How to spare the economy further crippling government intervention by suspending mark-to-market accounting
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Under the Financial Accounting Standards Board rules, namely SFAS 157, mark-to-market accounting was implemented to provide investors with a more accurate, up-to-date asset price. Yet, its application led to a rapid decline of asset values. Banks and corporations alike have been forced to write down assets and have been left with contracted balance sheets.
Banks will not begin to start lending to their communities until they can reappraise the value of the assets they already have on their books. To get the American economy running, Americans need access to credit so that they buy cars, take on mortgages, and pay for their children to go to college. We cannot wait for Treasury’s funds to slowly chip away at the credit crunch. With this reform, Washington would do more to stabilize the financial markets without costing the taxpayer a penny.
Newt Gingrich was Speaker of the House of Representatives from 1995 to 1999.
The current financial crisis has led to unprecedented peacetime government intervention in the national economy. Approximately $8 trillion of government purchases of equity in financial institutions, loan guarantees, and other credit has flowed from various federal agencies in a matter of weeks. Those who agree with Hayek that government agents are unable to collect and process the information that is necessary to direct a modern dynamic economy will wonder at the speed with which we have moved towards what Ludwig von Mises called “planned chaos,” and Hayek called “the road to serfdom.”
Regardless of issues, such as the risk to taxpayers, the real concern should be that we are expanding government in a way that Robert Higgs warned about in his 1987 book, Crisis and Leviathan, while ignoring a simpler noninterventionist approach.
There has been a good deal of literature on the cyclical effects of regulatory capital requirements, and in particular mark-to-market accounting. In a 2004 paper, University of Chicago and Harvard University professors Anil Kashyap and Jeremy Stein concluded that enforcing exactly the same capital requirements during the upside and downside of business cycles has the potential to add significantly to cyclical behavior and results in inefficient credit markets. An implication of their research is that capital requirements should be lower in a downturn when the cost of capital is high.
In the current credit crunch, mark-to-market accounting has exacerbated the already pro-cyclical effects of capital requirements. Wachovia having to sell its mortgage-based securities at fire-sale prices caused other financial institutions to mark the value of similar assets down, requiring them to raise capital, reduce their loans, or both.
As mortgage-based securities decline in value no financial institution wants to hold them, the market becomes illiquid, and the sales that do occur are under distress, further reducing bank capital. Rather than reducing capital requirements in a downturn, as suggested by Kashyap and Stein, mark-to-market accounting has the effect of increasing capital requirements, leading to further contraction of credit, a scramble for capital, and declining economic activity.
Rather than the government buying banks and other financial institutions, and lending trillions of dollars to whichever firm shows up with the best lobbyist, a simple solution is to allow financial institutions to account for their assets in a fashion that allows for a value closer to the true value of the underlying asset and yet is transparent, so investors and depositors may make a rational choice as to whether to invest in or make a deposit in the institution. Individuals acting according to their own plans and taking responsibility for their actions will outperform regulation. While there may be costs to eliminating mark-to-market capital requirements, the alternative of massive government intervention will be much greater in the long term.
Gary Wolfram is William Simon Professor of Economics
and Public Policy at Hillsdale College and former chief of staff to
Congressman Nick Smith.
The last time I looked I couldn’t find mark-to-market accounting in the Constitution of the United States. It must be the 11th commandment because it’s obviously sacred. I understand the president has the authority under the Emergency Powers Act, or some such legislation, to suspend the Bill of Rights in case of a national emergency. Well, we have a national emergency, so mark-to-market must be more important than the Bill of Rights.
If a foreign power destroyed a fraction of the wealth that mark-to-market accounting has in the past year, we’d go to war. I’m no accountant, but, as I understand it, mark to market is part of what they call “fair value” accounting, so it must be fair.
If so, I have a couple of questions. What’s fair about a financial institution being put out of business because a small portion of its bundled assets become impaired and the whole bundle must be treated as a loss? How is it fair that an expected loss of a few thousand dollars a few years from now, in some cases, must be treated as a loss of millions in the here and now? If a small number of mortgages behind a mortgage-backed security become impaired, or potentially impaired, why must the whole bundle be written off? If I have a sack of apples with a couple of bad ones, I throw the bad ones away—not the whole sack.
A man of faith in a godless age is hitting Americans where it hurts.
Mr. and Mrs. American Spectator Reader, let P.J. O’Rourke talk sense to your kids.
In Britain, defending your property can get you life.
It won’t take long for conservatives to scratch this presidential wannabe off their 2008 scorecard.
Was the President done in by the economy, or by the politics of the economy?