The 110-page "Emergency Economic Stabilization Act of 2008" has been written, and is going to Congress today.
Market reaction has not been favorable. As of 5:53am, Dow Futures are off 200, and Europe is trading 3% lower.
All of this points to an issue that I have yet to hear addressed directly: Targeting of asset prices, such as houses and stocks, rather than credit markets and systemic risks. It began under Greenspan (recall the "Put"), but under Fed Chair Bernanke started in January 2008.
Throughout this crisis, there has been chatter and attempts to stop the freefall in Housing prices — something that is counter-productive. Unless we want a Japan like decade of recession, we need to allow the various bad assets to seek their own levels via the open market.
Over the past few years, all the Fed has accomplished with this asset price targeting has been to prevent any capitulatory washout from taking place.
A classic example of this misguided asset price focus is in the Bailout’s suspension of mark-to-market pricing:
SEC. 132. AUTHORITY TO SUSPEND MARK-TO-MARKET ACCOUNTING.
(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under the securities laws (as such term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.*
That seems to be pulled straight from the Bank of Japan’s playbook: Take the right downs later rather than sooner, once the market returns to normalcy. That’s a deeply flawed philosophy.
Former SEC Chair Arthur Levitt lectures the Congress on why mark-to-market is so important.
"That’s why it’s both dismaying and puzzling that as Washington debates the Treasury’s bailout proposal, some of the largest banking and financial services trade groups are aggressively lobbying the SEC to suspend the mark-to-market, or fair-value, accounting standard currently in place, and to oppose any expansion of it.
To ask for a suspension in fair-value accounting is to ask the market to suspend its judgment. These trade groups claim that the fair-value accounting standard has distorted banks’ balance sheets, and has contributed significantly to the market’s volatility.
On the contrary, that gets things backward. It is accounting sleights-of-hand that hid the true risk of assets and liabilities these firms were carrying, distorted the markets, and have caused investors to lose the confidence necessary for our markets to function properly."
What the Fed, Treasury and SEC seems to fail to understand is that you CANNOT get a return to normalcy after a bubble — not until prices are allowed to fall to levels that bring in aggressive buyers. That is true for stocks, houses, and even financial institutions.
The plan as it is currently constructed fails to recognize that Housing prices still remain elevated, more foreclosures are likely, and that another 10-20% downside in real estate is quite likely.
Instead of focusing on asset prices, we should be looking at recapitalizing the banking institutions, providing liquidity to those that need it, and managing insolvency via FDIC.
Its time to fix what’s broken, and leave the assets pricing to the markets.
Futures Update: Dow futures down further at 7:02 am, with fair value approaching minus 237 on the Dow . . .
* The EESA also calls for a study of mark-to-market: "SEC shall conduct a study on mark-to-market accounting
standards as provided in Statement Number 157 of the Financial
Accounting Standards Board" SEC. 133. STUDY ON MARK-TO-MARKET ACCOUNTING.
Fed’s Folly: Fooled by Flawed Futures? (January 2008)
How to Restore Trust In Wall Street
ARTHUR LEVITT JR. and LYNN TURNER
WSJ, SEPTEMBER 26, 2008