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    Daily Digest – March 14

    by Davos

    Saturday, March 14, 2009, 4:01 PM

  • Talkback: I’m Nominating Chris, I hope you do too
  • Cramer Jon Stewart Face-off
  • Obama: Economic crisis ‘not as bad as we think’
  • Treasuries Drop as Stocks Gain, China Asks for Debt Assurance
  • Wen Voices Concern Over China’s U.S. Treasurys (H/T Turbo)
  • China "worried" about US Treasury holdings
  • Berkshire Loses Top Rating on Investments, Buffett Role
  • Companies at the Greatest Risk for Default
  • Illinois Income Tax May Jump 50 Percent (H/T Turbo)
  • Perry rejects $555 million in federal stimulus money
  • Geithner Seen As A Mistake, Steve Rattner The Fallback Plan
  • Larry Summers – The Root Cause of the Problems!
  • Giving The Fingerprint: Home Law Raises Concern
  • Charting Household Net Worth
  • Philly Fed State Coincident Indexes: Widespread Recession
  • B. of A. chief sees $50 billion in ’09 cash flow
  • B&B: Australia’s 2nd largest investment bank is bankrupt
  • Will Banks Start to Walk Their Talk? Don’t Hold Your Breath (Mark to Market Edition)
  • When Giants Fall 
  • Icelandic News in English (H/T Umapergrina)


Talkback: I’m Nominating Chris I hope you do too 

Do you know any heroes of the economy? Someone like Leonard Abess, the Miami banker who shared his $60 million bonus with his employees? Or maybe someone acting on a smaller scale to help those suffering during this recession. Maybe you? If so, post your recommendation in the comments section below or email [email protected] Your nominee could be profiled in an upcoming article. 

We are not looking for the big names that everyone already knows about. We want to hear about everyday people making a difference in their communities. 

Cramer Jon Stewart Face-off

Obama: Economic crisis ‘not as bad as we think’ 

WASHINGTON (AP) – Confronting misgivings, even in his own party, President Barack Obama mounted a stout defense of his blueprint to overhaul the economy Thursday, declaring the national crisis is "not as bad as we think" and his plans will speed recovery.
Challenged to provide encouragement as the nation’s "confidence builder in chief," Obama said Americans shouldn’t be whipsawed by bursts of either bad or good news and he was "highly optimistic" about the long term. 

The president’s proposals for major health care, energy and education changes in the midst of economic hard times faced skepticism from both Democrats and Republicans on Capitol Hill, as senators questioned his budget outlook and the deficits it envisions in the middle of the next decade.

But Obama, speaking to top executives of the Business Roundtable, expressed an optimistic vision and called for patience.

Richard Parsons, chairman of beleaguered Citigroup Inc., asked if Obama could offer some help in a national battle "between confidence and fear."

"A smidgen of good news and suddenly everything is doing great. A little bit of bad news and ooohh , we’re down on the dumps," Obama said. "And I am obviously an object of this constantly varying assessment. I am the object in chief of this varying assessment."

"I don’t think things are ever as good as they say, or ever as bad as they say," Obama added. "Things two years ago were not as good as we thought because there were a lot of underlying weaknesses in the economy. They’re not as bad as we think they are now."

"And my long-term projections are highly optimistic, if we take care of some of these long-term structural problems."

But in Congress, Obama’s budget plans were meeting resistance.

Sen. Kent Conrad, the chairman of the Budget Committee called the track of future deficits "unsustainable" and singled out Obama’s proposal for adding $634 billion in health care spending over the next 10 years.

"Some of us have a real pause about the notion of putting substantially more money into the health care system when we’ve already got a bloated system," said Conrad, D-N.D.

Treasury Secretary Timothy Geithner, testifying before Conrad’s committee, also encountered blunt questions about the administration’s plans for shoring up the nation’s banks. He reiterated the administration’s goal to lay out a private-public partnership to make up to $1 trillion in financing available to help banks clear their books of toxic, mortgage-related assets that have led to a national credit freeze.

