Never Sell America Short
We can fix this. If nothing else, that’s the message I hope readers take away from this column. Of course, the “this” is the run on the world banking system. Stock markets have plunged globally, gold prices have shot up, and U.S. Treasury-bill rates have plummeted to 10 basis points, the lowest since the 1950s.
We’re witnessing a desperate flight to safety by investors. Folks are running away from financial assets and financial institutions simply because confidence has disappeared.
This week, Treasury secretary Hank Paulson said “no” to a government bailout of Lehman. Paulson and Ben Bernanke then took over AIG with an $85 billion bailout, with the Treasury issuing roughly $100 billion in new T-bills so the Fed has the cash to resuscitate AIG.
All this was necessary. A collapse of AIG would have been unfathomable -- it is simply too interconnected globally. But it turns out this rescue mission only elevated investor fears. Shareholders are asking: “Who’s next?”
The bears are now raiding Morgan Stanley and Goldman Sachs, two national treasures. Meanwhile, the Reserve Fund -- an original money-market fund launched by Bruce Bent, a hard-nosed friend of mine who for decades has supported conservative political causes -- has seen its net asset value drop from $1 to $0.97. That’s a shocker. And the reason? The fund’s holdings of Lehman commercial paper were unsupported by letters of credit.
Money-market funds are supposed to be safe havens for mom and pop -- for Mary and Joe in McKeesport, PA. But everybody now wants T-bills and gold.
Well, it’s time for some perspective. The world is not coming to an end. The stock market has tumbled, but it’s still over 10,000. In late 2002 it was 7,500 and in mid-1982 it was 750. Are things really that bad?
With home prices falling, foreclosures and defaults are at the root cause of the run against all manner of mortgage-related bonds held by the banks. But as investment guru Don Luskin points out, foreclosures today are less than 3 percent. During the 1930s they were 50 percent. Or how about the unemployment rate? Today it’s 6.1 percent. Back in 1982 it was near 11 percent and for most of the 1930s it was over 20 percent.
As the oil bubble pops the underlying inflation rate is somewhere between 2 and 3 percent -- quite unlike the double-digit hyperinflation of the 1970s. Home prices themselves have fallen between 10 and 20 percent, but they’re still about 50 percent higher than at the start of the decade.
And there are constructive policy measures that can help fix the market’s problems.
Investor Zachary Karabell writes persuasively in the Wall Street Journal that “mark-to-market accounting in the aftermath of the Enron scandal makes no sense at all.” Many banks have taken huge losses on mortgage-backed securities and their derivatives because the SEC insists on mark-to-market. But Karabell asks: Why knock down these bond values, sometimes by as much as 100 percent, when the underlying home values embedded in the mortgages have only dropped 10 to 20 percent? And in the long run, the housing market will recover, as it always does.
Bad accounting rules like this are sinking the financial system. And why hasn’t the SEC restored the up-tick rule to stem cascading share-price declines triggered by manic short-sellers? Short-sellers are an important part of the stock market, and they add liquidity at crucial junctures. But until July 2007, they could only short a stock after the share price rose, not while it was continuing to decline. The SEC also should restore the net-capital rule, which limits banks to a 12-to-1 leverage ratio governing their debt. Over-borrowing by Wall Street is what got many firms into deep trouble.
A gathering consensus also seems to be forming around a new version of the Resolution Trust Corporation, which effectively disposed of bad savings-and-loan assets in the early 1990s. A new RTC could purchase underwater assets that proliferate through the financial system and are clogging the credit and loan arteries of our banks.
We clearly are in an emergency moment. But the government should opt for smart regulatory action rather than broad-based interference that could stifle the free economy. On Thursday afternoon, as rumors spread that Paulson was talking President Bush into a new RTC, the stock market soared 400 points. That’s what I call an endorsement.
The pessimists are now talking about the end of capitalism or a permanent decline of America. I don’t believe that for one moment. Specific regulatory reforms can get us out of this fix. And most of all, policymakers must maintain the low-tax, low-inflation, open-trade formula that has propelled this nation’s economy and produced so much prosperity for so long.
I say, never sell America short.