Value of Bank Assets–Meltdown or Misshmash

For the last half year there has been much agony in the news and by the pundits regarding the banking financial mess and how to restore our large banks to reboust health again.   We are all painfully aware of the billions and billions that has already been poured into the system by the Fed and the Treasury in this effort.   The problem is that the banks don’t have sufficient capital per the regulators.  The crux of the problem is in the mark to market accounting method. 

All accounting is designed to do two things primarily–i) give accurate information about value and ii)  provide data to determine the profitability of a concern.  The mark to market rule is only one device for determing the value of an asset.  It is not the only way.   For example if you want to know the value of a 2000 Ford Taurus you can get that  because there are many regular sales and auctions for them and similar assets.  The market sets the value and you can track the prices and come up with a very reasonable estimate for the car.   Many other values can be determined similarly.  We factor in depreciation when we value assets.  But that depreciation is merely an artifice, it is not a fact.  We assume something deteriorates at a particular rate over time withou really knowing that is true.  But it is a reasonable assumption based upon other known factors.  The assets that the banks hold now that cause the problems appear to be mostly securities that represent an interest in notes that are secured by mortgages.  The underlying asset is the note.  That is the core asset.  Long term payout instruments have been valued for decades using the discount method.  Under the mark to market rule the regulators say that there is no ready market for the securities of the banks (which in turn are an interest in the notes remember) because of the financial crisis and thus there is NO value or very little value in the bank’s security instrument and thus the bank’s asset value is greatly diminished.  It reduces the capital of the bank.  But the security is worth ultimately the value of the note.  That is the thing that generates value and profit.  Treasury bills are long term investments and they are discounted daily by investors to determine the worth of money now versus the worth of money years down the road.

Accountants and economists for ages have valued long term instruments on a discounted basis.  That is not new or arcane methodology.  Those underlying notes do have value, the vast majority of them will pay off in fulland on time.   A typical 30 year note/mortgage that on an amortized basis requires say a total of $300,000.00 in total payments can  be marketed for a discounted price.  A buyer will not pay close to the $300,000.00 for it because he is having to shell out cash now and will have to wait for 30 years to reap his payback and profit.  So he will offer, maybe, $125,ooo.00 for it.  But these instruments are long term investments and were intended to be such.  It is not hard to review the history of mortgage loans at a particular bank and see the payment history for lots of loans, determine the usual default rate by looking at 10 years or even 20 years of history.  You can come up with a pretty reliable number of what the cash stream will be for those notes.  Then you can discount it.  You could even double the default rate if you thought times were tough and they were going up for a while.  Even then the notes still have some value because of the mortgage. The improved real estate has value; a value that will increase over time. 

I would suggest that we rely on the traditional market to set these prices and that the banks not be required to artificially reduce the value of their assets.  We should use both methods.  Let the damn regulators keep the mark to market rule.  But in addition to that let the banks do another valuation based on traditional methods of discounting and valuation. Have complete disclosure of both and allow third parties to audit the notes in question.  Have a bidding system with all that data on the table.  Potential buyers could rely on what they preferred, not values mandated by bureaucrats.  The free market if it was allowed to work would quickly start setting the values of these securities and notes and the banks’ asset values would rise and we wouldn ‘t have to dump billions into them.  Just disclose everything and then step out of the way.  Let the banks use the traditional valuation method for regulatroy puposes for say a year.   By then the market values would be established but in the meantime we would save taxpayer money and the banks wouldn’t be closed due to accounting nicities that may not represent reality.  All values are subjective.  That will never change regardless of accounting methods. 

Boy that Israelis lobby has some clout.  You noticed that Charles Freeman although hand chosen by the White House bunch got dropped as soon as the lobby went after him.  I don’t have a strong opinion about him one way or the other but his removal as chief of the National Intelligence Council head nominee sure points out that power held by the Isreali supporters in Congress.  Another White House appointee bites the dust before every riding out to corral the herd.


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Filed under Economics, government, Politics

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