The financial markets are getting clobbered everyday to a point where it makes no sense anymore. It is not a question of 'Will', but 'When' the next write down is coming. If it not really ‘If’ but ‘Who’ will be the next bank to fail. One of the biggest problems is being blamed on the "Mark-to-Market" accounting rule. Mark-To-Market (MTM) accounting rules have turned a large problem into an ever larger one. MTM also known populary as ‘Fair Value’ accounting is facing opposition now from all quarters as it is forcing financial firms to treat all potential losses as if they were actual cash losses. i.e. this rule assumes that what people are willing to pay for an asset is always the same as the asset's value. This means that companies must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately (read today). Under such a rule, declining housing prices don't just reduce the value of defaulting mortgages. They reduce the value of all mortgages and all mortgage-related securities because the housing collateral protecting them is worth less. For e.g. lets say the mortgage was sold at X today. But when the value of the house reduces (especially now with the credit markets frozen up) and someone is only willing to pay X-5 for the same mortgage today, the rule says the firm must immediately write down a loss of 5 as the mortgage can be sold for X-5 today.
Its a tough rule since there is no market to establish the real value and not all assets that have no trading market are bad assets. Moreover, the firms do not have to sell them today itself, so does it make sense that they really have to value them at the prices they fetch today? Even if the firm does not sell at the low price, and even if the value of these assets is above the price at which others are willing to pay today, the firm must record them as losses on the books - the sole reason which is causing write down after write-down, thereby violating capital requirements causing the equity to tank and in turn the stock prices to fall. Once panic sets in, we have seen what can occur with Bear, Lehman and ML - people simply start panic selling, even when they know the underlying business of the company is fine. It looks like a vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent are bring forced to price assets at fire-sale values chasing away capital and leading to a further decline in asset values. All the banks have taken a hit because of this rule.
Further confusing investors, the rule has inconsistent application across industries and companies. MTM favors private companies over public companies. As the government is being so aggressive with the use of these capital regulations with the banks, we can see just about the only transactions taking place in the sub prime marketplace have been sales to private equity firms that do not have to mark assets to market prices.
Banks, though, are subject to regulatory capital standards and therefore can be rendered insolvent overnight based on an accounting write-down. The same is true of what happened to Fannie Mae and Freddie Mac, which had positive cash flow when they were nationalized by the Treasury. Here's something you won't believe: Fannie Mae and Freddie Mac have not drawn a dime from the Treasury's $200 billion facility that was created to bail them out. It was the use of mark-to-market accounting that allowed Treasury to declare them bankrupt. On a cash flow basis, they were solvent.
Because of all this, Washington finds itself in a somewhat awkward position in that its own rules is rendering many financial institutions insolvent in a manner which does not reflect their true value. A lot of big banks (Actually all of them) are currently lobbying heavily in Washington to get rid of the MTM accounting rule. But I think a mere accounting rule change won't reduce foreclosures or raise home prices -- then again, if spared drastic write downs, banks might be more willing to lend, raising home prices and reducing foreclosures. The economy might just jumpstart but at this point my guess is as good as yours and the truth is no one knows how things are going to play out.
Its a tough rule since there is no market to establish the real value and not all assets that have no trading market are bad assets. Moreover, the firms do not have to sell them today itself, so does it make sense that they really have to value them at the prices they fetch today? Even if the firm does not sell at the low price, and even if the value of these assets is above the price at which others are willing to pay today, the firm must record them as losses on the books - the sole reason which is causing write down after write-down, thereby violating capital requirements causing the equity to tank and in turn the stock prices to fall. Once panic sets in, we have seen what can occur with Bear, Lehman and ML - people simply start panic selling, even when they know the underlying business of the company is fine. It looks like a vast majority of mortgages, corporate bonds, and structured debts are still performing. But because the market is frozen, the prices of these assets have fallen below their true value. Firms that are otherwise solvent are bring forced to price assets at fire-sale values chasing away capital and leading to a further decline in asset values. All the banks have taken a hit because of this rule.
Further confusing investors, the rule has inconsistent application across industries and companies. MTM favors private companies over public companies. As the government is being so aggressive with the use of these capital regulations with the banks, we can see just about the only transactions taking place in the sub prime marketplace have been sales to private equity firms that do not have to mark assets to market prices.
Banks, though, are subject to regulatory capital standards and therefore can be rendered insolvent overnight based on an accounting write-down. The same is true of what happened to Fannie Mae and Freddie Mac, which had positive cash flow when they were nationalized by the Treasury. Here's something you won't believe: Fannie Mae and Freddie Mac have not drawn a dime from the Treasury's $200 billion facility that was created to bail them out. It was the use of mark-to-market accounting that allowed Treasury to declare them bankrupt. On a cash flow basis, they were solvent.
Because of all this, Washington finds itself in a somewhat awkward position in that its own rules is rendering many financial institutions insolvent in a manner which does not reflect their true value. A lot of big banks (Actually all of them) are currently lobbying heavily in Washington to get rid of the MTM accounting rule. But I think a mere accounting rule change won't reduce foreclosures or raise home prices -- then again, if spared drastic write downs, banks might be more willing to lend, raising home prices and reducing foreclosures. The economy might just jumpstart but at this point my guess is as good as yours and the truth is no one knows how things are going to play out.
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