The Dukes of Moral Hazard: The Dangers of Quantitative Easing

 

This brilliant and terrifying column was originally published at ProPublica and is republished here under a Creative Commons license.

by Jesse Eisinger
ProPublica, Nov. 10, 2010, 2:40 p.m.

Across the world, there are booms. Chinese Internet companies are flourishing. Energy companies are finding new sources of power. Commercial real estate is coming back.

Unfortunately, this isn’t happening in the real world, which is still crippled by sagging economies, but in the investing one.

If there’s a doggy stock, a dodgy loan or a slice of a complex credit security made to a questionable borrower — hedge funds want it now. Companies with junk bond ratings are flooding the markets with new issuance. If private equity firms bring a money-losing company saddled with debt to market, investors are eager to snap it up.

Thank the Federal Reserve. The central bank has embarked on its program of “quantitative easing,” a second round of experimental monetary policy in which the Fed buys up assets — like longer term government bonds — to bring down interest rates, which is supposed to spur lending and borrowing, thus reigniting the economy.

Nobody knows whether it will work to bring down the intractable rate of unemployment. But it has already worked in one significant way: the speculative juices of the markets are flowing.

What’s going on? As a Fed official explained it in a recent speech, one supposed benefit of the Fed policy is that it will add to “household wealth by keeping asset prices higher than they otherwise would be.”

So it’s levitation-by-decree. When the Fed moves, financial assets receive the opposite of collateral damage: universal blessing, deserved or not. Lower rates may or may not help more people find work. But there’s no doubt that the central bank has already helped the Henry Kravises and Lloyd Blankfeins of the world.

The Russell 2000 stock index, which is made up of smaller companies, has risen about 21 percent since September, when investors started to anticipate that the Fed would intervene in an aggressive fashion. A tiny Chinese Internet stock, China MediaExpress Holdings, is up more than 250 percent since mid-September. The private investors that own Harrah’s, the money-losing casino company, are bringing it public, and investors are going to gamble on it despite a crushing debt load.

Then there are something called B notes, bonds backed by commercial real estate loans. B-note holders are on the hook for the early losses if the loans go bad. They are as hot a commodity as everything else. Never mind that there’s a huge oversupply of commercial real estate in this country. Or that Wall Street just went through a disastrous episode for complex structured financial products of exactly this sort.

Without knowing a thing about finance, here’s how to tell it won’t work out well. Wall Street is the great master of the euphemism. The Street doesn’t call them junk bonds; they are “high yield.” Here, something isn’t just Triple A. It’s “Super Senior Triple A.” So when the best investment bankers can do is to dress something up with a lowly “B,” you know it’s trash.

Leverage, meanwhile, has made a glorious return. Interactive Brokers, a discount brokerage firm, has been running an advertising campaign that displays money spewing from printing presses. The firm will lend (for certain special customers)$566,000 for every $100,000. Ah, borrowing heavily for the purposes of trading in volatile markets. Maybe some Bear Stearns or Lehman Brothers bankers can explain the wisdom of this.

All of this is Finance 101. The cheaper money is to borrow, the more it makes sense to take a bigger risk with it.

But that doesn’t make it more palatable. It feels like an ominous replay of recent Federal Reserve emergency actions, which led to bigger and bigger bubbles. The Fed brokered the rescue of Long-Term Capital Management, bailing out the investment banks that had lent to the collapsing hedge fund. The Fed pumped money into the economy to save us from the Y2K computer bug. The Fed tried to rescue the economy from the bursting of the Nasdaq bubble, helping to create the housing bubble.

It’s like the exhausted “Saw” movie franchise; this isn’t just a sequel. It’s more like the third iteration of the second reboot — harder core, baser and for serious liquidity heads only.

Is this the price society has to pay for a better economy? Do we care if some hedge funders get rich as long as unemployment goes down, fewer people get thrown out of their homes and household debts are less crushing?

That would be a worthwhile tradeoff. But it’s far from clear that the Fed can get any real traction with its policies.

Over the past year, I’ve been investigating some of the more egregious conduct that occurred in the bubble years. In this column, I’ll be monitoring the financial markets to hold companies, executives and government officials accountable for their actions.

