Obama and McCain Don't Understand the Markets 12 comments
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I saw both John McCain and Joe Biden on CNBC this week, and I was astounded by the shallowness of their answers on how to address the current economic crisis.
Both offered the typical Capitol Hill solution to any problem – more regulations.
Each tried to disguise his answer in fuzzy language – McCain said he didn’t want “over-regulation” and Biden said he wanted “common-sense regulation”. But the bottom line is the same – neither of them has a real idea on how to deal with a financial crisis that has continued to escalate.
One of their blind spots goes right to the fundamental nature of the crisis that in the past few days has led to a fire sale of Merrill Lynch (MER), driven Lehman Brothers (LEH) into bankruptcy and has AIG (AIG) teetering on the brink of collapse.
The Democratic and Republican candidates think of it as a Wall Street problem and that “Main Street” shouldn’t be asked to “bail out” these fat-cat financiers. This is a flawed way of looking at a financial hurricane that will defy Washington’s usual approach of exploiting the “haves vs. have-nots” issue. This is a killer storm that will flatten everything in its path.
A call for more regulations shows just how out of touch these guys are when it comes to the realities of capital markets.
The cure is not more regulation – in fact, the current rules are a big reason why we’re in this dire situation.
Almost a year ago, an accounting rule known as FAS 157 went into effect. This rule has been called the “fair-value rule,” but it’s not working that way. FAS 157 is forcing companies to write off tens of billions of dollars in debt-related investments.
That’s because of FAS 157’s requirement of a “mark-to-market” valuation on these investments each quarter. Mark-to-market essentially means the value of these investments if they had to be sold immediately. Current uncertainties and liquidity issues have chased away just about all of the buyers for many of these investments, so the markets are distorted. When there are no buyers, under FAS 157 the value has to marked down, sometimes to zero. This is the case even for securities that could be sold in the future at face value once they reach maturity.
Overlaying FAS 157 with the demands of Sarbanes-Oxley creates a recipe for continuous quarterly write-downs until all value is gone. New York has lost its status as the world’s financial capital since Sarbanes-Oxley was enacted, and the harsh requirements of FAS 157 may accelerate that trend.
This is not a blind defense of the companies that have invested heavily in derivatives that Warren Buffett called “financial weapons of mass destruction” in 2002. In the next six years, these financial WMDs grew by 500 percent to more than $500 trillion. The sheer size of these derivatives has greatly increased the risks of catastrophe, and the danger is further elevated because of FAS 157 and Sarbanes-Oxley.
Source: U.S. Global Investors
Because global financial markets are woven in a complex web, turmoil in one sector is felt elsewhere. Some wounded financial companies are desperately selling healthy stocks to raise capital to stay afloat, and this heavy selling pressure is forcing down the price of these stocks. The same is being done by leveraged hedge funds that have been hurt by their investments in financial stocks – they need to raise money for shareholders who want out of their fund, so they are selling good stocks to get cash.
This talk of new regulation reminds me of one good rule that got away. The SEC eliminated the “uptick rule” for short-selling stocks last year, and this has facilitated a rise in illegal “naked shorting” that has hurt financial companies and impaired their ability to refinance.
The New York Times had an interesting op-ed article on this subject on Sept. 14 titled “Too Few Regulations? No, Just Ineffective Ones" by Tyler Cowen, an economics professor at George Mason University.
One of Cowen’s best observations was "financial regulation has produced a lot of laws and a lot of spending but poor priorities and little success in using the most important laws to head off a disaster. The pattern is reminiscent of how legislators often seem more interested in building new highways - which are highly visible projects - than in maintaining old ones."
He also pointed out that 70,000 new pages of federal regulations in a single year is not an uncommon feat, and that the inflation-adjusted spending by the federal agencies regulating banking and finance has gone up more than 40 percent since 1990.
New rules are what Washington knows how to do best – it’s how legislators measure their worth. And while there are times when new regulations make sense, this isn’t one of those times.
Hearing the solutions offered by McCain and Biden today reduces my confidence that either the Democrats or the Republicans have the knowledge or the imagination to take on the biggest economic crisis in America since the 1930s.
