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Sunday, February 8, 2009

The Great Government Issued Recession



The US is in a financial mess. And the US Treasury department got us into this. Here's how.

In 2007 the Feds promoted a change in the accounting rules banking and credit institutions can use to value assets. The newly applied rule is called "mark to market." This rule change is important because a bank must base it's own valuation on the value of its assets, and valuation of the loans its made.

The normal way to assess value of a loan is to evaluate the borrower's credit rating and reckon how likely the lender is to be repaid. Mark to market changes that. Mark to market requires that the lender reckon the value of a loan as if the lender had to sell the loan paper to someone else Right Now! as if the lender had to have a fire sale of all assets. This works for some assets for which there is a ready market (oil, for example), but undervalues long term investment, (housing loans for example).

A lending institution must have enough assets to cover loans. When the assets were recalculated by the new accounting rules to be worth much less, lenders had to call in some loans and stop giving new ones. Under the new rules, if a borrower came to a lender to ask for a loan, and the borrower had to recalculate his asset base to be worth much less. Old fashioned creditworthiness, by law, didn't matter. Borrowers couldn't qualify for a loan.

Business seized up. No credit flowed. Housing collapsed.

Naturally this devalued the realistic asset base of every lender in the nation. Some banks had problems because the genuine value of their loans is accurately the likelihood they will be repaid, but under the new federal rules, reality had nothing to do with anything. Major banks went into meltdown. Loans no longer were worth the face value of the loan. That is, a bank which made a loan immediately had to reckon it had lost money. Banks stopped lending.

American is a credit-driven economy... well, it was. Nearly every major bank went into some degree of insolvency. Some failed outright and were shored up with taxpayer debt (The only credit worthy borrower in this situation is the US government, i.e. you and me at the mercy of our elected rulers.) One investment agency went broke altogether.

Now Tim Geithner proclaimed "mark to market" of slow moving assets will not be repealed. Under the law, all asset valuations will be at fire sale prices. As long as the government insists on this troglodyte approach, our economy will remain in turmoil.

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For further reading about mark to market:

There is a more technical description at www.answers.com/topic/mark-to-market

And more critical discussion at www.investopedia.com/articles/financial-theory/08/mark-to-market-mayhem.asp

Also see a big-government leaning editorial at Slate, posted at www.slate.com/id/2187880, which agrees that the mark to market rule is not quite appropriately applied.

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An interesting and frightening element is that this is the same way the government started the Great Depression. Not with mark to market, but a rule change on the reserve requirement. In 1928 this change in rules caused the banks to stop lending and started to dry up the money supply. The mark to market rule change caused the banks to stop lending and started to dry up the money supply.

Do these people know what they are doing? If not, they are incompetent. If they know what they are doing, they are trifling with our lives.

Big Government does not care.

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