As the previous post might have mentioned, it was another bad day on the Street, with the Dow losing another 4%, to add to that amount lost last week. The Europeans lost double that on their indexes. The Asians lost a little more than we did.
So, now that the trading day is over, some ideas are being floated around to stem the hemorrhage of liquidity from the major financial institutions.
Everything from the sublime to the ridiculous.
Some suggest the sublime approach, that the Fed just keep lowering the rediscount rate, up to as much as a full 100 basis points (one full percent). In first aid terms, this is like putting a sieve on a sucking chest wound, when only an occlusive dressing will save the patient. Non starter. Lowering the rediscount rate works only when the banks HAVE cash to loan each other, and WANT to loan to each other. Neither of those preconditions are met at this point.
Then we get to the ridiculous. Suspend the banks' mark-to-market rules. To reconcile their books, banks are required to list the value of assets owned according to standard, acceptable market pricing of those assets. If that rule is suspended, the banks may put any price they choose on assets. If, for example, a tax accounting is due, they can price way low, say they took a loss, and pay no taxes. OTOH, if a bank examiner stops by and wants to see if they have enough capitalization on the books (reserves), they can list assets way high to satisfy the examiner. With no rules of what assets are actually worth, how will we ever again know what the fiscal health of the banking system is? This isn't free market, it's free-BOOTING marketing, or piracy.
This banking crisis is on us now because two years ago, banks got together and decided that they didn't need no steenking reserves, so they spent them all (on bad mortgage paper). Now that there's a crisis of confidence, they have no reserves, which deepens the crisis, so this suggestion of changing the accounting rules is just a smoke-and-mirrors trick to fool us into regaining our confidence and putting money back in the banks, who will promptly forget all the lessons, just like the Asian bankers did from their mini-crisis 10 years ago to their worse crisis of today.
Nope. Now that the crisis is on us, ride it out until bottom is found, probably around another 20% loss of total world capital. Rebuild from there. That's the only way to do it, for to start rebuilding on a false bottom will only speed the day when this will all happen again.
One point - the mark-to-market rule changes I've heard don't suspend them entirely, they only change from mark-to-market to mark-to-maturity.
IE, rather than have it on the books at today's price (50% or less of the total value of a bond package, since there IS no market to buy them), declare it as a long-term asset and book it at it's maturity value. Not a lot of wiggle room there for shenanigans, as the maturity value is pretty much fixed at a bond's creation. Still some room for the value to change (housing prices declining has reduced the value of the assets backing these bonds), but much closer to the actual value than what current accounting rules are giving us.
The (non-junk) bonds trading at 50-60% of maturity value currently have a lot of financial planners calling them "steals" as they're returning current ~10% cash flow and a significant capital gain at maturity, even if some of their assets are devalued.
Posted by: Aaron Neal | October 07, 2008 at 02:23