Death by compliance
The Gist: How regulation drove the 2008 financial crisis
Part of a series on the 2008 financial crisis. Find part one here, part two here, and part three here.
The folktale of the 2008 financial crisis attributes its origins to the notion that one of the most regulated industries in the United States - banking - was unregulated1. Or, acknowledging some reality, under-regulated. In fact, what drove the crisis was that banking - and related industries, like housing - were misregulated, if not overregulated.
Figure 1. Folktales can sometimes get it wrong: Jack (of beanstalk infamy) was a serial burglar who betrayed the kindness of a giant woman by robbing her hungry husband.
As befitting the fact that we are drowning in an ocean of regulations and have to retain a navy of lawyers to navigate it, there are several ways in which regulators shaped the crisis.
Let’s start with the private ratings agencies, who gave their highest endorsement (AAA) to the safety of mortgage bundles that turned out to be junk - and suffered little consequence for it. There were two significant preceding problems: first, that the government, in pursuit of safety, created an oligopoly of three rating agencies, weaving their judgements into its own rulebook: what a bank, broker, money fund, insurer, or pension could own, and how much capital it had to hold against it, came to hinge on one of their grades.2 A rating thus stopped being information you could weigh and became a regulatory license - a permission slip the state obliged you to purchase from a group with limited competition.
Second, Allison argues that the government, counter to safety, incentivized the agencies to be over-optimistic in their assessments:
“One factor that undoubtedly influenced the rating agencies was the way they were compensated. For years, the agencies had charged the buyers of the bonds for rating the bonds, a system encouraged by S&P, Moody’s, and Fitch and that led them to be more conservative because their clients were the bond buyers…. Tragically, in the early 1970s, the SEC, seeking to expand market access to ratings, forced Moody’s and the other rating firms to fundamentally change their compensation model in a way that created serious conflicts of interest. Under the new method, the agencies were paid by issuers—bond sellers, not bond buyers. The SEC was influenced by union and government pension plans that did not want to pay the cost of the ratings. Of course, the cost of the ratings was always embedded in relative bond yields, but it was less visible than the direct cost to bond buyers. Under government-mandated ‘issuer pays’ rules, the rating firms were motivated to lower their standards, fearing that issuers who were displeased with their ratings would yank their business and move it to a competitor rating firm.”
The shift from buyer-pays to seller-pays, along with the incentives, is real, but Allison’s attribution to the SEC is admittedly rare. Regulation had begun to change the rating product as far back as the Great Depression: the Comptroller began requiring that banks hold investment-grade securities - and the grader was a ratings agency. Before the rules, agencies rated bonds after issuance; the regulations created demand to rate securities before issuance, and placed the agencies in the position of performing a delegated governmental function - bank supervision - on the Comptroller’s behalf. The 1930s rules didn’t cause the 1970s flip in who pays - most scholars attribute that to the photocopier, which let investors free-ride on ratings and starved the subscription model, and to Penn Central’s 1970 default, after which issuers wanted to buy ratings to reassure a rattled market. What the old regulation did was make that flip stick: once a rating was a legal passport to the largest pools of capital, issuer-pays was both irresistibly profitable and impossible to discipline - the issuer now chose and paid the rater, while the law respected the verdict. Ironically, banning ratings agencies might have ensured a safer result than requiring them: buyers would have had to evaluate the risks entirely themselves. Of course, better yet would have been to allow the ratings agencies to function as they had originally, without a thumb on the scale.
As a result of thoroughly screwing up their one job, the rating agencies paid out more than two billion dollars between them - a fraction of a single year’s revenue - while emerging more entrenched than ever. Yes, Congress ordered the raters stripped from the law - but the removal is often cosmetic (rules now demand an “external assessment of creditworthiness,” which in practice means a rating), and Dodd-Frank simultaneously raised the registration and compliance costs of becoming a recognized rater, pricing out the very challengers that might have broken the big three’s grip.3 And a decade after Congress ordered the government to stop outsourcing its risk judgments to three private firms, the first crisis (covid) sent regulators sprinting back to those same three by name: some of the Fed’s emergency lending facilities had just that requirement.
