The Great Repression
posted by Lawrence Cunningham
Amid contending descriptions of the prevailing economic crisis, and candidates for causes and responses, I nominate The Great Repression and, in doing so, point out how unconscious exclusion of painful realities from the conscious mind caused the crisis and continues to infect policy responses to it.
No consensus appears on what to call the prevailing economic crisis, let alone diagnostics of its causes or prescriptions for cure. It’s not yet so severe to warrant Great Depression II or so mild to be called a mere recession. As something in between, some are tempted to call it a Great Recession.
People seem agreed that an asset price bubble, especially in housing, manifested crisis, but disagree on exact culprits. Consumers and businesses respond by curtailing borrowing and spending, but government’s responses are exactly the opposite.
All candidates for culprits ultimately involve false stories that people—citizens, business people, regulators and politicians alike—told themselves. Exemplars: the American dream of home ownership can be made available to all; housing prices tend inexorably upward; massive current borrowing can be repaid from future assumed prosperity; financial risk can be diversified, hedged, securitized away by carving up underlying financial instruments; regulators can let market participants self-monitor and self-correct; and politicians can safely respond to citizen appetites by sustaining all these false beliefs.
Yet these conscious beliefs unconsciously excluded painful truths—the essence of psychological repression. Not everyone can afford or handle burdens of home ownership; housing prices fluctuate according to supply and demand; excessive borrowing is dangerous; financial risk is real and pervasive and cannot be eliminated; markets, like people, including regulators, are imperfect; and politicians act in their short-term self interest in ways that can hurt constituents, not help them.
Equally repressed—excluded from the conscious mind—were recurring examples of similar asset bubbles that eventually burst, including as recently as early 2000’s tech bubble and dating to famous bubbles across the past five centuries.
Asset bubbles are akin to a massive social party of joyous and giddy dimensions. In those times of collective unconscious exclusion of painful memories and realties, party poopers are scarce. Few want to upset the gaiety of frothy markets that suggest flourishing abundance—for nearly all—and runaway riches for the super elite.
The result of the recent repression was a set of pro-cyclical proclivities. Virtually all systemic forces conspired to sustain and reinforce a multi-year boom in housing and financial prices, above what underlying economic attributes warrant.
Repression in economic matters may not always lead to doom. But the scale of unconscious denial of the past five years amounts to a Great Repression. That is the widespread and sustained, if unconscious, denial of economic reality on a scale sufficient so that eventual reckoning spells equally widespread and sustained financial devastation—of which we should now be collectively acutely conscious.
Trouble is, the temptation appears strong to continue to repress rather than to confront. After all, while people seem eager to reduce debt and spending and reset the economy, government’s plan, under the prior and current President, is to respond to the excesses with more excesses, especially massive borrowing and spending.
Perhaps the most acute example of continuing to ignore rather than accept painful realities appears in what Congress did last week on accounting. Traditionally, US accounting standards measured assets at the lower of their original cost or current value, a reliable and conservative way to represent economic exchange. Gradually, in the past few decades, these standards were amended to measure many assets at their prevailing prices, argued as a more relevant way to represent economic reality.
During the recent boom’s run up in market asset prices, those reporting transactions using accounting standards loved the chance to report at prevailing prices, as it made their financial positions look better. They championed this so-called fair value accounting. Now that asset prices have reversed dramatically, they complain that it is misleading to measure assets at prevailing prices. Instead, they want to measure them at imagined prices that would prevail if the current economic downturn were not a reality.
Last week, proponents of this repression accounting got their way. They persuaded Congress to use its political will to meddle in the traditionally professional and independent business of setting accounting standards. Setting accounting standards is usually the province of the Financial Accounting Standards Board (FASB), an independent expert body set up to be outside the reach of Congressional influence, precisely to insulate it from the latter’s political passions.
But now Congress has pressured FASB into letting assets be reported not according to prevailing economic realities but according to what they would be worth if the economy were growing and asset prices stable or rising. In short, Congress has prescribed repression as a solution to repression. They wish to sustain, not confront, The Great Repression.
Hat Tip: Stephanie Cuba
April 6, 2009 at 8:23 am
Posted in: Accounting
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Responses (23)
Christa - April 6, 2009 at 10:16 am
I like that you call Congress’s actions against the FASB “political passions.” Aren’t there any procedural safeguards against Congress meddling in otherwise insulated groups? Is the primary problem that all of these insulated groups were created by Congress or by another agency under the authority of Congress?
Lawrence Cunningham - April 6, 2009 at 11:03 am
Christa,
Yes. Congress, in the 1930s, vested authority to set accounting standards in the US Securities and Exchange Commission; the SEC has since the 1940s delegated most of that to professional accountancy bodies (the FASB since the 1970s).
