Gary North

June 4, 2009

Back in 1960, a scandal hit the country. It turned out that record companies had paid big-city disk jockeys money to play the firms' records. Congress was shocked! It passed a law making this illegal. The money was called payola: http://en.wikipedia.org/wiki/Payola

Stan Freberg, the great comic satirist, produced a record called The Old Payola Roll Blues. It made fun of a company that took a no-talent singer and made him a star. The record became a hit. Disk jockeys played it for free.

Congress has its own variation, called campaign contributions.

The Wall Street Journal posted a creative interactive chart that shows how much money the financial services industry gave to members of the House Financial Services Committee last fall.

The committee authorized legislation that allowed the Financial Services Accounting Board (FASB) to change the rules forced on the FASB by the Securities & Exchange Commission: mark to market, i.e., list the market value of assets, especially securitized mortgage packages. These securities had collapsed in value. Mark to market would have forced the financial services industry to count these capital losses as . . . capital losses! The deadline: April 1, 2009, when the new rules would be applied retroactively to first-quarter reports. The FASB changed its rules on April 3.

The chart is here.

The reality of the capital losses has not changed. The write-downs were not made. The losses remain. The banks are sitting on these losses, just as the Japanese banks have done for 19 years.

The Federal Deposit Insurance Corporation indefinitely postponed a central element of the Obama administration's bank rescue plan on Wednesday, acknowledging that it could not persuade enough banks to sell off their bad assets.

In a move that confirmed the suspicions of many analysts, the agency called off plans to start a $1 billion pilot program this month that was intended to help banks clean up their balance sheets and eventually sell off hundreds of billions of dollars worth of troubled mortgages and other loans.

Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.

This was the basis of Japam's zombie banks. They would not make loans to finance private industry. Economic growth slowed.

Geithner wants to preserve zombie banks.

The change in accounting was the origin of the stock market rally. It is based on jiggered accounting.

The real P/E ratio is much worse (higher) than real earnings would have established. There are fewer earnings.

Investors want to believe that accounting changes change reality. The public does not care. But when losses continue, and when the Treasury's deficit absorbs money that would have gone into stocks, when unemployment hits 11%, reality will make itself felt.

People want to live in fantasy land. This is especially true of Congress. Everyone wants to defer the day of reckoning -- an accounting concept.