There is now an air of sublime inevitability surrounding Barack Obama’s victory, but it’s worth remembering that immediately after the Republican Convention on 5 September, John McCain was in the lead.
There is now an air of sublime inevitability surrounding Barack Obama’s victory, but it’s worth remembering that immediately after the Republican Convention on 5 September, John McCain was in the lead.
Obama probably would have overtaken McCain anyway because of Sarah Palin, but what really turned the Democrat campaign around and made the Obama Presidency inevitable was the collapse of Lehman Brothers 10 days after the Republican convention on 15 September, precipitating a new and much worse phase of the financial crisis.
The Lehman collapse changed everything. It turned a grinding, slowly unfolding credit squeeze into a suddenly lethal choke, and produced the two things that President Obama will have to turn his mind to first; the Troubled Asset Relief Program and accounting standards.
Those might seem rather mundane after yesterday’s wonderful, inspiring, acceptance speech, but the truth is that the big plans will have to wait.
The credit crunch and recession now have their own momentum and with the US budget deficit heading for $US1 trillion there’s not much President Obama can do about it anyway. Healthcare will have to wait for the same reason, and he can’t just pull out of Iraq and Afghanistan.
Instead he needs to focus on the minutiae of financial mishap and moral hazard.
The Troubled Asset Relief Program was originally going to involve spending $US700 billion buying mortgage securities from banks, but things kept getting worse and the British Government showed the way by directly investing in banks in return for equity stakes. As a result the Bush/Paulson plan changed.
The US Government is now spending $US250 billion directly buying bank stakes. Barack Obama probably doesn’t need much convincing, but if he continues that program (which he should) existing shareholders of the banks need to be screwed and management replaced.
That’s what happened when the Bush Administration initially bailed out American International Group, an insurance company that turned out to contain a wild hedge fund.
The Government lent $US85 billion at a punitive interest rate and got 80% of the equity in return, and tossed out the management. But there was a second amount of $US37.8 billion provided later on what seems to be much less onerous terms.
And the Government seems to have got a worse deal on the $US10 billion it invested in Goldman Sachs than Warren Buffett got on his $US5 billion.
In other words the Bush Administration seems to be going to water on how the banks are recapitalised with public money, or perhaps just losing focus in its final dog days.
In any case, the viability and regulation of America’s banks is the core political issue in the financial crisis and, unlike with Franklin Roosevelt’s “new deal” and the Emergency Banking Act of 1933, it can’t be dealt with through sweeping gestures and big picture reforms. It needs to be done one bank at a time.
The accounting standards issue is related; there is now pressure building to weaken mark-to-market accounting.
In fact at the height of the crisis in October, the European Union demanded that the International Accounting Standards Board weaken the standard on fair value accounting (IAS39) to allow “reclassification” of assets along the lines of US standards, because US banks had an “unfair advantage” by being able to hide the real value of their assets.
The IASB complied immediately, which is unheard of in the glacial world of accounting standards, to ensure some discipline and transparency was put around what the EU was going to do anyway.
Reclassification allows a bank to move assets from the “hold for trading” category, in which they must be valued at market value, to the “hold to maturity” category, in which they may be valued at the lower of cost or recoverable value, which means face value minus default risk.
There is now a rising clamour both in the United States and Europe for mark-to-market accounting to be suspended altogether.
This would be an absolute disaster. Japan did it in the 1990s and the US did it during the savings and loan crisis of the late 1980s. In each case it prolonged the effect of the crisis far beyond what would have been its natural life.
Another problem with US accounting standards is controlled entities; US banks have been allowed to park too many of their debts in off-balance-sheet entities called “special purpose vehicles”, whose special purpose is merely to escape disclosure or tax.
For example Deutsche Bank testified before Congress recently that when it moved its US operations from US accounting standards to the International Financial Reporting Standards (IFRS), it had to bring an extra 200 entities back on to its balance sheet (although it then did the old reclassification shuffle and valued their assets at “hold to maturity”).
These are the things that Obama must get his considerable mind around – mark-to-market accounting, off-balance-sheet entities and bank recapitalisation deals – and he must hold the line on them.
They might seem like the sort of boring thing you have treasury secretaries for while you get on with saving the world, but the devil truly is in the detail. He must put on an eyeshade, clip on the sleeve-holders and sharpen the pencil.
US and international accounting standards must now be aligned; there must be an international crackdown on dodgy banking practices through precise, careful accounting standards and not through the blunderbuss of legislation; tight regulation needs to extend to all financial institutions – not just banks, but lending trusts and hedge funds as well; and there needs to be full disclosure of all credit instruments, including credit default swaps and other derivatives.
This article first appeared in Business Spectator
Smart Company is a sister publication to The Mandarin, catering to Australia’s entrepreneurs, small and medium business owners and business managers.
