Red herrings

The "new Financial Stability Plan" announced this morning by Treasury Secretary Tim Geithner made no mention of the removal of mark-to-market accounting, despite hints last week that the government might finally remove the disastrous accounting rule at the heart of the ongoing banking problem.

In fact, he made a statement which appears to perpetuate the reliance upon only market pricing, rather than alternate methods based on cash-flow valuation, when he said: "Our objective is to use private capital and private asset managers to help provide a market mechanism for valuing the assets."

Instead of the crucial central role of mark-to-market regulation, the Treasury Secretary indicated that the current problems have to do with a lack of lending and credit, saying: "Borrowing costs have risen sharply for state and local governments, for students trying to pay for college, and for businesses large and small. Many banks are reducing lending, and across the country they are tightening the terms of loans."

This assertion is not borne out by the available data, as we pointed out in our previous post entitled "It's a panic, not a Great Depression."

Other red herrings dragged across the trail include condemnation of Boards of Directors regarding compensation, and the specter of rising foreclosure rates. While both of these issues pack a significant emotional charge, arousing a visceral response in many listeners, neither one of them is as critical in destroying bank balance sheets as the far less emotional -- even downright boring -- issue of accounting regulations and specifically the "fair value" accounting regime that was put into place over the past several years, with the final stage going into effect in 2007 and -- in our view -- contributing directly to the panic of 2008.

We would suggest that the significant decline of the market after the Secretary's announcement has nothing to do with the analysis that the new plan is "too little, too late," as some in the media are already suggesting, but rather has more to do with the failure to address this critical problem.

We have no idea why policymakers are choosing to focus on "lack of lending" and other red herrings rather than steps which could immediately mitigate the problem. Perhaps they view these steps as too simple to be the real fix. This is not a good sign for future business activity and investment going forward, and suggests that the principles of selecting companies which we have discussed many times in this blog will become even more critical to investors in the years ahead.

For later posts on this same subject, see also:

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