Geithner hinted more money might be required beyond the existing $700 billion financial rescue fund. "We certainly can start with the resources we have," he said.

Meanwhile, House Speaker Nancy Pelosi, D-Calif., played down talk that Democrats would consider a second economic stimulus bill.

"I know that people have made suggestions that we should be ready to do something, but I really would like to see this stimulus package play out," Pelosi said. "It’s just not something that, right now, is in the cards," she added later.

The flurry of comments illustrated the complicated moving parts confronting Washington as the economy continues to decline, credit remains clogged and a new president advances broad and expensive initiatives. The money set aside to address those needs so far has been staggering-$787 billion for an economic stimulus designed to save and create jobs, the $700 billion approved by Congress for the financial rescue package and hundreds of billions more through programs from the Federal Reserve Bank.

Treasuries Drop as Stocks Gain, China Asks for Debt Assurance

March 13 (Bloomberg) — Treasuries fell for the first time in three days as China’s Premier Wen Jiabao said he’s concerned about the safety of U.S. government debt and stock gains sapped demand for the relative safety of government debt.

Ten-year notes headed for a weekly decline as Japan and China signaled new measures to boost their economies and the Standard & Poor’s 500 Index was poised for its biggest weekly increase since November.

"As people look at equities and corporate bonds, they are saying that they maybe don’t need to have that kind of money in Treasuries," said Andrew Brenner, co-head of structured products in New York at MF Global Ltd. "The comments from the Chinese premier let people know that the largest holder of Treasuries is concerned about adding to it. That gets people a little nervous."

The yield on the benchmark 10-year note rose five basis points, or 0.05 percentage point, to 2.91 percent at 10:32 a.m. in New York, up from 2.86 percent March 6, according to BGCantor Market Data. The 2.75 percent security due February 2019 fell 13/32, or $4.06 per $1,000 face amount, to 98 21/32.

Rates on three-month bills were unchanged at 0.19 percent after falling three basis points yesterday. The rate turned negative in December as investors sought the safest assets on concern the recession is deepening.

‘Where Else?’

China, the U.S. government’s largest creditor, is asking "the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets," Wen said today in Beijing at a press briefing after the annual meeting of the legislature. China held $696 billion of U.S. government securities at the end of last year, 46 percent more than 12 months earlier.

"China should be concerned, in that they hold roughly a third of their almost $2 trillion in FX reserves in U.S. Treasuries," said Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc. one of 16 primary dealers that trade with the Federal Reserve, in an interview with Bloomberg Television. "As a Chinese official put it a couple weeks ago, and I’ll paraphrase, he said, where else will we go?"

Japan’s finance Minister Kaoru Yosano said the government will inject 121 billion yen ($1.2 billion) into three regional banks. The world’s second-largest economy shrank an annualized 12.1 percent in the three months ended Dec. 31, the sharpest contraction since 1974, the Cabinet Office said yesterday.

Record Sales

The Standard & Poor’s 500 Index rose 0.9 percent after Bank of America Corp. yesterday said it was profitable in January and February, joining JPMorgan Chase & Co. and Citigroup Inc. in suggesting the nation’s biggest banks are recovering from a dismal 20008.

Treasuries handed investors a loss of 2.9 percent in 2009, according to Merrill Lynch & Co.’s U.S. Treasury Master Index. U.S. debt dropped this year as President Barack Obama’s administration sold record amounts of debt to fund a $787 billion economic stimulus package and service a budget deficit that may reach an all-time high of $1.75 trillion.

The Treasury sold $63 billion of notes and bonds this week. Goldman Sachs Group Inc. estimates the nation will almost triple debt sales this year to a record $2.5 trillion.

U.S. Treasury Secretary Timothy Geithner, Bank of England Governor Mervyn King and their Group of 20 counterparts will discuss remedies for a worsening economic outlook at a meeting of finance ministers near London starting today.

Yield Curve

The difference between yields on two- and 10-year notes narrowed to 1.91 percentage points from 1.92 percentage points at the end of last week and 1.44 percentage points Dec. 31. The spread may widen as longer-term bond issuance increases while target interest rates remain low, according to Peter Jolly, head of market research at National Australia Bank Ltd.’s investment- banking unit in Sydney.