FASB and predecessors face periodic political pressure from Congress that they must push back but do not always succeed in doing. (Examples: oil and gas accounting in 1970s energy crisis; pension accounting in 1980s; stock option accounting in 1990s/2000s; and now fair value accounting.)
Succumbing to political pressure risks compromising the board’s independence; resisting it risks terminating its existence. Neither is appealing.
Nate - April 6, 2009 at 2:21 pm
Great post. It seems to me that there are two dangers here. First, there is that by messing with FASB Congress will encourage investors to believe thing that just ain’t so, namely that Bank XYZ is as solvent as hell when in reality it is a brittle, brittle institution. Second, there is the danger that the market will notice what Congress is doing and will simply place less and less trust in reported balance sheets. In the worst of all possible worlds, Congress systematically skews the information markets act on, or in the better world the markets simply have less information to act on.
Frank - April 6, 2009 at 9:36 pm
I agree–”Great Repression” is a great term for it. There’s an interesting perspective on the mutual reinforcement of fantasy and hope in this quote from a successful hedge fund investor:
“Financial bubbles and exaggerated stories about globalization are nearly synonymous because the greatest uncertainties about the future of the world have involved questions about the rate and the nature of globalization. Such great uncertainty is the precondition for the great errors needed for great bubbles. Investors’ hopes and fears about the future will concentrate in those areas most levered to globalization. Conversely, it is unlikely that one could even start a mania surrounding the shares of a utility company or a regional business in secular decline, where the range of possible outcomes is more limited.”
“Even the most preposterous bubbles of recent decades — Japan in the late 1980s and high-end real estate today — would have been far more restrained, had they not been stoked much further by the narrative of globalization.”
from:
http://www.hoover.org/publications/policyreview/14801241.html
anon - April 7, 2009 at 8:10 am
Just a quick question: In such a scenario why do all (or just about all) investors delude themselves at once? You’d think a number of investors would see that a mass psychology is building and hedge their bets, thus creating the needed market adjustment without a crash. Isn’t it more likely to believe that an outside influence, such as (but not necessarily) loose monetary policy, changes the conditions for everyone so that investors don’t know that they are investing badly?
JeanE - April 7, 2009 at 9:56 am
Good article- I have trouble understanding a lot of the stuff that Congress is doing. Is this the same as “mark to market” practice, or is that something different?
One reason why people repress the facts is that most of us don’t even understand the terminology, much less the way all these things interact.
Rod Stanton - April 7, 2009 at 9:56 am
It would seem that the “rose colored glases” that JFK + lbj wore 48 years ago have been found. The world is not reality but what we wish/hope it were. Reality was than and seems to be now only for “right wingnuts”. I need my SOMA!
clazy - April 7, 2009 at 10:06 am
Why do they delude themselves all at once? Because they (and we) only think they know what they are doing.
Steve - April 7, 2009 at 10:15 am
Mass delusion is commonplace. Look at the man-made catastrophic global warming phenomenon. Nary a shred of actual hard scientific evidence (it is all based on models — sound familiar?) yet most of the world’s population accepts this obvious political gambit as “science”.
geokstr - April 7, 2009 at 11:10 am
I am a CPA, and have extensive experience in corporate accounting.
While “mark-to-market” may have been a reasonable policy in a normal economic situation, it is not in a crisis situation like this. To value your assets at their “current” market value is not always the best nor most realistic practice.
When the bubble collapsed, real estate prices dropped BELOW their underlying intrinsic value in a normal econoomy because of panic. Lenders stopped lending, and buyers stopped buying. This has driven home prices to a “fire sale” level that is not going to be long-lasting. While we may never recapture the real estate values at the height of the boom, the actual value is not the rock bottom we are currently experiencing. Once demand and lending return to somewhat more normal levels, prices will go up again to their true market value.
However, based on “mark-to-market” accounting, all mortgage loans, even those not in default, must be written down to these short-term unrealistic values of the underlying real estate. This one-time “loss” drives a lender’s equity to below the statutory level required, and it can easily go under simply because of this.
Determining how to implement a valuation policy of accounting that does not fall prey to these crisis situations is above my pay grade, but to think that the current depressed real estate values are indicative of the actual value of the property is just as misleading as those prices in the bubble.
Mike Devx - April 7, 2009 at 11:37 am
I think you are talking about the repeal of the “mark to market” rule.
I believe you are wrong on this issue.
Mark to market, passed during Clinton, required daily revaluation of worth based SOLELY on yesterday’s fluctuations in stock market prices. Further, due to other regulation, it required hard currency assets to cover the new valuation (again, based solely on yesterday’s fluctuations). The assets must cover all current debts.
This was inherently unstable. It also led to panics.
Good riddance to mark to market.
The next move must be the reinstitution of the uptick rule.
