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MAKING CENTS OUT OF THE NEWS
Blog #29
(July 30th, 2009)
TWO FOR THREE ON RE-MELTDOWN PREVENTION
By Tom McAllister, CFP®
Last fall, in the midst of the systemic meltdown of the U.S. credit system, I called for certain changes in regulation that I thought could interrupt the unraveling of the economy. (Several days later, Steve Forbes of Forbes Magazine called for the very same changes.)
My first recommendation concerned the rule, launched in 2008, requiring that banks, on their quarterly statements, show all their assets, including long-term real estate holdings, at current market value. I called this mark-to-the-market rule a "rule gone wrong", because mortgage assets were never meant to be priced quarterly. These huge bookkeeping charges on banks' income statements (when no real losses had occurred) caused unneeded and massive destruction among financial institutions, with many falling like dominos. Finally, in March of this year, the Financial Accounting Standards Board lifted the "mark-to-the-market" rule for mortgages and mortgage-backed securities. Trigger #1 to the meltdown now stands corrected.
Just as the "mark to the market" rule had caused untold damage to the system by being overly exacting, a second "rule gone wrong", one having to do with "short selling" of stock, caused damage to the system because it was overly lax. By way of reminder, a short sale is a transaction done by a person or an entity with borrowed stock, in which the seller is expecting a fall in price that will allow him to "cover" the sale with stock bought at a price lower than the sale price
There is nothing invidious about short selling per se. The problem began when a restriction, called the "up-tick rule", which had been in place ever since the Great Depression, was removed. With the up-tick rule in place, a short sale had been allowable only at a price higher than the last different transaction price. The up-tick was the safety feature of short selling that prevented hedge funds and speculators who were, with the aid of computer-driven program trading, precipitously driving down stock prices. The removal of the up-tick rule contributed to the financial meltdown. Fortunately, reinstatement of the up-tick rule is now under consideration.
Also having to do with short selling of stocks, a positive legislative development is that the Security and Exchange Commission made permanent its temporary ban against "naked short selling". In a naked short sale, the transaction is executed not with borrowed shares, but with "theoretical shares." Sellers are counting on covering their obligations later by buying the stock at a discount prices. Naked short selling is prohibited, but regulators were not alert to the widespread violations. During the financial meltdown, there were many instances of "fails" (failure of the seller to deliver stock when due after it had been sold), as hedge funds bet against troubled banks and investment firms. Thankfully, Trigger #2 to the meltdown now stands corrected, with the only thing left to do being to reinstate the up-tick rule.
The market meltdown of the past year brings into sharp focus the regulatory lessons we should have learned during the Great Depression. Rules were put into place in the 1930's and 1940's for the express purpose of preventing manipulation of stock prices. I am very encouraged in seeing a return to common sense regulation in both the stock and real estate markets.
Special alert to readers who have taken early retirement Social Security benefits:
A little-known option exists for those who start taking Social Security benefits after age 62, but before their "Normal Retirement Age". Upon reaching NRA (the age at which you would have received full benefits had you waited), you are allowed to REPAY the total amount of your early distributions and begin receiving full benefits as if you had waited until full benefits were due you. In effect, your will have gotten your early benefits in the form of an interest-free loan from Social Security.
I believe many of my readers have the means to employ this "reset" strategy by using their other resources to pay back Social Security.. If you fit this scenario, you should check with your local Social Security office as to your own situation.
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