A main focus will be the spectacle of returning speculation. It’s commonplace to lament Wall Street’s lack of a historical memory. But there is something different at work. Professional investors have learned the lessons of the financial markets’ serial bubbles and learned them well.

The lesson is: When the next one comes, I’m going to get mine. I’ll just get out early this time.

You can contact Jesse Eisinger at jesse@propublica.org

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Increase in foreclosure rate could mean banks knew they were seizing properties they didn’t actually own

In the 3rd quarter of this year banks repossessed a total of 288,345 properties – by far the largest quarterly total since the meltdown began. The 4th quarter of this year is likely to have the fewest repossessions of the meltdown because of “the decision by several of the largest lenders to halt filings after it was discovered that paperwork for many loans is missing or incorrect.” The increase is a sharp spike in the total number of repossessions. The 4th quarter numbers were a 7% increase over the previous quarter and a 22% increase over the same period of 2009. According to RealtyTrac: “A record total of 102,134 bank repossessions were reported in September, the first time bank repossessions have surpassed the 100,000 mark in a single month.”

So, did the banks know what was coming and try to get as many properties safely in to their possession as they could before the hammer came down? If this is not the case then why the increase?

Now I am not a real estate lawyer – to put it mildly – so I don’t know the answer to the following: Is it legal for banks to foreclose if they know that they cannot substantiate ownership? My guess is no. I hope the 50 state attorneys general now looking into this hunt around for any signs of foreknowledge by the banks. If the banks were doing something they knew to be illegal – as opposed to just making more mistakes – then it raises the question of whether or not there was a conspiracy to commit fraud. Were any of this to be true it would worsen the already dubious condition of many banks’ balance sheets.

What makes this even more interesting that it was just yesterday that analysts were cooing over the better-than-expected earnings J.P. Morgan. This was one of the reasons the press gave for explaining the very odd fact that the Dow closed at or over 11,000 for a fourth straight day. It is worth noting that the Dow has risen more than 1,300 points since July 2, presumably on the basis of all the good economic news of late. Could someone please remind what that news was? Anyone? Bueller?

As long-time readers know I view the stock market as much more of a leading psychological indicator than an economic one. I am still hoping for evidence that will convince me otherwise.

THEN AGAIN IT COULD JUST BE A COINCIDENCE: Bill McBride, who writes Calculated Risk, says: The banks are still catching up on the earlier foreclosure moratoriums – and extended periods for trial modifications.  This surge in repossessions was expected and I think unrelated to “foreclosure-gate”

 

A guide for the perplexed to the economic mess

The problem with the economy is clear, but it’s been obfuscated out of most people’s minds. So, to put it simply: Financial institutions loaned out a huge amount of money against assets that are now worth far less and whose value is still falling. Somehow, someway, the difference between these two numbers has to reconciled. Simply put, money loaned (X) – current value of assets (Y) = amount of debt to be accounted for (Z). Solve the equation and you know exactly how solvent our economy is.

This week we have found out that Y equals even less of X than previously thought – and the previously thought numbers were already pretty bad. That is because banks screwed up the paperwork so badly they are having major problems proving they do indeed have a legal right to the homes they gave mortgages on. Short form: The banks effectively gave that money away. So the debit side of their ledgers just got a whole lot redder and Z just got a whole lot larger.

Now Z was bad before this latest fiasco was discovered. How bad? Bad enough the banks and the government have gone out of their way to make to figure out what Z is worth. My theory is they believe – perhaps reasonably – disclosing Z will cause the world’s economy to go into freefall. Unfortunately Z is not going away. So because these groups cannot change the value of X and the value of Y keeps getting smaller, they have resorted to fiddling with the – and the =.

First, the government tried to purchase mortgage debt(X) from the banks. The problem with this is that selling X would mean declaring its value, i.e. providing a real number for Y. This would mean admitting what everyone knows – that a number of banks have debts well in excess of their assets.

Because this didn’t work, the government tried to alter the equation’s minus sign by giving banks enough funds to be able to withstand solving for Y. Under this plan we get X + $100s of billion – Y = Z. Given how hesitant banks were to take toxic asset relief payments (or whatever they’re calling it now) it is reasonable to conclude that Y = way more than hundreds of billions.

