The ‘D’ Word?

by on September 19, 2008 · 13 comments

Barack Obama argues that John McCain “hurt everyday workers with his longtime support for deregulation,” according to Politico.

Thomas Frank adds,

There is simply no way to blame [the failure of several large financial institutions], as Republicans used to do, on labor unions or over-regulation. No, this is the conservatives’ beloved financial system doing what comes naturally. Freed from the intrusive meddling of government, just as generations of supply-siders and entrepreneurial exuberants demanded it be, the American financial establishment has proceeded to cheat and deceive and beggar itself — and us — to the edge of Armageddon. It is as though Wall Street was run by a troupe of historical re-enactors determined to stage all the classic panics of the 19th century.

But as Steve Forbes points out, the “easy-money” policy of the Federal Reserve helped financial institutions pile up debt and bad assets.

 According to former FDIC Chairman William M. Isaac,

The biggest culprit is a change in our accounting rules that the Financial Accounting Standards Board and the SEC put into place over the past 15 years: Fair Value Accounting. Fair Value Accounting dictates that financial institutions holding financial instruments available for sale (such as mortgage-backed securities) must mark those assets to market. That sounds reasonable. But what do we do when the already thin market for those assets freezes up and only a handful of transactions occur at extremely depressed prices?

The answer to date from the SEC, FASB, bank regulators and the Treasury has been (more or less) “mark the assets to market even though there is no meaningful market.” The accounting profession, scarred by decades of costly litigation, just keeps marking down the assets as fast as it can.

This is contrary to everything we know about bank regulation. When there are temporary impairments of asset values due to economic and marketplace events, regulators must give institutions an opportunity to survive the temporary impairment. Assets should not be marked to unrealistic fire-sale prices. Regulators must evaluate the assets on the basis of their true economic value (a discounted cash-flow analysis).

If we had followed today’s approach during the 1980s, we would have nationalized all of the major banks in the country and thousands of additional banks and thrifts would have failed. I have little doubt that the country would have gone from a serious recession into a depression.

Easy money and mark-to-market are not deregulatory policies. They are examples of government intervention with unfortunate consequences.

The nature of unfortunate consequences is always unpredictable; the inevitability of unfortunate consequences, never so.

Easy money was supposed speed the transition from the dotcom and telecom bubbles to prosperity, and mark-to-market was so we would not have to suffer from similar speculative bubbles in the future. Yet here we have another burst speculative bubble.

According to Frank,

Thanks to the party of Romney and McCain, federal work is today so financially unattractive to top talent that it might as well be charity work. It’s one of the main reasons — other than outright conquest by the industries they’re supposed to be overseeing — that our regulatory agencies can’t seem to get out of bed in the morning.

France attracts its best and brightest to government service, but most of us don’t want to be like France — at least not in all respects. Although it is hard to fail in France, it is also hard to succeed.  

Maybe blaming the regulators is like the blame the messenger proverb. Perhaps the problem isn’t the regulators; it is regulation itself.

Although regulation always seems brilliant in theory, it usually fails in practice. Either it doesn’t work, it spawns corruption or both.   Or it backfires, as it did here.

  • eee_eff

    Of course, the obvious solution is: bring back the Glass-Steagall Act. It worked from 1933 to 1999….

  • http://bennett.com/blog Richard Bennett

    Some wag (might have been Krugman) observed recently that “just as there are no atheists in foxholes, there are no libertarians in financial collapses.”

    It's going to be a hard slog to convince the public that our collapsing financial system is the way it is because of over-regulation. Perhaps the wrong kind of regulation, but not the mere fact of regulation.

    I'm not a economist and don't play one on TV, but the massive increase in government debt over the last 7 years seems to be making itself felt in the current crisis. Wily bankers have invented a lot of tricky instruments to back bad loans because there wasn't any real money to back them, that having gone to the government. These derivatives and other forms of junk have evaporated, leaving us with the stark realization that our financial system has been running like a big pyramid scheme recently, but all these things come to an end.

  • http://srynas.blogspot.com/ Steve R.

    I fail to see how our collapsing financial system is correlated to “over regulation”. You correctly note that it was the banks that created this financial mess. The finger of responsibility should be pointed at the overpaid incompetent corporate executives who inappropriately used “innovation” to create the illusion of economic value.

    CNBC reported that the failures have been occurring in the unregulated financial markets. CNBC also raised the question of where were the corporate risk management managers? In theory, when financial instruments (mortgages, CDOs) are created, the financial firms would be expected to buy default insurance to hedge for the possibility of a default. Clearly the corporate risk management staff was “out to lunch” since the junk derivatives where not properly hedged, As a consequence AIG is now paying a price for not properly evaluating its risk. The issuance of securities devoid of real value and the lack of proper risk management are failures of the corporations to properly do their due diligence work.

