The Regulation and the Recession

Email Print


November 15,
2007, mark the date.

On this day
came the regulation that finally brought the recession.

Yes, up next
is a recession, a major credit crunch. It is way overdue and much
needed. The underlying forces of globalization, the rise of Asia
and productivity gains from new technology will however soon pick
the economy up again, given a few years. It will be a recession,
probably not and hopefully not a full blown depression.

The main reason
for the recession is the inflationary policy of the world's central
banks. Nixon left the gold standard on August 15, 1971; that's one
month before I was born, merely one generation ago. We are now about
to pay a major installment on the price for these 36+ years of reckless
monetary policy. This policy has massively distorted capital resources
and mental resources worldwide. A recession is needed to somewhat
reallocate capital and people’s attention. My generation has been
misled and misdirected. The lure of freshly printed money has distorted
the best and the brightest among us into Wall Street and real estate
deals when really they should have put their energies into productive

For now the
question begs, how long shall this recession last? When shall this
recession bottom out? Let us analyse this by focusing on how the
losses will show up in accounting, in the books and the balance
sheets of the institutions involved in the upcoming credit crunch.
This is not an exact science; I will not claim to have exact answers.
I will, based on some observations of time delay in the financial
industry, say something about the possible length of this recession.
I can guarantee you that it will not play out as suggested here;
there will be wildcards.

This recession
began showing its face in the summer of 2007 when the sub-prime
losses increasingly became apparent. Libertarian economic historians
will however mark November 15. 2007 as the important regulatory
date. This is when the new Financial Accounting Standards Board
(FASB) Statement No. 157 regulations for valuation of securities
came into effect.

Here is the
new Statement No. 157
by the FASB.

It basically
says that assets shall be valued according to three levels. Level
1 are directly measurable and marketable assets, Level 2 indirectly
so and Level 3 are non-marketable assets where previously there
has been room for various valuations practices based on arbitrary
"assumptions," no longer so. Now Level 3 assets will have
to be strictly revaluated and losses taken into the books. Level
3 are where the massive hidden losses are. Yet the hidden losses
in Level 3 will trickle over to losses in Level 2 and Level 1 as
they are revealed.

Pay attention

The Effective
Date of This Statement

This Statement
is effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within
those fiscal years. Earlier application is encouraged, provided
that the reporting entity has not yet issued financial statements
for that fiscal year, including financial statements for an interim
period within that fiscal year.

The provisions
of this Statement should be applied prospectively as of the beginning
of the fiscal year in which this Statement is initially applied.

The regulations
become effective for financial statements issued for fiscal years
starting after November 15, 2007. Most companies have fiscal years
corresponding to the calendar year, so this means the calendar year
of 2008.

The provisions
call for the new rules to be applied PROSPECTIVELY, that is BEFORE
the beginning of the fiscal year. For most companies that means
from January 1, 2008 or in Q4 2007, or possibly delayed to Q1 numbers
reported in April 2008. We can expect massive, I emphasise massive
losses to be reported in January 2008 and in April 2008.

Keep in mind
that accountants and money managers have known about this regulation
for some time already. They have been busy all summer and fall preparing
for this new regulation. They have been "in the know"
about the coming massive losses. Also keep in mind that as financial
insiders they are not allowed to tell anyone what they find; they'll
go to jail if they do. This is the veil everything seems to be behind,
that is why no one really knows for sure; no one actually really
knows for sure, they are forbidden to talk to each other. However
over the restaurant tables and in bars on Manhattan, on the golf
courses, the Yacht Clubs and in the gentleman's clubs they have
carefully tipped off their buddies in the other departments, their
MBA classmates, that something big and bad is about to unfold. The
news in the media this fall is what has leaked about the scary stuff
they have seen behind the veil.

Naturally then
the masters of the universe, the big boys on Wall Street, now partly
"in the know," have been busy all fall moving the losses
at par value from their own books over to their customers. This
will all become apparent in due time; there will be massive lawsuits.
Former Wall Street heroes will go to jail for transactions done
in late 2007, from cufflinks to cuffs.

All the financial
institutions on Wall Street are closely intertwined; the banks,
the financial houses, the funds, everything owns pieces of everything
else, one company's losses will show up as the next company’s losses
in the next reporting cycle, and so on all the way towards the bottom.
This ripple-down effect, the losses on other’s losses, will come
into play as the institutions report and take into account their
losses on each other; there is a significant delay here, cycle after
cycle, quarter after quarter, fiscal year after fiscal year.

Losses will
come in two varieties. There are the direct losses on assets that
have a ready price, Level 1 and Level 2. As shares and other assets
with an observable price fall they will be written down immediately
that very quarter. As the recession evolves the asset bubble will
deflate and prices go down across the board for these assets. Then
there are the Level 3 losses that will have to be "taken"
in, that is losses that someone, or rather a committee of former
geniuses, has to sit down and take in on their holdings. The Level
3 losses will be taken in wave after wave as they are unveiled.
This will meet major resistance; meetings and endless meetings,
board room fighting, outing of top executives who will be paid plenty
to keep their big mouths shut.

Losses will
thus become apparent in a zigzag motion back and forth between different
institutions holding them and between assets in Level 1,2,3. This
all will take time. Most large institutions report quarter by quarter,
but many less public institutions report year by year.

There will
be several attempts to finally clean it all out and get the losses
in the open. There will be false bull runs from that, but the cleaning
out will only reveal even more losses for others.

The last waves
of regular reporting based on the November 15, 2007 regulations
will come as late as 2009; most however will become apparent in
2008, fully reported early 2009. Bankruptcies will follow in the
wakes. Then in 2009 we will see increased ripple-down losses as
the losses on the losses become apparent and taken in. The full
effect of the ripple-down effect, the losses on the losses will
thus first become fully apparent during 2009, fully reported in
books presented in 2010.

Then politics:
the new US president's first priority in the new job in 2009 will
be the financial crisis on his (or god forbid; her) hands. The new
President will have enormous demands to do something, and do something
he will (President Paul changes these assumptions totally). You
can bet the new President will work to show confidence and action.
The action steps won't come right away, but the eventual solution
will for sure be to print more new money. There will be a new phase
of money supply expansion sometime in late 2009 onwards through
the first presidency.

The new President
will have his eyes solidly set on the next election in 2012: he
must make sure the economy has picked up by 2011 to ensure his re-election.
The entire government apparatus of the world's only superpower will
be aligned to get things going again by 2011. This can be done by
printing new money, and will therefore be done by printing new money.

Sometime in
2009/2010 most bad news is known. The new President has started
"doing something." That is when things might level off.

In the meantime
liquidity will be scarce; blown up asset prices will deflate across
the board; houses, shares, oil, art, silver and gold. Sell your
capital assets now, sit put on diversified currency cash and bonds
until the implosion has levelled off before re-entry.

21, 2007

Hans J.
Lysglimt [send him mail] is
the publisher of the Farmann
(publishing a free email newsletter in English and
Norwegian) from Oslo, Norway. Published since 1891, the classical
magazine regularly featured contemporary writings by Ludwig von
Mises through the early and mid 20th century.

Email Print