"The government has to issue a lot of bonds for the Obama fiscal-stimulus plan," Jolly said. "At some point we’ll see greater market indigestion, which means they’ll have to offer higher long-term yields to investors to entice them. At the same time the Fed will hold a low federal funds rate so shorter yields will stay low. We’ll see a sizeable re-steepening."

Ten-year yields will rise to 3 percent at the end of this month and reach 3.2 percent by year-end, Jolly said.

The Reuters/University of Michigan preliminary index of consumer sentiment rose to 56.6 from 56.3 in February, holding near a 28-year low amid mounting job losses and a deepening recession.

The U.S. trade deficit narrowed in January by 9.7 percent to to $36 billion, the Commerce Department said today in Washington, as Americans cut purchases of everything from OPEC oil to Japanese automobiles.

Libor-OIS Spread

Money-market rates show short-term borrowing costs are still increasing as banks hoard cash after almost $1.2 trillion of writedowns and losses since the start of 2007.

The difference between what banks and the Treasury pay to borrow for three months, the so-called TED spread, rose to 114 basis points, near the widest level since Jan. 9. The spread averaged 27 basis points from 2002 through 2006.

The London interbank offered rate, or Libor, that banks say they charge each other for three-month loans in dollars is 1.32, near the highest since Jan. 8, and up from this year’s low of 1.08 percent on Jan. 14. The Libor-OIS spread, a measure of bank reluctance to lend, is near its widest since Jan. 9.

Wen Voices Concern Over China’s U.S. Treasurys (H/T Turbo) 

"We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets. Frankly speaking, I do have some worries," Mr. Wen said in response to a question. He did not offer specific suggestions on economic policy to the U.S. government, but called on it to "maintain its credibility, honor its commitments and guarantee the security of Chinese assets." 

China "worried" about US Treasury holdings 

BEIJING (AP) – China’s premier expressed concern Friday about its massive holdings of Treasuries and other U.S. debt, appealing to Washington to safeguard their value, and said Beijing is ready to expand its stimulus if the economy worsens.
Premier Wen Jiabao noted that Beijing is the biggest foreign creditor to the United States and called on Washington to see that its response to the global slowdown does not damage the value of Chinese holdings.

"We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried," Wen said at a news conference following the closing of China’s annual legislative session. "I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets."

Wen’s comments foreshadowed possible appeals to President Barack Obama, who will meet with Chinese President Hu Jintao at a London summit of leaders of the G-20 group of major economies on April 2 to discuss the global financial crisis.

Analysts estimate that nearly half of China’s $2 trillion in currency reserves are in U.S. Treasuries and notes issued by other government-affiliated agencies. Washington is counting on China to continue buying Treasuries to fund its $787 billion stimulus package. Last month, visiting Secretary of State Hillary Rodham Clinton sought to reassure Beijing that government debt would remain a reliable investment. "They are worried about forever-rising deficits, which may devalue Treasuries by pushing interest rates higher," said JP Morgan economist Frank Gong. "Inside China there has been a lot of debate about whether they should continue to buy Treasuries." The comments come as finance ministers and central bankers of the G-20 gather in London this weekend to discuss the crisis and possible remedies.

U.S. Treasury Secretary Timothy Geithner is pressing for a new coordinated stimulus but European governments are reluctant to take on more debt before they see how current plans are working. The Europeans want to emphasize the need for greater regulation of markets, including a crackdown on tax havens and increased control over hedge funds.

In Beijing, Wen expressed confidence China can emerge from its slump "at an early date," and said the government is ready to expand its 4 trillion yuan ($586 billion) stimulus to boost growth in the world’s third-largest economy. Communist leaders worry about rising job losses and possible unrest amid a trade slump that saw Chinese exports fall 25.7 percent in February from a year earlier. They have promised to spend heavily to create jobs and boost exports.

"We already have our plans ready to tackle even more difficult times, and to do that we have reserved adequate ammunition," Wen said. "That means that at any time we can introduce new stimulus policies."

