The Perils of "Don't Ask, Don't Tell" Banking

There is a moral hazard with “don’t ask, don’t tell” mark-to-fiction accounting principles.

When banks are allowed to hide their losses, presumably because the truth is too painful for the economy to accept, then banks overstate profits. Based on overstated profits, banks provide excessive bonuses and compensation packages. Thus capital that should be reserved to cover anticipated future losses is instead distributed annually as compensation.

But these losses eventually must be disclosed and when they are the question arises, will the banks have sufficient capital to cover actual losses? And if they do not, what happens next? Can the financial industry absorb them or will the U.S. Treasury be required to cover them? If it is the latter what will be the implications on sovereign credit worthiness, interest rates, future taxation requirements?

Perhaps the accounting rules had to be altered last year to prevent a complete market meltdown and because assets could not be fairly valued due to market disruption. However, now that the crisis is over, isn’t it time to restore mark to market accounting and allow market forces to reshape the industry?

Are we not making matters worse by hiding the true financial position of these institutions thus allowing needed capital to shift into compensation?

If we must continue to “protect the industry from full disclosure”, should we not at a minimum impose substantial fees upon the industry to prepare for the ultimate judgment day? Will the $90 billion assessment proposed by the Obama Administration be sufficient?

Why Liberalism Does Not Succeed (and how it can)

Below are excerpts from a guest posting by Paul Brodsky & Lee Quaintance on Barry Ritholtz's The Big Picture blog site. To read the full article go to the website below.


http://www.ritholtz.com/blog/2010/02/we-are-all-austrians-now/

"The Austrian School views economies through the prism of natural economic incentives. It relies on the tendency of people to work for capital and then save it for the goods and services they want to consume. Money itself becomes a store of value.

Government policies and intervention would be acceptable, when need be, but only upon approval of the people. The government’s role would be relegated to protector of laws and property rights. It would also be an honest broker when natural imbalances from capitalism occur, as they always do. However, government would not be preeminent and, as it is today, omnipotent.

Would a society that accommodates a freer economic model be the death knell for today’s working class? No, in fact due to the unfathomable and growing debt assumed by developed societies over the last thirty years, the prospects for today’s working class look far bleaker than they would if the working class could earn and save at a global wage that reflected a global equilibrium.

Liberals should be screaming for such a system because it swings power back to the worker and away from the more successful among us that have access to credit. Conservatives should endorse it too because it encourages a more objective society."
The progressive movement will be more successful once it comes to terms with these concepts. By accepting that there are “natural economic incentives” in the market economy, liberals can then understand how to use these incentives to pursue social values.
One example is the pursuit of livable wages to eliminate poverty. Currently we are using two approaches to increase wages, the Earned Income Tax Credit and increases in the minimum wage. I would assert that the Earned Income Tax Credit (EITC) uses the natural economic incentives of the marketplace to encourage livable wages whereas increasing the minimum wage results in natural economic disincentives towards hiring new marginal workers.
In the marketplace, some workers do not have the education, training or skills that can justify a livable wage. This is simply an indisputable fact. The EITC recognizes this is a reality. It allows the employer to pay wages commensurate with the “value added” by this marginal worker and dictates that society will pay the worker a differential (tax credits) in order to provide the worker and his/her family with a livable wage.
On the other hand, increases in the minimum wage will “price out” a certain number of marginal workers who cannot contribute sufficient value to justify their cost to an employer and thus never gain the opportunity to develop the skills and abilities needed to become self-sufficient.
This is not to say that the minimum wage should be abolished or never increased. Rather it is to point out that there are ways to work in concert with “natural economic incentives” in order promote a strong market-based economic system while also achieving progressive goals. Clearly, the more prosperous the business community, the stronger the economy, the more opportunity there will be for job creation and the more resources (tax revenues) to pay for social initiatives.
There still exists a strong opinion among some within the progressive community that business must be required to pay higher wages irrespective of the economic cost to that business because it is for the common good. Unfortunately, this approach is detrimental to long-term economic prosperity of the businesses who are affected and thus to the general economy.
Once the majority of progressives accept that there are natural economic incentives and disincentives and once they begin to develop policies that are in harmony with natural economic incentives rather than punitive in nature, liberalism will be more successful in achieving its objectives and it will gain greater acceptance among the general population.