Reforms often do more harm than good.
This is currently the case with the "mark-to-market"
rule, which is imploding the US financial system by requiring financial
institutions to value subprime mortgages
at their current market values.
This makes a big problem for balance sheets. These financial
instruments became troubled prior to a market being established for them, as
they were marketed direct from issuers to investors. Now that they are troubled
and with their true values unknown, no one wants them. Their lack of liquidity
assigns them a low value.
The result is tremendous pressure on balance sheets. The
plummeting value of subprime derivatives is pushing institutions that own them
into insolvency, destroying their own stock values and forcing the financial
institutions to sell untroubled liquid assets, thus resulting in an overall
decline in the stock market.
The solution is to suspend the mark-to-market rule. Instead,
allow financial institutions to keep the troubled instruments at book value, or
85-90 percent of book value, until a market forms that can sort out values, and
allow financial institutions to write down the subprime mortgages and other
troubled instruments over time.
Suspending the mark-to-market rule would take pressure off
the stock market and make it unnecessary for the Fed to lower interest rates in
an effort to force liquidity into the economy through an impaired banking
system. The problem is not a general lack of liquidity, but liquidity for
poorly conceived new financial instruments. Low US interest rates could worsen
the crisis by accelerating the dollar�s decline. Now that inflation has raised
its head, more liquidity from the Fed adds to the economic distress.
It is mindless to allow a "reform" to cause a
financial crisis, but that is what is happening. Unfortunately, there are
people who argue that anything less than financial Armageddon would create a
It is certainly true that securitized subprime mortgage
instruments were a bad idea, that a lot of people who should have known better
opened floodgates to greed and fraud, and that "somebody should pay."
But it shouldn�t be the general public and the economy that pays.
It is also true that without the Federal Reserve�s
irresponsible low interest rate monetary policy, which produced a housing boom,
the subprime instruments would not have been created, or at least not in such
amounts. Rapidly rising real estate prices were expected to make the risky
loans good. What were issuers and the Federal Reserve thinking?
No doubt but that greed, fraud, and bad policy all played
their roles. But at the heart of the problem is a 1999 "reform" that
repealed an earlier reform known as the Glass-Steagall
In 1933 the Glass-Steagall Act separated commercial banking
from the securities business. It prevented securities speculation from
destroying bank capital and shrinking bank deposits from bank failures and runs
on banks by depositors. Congress and President Bill Clinton foolishly repealed
the Glass-Steagall Act in 1999.
The repeal of the 1933 law was driven by profit lust in the
banking industry and by "free market" ideology, which claims the
unfettered marketplace is always superior to regulation. In pushing the repeal
forward, Congress and Clinton ignored warnings from the General Accounting
Office that the banks needed to build up their capital levels before being
permitted to enter a broad range of securities businesses. The GAO also noted
that there were no regulatory structures in place to monitor the new financial
networks that would result from removing the wall between commercial and
However, greed and ideology won over sound advice. The
result is a crisis that, if mishandled, will be calamitous.
Craig Roberts [email him] was
Assistant Secretary of the Treasury during President Reagan�s first term.
He was Associate Editor of the Wall Street Journal. He has held numerous
academic appointments, including the William E. Simon Chair, Center for Strategic
and International Studies, Georgetown University, and Senior Research Fellow,
Hoover Institution, Stanford University. He was awarded the Legion of Honor by
French President Francois Mitterrand. He is the author of Supply-Side
Revolution : An Insider's Account of Policymaking in Washington; Alienation
and the Soviet Economy and Meltdown:
Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton
Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the
Constitution in the Name of Justice. Click here for Peter
Brimelow�s Forbes Magazine interview with Roberts about the recent epidemic of