In nearby Japan, Prime Minister Taro Aso called Friday for a fresh stimulus to help lift the world’s second-largest economy out of "an unprecedented economic crisis." The comments helped spark a rally in Japan’s stock market, where the Nikkei 225 stock index surged 5.2 percent.

China’s Wen and other officials point to rising bank lending, power demand and other signs the stimulus is taking effect. But growth in retail sales is weakening, suggesting it has yet to spur private sector spending and investment, which analysts say will be key to its success.

Wen said Beijing can meet its 2009 growth target of 8 percent, despite skepticism by private sector economists, who expect as little as 5 percent. That would be the strongest of any major country but could lead to more waves of job cuts.

"I really believe we will be able to walk out of the shadow of the financial crisis at an early date," he said. "After this trial, I believe the Chinese economy will show greater vitality."
The premier promised to focus on job creation and give more help to smaller companies, which he said generate 90 percent of Chinese new employment.

"We will pay all attention possible to this issue and we will never overlook this issue," he said.
Wen said Beijing wants the London summit to focus on the plight of poor countries. "We must see to it that we show concern for developing countries, and help developing countries – the least-developed ones in particular – become an important topic on the agenda," he said. 

Berkshire Loses Top Rating on Investments, Buffett Role 

Warren Buffett’s Berkshire Hathaway was stripped of its ‘AAA’ credit rating by Fitch, barely hours after S&P cut General Electric’s top-tier rating, as the global financial crisis pummels America’s corporate titans. 

Companies at the Greatest Risk for Default

Illinois Income Tax May Jump 50 Percent (H/T Turbo) 

Income taxes in Illinois could soon be going up by as much as 50 percent to combat deficits in a difficult state budget. 

As CBS 2’s Joanie Lum reports, Gov. Pat Quinn is reportedly considering raising taxes to deal with a growing budget deficit.

Quinn has been hinting about the problems in the state budget this year for some time. He gives his first address on the subject next Wednesday, and there is word that income taxes will go up as 50 percent.

The Chicago Tribune reports that Quinn wants to raise the state income tax to 4.5 percent from 3 percent.

Illinoisans have had a lower income tax rate than other states for some time. This would be the first increase in 20 years.

In addition, some business tax breaks would be eliminated, and Quinn promises to tighten state government spending.

Quinn will balance the increase by raising the standard tax exemption up to $6,000 per person from $2,000, to help low- and middle-income families.

The income tax increase could bring in nearly $4 billion. The budget deficit is expected to be more than $9 billion by the summer of 2010.

State lawmakers are also talking about raising gasoline taxes to pay for road and bridge construction. Fees on driver’s licenses and license plate stickers may also go up. 

Perry rejects $555 million in federal stimulus money 

From the center of a Houston hardware store, Gov. Rick Perry ignited a debate about Texas job cuts, business taxes and President Barack Obama’s so-called economic stimulus program Thursday by rejecting the federal government’s offer of $555 million in aid to the unemployed.

The action now moves to the Legislature, which can bypass Perry and take the offer as long as it changes state laws and blocks Republican Perry’s potential veto. Democratic lawmakers said Thursday they will try.

Perry said the money would come with too many strings attached. Taking the half billion would require the state to assist qualified out-of-work residents seeking part-time jobs, an idea that Perry said the state has rejected before, partly because it could discourage them from seeking full-time employment.

The federal money injection would also make Texas extend benefits to more low-paid workers, and Perry said the overall expansion would force business to make higher unemployment insurance payments.

He announced his stance near the Galleria at Bering’s Hardware, where descendants of the founder said they would have to pay about $12,000 more a year into the unemployment insurance fund to cover their 170 full- and part-time workers.

"Employers who have to pay more taxes have less money to make their payroll" and would have to raise prices on their products, the governor said. "The calls to take the (stimulus) money and sort out the consequences later are quite troubling to me."

What the critics say

Opponents said Perry was spurning workers hurt by the plummeting national economy. Taking the federal money would save on taxes and prices in the long run, they said.

