All the Regulators Need is More Power?
As we embark down the path of sweeping regulatory reform of the US financial system, it useful to review the results of the previous reform. Supposedly, accounting standards were overhauled and clarified under the Sarbanes-Oxley Act of 2002 to prevent companies from using accounting trickery to obscure their published financial results.
In recent days, a number of financial blogs have been agonizing over a letter from the SEC to certain public companies on SFAS 157, a new accounting rule for valuing asset backed securities such as those backed by collapsing mortgages. The SEC letter is supposed to clear up confusion over the rule, but it so poorly written and convoluted that companies are having difficulty interpreting it. Some are reading it in totally conflicting ways.
Read it yourself and see if you can make any sense of it.
Frustrated observers have taken to mocking the signature on the letter by a "Senior Assistant Chief Accountant," which does little to clarify the letter's authority.
People like the author of this letter are to be given enhanced new regulatory powers in the next wave of reform in order to prevent "the next Bear Stearns," which previous attempts at regulatory reform have failed to even diagnose properly.
Comments (9)
You seem to say that this new layer of regulations will soon be outpaced by the market, and I totally agree that this leads to a useless arms race.
I think I have read something like this, but I cannot remember where :
Fractional banking leads to a bank panic and prudential ratios are put in place, so banks are held back by these rules. But either they come up with new financial innovations, or new financial institutions (i.e. SIV's) jump in to seize the opportunity. This leads to a new round of regulations, new financial innovations, and a new panic, etc. In the end, the regulation has to extend beyond the "financial sphere" and rule which kind of entrepreneurial risks can and cannot be taken.
Can anyone help?
Published: April 1, 2008 2:02 AM
Here's how this works: you start with a system of essentially free enterprise. The government makes small interferences supposedly to make the "system" work better and make everybody (translated as the voters) richer and safer (both at the same time since no voter wants to hear about risk-reward trade-offs with their livelihood) than they would have been in a system where dog-eat-dog competition determined all economic outcomes.
These small interferences always have the effect of privatizing profits and socializing losses, because that's the only power the government really has, it can't make losses go away it can only spread them out over the population by force. These initial interferences cause the price of something to outpace it's real value (all upside , no downside) - and the market always corrects these situations eventually. When the market corrects there is always some big financial entity who is leveraged and threatens to take the whole thing down, because the government has artificially removed the risk for the players.
These crises always go the same way: During the panic phase the government wants to do anything to keep prices from going down (which is always the character of these crises) regardless of whether the prices are justified by economic reality. This phase always ends with the people with concentrated wealth getting bailed out because they are the only ones who have a significant effect on the system as a whole, arguments about too big to fail, etc.
The next phase comes when the voters get angry because a bunch of rich guys got bailed out by the taxpayer and they are having to pay for it. This is because the obvious result is that a bunch of rich guys get bailed out. What isn't as obvious is that the government has "fixed" this problem by making everything worth less, but appear to be worth more (inflation).
There are always 2 paths here: the government could remove the interferences with the market that caused the problem in the first place OR they can add more interferences to try and keep the last problem from happening again. These are usually regulations and new powers for the government to keep prices from going down, instead of preventing them from making them go up first place.
And so the next house of cards is built.
The inevitable outcome in the aftermath is as following: If the government is going to bail out rich guys who get themselves in over their heads and threaten to take down everybody then the government has the right to regulate their behavior in return, to supposedly make sure that the last crisis is not repeated. This is the moral dilema. Is it better to have a back-stopped system where private parties enjoy the profits and the tax-payer pays for the losses, or a system where the government eliminates the private profits all together and just runs the system "for the good of the people"?
Crony-capitalism (which really isn't capitalism, it only looks like it) or socialism? These are the false choices we are left with - and since we spent 200 years getting to this point it really doesn't feel like a revolution at all, it feels like a natural progression that couldn't have ended any other way.
Friedrich Hayek wrote a book about this.
Published: April 1, 2008 6:38 AM
DS: Nice.
Published: April 1, 2008 9:07 AM
DS,
Well put. You are right, it's not a revolution, it's a historical process. I like Rothbard's definition: (to paraphrase) that history is the struggle between power and freedom.
The nature of power is to serve power (the few), against the natural state of man: freedom (expressed in the will of the many).
Hayek outlined the consolidation of power in The Road to Serfdom and demonstrated the negative calculation of the political as apposed to the economic. Hayek's analysis fits nicely with the Rothbardian definition. The self-created crisis allows the "system" to consolidate further in a gradual "ratcheting effect" (Gary North's term).
Finally, we have Mises defining liberty with property. I believe this gives us the proper conceptual framework in understanding the existing historical process: central bankers are given a monopoly allowing them to inflate. The process of inflation creates a kind of hidden lien against all property. We know that this is simple confiscation by stealth, so naturally it's an erosion of property (freedom) for the benefit of power.
The end-game to this process is certainly Orwelian. I personally like Rothbard's ideas regarding revolution, and I believe that his basic premise states that revolution is the will of freedom against power. So perhaps in the final analysis revolution is the only tool at the disposal of the many against the few.
Published: April 1, 2008 10:38 AM
one more point and my rant will end: I think that the best way to conceptualize "market corrections" is to think in a Rothbardian framework. If the "crisis" is instigated by power (expressed through inflationary confiscation), then logically the correction is property (freedom) re-establishing its ability to appraise its true worth; in reality it's the will of the many expressed through property establishing itself against power.
This is the gunius of the Austrians: creating the intellectual tools to accurately understand not just economics, but history as well. a priory logic can give us a view of the fundamental and often conter-intuitive nature of reality.
Just as Einstein's conceptual framework of the nature of physical reality contradicted our intuitive understanding of the physics of our existence, so Austrian conlusions reached through the same revolution of conceptualization contradict our "common sense" understanding of economics and history.
If one can construct a universe around E=MC2, than certainly we can contruct a civilization around the concept that force and violence are wrong.
Published: April 1, 2008 11:05 AM
Although we are most likely “embarking down a path of sweeping regulatory reform” and while it will result in the adverse consequences listed here, SFAS 157 is not the culprit. The standard addresses all corporate assets, not just asset-backed securities. There are several occasions when the accounting standards require that assets are booked at their fair value, which is an accounting term that really means market value. SFAS 157 just clarifies what fair value means and recommends using the same valuation techniques that have always been used. The only problem that I have with it is that it does not permit a marketability discount for bulk securities.
Published: April 1, 2008 6:22 PM
is sfas 157 going to be applied to banks?
Published: April 2, 2008 10:32 AM
well, actually that rhetorical question is expressed rather poorly. what the question should be is: how could the fed not avoid embarassment (with its opaque valuation process for purchasing bank' paper), whilst corporations get the sfas157 treatment?
Published: April 2, 2008 10:52 AM
SOX, typical Govt. The Govt. tries to solve the problem, but creates all new problems. Negative externalities.
Published: April 2, 2008 10:56 PM