Real economic liquidity is generated by productivity, which increases income by either increasing revenues or decreasing expenses, or both. This is what creates real wealth and raises the standard of living. Printing money does nothing to raise the standard of living, and desperate calls for the government to do something in reality does nothing but transfer real wealth from one person to another.

A true deflation (which we are in) will continue until prices drop enough, and enough unsupportable debt is destroyed, that private capital begins to lend again because it sees good return for risk. Since the government cannot even create artificial liquidity right now because the banking system has no capital, we are now seeing desperate attempts by government to change the rules of capital requirement and rationalize the reasoning to do so.

If the SEC doesn’t eliminate (or ignore) mark-to-market accounting, then Congress will, by God. Of course, it’s the rules that caused this mess, and if we just get rid of them, all will be well. You can feel and hear this irrational thought process gaining momentum.

Financial firms like banks and brokers must value their holdings of securities (loans are still carried at cost, which is a risk no one is thinking about) to where the market values them (about 29% of the total assets banks value) because firms like these have so little capital relative to their assets and liabilities that to allow them to do otherwise would be very dangerous. FASB 157 further clarified what it means to mark to market…it narrowed further definitions and curtailed abuses. If banks had more capital there could be more lee-way in valuing them: you need capital to be able to hold onto risk through the bad times.

But banks/brokers accumulated debt securities like derivatives and asset-backed securities in such vast amounts that it is hard to describe. Even communist China is getting worried. Banks accumulated these securities in various forms by first cajoling regulators (or was it the other way around?) into basically eliminating all capital requirements and then using models to tell the regulators what the market would pay, which was complete hogwash. In good times while the debt was being created, regulators like Mr. Greenspan and Mr. Geithner were either fools or, well…fools.

Now that the amount is so vast that no one can properly value it or get rid of it (it’s too much even for the government to buy it up), we are having to change the rules mid-stream so we can ignore it.