But wait, you say! Many of these financial institutions have already repaid the bailout money! Yes, that is true. However keep in mind, they repaid it with money borrowed from the government. This is robbing Peter to pay Paul as imagined by M.C. Escher. Those staircases are never going to meet up but it allows both the banks and the government to say that they do while hoping that no one reads the fine print.

So being unable to either 1) increase X enough to do any good or 2) stop the actual value of Y from declining, the government tried letting financial institutions play lets pretend with the book value of Y. Recent changes in accounting rules let institutions can the value of a property at what they think it would go for in an “orderly” sale, as opposed to a forced or distressed one. Or, to quote the head of the central bank of Wonderland: “When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”

What all those measures did was to allow the economy to continue to operate because we all pretended the problem would somehow go away. This is an attempt to put off the day of reconciliation until some time in the far distant future when someone will have figured out a solution that won’t hurt. However, this is impossible. The solution will hurt, and it will hurt a lot.

All talk of growing our way out of the recession is absurd. It is based on the belief that we can continue to increase the size of the economy as was done earlier in this decade. Let’s make one thing clear: The last decade’s worth of growth was funded by loans against assets that were never worth those loans in the first place. Trying to go back to that means continuing to believe in the fiction that it was ever sustainable in the first place.

The healthy economy of our future won’t resemble this in anyway. We will have to accept far more modest growth and lower our expectations about always having the newest stuff. We may have to pay our farm workers enough that those jobs, and others like them, because financially appealing to American citizens. That will mean paying a lot more for food and other things.The US has to become home to manufacturing again. This will mean enacting things – like tariffs – that a lot of powerful corporations don’t want. NAFTA and other free trade agreements are going to have to change drastically.

Of course, we don’t have to do these things. Regardless of what we do, though, the economic equation will be resolved and that debt will somehow be accounted for.

But hey, the Dow’s over 11K so no worries, right?

Why I had to stop reading Michael Lewis’ The Big Short

I’m a fan of writer Michael Lewis. Liar’s Poker, Moneyball, Sandra Bullock Wins An Oscar, are all good books. As is The Big Short, his latest. I started reading it yesterday and by bedtime I was half-way through (it’s a short book and I’m a fast reader). When I got up this morning Mrs. CollateralDamage said I was making very unhappy noises in my sleep and I’ve felt on edge all day. I read some more of the book, realized I was getting increasingly agitated and finally put it down. This book is a non-fiction horror story, and one whose end we don’t yet know.

The Big Short is about four people who guessed (and bet) right about mortgage-related ponzi scheme which has led to our current economic “downturn”. What is probably upsetting me about the book is that it confirms my most cynical beliefs about the world. Several of the people in the book repeatedly ask questions of bankers, bond raters, bond salesmen and anyone else they can find in hopes that someone can prove to them that all this buying and selling of sub-prime mortgage securities isn’t just a house of cards. They want to know because they are betting that it is and want to find out if they’ve just blown their money. That, my friends, is a motivated investigator. They are either told they don’t understand how this all works (which we quickly realize means the person who should understand doesn’t) or they are met with blank stares. They try to tell regulators, they try to tell other investors, they even try telling the investment bankers who created this train wreck what is about to happen. AND NO ONE WILL LISTEN. They are Cassandra’s writ huge – except that they make a crap load of money, whereas Cassie just had to suffer.

The other terrifying thing about Big Short, is that it confirms my greatest cynical fears: That most of the people in places of power are either corrupt or fools. Now you’d think that after eight years of George W. I would already have had these fears confirmed but there’s something about Lewis stories of smug, arrogant idiots/crooks gaming the system that scared the feces out of me. It doesn’t help that I really don’t see any reason for the economy to improve. The head of our bankrupt government wants to spend more money. His opposition thinks the best way to deal with the government’s being bankrupt is to keep in place a tax cut for the richest people in the nation. The banks are pretending they’re solvent. People keep saying it’s up to consumers to spend our way out of this mess but it’s overspending that got us into the mess in the first place.  And no one but no one is talking about what happened to all the debt created by the mortgage fiasco. Wall St. and the financial press seem to think that as long as the Dow is over 10K all is right in the world – EVEN THOUGH NONE OF THE PROBLEMS THAT GOT US INTO THIS HAVE BEEN ADDRESSED. Meanwhile no one who was responsible for any of this is going to jail and the nation continues to bleed money and people in two wars everyone knows we have no business fighting.

