National Public Radio is reporting this morning that the Senate is scheduled to vote tonight on a financial bailout bill that will be at the core the same as the bill defeated in the House on Monday, with a new element making a bad bill worse: the new version would loosen accounting requirements on bank reporting of their assets.
To a substantial extent the financial crisis has been caused by banks being allowed to disguise overvalued or worthless mortgages with the smoke and mirrors of complex "mortgage-backed securities" that created the illusion of hedging against non-performance of mortgage loans without actually doing so. Such securities form part of the "bad paper" so often mentioned in the media, together with mortgages that were unsustainable from the get-go -- in some cases created fraudulently, in others the result of imprudent borrowing -- and with mortgages that were legitimate at the time they were made, but which have been rendered problematic by falling real estate values.
The smoke and mirrors practices were worsened by "bundling" such securities into even more complex "instruments" together with solid or marginal but potentially real-value mortgages, whose value was dragged down by being bundled with the bad paper.
Now the revised Senate bill is proposing a change in bank accounting practices that amount to giving the banks new smoke machines and distorting mirror factories.
The proposal to relax accounting rules appears to be the same as one unfortunately included in the alternative "No BAILOUT Act" (never trust cutesy capitalized acronym titled bills) being proposed in the House by progressives led by Oregon's Peter DeFazio among others. David Sirota describes the provision this way:
Right now, federal law mandates that banks assess their assets on a "mark-to-market" basis - that is, what their assets could be sold for right now, rather than what they could be sold for in the future. The theory is that during a housing and financial crisis, the "mark to market" value of mortgages is artificially low, even though those mortgages represent houses with actual value (for instance, because no one wants to buy mortgages right now, many mortgages are valued at zero on a mark-to-market basis, even though they represent homes that could ultimately be sold for value). Because what a bank can lend out is a multiple of the assets they own, proponents of the accounting change argue that the mark-to-market system is forcing banks to devalue their assets and therefore contract credit. They say that changing the accounting rule to allow banks to list their assets at an "economic value standard" (ie. higher than mark-to-market) will therefore loosen up credit.
The problem with this accounting change is that it would allow banks to leverage even more against assets whose value is still unknown. That, says some opponents, could simply push off - and potentially make more intense - an inevitable day of collapse in the banking system.
(Hat tip to torridjoe in comments at the thread on the DeFazio proposal).
Christopher Hayes at The Nation offers a more favorable interpretation which at least makes comprehensible why progressive lawmakers might support such a move:
1. Require the Securities and Exchange Commission (SEC) to require an economic value standard to measure the capital of financial institutions.
This bill will require SEC to implement a rule to suspend the application of fair value accounting standards to financial institutions, which marks assets to the market value, no matter the conditions of the market. When no meaningful market exists, as is the current market for mortgage backed securities, this standard requires institutions to value assets at fire-sale prices. This creates a capital shortfall on paper. Using the economic value standard as bank examine[r]s have traditionally done will immediately correct the capital shortfalls experienced by many institutions.
However, the reason "no meaningful market exists" is that the previous smoke and mirrors practices rendered the economic value of most of the assets in question opaque and unknown. In those circumstances, it appears that this proposal would allow banks to assign arbitrary nominal values that would shore up the overall appearance of their books, and stave off bankruptcy. But it would not make the real value of the specific "illiquid assets" any clearer, and banks still would not be able to sell them or borrow against them because potential buyers or lenders don't buy or lend against the overall appearance of the books, they buy or lend against the value of specific assets. Thus it will not relieve the credit liquidity crisis.
It is also at the level of the real economic value of property that the related foreclosure crisis rests. A great many of the homeowners facing foreclosure do so because of sharp declines in the real economic value of the properties they bought, such that they no longer provide security for the amount of money they borrowed to buy the property. The foreclosures in turn further lower the economic value of surrounding properties, depressing the economies of entire municipalities and local regions, likewise affecting the value of residential rental and commercial properties, in a cascading vicious cycle that accounting tricks will do nothing to change.
A progressive approach to the conjoined crises needs to begin with the principle of stabilizing the value of real estate and keeping people in their homes. The liquidity crisis should be addressed by rendering the value of mortgages and a more limited, better regulated set of mortgage-backed securities transparent again, re-forming the market by allowing market actors to once again negotiate and agree prices and loans based on assessable values.
Secretary Paulson's proposal could more or less be made the basis of such an approach. It would require very steep discounts in the purchase of the "distressed assets," so that the likelihood that the actual economic value of properties hidden amid the worthless "bad paper" to which it is tied would cover a substantial portion of the public funds used, if not all of it. That risk could be further covered by a securities transaction tax like that included in the proposal by DeFazio et al.
However, at present the Paulson proposal as embodied in the failed and apparently to be resurrected legislation is merely permissive of steps to safeguard public money put into a bailout, and says nothing about the crucial issue of the terms on which illiquid assets would be purchased or how prices would be determined, leaving those matters in the hands of a Treasury Department itself run by Wall Street financiers.
Assets bought under any Paulson-like plan should not be controlled by the Treasury Department, which is too corrupted by conflicts of interest to be trusted. Rather they should be controlled by a newly created entity specifically charged to triage and restructure them into actual mortgages, securities that may prove to have value when the situation is stabilized, and really worthless securities, and to renegotiate mortgages with homeowners based on current property values and affordable payments. That entity should have an explicit preference for such renegotiated mortgages over foreclosure as way for real marketable value to be re-established.
Personally I would favor in addition that the government get an equity stake in financial institutions bailed out in this manner as a further guarantee of the public risk.
There are several ancillary issues that probably would need to be addressed. In some cases current mortgage holders simply will not be able to afford the houses they tried to buy, even with revaluation. In those cases affordable rents should be established to allow people to stay in their homes until the property is sold, if they wish, rather than foreclosing and leaving properties empty to hurt entire neighborhoods and localities. For the sake of equitability, a medium-term temporary program should be established to aid mortgage-holders who have not quite been driven to the point of default and whose mortgages thus would not be taken over by the government, but who are hard-pressed and close to the margin. And steps should be taken to ensure that the administration of the new agency is not simply contracted out to private financial entities for excessively lucrative fees that would reward the same persons and entities who created the crisis.
The exact mechanisms to do these things might need to be worked out over a longer period of time, but the principles should be put in a binding way into any immediate legislation.
Jobs with Justice,
the solidarity program of the AFL-CIO *, has called for protests today against any bailout that protects big financial capital at the public expense, or that fails to help ordinary Americans and addressing the foreclosure crisis at the bottom of the wider problems. Their call has been backed by the United for Peace and Justice anti-war coalition and other progressive organizations.
In Portland Jobs with Justice has called a "No Blank Check for Wall Street" demonstration at 5 pm today, Weds. Oct 1, at the Federal Building, SW 3rd and Madison, Downtown Portland.
* Correction: I am reliably informed that Jobs with Justice is not in fact a program of the AFL-CIO, either nationally or locally, although my informant says "we are pals." I apologize for the error.