Looking for Government Help? Here is the Scorecard
If it were not so serious, it would be amusing. So many who generally believe in free markets and small government are suddenly unhappy whenever there is no government intervention. Whenever we hear a criticism like this, we try to look back at the history for that pundit. Did the criticism appear before or after a problem was evident?
At "A Dash" our focus is on interpreting actions and helping investors, but a summary assessment will prove helpful.
The Mission and the Players
The Congress has done a good job. Anyone who does not understand this has no grasp of the legislative process — especially the passage of completely new ideas. A bi-partisan stimulus bill was passed in record time. Congress also passed the requested Treasury authority to intervene with Fannie and Freddie and a mandate to do more for housing. This legislation was delayed for a month because of a single GOP Senator. History may take note of this, although his electorate will probably not get it.
The Fed has been imaginative. The various Fed lending facilities, agreements with European Central Banks, the Bear Stearns intervention, to name only the most important, were important additions to the simple and major reduction in interest rates. If one goes back one year, none of the pundits were recommending actions like this, so the Fed gets credit for imagination and resolve.
Hank Paulson has been on the case. Working within an administration that wants to limit government involvement, Paulson has walked a tightrope. He preferred not to intervene, famously wielding a bazooka, but was ultimately left with no choice. He recognized the need to increase mortgage lending, something that could not be accomplished with independent GSE's. He and Fed Chair Bernanke were probably responsible for selling this within the Bush Administration. In so doing, he probably pronounced a death sentence for public/private partnerships of all types for the next generation. This may prove to be a wise recognition of the failure of this model. Or maybe it goes too far.
The SEC has been a non-entity. The only action has been a controversial temporary restriction on naked short selling. The end of this ban coincided with the attack on Fannie and Freddie. We certainly do not object to short selling, and the rules for stock borrows should have been enforced consistently over the past several years. This is an area of SEC responsibility. The action probably affected the market temporarily, but generally sparked confusion and criticism.
The Bush Administration has followed the Paulson lead and approved the key legislation, but this was not enough. Our political system requires leadership, and this comes from the President. The sad historical fact is that leadership was required at the very moment that our President had a low standing in polls and a disinclination to act. It was the wrong man, in the wrong place, at the wrong time.
The market and leading pundits have focused their fire on the Fed. There is a simple reason for this. The Fed is the only institution that can act without additional approvals — by legislation or by voters. We have come to expect them to solve all problems, even though the tools are limited.
We look to the Fed because we have nowhere else to turn.
The Bailout Decisions
Government intervened decisively with Bear Stearns and with Fannie/Freddie. Government actors have chosen not to act in the cases of Lehman and AIG. Why the distinction?
In the case of Bear, the Fed acted because there was no alternative. The investment bank model requires short-term borrowing and confidence by counter parties. There were no facilities in place to provide temporary lending when these requirements broke down. Bear Stearns suffered from being the first victim. The firm lost essential confidence, and there was no choice.
In the case of Fannie and Freddie all of government wanted to act in support of mortgage lending. The legislation empowered the Treasury to act because Congress wanted to expand mortgage lending. When it became clear that the market would not support an expansion of the balance sheets of the GSE's, Paulson was left with little choice.
Neither of these situations set a precedent for a general bailout of any financial firm. All of the major players embrace a free-market philosophy and strongly prefer private solutions.
In this context, today's policy pronouncements make sense. No government agency embraces a policy of absorbing bad paper from private corporations. They seek to achieve some stability by cooperating with and facilitating the actions of the private sector. This is what we should expect.
The Real Culprit?
There is a body which has exerted maximum influence in the current situation. This body was not elected by anyone and has no direct accountability to the people of the United States. The accountability is two layers deep. It is empowered by the SEC, the weakest actor during this crisis.
The body in question is a group of accountants making up the Financial Accounting Standards Board. In one of the worst-timed new policies in history, they instituted a radical change in accounting standards, FAS 157, at a time of maximum fragility to the financial markets and the economy.
Even if one agrees that financial entities should recognize mark-to-market principles (something that we generally endorse, as noted here) this was not the time and place to implement and enforce this policy. It is not embraced by other countries, probably affecting LIBOR. Given the US commitment to merge with international accounting standards, it will probably be abandoned in the next few years.
Briefly put, we will use this standard only for a few years, at the worst possible time in history.
[Readers who recognize the need for a de-leveraging of financial markets please note that our objection is not with the end, but with the means and the timing.]
We embarked upon a self-induced death spiral, forcing the marking of assets for which there is no valid market method due to extreme illiquidity. When historians look back at this black period of policy making, they will find that important decisions were delegated to a group that had no concept of the big picture and no accountability.
At "A Dash" we were early critics of this decision and the delegation of power. Interested readers can review the history of our commentary from this list. The mainstream media were missing in action on this topic.
The biggest positive for the market would be a recognition of this mistake. Those supporting the abandonment of FAS 157 now include David Malpass, Vince Farrell, and Larry Kudlow — all people who are strong supporters of free markets.
The Treasury and the Fed cannot solve this problem.
Is Christopher Cox paying attention?
While we do not really expect a change in this policy, investors and traders should pay attention. Were action to be taken, it would be a strong bullish signal.