ON SOLUTIONS FOR THE CREDIT CRISIS

AVOIDING THE BRINK

Steve Forbes has two prescriptions on how to end our current financial crisis.  Both make sense, but the second one especially deserves some attention since it's not been as discussed by the investment community as perhaps it should be.  Here's what he suggests to start:

"The Bush administration must take two steps immediately to quickly halt the unending, enervating credit crisis: shore up the anemic dollar and, for the time being, suspend "marking to market" those new financial instruments, such as packages of subprime mortgages."

The piece then goes on to discuss both in detail, but I'd like to highlight in particular what says about the second suggestion:

"The other measure: The Treasury Department and the Fed should get together with the SEC, the Comptroller of the Currency and other bank regulators and announce that financial institutions for the next 12 months will no longer write down the value of exotic financial instruments (primarily packages of subprime mortgages).

Instead, writedowns will occur only when there have been actual losses on those assets. If a mortgage defaults, a bank will then--and only then--recognize the loss.

It's preposterous to try to guess what these new instruments are worth in a time of panic. Such assets are being marked down to increasingly arbitrary low levels. But when a bank books such a loss, it must replenish depleted capital, even though cash flows for most financial firms are still positive.

Worse, when forced by panicky regulators and lawsuit-fearing accountants to write down the value of these securities, institutions will dump assets in a market where there are temporarily few or no buyers. The result is a spiraling disaster. So let's have a time-out on markdowns until we actually have real experience in what kind of losses are actually going to occur."

There are of course negative consequences and execution issues surrounding both suggestions. 

But these are extraordinary times, and many other suggestions to address the crisis are far more motivated by political considerations (the $150 billion plus "bipartisan" Growth package, comes to mind) than the Forbes prescriptions.

The "marking to market" suspension is one that should be considered in some form.

Comments

[Dennis Chan]

What horrible idea from the supposedly free market champion Steve Forbe! He is really a socialist in disguise. Please don't let the market set the price and let the Big Brother (government) control the price instead. The original sin of all these messes comes from the Fed controlling the price of money, otherwise known as setting the Federal Fund interest rate. It is the ultimate form of price control by the Big Brother and yet it has been going on for so long (almost 100 years?) that the sedated mass don't even question it.