Everyone agrees that no women’s
basketball team in the world can beat the Los Angeles Lakers. Change just one
rule however, and you can change the outcome of a game. Make everyone play in
high heels!
There’s lots of angst over how
effective will be the Rescue Plan with $700 billion of taxpayer’s money and will
the culprits responsible for the credit crisis be rewarded or punished. Daily
more and more information is elicited about Fannie Mae and Freddie Mac’s role in
sparking the collapse of the credit markets. Also, the hidden role of the Wall
Street giants: investment banks that irresponsibly held 3 dollars in reserve for
every hundred dollars loaned out. And did credit industry regulations or
deregulations contribute and magnify the situation? Incredibly, today we’re
learning with trepidation the Credit Default Swap market may dwarf everything so
far and hence, yet a bigger threat ($45 trillion vs. the $7 trillion mortgage
market) awaits us.
Once you get past the Federal
Reserve’s increase in the money supply (cheap money) without which widespread
economic booms and bubbles are impossible, the preponderance of evidence to date
points to Fannie Mae and Freddie Mac as eagerly providing a place for Wall
Street banks to dump suspect loans they would never keep in their own
portfolios. Fannie Mae and Freddie Mac were created by Congress and urged or
pressured by Congress to facilitate the making of highly questionable loans even
after Fed Chairman Greenspan, President Clinton and President Bush numerous
times objected.
Regulations and not “deregulations”
appear to have caused the second shoe to drop. But we have a centipede and
there are many more shoes to drop. In 2002 Congress adopted the new
Sarbanes-Oxley accounting principles requiring “Mark to Market” of an
institution’s assets at a particular point in time. For instance, if a dozen
distressed homes in your neighborhood suddenly drop 30% in value, a lender that
may have 200 home loans in the same subdivision is required to revalue all of
them at a lower fire sale price even though some or most are not in default. The
lender then has to set aside reserves for all the loans and consequently has
less money available to make other loans.
The absurdity of the regulations
becomes apparent if you look at home prices in Rancho Santa Fe. According to
the July sales statistics, the median priced RSF home plummeted 74.7%. Who
seriously believes that all of Rancho Santa Fe was suddenly worth 74% less? One
day the median priced home is $4,675,000 and the day after Mark to Market is
enforced, they all are worth $1,013,750. Deregulate the requirement, and the
following day the median price returns to $4,675,000. Obviously, this is a
simplistic explanation as there are legitimate reasons for adopting specific
regulations in anticipating future problems. We are, however, losing trillions
of dollars in real estate values because of the unintended consequences of
Sarbanes-Oxley adopted in response the 2001 collapse of Enron. Ask yourself --
is maintaining “Mark to Market” in its present form worth $700 billion? It
might prove interesting to see if changing just one rule, suspending
(deregulating) it would mitigate the situation. Why should any lender have to
write down a loan when all the payments have been made on time?
It’s amusing to hear pundits blame
the free market and failure of capitalism for the situation. Banks may be able
to distribute money but by law they certainly cannot coin it. Only the U.S
Treasury and the Federal Reserve can do this and they are not capitalistic or
free enterprise entities. They are the government – the “Unfree Market.” The
Fed’s “below free market interest rates” fueled the housing boom and every
Congressman, banker and real estate broker loved it!
Even more amusing to hear is so many
people clamoring for more government intervention in the economy with their
blind faith in higher taxes. Let the blind lead those who can see. These people
might just as well turn their economic decisions over to their next door
neighbor. After all, politicians and bureaucrats are just someone’s next door
neighbor, and going to work for the government does not imbue them with some
superhuman knowledge, selflessness, or wisdom. Already by their ignoring the
Fed’s critical role in setting the stage while winking at the discords of
irresponsible homebuyers, brokers, bankers, investors, Fannie Mae and Freddie
Mac -- all are punished!
Defensively, the promoters of always
more rules, sort of Voltaire like, will defend to the death the idea that their
regulations played absolutely no part in what’s happening in credit markets.
Will the $700 billion Rescue Plan
work? Without it things certainly would have gotten worse. Will it solve the
problem? No more than the Bear Stearns take over by J.P. Morgan costing the
taxpayers $29 billion, the FHA $300 billion federal guarantee program, the $200
billion bailout for Fannie and Freddie, the $85 billion AIG bailout, and the
Treasury’s authorization to purchase $10 billion in mortgage-backed securities
has solved the problem. Will more or fewer rules and regulations help? How many
more shoes will the centipede drop?
On the blindingly bright side, when
prices drop 30% to 50% investment opportunities of a lifetime pop up.
