Forbes: Repeal Mark-to-Market for Assets

Steve Forbes has been calling for Mark-to-Market to be repealed since before the financial crisis last fall. He repeats himself very convinicingly in the Wall Street Journal today.

Back when the $700 billion TARP program was being debated during the heat of the presidential campaign, Newt Gingrich was calling for Mark-to-Market to be based on a 3-year rolling average.

In the wake of the accounting scandals of Enron, WorldCom, etc. earlier in the decade, the Bush administration, along with Congress, tried to tighten up accounting standards. As part of this whole push, the SEC re-instituted Mark-to-Market accounting. The rule says that if you are holding something that drops in value, you have to reflect that loss of value in your net worth. For banks, this loss of value increases their capital requirements, the amount of cash on hand they must keep to meet their obligations.

So when the housing market started falling, any banks with Mortgage-backed securities had to start marking down their asset values. Because of the lack of transparency as to which MBS's were solid and which were in trouble, no one was willing to buy any of them and the MBS market collapsed. Regulators forced banks to mark their MBS's down by as much as 80%, even when the underlying mortgages had only dropped less than 10%. Banks were hit with the double-whammy of being unsure who it was safe to lend to as well as having their capital requirements dramatically raised. As a result, the credit market froze, and the wider economy soon began to be affected by the lack of credit. Businesses startups could not find funding, and existing businesses had trouble finding short term payroll loans, or loans for projects to expand their business.

Mark-to-Market does not make sense for troubled Assets whose underlying value has not dropped nearly as much as the short-term distressed value. It is pro-cyclical. That is, it increases banks' ability to lend when the market is going up, further inflating asset bubbles, and hurts banks' ability or willingness to lend when the market is going down, greatly exacerbating financial distress.

Mark-to-Market was finally discontinued in 1938 near the end of the Great Despression, after helping cause the financial crisis at the start of the Depression. It was just reinstituted in 2007, just in time to help kick-start this recession.

Steve Forbes also casts blame for removing the uptick rule on short selling, a practice where someone borrows a stock and then sells it, assuming the price will drop so they can buy the stock at a lower price to repay the original lender, pocketing the difference between what they sold it for and what they paid to buy the stock back. The uptick rule said that you could only do this after the stock price had risen, stopping investors from being able to artificially drive down the price of a stock by repeated short-selling. You can see that without the uptick rule, there is a perverse incentive for short-sellers to pick a stock and drive it down as much as possible.

Forbes also blames the SEC for not properly enforcing the rule against naked short selling, where a trader doesn't even bother to borrow a stock before short selling it. I have no idea how much this happened, but to the extent it did, it would drive stocks down.

From a political perspective, on these specific accounting and enforcement rules, you can fairly blame the Bush administration, but an equal amount of blame must go to Democrats and the Obama administration. I am not aware of a single Democrat that has called for a change to these rules. Only free-market conservatives have been talking about this. Democrats are too busy blaming "greed on Wall Street" to realize that bad goverment regulations and rules are 10 times worse.

This is much more complicated than who is for regulation and who is against regulation. Conservatives believe that a proper role of government is to ensure orderly markets and aggressively prosecute those who break the law and try to profit by illegal means. To the extent that smart & effective regulations are necessary to accomplish this, conservatives fully support regulation. But when regulations are unnecessary, don't make sense, reduce economic stability, or are economicly harmful, conservatives oppose them.

These are important rules at the heart of the financial crisis, and they are barely being talked about. If this isn't evidence of the need for a better medium to include all Americans in a more serious and constructive dialogue about the best way forward, I don't know what is. Instead, we get lost in all this nonsense of which politician said what, how long will Obama's popularity last, is the Republican party down for the count, etc. The coverage of the presidential election was 3/4 about the horse race (who was campaigning where, what the latest polls were) and only 1/4 about which policies were best.

WSJ: The Obama Economy

"The market has notably plunged since Mr. Obama introduced his budget last week, and that should be no surprise. The document was a declaration of hostility toward capitalists across the economy." see the full article

Bastiat: What Is Seen And What Is Not Seen

I cannot think of a better essay that should be read by all right now than Frederic Bastiat's What Is Seen and What Is Not Seen. His simple yet thorough examples are clear and understandable to the average person, and many are uncannily applicable to the current debates our coutry is having right now.

Bastiat was a French economist and statesman from the mid 19th century who led the fight against socialism at that time. He has the same unique ability that Milton Friedman had of taking complex economic issues and breaking them down into understandable terms.

I found amusing his exasperation at the end of the 3rd section in his essay which dealt with Taxes:

Good Lord! What a lot of trouble to prove in political economy that two and two make four; and if you succeed in doing so, people cry, "It is so clear that it is boring." Then they vote as if you had never proved anything at all.

Trust me, read it and I think you will gain a much better understanding of economics. Don't delay. Go read it now!

Sowell: Housing Crisis Caused By Government

I am utterly disgusted with the braindead way that people will accept the premise that "we tried the free market with no regulation for the last 8 years and look where it got us." Obama, other Democrats, and so many in the media incessantly repeat some variation of this premise. Every conservative argument for free markets is met with a response that the free market was how we got into this mess, and the voters just voted for change. It makes me want to puke.

The voters voted for Obama and Democrats because the country and the economy had been talked down for 6 years, so Bush's numbers were really low, and we were in the middle of a financial crisis. Every similar situation in American history has resulted in the party that did not have the presidency winning the presidency. Simply put, a lot of ill-informed voters made a big mistake.

The most maddening part of all is that the financial crisis was caused by the housing bubble bursting, and the primary culprits responsible for the housing bubble were DEMOCRATS! Thomas Sowell has a great piece on this.

