Is Government Part of the Problem or the Solution?

They’ve likened the economy to a nasty car crackup, so it’s fair to ask whether our Congressional/Treasury/regulatory authorities are hauling the wreckage off the highway so traffic can start moving again, or whether they’ve blocked the highway with their emergency equipment and made the backup worse. I’m not optimistic. Let’s look at what’s been done, proposed, and what’s next in store:

The Debutante. Secretary Geithner’s debut last Tuesday was a dismal failure. The reason: style matters, and Geithner’s political skills appear well below his pay grade. Worse, he was ill-prepared. His audience expected particulars. Instead, he offered doomsday rhetoric that gratuitously heightened doubt and uncertainty.

The Banking “Plan”. The only definitive item in Geithner’s presentation was the plan to “stress test” banks with assets of more than $100 billion, in order to determine whether and how institutions would receive future government lucre. But stress-testing is nothing new, and is expected in an environment such as this one. All large banks already stress-test their loan and investment portfolios. As Tom Brown notes, stress-testing is not an especially useful all-purpose test, so it’s doubtful that it can be the centerpiece of the Treasury’s plan, or that it signals an important regulatory or policy change. After all, regulators continue to close insured institutions every weekend.

The Mortgage Foreclosure “Plan”. While it’s become pretty clear that loan modifications don’t do much to help delinquent borrowers, Congress has nonetheless demanded that lenders do more to mitigate foreclosures. Recall that the OCC and OTS jointly published a report last fall that found that 54% of modified loans re-default within six months. So is this only a matter of throwing good money after bad? Unfortunately, no. The government’s push to mitigate foreclosures has introduced game theory and moral hazard into mortgage markets by encouraging responsible homeowners to act less responsibly. Foreclosure moratoriums, principal cramdowns, and the like threaten to permanently impair mortgage securitization mechanisms, and will likely lower the mark-to-market value of most asset-backed securities, regardless of their cash flow and credit performance.

In last week’s House Financial Services Committee’s hearing/show trial, Goldman Sachs' (GS) CEO Lloyd Blankfein testified that mortgage cramdowns could cause less capital to flow into mortgage markets. It bears mentioning that the value eroded by irresponsible government actions will increase investor losses and taxpayer costs worldwide.

Congressional Hearings. And speaking of last week’s TARP accountability hearings, could anything better prove the old aphorism that legislatures are meetings of idle people? How did these hearings serve the Treasury’s goal of attracting private capital to the banking sector?

Executive Pay Caps. There is probably no better example of legislative excess than the spectacle of Banking Committee Chairman Senator Chris “Friend of Angelo” Dodd inserting new and retroactive pay caps on bank executive compensation. Dodd is in trouble with his constituents back in Connecticut, where the Hartford Courant has reported the evolution of his many explanations for his sweetheart Countrywide mortgages. Congress should not be in the business of dictating private-sector compensation. It’s outrageous that this Senator, in particular, wants to get into the act.

Mark-to-Market Accounting. It continues to amaze that our authorities won’t even speak of the principal root causes of this wreck, namely mark-to-market accounting for illiquid and hard-to-value investments. FAS 157 valuations are unrealistic even as the rule creates very real capital adequacy and insolvency problems in banks, insurers, and others.

No doubt some vital issue is missing from this list, but it’s hard to conclude that our public servants are on the job. They’re either ill-prepared, working at cross purposes, covering keisters, practicing legislative legerdemain, rubbernecking, or actively contriving to make serious problems worse.

No surprise that you and I are caught in the gridlock, left to wonder when the traffic will flow again.

Comments

[chris james:]

I really do not feel that mark-to-market is much of a problem. Most savvy financial statement readers understand the complexity of mark-to-market adjustments and realize that if and when the economy bounces back into positive territory, so will the valuations of many assets. They also tend to focus more on cash flow anyway, which is not affected by mark-to-market adjustments (they are non cash items). I agree that some revisions should be made to mark-to-market rules, including the ability to factor in ask prices when performing valuations (SFAS No. 157 permits only the consideration of bid prices), the ability to recognize recoveries in asset value for assets that have been written down for other than temporary impairment, and enhanced guidance regarding acceptable valuation methods, particularly for Level 2 and 3 assets in illiquid markets. However, I believe that mark-to-market adjustments are essential to properly understand a company's balance sheet. The balance sheet should be a decent beginning point for the valuation of a business (as well as serving other purposes). Without fair market valuations being factored in, the balance sheet would start to become worthless for overall business valuation purposes.

