October 15, 2008
Mark to market study begins
Speaking of mark-to-market, here is part of the announcement from last week by the SEC -- SEC Commences Work on Congressionally Mandated Study on Accounting Standards; 2008-242; Oct. 7, 2008:
Under legislation enacted last week to help stabilize financial markets, the SEC is required to conduct a study of "mark-to-market" accounting. The study is to be completed by Jan. 2, 2009, in consultation with the Secretary of the Treasury and the Board of Governors of the Federal Reserve System. Under the terms of the EESA, the study will focus on:
1. The effects of such accounting standards on a financial institution's balance sheet
2. The impacts of such accounting on bank failures in 2008
3. The impact of such standards on the quality of financial information available to investors
4. The process used by the Financial Accounting Standards Board in developing accounting standards
5. The advisability and feasibility of modifications to such standards
6. Alternative accounting standards to those provided in [Financial Accounting Standards Board] Statement Number 157
Posted by Ken Jarboe at 9:51 AM | Comments (0) | TrackBack (0)
Mark to market not the problem
Floyd Norris makes a great point in his blog today -- The Problem Is the Assets, Not the Mark:
The CFA Institute, the organization of certified financial analysts, distributed a questionnaire to its members on Thursday, and so far has received more than 5,000 responses from people whose job it is to review financial statements and make investment recommendations.
It should come as no surprise that they are more concerned about banks overvaluing assets than about the possibility that mark-to-market accounting is causing assets to be valued at unreasonably low levels.
So, remind me again why it is a good idea to keep cooking the books?
Posted by Ken Jarboe at 9:45 AM | Comments (0) | TrackBack (0)
The shift in tactics
A story in today's Washington Post describes the story behind the story of Paulson's Change in Rescue Tactics:
Treasury officials were probing deeper into the books of the nation's banks and concluding that there were so many troubled assets that simply using government cash to buy them up -- the strategy Paulson had pitched -- wouldn't be enough to jump-start the markets. The troubled bank Wachovia alone had $312 billion in such assets.
. . .
Federal Reserve Chairman Ben S. Bernanke had privately urged that approach [of direct injection] for weeks, but he vigorously endorsed Paulson's rescue package in part because he knew it left Paulson enough flexibility to change direction.
. . .
during the debate over the rescue bill, Paulson told lawmakers he was reluctant to inject capital into banks in part because direct investments smacked of big-government nationalization. Aside from his free-market inclinations, emphasizing that option could have led some Republicans to vote against the bill.
Moreover, if he had called attention to the provisions in the bill that made cash injections an option, stockholders in banks could have concluded that the government was about to wipe them out, as it had investors in mortgage firms Fannie Mae and Freddie Mac and insurance giant American International Group, driving stock prices down and making the need for a bailout all the more urgent.
I realize that this direct injection is the preferred method of many economists. But it is not without risks as well. As the Post story points out:
Through asset purchases, the government has considerable power to control exactly which assets get bought and which don't. With injections of preferred stock, the government has no explicit authority to ensure that banks use the new capital to increase their lending to ordinary families and businesses. There is a risk they could become "zombie banks," technically solvent but unwilling to make new loans.
The response:
Government officials said they have been deeply worried about that risk and intend to use their regulatory power to lean on the banks to take advantage of their new capital by making new loans.
I'm not sure these regulatory are a strong enough tool to prod zombies. Some are concerned that the Treasury plan doesn't go far enough in giving the US a shareholder vote through common stock. As Nobel laureate Joseph Stiglitz was quoted in the Wall Street Journal, "As we pour money in, they can pour money right out. We don't have a veto." I'm not sure that I would support Treasury voting common stock or sitting on the Board, ala the European plan. But I would like to see some clear "anti-zombie" provisions.
I would also like to have seen the banks pledge their intellectual property as collateral. I know this might seem an added complication to the process -- but we need to start thinking like we really are in the 21st Century.
Finally, we still have to deal with how to get the bankers' books cleaned up. No wonder Wachovia was in trouble -- with $312 billion of toxic assets on its books that the outside world didn't know about. It is examples like that which reinforce the hording instinct. So the sooner the TARP auctions are set up to start buying those assets, the better.
Posted by Ken Jarboe at 7:59 AM | Comments (0) | TrackBack (0)
October 14, 2008
Krugman's Nobel Prize
Many congratulations to Paul Krugman for winning the Nobel Memorial Prize in Economics.
I have not always agreed with Paul (especially on his early thoughts on competitiveness
- see Peddling Prosperity: Economic Sense and Nonsense in an Age of Diminished Expectations)
But his work on trade and economic geography are truly path breaking. Here are a few references to some of that work:
Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition, and the International Economy
Strategic Trade Policy and the New International Economics
Geography and Trade (Gaston Eyskens Lectures)
Development, Geography, and Economic Theory (Ohlin Lectures)
Posted by Ken Jarboe at 10:01 AM | Comments (0) | TrackBack (0)
Finding "fair value"
In the search for solutions to the financial mess, some politicians and pundits have latched on to the rules for "fair value" or "mark-to-market" accounting as the villain. They claim that these rules cause financial institutions to fall into a situation of undercapitalization because of low asset valuations.