Sorry, Mr. Lewis, I can’t take anymore. I’m going to go read something much more soothing, like World War Z or John Dies At The End. As my old drinking buddy John Milton once told me, “Stare into the abyss long enough and it starts to stare back.” Well, at least St. Peter told me I was the nicest of the damned…

 

Who could possibly have seen the banking disaster coming?

What was the theory behind the Glass-Steagall Act? Foremost, it was meant to restore a certain sobriety to American finance. In the 1920s, the banker had gone from a person of sober rectitude to a huckster who encouraged people to gamble on risky stocks and bonds. As [chief congressional counsel Ferdinand] Pecora noted, small investors identified banks with security, so that National City salesmen “came to them clothed with all the authority and prestige of the magic name ‘National City.’” It was also argued that the union of deposit and securities banking created potential conflicts of interest. Banks could take bad loans, repackage them as bonds, and fob them off on investors as National City had done with Latin American loans. They could even lend the investors money to buy the bonds. A final problem with the banks’ brokerage affiliates was that they forced the Federal Reserve System to stand behind both depositors and speculators. If a securities bank failed, the Fed might need to rescue it to protect the parent bank. In other words, the government might have to protect speculators to save depositors.

— Ron Chernow, The House of Morgan, 1990, pg. 375. (Emphasis added)

 

The repeal of Glass-Steagall was passed by Congress and signed into law by President Clinton in 1999.

The arguments made to repeal the act were primarily

1. Depository institutions will now operate in “deregulated” financial markets in which distinctions between loans, securities, and deposits are not well drawn. They are losing market shares to securities firms that are not so strictly regulated, and to foreign financial institutions operating without much restriction from the Act.
2. Conflicts of interest can be prevented by enforcing legislation against them, and by separating the lending and credit functions through forming distinctly separate subsidiaries of financial firms.
3. The securities activities that depository institutions are seeking are both low-risk by their very nature, and would reduce the total risk of organizations offering them – by diversification.
4. In much of the rest of the world, depository institutions operate simultaneously and successfully in both banking and securities markets. Lessons learned from their experience can be applied to our national financial structure and regulation

Emphasis added

New reg lets banks ignore actual value of “underperforming” loans

It is only fitting that on Halloween the Federal government is increasing the number of zombies among us.

Federal bank regulators issued guidelines allowing banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.

The rationale?

While CRE (commercial real estate) borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts. In such cases, financial institutions and borrowers may find it mutually beneficial to work constructively together.

Nothing inspires confience in me like the phrase “financial institutions and borrowers may find it mutually beneficial.” Especially since banks are not required to only apply this rule to “creditworthy customers who have the willingness and capacity to repay their debts.”

I really can’t top what Doug McIntyre wrote at DailyFinance.com:

The FDIC appears simply to be taking losses that would be incurred in the normal course of business and pushing the true accounting for them into the future. It is to the political benefit of Washington to make it appear that the banking sector is getting better. It also probably helps the FDIC, which is essentially insolvent, from having to come up with billions of dollars to insure deposits at failing banks.

Some can argue that this regulation just does for commercial real estate what had already been done for home mortgages. In April, the Financial Accounting Standards Board approved a new set of rules allowing financial firms to fiddle with how big their real-estate losses are. (New accounting rules let bankers set the value of their own toxic assets)

When I use a word," Humpty Dumpty said in rather a scornful tone, "it means just what I choose it to mean – neither more nor less.”

HOORAY? Sub-prime mortgages “back to pre-crisis levels”

The Fed says sub-prime mortgages again make up more than 20% of the nation’s outstanding mortgages.

After plummeting in early 2008, the share of borrowers with FICO credit scores lower than 660 has returned to just higher than 20 percent, the same share as when subprime securitization peaked in 2006.

Once upon a time this number was a bad thing because all those loans were held by private institutions many of which basically collapsed when it turned out people couldn’t pay them off.

