7 Steps To Restore Functioning Markets 22 comments
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Much of what has been written about the financial crisis has focused on the why, as opposed to the what now? This has led to the inevitable finger-pointing, posturing, grandstanding and the like. Personally, I'm sick of it. We're in trouble: the time has come for the conversation to shift from bad guys and witch hunts to what the hell are we going to do now?
Greg Mankiw, in an Op-Ed in Sunday's New York Times, summed up the key question when thinking about policies and actions to be taken to extricate us from this ongoing chaos: But Have We Learned Enough? Based upon the steps taken to date: probably not.
While I'm neither economist nor policy-maker, I've got a few thoughts on what I think has to be done before we can even entertain the possibility of a macroeconomic recovery.
#1: Rigorous application of mark-to-market accounting rules, with the further tightening of the rules enabling certain assets and liabilities to be carried off-balance sheet. Bottom line, without full financial statement transparency and integrity in financial reporting, investors will remain cynical and suspicious about the financial health of firms across all industries. This needs to be fixed immediately.
#2: Immediate push to list over-the-counter (OTC) derivatives transactions. Partially related to #1 above, the magnitude and lack of transparency around all manner of off-balance sheet contracts is creating fear among counterparties and investors alike. If we can put a man on the Moon, we can work rapidly to move OTC transactions - interest rate swaps, credit default swaps, etc. - to a listed medium where transparency and counterparty credit management are the hallmarks of its operation. This is where exchanges like the CME need to step up and lead us forward.
#3: Work with laser focus to keep credit-worthy people in their homes. This is absolutely critical. The decline in housing prices, spurred on by rising foreclosures and a rising inventory of unsold homes, will be the root cause of the next big leg down in economic activity. Debt will eventually overwhelm equity value in much of our housing stock, causing people to either walk away from their mortgages or to default. Without a brake in the decline of housing prices, consumption will plummet, unemployment will rise and a downward deflationary spiral will take hold. We are well beyond the issue of "fairness" (e.g., if somebody agreed to a poorly-structured mortgage that's their problem) and onto figuring out how to stop the negative loop in its tracks.
#4: Revamp corporate compensation structures. Leaders need to be aligned with shareholders. Current compensation structures don't do this nearly well enough. Board of Directors and investors alike have failed miserably in supporting, and, in fact, insisting upon, rational and fair compensation regimes. What once used to be a PR issue is now an issue of survival. A lack of trust is one of the biggest problems facing investors today, and being able to believe in both the integrity of firm financial statements and firm management would go a long way to making companies far more investable than they are today.
#5: Rebuild core infrastructure. Forget about "bridges to nowhere." Our roads, airports, bridges, subways and sewers are in a state of staggering disrepair. We will have millions of hard-working, skilled employees out of jobs as soon as the U.S. auto industry and several others pare back in order to have any chance of survival. These workers should be re-trained and re-deployed into projects that can benefit from their skills and experiences, and which can provide them with a fair wage to keep them in their homes and to hopefully keep them as able consumers. Because without the consumer, which still accounts for 2/3 of our economic output, we're screwed. I know we have a cataclysmic deficit. Believe me, I know. But the way we can pay off the deficit is by getting our economic engines going again, and investments in productive projects like these will help individuals, states and local governments through the difficult times, while laying the foundation for an economic boom when conditions turn back up.
#6: Maintain domestic control over our policies but coordinate closely with our global allies. Given the startling interconnectedness of our economies, unilateralism is simply an insufficient vehicle for addressing our deepest problems. It is akin to controlling pollution - if the U.S. sharply reduces emissions but India, China and Russia preserve current policies - the impact of our efforts will be sharply muted. Without having elements of 1-5 pursued by our Eastern and Western partners, who are suffering from many of the same problems we are, our actions will work with disappointing effect.
#7: Leverage cooperation with our allies around our economic welfare to bleed into social welfare. At times of economic unrest, seeds of social discontent are sown that can have catastrophic effects. We need to be extremely attuned to this risk and to work together with our allies to ensure that we remain united and strong against hostile, divisive forces, be they terrorists, hate groups, or others that seek to capitalize upon people's fears by making them insular, angry and, ultimately, hostile. This also applies to governments that seek to use war as a vehicle for distracting an unhappy populace, harm innocent people and threaten ourselves and/or our allies.
