Fed & Treasury Needs to Stop Targeting Asset Prices
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.
>
Previously:
Fed's Folly: Fooled by Flawed Futures? (January 2008)
http://bigpicture.typepad.com/comments/2008/01/feds-folly-fool.html
Source:
How to Restore Trust In Wall Street
ARTHUR LEVITT JR. and LYNN TURNER
WSJ, SEPTEMBER 26, 2008
http://online.wsj.com/article/SB122238715655877159.html
Monday, September 29, 2008 | 07:14 AM | Permalink
| Comments (62)
| TrackBack (0)
add to de.li.cious | 
digg this! | 
add to technorati | 
email this post
TrackBack
TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d8341c52a953ef010534d734b0970b
Listed below are links to weblogs that reference Fed & Treasury Needs to Stop Targeting Asset Prices:
Comments
Gasparino on CNBC this morning, apparently in his role as spokesperson for the McCain election campaign.
Its shameful that CNBC tolerates this sort of naked partisanship from a reporter. You would think after Gasparino was so totally wrong about Fuld they might rein him in, but no.
(Liesman and Becky Quick do a nice job focusing on facts).
I know you don't watch tv, but this is really a joke. These guys are simply awful This crap is intolerable, and I am switching over to Bloomberg.
Posted by: Scott | Sep 29, 2008 7:23:46 AM
So, if I understand this correctly, this takes at least one of the corrupt practices that led us into this situation, and codifies it into law as part of the 'emergency' action?
I'm speechless.
Posted by: xon | Sep 29, 2008 7:33:27 AM
This is awful . Bush on CNBC this am. Please someone give him some bubblegum and SpongeBob video and get him off. Matters worse, followed by Cramer.......
Posted by: Bill | Sep 29, 2008 7:47:57 AM
I believe this problem of letting markets work the way markets are suppose to work, has been mentioned once or twice on this blog. SARCASTIC TONE INTENDED!
Posted by: JustinTheSkeptic | Sep 29, 2008 7:54:42 AM
Congress to homeowners: drop dead (good news for me though, I'm out lowballing with cash in hand and no house to sell)
http://www.creditslips.org/creditslips/2008/09/congress-to-hom.html
Posted by: txchick57 | Sep 29, 2008 7:58:27 AM
So far nobody has written about the huge urban investment program, potential rent control program and the huge speculative bet Congress and the administration are making.
Posted by: Donald E. L. Johnson | Sep 29, 2008 7:58:34 AM
Heard the same thing from Gapbags mouth. He's just a shameless fool and CVNBC (Jack Weich) should be fired. That's naked partisanship. To say that Republicans added anything other than an idiotic "mortgage guarantee" to make the plan better is just wrong.
My question is why the Congress did not follow Buffet's idea with Goldman. That would have truly injected funds into the banks. Hussman has a good analysis this AM on why nothing is really being done about solvency.
Posted by: grumpyoldvet | Sep 29, 2008 8:00:58 AM
Let me see if I understand this Bush/Paulson thinking: if we allow the banks to pretend that they are solvent, they can continue to make loans to those who pretend they can pay them back - is that about right?
Posted by: Winston Munn | Sep 29, 2008 8:01:06 AM
Gaspy has gone goofy. He even referred to that House Republican from Alabama. Uhh, I think he means Senator Richard Shelby. But to be fair to Charlie - and everyone here knows I am the most ardent Obama supporter - the whole state of American cable television journalism is plain abyssmal. I saw Melissa Lee position herself as some sort of economist on MSNBC this weekend and her entire argument on behalf of the bailout was 100% fallacy. The bailout is needed because the bailout is needed.
Back to the original topic, BR, you are absolutely right. We must combat global deflation also known as worldwide bubble asset price correction. And if anyone thinks small businesses will "get the credit they need" as a result of this bailout, they have been smoking those Westburies again.
Posted by: CNBC Sucks | Sep 29, 2008 8:02:27 AM
I agree with you BR, however, are we not piss'in in the wind? The bill has been created and will be passed over the next couple of days. Additionally, the American sheeple have been convinced that this will solve all the worlds problems.
A better approach might be to see how we as business people, bankers, brokers and homeowners can get a piece of this money. I personally am tired of fighting the tide of stupidity and socialism. I am now ready to find my teat for some American money...
