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Decoder: Marking losses in write-downs

Marketplace Staff Feb 26, 2009

Decoder: Marking losses in write-downs

Marketplace Staff Feb 26, 2009


Steve Chiotakis: There’s a vote in the U.S. House on a measure aimed at helping
homeowners facing foreclosure. The plan allows struggling mortgage holders to go before a bankruptcy judge to reduce principal and interest on those loans.

The mortgage industry, of course, doesn’t like the bill because it’ll cost them more money. It’s because of all those bad loans that we’re in this situation to begin with — American banks such as Citigroup seem to be burning through cash by the day. And just this morning, the Royal Bank of Scotland reported it lost $34 billion last year. That’s the largest loss in British corporate history.

There’s a central player in all this drama on bank balance sheets. In accounting, it’s called a write-down. And it’s the focus of our latest Marketplace Decoder. Bill Radke explains how it works.

Bill Radke: Rather than starting with a bank, let’s go visit the Johnsons. Mrs. Johnson’s been looking at the household financials.

Mrs. Johnson: Honey, You know you wanted to build a deck out back. I think we should hold off.

Mrs. Johnson: Why? I thought you said we were in good shape.

Mrs. Johnson: We were . . . on paper. But now we have to write it all down.

Mr. Johnson: You need a pencil?

Mrs. Johnson: No, I mean write it down like accountants do. When a company’s assets aren’t worth what they used to be, the accountant — you know, me — writes down their value.

Mr. Johnson: Honey, we’re not a company.

Mrs. Johnson: No, but we have assets. Our investments have lost more than 30 percent in this market. We have to write them down.

The Johnsons are clearly having a tough time right now, but imagine how things look for America’s banks.

Dennis Beresford is an accounting professor at the University of Georgia. He says banks and other companies are dealing with write-downs almost every day.

Dennis Beresford: It’s simply a loss that a company has had to take as result of some transaction that they’ve made in the past.

The accountants record the new, lower asset value on the company’s balance sheet. Like the Johnsons, they literally write it down. Now, we’re not too worried about the state of the Johnsons’ portfolio. But we are worried about the banks. They are writing down everything from shares to houses to companies they’ve acquired.

Beresford: If a bank writes down the value of its securities or its loans, then they’re going to have less capital. That reduces the equity that they have and their ability to make loans in the future.

Fewer loans means less growth, and that’s bad news for everyone.

But here is some worse news: Banks only have to write down assets if they’re willing to trade them. As for the assets a bank wants to hold on to, well, the bank can price those assets at what it hopes they’ll be worth. Which means we won’t know a bank’s true value until it feels like coming clean.

I’m Bill Radke For Marketplace.

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