The key problems are that of a weak economy and a lack of trust. Banks aren't motivated to lend because they don't see a risk/reward profile that warrants it. Why lend to businesses if consumption is collapsing? Why offer mortgages if housing prices are falling? Why lend to other banks if I don't believe their financial statements? What Messrs. Paulson et al didn't internalize is that simply giving banks capital doesn't mean they will offer it. They would rather sit back, be hyper conservative and ride the yield curve on their cash. Safe. Stable. Low returning, yes. But they won't go bust.
Without question, all policies should be geared towards getting our economic engines going again, and protecting against those forces that could threaten it. There are many more ideas beyond the seven listed above, but I believe these represent the least we can and should do to give ourselves the best shot of averting a truly ugly economic outcome over the next decade.
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This article has 22 comments:
We just don't need that many.
(Home, Student loans, auto, credit cards)
AND make max interest charged for credit cards no more than 4 times the Fed./Discount rate.
and no more than 3 times for the home loans.
Other part of the money goes for free College education or have the college tuition to be no more than 5% of the state median income.
Last but not least outlaw home equity loans.
This way consumers will have no debt, and start buying again.
Banks will lend because consumers has no outstanding debt.
Mark to market accounting has created a self-fulfulling set of liquidity crises - there is no market, so companies that would otherwise be able to hold to maturity are forced to conduct fire sales, which further depresses the market...and so on until we have a Depression.
The problem we face is misallocation of investment, too much money 'invested' in areas where there is an insufficient amount of actual ability to sustain the investment. The only valid way to correct the problem is to sell the illiquid assets for whatever price can be had and move along.
If that means all of Wall Street goes under then c'est la vie. The ones who take their place will have a object lesson fresh in their minds to guide their business decisions in the future.
Rewarding poor business practices by politically connected cronies is a recipe for disaster. We will end up regretting it.
Mark to Market took the ballast out of the bottom of the ship. As a result balance sheets are no longer reliable, hence borrowers and lenders are no longer secure in the stability of their financials. AND SO everyone hunkers down and hoards cash - just in case.
I thought this article was basically a loada crap.
SARBOX and mark to market is the root cause, the EU commission and many economists in this country agree with me. This travesty has destroyed balance sheets not only of banks, but every enterprise.
The balance sheet is like the ballast in the hull of a ship. It provides the essential stability by which the ship can sail thru stormy weather. Mark to market has removed all the ballast from the balance sheet, creating unstable financials and hence making all borrowers - and lenders -suspect as to creditworthiness. What does a rational person do when faced with increased uncertainty? He hunkers down, hoards cash, tightens up loan requirements.
That'sa fact Jack, you don't know diddly. IMO
My comment is not emotional, it is analytical, and certainly rational.
and you don't have a clue.
We're living in Hamilton's Curse, a book to be released soon written by Thomas J. DiLorenzo.
Yes. Who needs transparency? Much better to have all those trillions of dollars of leveraged paper (whose value is based on management assumptions or expectations) and their losses hidden in level 3 assets so that the firm's financial status goes from AOK to bankrupt over the weekend ala Bear Stearns.
Just the ticket to give a potential shareholder a nice warm fuzzy feeling when considering a stock in the financial sector.
Does anyone actually think that non-disclosure of all that leveraged risk would improve market performance of financial stocks without the gub'mint stepping in? Who in their right mind would keep, much less buy, a financial if you didn't know how deep the doo-doo was on their balance sheet?
Right. Ignorance is bliss. Bury your head in the sand, everything will be just fine once we get through bankruptcy proceedings. We'll send you a check for your shares if we have anything left over after paying our creditors off. Sorry about that.
You'd be bettter to say "who needs a sailboat with no ballast in the keel?" "Who needs a balance sheet with longstanding assets that change value quarterly at the whim of a regulator"
Mark to market is plain stupid, As are the idiotice bromides and hackenyed excuses its supporters put forth.
