Something you never knew existed may be one of the biggest reasons the economy has been in shambles for the past 6 months. Shortly after ENRON, the powers-that-be in their infinite wisdom reinstated (see below) some accounting rules called “Mark-to-Market.” These rules came into full effect in 2007, just in time to artificially exacerbate the downturn. Like most regulations, is sounds like a logical and down-right necessary rule. It says that companies must value their assets at the current market price and factor that into their bottom-line. What this means is when something is trading at 20 cents on the dollar, the company must subtract 80 cents for each of those dollars from their cash on hand and other assets, even if they don’t sell it and have no plans to. This is a problem, especially for banks. They hold a majority of these bad assets, called “mortgage backed securities”, that no one wants because no one understands how much they’re worth. Banks have capitol requirements in order to be considered solvent, but when they have to act like these 20 cent securities are real losses, they must hoard cash to make up the difference. Thus, they have no cash on hand to lend to others and we suffer the current “credit crunch.”
Notice at the beginning I said “reinstated.” This is because we have had this rule in practice once before. You may have heard of it. It’s called the Great Depression. Mark-to-market was in full swing early on until FDR got rid of it. Since then, we have had relatively smooth and prosperous economic growth, until now. Last week I wrote my senators and congressman and told them they desperately needed to get rid of M2M. I found out the next day that Brian Wesbury (my favorite economist) was asking his readers to do the same. This week there was a hearing on capitol hill concerning M2M and there is finally bipartisan support for its elimination (before now there was zero support). In true political fashion, congressman trucked in the regulators and chastised them on national TV as if Congress had not been equally an inept up until now.
However it happens, the elimination of M2M in its current form will mean a massive recovery in the stock market. If you are not already invested, you should be right now (assuming you have any money on hand). I am fairly confident that after we pull out of this, we will not see these market levels again. Meaning the stock market is now the cheapest it will be in any of our lifetimes. I’ve been investing the whole way down, and am currently down 40%. Any money that is put in now will be doubled just by the market getting back to the all time high (DOW=14,165). I have heard the peak is still a fair value if not slightly undervalued currently.