Essays on Rebuilding America: The Panic of 2008 Lead, follow or get out of the way
by Col. Frank Ryan, USMC Ret.
The markets are reeling. Unheard of 600 point swings in the DOW are now becoming commonplace. Two Billion shares are traded daily. A sudden 75 basis point drop in the Fed Funds rate sparks a rally. What turmoil!
The markets are trying to tell us something. Absent strong leadership from the Federal Reserve, our government, the CPA community and corporate executives, the market is filling the leadership void with panic.
The greatest devaluation of assets in over 40 years is taking place in the markets as we speak. Assets at financial institutions are being written down in record amounts. Yet, the write-down of assets at financial institutions is reflective of a temporary revaluation of assets and not a long term valuation reduction. I question whether such a write-down of assets in entirely appropriate.
The write-down of assets is reflective of accounting rules and regulatory requirements and, in some cases, relies on only short run assets values. The written down values are, however, not necessarily reflective of the long term value of those assets. Any freshman economics student will tell you that there are very short run, short run and long run planning and valuation horizons. Unfortunately, regulatory requirements and the misunderstanding of accounting standards do not take into account these timing differences in any substantive way.
The overreaction in valuing assets is not benefiting the public nor is it benefiting the shareholder. The CPA profession has, as a core building block of our profession, to be objective. The current asset write downs may appear to be conservative in nature but in reality they are neither conservative nor accurate. The aftershock of the asset devaluations taking place in the market today will be felt for decades to come. The financial services industry will be taken to task in the next few years when the real values of the underlying assets are determined.
The mortgage crisis and politically/regulatory motivated solutions are at the forefront of a crisis which must be contained. Containing the crisis must include decisive action by the Federal Reserve, all levels of government, corporate executives and the CPA profession. It is our leadership in calming the markets by decisive, well thought out actions that will calm the markets and restore stability.
The mortgage crisis is being attacked as a problem of resetting interest rates and the substantially higher payments which must then be covered by overextended homeowners.
To our detriment, our diagnosis is of the symptom and not of the disease. If the disease were the resetting of mortgages, then the problem would be confined to homeowners with reset mortgages. In reality, the underlying problem is the leadership void manifested in the under-reporting of the inflation that millions of Americans are facing, as well as an unforgiving legal and regulatory system that encourages overreactions in asset valuation writedowns in order to prevent lawsuits claiming the overstatement of these same assets.
If we merely attack the symptom of the variable mortgage interest rates, we will have successfully cured a hangnail but lost the patient to recession and lost substantial wealth in the process.
With the problems we have today, we must also take fiscal policy into account as well as monetary policy and regulatory restraint. Fiscal policy requires discipline from our elected leaders. To solve the problem of significant inflation today, the very responsible actions of the Federal Reserve must be met by fiscal restraint at every level of government, including Federal, State and local governments, to reduce the massive deficits that they are incurring. Tax cuts without spending cuts will not calm the markets. The tax cuts are reactive in nature and, therefore, will have short lived effects.
Additionally, corporate governance and responsible corporate behavior require long term solutions that look beyond the current quarter and fiscal year relative to asset values. If necessary, executives should question the asset write downs with greater economic rigor. It is crucial to remember that fraud can occur with the undervaluation of assets as much as with the overvaluation of assets. Future performance improvements may merely be the result of an overreaction to the write-down of assets which is taking place.
To calm the panic of 2008 requires that we understand the problem. If we continue to believe that the problem is merely one of interest rates, the spillover effects of the crisis will be severe. Only by a combined monetary policy, disciplined fiscal policy, and responsible corporate governance and regulatory compliance will a long term stable solution be found.
To lead us out of this panic, the Federal Reserve needs to lead the way with sound, timely and realistic interest rate reductions. The Federal government needs to significantly reduce spending. Corporate executives and the CPA community need to look at long term values of assets and not at temporary dislocations to markets. As financial executives we need to lead, follow or just plain get out of the way.
Frank Ryan is a member of the Lincoln Institute Board of Directors and lectures for the AICPA and BLI on management related topics. He can be reached at [email protected]