Forbes Dual Proposals

Steve Forbes has come up with a two pronged approach to fixing the credit crunch. The first I wholeheartedly agree with while the second sounds sensibly enticing however ultimately flawed. Here is the first...

The weak dollar is pummeling equities, disrupting the economy, distorting global trade and giving hundreds of billions of dollars in windfall revenues--through skyrocketing commodity prices--to our adversaries such as Iran and Venezuela. Not since Jimmy Carter has the U.S. had a President so oblivious to the damage done by an increasingly feeble greenback.

The Federal Reserve can rally the markets for a day or two by finding some new mechanism through which to lend more money to banks and other financial institutions. But this is the proverbial Band-Aid for a patient who is beginning to hemorrhage.

The Administration acts as if the dollar were like the sun, its rising and falling beyond any control. Countless times experience has shown that notion to be false. The U.S. Treasury Department could buy dollars in the currency exchange markets. Our allies would gladly cooperate with such an operation; their exports are being hurt more and more. The Fed could mop up some of the excess liquidity it has created since 2004, even as it makes targeted loans to beleaguered banks and financial houses.

Forbes goes onto compare Bush to Carter in terms of obliviousness of the dollar's impact on everything else. Forbes is right on all counts most importantly on the one that says that the U.S. Treasury can and has bought and sold the dollar in large quantities on the open market in order to stabilize its price. It can and should start buying the dollar now and so should the Fed. In fact, for the most part, the central banks of the world act in unison not to allow any of the currencies to fall or rise too much. What we are seeing now is the total breakdown of Treasury policy as well as communication among the central banks of the world. It is a total incompetent lack in judgement that the Bush administration has stood by as though it is helpless to effect the move of the Dollar. This is something that should have happened a long time ago.

The Treasury Department and the Fed should get together with the SEC, the Comptroller of the Currency and other bank regulators and announce that financial institutions for the next 12 months will no longer write down the value of exotic financial instruments (primarily packages of subprime mortgages). Instead, writedowns will occur only when there have been actual losses on those assets. If a mortgage defaults, a bank will then--and only then--recognize the loss.

It is always tantalizing to replace the actions of a panicked market for regulation and artificial moves, but it always winds up making things worse. I read something a couple weeks back that makes a lot of sense...

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

What Forbes wants is to stop the vultures looking for obscene profits for at least a year. It is always tantalizing to tinker with markets during crisis but never effective. This market, like all markets, will have winners and losers, and what Forbes wants to do is stop the losers from losing. While this sounds like a good idea, it won't necessarily right the ship. First, this crisis will last much longer than a year. Second, the vultures want deals not fairly valued mortgages. For every big loser during a panic there are those that win big as well. Unless you give them an opportunity to clean up there will be no one to lead the market going forward. These mortgages backed securities could take years if not decades before we can figure out their value. In the meantime, the only way to get liquidity is for the so called vultures to swoop in with deals.

Forbes goes on to say that it is preposterous to try and value these MBS in a panicked market. That of course is the point of markets. If a security were fairly valued there would be no interest in buying it. The point isn't to figure out what the fair value of these vehicles is. The object is to get the so called vultures to take an interest in buying them. That will happen only after they have fallen enough. No amount of tinkering with the MBS will solve the liquidity crisis. What we need is for the market to do its job and let the leaders of the next revolution swoop in when they have seen prices fall enough.