Mistakes Of the Past Live Again
03 October 2008 – The New York Times – Late Edition – Final – 1
”Reality is bad enough. Why should I tell the truth?” — Patrick Sky, songwriter
As the ideas fly for saving the financial system, it is amazing — and appalling — how many of them seem to be straight out of the playbook from the savings and loan crisis.
Then, as now, Congress decided to reassure investors by more than doubling the amount of deposits that could be insured. Then, as now, legislators put pressure on regulators to change accounting rules to make the financial institutions look healthier than they were.
”It turned a $25 billion problem into a $350 billion problem,” said Robert R. Glauber, who was under secretary of the Treasury from 1989 to 1993 and put together the Resolution Trust Corporation, which eventually sold off all the bad assets the government received from failed savings and loan associations.
The raising of the deposit guarantee limits in 1980 to $100,000, from $40,000, made depositors less concerned about the health of their institution, and made it easier for dying institutions to attract deposits. Raising the figure to $250,000 now could have the same effect.
In 1981, regulators allowed troubled savings and loans to issue pieces of paper with the Orwellian name of ”income capital certificates.” In fact, the thrifts had neither income nor capital, but the certificates allowed them to pretend they were solvent. That let them stay in business for years to come, during which time they could gamble, and lose, much more money.
Now banks and legislators are pushing for a change in accounting rules to end mark-to-market accounting for financial assets. They are sure that market values are too low, so why not just assume they are really higher?
That illogic has caught on, particularly among Republicans. The bailout bill calls for a study of the damages caused by mark-to-market accounting, and invites the Securities and Exchange Commission to suspend the rule.
Apparently in response to that pressure, Christopher Cox, the chairman of the S.E.C. and a former Republican congressman, put out a clarification of the rule that might have persuaded all sides that he stood with them.
The American Bankers Association concluded that he had slapped down auditors who were forcing banks to unreasonably reduce the value of assets no one was buying. Some accountants thought the statement would not change anything. Auditors cringed, awaiting appeals of clients to let them value assets as they please. They worried more when they learned that Mr. Cox wanted to meet with the heads of all the big accounting firms, something he will do on Friday.
This may yet prove to be a brilliant move from the most political — and least market-oriented — S.E.C. chairman I can remember. It could persuade Congress not to make things worse, and not really give the banks new permission to fudge their books. But even if that happens, it has reinforced the impression that this S.E.C. responds to political pressure, and that is not good. Told that I was writing about political influence and the S.E.C., Mr. Cox declined to be interviewed for this column.
The accounting furor came only weeks after the S.E.C. hurriedly put limits on short-selling, and then increased them. The toughening of the rules came hours after Senator John McCain, the Republican nominee for president, said Mr. Cox should be fired because he had not done enough to protect companies from short-sellers.
Whatever the virtue of those rules, the fact that few people, in or out of the S.E.C., were consulted before they were issued led to a series of amendments and made the commission appear disorganized.
It was almost 8 p.m. Wednesday — the evening before the short rules were to expire — by the time the commission announced it would extend them. Now you cannot sell financial stocks short until Oct. 18, or three days after the bailout legislation is passed, whichever comes first.
Mr. McCain chose to get involved in the accounting fight as well, but this time he praised the commission. ”John McCain is pleased to see that the S.E.C. has finally decided to permit alternative accounting methods to mark-to-market accounting for securities where no active market exists,” his campaign said after the S.E.C. interpretation was issued, taking for granted that the bankers had prevailed.
”There is serious concern that these accounting rules are worsening the credit crunch, making it difficult for small businesses to stay afloat and squeezing family budgets,” the statement, attributed to a McCain adviser, Douglas Holtz-Eakin, continued. ”In March, John McCain called for a meeting of accounting professionals to discuss whether mark-to-market accounting was magnifying problems in the financial markets.”
This is the same Mr. McCain whose Senate career was nearly derailed by his involvement in the savings and loan scandal, when he and other senators forced meetings with regulators in a successful effort to avoid the seizure of Lincoln Savings, a thrift controlled by Charles Keating, who was a major contributor to the senators. The argument then was that Lincoln was sound, despite the numbers.
Lincoln‘s eventual failure cost the government $2 billion, far more than it would have cost had regulators acted sooner.
Mr. McCain has said that the ”Keating Five” scandal showed him the dangers of loose campaign financing laws. It evidently did not show him there was any danger in calling for lenient accounting rules to beautify bank balance sheets.
It is possible, perhaps probable, that many mortgage securities are undervalued now, amid the kind of uncertainty and fear that caused investors to doubt whether AAA-rated General Electric was really safe. But the solution is not to give the banks a new license to print the numbers they choose. ”Sophisticated institutions are afraid to trade with each other,” Mr. Glauber said, ”because they don’t believe each other’s balance sheets.”
To get them to believe will require a lot of capital to be injected. The plan from Henry M. Paulson Jr., the Treasury secretary, calls for the government to buy securities from banks for more than current market value but less than the government hopes they will be worth someday.
Whether it will succeed depends in part on whether banks conclude that other banks are solvent after the money arrives and the dodgy securities depart.
On Thursday, as the politicians considered whether to push for bad accounting, the International Monetary Fund issued a report on financial crises around the globe. One part had recommendations for government action:
”Speed is of the essence to minimize the impact on the real economy,” wrote Luc Laeven, an I.M.F. economist.
”Too often,” he added in what could have been a description of how the S.&L. crisis was mishandled, ”regulatory forbearance and liquidity support have been used to help insolvent financial institutions recover — only to have it become clear later that delaying decisive intervention increased the stress on the financial system and the economy.”
To avoid that mistake, he said, ”policy makers should force the early recognition of losses and take steps to ensure that financial institutions are adequately capitalized.”
Patrick Sky was one of my favorite singer-songwriters in the 1960s. I don’t think the bankers have licensed the song quoted at the top of this column, but it would be an appropriate choice.
Personally, I think it is foolish for the banks to mount this campaign. It will raise more questions about the value of their assets when many investors — as well as the banks themselves — already doubt the numbers.
But these are the same banks that got into this mess by creating and buying the toxic securities that they now claim are worth more than they will pay for them. Foolish decisions from such institutions should not come as a surprise.