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— Judgment Call —
 Political leaders told us last week that if the Wall Street bailout
bill did not pass, the stock market would drop by 1,000 points and
millions of people would lose their homes, jobs and credit cards.
Congress passed the bill, yet the markets have gotten worse. I believe the problem is that the bailout package does not deal with any of the four fundamental issues that must be addressed immediately: fear, bank capital, fiscal stimulus and help for homeowners. Fear: The financial markets are frozen throughout the world. Banks will not lend to other banks and, to the extent they do, the cost is exorbitant. There is a lot of liquidity but it is being hoarded.
Which banks will fail and how will their creditors be treated? Will
the government protect just the insured depositors or will it protect
the uninsured depositors, bond holders, and other general creditors?
The government has handled these claims in different ways in the
failures to date, so there is considerable anxiety in the markets. There is a way to get money flowing through the banking system and financial markets almost instantaneously. The Federal Deposit Insurance Corp. has the authority to declare an emergency in the financial markets if the secretary of the treasury requests it. If an emergency is declared, the FDIC could announce that until the crisis abates, all depositors and other general creditors will be protected if an FDIC-insured bank fails. What would this cost taxpayers? In my view, nothing -- indeed, it should save taxpayers a lot. It will get the financial markets working, help put the economy back on track and reduce the bank failure rate.We already have an implicit guarantee in place for the largest banks, which control the bulk of our banking assets. Making the guarantee official during this crisis and extending it to the rest of the banks is essential and reasonable. As I write this article, Ireland has guaranteed its banking system and Denmark and several other European countries appear headed in that direction. If enough follow, the U.S. will have no choice but to act. Bank capital: The Securities and Exchange Commission adopted fair value accounting in the 1990s. This rule required financial institutions to mark their securities to market. I have argued against fair value accounting for more than two decades because I know that we could not have contained the severe banking problems of the 1980s if we had to deal with fair value accounting rules. A bad idea became highly destructive when the SEC decided to continue fair value accounting after the market for mortgage securities evaporated last year. In the absence of a market, the SEC forced banks to mark these assets to an arbitrary index. Mortgage securities were marked to a fraction of their true economic value, which destroyed $500 billion of capital in our financial system. Since banks lend about $10 for each dollar of capital, the SEC's rule diminished bank lending capacity by $5 trillion. Is it any wonder we have a severe credit contraction? Even now, the SEC continues to fiddle while the financial system and the economy burn. The SEC needs to suspend fair value accounting -- act now, study it later. This will begin the process of restoring bank capital so banks can start lending again. Instead of the Treasury and Federal Reserve taking over our lending markets, we need to help our private banks do the job. Another readily available tool to restore bank capital is one that the FDIC used in the banking crisis of the 1980s to give capital-short, but otherwise viable, banks injections of capital to help them get through difficult economic times. The program was a big help in the FDIC's resolution of the $100 billion market insolvency in the savings bank industry at a total cost of less than $2 billion. A precursor of the 1980s program was the Reconstruction Finance Corporation, created to provide capital to banks during Great Depression. The FDIC should resurrect this program immediately. It will limit the failures of community banks and put them back into the lending business more quickly. Fiscal stimulus and help for homeowners: The bailout bill will not solve our banking crisis because it is not attacking the right problems. Instead, we should direct a good portion of the bailout money to providing permanent stimulus to the economy and to helping families who are in danger of losing their homes. I believe Congress should get off the campaign trail and get back to Washington to get the bill right this time. The world is looking to us for leadership. William M. Isaac is chairman of Secura Group, a leading financial institutions consulting firm, operating as a division of LECG LLC. Before founding Secura in 1986, he served for nearly eight years as a member of the board of directors of the Federal Deposit Insurance Corp. and was FDIC chairman from 1981 through 1985. Comments
From: Steve Beranek,
The problem is that we live in an age of entitlement. People thought that they were entitled to things eg. big home, that they trulty could not afford. Once these families became so far in debt they could no longer be consumers. Their only option was to not pay their mortgage- especially since they had no equity. I believe many of these people could still make their mortgage payments, but there is no incentive. Part of the TARP should be that if a family defaults on a home loan that this would become part of their permanent financial record. For them to ever buy a home again would require at least 20% equity. Additionally, families should not be given so much credit card eligibility. This maximum should be no more than six months wages- no matter what their net worth.
Posted on:
October 9, 2008 1:21 PM
From: erich@dmicapital.com,
It saddens me that someone like Mr. Isaac opposes fair value accounting, i.e. accurate financial statements. Have any of the large banks which have failed recently reported a negative equity? No. Does Mr. Isaacs propose that private contracts containing collateral clauses be voided, to prevent cash calls? Because that is the only sure way to make lenders ignore reality. I have a super duper idea. How about we change accounting rules so that all failed financial companies get a credit. Credit = (Liabilities - Assets) * Adjustment Factor. The Adjustment Factor initially is set at 10, but can be increased at any time by the Sec Treasury. Presto, everyone is solvent! Finally, why does he want to hurt people who haven't bought homes yet by inflating housing prices? Shouldn't we all be opposed to artifically inflated prices, by now?
Posted on:
October 9, 2008 1:30 PM
From: Jim D,
Clearly Rome is burning, and we need to take fuel away from the fire. FASB 157 will be viewed by historians as the Smoot-Hawley bill of this decade. A bill that might have been well intentioned, but one that carried disastrous unintended consequences. I agree w/ the author, lets patch the holes in this boat and live to come back and fix the real issues during a calmer time.
Posted on:
October 10, 2008 10:24 AM
From: Ralph Monda,
Bill, I have some ideas that may help with the stimulas.Also other means for Gvmt.to be paid back from Wall St.Also some insight on compensation.If you recall I was the one at the time that won almost all of the Dealers ie; G.S.,S.B.,Drexel,lehman etc;.We serviced them from Gvmt and Muni clearance funding repos et all one stop shopping.
Posted on:
February 25, 2009 11:55 AM
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Your statement on fair value accounting is the worst idea ever. By the govt. using the TARP to set a price for securities in the market, they're effectively increasing the mark to market value of securities banks are holding and will thus restore a large part of their capital base. If you think early 2000 was bad with accounting fraud, the SEC taking the legs from under FAS 157 is going to create that sort of environment all over again. Then in 5 years when there are a ton of 'walking dead' - i.e. companies who have been hiding dirty secrets on their balance sheet, you'll say that we should have seen this coming. Fair Value accounting protects investors overall - this is a 4+ sigma event we're experiencing and should not cause us to rethink good policies that were put into place for a very good reason.