Feb 19 09:39 AM

[Alphameister:]

Excellent article! I wish I could give more than one "thumbs up" to ED K on his comment. Big, intrusive government is the primary cause of all our major economic problems. If only one of those bankers had possessed the guts to say as much to the stupid and corrupt politicians grilling them on national TV.

Feb 19 10:25 AM

[atlasman:]

Well done and about time an article like this was posted.

Feb 19 10:45 AM

[NITRAM:]

Strarting with Paulson, the government has screwed the entire economy.Paulson helped his friends and then left town. Now we have the most inept and crooked government in history. Obama is a racist who wants socialism. He attended a church for twent years and never heard the Rev Wright spew his hatred. Geither is to good to pay taxes. Emanuell was part of the billions of dollars lost at Freddy Mac. He was a board member. Barney Franks took millions from Fanny and Freddy. Charles Rangel doesnt believe in paying taxes. Daschell is to important to pay taxes.While asking corporate America to reduce income. Congress, under the guise of a raise increaded their expenses accounts by about $1,000,000 each. They do not have to justify to the tax payers or the I.R.S. how this money was spent.

BOTTOM LINE. Our president administartion and Pelosi with her court jesters will drive us in to full blown DEPRESSION

Feb 19 12:38 PM

[User 347440:]

Many of the banking regulations added during the Depression era have been legislated out of existance by each president and congress going back to at least 1980. Presidents and congresses from both side of the aisle have done their part.

Now, congress is divided into numerous commitees so that congressional members can concentrate of a slice of the big picture. Where were these people? Why didn't they see this coming? They were warned numerous times by numerous people.

If you think this is a problem isolated to the last years, keep your head in the sand and hope this mess blows right over you.

Funny that the guys that were elected to watch over the finances of America have the nerve to parade a bunch of CEOs in front of them and lecture them on their mistakes. Meanwhile, if you track the money flow, alot of that money made it back to these idiots via campaign contributions.

Does that make these congressmen and women complicate? I would think so. They're all crooks.

Feb 19 04:42 PM

[InnocentsAb...:]

OK. So -- the banking crisis is due to over - conservative accounting. Yes.

Not to leverage. Not to incompetence. Not to poor management structures. And not to just plain old bad business models.

Just mean old hard nosed conservative accounting. Good. We can solve everything -- just get some new accountants. There are a bunch now freed up from recent employment in the Bernie Maddoff branches of UnoCredit and Banco Santander. We can import them at extra low cost - problem solved.

Feb 20 01:19 AM

[Ferdinand E...:]

The author of this article and my good self are definitely not on the same page, but if I were in President Obama's platoon I would read it very carefully and make sure that I could answer the charges at any hour of the day or night.

Feb 20 10:08 AM

[henarl:]

I believe Reagan aswered the title question several years ago. If anything, it's even more obvious now!

Feb 20 12:58 PM

[speculari:]

Geithner appears to be A.W.O.L. or, may be simply "missing in in-action".
I would not trust this "kid" with my car keys, to say nothing of the Treasury department.
Mark - to - Market Accounting is another of those "fuzzier than thou" ideas foisted upon a system by some "brilliant" accountant who, likely, had difficulty tying his shoes in early & formative years.
As for Senator Dodd.... #**@&&^$#@^%&a... This is a man who has definitely been educated far beyond the level of his intelligence. Apart from his misdeeds with his "sweetheart" mortgage deals, and his complicity in the CRA/Fannie/Freddie debacle... and, the monies accepted from those entities; He also sent the markets into a wild "tizzy" on this Friday - with his comments to the effect that "the banks may have to be nationalized"... AS the King of Spain said to Hugo Chavez a while ago... WHY DONT YOU JUST SHUT UP! The stink of rotting fish is palpable around this man.

Feb 21 03:12 AM

[wallster:]

"OK. So -- the banking crisis is due to over - conservative accounting. Yes.

Not to leverage. Not to incompetence. Not to poor management structures. And not to just plain old bad business models. "

Of course. Haven't you been paying attention? If the big bad FASB hadn't been forcing banks to look at actual transaction prices when valuing their securities we never would have had this problem!

Hopefully Obama will pardon Andy Fastow soon, once he gets the banks up to speed on mark-to-model accounting, we can do away with those pesky market prices and it's prosperity here we come!

Mar 16 06:13 PM