"Texas families are hurting and are worried about how they are going to keep their homes and pay their bills," said state Sen. Rodney Ellis, D-Houston. "Today, Gov. Perry told them: ‘good luck with that.’ If the governor won’t do his job, we’ll go around him."

Republican Jim Pitts of Waxahachie, chairman of the Texas House Appropriations Committee, seemed prepared to join forces. He voted to accept the federal unemployment aid. He was joined by four Democratic state representatives at an Austin meeting of a legislative committee studying the stimulus aid. Rep. Myra Crownover, R-Denton, voted no.

Waco-based economist Ray Perryman had just told the committee, "We’re probably better off taking the money." Without the funds, Perryman said the state’s unemployment fund is projected to run dry this year, possibly triggering higher unemployment insurance levies on employers even without the state’s acceptance of federal funds.

The latest figures

With a rising unemployment rate of 6.4 percent, well below the rate of other big states, Texas reported a record loss of 77,800 jobs in January.

In 2008, 20 percent of out-of-work Texans were eligible to collect benefits, according to the U.S. Labor Department.

Only South Dakota, at 18 percent, had a lower eligible portion.

U.S. Sen. Kay Bailey Hutchison, primed to face Perry in the 2010 Republican primary for governor, warned about consequences like the one mentioned by economist Perryman – without saying whether Perry made the wrong decision: "With the state unemployment fund dangerously close to falling below the legal threshold, it is imperative (he) does nothing that potentially burdens small businesses with higher taxes in tough economic times or pushes those who have recently become unemployed and their families into further economic peril." 

Geithner Seen As A Mistake, Steve Rattner The Fallback Plan 

A friend reports chatter within the Obama administration that Tim Geithner was a bad choice for Treasury Secretary and that Quadrangle partner Steve Rattner (currently the car czar) was brought in partly to have a good relief pitcher on hand. 

This doesn’t surprise us: We think that, in this crisis, Tim Geithner is clearly the wrong man for the job. But this is also only unconfirmed chatter at this point.

Would Steve Rattner be a better Treasury Secretary than Tim Geithner? Our immediate reaction is yes. Steve has worked on multiple sides of the fence–as a journalist, banker, and investor–and he has a lot more experience than Tim does.

Is he too close to Wall Street? Possibly. But Wall Street experience isn’t bad in this case: Knowing how the game works and what the special interests are is good. The key is to not have that as your only frame of reference–as, in our opinion, both Hank Paulson and Tim Geithner do. 

Larry Summers – The Root Cause of the Problems!

Giving The Fingerprint: Home Law Raises Concern

Real estate certainly has its risks and fraud is a growing problem, but now there’s a new law that’s supposed to protect buyers. As CBS 2’s Mike Puccinelli reports the new law will also place an unusual burden on the seller.

Fingerprinting is something we often associate with crime. So the fact that Cook County home sellers–and homeowners across the state–will soon have to provide a thumb print left some people shocked.

Charting Household Net Worth 

To put data from the chart above in perspective, the one below compares the data to GDP. I’m using annual data here, so the increase at the end of 2008 is understated. GDP for the full year 2008 was higher than 2007. But Q4 2008 GDP was lower compared to Q3. So towards the very end of the year, the denominator (GDP) is going down even as the numerator (Debt) is going up. On a percentage basis, this means Debt/GDP is presently rising at an accelerating rate. 

Philly Fed State Coincident Indexes: Widespread Recession 

Here is a map of the three month change in the Philly Fed state coincident indicators. Almost all states are showing declining activity over the last three months.

This is what a widespread recession looks like based on the Philly Fed states indexes.

On a one month basis, activity decreased in 49 states in January (Louisiana was the one exception). Here is the Philadelphia Fed state coincident index release for January.

The Federal Reserve Bank of Philadelphia has released the coincident indexes for all 50 states for January 2009. The indexes decreased in 49 states and increased in one, Louisiana, for the month (a one-month diffusion index of -96). For the past three months, the indexes have increased in one state, Wyoming; stayed flat in one state, Louisiana; and decreased in the other 48 states (a three-month diffusion index of -94).

