Economy Awareness Seminar 2008 Essay Winners

Editor’s Note: David Drago submitted one of the ten winning essays in our Economy Awareness Seminar 2008 cash prize giveaway. This is the tenth and final submission to be featured in our Contest Winners Series. Thank you to all of the applicants.

There is a new buzz word on the tongues of all Americans, “crisis.” Over the last two years America has weathered a crisis in oil, housing, credit, banking, and now I would suggest a new crisis, a “Resolution Crisis.”

Whether analyzing our short-term or long-term problems, lawmakers, politicians, and Wall Street pundits alike have been frantically trying to fix this global disaster. As of right now, two major solutions have resulted from their toil: mock nationalization of the banking system and a $700 billion bailout bill filled with more pork than a butcher’s shop. Both have been met with extreme volatility in the market, and Bernanke has confessed that these measures are not long-term solutions. Therefore, I would suggest that American needs changes on a more fundamental level to fix the crises afflicting the modern-world; this is our “Resolution Crisis.”

The problem with these crises is, besides the banking industry, the fundamentals in the market were relatively sound. It was only after banks stopped lending to other institutions that the crisis spilled over into other industries. As a result, there was a global strategic reduction in interest rates and the two previous plans to inject liquidity into the market. I would make the claim that while this may temporarily ease the ability to receive credit from banks; it has done nothing to help the institutions that rely on commercial paper as a source of funds. Also, while there has been a reduction in the price of crude, which represents billions of dollars saved, the taxpayer still is paying the costs. Finally, the SEC rule 10a-1, better known as the uptick rule was eliminated on July 6, 2007. This has allowed massive hedge funds the ability to have huge short positions and place downward pressure on the economy.

As a temporary fix, the government purchased failing securities that might end up being profitable for the government, i.e. Savings and Loans. However, I would argue that in order to implement a long-term solution there are three major culprits that need to be addressed in order to fix the ailing economy. They are the mark-to-market accounting, naked short selling, and the uptick rule. The reason a majority of the banking institutions have become insolvent is due to this accounting rule. Since it is nearly impossible to place an intrinsic value on these CDOs and subprime assets, the bank is forced to mark them to zero. This creates negative equity for the bank as liabilities become greater than the bank’s assets. However, these securities have a long-term value; therefore I would suggest a change to the accounting rule that allows banks to establish a conservative long-term value for a portion of their assets. Finally, naked-short selling allows an institution to leverage the amount of their short positions by not owning the underlying assets. If SEC rule 10a-1 was reinforced with a new clause eliminating naked shorts, the downward pressure in the market would be relaxed.

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