Investor Zachary Karabell writes persuasively in the Wall Street Journal that “mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all.” Many banks have taken huge losses on mortgage-backed securities and their derivatives because the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values, sometimes by as much as 100 percent, when the underlying home values embedded in the mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.
Bad accounting rules like this are sinking the financial system. And why hasn’t the SEC restored the up-tick rule to stem cascading share-price declines triggered by manic short-sellers? Short-sellers are an important part of the stock market, and they add liquidity at crucial junctures. But until July 2007, they could only short a stock after the share price rose, not while it was continuing to decline. The SEC also should restore the net-capital rule, which limits banks to a 12-to-1 leverage ratio governing their debt. Over-borrowing by Wall Street is what got many firms into deep trouble.
A gathering consensus also seems to be forming around a new version of the Resolution Trust Corporation, which effectively disposed of bad savings-and-loan assets in the early 1990s. A new RTC could purchase underwater assets that proliferate through the financial system and are clogging the credit and loan arteries of our banks.
We clearly are in an emergency moment. But the government should opt for smart regulatory action rather than broad-based interference that could stifle the free economy. On Thursday afternoon, as rumors spread that Paulson was talking President Bush into a new RTC, the stock market soared 400 points. That’s what I call an endorsement.
The pessimists are now talking about the end of capitalism or a permanent decline of America. I don’t believe that for one moment. Specific regulatory reforms can get us out of this fix. And most of all, policymakers must maintain the low-tax, low-inflation, open-trade formula that has propelled this nation’s economy and produced so much prosperity for so long.
I say, never sell America short.