Today it is a good thing because Government-backed agencies Fannie Mae, Freddie Mac and Ginnie Mae "are providing unprecedented support to the housing market — owning or guaranteeing almost 95% of the new residential mortgage lending." So all is jake now that you, me and every other US citizen are guaranteeing these turkeys.

The reason for this rebound is not that due to any increase in the financial stability of people with lousy credit scores. No, it’s because the Federal Housing Authority seems determined to recreate the housing bubble “by providing vital insurance that enables borrowers to qualify for loans with as little as 3.5% down.”

The FHA is, of course, a picture of fiscal health. The agency recently admitted that “a soon-to-be-released audit will show that its reserve fund has fallen below the level required by law, meaning it will not be enough to cover 2% of all outstanding FHA mortgages.”

One solution proposed to get the agency’s reserves back up to what the law requires:  Raise the minimum down payment on FHA loans to 5%.

But – reports the LA Times — “new FHA Commissioner David H. Stevens said such a move could threaten the nascent housing recovery. A person looking to buy a $300,000 house, for instance, would have to raise an additional $4,500 for the down payment.”

If you can’t afford another $4.5K for the down payment, you probably can’t afford $300K either.

Says who?

The FHA itself. That’s because – just like in the last housing bubble – the lenders don’t really have a clue as to how much the borrowers can repay. We know this because the FHA has admitted it really hasn’t done much to screen the lenders for things like basic competence.

According to a report by the FHA inspector general: “The agency approved nearly 3,300 lender applications in fiscal 2008, more than triple the year before. But the number of workers evaluating applications remained the same. In a review of 22 approved applications, the audit found that only one contained all the necessary documents.”

History repeats itself first as tragedy then as farce, someone once said. Unfortunately the farce doesn’t leave you any better off than the tragedy.

By the time this is all done the economy will look like it’s been hit by a typhoon of monkeys.

BON TON ROULEZ!!!

Bank fails after taking “Jesus saves” literally

Riverview Community Bank of Ostego, MN, whose founder said God told him that He “would take care of the bottom line,” was closed by the FDIC last Friday.

Chuck Ripka, one of the bank’s founders, once told the Star Tribune that God spoke to him and said, "Chuck, if you pastor the bank, I’ll take care of the bottom line." Ripka and his staff would pray with customers in the bank’s Otsego branch and even at the drive-up window. (A story I once heard about not mixing money lenders and temples suddenly comes to mind.)

Seems the Good Lord didn’t tip Mr. Ripka to the fact that home prices do not always head toward Heaven. The bank was an aggressive real estate lender and at one point had the fourth-highest concentration of real estate loans-to-capital of any community bank in the Minnesota. Riverview’s mistakes weren’t limited to bad loans it seems. Earlier this month it had reached an agreement with the Fed to cease paying dividends and correct violations of law spelled out in a May letter from the Fed. The order didn’t identify what laws were broken.

 

(And speaking of banks in need of divine intercession, check out: Citigroup’s "Hail Mary Pass": How To Know Citigroup Is In Serious Trouble)

If the Wall Street Journal Is So Smart, How Come They Agree With Me?

Me:

Second, housing starts are at a nine month high! Great, just when a huge amount of housing stock is about to be dumped on the market, aka, more foreclosures.

Them:

Recovery Obstacle: So Many Houses

They have to get better reporters over there.

The stock market is an idiot

Yesterday the NYSE broke 9,000 and huzzahs and hosannas rang through the land. Redemption was at hand and all was right with the world. This was a sure sign the economy was recovering.

"What I like about the rally that we’ve seen so far is the breadth of it. It’s not really confined to a single sector. It’s broadly spread. That gives me confidence," said John Coyne, president of Philadelphia-based Brinker Capital, with $8 billion under management. "It’s been a wonderful run-up here. It’s certainly helping to restore investor confidence, given the trauma that people went through."

This all came about because of better earnings by Goldman Sachs, Ford and and the great good news that sales of previously owned homes rose 3.6 percent in June, the third consecutive monthly improvement! Never mind that Goldman’s money is based on accounting tricks and a fixed game or that the sale of homes is up because the price of homes is falling faster than Alan Greenspan’s reputation. It’s all good.

