Fed & Treasury Needs to Stop Targeting Asset Prices

The 110-page “Emergency Economic Stabilization Act of 2008” has been written, and is going to Congress today.

Market reaction has not been favorable. As of 5:53am, Dow Futures are off 200, and Europe is trading 3% lower.

All of this points to an issue that I have yet to hear addressed directly: Targeting of asset prices, such as houses and stocks, rather than credit markets and systemic risks. It began under Greenspan (recall the “Put”), but under Fed Chair Bernanke started in January 2008.

Throughout this crisis, there has been chatter and attempts to stop the freefall in Housing prices — something that is counter-productive. Unless we want a Japan like decade of recession, we need to allow the various bad assets to seek their own levels via the open market.

Over the past few years, all the Fed has accomplished with this asset price targeting has been to prevent any capitulatory washout from taking place.

A classic example of this misguided asset price focus is in the Bailout’s suspension of mark-to-market pricing:


(a) AUTHORITY.—The Securities and Exchange Commission shall have the authority under the securities laws (as such term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board for any issuer (as such term is defined in section 3(a)(8) of such Act) or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.*

That seems to be pulled straight from the Bank of Japan’s playbook: Take the right downs later rather than sooner, once the market returns to normalcy. That’s a deeply flawed philosophy.

Former SEC Chair Arthur Levitt lectures the Congress on why mark-to-market is so important.

“That’s why it’s both dismaying and puzzling that as Washington debates the Treasury’s bailout proposal, some of the largest banking and financial services trade groups are aggressively lobbying the SEC to suspend the mark-to-market, or fair-value, accounting standard currently in place, and to oppose any expansion of it.

To ask for a suspension in fair-value accounting is to ask the market to suspend its judgment. These trade groups claim that the fair-value accounting standard has distorted banks’ balance sheets, and has contributed significantly to the market’s volatility.

On the contrary, that gets things backward. It is accounting sleights-of-hand that hid the true risk of assets and liabilities these firms were carrying, distorted the markets, and have caused investors to lose the confidence necessary for our markets to function properly.”

What the Fed, Treasury and SEC seems to fail to understand is that you CANNOT get a return to normalcy after a bubble — not until prices are allowed to fall to levels that bring in aggressive buyers. That is true for stocks, houses, and even financial institutions.

The plan as it is currently constructed fails to recognize that Housing prices still remain elevated, more foreclosures are likely, and that another 10-20% downside in real estate is quite likely.

Instead of focusing on asset prices, we should be looking at recapitalizing the banking institutions, providing liquidity to those that need it, and managing insolvency via FDIC.

Its time to fix what’s broken, and leave the assets pricing to the markets.


Futures Update: Dow futures down further at 7:02 am, with fair value approaching minus 237 on the Dow . . .


_______________ * The EESA also calls for a study of mark-to-market: “SEC shall conduct a study on mark-to-market accounting standards as provided in Statement Number 157 of the Financial Accounting Standards Board” SEC. 133. STUDY ON MARK-TO-MARKET ACCOUNTING.


Previously: Fed’s Folly: Fooled by Flawed Futures? (January 2008) http://bigpicture.typepad.com/comments/2008/01/feds-folly-fool.html

Source: How to Restore Trust In Wall Street ARTHUR LEVITT JR. and LYNN TURNER WSJ, SEPTEMBER 26, 2008 http://online.wsj.com/article/SB122238715655877159.html

Originally published at The Big Picture and reproduced here with the author’s permission.

3 Responses to "Fed & Treasury Needs to Stop Targeting Asset Prices"

  1. Guest   September 29, 2008 at 10:05 am

    This FRB should be blown away. Support HR 2755 ABOLISH THIS FRB nationalize the Central Bank system

  2. Guest   September 30, 2008 at 3:21 pm

    Even the Financial Accounting Standards Board’s couldn’t figure out how to deal with the mark-to-market accounting shortly after the Enron debacle. Even the Arthur Andersen accounting firm had problems with it which led to its failure too. Enron filed for bankruptcy 2001. The Financial Accounting Standards Board’s has had 7 years and they did nothing. nomedals.blogspot.com

  3. Guest   September 30, 2008 at 6:03 pm

    The reason FASB 157 is killing the banks is because in the CDOs and Mortgages there is 2 distinct things. CASH FLOW and underling asset value. These can differ. In the entire USA 6% of mortgages are behind and 3% are in foreclosure. that means that Nationwide 90% of people are paying their mortgages(90% of cash flow still there) BUT as a nation the housing prices have dropped anywhere between 15-40%. Because of the standard Banks are required to write off 40% of the asset. Even though it is still producing 90% of its inital return. SO is the asset worth 90% or is it worth 60%? OR maybe somewhere in between? FASB 157 makes Banks write down the entire 40% and expense it as a loss at the time of the write down. I dont know the answer but that is what is killing the banks capital.. Cash flow is not keeping up with total writedowns.