We truly have put the foxes in charge of the hen-house. The Democrats primarily caused the problem, and then won an election because the Republicans had the presidency when the consequences hit. It is as if the guard-dog let the fox slip by him and nab a hen, so the farmer puts the fox in charge of hen-house security because the guard-dog wasn't doing a very good job.

Krauthammer Hits Obama on Diplomacy Blunders

Krauthammer hits Obama pretty good on his foreign policy blunders so far.

All of Charles Krauthammer's articles are well-worth reading.

I don't agree with him 100% of the time, but he is one of the smartest guys around. Thomas Sowell is another.

Housing Price Decline Not Done Yet

Hat tip to Save The GOP where I found the above chart.

As you can see from the chart, from 1997 to 2007, we did not just have a housing bubble, but rather a housing spike. Prices spiked by over 80% and are only half-way back to historical levels. The spike was caused mostly by a combination of the following factors:

The growth of subprime loans and other poor lending/borrowing practices

The increase in flipping houses and other speculation, especially in certain markets

The expansion of Fannie Mae & Freddie Mac into the subprime market, fueled by primarily Democratic support for "affordable housing"

The increasing volume of foreign capital from the trade deficit that was used to invest in the US housing market

The "easy money" policies (i.e., low interest rates) by Alan Greenspan at the Federal Reserve during the early part of the decade

Throwing money at this problem at this point is a losing battle, and it is bad policy as well. Do we really want to attempt to spend enough taxpayer money to prop up the housing market well above its historical level? To do so would be to continue to allocate more dollars toward housing than is necessary, leaving less in everyone's pocket to spend on other needs/wants.

A lot of people have been priced out of the market (especially under traditional lending standards like 20% down!), and a housing market correction back to more historical levels will allow many to buy their first house or upgrade to a better one at a lower cost.

The faster the market is allowed to correct and stabilize at a more historical level, the faster people will have the confidence to jump back into the market and buy a house. No one wants to buy a house if they think its value is going to drop by another 30-50%. Once people see that prices have stabilized at what seems like a bargain price, they will start buying houses again. The longer we prevent this from happening, the longer there will be negative spillover effects throughout the rest of the economy.

However, the housing correction is massive enough it has already caused the financial crisis. Too many banks had too many Mortgage-backed Securities (MBS's) which, with the falling housing prices and the complexity of how mortgages are packaged, sliced, and repackaged, no one knew the price of. Since banks were holding significant levels of MBS's, and other banks didn't know how much they were worth, there was a crisis of confidence and lending between banks ground to a halt, resulting in the frozen credit market. The government had to take action to thaw the market to avoid a severe economic shock.

So the government must keep a close eye on the effects of the housing correction, and make sure it does not trigger a disaster, but otherwise the correction should be allowed to proceed.

Once the correction has brought prices back down near historical levels, that is the point at which more government action might be justified in order to prevent an over-correction.

Paul Ryan: Return to stagflation?

Paul Ryan, Republican US House Representative from Wisconsin, is quickly becoming one of my favorites.

He has an Op-Ed in the NY Times yesterday that is right on the money.

Increased government spending is at best a short term boost to GDP at the larger expense of long term capital and investment. Government spending is very inefficient -- approximately 30% of every dollar that flows through Washington is wasted on administrative costs. I say wasted because all those administrative costs are completely avoided if people simply keep more of their own money and spend it directly. In addition, the government can only spend money after it taxes, borrows, or prints it. Lets take those one at a time:

1. Higher tax rates hurt the economy by discouraging higher productivity. If you could work additional hours at your job, make extra effort to educate yourself more, or install automation or technology to increase your business' productivity, but half of every dollar of increased income is taken by the government, you may not make that extra effort or investment. If the government raises the tax rate by 3% or 5%, more and more extra effort or investement is not undertaken, and the productivity of the economy as a whole suffers. Additionally, more money flowing through Washington means more government power and instrusion on citizens' lives, a loss of freedom. What proponents of larger government spending really believe is that they know better than taxpayers what their money should be spent on.

2. Borrowing money hurts the government's financial standing, and costs taxpayers hundreds of billions in interest annually. Borrowing is limited by how much money our citizens and other countries have to lend, and if we get so overburdened by debt that lenders lose confidence that lending to America is a safe investment, we are really in trouble. As Ryan points out in his Op-Ed, many other countries do not have the money to lend right now, so we may have trouble finding enough money to borrow to finance all this government spending. Anything that is borrowed today will have to be paid back by future generations which will be a significant drag on our economy at that time. The current rate of borrowing is completely unsustainable in the long term.

3. Printing money will cause inflation. If there is more money to spend, prices are driven up in the same way having extra money passed out to bidders at an auction would result in higher bids for auction items. At the end of the day, bidders simply paid more for the same items, and each individual dollar was less valuable and had less purchasing power. Inflation really hits the elderly and others on fixed incomes, as well as those on tight budgets, and eats away at investment income. Owners of real assets, such as real estate or equipment, are better off after inflation because they can now sell their assets at a higher price. So inflation hurts low income earners worst and helps more wealthy owners of real assets. While I actually agree with the concept of pumping more money into the financial system to stabilize it last year by counteracting the credit crunch, I don't know if anyone has a grasp on whether we've printed too much, too little or about right so far. What I do know is that as soon as confidence rebuilds and money starts coming off the sidelines, we must aggressively slow down the rate of printing money or risk double-digit inflation.

The lessons from the Japanese over the last 2 decades, and from the Stimulus checks sent out in 2001 and 2008, are that one time payouts to citizens only cause a small short-term increase in GDP from the short term spending, and hinder rather than help overall economic growth.

These lessons are completely lost by President Obama and Democrats in Congress, who are much more interested in pushing through a Democratic wish-list of spending projects while they have the votes and enough political cover from Obama's recent election victory and non-stop fear-mongering.