    Those who abuse the “free market system”,should accept the responsibility and the consequences of their failures. Solving the regulation issue is simple, if you don't want regulation, act responsibly. Those who can't be responsible should be regulated.

  • http://srynas.blogspot.com/ Steve R.

    Hance: Regulation, as you discuss, may have exacerbated the meltdown of our financial institutions. The problem with that line of reasoning is that regulation did not make these overpaid incompetent executives create the financial instruments that failed. Not only that, but the corporate creators of these financial instruments failed to appropriately evaluate the value/risk of these investments. Plain and simple, the meltdown of our financial institution is the result of corporate incompetence. The finger of blame should be pointed to those corporate executives who created these financial instruments and put our financial system in jeopardy.

  • Dave

    Hance,

    Totally agree — good rebuttals to Thomas Frank's arguments. We came to much the same conclusion in our September 19 post on the Taylor Frigon Advisor. The events of last week are not an indictment of free markets — they are an indictment of intervention.

    Dave Mathisen

  • eee_eff

    Plain and simple, the meltdown of our financial institution is the result of corporate incompetence. The finger of blame should be pointed to those corporate executives who created these financial instruments and put our financial system in jeopardy.

    that's exactly right. But now the Bushies are going to reward incompetence and bail out AIG and several other corporations that should just be let to fail. Of course, the systemic effects have to be thought through, and some mechanism to protect a certain percentage of AIG's creditors would not be out of order.

    What will happen now?

    I think the dollar will be brought under tremendous pressure–the simple reality is this: promising a trillion dollar + bail out implies you are either goint to raise taxes or print money.

    It is an election year, so you get exactly one guess as to which option the powers that be will choose.

    NEW YORK, Sept 19 (Reuters) – The dollar may rise next week amid hopes a U.S. government plan to contain the credit market crisis that is threatening the country's banking system will bring relief to wobbly global markets.

    But details associated with the plan, which could cost hundreds of billions of dollars, also pose a risk to the U.S. currency, especially given concerns about the widening budget deficit, analysts said.

    “There are some rumors that Congress will attach some new spending bills to it as well. The dollar is now much more exposed to event risk,” said Marc Chandler, head of global currency strategy at Brown Brothers Harriman in New York.

    Instability in a complex system is very hard to control–you whack it down one place, and it emerges in another.

    By the way, why are there no libertarians on TLF decrying the massive statist intervention the Bushies are planning? Could it be that when a large corporation or a group of shareholders benefits, as in the case of the AIG buyout, suddenly the libertarians loss their ability to criticize market interventions????

  • http://srynas.blogspot.com/ Steve R.

    “By the way, why are there no libertarians on TLF decrying the massive statist intervention the Bushies are planning? … suddenly the libertarians loss their ability to criticize market interventions????”

    Seems to me that a page out of the Democratic Playbook is being stolen. The Democrats say that homeowners should not be held responsible for their failure to manage their money competently and should be bailed out. Likewise the case is being made here that corporations should not be held accountable either since it is not their fault and they should also be bailed out. Even the auto industry is putting out its needy hand. I guess the concept of responsibility is only a fiction and everyone is entitled to a government dole. The welfare state.

  • http://enigmafoundry.wordpress.com eee_eff

    Seems to me that a page out of the Democratic Playbook is being stolen. The Democrats say that homeowners should not be held responsible for their failure to manage their money competently and should be bailed out.

    One item should be recalled here: The Bankruptcy Reform Act of 2005 unleashed a whole stream of lending that was not economically viable. There' was a rapid increase in credit card debt that banks pushed quite aggressively.

    So do I feel sorry for those banks that stopped doing their due diligence? Not for a second!

  • http://srynas.blogspot.com/ Steve R.

    Here is a YouTube video (9/23/2008) between Larry Kudlow and Senator Bernie Sanders of Vermont. Bernie humorously points out the amazing overnight “conversion” of Larry Kudlow (a free market advocate) to “socialism” now that free market has failed and these companies need to be bailed out.

    http://www.youtube.com/watch?v=Lkqb1pQrCcg

  • http://srynas.blogspot.com/ Steve R.

    Here is a YouTube video (9/23/2008) between Larry Kudlow and Senator Bernie Sanders of Vermont. Bernie humorously points out the amazing overnight “conversion” of Larry Kudlow (a free market advocate) to “socialism” now that free market has failed and these companies need to be bailed out.

    http://www.youtube.com/watch?v=Lkqb1pQrCcg

  • Pingback: dword - StartTags.com

  • Pingback: Learn more

  • Pingback: AMC Intro Video

Previous post:

Next post: