Today the Treasury Secretary released the following statement:

“I and my colleagues at the Fed and the SEC continue to address the market challenges we are facing on a daily basis. I am committed to continuing to work with my fellow regulators to use all the tools available to protect our financial system and our economy.”

While Congress and the White House consider next steps, the Treasury and its fellow regulators should follow their own counsel and take without delay the one regulatory action within their discretion that can help immediately to calm markets and dramatically reduce the taxpayer risk in any necessary government intervention: suspend mark-to-market.

Chief economist Brian S. Wesbury and his colleague Robert Stein at First Trust Portfolios of Chicago estimate the impact of the “mark-to-market” accounting rule on the current crisis as follows:

It is true that the root of this crisis is bad mortgage loans, but probably 70% of the real crisis that we face today is caused by mark-to-market accounting in an illiquid market. What’s most fascinating is that the Treasury is selling its plan as a way to put a bottom in mortgage pool prices, tipping its hat to the problem of mark-to-market accounting without acknowledging it. It is a real shame that there is so little discussion of this reality.

If regulators on their own – or Congress, if regulators fail to use their discretion – can fix 70% of the financial crisis by changing the mark-to-market accounting rule, we should change the rule first before attempting to pass another reevaluated bailout package.

“Mark-to-Market” Accounting and the Origins of the Financial Crisis

Mark to market accounting (also known as “fair value” accounting) means that companies must value their assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately. Under such a rule, declining housing prices don’t just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worth less. Moreover, when a company in financial distress begins firesales of its assets to raise capital to meet regulatory requirements, the market bottom prices it sells out for become the new standard for the valuation of all similar securities held by other companies under mark-to-market. This has begun a downward death spiral for financial companies large and small.

More foreclosures and home auctions continue to depress housing prices, further reducing the value of all mortgage-related securities. As capital values decline, firms must scramble to maintain the capital required by regulation. When they try to sell assets to raise that capital, the market values of those assets are driven down further. Under mark-to-market, the company must then mark down the value of all of its assets even more.

The credit agencies see declining capital margins, so they downgrade the company’s credit ratings. That makes borrowing to meet capital requirements more difficult. Declining capital and credit ratings cause the company’s stock prices to decline.

Panic sets in, and no one wants to buy mortgage-related securities, driving their value under mark-to-market regulations down toward zero. Balance sheets under mark-to-market suddenly start to show insolvency. This downward spiral shuts down lending to these companies, so they lose all liquidity (cash on hand) needed to keep company operations going. Stockholders—realizing that they will be wiped out if the companies go into bankruptcy or get taken over by the government—start panic selling, even when they know the underlying business of the company is fine. The end result for the company is stock prices driven towards zero and bankruptcy or government takeover. The criminal liabilities imposed under Sarbanes-Oxley have driven accountants to stricter and stricter accounting evaluations and interpretations and have prevented leading executives from resisting them.

The Problems with Mark-to-Market Accounting

William Isaac, Chairman of the FDIC in the 1980s under President Reagan, recently wrote in the Wall Street Journal, “During the 1980s, our underlying economic problems were far more serious than the economic problems we’re facing this time around….It could have been much worse. The country’s 10 largest banks were loaded up with Third World debt that was valued in the markets at cents on the dollar. If we had marked those loans to market prices, virtually every one of them would have been insolvent.”

Isaac continues, “But what do we do when the already thin market for those assets freezes up and only a handful of transactions occur at extremely depressed prices?...The accounting profession, scarred by decades of costly litigation, just keeps marking down the assets as fast as it can.”

Isaac concludes, “This is contrary to everything we know about bank regulation. When there are temporary impairments of asset values, due to economic and marketplace events, regulators must give institutions an opportunity to survive the temporary impairment. Assets should not be marked to unrealistic fire sale prices. Regulators must evaluate the assets on the basis of their true economic value (a discounted cash flow analysis). If we had followed today’s approach during the 1980s, we would have nationalized all of the major banks in the country and thousands of additional banks and thrifts would have failed. I have little doubt that the country would have gone from a serious recession into a depression.” (emphasis added).

Similarly, University of Chicago Law Professor Richard Eptstein, among the best in the country at law and economics analysis, recently wrote about mark-to-market accounting for today’s mortgage-related securities, “Unfortunately, there is no working market to mark this paper down to. To meet their bond covenants and their capital requirements, these firms have to sell their paper at distress prices that don't reflect the upbeat fact that the anticipated income streams from this paper might well keep the firm afloat.”

Alex Pollock, former head of the Federal Home Loan Bank of Chicago, explains that when the economy is in the midst of a severe downturn, the use of mark-to-market accounting “reinforces the downward cycle of panic-falling prices-losses-illiquidity-credit contraction-more panic-further falling prices-greater reported losses-no active markets. Fair value accounting adds momentum to a destructive downside overshoot.” [LINK http://www.aei.org/publications/filter.all,pubID.28370/pub_detail.asp]

Reform or Bust

Because existing rules requiring mark-to-market accounting are causing such turmoil on Wall Street, mark-to-market accounting should be suspended immediately so as to relieve the stress on banks and corporations. In the interim, we can use the economic value approach based on a discounted cash flow analysis of anticipated income streams, as we did for decades before the new mark-to-market began to take hold. We can take the time to evaluate mark-to-market all over again. Perhaps a three year rolling average to determine mark-to-market prices would be a workable permanent system.

It is not widely understood that the adoption of mark-to-market accounting rules is a major factor in the liquidity crisis which is leading companies to go bankrupt. But it is destructive to have artificial accounting rules ruin companies that would have otherwise survived under previous rules.

For companies like Bear Stearns, Lehman Brothers, and American International Group (AIG), suspending mark-to-market rules will come too late. But for the remaining vulnerable banks and corporations, doing away with the current mark-to-market accounting rules will safeguard against destructive pricing volatility, needless bankruptcies, job loss, and huge taxpayer bailouts.

Suspending Mark-to-Market Only the First Step to Economic Recovery

In the wake of today’s vote, suspending mark-to-market is an extremely important first step to take, but only a first step.

Congress should also consider a bold and dramatic program to restart economic growth and rebuild market efforts.

In particular, the Congress should look at the impact of the Irish 12% corporate income tax on attracting investment and jobs to Ireland and consider a dramatic cut in the United States corporate income tax (the highest in the world when combined with state taxes) as a step toward attracting high value productive and desirable jobs back to the United States.

The Congress should look at the Chinese and Singapore growth patterns and match them by zeroing out the capital gains tax to induce massive flows of private capital to rebuild the market and minimize the need for a taxpayer funded bailout.

The Congress should repeal Sarbanes-Oxley, which failed to warn of every single bankruptcy but provides a $3 million a year accounting and regulatory expense for every small company wishing to go public.

This is the kind of pro-growth, pro-entrepreneur program that would accelerate the American recovery and lead to the next economic period of real growth.

By Newt Gingrich

FamilySecurityMatters.org Contributing Editor Newt Gingrich is the former speaker of the U.S. House of Representatives and author of "Winning the Future."

http://www.familysecuritymatters.org/publications/id.1344/pub_detail.asp

Comments are welcome at redstatepatriot@hughes.net. Please include the title of the article as your subject line. Selected responses, in whole or part, may be published (appended to the article).

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And they were severely punished and isolated by Chamberlain. And as I read that, I realized that that's really where we are today. Our current problem is tragic. You have an administration whose policy is inadequate being opposed by a political left whose policy is worse, and you have nobody prepared to talk about the policy we need. Because we are told if you are for a strong America, you should back the Bush policy even if it's inadequate, and so you end up making an argument in favor of something that can't work. So your choice is to defend something which isn't working or to oppose it by being for an even weaker policy. So this is a catastrophe for this country and a catastrophe for freedom around the world because we have refused to be honest about the scale of the problem.

Let me work back. I'm going to get to Iran since that's the topic, but I'm going to get to it eventually. Let me work back from Pakistan. The dictatorship in Pakistan has never had control over Waziristan. Not for a day. So we've now spent six years since 9/11 with a sanctuary for Al-Qaida and a sanctuary for the Taliban, and every time we pick up people in Great Britain who are terrorists, they were trained in Pakistan.

And our answer is to praise Musharraf because at least he's not as bad as the others. But the truth is Musharraf has not gotten control of terrorism in Pakistan. Musharraf doesn't have full control over his own government. The odds are even money we're going to drift into a disastrous dictatorship at some point in Pakistan. And while we worry about the Iranians acquiring a nuclear weapon, the Pakistanis already have them. So, why would you feel secure in a world where you could presently have an Islamist dictatorship in Pakistan with a hundred-plus nuclear weapons? What's our grand strategy for that?

Then you look at Afghanistan. Here's a country that's small, poor, isolated, and in six years we have not been able to build roads, create economic opportunity, wean people off of growing drugs. A third of the GDP is from drugs. We haven't been able to end the sanctuary for the Taliban in Pakistan. And I know of no case historically where you defeat a guerrilla movement if it has a sanctuary. So the people who rely on the West are out bribed by the criminals, outgunned by the criminals, and faced with a militant force across the border which practiced earlier defeating the Soviet empire and which has a time horizon of three or four generations. NATO has a time horizon of each quarter or at best a year, facing an opponent whose time horizon is literally three or four generations. It's a total mismatch.

Then you come to the direct threat to the United States, which is Al-Qaida. Which, by the way, we just published polls. One of the sites I commend to you is American Solutions.com. Last Wednesday we posted six national surveys, $428,000 worth of data. We gave it away. I found myself in the unique position of calling Howard Dean to tell him I was giving him $400,000 worth of polling. We have given it away to both Democrats and Republicans. It is fundamentally different from the national news media. When asked the question "Do we have an obligation to defend the United States and her allies?" the answer was 85 percent yes. When asked a further question "Should we defeat our enemies?" Its very strong language - the answer was 75 percent yes, 75 to 16.

The complaint about Iraq is a performance complaint, not a values complaint. When asked whether or not Al-Qaida is a threat, 89 percent of the country says yes. And they think you have to defeat it, you can't negotiate with it. So now let's look at Al-Qaida and the rise of Islamist terrorism.

And let's be honest: What's the primary source of money for Al-Qaida? It's you, re-circulated through Saudi Arabia. Because we have no national energy strategy, when clearly if you really cared about liberating the United States from the Middle East and if you really cared about the survival of Israel, one of your highest goals would be to move to a hydrogen economy and to eliminate petroleum as a primary source of energy. Now that's what a serious national strategy would look like, but that would require real change.

So then you look at Saudi Arabia. The fact that we tolerate a country saying no Christian and no Jew can go to Mecca, and we start with the presumption that that's true while they attack Israel for being a religious state is a sign of our timidity, our confusion, our cowardice that is stunning.

It's not complicated. We're inviting Saudi Arabia to come to Annapolis to talk about rights for Palestinians when nobody is saying, "Let's talk about rights for Christians and Jews in Saudi Arabia. Let's talk about rights for women in Saudi Arabia."

So we accept this totally one-sided definition of the world in which our enemies can cheerfully lie on television every day, and we don't even have the nerve to insist on the truth. We pretend their lies are reasonable. This is a very fundamental problem. And if you look at who the largest owners of some of our largest banks are today, they're Saudis.

You keep pumping billions of dollars a year into countries like Venezuela, Iran and Saudi Arabia, and Russia, and you are presently going to have created people who oppose you who have lots of money. And they're then going to come back to your own country and finance, for example, Arab study institutes whose only requirement is that they never tell the truth. So you have all sorts of Ph.D.s who now show up quite cheerfully prepared to say whatever it is that makes their funders happy – in the name, of course, of academic freedom. So why wouldn't Columbia host a genocidal madman? It's just part of political correctness. I mean, Ahmadinejad may say terrible things; he may lock up students; he may kill journalists; he may say, "We should wipe out Israel;" he may say, "We should defeat the United States;" but after all, what has he done that's inappropriate? What has he done that wouldn't be repeated at a Hollywood cocktail party or a nice gathering in Europe? And nobody says this is totally, utterly, absolutely unacceptable. Why is it that the No. 1 threat in intelligence movies is the CIA?

I happened the other night to be watching an old movie, “To Live and Die in L.A.,” which is about counterfeiting. But the movie starts with a Secret Service agent who is defending Ronald Reagan in 1985, and the person he is defending Ronald Reagan from is a suicide bomber who is actually overtly a Muslim fanatic. Now, six years after 9/11, you could not get that scene made in Hollywood today.

Just look at the movies. Why is it that the bad person is either a right-wing crazed billionaire, or the CIA as a government agency? Go look at the Bourne Ultimatum. Or a movie like the one that George Clooney made, which was an absolute lie, in which it implied that if you were a reformist Arab prince, that probably the CIA would kill you. It's a total lie. We actually have Seals protecting people all over the world. We actually risk American lives protecting reformers all over the world, and yet Hollywood can't bring itself to tell the truth, (a) because it's ideologically so opposed to the American government and the American military, and (b), because it's terrified that if it said something really openly, honestly true about Muslim terrorists, they might show up in Hollywood. And you might have somebody killed as the Dutch producer was killed.

And so we're living a life of cowardice, and in that life of cowardice we're sleepwalking into a nightmare.

And then you come to Iran. There's a terrific book. Mark Bowden is a remarkable writer who wrote “Black Hawk Down,” has enormous personal courage. He's a Philadelphia newspaper writer, actually got the money out of the Philadelphia newspaper to go to Somalia to interview the Somalian-side of Black Hawk Down. It's a remarkable achievement. Tells a great story about getting to Somalia, paying lots of cash, having the local warlord protect him, and after about two weeks the warlord came to him and said, "You know, we've decided that we're very uncomfortable with you being here, and you should leave."

And so he goes to the hotel, where he is the only hard-currency guest, and says, "I've got to check out two weeks early because the warlord has told me that he no longer will protect me." And the hotel owner, who wants to keep his only hard-currency guest, says, "Well, why are you listening to him? He's not the government. There is no government." And Bowden says, "Well, what will I do?" And he says, "You hire a bigger warlord with more guns," which he did. But then he could only stay one week because he ran out of money.

But this is a guy with real courage. I mean, imagine trying to go out and be a journalist in that kind of world, OK? So Bowden came back and wrote, "Guest of the Ayatollah," which is the Iranian hostage of 1979, which he describes as the first shots in Iran's War against America. So in the Bowden worldview, the current Iranian dictatorship has been at war with the United States since 1979.

Every conceivable tenet of international law was violated when they seized the American Embassy and they seized the diplomats - killed Americans in Lebanon in the early '80s - killed Americans at Khobar Towers in '95. The Clinton administration deliberately avoided revealing the information, as Louis Freeh, the director of the FBI, has said publicly, because they didn't want to have to confront the Iranian complicity.

And so you have an Iranian regime which is cited annually as the leading supporter of state terrorism in the world. Every year the State Department says that. It's an extraordinary act of lucidity on the part of an institution which seeks to avoid it as often as possible.

And you have Gen. Petraeus come to the U.S. Congress and say publicly in an open session, "The Iranians are waging a proxy war against Americans in Iraq." I was so deeply offended by this it's hard for me to express it without sounding irrational. I'm an Army brat. My dad served 27 years in the infantry. The idea that an American general would come to the American Congress, testify in public that our young men and women are being killed by Iran, and we have done nothing, I find absolutely abhorrent.

So I'm preparing to come and talk today. I got up this morning, and a friend had sent me yesterday's Jerusalem Post editorial, which if you haven't read, I recommend to you. It has, for example, the following quote: "On Monday, chief Palestinian negotiator Saeb Erekat said, 'The problem of the content of the document setting out joint principles for peace-making post-Annapolis has not been resolved. One of the more pressing problems is the Zionist regime's insistence on being recognized as a Jewish state. We will not agree to recognize Israel as a Jewish state. There is no country in the world where religious and national identities are intertwined.' "

What truly bothers me is the shallowness and the sophistry of the Western governments, starting with our own. When a person says to you, "I don't recognize that you exist," you don't start a negotiation. The person says, "I literally do not recognize" and then lies to you. I mean the first thing you say to this guy is "Terrific. Let's go visit Mecca. Since clearly there's no other state except Israel that is based on religion, the fact that I happen to be Christian won't bother anybody." And then he'll say, "Well, that's different."

We tolerate this. We have created our own nightmare because we refuse to tell the truth. We refuse to tell the truth to our politicians. Our State Department refuses to tell the truth to the country. If the President of the United States, and again, we're now so bitterly partisan, we're so committed to red-vs.-blue hostility, that George W. Bush doesn't have the capacity to give an address from the Oval Office that has any meaning for half the country. And the anti-war left is so strong in the Democratic primary that I think it's almost impossible for any Democratic presidential candidate to tell the truth about the situation.

And the Republicans are isolated and trying to defend incompetence. The Democrats are isolated and trying to find a way to say, "I'm really for strength as long as I can have peace, but I'd really like to have peace, except I don't want to recognize these people who aren't very peaceful."

I just want to share with you, as a grandfather, as a citizen, as a historian, as somebody who was once Speaker of the House, this is a serious national crisis. This is 1935 or 1936, and it's getting worse every year.

None of our enemies are confused. Our enemies don't get up each morning and go, "Oh, gosh, I think I'll have an existential crisis of identity in which I will try to think through whether or not we can be friends while you're killing me." Our enemies get up every morning and say, "We hate the West. We hate freedom." They would not allow a meeting with women in the room.

I was once interviewed by a BBC reporter, a nice young lady who was only about as anti-American as she had to be to keep her job. Since it was a live interview, I turned to her halfway through the interview and I said, "Do you like your job?" And it was summertime, and she's wearing a short-sleeve dress. And she said, "Well, yes." She was confused because I had just reversed roles. I said, "Well, then you should hope we win." She said, "What do you mean?" And I said, "Well, if the enemy wins, you won 't be allowed to be on television." I don't know how to explain it any simpler than that.

Now what do we need to do?

We need first of all to recognize this is a real war. Our enemies are peaceful when they're weak, are ruthless when they're strong, demand mercy when they're losing, show no mercy when they're winning. They understand exactly what this is, and anybody who reads Sun Tzu will understand exactly what we're living through. This is a total war. One side is going to win. One side is going to lose. You'll be able to tell who won and who lost by who's still standing.

Most of Islam is not in this war, but most of Islam isn't going to stop this war. They're just going to sit to one side and tell you how sorry they are that this happened. We had better design grand strategies that are radically bigger and radically tougher and radically more honest than anything currently going on, and that includes winning the argument in Europe, and it includes winning the argument in the rest of the world. And it includes being very clear, and I'll just give you one simple example because we're now muscle-bound by our own inability to talk honestly.

Iran produces 60 percent of its own gasoline. It produces lots of crude oil but only has one refinery. It imports 40 percent of its gasoline. The entire 60 percent is produced at one huge refinery.

In 1981, Ronald Reagan decided to break the Soviet empire. He was asked, “What's your vision of the Cold War.” He said, "Four words: We win; they lose." He was clearly seen by The New York Times as an out-of-touch, reactionary, right-wing cowboy from California who had no idea what was going on in the world. And 11 years later the Soviet Union disappeared, but obviously that had nothing to do with Reagan because that would have meant he was right. So it's just a random accident the Soviet Union disappeared.

Part of the war we waged on the Soviet Union involved their natural gas supply because we wanted to cut off their hard currency. The Soviets were desperate to get better equipment for their pipeline. We managed to sell them through third parties very, very sophisticated American pipeline equipment, which they were thrilled to buy and thought they had pulled off a huge coup. Now we weren't playing fair. We did not tell them that the equipment was designed to blow up. One day in 1982, there was an explosion in Siberia so large that the initial reflection on the satellites looked like there was a tactical nuclear weapon. One part of the White House was genuinely worried, and the other part of the White House had to calm them down. They said, "No, no, that's our equipment blowing up."

In the 28 years since the Iranians declared war on us, in the six years since 9/11, in the months since Gen. Petraeus publicly said they are killing young Americans, we have not been able to figure out how to take down one refinery - covertly, quietly, without overt war. And we have not been able to figure out how to use the most powerful navy in the world to simply stop the tankers and say, "Look, you want to kill young Americans, you're going to walk to the battlefield, but you're not going to ride in the car because you're not going to have any gasoline."

We don't have to be stupid. The choice is not between cowardice or total war. Reagan unlocked Poland without firing a shot in an alliance with the Pope, with the labor unions and with the British. We have every possibility if we're prepared to be honest to shape the world. It'll be a very big project. It's much closer to World War II than it is to anything we've tried recently. It will require real effort, real intensity and real determination. We're either going to do it now, while we're still extraordinarily powerful, or we're going to do it later under much more desperate circumstances after we've lost several cities.

We had better take this seriously because we are not very many mistakes away from a second Holocaust. Three nuclear weapons is a second Holocaust. Our enemies would like to get those weapons as soon as they can and they promise to use them as soon as they can.

I suggest we defeat our enemies and create a different situation long before they have that power.

Newt Gingrich
Former Speaker of the House of Representatives

The above is a transcript of remarks delivered to a Jewish National Fund meeting November 15, 2007 at the Selig Center

Hat tip: Mike Milner

Comments are welcome at redstatepatriot@hughes.net. Please include the title of the article as your subject line. Selected responses, in whole or part, may be published (appended to the article).

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