Amity Shlaes: Paulson Plan Bring On Accounting Deja Vu

Amity Shlaes compares the government’s response to the current crisis to its initial response to the S&L industry’s troubles of the early 1980s. She’s not encouraged! And she thinks she knows why the markets have gone straight down ever since the Paulson package was passed. First, what went on last time:

[Federal regulators] coerced healthy institutions into absorbing sick ones. The device in this instance was goodwill, an accounting maneuver that turned a financial shortfall into a paper asset. . . .

The technique was based on the faith that the books of the thrifts would look better -- eventually. This is rather like the argument that softening our ``mark-to-market'' accounting rule will buy time for mortgage-backed securities to prove they can be worth something more, later. In 1980, as the S&L troubles were building, lawmakers also raised deposit insurance to $100,000 from $40,000 and gave the thrifts new powers to expand the range of their investments.

Suddenly, S&Ls seemed profitable, at least for a moment in 1983.  . . .

But of course, it didn’t last. Through forced consolidation, the government helped create $16 billion in goodwill in 1981 and 1982. By 1985, the industry had just half the capital regulators were pretending it had. Which means the S&Ls’ problems had been papered over rather than solved. The real industry crackup didn’t happen until the end of the decade, and culminated with the RTC buying and disposing of hundreds of billions of dollars worth of troubled assets.

The 1980s saga informs Shlaes’ take on the Paulson plan now:

But my own conclusion, and probably that of many shareholders, is that, upon reflection, we see too many similarities to the old goodwill to be confident. Accounting alchemy can be criminal fraud -- Jeff Skilling at Enron Corp. -- or it can be ``only'' political fraud.

Among a million other things, the bailout law reiterates that the Securities and Exchange Commission has authority to fiddle with the definition of mark-to-market. This week's declines by stock markets aren't emotional. They are the prudent actions of a crowd crying ``fraud'' and anticipating the inevitable.

I almost agree. In the 1980s, everyone knew goodwill was tissue, and hoped the industry would grow its way out of the problem. Now, there seems to be wide agreement, from everyone from Warren Buffett on down, that the marks institutions have taken on their mortgage-related assets are too severe. It’s hard to argue, I think, that mark-to-market now is a re-run of the goodwill make-believe of the 1980s. If anything, it’s the goodwill charade turned on its head. But I’m willing to be convinced. Additional arguments welcome. . . 

Comments

[formerhawk:]

Well I'll comment. Just suppose that the toxic assets that have been marked to 20 cents on the dollar turn out to be worth 40 cents, or 60 cents on the open martket after the fed auction begins. Think about mark to market then. All of a sudden everybody turns a profit this quarter until the next time when the asset goes down again. Mark to market just increases volitility in an incredably volitile market. I have a problem with this because I am an investor, I invest in companies that I expect to have value and profit from their endeavors. I am not a gambler. My view of what this market has become is a gambling casino where anyone with a terminal can participate. Mark to market contributes to this volitility. Mark to maturity may be a better choice. We must take back our markets and stop the casino mentality. Your comments....

2008 Oct 10 09:13 AM

[rm:]

Will my mutual fund account statement suspend mark-to-market accounting until things turn around? I mean, hey, those stocks have GOTTA be worth more than that.

Can I use these same tactics to refinance my house, based on its old value?

Trust me- when this thing blows over, I'm sure it'll return to its former luster.

Besides, I'm a "hold-to-maturity" kinda guy.

Oh, and by the way, could the government put a temporary ban on anyone in my neighborhood selling for awhile? Listen- their selling is hurting my home's value... it's like SHORT SELLING!

While we're at it, could we institute a no-confidence provision? That way, we'd have a chance to dump the whole lot- executive and legislative branch- in one fell swoop.

Has it occurred to anyone that Main Street folks might prefer some short-term pain to this steaming load that's being forced down our throats?

2008 Oct 10 09:28 AM

[Cuda:]

1. My understanding of mark-to-market is that it requires the asset (in this case, the real estate) to be devalued- simply because comparable properties sold for less- even though the loan may not be delinquent.


2. What really set off the S&L crisis, in my opinion, was the Tax Reform Act of 86, which eliminated the mortgage interest deduction for all except primary residences, causing the values of second homes and investment properties to drop drastically- to the point that owners couldn't afford to keep them (keep in mind that mortgage rates at the time were still in double digits)

2008 Oct 10 01:47 PM

[paso11:]

fair value accounting is the messenger not the cause, it may have contributed to the pain but ultimately it helped to highlight the greed, poor risk management and other issues. As an investor I want financial statements to reflect economic reality and to be prepared on a prudent basis. Besides accountants didnt tell Wall St to buy and manufacture mortgage backed securities in the first place.

2008 Oct 10 07:27 PM

[glassbox:]

The problem with mark to market and short selling and the hosts of like mechanism is that it attempts to establish a price for that asset based on the last done transaction. We all know that one sparrow does not make spring but this is exactly what is happening to the capital markets. We have allowed the proliferation of tools that has completely distorted pricing all in the name of efficiency. How else could we have have done this? I really don't know but I do agree with formerhawk that the market integrity as a efficient and optimal allocator of capital and resource (for the longer term) should be re-established. We have allowed traders and short term casino mentality to take over, to the detriment of everyone - including the same people who are proponents of this mentality.

Casino thinking should be restricted to the casino and not get into people's 401Ks and pension.

2008 Oct 11 12:22 AM

[imnotadoofus:]

As a professional investor I have argued with colleagues that the mark to market imposition imposed by FAS 157 and 159 beginning late in 2007 would have consequences. A CEO of a mortgage REIT told me that he was concerned about Bear Stearns. I asked why and he said that with $300 billion in assets it only required a 5% haircut to eliminate its capital, which was $15 billion. I thought he was too pessimistic since the Bear was a venerable Wall Street institution, but he suggested that FAS 157, the "fair value" accounting rule, would wipe out its capital.

So much for the Bear. Now it--FAS 157--has further eroded capital across the financial sector and has been instrumental in the demise of WaMu and probably the cause of the impromptu marriage of Wells and Wachovia. But it also was partly responsible--in my opinion--for the many other disasters that have these past few months. As capital is eroded by the irrational mark downs, investors and wholesale funding agencies pull their lines and/or withdraw funds. And the rating agencies also contribute to the downward spiral by calling into question the ability of institutions to survive its downgrades. All this because of a foolish mark-to-market rule that bears little resemblance to the actual value of the assets in question. ABX and CMBX are the arbiters, not the discounted cash value of the asset in question, whether pooled real estate mortgages or other assets similarly packaged and sold world wide. So goes the conflagration!!!!!

2008 Oct 11 08:43 AM