futures? (January 2008)
How to Restore Trust In Wall Street
ARTHUR LEVITT JR. and LYNN TURNER
WSJ, SEPTEMBER 26, 2008
The chairman of the Securities and Exchange Commission, a longtime proponent of deregulation, acknowledged on Friday that failures in a voluntary supervision program for Wall Street’s largest investment banks had contributed to the global financial crisis, and he abruptly shut the program down.
The S.E.C.’s oversight responsibilities will largely shift to the Federal Reserve, though the commission will continue to oversee the brokerage units of investment banks.
Also Friday, the S.E.C.’s inspector general released a report strongly criticizing the agency’s performance in monitoring Bear Stearns before it collapsed in March. Christopher Cox, the commission chairman, said he agreed that the oversight program was “fundamentally flawed from the beginning.”
“The last six months have made it abundantly clear that voluntary regulation does not work,” he said in a statement. The program “was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily. The fact that investment bank holding companies could withdraw from this voluntary supervision at their discretion diminished the perceived mandate” of the program, and “weakened its effectiveness,” he added.
Mr. Cox and other regulators, including Ben S. Bernanke, the Federal Reserve chairman, and Henry M. Paulson Jr., the Treasury secretary, have acknowledged general regulatory failures over the last year. Mr. Cox’s statement on Friday, however, went beyond that by blaming a specific program for the financial crisis — and then ending it.
On one level, the commission’s decision to end the regulatory program was somewhat academic, because the five biggest independent Wall Street firms have all disappeared.
The Fed and Treasury Department forced Bear Stearns into a merger with JPMorgan Chase in March. And in the last month, Lehman Brothers went into bankruptcy, Merrill Lynch was acquired by Bank of America, and Morgan Stanley and Goldman Sachs changed their corporate structures to become bank holding companies, which the Federal Reserve regulates.
But the retreat on investment bank supervision is a heavy blow to a once-proud agency whose influence over Wall Street has steadily eroded as the financial crisis has exploded over the last year.
Because it is a relatively small agency, the S.E.C. tries to extend its reach over the vast financial services industry by relying heavily on self-regulation by stock exchanges, mutual funds, brokerage firms and publicly traded corporations.
The program Mr. Cox abolished was unanimously approved in 2004 by the commission under his predecessor, William H. Donaldson. Known by the clumsy title of “consolidated supervised entities,” the program allowed the S.E.C. to monitor the parent companies of major Wall Street firms, even though technically the agency had authority over only the firms’ brokerage firm components.
The commission created the program after heavy lobbying for the plan from all five big investment banks. At the time, Mr. Paulson was the head of Goldman Sachs. He left two years later to become the Treasury secretary and has been the architect of the administration’s bailout plan.
The investment banks favored the S.E.C. as their umbrella regulator because that let them avoid regulation of their fast-growing European operations by the European Union.
Facing the worst financial crisis since the Great Depression, Mr. Cox has begun in recent weeks to call for greater government involvement in the markets. He has imposed restraints on short-sellers, market speculators who borrow stock and then sell it in the hope that it will decline. On Tuesday, he asked Congress for the first time to regulate the market for credit-default swaps, financial instruments that insure the holder against losses from declines in bonds and other types of securities.
The commission will continue to be the primary regulator of the companies’ broker-dealer units, and it will work with the Fed to supervise holding companies even though the Fed is expected to take the lead role.
The Fed had already begun regulating Wall Street firms that borrowed money under a new Fed lending program, and the S.E.C. had entered into an agreement under which its examiners worked jointly with Fed examiners, an arrangement that is expected to continue.
The S.E.C. will still have primary responsibility for regulating securities brokers and dealers.
The announcement was the latest illustration of how the market turmoil was rapidly changing the regulatory landscape. In the coming months, Congress will consider overhauls to the regulatory structure, but the markets and the regulators are already transforming it in response to events.
Still, the inspector general’s report made a series of recommendations for the commission and the Federal Reserve that could ultimately reshape how the nation’s largest financial institutions are regulated. The report recommended, for instance, that the commission and the Fed consider tighter limits on borrowing by the companies to reduce their heavy debt loads and risky investing practices.
The report found that the S.E.C. division that oversees trading and markets had failed to update the rules of the program and was “not fulfilling its obligations.” It said that nearly one-third of the firms under supervision had failed to file the required documents. And it found that the division had not adequately reviewed many of the filings made by other firms.
The division’s “failure to carry out the purpose and goals of the broker-dealer risk assessment program hinders the commission’s ability to foresee or respond to weaknesses in the financial markets,” the report said.
The S.E.C. approved the consolidated supervised entities program in 2004 after several important developments in Congress and in Europe.
In 1999, the lawmakers adopted the Gramm-Leach-Bliley Act, which broke down the Depression-era restrictions between investment banks and commercial banks. As part of a political compromise, the law gave the commission the authority to regulate the securities and brokerage operations of the investment banks, but not their holding companies.
In 2002, the European Union threatened to impose its own rules on the foreign subsidiaries of the American investment banks. But there was a loophole: if the American companies were subject to the same kind of oversight as their European counterparts, then they would not be subject to the European rules. The loophole would require the commission to figure out a way to supervise the holding companies of the investment banks.
In 2004, at the urging of the investment banks, the commission adopted a voluntary program. In exchange for the relaxation of capital requirements by the commission, the banks agreed to submit to supervision of their holding companies by the agency.
Bill King, who I have quoted many times in this space, puts forth an intelligent alternative to the two plans circulating D.C. — the DOA Paulson Bailout plan, and the even sillier House Republican Plan.
I would strongly suggest the economic staff of both Presidential candidates review this.
Here are Bill’s starting premises:
• The US credit system is broken.
• The Paulsen-Bernanke Bailout Plan does not insure that those banks and brokers that receive bailout aid will increase lending. The reality is the market is hoarding liquidity and these banks are likely to do the same. More importantly consumer lending has been a small, often insignificant part of their business. They made money by trading and through securitization of debt.
• It is necessary to create a new system parallel with the existing dysfunctional system in order to mitigate the inevitable economic and financial damage and to facilitate, as seamless as possible, the transition to a functioning financial system or new model of credit and banking.
• The Wall Street model, securitization and extreme leverage, is obsolete.
• US financial institutions need to recapitalize.
• Hank and Ben assert that it is paramount to keep credit flowing to consumers; the bail out is a necessary adjunct.
• Paulsen and Hank’s bailout plan is tantamount to bailing out Univac, Digital Equipment, etc, in the eighties, which would’ve retarded the development of Dell, Microsoft, Intel and other nascent technology companies.
• It’s wasteful & foolish to put more money in an obsolete non-functioning system
• Big banks and brokers made most of their earnings over the past several years in trading, not consumer lending. And now their derivatives are THE problem
• If you want to get money to the consumer: the less middlemen, the better.
• Decentralization of liquidity, lending and risk is necessary to refurbish the financial system. The illiquidity of a few large banks is collapsing the system.
If you missed my boy Chris Whalen of Institutional Risk Analytics on SquawkBox, you missed some seriously straight talk:
on the $700B bailout, with Chris Whalen, Institutional Risk Analytics and CNBC’s
See also: Chris Whalen of the The Institutional Risk Analyst:
Good stuff . . .