|
You know
something’s up when both the secretary of the Treasury
and the chairman of the Federal Reserve give speeches
calling for a new mechanism to allow them to manage the
orderly liquidation of a major financial institution.
You have
a sense that things are getting desperate when General
Motors has to offer six-year loans at zero-percent
interest to unload its gas-guzzling trucks and SUVs, and
people openly speculate about how long it will be before
the automaker runs out of cash.
And you
can feel the foundation shaking under Wall Street when
Fannie Mae and Freddie Mac have to pay three-quarters of
a percentage point more to borrow money than the US
Treasury, which implicitly guarantees their debt, and
top government officials feel compelled to reaffirm
their support.
We’re
nearing that delicate point in the cycle when even the
usual cheerleaders have hung up their pompoms, consumer
and business confidence has disappeared and investors
are driven mostly by fear rather than greed.
What
started out as a credit crisis and then morphed into a
broader financial crisis has finally worked its way into
the real economy. That economic downturn—a recession,
inevitably—is beginning to wash back on the already
weakened financial sector, creating the kind of
self-reinforcing vicious cycle that is difficult to
control.
This is
the way a market economy corrects for its excesses—in
this case, an excess of cheap debt that had the effect
of inflating the demand for goods and services and the
value of stocks, bonds, real estate and commodities. Now
that that cheap credit has disappeared, the value of
most of those assets has fallen while some of that
demand for goods and services has begun to disappear.
As part
of that “de-leveraging” process, households and some
businesses are being forced to reduce their indebtedness
either by paying it down or admitting that they can’t.
But it is in the financial sector, where debt was piled
on debt in ever-more complex arrangements, that things
have begun to get real dicey.
Prices
for many credit instruments have collapsed, forcing
banks and investment houses to take billions of dollars
of real or paper losses. Meanwhile, creating new credit
has been dramatically curtailed.
In such
an environment, it is understandable that regulators
want to force banks and other financial institutions to
raise large amounts of fresh equity capital to replenish
what has been written off. It is encouraging that
regulators want to demonstrate that they have learned
from their past mistakes by clamping down on loose
lending and requiring more honest accounting. But there
is a danger in pushing these things too fast and too
far.
While it
may make sense, for example, to require any one
institution to raise billions of dollars in new capital
from equity investors, it may be unwise to make all of
them raise it all at the same time. The effect may be to
unnecessarily increase the cost of that capital, drive
down already-depressed stock prices, jeopardize credit
ratings and raise borrowing costs—hardly a winning
strategy for nursing a financial institution back to
health.
Similarly, we all applaud the belated effort of
accounting regulators to prevent institutions from
hiding liabilities or avoiding capital rules through the
use of “off-balance sheet” vehicles. But requiring them
to make the changes now, in the middle of a credit
crisis, is a bit like throwing gasoline on a fire you’re
trying to put out.
There’s
also the hot issue in regulatory circles of “fair-value
accounting,” which has to do with how to assign a value
to complex securities that are in such bad odor that
they can be sold only at a deep discount to the value of
the assets that lay behind them.
Accounting purists want to force banks to value these
securities at current market prices and take the huge
writedowns, arguing that if and when the markets
recover, they can record a profit in future quarters.
But things will never get to that point if, as a result
of massive writedowns, these institutions are put out of
business or forced to raise cash by selling the
securities into already-depressed markets.
A
financial crisis like this one calls for policymakers
and regulators who can keep a cool head and remain
flexible and practical rather than insisting on strict
adherence to economic orthodoxies. Not every instance of
regulatory forbearance need be viewed as a step down a
slippery slope toward Japan-like stagnation.
Nor is
it particularly constructive to characterize every
instance of government involvement in the private
sector—whether it be refinancing a troubled home
mortgage, opening the Fed lending window to
cash-strapped investment banks or orchestrating a
private-sector rescue of a failing hedge fund—as a
massive government bailout.
As for
Fannie and Freddie, nobody would be particularly happy
if it became necessary for the Treasury to inject some
fresh capital into the mortgage
giants, in exchange, say, for newly issued preferred
stock that could be sold back at a profit when the
mortgage market recovers. But even the editorialists at
the Wall Street Journal acknowledged that this wee bit
of socialism might be the most effective and least
costly way to keep the mortgage market functioning and
prevent a meltdown in global credit markets.
A
financial crisis is not a morality play. What matters
most isn’t the precedents that are set, the amount of
taxpayer money that’s implicated or whether people are
made to suffer fully for their financial misjudgments.
In the end, what matters most is that we get through it
as quickly as possible with an economy and a financial
system intact. |
