Bank investors are really desperate determined.
From Monument Securities’ Stephen Lewis.
A story that ‘mark-to-market’ rules for valuing banks’ assets might be abandoned was the basis for a 250-point rally in the Dow Jones industrials index. The US Treasury and the SEC subsequently denied having discussed the suspension of these rules but investors were not daunted. They have faith in Mr Geithner to find a way to banish the spectre of bad debts and writedowns, so freeing the banks to lend again as they did in the past.
As noted above, the SEC and Treasury have already said they have no intention of suspending mark-to-market rules, which aims to value assets at their current market value. But, as Lewis reminds us, the idea of a suspension of those rules is not that far-fetched.
In fact, the very notion of a US bad bank, the prospect of which is still being debated though it looks increasingly unlikely, involves a de facto suspension of the rule — if you want to avoid further writedowns for the banks. As Lewis puts it:
The reason why these experienced legislators are tying themselves up in knots over ‘marking-to-market’ is that accounting rules have a critical bearing on the pros and cons of setting up a ‘bad bank’. A key issue in creating a ‘bad bank’ is the pricing of the impaired assets it will purchase. Such pricing decisions establish real prices for those assets, perhaps for the first time. The prices so determined may be above or below those at which other banks may be carrying similar assets on their books. If the prices are lower than previous market-wide valuations, all banks holding such assets will then be obliged, under the ‘mark-to-market’ rules, to take further writedowns. The ‘bad bank’ may, in that case, do more harm than good with respect to restoring the banking system’s lending capacity.
Of course — paying over-market value for toxic assets at the expense of the US taxpayer would avoid this problem — but it’s not exactly politically popular.
And as Lewis points out, it probably wouldn’t even solve the problem anyway.
There would be serious difficulties in moving away from ‘fair value’ accounting principles at this late stage. Changing the accounting system does not change the underlying economic reality. All the same, there could be a potential gain from making the change, if it would boost confidence in the banking system. However, no-one, not even the banks themselves, would now believe that bank counterparties were safer, simply on the grounds that the figures they presented and the capital ratios they published were stronger than they had appeared on a previous method of accounting.
It’s a definite Catch-22. Accounting tricks only work so long as you – and everyone else – pretend they’re not accounting tricks.
Related links:
Bad bank, bad pricing – FT Alphaville
Bailout talks turn to more equity stakes – WSJ