(Also never mind that UPS reported disappointing second-quarter earnings and doesn’t expect business to pick up over the next few months. Now that, ladies and gentlemen, is a reliable economic indicator.)

PAY ATTENTION:

THE STOCK MARKET AT 9,000
IS NO SMARTER THAN IT WAS AT 13,000.

There is a continuing and unfounded belief that stock markets somehow reflect reality. They don’t. They reflect the psychology of investors – whether individual or institutional. It is not a picture of what is but of what investors think will be. The Dow at 13,000 reflected nothing but the fact that too many people believed US housing prices could only move in one direction. Conversely, The Dow at 6,450 reflected people’s belief that our banking system was dead in the water.

I believe the current market numbers reflect mass denial. Denial that the US is populated by zombie banks, denial that unemployment is in double digits, denial that these profits have come because of slashed expenses – which is hardly sustainable. The rise in the Dow and other markets is more a reflection of wishful thinking and short-term profit-grabbing than it is anything else.

It could be that the above paragraph is wrong. Maybe recovery is upon us and the billions of dollars lost by banks and people in the meltdown do not need to be accounted for. Even if I am wrong about my assumptions and outlook I am right about this: The markets are no better at augury than the Romans were who relied on the flight of birds or examining the livers of sheep. If they were then we would never have crashes.

Why is Citi still in business?

Last week saw some quite impressive accomplishments, even by Citi’s august standards. In just a few days it tried to come up with a new way to overpay its investment bankers and traders, then it had to remind its staff NOT to accept undocumented mortgages and finally its Japan operations were shut down because of money laundering.

Woot!

Last Tuesday, Citigroup walked into a feces storm entirely of its own making by announcing it would raise salaries by 50% to offset cuts in bonuses.

To be fair to Citi, they are taking (well-deserved) crap for the entire industry on the salary issue. BofA, Morgan Stanley, UBS and others are also trying to dodge the bad PR when huge bonuses are awarded following huge losses. So now instead of bonuses for bad performance execs will just get a huge salary for bad performance. It’s all about retention – or so Citi would like us to believe. Quote from the NYT: “Citigroup executives are so eager to keep employees from fleeing, that in some cases, they are offering them guaranteed pay contracts.” Well, given that those contracts are being paid for with $45 billion of US taxpayer debt who can blame them. Citi is once again free to play with someone else’s money and are being just as responsible as they were the last time. BTW, the idea that these raises are going to the rank-and-file is absolute hogwash. As Alphaville notes, “the biggest increases will go to investment bankers and traders.”

Also on Tuesday, Citi temporarily stopped buying new loans after “discovering” it was missing property appraisals and documents showing borrowers’ incomes.

The discovery came in Citi’s correspondent division, which buys loans from banks and independent mortgage firms, and was responsible for about half of the bank’s $115 billion in mortgages last year. Two great quotes about this:

“There remain key areas that fall short of our quality- control process. We ask you to review your processes and join us in this effort to collectively address these areas of concern.”  — Brad Brunts, a managing director at the bank’s CitiMortgage division.

And this from an analyst

“It is better to pull people off the line, and have a thorough re-education of what goes into a loan, so they can come back and do this the right way.”

Not a good sign when you have to re-train people processing mortgages on the most basic elements of how to do their jobs. Are these some of the folks being offered those guaranteed contracts?

• Finally, on Friday Japan ordered Citi to halt the marketing of all financial products to retail customers for a month because of bank “failed to implement sufficient measures aimed at preventing suspicious transactions, including money laundering.” 

This really takes the idea of not verifying income to a new level.

RealityFrame’s comment about the raises could really be applied to pretty much everything the bank touches: Anybody want to dispute that those banksters aren’t indeed the "best and the brightest"?

Obama tries to revive hopeless “Hope for Homeowners” plan

Last fall the Administration unveiled its "Hope for Homeowners" program in the hopes it would allow some 400,000 troubled homeowners to swap risky loans for traditional 30-year fixed-rate mortgages with lower rates.

“Instead only a handful of borrowers have been able to qualify, and as of earlier this spring only one loan had completed the program. It was launched by the government last fall but has so far has been a failure, proving unattractive to banks required to absorb large losses.”

Having failed to come up with a program that makes sense, Treasury will now give $2,500 bribes to “to entice [banks] to participate.”

New accounting rules let bankers set the value of their own toxic assets

My latest from over at BlownMortgage:

The Financial Accounting Standards Board (FASB) has approved a new set of rules allowing financial firms to fiddle with how big their real-estate losses are.

The change is in mark-to-market accounting rules, which say companies must value assets at prices reflecting current market conditions. But now the phrase “current market conditions” will have a big asterisk next to them. Now the assets will be valued at what they would go for in an “orderly” sale, as opposed to a forced or distressed sale. Smoke-and-mirrors has nothing on ink-and-paper.

“The changes … allow companies to use ’significant’ judgment when gauging the price of some investments on their books, including mortgage-backed securities.“

Or, as Lewis Carrol put it in the aptly titled Through The Looking Glass:

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”
“The question is”‘ said Alice, “whether you can make words mean so many different things.”

Those in favor of the rule change include Citigroup, Wells Fargo, members of The House and the American Bankers Association. (What a list! It is difficult to think of a group more dedicated to playing “let’s pretend” when it comes to accounting.) They argue forcing banks to mark assets to firesale prices when the markets have gone dormant has fueled the financial crisis through the writedowns, big earnings hits, damage to capital ratios, and a reduced ability to lend. In other words, if you don’t like the reality of the situation just ignore it. Ah, there’s nothing like seeing capitalism in action — the invisible hand of the marketplace being chopped off before it can distribute goods and services at the prices they would actually sell for.

Why is it that we needed strict accounting measures when these assets were inflating the banks’ balance sheets but now that they are deflating those same numbers it is time to change them?

FDIC head Sheila “The Voice of Reason” Bair seems to have her doubts as well: “Banks need to have flexibility” in valuing assets but the fair market rule shouldn’t be scrapped, [she] told a gathering of bank executives Wednesday. “There needs to be integrity in those bank balance sheets.” Wasn’t theeir lack of integrity how this all started?

Here’s my favorite line in the AP story: “Critics say the rule mandates onerous write-downs and saps investor confidence in banks.” There is no confidence left to sap, guys. Coming up with new ways to officially approve your guestimates just proves how justified the lack of confidence is.

While I am unimpressed by the FASB’s lack of a spinal cord, the true blame lies elsewhere for this one:

At a hearing last month, a House panel wrung a pledge from FASB Chairman Robert Herz to try to issue guidelines in three weeks that would relax the mark-to-market rule. The head of the House Financial Services subcommittee, Rep. Paul Kanjorski, D-Pa., had held out the threat of legislation to pressure the standard-setting board to take the steps.

The inmates are now officially in charge of the asylum.

How broken is the banking system?

My latest from over at BlownMortgage:

The most important number not included in Mr. Geithner’s bailout plan has nothing to do with who gets how much. That is all just fine-tuning and clearly not a number Geithner & Co. have figured out yet. (Why release a plan before you have figured that out? I dunno either.) The most important number not included in the bailout plan is one he knows and isn’t telling: How big is the problem? … (more)

Cut the bull and call it a Depression already

More of my happy thoughts from over at BlownMortgage:

Two weeks ago the National Bureau of Economic Research officially confirmed what we already knew: We have been in a recession for the past year. This begs the question, how long until we declare World Depression II?

The (disputed) technical definitions of Recession and Depression make them lagging economic nomenclature. Economists debate whether we are in a swamp while everyone else worries about the ever-increasing number of alligators. The lack of an official declaration of recession mostly just gives the chattering classes something to do while avoiding taking action.

“Is it a crisis?”

“There is no crisis!”

“Is there a large, green creature eating my leg?”

“There is no large, green creature eating your leg!”

Allow me to go out on a very, very sturdy limb and declare a Depression. The economy isn’t going to recover by the end of next year. There is a only a dim possibility it will recover the year after that. But no one in an “official” position is willing to be the bearer of that piece of bad news.

Doubt that it is (or soon will fit the technical definition of) a Depression? Look at the actual numbers…