(Notes for Remarks Made at a Joint Atlas/NCPA Breakfast on Friday, September 26, 2008)

I'm still under the influence of our "Cowboy Chic" night last night. I can relate to the cowboy part, but I'm not so sure about the chic. Given our preoccupation with the ongoing financial crisis, it reminded my of the way a cowboy doubles his money: "He folds it over and puts it back in his pocket."

My research has turned up only one cowboy poem about banking and collateral. To summarize, the cowboy went to the bank to borrow some money. The banker said he'd have to have some collateral and asked the cowboy: "How many cows you got?"

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The New York Times has asked me to participate in a new blog, Economix, and my first posting appears today.  In it I argue for a more narrow view of moral hazard in the context of the current financial crisis. You can read it here.

If all goes as currently planned, I will have a post each Wednesday and others will take the other days of the week. I'm not giving up this blog which I do for NCPA. I may have bitten off more than I can chew. 

To find the new blog go to economix.blogs.nytimes.com.

Today I did an interview on the Jim Blasingame Show on how the current financial crisis will affect small businesses. For the full interview go here.

I recently did an interview for NPR where I answered listeners' questions about the credit crisis. Listen to the interview here.  

"On September 18, I was one of a group assembled by nytimes.com to respond to questions emailed in by readers. Here are the questions directed to me, which I had a chance to answer. The process was arranged and coordinated by Catherine Rampell of nytimes.com."   Bob McTeer

Does "Bailout" = "Nationalization"?

By Catherine Rampell

One of our first questions comes from Charles Callaway, who asks about the difference between a government "bailout" and "nationalization" – is it just semantics?

How does the bailout of A.I.G. differ from nationalization (excluding the obvious "only 85% of the company" and "conditional warrants")? – Charles Callaway

One of our panelists, Bob McTeer, an economist and former member of the Federal Open Market Committee, responds:

You are right. It was a takeover rather than a bailout – including having the secretary of the Treasury fire the C.E.O., who had only been on the job a few months. Being less that 100 percent may increase the chances of a quicker return to private hands. – Bob McTeer

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Here's an interview I did for Bloomberg on Sept. 15. Click here.  

Below is a piece I did for forbes.com.  You can access it by clicking here.

Commentary
Why Mark To Market?
Bob McTeer 09.15.08, 12:50 PM ET

I was afraid of accounting in school; I still am. Back then, I feared it would wreck my grade point average; today, I fear it will wreck our financial system.

It has come uncoupled from common sense. It's ceased being a tool for business and has become its master–and not a benevolent master at that. It's causing unnecessary failures of basically healthy businesses and contributing to the downward spiral of our credit markets.

I refer primarily to mark to market accounting, which forces firms to revalue their assets to current market values even when the market is frozen or dysfunctional and even when the assets could be held to maturity and redeemed at face value.

If a bank loan goes into default, it makes sense to write it off the books. If a borrower has missed several payments, it makes sense to set aside a provision for the likely loss. But if a security trades lower because market interest rates have risen or because of problems in the market itself, requiring an immediate write-down is unduly harsh, because capital is reduced by the same amount.

Because capital is usually, and legitimately, a small percentage of assets, capital can easily go to zero and a perfectly sound institution can be declared insolvent and taken over by its insurer or some other government agencies.

"Prompt corrective action," also adopted as one the "reforms" of the early 1990s, makes the matter worse by allowing the authorities to pull the trigger before capital reaches zero. Its purpose is to reduce the cost of "resolving" (read "taking over") troubled institutions, but what it amounts to is shooting the sick and wounded to expedite the burial. Efficiency and cost effectiveness trumps fairness.

Were Fannie Mae and Freddie Mac insolvent when the government took them over? Did their capital reach zero? I don't know, but I doubt it. It all depends on how much capital was reduced by marking assets to market. People will say management had an incentive to write their assets down to little. Granted, but might the government have had an incentive to mark them down too much to justify a "conservatorship," which was apparently its preferred solution?

As I write this, there is much discussion of private sector purchases of weakened financial institutions and the disincentive provided by the prospect of triggering mark-downs by doing so. The purchasee already has low marks, which will be inherited by the purchaser, in addition to which the ratings agencies are likely to downgrade the new entity and trigger other negative events.

Isn't it ironic, and galling, that the rating agencies helped create our current problems by looking through rose-colored glasses during the good times, and now they are exacerbating it by looking through their dark shades.

Mark to market rules and strict ratings may be appropriate (though unfair) in the good times as a means of preparing institutions for the bad times. That doesn't mean they should be rigidly applied or even tightened up during the bad times. Hard exercise may boost your immune system to help stave off disease. Hard exercise after the onset of the disease may not be such a good idea.

Critics of some mild regulatory forbearance during this most serious of crises since the Great Depression will no doubt cite transparency as essential, but the two can go together. I'm not advocating hiding temporarily impaired assets. They can remain on the balance sheet with a footnote explaining the intent to hold to maturity.

It is time for common sense to come before accounting purity and cut our losses. It's one thing to become a victim of a bad loan or a bad economy. It's quite another thing to become a victim of unnecessarily strict accounting rules.

Bob McTeer is a distinguished fellow at the National Center for Policy Analysis and former president of the Federal Reserve Bank of Dallas.