But beyond their incentives, John B. Taylor notes, “The rating agencies underestimated the risk of these securities because of a lack of competition, poor accountability, or, most likely, an inherent difficulty in assessing risk due to the complexity.” Allison explains:
“Their mathematical rating models failed. This occurred for a variety of reasons. First of all, the subprime market was growing so rapidly that the loan loss ratios were understated… only when a portfolio matures can losses be properly estimated. Since subprime lending on this scale was new, there was no long-term history that could be used to evaluate the amount of losses likely to be incurred during a period of stress. The last real estate correction had been more than 10 years earlier (in the early 1990s) and had been milder. In addition, this early 1990s correction was primarily in the commercial real estate market instead of residential real estate markets, and there was not a large subprime home-lending business in the 1990s that could be used for comparison. Also, the rating agencies’ models were weighted heavily toward recent years (2003–2005), when losses had been very low because of rapid real estate appreciation.”
This was obviously shortsighted. And Allison, the CEO of BB&T, which was profitable in every quarter of the crisis, proudly shares that “One reason that BB&T did relatively well during this crisis is that we purchased a much smaller portfolio of S&P/Moody’s/Fitch-rated mortgage bonds than many of our competitors. The reason for this decision was that we chose to analyze the bonds ourselves.”
Other institutions were too trusting - and too reliant on the idea that if they were merely following government regulations, they were protecting themselves. The whole business of banking relies on the idea that a dollar can be in two places at once: in your savings account for you to withdraw at any time and simultaneously lent out for someone’s mortgage. That fragility inspires bank regulation, and one of the government’s main tools is the capital requirement: the government makes a bank fund some slice of its assets with its own capital - equity that eats losses before depositors or taxpayers do - and that slice is supposed to grow with the riskiness of what the bank holds. In theory. In practice it also encodes policy choices, some of them perverse. Allison notes “A financial institution had to have 8 percent of the loan value as capital for a traditional business loan, but needed only 4 percent capital for a home mortgage loan and 1.6 percent capital for a highly rated home-mortgage-backed security.”4 The practical, incredible effect was that “Banks had to hold less capital for a subprime mortgage loan than for a loan to Exxon,” one of the biggest and most profitable corporations in America, which has never missed a bond payment. Most institutions took the ratings seriously without looking under the hood and wound up holding a fleet of clunkers.5
Figure 2. Imagine the gambler who is told he owns a Ferrari, bets the keychain to settle up - and learns, as the mafia does, that it starts a twenty-year-old Volvo.
The ratings told banks that junk was gold but deposit insurance told most depositors not to care. Normally a depositor wants the safest bank he can find for his cash, and the surest tell that a bank is reaching for risk is that it pays a conspicuously high rate - the premium is the enticement to engage in risk. Deposit insurance dissolves that instinct: below the insured limit, the insured depositor keeps the extra yield and the taxpayer (through the FDIC) eats any loss.6 As a result, the riskiest banks raise money the fastest - just so long as they satisfy regulators. Allison: “IndyMac, Golden West, Washington Mutual, and Countrywide were all large financial institutions that effectively failed. In all cases, the companies funded high-risk loan portfolios by paying above-market interest rates for certificates of deposit using FDIC insurance.” Instead of reforming deposit insurance to get more customer feedback, the government catered to consumer fears - Will Luther notes that: “the maximum deposit balance insured by FDIC was increased from $100,000 to $250,000 in 2008, reducing the incentive for those with deposits in excess of $100,000 to monitor banks even further.”7
The fundamental problem is that uninsured depositors have every incentive to keep banks safe and regulators do not: the latter either want a comfortable government job that will keep them employed more or less forever no matter what happens to the banks they supervise or they want to get a job at a bank. Though civil service protections can make regulators wholly unaccountable, they roughly have to satisfy their political masters, who routinely blame the banks in order to deflect blame from themselves and then call for more regulation no matter whether it would have prevented a crisis in the first place. Allison even argues that regulators are much more prone to pursue political objectives than sound banking - Democrats push credit toward favored borrowers, Republicans push enforcement toward favored targets. Further, while deposit insurance is a pre-bailout for most depositors who chose to do business with a risky bank, the government compounded the problem by routinely (but not always) bailing out uninsured depositors and bondholders, if not bank-equity owners, thereby ensuring that fewer parties with skin in the game pay attention. Smaller banks got less help but the bank that inspired the phrase “too big to fail” was Continental Illinois in 1984, the seventh-largest bank in America, which got excessive relief and encouraged moral hazard. More recently, in 2023, Silicon Valley Bank, which had a name that screams risk-friendliness, received a total bailout when entrepreneurs who had received sweetheart mortgages and special banking treatment cried out that they couldn’t meet payroll. In the “disastrous” alternative of Silicon Valley Bank failing without government help, uninsured depositors would have gotten more than 85 cents on their dollar - and yet would have been more cautious about where they banked next time. The best regulation is to let banks fail, regularly, and quickly. In a previous era, extended liability was much more worrisome to shareholders than any regulator, and the imprudent faced the consequences of their actions.
