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.

Easy way to tell truth from spin on fixing the banks

Originally ran at BlownMortgage

There’s way more chaff than wheat in the air when it comes to understanding what’s wrong with the bank. Because of this it can be easy to get caught up in jargon and sound-bites and lose track of what the issues really are.

Two National Public Radio entities are doing a superb job at managing the noise-to-signal ratio. One is the show This American Life and the other is the blog/podcast Planet Money (the Planet’s pieces are also heard on regular NPR news shows). The two shows frequently team up and their latest look at the the big picture – entitled Bad Bank — is particularly worth listening to.

In the episode, Adam Davidson and Alex Blumberg explain in an easy-to-understand-without-being-stupid way exactly what went wrong. They also make a strong case for some very simple solutions. Not fun. Not easy. Just simple. These solutions are simple enough that it is also easy to see exactly why no one in power is yet willing to initiate them.

Alex Blumberg: If you want to understand this crisis right now, this banking crisis, you need to understand this one thing. And it’s one thing, Adam, that the mainstream media is afraid to touch.
Adam Davidson: They’re afraid because they think it’s really boring.
Alex Blumberg: Right because, what this central thing is, this thing that we need to discuss right is a bank balance sheet.
Adam Davidson: But please, do not despair, because we think we’ve come up with a way to explain this to you, and we actually think it will be pretty enjoyable. So, to begin, let’s imagine the simplest bank in the world. I would like to call it Adam’s Bank.

The pair then go on to explain the basics of mortgages and how banks work and make a profit in an amusing and interesting way. They do this by using an imaginary mortgage on an imaginary dollhouse and with the help of various experts like Columbia Business School professor David Beim.

Alex Blumberg: David Beim is saying, you don’t want to mark it to market. Mark to market, that’s another phrase you might have heard. And it applies to exactly the situation Adam is in right now. He’s got a dollhouse on his books for 100, but if he had to sell it now, he could only get 50 – that’s the market price, what he could get right now. Marking it to market means Adam would have to enter the market price – 50 dollars – or 20 dollars – or whatever it really is – into his books.
BEIM: And the bankers have all been saying ‘please don’t make me do that,’ because if you do, I’ll be declaring bankruptcy. If I show all those, the reduction from 100 all the way down to 20, you’ve just wiped out my entire capital and more, I’m going to have to go to the government and say, close me down, I’m broke. And bankers find that hard to do. and furthermore, regulators don’t want it to happen to all the banks at once. Certainly not all the big ones.
Alex Blumberg: Now obviously, in the real world, the assets that the banks have on their books are more complicated than dollhouses. But, if the banks had to sell them now, in today’s market, they’d almost certainly take a huge loss. A loss big enough to wipe out their capital and shut them down.

Also helping out is a former IMF economist named Simon Johnson and it is Johnson who lays it all out in language so clear even a politician, CEO or journalist can understand it.

JOHNSON: You know, what would the U.S. tell the IMF to do if this were any country other than the U.S.? If you covered up the name of the country, and just showed me the numbers, just show me the problems, talk to me a little about the politics in a generic way. With the financial system, you have a boom, and then the crash, what would the U.S. tell the IMF to do, I know what we would do, I know what the advice would be, and that would be, take over the banking system. Clean it up, re-privatize it as soon as you can.

Account for the bad debts, throw out the bad management, take the hit and move on. That really is the only way out of this mess. Until that happens – and it doesn’t matter if you call it nationalization or some other euphemism – nothing will change. Keep that in mind when listening to the chattering classes and it becomes quite easy to know when you are being lied to.

Treasury thinks maybe foreclosures actually are a problem

My latest from over at BlownMortgage.com:

Latest news has it that the Treasury Dept. is thinking really, really hard about maybe using some of the $700 billion from the Troubled Assets Relief Program (TARP) to do something about home foreclosures.

Neel Kashkari, who has to administer the Troubled Assets Relief Program, told Senators, “We continue to aggressively examine strategies to mitigate foreclosures and maximize loan modifications.” It is well worth noting Kashkari offered no actual details as to what this might mean.

This doesn’t seem to indicate any change in Henry Paulson’s willingness to consider an FDIC plan to help homeowners. “Under the FDIC proposal, the government would seek to encourage lenders to modify loans by offering to share the cost of any defaults. The FDIC has said its proposal could prevent about 1.5 million foreclosures.” Paulson has said that use of TARP money for this would be a misuse of the funds. This is odd given his willingness to spend the money on just about anything except homeowners.

On the bright side: He’s only got 47 more days on the job.

There’s more (including a long quote from CollateralDamage Sr.) here.

What is the definition of “depression”?

More from me at BlownMortgage:

It is difficult to believe but earlier this year people were still debating whether or not we were in a recession. The debate broke down along the lines of, “We haven’t met the technical definition of a recession” vs. “If it smells, like a duck, quacks like a duck and looks like a duck then it’s a duck.”

One of the reasons for the debate was because there are so many different definitions of a recession.

The standard definition used by idiots and journalists (like me!) is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.

Idiots and economists (like them!) don’t like this because it leaves out the unemployment rate and consumer confidence as indicators. “By using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected.” Sadly, that’s not going to be an issue this time around.

BTW, now that the extension of unemployment benefits has passed the Senate expect to see a sharp increase in the unemployment rate — which only counts people who are collecting unemployment insurance. You are no longer officially counted as unemployed if you are not collecting insurance. A lot of people who used up their benefits but aren’t employed will now re-appear magically on the roles. They will just as magically disappear in seven weeks when their benefits are used up and the rate will go down again. However, those people won’t be any more employed.

Nothing happens until the new prez takes over. Good or bad?

My latest from BlownMortgage:

In a time of economic crisis, where every moment brings more bad/alarming news, what does it mean that the government is essentially in a holding pattern for the next two months?

Many people are concerned this will mean a continuation of the Paulson strategy of throwing good money after bad. (”Am I the only one worried that by the time Obama is sworn in on January 20th, the Paulson Treasury will have run through almost a trillion dollars to little or no effect?“) Currently there are attempts to qualify GM as a bank so it can get a cut of the bailout money (LOL!!!). A similar request by GE makes more sense to me because GE is a well-run company. Several large cities are also making requests for funds. Personally, I’d give funds to Wasilla before I’d hand a dime to GM.

Still others think that Paulson and the Congress will take this moment to do nothing — and that’s a good thing. Oklahoma Sen. Jim Inhofe thinks this is such a good thing that he wants to legislate a freeze on the remaining bailout cash. (Inhofe’s willingness to rip Paulson a new one is a great indicator of how the Bushies are closer to dead-duck instead of merely being lame: Senator Inhofe suggests Paulson “may have given the [bailout] money to his friends.”)

There’s more where that came from…

Obama carried all the “really” red states

My latest from BlownMortgage (with charts and facts and everything!):

Popular opinion has it that Barack Obama won because he took some red states away from John McCain. Nonsense. Obama won all the red states. And McCain won all the black states. But this has nothing to do with that stupid red state/blue state dichotomy. This is about the much more tangible difference between red (ink) states vs. black (ink) states.

As this chart from the Wall Street Journal shows, Obama carried 18 of the 20 states where housing prices have dipped into the red – according to the Office of Federal Housing Enterprise Oversight house price index for the second quarter. Those two that went for McCain? Arizona and Alaska – which makes their anomalous standing understandable.