No doubt my title is an exaggeration, but not as much of one as you may think.  Large and important financial institutions are toppling, and it's often not very certain why.  After failures, we usually find problems to blame the failure on that aren't really the trigger for the failure. They may just be questionable practices that might have caused a problem some day. Learning the wrong lessons is common.

My first financial crisis to witness up close and personal was the Maryland S&L crisis in 1985. Maryland had over a hundred state-chartered, privately-insured S&L's that started experiencing a silent run when thrifts with similar insurance arrangements in Ohio experienced difficulty. The run in Maryland grew and eventually broke into the open, and all of them (102 as I recall) were closed to be reopened one at a time as they passed financial exams that validated their soundness.

As head of the Baltimore Branch of the Richmond Fed at the time, I played host to over 300 examiners from multiple agencies that descended on Maryland to perform the examinations.  The logistics were interesting.

The examiners found some irregularities in some of the larger thrifts that eventually led to a few (very few) prosecutions.  This created the myth that these irregularities were what caused the crisis.  They may have caused problems eventually, but what caused the crisis was simply the similarity of the Maryland insurance arrangements to those in Ohio. 

The loss of confidence (or fear) was not well founded in most cases, perhaps all cases, but few financial institutions are liquid enough to withstand a run, no matter how solvent they may be.  This is no doubt also true of some nonfinancial institutions.  Fear can trigger a run without any underlying cause.

Federal Deposit Insurance changes that dynamic for insured institutions.  If your deposits are insured, you have little reason to stand in line for your money.  Access to the Fed's discount window also provided a useful source of back-up liquidity for solvent institutions.  The availability of good unpledged collateral has generally been considered sufficient evidence that the problem is one of liquidity rather than solvency.

I don't know the details of the Bear Stearns situation, but I do find it believable that it was a sound institution just a few days before its demise. It may have been undercapitalized, it may have been overleveraged, and it may have been guilty of other financial sins; but I doubt that it was much more guilty of these sins the week of its demise than it was months or years earlier.  All I know that changed was a sudden loss of confidence, whether it was rational or irrational.  What did Bear in was simply fear.

Alan Greenspan and others have warned about Fannie Mae and Freddie Mac for years.  Their view was that their debt was backed by the U.S. government gave them a competitive advantage in borrowing money. Their ability to grow was virtually unlimited given that advantage.  Congress didn't heed the warnings, presumably because they approved of their contributions to growing the nation's housing stock and, perhaps, because of their lobbying clout.

People now say that Fannie and Freddy were undercapitalized, but, as I understand it, they met their legal capital requirements.  The point is that, whatever their shortcomings with respect to capital and leverage, they were not new; they existed months or years ago.  What was new was a sudden loss of confidence, perhaps, ironically, triggered by a report from an analyst from Lehman Brothers.

Freddie and Fannie were not bailed out; they were taken over by the government. Presumably, the rationale for their "conservatorship" was that their assets, after marking them to market, were insufficient to cover their liabilities. Marking to market assets that can be held to recovery or maturity is a rather arbitrary excuse to take over a private enterprise.  "Prompt corrective action" may save the government some money by not waiting for an actual failure to occur; but it's almost literally a license for a government agency to confiscate private property.  I call it shooting the sick and wounded.

I don't know the details of Fannie and Freddie's situation, but I haven't heard anything that suggests that it had deteriorated dramatically or that their managements were doing something wrong.  Their losses had the same national origins as the losses of many other well run firms. What happened in the end was simply a loss of confidence.  What happened was fear.

I hear much outrage expressed on financial TV about the deferred compensation owed to the former CEOs of Fannie and Freddie.  I'm a little jealous too.  I'm also jealous of all those athletes who make more in a week than I make in a year because they have a talent for hitting little round balls or throwing larger round balls through hoops.  It just doesn't seem fair to me. 

But, while I've heard much outrage over Fannie and Freddy's CEO compensation, I haven't heard a word about what the CEOs did wrong that makes the outrage so strong. What did they do to justify breaking their contracts?  Yes, the GSE's lost money, but for the same reasons, essentially, that many other financial institutions have been losing money.  They sank in the same quagmire as all the others; so why are we treating them as villains rather than victims?  Why are we so mad at them? 

(Disclosure:  Richard Syron, the ousted CEO of Freddie, and I served together when he was president of the Boston Fed and I was president of the Dallas Fed.  In fact, we sat next to each other at FOMC meetings. He was a good, ethical and competent guy then, and my guess is that he remained so in his subsequent ventures.)

I don't know what will happen to Lehman over this weekend, if anything.  But why should anything happen?  Aren't they essentially the same as they were a year ago?  What's new? All I can figure is they may be in the on-deck circle to become the next victim of fear.

Corny as it sounds, it does seem that the main thing we have to fear is fear itself.  What a shame.  We need a time out.

Here's a few samples of interviews I did for The Money Show in San Francisco on August 7th (click the title to see the interview).  If your organization would like a speaker who is half as good as Allan Greespan for a fifth of the cost, e-mail me at bobmcteer@yahoo.com. 

Weak Greenback Helps

Inflation Talk Overblown?

No More Bailouts?

Give the Fed a Break!

Trust the Numbers?