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A Stitch in Time Would Have Saved Nine
By: Dr. Charles Lieberman
Date: 10/6/2008
Having missed any chance to contain the brewing credit crisis before it became a serious problem, it is now time for Treasury and the Fed to become aggressive in improving credit availability and market confidence in the banking system. While Treasury Secretary Paulson wanted the system to heal itself without intervention, government must now work overtime to repair the damage. The Fed is likely to lower interest rates by 50 basis points soon, add excess reserves to the system, mark-to-market rules have been clarified in a way that allows firms to take much reduced write downs, and the possibility remains for a second fiscal stimulus package.
The rescue package passed this week will supply considerable liquidity to the market, although it will take some time for the cash to show up. Still, there is an immediate psychological benefit, since investors have fled out of fear that failures will be widespread. In time, financial institutions will be able to offload assets that have fallen in value in exchange for cold, hard cash, thereby improving actual market liquidity. Still, more needs to be done. Risk spreads are at extreme levels, increasing the cost of finance, at the same time that the supply of credit is impaired. The Fed can help by lowering the cost of funds, while it increases bank reserves to boost bank liquidity.
The SEC issued a "clarification" on the last day of the quarter that effectively watered down previous practices for writing down financial assets. The SEC's statement explicitly allows firms to use actual cash flows to determine asset values and to disregard market prices, if those prices are considered disorderly and not indicative of an asset's true value. This will permit firms some leeway and asset value write downs are likely to be reduced when financial firms report for the third quarter. At a minimum, this is a form of suspending mark-to-market rules. Critics complain that firms will be able to hide losses. That criticism assumes that all the market prices are real and not the result of distressed transactions, which is clearly not the case.
Consumers have, no doubt, been frightened severely by the turmoil and the statements of public officials. This is already manifest in weak car and retail sales. Falling crude oil prices will reduce stress on household budgets, but consumers must still be willing to spend. Thus, government must help restore consumer confidence. All this will be needed to help improve financial market and economic conditions. Near-term, conditions will remain rocky. Thus, policymakers have much to do to improve prevailing conditions.
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