Posted by: austincompany | Sep 29, 2008 8:06:52 AM
You're dreaming in Technicolor... This is not 1987, the largest demographic goup does not have many more years to rebuild their nest egg.
Even if it does not work, instinctively they're going to do whatever it takes to prop up asset values as long as possible. In fact for the next little while, their every move will be focused on propping up those asset values. The writing is on the wall.
Posted by: D. | Sep 29, 2008 8:07:26 AM
Gasbag is nothing more than a schoolyard bully. Wouldn't let Liesman get a word in edgewise, kept talking over him and muscling his way thru. Someone should take this guy out and kick th shit out of him. Kernan is also an ass clown and Carl, just ayoung snotnose trying to gain points. Rick Santelli is the only rational one, followed by Liesman with Becky Qiuck bring up th rear.
Posted by: grumpyoldvet | Sep 29, 2008 8:11:01 AM
how to repair the outflow of American savings to build foreign factorys?
how to keep Americans solvent until that happens with falling home prices?
um - mark to market? - how about a new system with safeguards instead
talk on the street over the weekend - the JPMorgan Chase aquisitions of 2008 are upsetting some - time to get regional banking strong again - (turn in your credit card for a local bank)(expanded tier cable plans)
I know BushCo is leaving soon (not soon enough)(laws in some mechanisms) but baby steps needed
Posted by: Greg0658 | Sep 29, 2008 8:15:10 AM
Scott and others are on the same wavelength as I am this morning. Gasparino is a raving moron. That he's in the bag for the House Republican Demagogue Caucus is no surprise (remember, Cantor, Putnam, Blackburn are the exact same fools who can't spend money fast enough if it's for bombing the shit out of some brown people somewhere). But that he's peddling still more of his non-stop revisionist history is even more shameless.
He's a mook, a stain, a steaming puddle of rancid puke.
Essentially.
Posted by: The Original DC | Sep 29, 2008 8:15:53 AM
First time homebuyers are still left out of the game. After all this bailout garbage, banks are still going to want 20% down. There are very few 20 somethings who can come up with that, now and after the bailout. Home prices are still looming.
Posted by: HomeRun | Sep 29, 2008 8:16:21 AM
yep, throwing a TARP over the Elephant in the middle of the room..
that should do wonders..
like CNBC, Congress, knows its Target Market: the willfully-deluded 'Cained Peep clinging to their halcyon hallucinations of a 401(k)-fueled ejection-seat ride out of the Vermin Olympics that they, themselves, have animated.
txchick, if you're looking to be a 'landlord' going fwd:, you might think again..
Posted by: Mark E Hoffer | Sep 29, 2008 8:22:18 AM
"you CANNOT get a return to normalcy after a bubble"
Unassailable. That ought to be printed over and over and over. Failure to understand that fact is going to cause a lot of grief - more than we've already seen.
Posted by: wally | Sep 29, 2008 8:22:20 AM
Agreed with all points regarding Gaspy. I just retain a sentimental soft spot for him because he accused Dennis Kneale of being Client #1 on the air.
The bailout will help neither home prices nor stock prices in the short run or the long run. It might prevent a rapid financial system meltdown, and maybe that is the only positive. But I don't think that little construction company on 60 Minutes last night is going to have any better chance of getting a loan.
Posted by: CNBC Sucks | Sep 29, 2008 8:31:50 AM
Major Bernanke/Paulson mistake was Lehman.
Lehman's Demise Triggered Cash Crunch Around Globe
Decision to Let Firm Fail Marked a Turning Point in Crisis
"...Lehman's bankruptcy filing in the early hours of Monday, Sept. 15, sparked a chain reaction that sent credit markets into disarray. It accelerated the downward spiral of giant U.S. insurer American International Group Inc. and precipitated losses for everyone from Norwegian pensioners to investors in the Reserve Primary Fund, a U.S. money-market mutual fund ..."
http://online.wsj.com/article/SB122266132599384845.html
Posted by: Marek | Sep 29, 2008 8:37:42 AM
Totally agree Barry. Suspending the rule is going in the wrong direction. Also, here's a dumb question. If there's a credit crunch on, how does the US Govt borrowing $700 Billion help? Just seems a little ironic. Also Roubini says this plan isn't going to have much effect since many homeowners are upside down.
