There is one big difference. Or perhaps two. First, I write my blog so that my family (read - my kids), should they ever decide to read it, will know more about me and what I was like and what I did when they were young. But, two - and equally important to all of my current readers - I write about things that I feel are important, and that can prove helpful in my kid's (or anyone's) life. Yes - even yours.
Sometimes my information is informative. Sometimes my stories are just stories about what I'm doing at the moment. With any luck, those will at least contain some entertainment value for the reader. As an aspiring writer, one would think that I would blog constantly. Unfortunately, my mind is such a mess that I can't really be expected to clear it out on an ongoing basis to generate enough useful information to blog about. (That's my story, and I'm sticking with it!)
What prompts this particular post is one of the financial market newsletters that I check out (Incredible Charts). I've referred to it before, but I don't know that I told you why. One reason that I like this newsletter is that it is written by a South African, living in Australia (Collin Twiggs). While writing about the U.S. (and other) markets, he brings a perspective that Americans will not (and many cannot) see. First let me start with a quote from his most recent newsletter (dated this morning):
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.
~ Henry Ford
I believe that this is especially true today.
Next, let me pull out the opening paragraph of this morning's newsletter for you:
The Fed is to buy an additional $750 billion of mortgage-backed securities (bringing the total to $1.25 trillion), an additional $100 billion of agency debt (bringing the total to $200 billion), and $300 billion of longer-term Treasury securities. (FRB) The total of $1.75 trillion may not fully offset the deflationary effects of the collapsing debt bubble, but should go some way towards stabilizing housing prices over the next six months — and consequently bank collateral.
Keep in mind that this is separate from and in addition to the bailout funds that have already been authorized to institutions such as AIG, with still more likely to follow. Back in September I talked about this. Generally, injecting money into the money supply leads to inflation. (Definitions of inflation: too many dollars, chasing too few goods which drives prices higher. But I think I like this one better: the act of filling something with air. (in this case, the economy)) But currently we are in a deflationary period where the price of assets is declining (see housing and the price of oil). Not being an economist (thank goodness) I have no idea which of these conflicting forces will dominate in the end.
But what really led me to making this post was a mention of the fight to change the mark-to-market pricing of so-called "toxic assets" or "troubled assets" depending upon which news source you happen to be listening to at the moment. This change is being considered by the Financial Accounting Standards Board. The following statement comes from the web site header of this organization:
Serving the investing public through transparent information resulting from high-quality financial reporting standards, developed in an independent, private-sector, open due process. (Italics are mine)
Here is the opening paragraph of their mission statement directly from their website:
The Mission of the Financial Accounting Standards Board
The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.
Now, keeping all of this in mind, this was reported by the Wall Street Journal on March 13, 2009: (Excerpts only. Click on the link for the full article.)Regulators said they are exploring ways to give banks a break on accounting, but their efforts ran into criticism from lawmakers in Congress who want faster action to prevent downward spirals.
The banking lobby said mark-to-market rules have forced banks to place unrealistically low values on hard-to-trade assets. Banks said the rules cause unnecessary hits to their capital levels, forcing them to raise money on punishing terms.
Speculation about changes to mark-to-market rules have helped drive bank shares higher in recent days.
Defenders of mark-to-market rules said it is the most-accurate way to put a value on a company, and weakening the principle would mask bad balance sheets and undermine confidence in the markets.
"Financial Accounting Standards Board Chairman Robert Herz defended the standards..."
The accounting board and regulators said they are looking at modifying the rules that apply to securities when their market value falls below book value and the securities are deemed to be permanently impaired. The board and the Securities and Exchange Commission are considering allowing banks to limit write-downs to the losses that stem from the weakened credit of the borrowers behind the securities, for example, homeowners paying back mortgages.
Still, lawmakers expressed frustration that the accounting board and SEC aren't moving faster. "If you don't act, we will," said Rep. Gary Ackerman, a Democrat from New York.
Okay - so that's some pretty heavy-duty reading. Let me try to break it down for you in terms that make more sense to me.
Let's say I buy a toaster. The toaster is uniquely designed and very attractive, and it cost me $30. I carry the toaster as an asset valued at $30 on my personal balance sheet. Mark-to-market rules state that I have to value the toaster at its market value. Well, as soon as I walk out of the store, the toaster is worth less than $30. How much less is the question. It is worth what someone else is willing to pay. No more. No less.
