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Bankers need to get the price right
Paul Kedrosky
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TEXT OF COMMENTARY
Kai Ryssdal: As Jeremy Hobson alluded to, one of the reasons Wells Fargo is expecting such a bang-up first quarter is that the rules have changed. Last week the board that gets to decide these things loosened up the rules on what's called Mark-to-Market. Companies now have more leeway to assign a value to an asset where no market for it exists. Commentator Paul Kedrosky thinks the banks are being allowed to pull a fast one.
PAUL KEDROSKY: Some people have convinced themselves that a cause of the current crisis was the awful, terrible idea of pricing things properly.
Heresy, I call it. Price things at a level at which you can sell them on the open market? Where else but in banking would you see such a silly idea? Other than in malls, of course. And corner stores. And car dealers. OK, pretty much everywhere.
Why do bankers want their own pricing rules? Good question. First, bankers and their boosters argue that it makes no sense to price things to market when you have no intention of selling them.
OK, but even though I don't plan to sell my Beanie Baby collection right now I would like to know what they're worth. Banks aren't different; they just like to pretend they are if it keeps them from being taken over by the FDIC.
Second, banks say that some markets are "distressed," so they can't get proper prices for their wacky paper. Nice. The market for some deranged credit derivative is gone, never to return, so I get to make up a price. Call it "Mark-to-Myth" -- preferably, high myths.
So, let's summarize: Bankers don't want to price crappy assets that they shouldn't have bought in the first place, so they cross their fingers and say that they're going to hold those assets forever. And if you call their bluff and tell them to price the dreck anyway, then recent changes in accounting rules mean they get to say the market is "distressed" and so they can make up prices.
No thanks. Fibs, funny money and fake markets are no way to fix banking. And anyone who feels otherwise... well, I have a bunch of $1000 purple and yellow Beanie Babies waiting for you right here.
Ryssdal: Paul Kedrosky is a senior fellow at the Kaufman Foundation. He is also the editor of the business blog, "Infectious Greed."
This situation continues to resemble the coyote in the roadrunner cartoons, walking off the cliff but it doesn't fall until it looks down. Or a "don't ask don't tell" situation. In other words, denial. The underlying problem is that mortgage securitizations are worth less than they were rated by rating agencies and then overvalued. While many people make their mortgage payments, others can not, both because of the nature of many mortgage products, particularly the adjustable rate mortgages that were underwritten only to low initial teaser rates and not to succeed long term. Add in the Ponzi-like creation of derivatives, aptly described by a Chinese spokesman as a hall of mirrors. Throw in the collapse of the housing bubble and then all of the jobs that have been lost due to the financial meltdown. The latter shows the inherent craziness of trying to make "innovative" financial products the source of products rather than real production. It is one thing to wait out a bad period, but the underlying issue is that many banks are really insolvent, and unable to cover their deposits. The first step is to fix the bad mortgages so their value can be determined. The administration is making some steps but it is not clear they are enough. The next step is sane regulation of the financial sector.
Your commmentator either doesn't understand the issue at hand or is disingenuous. Worse, he begs the question with the sarcastic rhetorical question regarding the "awful, terrible idea of pricing things properly." That is exactly the issue at hand.
If you are concerned about banks fulfilling their crucial role in the economy- that is, to provide credit while serving as stewards of depositors' funds- you must relieve them of the arcane, inaccurate, poorly conceived methodology of so-called "fair value" accounting. Why would a bank extend, say, a mortgage loan to ANYONE when it suspects that, due to the lack of liquidity in the secondary market for mortgage-backed securities, it will be forced to write down that mortgage by 30-40-50% within 6 months of origination, regardless of the actual performance or quality of that mortgage? That is precisely what has been happening to banks for the last 16 months. Ergo, they aren't lending, and the recession deepens.
Banks have been extending credit and carrying all types of loans- corporate, commercial, auto, mortgage, credit cards, etc- on their books at the principal balance (less impairment charges for lower quality loans) for eons. Since mortgage-backed securities are, in fact, securities, this approach might not be appropriate, but at the end of the day, MBS are, in fact, backed by real mortgages on real homes, and despite the best efforts of people like the commentator, the vast majority of them are performing. So if a bank holding a portfolio of MBS is receiving cash flow (unlike Beanie Babies, which do not generate cash flow...nice analogy) and finds that 94%+ of the mortgages in that security are performing, why on earth would you want them to be forced by MTM accounting rules to carry the security at, say, $.50 on the dollar thereby making them undercapitalized by regulatory definition? That is lunacy. The increased flexibility to value MBS recently issued by FASB will help restore asset valuation to sane levels.
Please, do your listeners a favor. When you have a segment on the show about such an important issue, find a commentator who actually understands the pros and cons and can present them in a thoughtful manner, not the sarcastic and disingenuous tone of your commentator.
He is correct when it comes to a true commodity. However, mortgages are not a true commodity. You make money with commodities by buying and selling them. Mortgages make money even when they are not being bought and sold when people make payments. So the comparison and therefore the markets are not the same.
"Bankers need to get the price right"
Really?
A market price means a willing buyer AND a willing
seller. Not as P.K. says---
" Price things at a level at which you can sell them on the open market?" There isn’t a market price if both parties are not willing.
Accounting rules are often bizarre, even in good times. But some are especially so in bad times. That's why financial analysts have a function to perform, which accountants are not trained to perform. Cf. this lack of sophistication below:
"Good question. First, bankers and their boosters argue that it makes no sense to price things to market when you have no intention of selling them."
B.K.'s curiosity, no matter how strong, about the worth of his Beanie Babies is not a useful analogy here.
"OK, but even though I don't plan to sell my Beanie Baby collection right now I would like to know what they're worth. Banks aren't different;"
To the contrary, they are different. KB isn't a depository institution, which has first and foremost to be liquid enough to meet withdrawals and to be convincing that it can. Now that the Fed. govt has assured a bail out, that convincing has been achieved. In the long run, solvency maybe an issue but only if someone forces it so.
And then this: "’Second, banks say that some markets are "distressed," so they can't get proper prices for their wacky paper. Nice. The market for some deranged credit derivative is gone, never to return, so I get to make up a price. Call it "Mark-to-Myth" -- preferably, high myths.’"
Much of what the aid to AIG is all about is making good on its liabilities to holders of derivatives, which in KB's example is the banks, since it an asset they are valuing, not a liability. Maybe they will have value when they mature, which does not mean 'held forever'. KB certainly is pulling the plug before he knows anything about what will be paid off at maturity.
Thankfully, I do not need to comment on his summary. Or explore further his commentary to support my conclusion.
So, to conclude: Please have someone who knows what he is talking about when you want a cute financial story about what you perceive as an absurdity. There are so many absurdities these days, especially in govt policies and proposals, you actually do need a real expert.
Finally, accounting is a great invention of a 14 or 15th century monk (or monks), as I recall; but, nonetheless, it does have its severe limitations, inevitably.
Sincerely, FBR
