Price controls, revisited
A year ago I was advocating Price Controls on the wounded classes of structured finance bonds (mostly mortgage bonds, back then).
The market for the bonds was so tight and fearful as to be a useless pricing mechanism — and accounting regulations requiring banks, etc to writedown their holdings in accordance with this (non)market — to “mark to market” — would thus just lead to a downward spiral nobody could stop.
Better then to swallow one’s pride and jejune Laissez Faire dogma, and simply institute controls. For six months. Or a year. And let the wounded assets live out their lives, returning, little doubt, much more than the wounded marks implied.
The few people knowledgable who heard this idea laughed. Price controls? The notion blew their Reagan-bred minds.
Today Vince Farrell, a longtime presence on Wall Street and CNBC, as a guest pundit, has this to say today re one of the basic problems:
Accounting rule FAS 157 implemented just last year requires assets like the collateralized debt things to be marked to market. The issue in a horrible time like this is that there is no market, or no rational market anyway.
The banks and insurance companies that own these things are being forced to mark them down. But they believe them to be worth far more than the markdowns. AIG in an August filing disclosed it had written down some of its subprime-related securities by 60% to 80%, and some of its prime mortgage related issues by 60%. The company thought the economic loss would be $10 billion of the $25 billion they had taken as a markdown for this category. But the market for these things was at lower, distressed levels, and they ran out of capital to support the marks.
If RTC II entered the market with a bid for these securities, the free fall in price might be halted. There have been almost $500 billion in writedowns/markdowns taken by financial institutions. Against this, about $400 billion in new capital has been raised. (I’m wrong on the exact numbers but directionally right.) The government would need to fund RTC II with $500 billion, I’m guessing, to stand as buyer of the marked-down paper. With a bid in the market, the price would stabilize and the holders might not need or want to sell.
I’m philosophically opposed to government intervention in the markets. Proposing a $500 billion fund sounds weird. But look at what the government has pledged in reaction to the market. It’s time to act, not react. Pragmatism trumps all, and if the RTC II did buy these assets, I think it would wind up making a lot of money for the taxpayer! The values being forced on our financial institutions are hysterically low. We are destroying viable companies for the sake of an accounting convention that was not handed down to mankind from the mountain. Either change or suspend FAS 157 or set up RTC II.
The third alternative is to institute price controls.
