Cheap Stimulus

President Obama tells us recently that "stimulus" = "spending," and that therefore any money spent by the government regardless of purpose will be a stimulus to the economy. For an alternative view, see "Rat Hole Stimulus Bill 2009" below. But assuming arguendo that the President is right, might it not be prudent to at least think about stimulus spending that, you know, doesn't cost so much? Let me give a few examples.

Mark to Market. This economic fiasco is, by all accounts, driven primarily by the collapse of the real estate and financial sectors of the economy. So why not a stimulus that not only would directly shore up the balance sheets of banks, but also encourage lending and ... will not cost a dime in federal money? I think it was Bill McGurn who wrote an excellent Wall Street Journal article last October or so, who said in effect that we don't know that suspending the mark to market accounting rules would help banks, but since we are contemplating spending $750 billion, why not just give it a try first? After all, suspending an accounting rule is cost-free; billion dollar bail-outs are expensive.

But that type of reasoning is too subtle for the political class. As an accounting disabled person, I don't know much. But I do know that whereas liquid markets are an excellent indicator of the current value of an investment, they are not the be-all of valuation. Markets can be wrong, and sometimes, it is the sellers who refuse to sell at low prices who are correct. If my house price goes down $100,000.00 (which would bring my palatial home down to approximately -$50,000.00), I can decide that the market is stupid and hold onto my investment until the market corrects itself. This kind of contrarian thinking happens all the time. The oldest rule in investing is "buy low, sell high." How is that possible if the market is always right?

But banks have a particular problem with market pricing of their assets. By law, banks have to maintain a minimum amount of capital. When they (perhaps stupidly) buy huge amounts of sub-prime mortgages and the market in those suddenly turns nasty, then mark to market rules require them to immediately recognize billions of dollars in lost capital. But those assets are not lost in reality (the banks still own the paper), but only because of an accounting rule, a theoretical construct. No one really knows what these assets are worth, and so why can't a bank decide they are worth more than the market thinks, and hold onto them until the market corrects itself?

Sure, savvy investors will have their own ideas as to what these assets are worth, and if they see Bank of America has valued them well above what they deem reasonable, they will pull up their handy calculator and conclude that BOFA is insolvent. And then sell short. BOFA's stock price will plummet (as it's doing now), but BOFA will not face an immediate capital crisis, and will thereby have time to work-out the problem and find out if the short-sellers are correct. This is how markets function, and mark to market short circuits this process to the detriment of banks, lending and our economy.

But again, suspending mark to market wouldn't cost a dime of taxpayer money. Why not get rid of an abstract accounting rule and see what happens?

To Be Continued ....

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