classical economics
for analysis,  forecasting
and policy design

Waiting for Chinook
By Wayne Jett
© March 13, 2009

                                By Charles M. Russell ca 1887                   
By Charles M. Russell ca 1887

    The Winter of 1886-87 killed hundreds of thousands of livestock in the plains of America and inspired Charley Russell’s postcard-sized watercolor of a Montana ranch scene. “Chinook” was the Indian name for a southern breeze bringing warmth in the Spring.
    On February 4, Harry Markopolos testified to the House Sub-committee on Capital Markets that the Securities & Exchange Commission has given license to all big players on Wall Street to engage in fraudulent trading practices without fear of legal retribution. Since then, major business enterprises including General Electric, Bank of America, Wells Fargo and others have stood alone, much like Russell’s starving steer in the snow, fending off circling wolves and hoping for a warm breeze.
Kanjorski’s Hearing
    A hint of warm breeze came March 12, also from Chairman Paul E. Kanjorski’s Sub-committee on Capital Markets, which heard testimony from two panels regarding effects of “mark-to-market” accounting rules on bank capitalization. The first panel, comprised of SEC, Financial Accounting Standards Board and Controller of the Currency representatives, was complacent with the status quo, intimating further clarification might be forthcoming within three months. Irate members of the Sub-committee promptly extracted a commitment from FASB to act by April 1 or the Sub-committee would proceed with remedial legislation.
    The second panel of seven presented excellent testimony from beginning to end, depicting outrageous accounting treatment of financial assets under rules adopted primarily in November, 2007. Even after evaluation of cash flow, underlying collateral and delinquency status of individual mortgages in portfolios, auditors and regulators insist upon valuation based on market bids for purchase. Portfolios of AAA securities performing at 98 per cent have been marked to 65 cents on the dollar, thereby destroying billions in bank capital and trillions in bank lending capacity.
Isaac, McTeer, Others Answer
    Each member of the second panel deserves specific mention because each told specific facts that demonstrate so clearly the absurdity of present accounting regulation. Each seemed better than the last. Of the seven, Bill Isaac, former FDIC chairman under Carter and Reagan, was most outstanding due to his close familiarity with banking and his willingness to speak somewhat directly towards the misfeasance of regulators. At least to a degree, he openly joined members of the Sub-committee in viewing FASB and SEC as complicit in causing the problem and urged legislative action to “nail ‘em” rather than allow further delay and destruction of capital.
    With all of this said, by the time SEC and FASB returned to their suites, most likely they concluded the Senate’s Chris Dodd and Charles Schumer will quash any similar legislative sentiments in that chamber. FASB will probably offer an inadequate response after April 1, thus requiring first quarter reporting according to the existing insanity, and the accounting can will be kicked down the street at least a period of months. The likelihood of a corrective bill signed into law promptly is almost nil. Remember, FDR didn’t end mark-to-market accounting until 1938, five years after he took office, although its flaws were obvious from the outset. Similar short-side influences are active in Washington today.
    Such influences may have inspired the comments of House member Alan Grayson (D-FL) to the second panel. Mr. Grayson complained they were “trying to change the rules in the middle of the game” and asked why he should not be entitled to “longer inches” so he could be 5’8” rather than 6’4” and would not bump his head as he goes through doors. Supercilious rhetoric flows when predatory billionaires tell a politician to get out there and say something. If Mr. Grayson is unaware his comments lend aid to financial racketeers, he should be educated.
Cover Story for Naked Short Selling
    Another negative to be acknowledged is that mark-to-market accounting provides the cover story for naked short selling assaults against financial shares. Sophisticated investors know marking down the book value of mortgage assets does not change their real economic value, so they would not dump their long positions due to such a write-down. But naked short selling, particularly by market makers in credit default swaps and options destroys the share price of a financial firm holding those mortgage assets. This destruction of share price by naked short selling occurs with mark-to-market rules as cover story for why it is happening, but can also continue just as effectively without mark-to-market. All the naked short sellers have to do is spin the slightly more convoluted story that “the market” doesn’t believe the true value accounting and insists on pricing shares at severely marked-down levels.
Nail ‘Em!
    In short, “Chinook” has not come. The killing winter still prevails in financial markets. Actions necessary remain as follows:
(1)    End mark-to-market FASB Rule 157;
(2)    Enforce prohibition of all naked short selling, including by market makers of options and credit default swaps under the “Madoff exemption;”
(3)    Declare void all credit default swaps except to the amount of underlying bonds delivered by the claimant; and    
(4)    Remove SEC discretionary authority over investigation and prosecution of financial crimes, and create a special strike force in the Department of Justice for the purpose, including recovery of stolen proceeds.
    Contact your congressmen and senators. Grab them by their lapels. This is not over. If ordinary Americans do not capture the allegiance of both the House and the Senate on these issues now – not two years from now – the existing Great Depression will deepen and extend. ~