Three action steps to restore the U.S. economy
While the American economy and global markets remain entrenched in a slogging mode and the country awaits the relief promised by bailout plans, there are three action steps that could make a significant positive impact on the economy and the markets if implemented.
The first two have developed considerably more traction in recent days among officials. All three would provide much needed stimulus for the economy stability for the markets while incurring minimal, if any, costs.
Return the Uptick Rule
In July 2007 the Securities and Exchange Commission suspended the Uptick Rule (Rule 10a-1) implemented in 1938. The rule was established to prevent market manipulation and avoid the financial crime known as a "bear raid." Functionally, the Uptick Rule regulates short selling in financial market by mandating (with certain exceptions) that listed securities must be sold short at a price above that of the immediately preceding sale or at the last sale price if it is higher than the last different price.
The Uptick Rule served as a governor of financial markets, especially in times of market turbulence. If there are doubts about the rule's effectiveness, look at the VIX Index (measure of volatility) since July 2007. Without exception, volatility has been higher since that time and set all-time records in October and November. The point is that without the Uptick Rule, stocks can be sold short to the point of crippling the underlying corporate entity's financial condition — even if the underlying corporate entity has a stable business and strong financial fundamentals.
Without the Uptick Rule, the U.S. financial markets, which are more accessible than ever to global investors, are more susceptible to the actions of those investors who may not have the collective best interests in mind.
Restoration of the Uptick Rule has started to attract support from strong quarters in recent days, and SEC Chairwoman Mary Schapiro has indicated this change could take place within a month.
Suspend "mark-to-market" accounting
Mark-to-market is an accounting method that assigns a value to a position held in a financial instrument based on the current market price for that instrument or similar instruments. In the current environment, mortgages and mortgage-backed securities are difficult to value and liquidity is virtually non-existent.
This policy, also known as "fair value" accounting, is practiced by banks, insurance companies and other financial institutions. And it works when the economy is strong and securities are very liquid. However, when the credit crisis hit in 2007, the market for subprime securities seized, and regulators and auditors continued to press banks and financial institutions to mark down the book value of their holdings, even when the obligations were being fully met. These mark-downs impair the capital position of institutions, ultimately requiring additional capital to meet regulatory mandates. In an ironic twist, these government regulations have contributed to the need for the government to inject capital into the banks.
By suspending this practice for regulatory calculations and allowing mortgages and mortgage-backed securities to be carried at cost, banks and other financial institutions won't have to worry as much about funding their loan-loss reserves or being in a state of insolvency. Most importantly, banks and other financial institutions will have the capital needed to practice their primary historical function: lending money.
In recent days, both Steve Forbes and Warren Buffet have stepped forward and supported the suspension of this practice. Even Fed Chairman Ben Bernanke, while opposing the suspension, recognized the shortcomings and is working with the SEC and FASB to provide more guidance on determination of asset values in illiquid markets.
3.5 percent, 30-year fixed mortgages
The government would offer (through 12/31/09) 3.5 percent, 30-year fixed mortgages to anyone with an existing mortgage or first-time home buyers with new mortgages.
The current economic situation was created and fueled to a significant degree by the increase in home values and corresponding mortgages associated with over-inflated home values. The current economic slump won't turn around until the mortgage issue is addressed. This proposal rewards the 80-90 percent of mortgage holders who have made their payments and paid their property taxes.
There are good reasons for supporting this action item. It would allow individuals to refinance their existing mortgages regardless of current employment/income. Forbearance on appraisals for existing mortgages will eliminate the need to evaluate the current state of owners' equity. Competition among banks for the origination business would be helpful. And, as in the past, those who choose to refinance will need to assess refinancing costs associated with different mortgage providers. If these mortgages were allowed to be transferable/assumable by future homebuyers, they would hold great appeal to that portion of the work force that is increasingly mobile.
The implementation of these three steps would increase consumer confidence; lessen volatility in the stock market; stimulate the economy; allow banks and financial institutions to focus on assisting home owners; and improve financial conditions for business owners. All can be done with minimal cost.
Robert C. Boylen is a partner with Norris, Perné & French LLP. Julie M. Ridenour is the firm's director of business development.