Current rules require banks to price their toxic assets the same way as the toaster. But their argument is that nobody wants to buy a mortgage that is not being paid on a house that is worth less than the loan amount. Never mind that just finding the mortgage can be a difficult process because it was packaged up with a bunch of other mortagages and sold to someone else. So how can it be properly valued?
It is worth what someone else is willing to pay. No more. No less.
Now my toaster just makes burnt toast. Can it be fixed? Maybe. But at what cost, and how difficult will it be and how long will it take? Certainly, this toaster is a lot less attractive now. But someone offers me $1 for it. Do I sell it, or do I keep it? If I keep it, I can value it as $30 more toward my net worth. If I sell it, I reduce my net worth by $29. I don't really want to do that.
FASB says that my toaster is worth $1. (Mark-to-market accounting)
This is where the government comes in as represented by Rep. Gary Ackerman above. It goes something like this:
"Ernie, we don't want you to experience that hardship of having to reduce your net worth by $29. That's not good for anyone. We think that you should be able to value your toaster at what you think it's worth." Naturally, I am going to place a higher value on it. But is it a realistic value? Not likely.
So much for the "transparent information" "developed in an independent, private-sector, open due process".
This is why I think that this current financial crisis is going to extend longer and deeper than most people currently believe.
Keep in mind that the chairman of FASB is currently defending the standard, but with congressional pressure, I don't know that his position will prevail. So the waters get murkier still.
I welcome any thoughts on these ideas.
PS: When my kids read this after they're grown, that uniquely designed, attractive toaster (which was repaired and well maintained) is likely to be worth $100 or more.
(For more on this, please read the first two comments.)
4 comments:
ahh, but here is where your analogy is incomplete. Your toaster is worth $1, which brings down the value of all of your neighbors' toasters, though NO fault of theirs. Granted, that is what free markets do. But when everyone's toasters lose value, and they owe more than they can ever hope to sell that toaster for, why pay the toaster loan? People start to default on their toaster loans and further devalue the toaster market.
Should the government just sit by and watch the toaster market implode, hoping that it will ultimately resolve on it's own before entire neighborhoods become crime-ridden and rundown?
This is a tough question and one there are no easy answers to.
Ahhhhh... you missed my point.
I'm not saying that the government should not provide assistance. I am saying that they should not impede the representation of the true value of these assets. Creating a false value for accounting purposes can only lead to further erosion of trust and consumer confidence in our banks and banking system. I firmly believe that consumer confidence is the only thing that will resolve this crisis, especially if these smoke and mirrors processes continue. And that consumer confidence could take years to return. People (generally) don't buy anything they don't have to if they are unsure of their income stream.
How many people will never really be able to sell their toasters for what they owe on their toaster loan? Maybe some of them who bought at ridiculously high prices and deserve to lose their toasters anyway, but I think for a lot of people who weren't planning to just flip their toasters in a short time frame, the value will go back up, even if it means not selling as soon as they want.
If you have too much government intervention no one will ever buy a toaster responsibly again because they won't really have to take on the risk of toaster-ownership.
Let me make a comment that gets back to the heart of your article (rather than worrying about the neighborhoods of the underlying mortgages - which is not irrelevant, because it is a huge part of what happened with the formulas for valuing the securitized mortgages in the first place, but I digress):
The problem with the mark-to-market rules, as I see it, is that it is two fold: first, it is only the short term, "snapshot" value of what is maybe the current value of the firm. That "short term" focus makes the bank look like it's worthless and thus should be shut down, despite the fact that regular banking operations and other investments are as sound as ever. Cash flow is unchanged. It's an accounting breakdown, not an actual loss of profitability (in some cases, according to what I've read). Letting the banks operate until the actual value of those assets is better determined could lead to fewer failures. Second, mark-t0-market is a horrible idea in the face of illiquid assets. Illiquid assets, by definition, do not have "market" value, or at the very least, a much more uncertain value. How do you value something that can't be valued? Esssentially, that's where the mortgage-backed securities are now - no one really knows what they're worth, so no one will purchase, which drives the "market" value down to $0, where really it's just an illiquid asset that has some value that will be determined later. how do you effectively account for that? Finally, I think it could be argued that the downturn could be shorter than expected, because those assets have more value than is being accounted for right now - essentially everthing in a securitized mortgage is toxic by association (and ignorance) and being valued at approximately $0. It is almost certain that some percentage of those underlying mortgages are worth $0, while others are worth their full amount and others at something in-between. Once it becomes clear that payments are still coming in on a large percentage of those mortgages and value is better ascertained (instead of the hysterical rush that's going on now), things could look up. Who really knows, though. That's the problem, no one does.
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