Figure 3. Imagine if your babysitter got paid regardless of what happened to your children. Or, alternatively, if her prospects of getting rich depended entirely on what the children thought of her. Those are your two choices in a bank regulator - and why regulators can’t really be trusted to prevent crises, no matter their instructions or power.
And yet perhaps the biggest boogeyman of the 2008 folk tale is the 1999 repeal of Glass-Steagall, a Great Depression era law that forbade banks as you traditionally think of them - the kind of place where you get a mortgage - from combining with investment banks, on the notion that the latter have a risk-taking culture that should not spread. This idea, for example, is central to Wikipedia’s framing (alongside Congress’ commitment to affordable housing and the Federal Reserve’s easy money). The problem with this theory is that institutions that were the products of the repeal were generally stronger during the crisis, being better diversified, and even provided options to absorb failing institutions that were more purist. The one real exception is Citigroup - itself the merger the repeal was written to bless, and one of the sickest banks in the crisis. But that cuts the other way: if combining the two businesses were the disease, the universal banks should have been uniformly the sickest. Instead they were more often the shock absorbers than the casualties. The trouble was not that conventional and investment banking were allowed to combine; the trouble was that conventional banking was so regulated that lending migrated to other institutions, including investment banks, that would comprise “the shadow banking system”8: activity fled into the shadows to escape capital requirements while still enjoying the system’s implicit guarantees.9 Moral hazard migrated faster than capital - and when it became unclear what collateral was good, the whole credit system froze up.
Yet investment banks had subjected themselves to capital requirements. In 2004, the SEC allowed the five biggest investment banks - including Bear Stearns and Lehman Brothers - to begin using a similar capital requirement calculation to banks. A folk tale view is that this allowed the investment banks to increase their leverage - but leverage was higher for these companies in 1998 than in 2006 (and investment banks were expected to have higher leverage ratios than traditional banks). The more telling problem was that the rule-change incentivized investment banks to load up on AAA-rated mortgage-backed securities because that made their capital requirements look better. Alan Greenspan, pressed in Congressional testimony while in retirement, said he had discovered a flaw in his worldview: he thought that companies would ultimately protect themselves. In a truly free market, companies may never have chosen such mortgages as their fundamental securities, but the government heavily incentivized them to do so, and managers perhaps were more concerned about their annual bonuses than the health of the company, which seemed poised to be saved by the government if anything went awry anyway - besides, everyone was doing it! The rules had severed the link between the person choosing the risk and the person bearing it.
That brings us to the instrument that became the crisis’s most infamous (and genuine) accelerant: the credit default swap. A credit default swap is just insurance on a bond - you pay a premium, you collect if the borrower defaults. The catch is that AIG sold mountains of it without the reserves a real insurer must keep. The Commodity Futures Modernization Act of 2000 had placed these contracts beyond the CFTC - and beyond state insurance and anti-gambling laws - so no regulator anywhere made AIG fund its promises. AIG Financial Products wrote protection on roughly half a trillion dollars of securities, set aside almost nothing, and when its credit rating slipped, the collateral calls it couldn’t meet triggered a $182 billion federal rescue. Most credit default swaps performed exactly as designed; AIG’s unit was the rogue exception, running bets headquarters barely understood. But they fed the crisis anyway by manufacturing false comfort: the securities were AAA and the losses were insured, so why look closer? AIG itself never did - it took the ratings on faith instead of reading the loans beneath them, the same skipped homework as the banks it insured, and it survived only because the government caught it. This is a place in our story where the absence of a rule, not its distortion, was the trouble - and even here the qualifications pile up. It was hardly the main cause. AIG could have been left to fail to the system’s long-run benefit: tellingly, much of that $182 billion never stayed at AIG but flowed straight through to its counterparties. The government’s own bailout watchdog faulted the Fed for paying full freight rather than driving a bargain: a backdoor rescue of the very firms that had trusted AIG without checking. And had derivatives been regulated, the same authorities who everywhere else were declaring mortgage risk negligible would likely have written the hedging rules with the identical blind spot. In an ideal world, capital would have had to follow the risk wherever it traveled - an insurer writing half a trillion in protection would have had to fund it like one - and a firm that miscalculated would have been left to fail, its sophisticated counterparties made to swallow the losses they hadn’t bothered to guard against, the lesson learned once and for good.
