Don't Bite The Hand That Feeds You

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How to Deal With a 3 A.M. Fear

Can it be that as recently as 2006, financial firms accounted for almost one-third of all the corporate profits in the United States? Or that money was so free-flowing that a single bat mitzvah party could be estimated to cost $10 million?

That era is gone with the wind. Now we face a severe recession, frightening jumps in unemployment, a breathtaking collapse of equity and real estate prices. Now we face a major discontinuity with what has gone before — a real, grinding, 3 a.m. fear, replete with nightmares of bread lines.

Not to belabor the obvious, but much of that fear comes from the crushing downward movement of mortgage-backed bonds and derivative securities linked to them. These losses transformed local housing declines into a global crisis and, along with the breathtaking fall in stock prices, have remained the primary engines of disaster.

Now, some of the decline in the financial markets is occurring for a very good reason: real concern about profits and coupon payments. But some of it is simply a result of the internal workings of the markets, which are pushing securities relentlessly down.

How can we fix the system and prevent these unnecessary losses, which are causing such widespread harm?

Here are three possible solutions:

REIN IN A RULE Immediately end the near-universal applicability of the accounting rule formally known as FAS 157. This is the “mark to market” rule that requires banks and other finance houses to value securities at current market prices, even when they may plan to hold those securities for some time.

The rule was intended to provide greater transparency. But its deficiencies are glaring. It allows short-sellers to basically price mortgage-backed bonds and to make them trade for pennies, even if the bonds are still meeting their payments. This “mark to market” price often does not come even close to the value of future cash flows that can reasonably be expected. The “mark to market” price is just the price at which the last short-seller made his sale.

This accounting rule kills banks and insurers, kills credit generally and makes taxpayers pay off the profits of short-sellers. It’s time to stop this giant gift to those sellers.

REVIVE A RULE End “naked short-selling” and bring back the “uptick” rule. The naked short-seller can sell shares without having borrowed the stock first. This is like tossing great white sharks into the kiddie end of the pool.

And then there’s the mystery of why the Securities and Exchange Commission ever ended the rule that requires an uptick in a share price before a short sale. The elimination of that restriction brings a major downside bias into prices.

Mary L. Schapiro, the new chairwoman of the S.E.C., should bring back the uptick rule. Yesterday wouldn’t be soon enough.

ADD A RULE Don’t allow speculators with no insurable interest to buy credit-default swaps on bonds.

When used properly, these instruments can function as a legitimate kind of insurance. Yes, if you are a real buyer of the bonds of a given company, you should be able to buy insurance. But you shouldn’t if you are just a shark circling prey, bringing blood into the water.

Allowing speculators to buy C.D.S.’s merely to bet against a firm in difficulty just blasts the prices of bonds, kills the balance sheets of banks, insurers and hedge funds, and throws fear into the system.

Unwinding C.D.S. agreements that are already in place would be complicated, but it can be done, as Gretchen Morgenson has written.

THE situation is grave. Why do we allow the continuation of practices that are killing all faith in the future, demolishing lending and battering retirement hopes?

Yes, Wall Street brought much of this upon itself. But we have to save the markets for the rest of us. If that means saving some of the fools and knaves, so be it.

Ben Stein is a lawyer, writer, actor and economist. E-mail: [e-mail].