The people who brought you the Long-Term Capital Management debacle want banks to get serious about cutting their own leverage, applying fair value accounting to a wider range of assets.
Writing with two colleagues in the Financial Times on Tuesday, Nobel Laureate Robert Merton said banks, their regulators and legislators are conspiring to conceal depressed asset prices in order to avoid dealing with the consequences of insolvency. He wants wider adoption of fair value accounting to force banks to fess up to losses and raise more capital.
Speaking on Bloomberg radio, Merton’s long-time associate and fellow laureate, Myron Scholes, concurred.
This is very refreshing, an honest appraisal of the disease still infecting the financial system---leverage---from two prominent economists who learned the hard way that leverage kills.
These days it’s de rigueur to declare that the worst of the recession has passed, that we’re on our way to “recovery.” Never mind that big banks remain insolvent. Take away the government guarantees that provide them cheap financing and protect the value of their assets and many would be at risk of collapse.