Morph366 - April 7, 2009 at 12:35 pm
Very insightful article and fully reveals the extent to which human beings are capable of self-deception.
One can call it repression but I prefer to call it self deception because it implies more of an act of volition i.e. we choose to ignore the painful realities rather than repress them.
I see it as all part of a bi-polar culture which is becoming increasingly inter-woven with capital markets that are themselves becoming more bi-polar.
Thomas - April 7, 2009 at 12:35 pm
Geokstr the CPA, while what you say may be true in some areas, it’s my observation that home prices higher-end areas (in my case, Newport Beach, CA) are not only not reaching irrationally low “fire sale” prices, they’re still well above what fundamental economic factors (local incomes, rent-to-cost ratios) should support. Case in point are several homes still priced up to 30% higher than they sold for in 2003 — six years into the boom, and three years into the bubble.
Lenders have not “stopped lending.” When a qualified buyer (i.e., one with enough income to service a loan) applies for a loan to buy a fairly-priced property, he gets a loan at a ridiculously low rate. The “fire sale” argument is nonsense, flacked by people who want bubble pricing to return.
Some Guy - April 7, 2009 at 1:09 pm
Folks like geokstr aren’t deluded, they are actively engaged in puffing up assets. By the way, no CPA in his right mind would call today’s housing prices a short-lived “fire sale.” This whole “prices will overshoot” garbage is the latest line from the banks and the realtors. They’re both engaged in a massive public education campaign to get Congress to allow them to continue defrauding their customers. (Not that the realtors ever really stop.)
raytayzmd - April 7, 2009 at 1:39 pm
…well, yippee — someone else with a less than brilliant opinion on the current situation…and, like all the other “insights” being offered daily by every “sidewalk superintendent” under the sun, contributes essentially nothing…so the “proponents of this repression accounting got their way” and you’re unhappy about it…all I can say is “BFD.”
Joseph Somsel - April 7, 2009 at 2:08 pm
Another lie politicians tell each other and us is “negawatts” are real. This was Amory Lovins’ invention back in the late 1970s and is a way to charge people to pay others to NOT use energy.
Would anyone with a lick of sense pay money out of their own pocket to someone else to not use energy? Of course not, but it is government policy to FORCE people to do so.
It is REPRESSION to imagine that there is any financial or accounting sense in negawatts.
Remember, energy is one of Obama’s plank for hopeful change to American society and its economy.
wahsatchmo - April 7, 2009 at 2:37 pm
Both Thomas and Some Guy proved geokstr’s point for him. The assets being valued are pools of mortgage loans, not the real estate itself. There is a disconnect between the value of the mortgages and the value of real estate.
The principal balances of the mortgages may exceed the value of the underlying real estate, but their true value is dependent upon the actual repayment history of the borrowers. Mark-to-market forced the asset holder to write the value down to essentially the lowest value at the date of the financial statements, based not upon the performance of the mortgage, but based upon the fluctuation of the underlying collateral. The major flaw in this valuation technique was that it would essentially assume that the mortgage asset would have to be sold in a distressed sale during a down market, not in an arm’s length sale despite the intention of the asset holder to hold the mortgage to maturity. Anyone familiar with valuation techniques knows that there is a substantial difference between a liquidation methodology versus a negotiated sale methodology.
Regulations then required that the bank or mortgage holder generate additional capital to maintain leverage ratios based upon this distressed valuation. To generate capital, asset holders sold off their better performing mortgages because they could be immediately liquidated. Unfortunately, this had the effect of weakening their overall mortgage portfolios, forcing more write downs and more capital calls. In other words, requiring banks to value assets at liquidation prices forced them via regulation to liquidate those assets. Mark-to-market rules, ironically, forced banks to act without consideration of the market, thereby depressing the market further.
This is just one piece of the puzzle, but it’s pretty clear that geokstr is not trying to re-inflate the housing bubble.
Dana H. - April 7, 2009 at 2:41 pm
The problem is not mark-to-market or any other accounting rule. The problem is government-mandated accounting rules via the FASB. As long as it is open about the standards it is following, a company should be free to choose whatever rules it thinks appropriate. It should not have to follow a government-mandated set of rules that can be changed on a whim in very destructive ways.
As for your main theme, there is indeed a widespread effort on the part of the government to refuse to face or to cover up the reality behind the current crisis. But the best word for this is not “repression”. Ayn Rand had a better term for it — “evasion” — which she called the essence of evil.
Rich Rostrom - April 7, 2009 at 3:03 pm
The problem is that Congress has already intervened in accounting practice by mandating immediate “mark-to-market” pricing of assets. This was intended to prevent another Enron-style fraud.
This had unintended effects on banks, which are required to maintain certain levels of capitalization. When the market in mortgage-backed derivatives dipped, banks had to mark down these assets immediately, creating capitalization issues, and forcing asset sales – further depressing the derivative markets.