MARK TO MARKET DOES NOT WORK. IT is the root casue of this financial disaster.
MArk my words, mark to market will disappear, it will go out like a light witihn 6 months. Like a cheap hooker who disappears immediately and quietly without a word of praise of blame.
The EU Commisssion is already to dump it, the Treasury has already made wimpers thru SEC about "modifyig" mark to market so it can be ignored during times of troubling markets.
A really dumb idea put forth by really ignoant politicians and theoreticians and D/A academics.
Dump the whole idea, and watch markets begin an inexorable return to normal.
Right now the balance sheet and Equity and return on Equity don't mean squat, BECAUSE no one knows what the value of the underlying asets will be next quarter.
Finally mark to market sets up a self distructing feedback loop in BOTH directions. IF/AS asset values go up -in good markets- the result is phony profit inflation and more borrowing than is otherwise justified.
In bad markets as asset values are collapsing, MtoM accelerates and exacerbates the collapse making a bad situation worse.
You can't argue with the reality of what has happened.
Inadequate regulation played an important role. The Fed, the SEC, the Congress, Republicans and Democrats all failed the system by allowing the investment community to engage in unregulated gambling. Some very smart people (Paulson, Actman etc.) saw the cataclysmic potential and made billions.
The rating agencies simply did not perform their essential duty of recognizing risk. Like everyone else on the gravy train, they were making big money so why hit the brakes and throw the train off the tracks?
In the bigger picture, the housing bubble driven by cheap money and the interest of investors around the world in maximizing profits was only one of a string of such bubbles (technology, deregulated utilities and energy being among the others) that suggest that simple investor greed
plays a large role.
Altogether, the facts suggest that human nature cannot be discounted when crafting economic and regulatory policy. All the historical patterns and algorithms in the world cannot create a system that protects against human nature.
The picture of that seemingly wise and experienced gentleman Alan Greenspoan acknowledge that all of his 40 years of economic research and planning had failed to account for the power of human greed seemed to me both pathetic and ludicrous at the same time.
yes, there are differences of opinion over the mtm issue. the fact that the eu and several economists (and i know many of them) agree with your viewpoint doesn't make either them or you right. mtm doesn't reduce ballast - lousy investments that are improperly financed does. spend some time reading my blog on the topic. i've given a lot of thought to the issue of mtm and transparency and actually think i've got some pretty good support for why a funding-based mtm framework is superior than anything we've got today.
as it relates to sarbox, i have felt it has been poorly implemented and applied as well. i do take issue with viewing it as a catalyst for the market meltdown, but i agree that it was poorly conceived and even more poorly enacted.
Apparently you don't know what ballast is and so you mis the metaphor =ok
I already told you what I thought of the article = "a loada crap" so I see no reason to repeat myself.
You responded by calling me emotional and irrational.= way to go!!!
I see no reason for continuing a dialogue with you.
PS when you write something and make assertions and claims, then when people do not like your assertions and do not agree with your claims, you should be prepared to accept their criticism as valid criticism and honest feedback on what they thought of what you wrote.
If not, then suggest you don't write.
I stand by my opinions
A good way to control this is to severely limit the leverage of hedge funds, and restrict their trading activity. These financial parasites have engaged in predatory trading games, and if we had a justice dept. with an effective AG at the helm, we would have already had vigorous prosecution on this front, instead of what amounts to acquiescence. There are laws against racketeering on the books - let's enforce them.
Finally, I believe we should create one huge bank - call it FedBank - and have it run responsibly, not by the old guard that plays the typical banker's game of letting people borrow money during good times, then trying to seize their property during the temporary collapses. Banking is a really dirty business, and always has been - but with the right kind of people running it, it can be cleaned up to a degree.
The guys who ran the mortgage bubble up to absurd levels, and now are sitting back and taking govt. money but refusing to lend - well, maybe we can reopen Devil's Island and send all of them there for an extended stay.
yeah he did. bankers need jobs too.
huh. so what your saying is is that they would still have cash reserves? ... oh no bankers need jobs too. they get bored easily.