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US structured finance

Why do accounting and market structures matter? Capitalism will not work without markets by which investors can efficiently exercise their freedom to exchange assets. It is freedom to exchange assets (particularly financial assets) that gives capitalism its ability to adjust and allocate resources efficiently to create economic growth.

Recent experience, in Japan and the US, shows that we can pour all the liquidity we want into a system, but without reliable information and rules that are not rigged, investors will not invest enough money in those businesses that produce growth. Unreliable information, barriers and loopholes limit what investors want, so they preclude or defer economic recovery. As a result, everyone loses.

Investors' preferences are apparent in market behavior. Reliable and efficient markets support stable and sustained growth by a level, and low, relative cost of capital for growth companies. Rigged and opaque markets create vacillating, and far higher, relative capital costs.

When growth companies must pay more for capital than others, growth is not supported.

US markets became rigged as a result of a series of actions between 1989 and 1998. That is the root cause of today's worldwide economic malaise. In the US, a president who did not create the rules that rigged the market may lose his reelection bid if we fail to fix them in time. Despite the lowest interest rates in 40 years and record budget deficits, it seems possible that he will be blamed because the US recovery from the recession of 2001 has been anemic and jobless.

What's the solution?

First, markets won't function efficiently if investors are denied certainty regarding the information provided to them. That's what's at stake in debates on change of accounting rules. For an article that explains this, see "The FASB and the Capital Markets," John M (Neel) Foster, The FASB Report, June 2003 (available at under Articles & Reports).

Second, markets are rigged when rules create needless: (1) barriers that limit access for parties and (2) loopholes that favour particular access. Both cause liquidity to flow to places where it is not needed. Both, moreover, are pursued by those who seek to profit by controlling and allocating liquidity. What they miss is that nobody wins at this type of Monopoly. The victor at Monopoly may hold all the property but all its potential customers are broke, leaving the winner as broke as the losers.

For a history of barriers and loopholes, and their consequences in US market behavior, see "Who Let the Bears Kill Goldilocks?", Futures & Derivatives Law Report, Volume 23, Number 5, July-August 2003. For some, the article may only cure insomnia. It shows that politicians, firms, and investors come and go. Sound markets support them, and rigged markets eventually expel them like the losers (and winners) in a global game of Monopoly.

Market rules that produce certainty, and allow neither barriers nor loopholes, are what we must create for worldwide economic recovery.

How can rulemakers distinguish barriers from loopholes?

One must study the consequences of each action. If eliminating a rule levels the playing field and grants no advantage to particular groups, the old rule was probably a barrier. Conversely, if a rule that creates an advantage is replaced by one that levels the playing field, the former rule was probably a loophole in need of closing. Finally, if certain players are advantaged by creating or eliminating a restraint, one is probably erecting a barrier or creating a loophole, respectively.

Accounting can be based on principles or rules. That does not matter. Accounting by either method leads to abuse and evasion if accounting standard-setters create barriers and loopholes to freedom of exchange.

Laws of market regulation and investor preference, as well as their economic consequences, have a clout that either humbles or destroys standard-setters, regulators, and elected officials. US leaders can repeat the mistakes of history or they can learn from them. For everyone's sake, I hope they choose the latter, and soon.

Frederick Feldkamp

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