Monday, September 22, 2008

Bigger, Faster Legislation Is Not Better

A friend of mine once complained that our form of government is often far too slow in responding to issues. I answered that there are plenty of dictatorships where things get done rapidly.

Our Founders intended for government to be a thoughtful, deliberative process. It has been my observation that, except for a small handful of instances, we create bigger problems when everyone in Washington quickly agrees about major issues and politicians on both sides of the aisle line up to pass legislation Pall Mall.

Now, Congress is poised to pass the Bush Administration’s $700 billion “relief package” (aka bailout) of big Wall Street firms that have taken risky financial positions over the past few years (see AP article). You, the American taxpayer, are about to be put on the hook for more money than you can imagine. In a bizarre accounting action, it probably will even be excluded from the federal budget so that we don’t have to feel so bad about it year after year.

A few (apparently very few) are urging a slower, more deliberative approach. Others (including some that actively helped cause the crisis) are clamoring for stronger oversight than is planned by the administration. They also want caps on the salaries of executives of companies that receive a government bailout. But most Washington insiders expect the legislation to pass this week.

Democracy Lover noted in a comment on this post, “Now the "free market" Republicans (with Democratic assent) have engineered the largest nationalization in human history and created the largest socialist bank ever.” And that was before this latest power grab to assume even more control of U.S. financial markets.

Clinton confidante Lanny Davis writes in today’s Wall Street Journal:
“Now I know what former Sen. Gary Hart meant when he told an audience of wealthy Republican businessmen during his 1984 presidential campaign, "I know why you are conservatives -- you favor private enterprise for the poor and socialism for the rich."”
The knee-jerk reaction to all of this is to increase government regulation. The funny thing is that it was more regulation — brought on as the result of the Savings and Loan crisis in the 80s and 90s — that is at the heart of the current crisis.

The CEI’s John Berlau explains in this WSJ article and this subsequent post that mark-to-market rules have caused otherwise stable banks to write down the value of their mortgage assets. The rules were intended to prevent banks from hiding bad loans, but instead they have caused a wholesale devaluation of loans.

Think about it this way. A poorly cared for home in your neighborhood is foreclosed on and sold for 32% of its normal value. Instead of marginally affecting the general home values in the neighborhood, mark-to-market would essentially dictate that all homes in the neighborhood — including yours — are suddenly worth only 32% of what they were worth the day before the foreclosure sale took place.

Berlau goes on to explain that the proposed $700 billion power grab will not only fail to resolve the problem, but will actually function to make matters worse. It will cause more “fire sales,” causing loan values at even stable banks to be marked down to pennies on the dollar. Berlau suggests that this will not save the economy, but will “build a Big Government that serves Wall Street.”

The lesson is that when both parties line up to pass major legislation, you’d better hold onto your pocketbook. I have felt that divided government might generally prevent these kinds of actions, but we have divided government today and we’re still going to pass this bad deal. So just go back to your daily diversions and ignore the massive KA-CHING you hear coming from inside the Beltway and from Wall Street.


Anonymous said...

I have been thinking about the dangers of a fast moving government as well. The only things the government should move quickly on is inconsequential things like renaming the cafeteria "freedom fries."

What risks are we really taking if Congress simply promises to consider this legislation and then does not get around to it until sometime in October. I would think that their assurance to act would serve to calm the market anxiety somewhat for a couple of weeks. After all, many financial institutions are actually relatively immune from the immediate problem.

Scott Hinrichs said...

In an election cycle, politicians believe that it is imperative that they appear to be doing something about the crisis. They are eager to cast themselves in the hero role.

Besides, in a long-held tradition to allow for campaigning, once Sept. 26 hits, no real legislation will be considered until after the November election. So this is their last chance to play hero until November.

Scott Hinrichs said...

If you need something to help you smile about this debacle, watch Uncle Jay's explanation.

Charles D said...

IMHO, the best thing the Congress can do is throw the Paulson plan in the wastebasket and start over.

We have a credit crisis. Since when is borrowing money to reward speculators who took stupid risks a way to solve a credit crisis?

We have a loss of confidence in our financial system due to inadequate regulation, lack of accountability, and rampant greed. So Bush/Paulson want to solve it by handing a trillion or so dollars to a greedy former investment bank CEO to spent as he sees fit without accountability and with no additional regulation?

You're right that politicians need to appear to be doing something, and they also like to keep themselves in a position to deflect blame for things that are or may be going wrong. Well, I hope you will join me is saying that any Congressman or Senator who votes for this package in anything like this form should be voted out of office in November regardless of party.

Scott Hinrichs said...

I will gladly join you in that resolve. I note that none of our senators that are running for president or vice president are going to be present so that they don't have to go on record for voting for or against this legislation.

Scott Hinrichs said...

A couple of former SEC big wigs challenge the view of those like John Berlau that favor dumping the mark-to-market rules in this WSJ op-ed.

They say that "those who blame fair-value accounting for the current crisis are guilty of the financial equivalent of shooting the messenger. Fair value does not make markets more volatile; it just makes the risk profile more transparent."

It makes sense when they write, "This knowledge ... is fundamental to determining whether or not an institution has sufficient capital and liquidity to justify receiving loans and capital. It's like your personal balance sheet: If you say everything you own is worth twice as much as it is in today's market, then you are misleading those who are relying on the data you give them, and you will ultimately destroy their trust and willingness to do business with you."

I will need to study this in greater detail to understand the pros and cons of mark-to-market.