Till now we’ve focused on federal regulation, but there’s a surprisingly plausible case that local regulation drove the crisis, especially state, county, and city constraints on housing. But wait - how could limits on housing contribute to a housing bubble? In a market where supply can quickly expand, the subsidy may produce more houses without increasing prices - that’s more or less what happened with the GI Bill and the creation of suburbs in the aftermath of World War II. But in the 21st century, zoning, permitting, geography, and neighborhood vetoes restricted supply expansion in lots of areas - think Coastal California and the Northeast - while cheap credit ensured that the existing housing stock there skyrocketed in value. Yet how does this explain the run-up in prices in Phoenix and Las Vegas which sit on cheap, flat desert under light zoning? The argument is that they were the release valve. As the locked-up coastal cities priced ordinary families out, those families - and their home equity, and the speculators trailing them - flooded the Sand States. Demand outran even the building, so prices climbed anyway but when the migration from California abruptly stopped in 2006, the next wave of buyers never arrived and they experienced among the steepest declines in the country. Another category of places - Texas and Georgia - saw prices rise 20-25% (substantial compared to history) without a significant decline.10 Both Thomas Sowell and Kevin Erdmann make the argument that local regulations drove the crisis. Erdmann rejects a national credit problem in the lead up - but, like others on the right I’ve mentioned who think the Fed did okay before the crisis, thinks that the Fed screwed up in its response by being too tight.11 Sowell fits better with the rest of these essays: Loose money and the subsidy machine determined the size of the national credit wave; local zoning determined where it broke. And, to return to a theme: housing supply remains quite restricted in significant parts of the country.
Let’s conclude our survey of regulations that contributed to the crisis with two claims Allison makes that are still more controversial. First, nearly uniquely, Allison argues that New York Attorney General Eliot Spitzer’s crusade against Wall Street changed the business model of investment banks from overwhelmingly playing with other people’s money to playing with more of their own than ever before. While one might think that would create better incentives for prudence, they were too focused on the increased potential returns without the increased risk - and when their bets failed, the firms were sunk (whereas, under the old model they would have been able to patch up and sail on)12. The business transition is real, but few attribute it to Spitzer: the usual credit is assigned to the 1990s transition of investment banks from partnerships (where the money of the partners is at stake) to public companies (where the money of the shareholders is at stake, which is more abstract for management).
Second, Allison argues that fair-value accounting deterred recovery, and that the rebound began once it was relaxed.13 The rule requires a bank to mark its assets to what they would fetch today. In a frozen market, Allison says, “today” means fire-sale prices that bear no relation to an asset’s worth to a holder who doesn’t have to sell - and BB&T didn’t. Because regulators size a bank’s capital against the marked value of its assets, every dollar of markdown was a dollar of capital gone; at roughly ten-to-one leverage, that is ten dollars of lending or bargain-hunting forgone. Worse, markdowns can feed on themselves: forced write-downs erode capital, which forces sales, which push prices lower, which force more write-downs - doom loop that turns a liquidity scare into a solvency crisis. That danger is real.
But so is the danger fair-value accounting exists to prevent. Let a bank carry impaired assets at what it hopes they’ll someday be worth, and you breed the zombie: an insolvent institution hiding its losses and gambling for resurrection. Savings-and-loans offer the premier example: Rendered deeply underwater when the Fed sent interest rates soaring, thousands were permitted to ‘grow out of it’ - and their desperate bets on commercial real estate and junk bonds turned a manageable hole into a $150-billion cleanup. Post 1989 Japan, letting its banks carry dead loans at face value, bought a lost decade of zombies crowding out the living. Fair value forces a bank to settle, today and in public, a question no one can answer until later: is this asset merely cheap because the market has seized, or genuinely impaired? Mark it down and you punish the holder who’d have been vindicated by waiting; forbear, and you shelter the one who should have been wound up. BB&T was the first kind; the thrifts were the second - but it’s hard to tell which is which in the moment. As a result, fair-value accounting is contested on the right. Notably, recovery did start around when accounting rules were relaxed - but there was a lot going on at the same time, including stress tests for the big banks and even the Fed’s quantitative easing program.
