Wednesday, October 1, 2008

An Old Hand Counsels Lawmakers

Something to think about, an alternative to the $700 Billion bailout.

Walter Isaac was chairman of the FDIC during 1981-1985. His suggestions are: The Securities and Exchange Commission and bank regulators must act immediately to suspend the Fair Value Accounting rules, clamp down on abuses by short sellers, and withdraw the Basel II capital rules. These three actions will go a long way toward arresting the carnage in our financial system.

The accounting rule is marking-to-market; Basel II has to do with capital requirements.

The S&L crisis in the 1980s, during the first Bush presidency (coincidence? I think not), was serious.

The country's 10-largest banks were loaded up with Third World debt that was valued in the markets at cents on the dollar. If we had marked those loans to market prices, virtually every one of them would have been insolvent. Indeed, we developed contingency plans to nationalize them.

In the current crisis, the numbers are large.

The dark cloud on the horizon was about $1.2 trillion of subprime mortgage-backed securities, about $200 billion to $300 billion of which was estimated to be held by FDIC-insured banks and thrifts. The rest were spread among investors throughout the world. The likely losses on these assets were estimated by regulators to be roughly 20%. Losses of this magnitude would have caused pain for institutions that held these assets, but would have been quite manageable.

What caused it?

The biggest culprit is a change in our accounting rules that the Financial Accounting Standards Board and the SEC put into place over the past 15 years: Fair Value Accounting. Fair Value Accounting dictates that financial institutions holding financial instruments available for sale (such as mortgage-backed securities) must mark those assets to market. That sounds reasonable. But what do we do when the already thin market for those assets freezes up and only a handful of transactions occur at extremely depressed prices?

If we do not halt the insanity of forcing financial firms to mark assets to a nonexistent market rather than their realistic economic value, the cancer will keep spreading and will plunge the world into very difficult economic times for years to come.


Equally egregious are the actions by the SEC in recent years lifting the restraints on short sellers of stocks to allow "naked selling" (shorting a stock without actually possessing it) and to eliminate the requirement that short sellers could sell only on an uptick in the market.

Why was that done? Lobbying?

We are almost out of time if we hope to eradicate the cancer in our financial system.

There is, of course, another side.

Critics of some of Mr. Isaac's ideas are lining up. Accounting firms and consumer advocates say loosening accounting rules in the way he has proposed would allow banks and other financial firms to value assets at inflated amounts, deceiving investors about the value of troubled assets.

And there are other pertinent details, such as: Mr. Isaac, a 64-year-old resident of Sarasota, Fla., is chairman of the Secura Group, a Washington-based firm that advises banks and other financial institutions on dealing with regulators. He is also a contributor to many members of Congress, having given more than $80,000 to federal officeholders and political-action committees since 1990, according to the Center for Responsive Politics, a Washington watchdog group.

Why is no one else advocating his proposals?

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