Yes, I will concede that there is a danger of valuing these assets at fire sale prices.
But the old way of accounting was simply wrong. Based on amortized costs, at best it was an ostrich-head-in-the-sand approach. At worst it was just another way to cook the books. As was noted in an earlier posting, one of the reasons why banks are afraid to lend to one another is that they know the types of accounting games that came be played -- and they simply don't trust their counterparties' books.
Well, it looks like in Europe at least, the politicians have partly won. But according to the Financial Times, at least Gordon Brown is raising the voice of sanity - (Fair value accounting rules eased):
The issue has stirred up a political storm with French and Italian leaders, among others, pushing for an easing of the rules. However, Gordon Brown, UK prime minister, said in a press briefing: “Some people are looking for a get-out-of-jail-free card and an easier way of registering their financial position than is the truth.”
He warned that changing the accounting was not a quick solution. He said the world had to find “a level playing field” and not just offer “a breathing space”. “It’s just a lot of money put on one side of the accounts to make things look better.”
Brown is absolutely right. We need to find a level playing field to deal with hard to value assets -- and not just with the current troubled assets. As we move further into the I-Cubed Economy, all sorts of other intangibles assets will need to come into play. We will need transparent and reliable methods for valuing these assets.
There are other methods. As Susan Woodward, a former SEC Chief Economist, points out, Fannie Mae has accurate models for valuing mortgage assets (Rescued by Fannie Mae?):
Some argue that Fannie is discredited for this work because it, too, has losses on riskier mortgages. But Fannie's losses arose from a failure to reserve adequately for losses that were anticipated by its models. Fannie's business people overrode the risk managers when making the decision to keep reserves too low. The models were right.
We need to explore and officially adopt these models. The old head-in-the-sand approach is responsible for getting us into the mess we are in. It will not help us get out. Nor will it help us prosper in the future.
Posted by Ken Jarboe at 9:45 AM | Comments (0) | TrackBack (0)
October 13, 2008
How it looks to the V.C. world
The Dow may have rallied yesterday, but we are still a long way from an economic turnaround. If you want a clear explanation of what happened in the financial meltdown and the consequences, I would recommend this presentation from Sequoia Capital, one of the premier venture capital funds: “RIP: Good Times” (thanks to the blog VentureBeat). This presentation was given by Sequoia to the companies it invests in. Not a pretty picture.
Posted by Ken Jarboe at 8:21 PM | Comments (0) | TrackBack (0)
October 11, 2008
From systemic to scapegoats
Even as we search for solutions to the financial crisis, the search for the "why" is also underway. Congressional hearings are planned. Politicians have already pointed the finger (as have some average citizens using the middle finger). While it is important to understand the "why", it is interesting how the answer is influenced by ideological and political filters. The Republicans and the right are blaming the crisis on housing loans to poor people; the Democrats and the left are blaming greedy Wall Street speculators.
This rush to find scapegoats is part human nature. That does not mean it is correct. Understanding the "why" will take more than playing to the current political climate. So, come on guys and gals: what part of "systematic" in "systematic crisis" don't you understand?
Posted by Ken Jarboe at 10:07 AM | Comments (0) | TrackBack (0)
October 10, 2008
Missing the fundamentals
For all the pain and anxiety and drama associated with the financial meltdown, the crisis is only a part of the overall picture. Overshadowed are the problems with underlying economic fundamentals. For years, people have been comparing our situation to the frog in the pot. Put a frog in a pot of boiling water and the frog will try to jump out. Put a frog in a pot of water and slowly turn up the heat, the frog will boil alive. The slow build up economic problems is like that frog sitting in that pot: the gradual increase in the heat isn’t enough to cause action.
Now, it is as if someone took a sharp pin to that slowly boiling frog. The pin will cause the frog to jump, while the slow boil will go unnoticed until it is too late. Solving the credit crisis won’t turn down heat. But we can hope that the sharp pin shocks the frog enough to cause it to jump out of the pot.
Easy credit is what kept Americans afloat for the past decade. With stagnant wages and families already relying on two incomes, the only recourse for many was borrowing. Borrow on easy terms to get that house you otherwise would not be able to afford; borrow on your house’s equity; borrow on your credit cards to do your patriotic duty, as the President stated after 9/11, to go shopping. And easy credit made up for the hemorrhaging of international accounts as money flowed out to other nations to pay for our trade deficit. (In some ways, we may have the last laugh as all that financial paper we sold them in return for goods and services may turn out to be worthless.)
Solving the financial crisis won’t solve the trade deficit, for example. I won’t go into the long litany of economic issues and problems. I will mention one: wage stagnation. Productivity gains – which have kept this economy going – used to be broadly shared. Somewhere over the past couple of decades the linkage between wages and productivity snapped. As a result, while the economy has grown, wages have not. If we are to put the country back on the right track, that needs to be fixed. Overcoming the financial crisis is the first step. But we also have to keep the frog jumping straight up and back into that pot. Otherwise the frog will be back where it was, boiling alive.
Posted by Ken Jarboe at 10:24 AM | Comments (0) | TrackBack (0)