Importantly, the raw losses on subprime mortgages were, in the end, modest - some $300 billion, less than what the dot-com bust vaporized during a relatively mild downturn. What turned a manageable housing loss into the worst crisis since 1933 was not who got the loans but where the losses sat and how they were funded: inside enormously leveraged banks that financed themselves with short-term money against collateral no one could value, so that the first whiff of doubt set off a run and a fire sale. But the fragility was a result of the rules: The government’s capital requirements blessed banks to lever up into exactly the AAA mortgage paper that blew up. Deposit insurance and the expectation of rescue invited risk-taking. The dot-com losses fell on diversified shareholders, who simply got poorer; the mortgage losses were loaded, by regulatory design, into the most fragile container the financial system possessed.
Ultimately, in the 2008 financial crisis, plenty of private institutions played by the rules of the game without thinking about the consequences for themselves if the rules were wrong. There were genuine Wall Street villains as well as firms that simply trusted the system too much - and both deserved to go bankrupt. But “the greatest trick the Devil ever pulled was convincing the world he didn’t exist.” Where, in The Big Short and the other popular retellings, is the government which paved the road (probably with good intentions) to crisis? The government incentivized risk in many ways - from easy money, to housing subsidies, to regulations that discouraged caution (especially about housing). Not all the sources I’ve cited agree with each other about everything - but they do agree that the government set us up for the misery of 2008.
Figure 4. The federal government has made housing as affordable as college. It’s not a paradox of subsidy, it’s the bill.
It is fair to ask: if so little of this has been undone, why hasn’t it happened again? The rulebook has roughly tripled in thickness - Dodd-Frank, the Volcker Rule, far higher capital requirements - yet the machinery that produced the crisis is largely intact: a whimsical Fed, the standing guarantee on deposits (including for the uninsured where the bank or its customers are politically connected enough), the reflex to rescue, a government that still stands behind the overwhelming majority of new mortgages, and a housing market once again perched well above its historic relationship to incomes and real value. Just because not everyone could see the problems accumulating before 2008 does not mean that they were not there - and the seeds of the next crisis are undoubtedly being planted somewhere now where the incentives permit it.
And yet. For all the genuine faults we’ve catalogued, the crisis might still have been dulled, even averted, had the government met it with more consistency and a firmer stomach for just deserts. That is the subject of another series: what the rival schools of thought believe should have been done instead.
John Allison: “One of the most fundamental myths being promulgated is that the banking industry was deregulated during the Bush administration, and that this was a major cause of the financial crisis. Nothing could be further from the truth. The regulatory burden was increased significantly during the Bush years. In fact, regulatory cost was at an all-time high (until the current period) during the peak of the bubble (2005–2007). Banks’ operating statements reflect this cost increase, as does the multithousand-page increase in various government regulatory documents. Government spending alone (excluding costs that the industry incurred and that must be paid by the companies being regulated) on financial regulations (not company bailouts) increased, in adjusted dollars, from $725 million in 1980 to $2.07 billion in 2007.1 The financial industry was not deregulated, it was misregulated. During the Bush administration, three major new financial regulatory acts were passed: the Privacy Act, Sarbanes-Oxley, and the Patriot Act. The primary regulatory focus was initially on Sarbanes-Oxley and then on the Patriot Act… In the case of BB&T, our internal auditors are audited by our external auditors, the NC State Banking Examiners, the Federal Deposit Insurance Corporation (FDIC), and the Federal Reserve. These are auditors auditing auditors auditing auditors.”
Allison: “These subprime-backed mortgage bonds had been rated by Standard & Poor’s (S&P), Moody’s, and/or Fitch. These three rating agencies have the equivalent of a government-sanctioned oligopoly. They are the only rating firms that the Securities and Exchange Commission (SEC) allows to provide credit ratings on bonds to meet ERISA requirements for public pension plans… Starting in 1975, the SEC designated S&P, Moody’s, and Fitch as ‘nationally recognized statistical rating organizations’ (NRSROs) and decreed that their ratings were to be relied on by institutional investors and investment banks for meeting regulatory and capital requirements.”
“Specifically, the Basel accord of 1988 stipulated that if banks held securities issued by government-sponsored entities, they could hold less capital than if they held other securities, including the very mortgages they might originate. Banks could originate a mortgage and then sell it to Fannie Mae. Fannie would then package it with other mortgages into a mortgage-backed security. If the very same bank bought that security (which relied on income from the mortgage it originated), it would be required to hold only 40 percent of the capital it would have had to hold if it had just kept the original mortgage.” - Horwitz and Boettke. In 2001, the should-be-notorious Recourse rule extended that to private-labeled mortgage-backed securities, which gigantically opened up the marketplace for this.
The UChicago economist Raghuram Rajan warned at the Jackson Hole Fed conference in 2005 that banks were being incentivized to take on too much complexity and was criticized as a “luddite” by Larry Summers. He subsequently wrote an account of the crisis called Fault Lines.