Posted by: Jay | Sep 29, 2008 8:39:02 AM
Barry, Perhaps you can clarify something.
It seems that one of the underlying issues in the current "crisis" is "mark to market" accounting rules that were established for securities that have no value other than their current market value.
When a financial system takes a lot of fixed income instruments (loans) and bundles them into a much smaller number of "securities," the value of the securities then become potential targets of market manipulation that has nothing to to with underlying value. I don't pretend to fully understand this situation but these mortgage instruments have a value that is independent of a particular auction market at a particular time.
Assuming that they don't, produces an accounting fallacy and potentially undervalues assets. While a market price is one way of assigning a value, the underlying income stream and the value of the property that is mortgaged are not necessarily determined by the current auction market for a security.
For example just because one desperate seller sold his new Corvette for 1/3rd of what he paid for it the day before, does not mean that all similar Corvettes should or would be sold for that price. All insurance companies should not then be allowed to pay only that distressed price in the event of an accident that totals any Corvette they insure. If that were the case, insurance would be worthless.
If instead of counting on the balance sheet of a holder the value of a similar CDO at a particular market and time, the holder should have the option of assigning value based on a risk adjusted value of the income stream and underlying assets. If an asset backed instrument as a risk factor of .8 relative to a treasury bond, it should have a value of .8 times the treasury with equal income.
For example if a given CDO with a risk factor of .8 has a value of $100 based on its income stream of 5% ($5 per year) but a Treasury that produces $5 per year has a cost of $120, the CDO would be fairly valued at $100. Even if a current market transaction results in the sale of a similar CDO at $50, that sale should not cause all CDOs to be automatically marked down to $50 on the balance sheet of the holder. Particularly if the underlying income continues, the CDO's balance sheet value should remain unchanged.
It would seem that a simple change in the way that income producing securities are valued would eliminate the potential for market manipulation. Is it possible that very large holders of income assets (like China or the UAE) might intentionally drive down market prices of their own securities (at least temporarily). Is it possible that they would then be able to buy banks or other financial companies (or other companies) at a "fire sale" prices in the resulting tumultuous equity markets?
Please clarify your position on this. Do you have evidence that such manipulation is not a part of the current financial crisis?
Posted by: JustOne | Sep 29, 2008 8:40:17 AM
While I don't have a lot of confidence in allowing value to be determined by a commission, I don't think the market is all that accurate either. It was the market that said that homes in Anthem, Az were worth over a thousand times the monthly rental price. I don't think we should kid ourselves that the market is always the best way to price assets.
Having said that, there is no question in my mind that homes prices are still too high and need to correct further.
Posted by: Steve in Fly-over land | Sep 29, 2008 8:51:26 AM
Barringo,
You've just witnessed a de-facto exercise of the yet unapproved Paulson/Anke plan.
Wachovia just did P/A/Bair a favor and bit the dust before the plan would've been used alternately to accomplish the same thing Bair did.
You go Guril!!... You Sheila Girl you!
I'd vote for Sheila for VP. Heck, I'd vote for her as President.
Posted by: Eclectic | Sep 29, 2008 8:54:28 AM
There is no market. So mark-to-market accounting is useless.
We have to use something else.
Posted by: VG | Sep 29, 2008 8:54:40 AM
I'm afraid I have to take the opposite stance of you on mark to market accounting in a liquidity crisis. One of the biggest fundamental problems right now is that there are A LOT more sellers than buyers of mortgage securities, which in turn drives more sellers, which in turn drives a lack of buyers. This does not necessarily indicate "value," just a lack of equilibrium in buyers/sellers. It is a circular process that will not stop unless banks are allowed to work out their problems over a multi-year period rather than being forced to continually raise capital to an increasingly skeptical market. We went through a banking crisis in the early 1980s where most banks held massive amounts of emerging market debt that was seriously impaired at the time. The difference was the FDIC allowed banks to work out their problems over a multi-year period without forcing mass liquidation via mark to market accounting. Eventually the world will move back into equilibrium and forcing a mass liquidation does not help anyone, especially at this point. Just my humble opinion, I respect yours as well.
Posted by: Ben | Sep 29, 2008 9:08:36 AM
