Monday, September 15, 2008

“Legislate in haste, repent at leisure”

Jerry Bower has a great insight into the Lehman Meltdown.  It's similar to the same problem that we had before 911, when the Clinton administration banned all information exchange between the FBI and the Justice Department.

Debunking Laissez Faire Lehman
This morning on CNBC Governor John Corzine (D) of New Jersey blamed the current crises in the market on what he called the "laissez faire" mood of regulation which we have seen "over the past decade.” Does he even believe this stuff? Lehman Brothers, like Bear Stearns and others was basically lobotomized by Corzine’s former colleague Eliot Spitzer, who severed communication between the research divisions of these firms from the trading operations. He did this in the name of "conflict of interest." Who’s interest was served by severing the higher brain functions of these firms from the rest of the nervous systems? With one populist fell swoop, allegedly designed to make Wall Street safer for investors, Spitzer made it dumber. 

The most destructive aspect of government control is always its unpredictability. It’s not that the regs are costly (they are, though), it’s that new regs undo prior decisions. Large financial institutions like Lehman Brothers [LEH 0.19    -3.46  (-94.93%)   ]built their balance sheets under certain sets of rules. But then those rules were changed. In the wake of the Enron scandal, numerous regulations were modified in ways that guarded against future attempts to make corporate earnings appear to be higher than they really were. No one seemed to be guarding against the opposite danger; that these new regulations would force companies to report their earnings under the most pessimistic assumptions. It was not, at the time, considered dangerous to force companies to downplay earnings.........
However, when the climate of opinion shifts to panic selling, then all of the rules, with all their draconian penalties and their figurative death penalty for Arthur Anderson, and their literal death penalty for Ken Lay, and the steady stream of perp walks for corporate execs push an already panicky market into full-blown heart-palpitation mode. It’s not just Sarbox, and Spitzer; it’s stuff like FASB 157, which forces firms to "mark to market" even when the market has collapsed. Under political pressure the financial accounting system now takes localized panic pricing and imposes it on the whole system.

These companies built their balance sheets over many decades under what were then the Generally Accepted Accounting Principles. Did we think that changing those rules in a flurry of legislative retribution would not have tremendously disruptive effects on those balance sheets? Did our legislators think about the effects at all? Apparently not.


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