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This article has 12 comments:
Don't blame it on the rule. Blame it on the banks. They took massive risks, and the rule effectively pinned them to the wall. They had to actually show the toxic garbage on their books. That's when the house of cards came falling down.
Would you prefer them not to show us their books? Would it have been better to allow that huge unregulated market to keep going? And what then? What happens when a multi-billion dollar company has a multi-trillion dollar debt thanks to high leverage? Should we pretend everything is fine until the whole system implodes?
Greed and hubris by the banks are once again leading the charge into economic destruction. It isn't the first time and probably won't be the last time.
Greed is the power behind capitalism, but it is also it's nemesis. Too much greed destroys free markets. This is just another example.
~X~
as for obama and mc cain being ignorant as school children about economic issues, does it make a difference? bush had an MBA and was as dumb as a stump. we're a country of the blind leading the blind.
How do you fix it? Well first off, no red-blooded capitalist would oppose mark-to-market accounting; after all, that is indeed the *just* price of the time, and the investors (owners) have a right to know the value of their assets. As for SOX, yes it costs money and time to comply with, but there was a reason it was passed you know...a failureof clarity of books (Enron/Arthur Anderson).
Oh yeah, you do recall that MTM accounting allowed Enron to show millions in unrealized profits (marked against their optimistic curves in very illiquid markets)? It actually worked out quite well for a lot of people....until it didn't.
Besides, the real problem is that banks assumed real estate would always go up, and decided to extend credit to anyone in exotic loans, packaged in ways that no risk model could reasonably model, enhanced by various credit insurances, and ultimately interweaving a great number of counterparties in a house of cards that no one could correctly understand (after all, there were no histories of default profiles for these loans of various types).
On the other hand Biden's positions were the opposite and was typical of a politician of an opposing party running for office. there was no real fundamental economic understanding that i saw.
Finally, MTM and other accounting changes puts international companies on equal accounting principals. although it is unfortunate these changes came exactly when certain companies had the most to hide, they knew it was going to happen and had time to adjust their toxic soup.
Actually there is another alternative.
AIG has already experienced the appropriate medicine. Strike a deal with every one of these pigs along the lines of Paulson (doing a remarkable version of Franklin Roosevelt). (e.g. You want money. We got money. Now let's see what you're really worth and how important it is for you to stay afloat.) The U.S. Treasury made $15 Billion today on the AIG deal, and at a 10% interest rate on the borrowed capital will continue to make money off these Hank Greenburg-inspired scum.
Let's finally face it and celebrate the fact that the U.S. Government has always been in the business of business and finally take ownership to that fact. If we truly believe in the ability of business to make a buck, let them make that buck and shovel back our share of the profits when they fail to understand that they aren't the most brilliant lights in the sky flying home to Uncle Sam when their greed exceeds their intelligence.
Perhaps, this dose of medicine will finally convince the pigs that they should be a little more cautious and a little less like the hubris espoused by the author of this article.
do you really believe this? the pigs just won my friend. they were rewarded for their incompetence and greed with your tax dollars and mine.
at our founding, gov't was not intended to be all things to all people, as are expectations of too many citizens today.
if POLITICING were a part time job, incumbants would not be so imbedded in positions, unlikely to do[perform?] so many legislative acts, spend more time in the realities of life.
the easiest way to seperate/limit this inappropriate alliance[ POLS and BANKERS] is to toss the POLS[bankers aren't elected].
THE VOTE IS YOUR'S MR/MS CITIZEN. BREAK THE ALLIANCE; RECOVER YOUR HERITAGE.
SIGNED: GERRY MANDER
The rules are not being enforced and part of the reason has to do with the internet regulation laws congress passed. To clean up the entire mess we need to scrap all computer ran trading and start from scratch and work our way through the process one program and regulation at a time.
Computer ran programs designed to create a profit from short selling is and has been a dangerous toy to play with in a sensitive economic market. Long purchases are alright, daytradig causes more problems.
Anyone willing to take a look at historical charts and the introduction of computer ran trading?