Unadvertised but recovering your account from a failed bank can take a while even if you’re ultimately made whole.
“The shadow banking system mainly consists of nondepository banks and financial firms—like hedge funds, money market funds, investment banks, and insurers—which grew enormously in the past decade and came to play an increasingly important role in lending to businesses, distributing securities, and insuring debts. By 2008, some estimates of the size of this shadow banking system placed it on a par with the more traditional deposit-based banking system… One of the interesting questions is, why did the shadow banking system get to be so large in the first place? Why did so much funding leave the traditional commercial banking system? The simple answer is that government rules and regulations made commercial banks less and less competitive by driving up their cost of operations.”
To the degree that the repeal of Glass-Steagall contributed to the idea that implicit guarantees were still out there, that’s a reversal of the usual story that fears conventional banks were contaminated by investment banks. Regardless, the problem was that any institution had an implicit guarantee.
Erdmann also thinks that regulations came down too hard on lending standards, which is more contrarian than others.
Allison: “At the beginning of the financial crisis, investment banks were leveraged about 30 to 1. Given their leverage, it is not surprising that the large investment banks and highly leveraged large commercial banks were some of the first financial institutions to have problems during the financial crisis (Bear Stearns, Lehman Brothers, Goldman Sachs, Morgan Stanley, and Citigroup). The leverage of investment banks has risen significantly in recent years for a variety of reasons. One important reason is the settlement that the investment banks reached with Eliot Spitzer, the attorney general of New York State. Spitzer attacked the traditional business model that investment banks had used for many years. Under this traditional model, these banks had relied on their financial research to generate investment banking business. According to Spitzer, the investment analysts could not be independent if they helped the investment bankers to develop clients who would issue stocks, sell bonds, and so on. Of course, all market participants knew that the analysts were influenced by their client relationships. Spitzer “discovered” this lack of independence (which everybody else had known for at least 50 years). The change that Spitzer imposed significantly reduced the profitability of the investment banking analysts model. To replace these lost profits, investment banks began to trade more and more for their own account (instead of trading other people’s money), raising their leverage and therefore their risk position. It also potentially created conflicts of interest, as the investment bank’s own positions in various investment instruments were more likely to be counter to their clients’ and because the investment banks’ investments were so large that they could potentially affect market prices. This shift from trading clients’ money to trading their own capital was facilitated by the SEC. The SEC allowed the investment banks to use mathematical modeling under the international capital guidelines (Basel Accords) to set capital ratios. Under these guidelines, the investment banks were able to significantly increase their leverage and maintain much higher leverage positions than comparable commercial banks. Before there was the Federal Reserve, private banks typically had leverage ratios of 2 to 1 or 1 to 1. In adverse times, the more capital you have as a cushion, the better the protection for creditors and depositors. If banks had had capital ratios at this level in 2007, there would not have been a financial crisis in 2008–2009”
Allison: “One of the basic requirements of the law of supply and demand is that there must be a willing buyer and a willing seller. During the chaos created by the random type of government policies just described, this basic condition did not exist. As a simple example, suppose my home is on the market for $600,000. With the huge uncertainty created by government decision makers during the financial crisis, the few buyers that are out there are looking for a fantastic deal and will pay only $300,000 for my house. I will not sell my home for $300,000. I do not owe anything on the home, and I can easily afford to wait until the market calms down. However, under fair-value accounting, my house would be valued at $300,000, and if I were a bank, I would take a $300,000 loss on the house through my income statement. This outcome is inconsistent with the law of supply and demand. Under this economic law, there must be a willing buyer and a willing seller for a market price to be established. The fact that Tom Brown had to sell his house for $300,000 because he was in severe distress does not mean that I have to or will sell my house for this price… There are a number of other significant problems with fair-value accounting. Proper finance theory would value assets based on a rational projection of future cash flows from those assets, not liquidation value under stress… “Bill Isaac, chairman of the FDIC during the financial crisis of the early 1980s, has stated on numerous occasions that the U.S. financial system would have failed in the 1980s if fair-value accounting had been utilized at that time. In September 2008, a few days after Lehman failed, he wrote: “If we had followed today’s approach during the 1980’s, we would have nationalized all of the major banks in the country and thousands of additional banks and thrifts would have failed. I have little doubt that the country would have gone from a serious recession into a depression.”” A caution: the house example is an analogy - houses themselves were not marked to a distressed sale, we’re talking about securities.