Present efforts to relax mark-to-market for short-term bank-regulation purposes are a legitimate move to remedy unintended effects of a previous intervention.
Incidentally, this has little to do with the values of underlying real estate.
Rob Bennett - April 7, 2009 at 3:03 pm
In such a scenario why do all (or just about all) investors delude themselves at once? You’d think a number of investors would see that a mass psychology is building and hedge their bets, thus creating the needed market adjustment without a crash.
The problem is Passive Investing (the idea that there is no need to “time” the market by lowering one’s stock allocation at times of insanely high stock prices).
The market is in its natural state self-regulating. When prices get too high, people naturally sell, bringing prices back down to reasonable levels. But every now and again, the idea catches on that “timing” is not necessary (or not even possible!). Once this idea catches on, the market is like a car without breaks. All price discipline is gone and investors are sure to vote themselves huge raises, setting things up for a huge stock crash down the road a bit.
There have been four times in U.S. history when large numbers of investors have come to believe that it is not necessary to pay attention to stock prices (when we have gone to a P/E10 level above 25). The average price drop in the years following is 68 percent. We have experienced an economic crisis on each of these occasions. There have not been any cases since 1900 in which we experienced an economic crisis without first going to a P/E10 level of 25.
To “time” the market is to care about prices. To cause a stock crash, we first need to persuade millions that “timing doesn’t work.” It’s crazy not to care about the price of any asset you buy. But millions of smart people today believe that “timing doesn’t work.” The popularity of Passive Investing destroyed the mechanism by which the market self-regulates.
Rob
Will Myers - April 7, 2009 at 4:16 pm
I was agreeing with your basic thesis right up until you implicated the repeal of fair value mark-to-market as an example of the repression.
Fair value mark-to-market (MTM) ITSELF was an example of the repression of reason and logic. Just because a financial instrument that still has active revenue streams will only sell for next to nothing in the midst of a global panic DOESN’T mean that it’s actually WORTH next to nothing. But fair value MTM forced institutions to write them down and then balance their portfolios to maintain capital requirements, this resulted in an irrational selloff that FURTHER eroded asset prices and was instrumental in the global financial death spiral. In the midst of a panic, fair value MTM amounted to voodoo accounting and was counter productive in the extreme. Its repeal (they made it optional) is a return to sanity. geokstr and Mike Devx wrote very reasonable comments, attacking them is just stupid.
Victor Erimita - April 7, 2009 at 6:55 pm
Mark-to-market may not have been “the” problem—no one problem is “the” problem in this fiendishly complicated mess. But mark-to-market was a very big part of what triggered the collapse. It happend about a year ago when all the investors and institutions that had bought these enormous packages of securitized mortgages (or, more precisely, enormous packages of pieces of mortgages—”tranches” in the trade—) realized they had little or no idea what they actually had bought and now owned, often under enormously leveraged debt ratios, and the market for them froze. Instantly, therefore, the “market value” of these assets became zero. This despite the fact that the underlying collateral and the underlying performance of the debts they secured, was nothing like zero.
Enter mark-to-market, a rule set to avoid Enron-style asset inflation, and the mother of all unintended consequences was the result. As others have explained, this forced banks and other institutions to value assets that, yes, were worth less than 100 cents on the dollar, but that were still worth in most cases maybe 90-some cents on the dollar at zero. This was sheer folly and was the main reason the credit markets froze, which was the main reason the economy froze, which is now the main reason the entire world economy has all but collapsed.
Yeah, that was a great rule, and it would be just terrible if banks were now allowed to use accounting standards that did not value their mortgage portfolios, most of which are still performing just fine, at zero. The fact is, mark-to-market fundamentalism, in a rare market collapse scenario like we have now, is at least as distorting and damaging as allowing banks or others to inflate their asset values. How can everything just suddenly be worth zero? What sane interest does it serve to insist that is the case? It’s utterly idiotic. Why is that so hard to see?
A.J. Sutter - April 7, 2009 at 9:29 pm
Rather than debating the pros and cons of fair value accounting per se, I think the point of Lawrence’s post was that people are trying to have it both ways. In other words, they demand FVA when times are good, and now they demand to get rid of it when times are bad. The result in each case is to inflate their balance sheets, no matter what is happening in the real world.
Dana H’s comment, “As long as it is open about the standards it is following, a company should be free to choose whatever rules it thinks appropriate,” is an intriguing extension of “repression accounting” into deception accounting. It would make it intercomparison between companies’ financial statements well-nigh impossible for an average investor. The truth would be “disclosed,” but buried beyond the competence of anyone but experts, if even them, to discover. This is in a way a kind of ultra-leftist or anarchist proposal — it takes the class struggle to a new level, namely between subclasses of the investing class.
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