The Obama administration, under the leadership of National Economic Council Chairman Lawrence Summers and Treasury Secretary Timothy Geithner, has announced forceful plans to put the financial crisis behind us.
Sadly, much of what the administration must cure has been caused by well-intended but flawed rules and regulations, many of which are strongly pro-cyclical. If these rules and regulations are not changed, many of the dollars made available through the administration's plans will be soaked up by the black hole of pro-cyclical regulatory demands.
Right now — not after the financial system is burnt down, but right now — we desperately need to suspend and ultimately reconsider mark-to-market accounting at financial institutions, except perhaps for the trading book. Our financial system existed in America for over 200 years without mark-to-market requirements. Many financial assets are very difficult to value, especially when markets are in turmoil, and we continue to mark to market assets but not liabilities. Now is not the time to engage in this radical experiment.
Perhaps the most dangerous aspect of mark-to-market rules is requiring the remarking of other-than-temporarily impaired investments. The impairments are severely driving down the values of held-to-maturity assets. This increases the need for capital and cuts off lending — just what the president and the Treasury secretary want so badly to avoid.
Overly restrictive accounting rules caused many bankers to enter this down cycle with inadequate reserves by forcing increased reliance on mathematical models and less on judgment in calculating the allowance for loan and lease losses. We must not repeat this mistake now and force them to increase reserves above what their best judgment dictates.
Similarly, it is counterproductive now to require capital standards that exceed well-capitalized minimums. The proverbial horse is out of the barn. The imposition of such requirements — when even the best borrowers are having trouble accessing the debt markets — in essence requires bankers to sell their best assets and reduces their capacity to make the safest of loans.
Short-selling attacks are undermining investor and consumer confidence and causing silent bank runs. The uptick rule, which was in place for over 50 years, is gone, and regulators have failed to stop self-serving rumormongering. Everyone in finance knows that some short-sellers spread scurrilous rumors to drive down prices and increase their profits.
Isn't it time the regulatory community dramatically heightened surveillance and penalties for such behavior? We have a new, immensely capable chairman of the Securities and Exchange Commission. Let's hope she brings back the uptick rule and takes other steps to stop short-seller attacks.
Two other rules that need to be changed are the Federal Reserve Board's Regulation 23A and Regulation Y (regarding the acquisition of bank holding companies and banks).
Now is the time to encourage the flexible use of funding within a holding company family. After all, it should be clear that if the holding company is in trouble, so is the bank. Though the Fed has shown admirable flexibility in this area in light of the financial storm, a much more aggressive change in the rules and their application is needed now — if only for a holiday period.
Similarly, the Fed again should be praised for its willingness to be flexible in respect to Reg Y, but now we should open the door much wider, at least for a holiday period, to encourage private pools of capital to come into the banking system. This would save taxpayer dollars, avoid nationalization or failure in a number of cases, and put private-sector money at risk to solve the banking crisis.
The government should take all these steps without delay. Every day agencies fail to act on these matters, more institutions will get in trouble, more taxpayer money will be put at risk, and the economy will decline further.
Also, it goes without saying that bankers should seriously consider the programs that Secretary Geithner announced. However, any bank that can rely on private solutions will be much better off. As everyone can see from the political discourse in this country — whether on talk shows or in speeches — taxpayers are inflamed, and policymakers will exact ever more onerous pounds of flesh from financial institutions that have to turn to the government for financial help.