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September 25, 2008

This would be simpler than a bailout

Quote of the Day:
“At this point, Congress is being asked to support an uncertain entity, costing an uncertain amount of dollars, for an uncertain duration – a decision that will have implications for generations to come and requires absolute certainty.”
– Congressman Jeb Hensarling, TX, and Chair of the House Republican Study Committee

Subject: This would be simpler than a bailout

A few simple words in an arcane regulation may be a major cause of the current financial “crisis.” Removing this regulation would be simpler and cheaper than the proposed bailout.
Financial Accounting Standard 157 is a regulation imposed on businesses by the quasi-private Financial Accounting Standards Board (FAS). This rule is also incorporated into the regulations of the IRS and is further enforced by the SEC and the FDIC. FAS 157 requires businesses to mark down assets to the lowest price for which similar assets have been sold in the market.

The jargon term for this regulation is “mark-to-market.” Mark-to-market forces good securities to be valued at the same price as bad securities.

It’s important to understand that a security may be sold at a low price for many reasons. The firm selling the security may simply need to generate cash, and be willing to take a loss for that purpose. A security may also be sold for a low price because one or more of the mortgages behind that security is in arrears or default. But once a security is sold for a low price, something startling happens . . .

All other firms are forced to pretend that their mortgage backed securities are also worth that low price, even if none of the mortgages backing their securities are in arrears or default! This leads to a chain of catastrophic consequences . . .

Company balance sheets suddenly become unbalanced. Credit rating firms downgrade the companies that suffer this fate, resulting in margin calls, higher interest rates, and falling stock prices. Firms that were having no trouble paying their bills suddenly find themselves on the verge of bankruptcy.

This has happened repeatedly over the past few months. In the absence of “mark-to-market” it’s possible that no firms would have gone bankrupt, or clamored for government funding.

Treasury Secretary Paulson and Fed Chairman Bernanke have both been asked about the “mark-to-market” problem. They have responded with jargon and gibberish. We suspect that it would be highly embarrassing for government officials to admit that a federal regulation has led to so much heartache for so many people.

House Banking Chairman Barney Frank continually claims that the current problems were caused by deregulation. He, like most politicians, have powerful incentives to always exempt the government from blame. And many CEOs have powerful incentives to remain silent about such things in order to retain access to government favors. The fact is . . .

This entire problem has been caused by government money and government regulations, from the creation of the housing bubble to the bursting of that bubble, to the current plan for a bailout. 

Were the politicians to come clean about this they might find their careers hanging from metaphorical lamp-posts. And so they will not come clean, but will instead hide behind jargon and gibberish and blame everyone but themselves.

Worse still, they will use their own failures to grant themselves more power.

Now, here is something truly stunning . . . The current bailout plan could have unintended consequences as a result of the mark-to-market regulation. The plan is designed to purchase securities at the lowest possible price, using various tools, including reverse auctions. But think about what this means. Under mark-to-market all holders of similar securities will then be forced to mark down their securities to that lowest possible price, potentially driving many more firms toward bankruptcy, and into the arms of the federal bailout.

Instead of lifting the markets the bailout plan could actually cause a race to the bottom.

Here’s what we need to do. We need to continue to oppose the bailout, and to ask for an end to the “mark-to-market” regulation. This would be a simpler approach, and should be tried first. We have created a new “reduce regulation” campaign that you can use for this purpose. Ask for an end to “mark-to-market” in your personal comments. You can send your message using our proprietary Educate the Powerful System.

Meanwhile, the House has used the distraction caused by the Big Bailout to sneak through an additional $25 billion bailout of Detroit automakers.

Fortunately, we still have time to block this in the Senate, so please send a message to both the House and the Senate opposing this bailout. You can use our generic campaign to cute spending for this purpose.

Please also consider making a contribution or monthly pledge to help us weather the economic downturn. You can contribute here.

Thank you for being a part of the growing Downsize DC army.

Jim Babka
President, Inc.

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