Friday, April 3, 2009

Mark to mock-up

In case you missed it: the allegedly independent Financial Standards Accounting Board (FASB) just succumbed to heavy political pressure from our duly elected pawns of the banking industry and did away with "mark-to-market" reporting. What does that mean? Basically, it means that banks now are allowed to lie about the value of their assets.

Yes, I know. You thought they probably were lying all along -- and, pretty clearly, they were lying. Under the new rules, however, they now are specifically authorized to lie by FASB.

Under mark-to-market accounting rules, banks report the value of their assets based on market value -- that is, what somebody is willing to pay for them. Of course, since the beginning of the current banking crisis, no investor has shown any interest at all in purchasing the derivatives now commonly called "toxic" assets. One might think that would give those assets a mark-to-market value of zero, but actually that left the banks fairly free to value them, shall we say, optimistically, based on what they might fetch once the "liquidity crisis" was resolved. Once investors had some free cash and some affordable credit again, the banks maintained, those frozen assets would be purchased at fairly high prices.

The whole Obama plan for unfreezing the banking system seems to be based on the assumption that the problems banks are having with those assets are problems of liquidity -- that if government provides enough cheap credit and takes on nearly all the risk, then the market for derivatives will start moving again. With so much government incentive, the more adventurous hedge fund managers are beginning to show interest -- and others are sure to follow. The problem for the banks is that hedge fund managers are notorious bargain hunters. Even with government assuming 93% of the risk, they still will do their best to low-ball the banks when they make their offers.

Under mark-to-market, a low-ball offer of 20 cents on the dollar, even if a bank refused to accept it, would establish a market price. If the bank had been valuing the asset at 80 cents on the dollar, it would be forced to write down the asset's value by 75 per cent. Enough write-downs of that magnitude, and it would be impossible for the bank to pretend it still was solvent. The new rules make it possible for banks like Citi and B of A to hide their zombification and avoid being sent to their graves.

Those who recognize that our banking problems are problems of solvency, rather than liquidity, tend to believe that it is better to bite the bullet now -- admit that most of the "wealth creation" that took place in the finance industry over the past ten years was an illusion, and that an investment in Citigroup really was no better than an investment in Enron. The Enron scandal, you will recall, was made possible by lax accounting standards -- and yes, all Enron's investors were wiped out.

So now FASB, certainly with approval from the Obama administration, is relaxing accounting standards for the big financial firms. Why? Do the president and his economic advisors really believe the toxic assets have significant value -- that is, that the problem really is entirely one of liquidity? More likely, they are just really, really hoping the assets have some real value -- that questionable loans written to finance questionable loans written to finance pools of questionable loans collateralized by real estate might actually be worth something.

Clearly, though, the real estate collateralizing those loan pyramids will never have the value it was assumed to have when all those loans were written. Remember? Why do you think they called it a real estate "bubble?" As it was with Enron, and as it was with Bernard Madoff, the huge profits investors enjoyed during the run-up to the collapse were paper profits -- not real profits. No real value was added to the economy while it was taking place, and the "losses" suffered by investors in real estate derivatives are paper losses.

It's not that hard to put a market value on a straight mortgage backed security -- that is, one directly collateralized by mortgages. There is available data on how the mortgages in the pool are performing -- how many homeowners are up to date on their payments, how many are late by one, two, or three payments, how many are actively in default, and how many already have been foreclosed. It is my sincere hope that the banks will not be allowed to fantasize the value of those assets, and that Geithner's "stress tests" will ascertain their real, current values.

It is a lot harder to put a market value on securities several times removed from the collateral that ultimately guarantees them. A highly motivated hedge fund might invest in tracking down their real value before offering to buy such securities. More likely, though, hedge funds will do a few computer simulations to select a bouquet of securities with a high probability of producing a profit after a 93 per cent assumption of risk by government is factored in. In the meanwhile, you can bet the banks will be finding ways to game the system and unload the worst of their assets at taxpayer expense. Now that mark-to-market is gone, it will be that much easier.

To me, it looks like the Obama administration has decided that saving the big banks is better for the public good than letting them fail. It looks like Obama (read Geithner and Summers) believe our best course of action is to restore the system that created the current crisis -- albeit with more regulation. To get there, though, the taxpayers have to bail out the very same assholes who fucked it all up in the first place. (Note to readers: when vicworld resorts to foul language, vicworld is very angry!)

The solution they appear to propose is to distribute those paper losses between the financial firms and the ordinary taxpayers -- even though the ordinary taxpayers are the ones who have suffered the real losses. Think about the family that saved for years to afford a down payment on a house with a conventional mortgage, only to see the bottom fall out of home prices and find themselves underwater. Think about the families who have seen the price of their homes plummet because they live in neighborhoods with many foreclosures. These are people who had no reason to believe they were taking on excessive risk. They were screwed, both by the financial industry and by the government that failed to oversee and regulate that industry. If there is any good reason those people should be subsidizing speculators, I can't think of it.

Now, Geithner says government should have the authority to take over any firm that creates "systemic risk." Once again, the details are missing, though. Is there a real plan to help those of us who are not "masters of the universe?"

Right now, I have very serious doubts.

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