Let's Play Pretend: Letting Banks 'Mark to Make-Believe'

Many of the problems presently facing the world financial system (and consequently the world economy as a whole) can be blamed squarely on the deregulation of American super-banks. Although it would be a somewhat hollow gesture, one of the primary pursuits of policy-makers probably should be to un-deregulate the U.S. banking system, and bring these super-destructive super-banks to heel.

Unfortunately, it seems that quite the opposite is going to happen. The Financial Accounting Standards Board has just untied one of the few remaining mooring lines holding these super-banks to reality. The change in policy means that banks will no longer need to mark their mortgage-backed securities to market values, but rather "value the securities instead at their value in a normal market."

The problem centres around this concept of a "normal market." Who defines what "normal" is, and how it is defined? We sincerely doubt the FASB will be defining "normal." The most likely definer is the super-banks themselves. These banks are not known for their, shall we say, sobriety. Simply put, the FASB has effectively allowed banks holding mortgage-backed securities to value them in their favourite manner: marked to make-believe.

If this isn't an invitation to cook the books, we don't know what is. Given the track record of these super-banks, we would be very surprised indeed if this new policy isn't thouroughly abused to the hilt. Now that the super-banks can call the value of their mortgage-backed securites whatever they wish, they can use them to effectively wipe out most (if not all) of their gambling debts. They will then appear much stronger (i.e. solvent) then they actually are, and thereby dig an even deeper grave for themselves, their customers, and their investors.

The Worst is Yet to Come

What caused this Depression? Can anything be done to make things better? Can anything be done to make them worse?

A lot of things caused this Depression. It might be easier to to list what didn't cause it. At the top of the list would be 'a loss of consumer confidence'. In a nutshell, the origin of the Depression can be found in the prosperity which preceded it. Flaws in the economic system eventually crashed the system. There are many theories of what causes Depressions - many of them have much merit and they are not mutually exclusive.

One theory is that disparities of income and wealth create Depressions. These disparities were glaringly obvious in both the 1920s and the 1990s. So, to answer the second question, perhaps ameliorating these disparities would be helpful - some novel approaches could include creating a maximum wage, or introducing property taxes on financial assets. And, to answer the third question, if the opposite direction is being taken by public policy, it is probable that policy is actually making things worse.

In the present bailout-of-banks mode, financial assets are being protected even as millions of ordinary workers lose their jobs. The result of this is that the very wealthy are becoming less poor than they otherwise would in a freer system, while workers become comparatively much poorer. Thus disparities of wealth and income are not being allowed to narrow and lay the groundwork for a healthier economy. Public policy is actually making the situation worse.

Another theory of Depressions is that too much capital has been allocated towards uses where it is not really productive. This applies very neatly in the present circumstances to - say - automobile manufacturers or making McMansions in exurbia. What could be done to make things better is allow capital to slip away from these uses and towards what people want. Unfortunately, public policy is attempting to prop up both failing automakers and sagging house prices. Again, this will make the Depression worse.

We could go on. At almost every step, the reaction of policy makers is not only to not do helpful things, but to do exactly the worst possible thing. It's going to be a rough ride, folks.