The second graph is of the monthly Philly Fed data of the number of states with one month increasing activity. Most of the U.S. was has been in recession since December 2007 based on this indicator.

Last month (December) the number of states with increasing activity was reported as zero, but that has been revised to two. So the current month – with only one state showing increasing activity – is the record for fewest states with increasing activity. 

B. of A. chief sees $50 billion in ’09 cash flow 

SAN FRANCISCO (MarketWatch) — Bank of America Corp. expects to record more than $100 billion in revenue and $50 billion in profit, before taxes and provisions, this year and has been profitable in January and February, Chief Executive Ken Lewis said Thursday. 

"That kind of cash flow can solve a lot of problems, given time and an improving U.S. economy," he said in remarks delivered at the Boston College Chief Executives’ Club.

Bank of America shares jumped more than 14% to $5.47 in afternoon trading, marking the third straight day of gains for the stock and shares of Citigroup and J.P. Morgan. All three banks in recent days have similarly reported a profitable start to 2009.

In his address, Lewis also weighed in on the hot-button issue of bank nationalization, saying the government could "compel" Bank of America (BAC:5.76, -0.09, -1.5%) to take more capital based on the results of the Treasury Department’s upcoming stress test of banks, Lewis said.
However, Lewis stressed that he thinks Bank of America won’t need more public support.
"I’m confident we’ll pass the stress test," he said. 

B&B: Australia’s 2nd largest investment bank is bankrupt 

The goings on down under are not getting that much play in the press outside of Oz. But, Babcock & Brown, Australia’s second-largest investment bank has just gone under. 

The corporate undertakers were finally called in on Babcock & Brown yesterday after noteholders in New Zealand voted against a proposal that would have stripped back their debt’s privileges and offered little in return.

But the real shock may still be about to hit. The administrators, Deloittes’ David Lombe and Simon Cathro, have, in effect, taken over a corporate shell while the assets of the group remain out of reach in a Babcock subsidiary, Babcock & Brown International Pty Ltd.

Babcock’s only real connection to BBIPL is its 99.7 per cent shareholding, now worthless, and the $600 million from Babcock noteholders which was lent to BBIPL.

The loan is also, in effect, worthless because it is "subordinated" to the $3.2 billion debt from BBIPL’s banks, which is already swamping its deflating asset values.

Mr Lombe said yesterday that the listed Babcock company now in administration had "very few assets and a small amount of cash". He said the administrators would be looking into what rights Babcock had in terms of recoverable assets. "That will involve a substantial investigation," he said.

Babcock’s board and management released a statement to the market yesterday saying they "deeply regret the loss of subordinated note and shareholder value that has occurred and acknowledge the financial hardship this has caused".

The board said it was disappointed the restructure of the notes was not achieved and stuck by its claim that that would have produced a better result "for all investors in the company’s securities".

The outcome for noteholders should not be a surprise as they were warned of the meagre prospects should Babcock collapse.

This comes as a surprise to no one in Australia as the newspapers there have chronicled the problems at B&B for months now. The real question now is Macquarie.

As evidence mounts that Australia is not going to escape this global recession, more and more problems are popping up in Australian finance and lending, particularly in the residential property sector. Macquarie would be well-advised to raise capital sooner than later. These are developments to watch.

Will Banks Start to Walk Their Talk? Don’t Hold Your Breath (Mark to Market Edition)

The new meme from big embattled banks, starting with Citigroup’s leaked Pandit memo yesterday and Bank of America CEO Ken Lewis’ declaration that the bank will be profitable in 2009, is that things will be OK and all this talk of nationalization is unwarranted.

I’ll reserve judgement till the fat lady sings. The record of financial crises suggests the housing market has lower to go (which is consistent with the notion that prices need to revert to historical norms relative to incomes and rents) and that unemployment is far from its peak (the Reinhart/Rogoff historical comparisions suggest US unemployment will reach 12%).

The flip side is the point made by John Hempton: US banks earn fat spreads, so their earnings power is good (for those who read his detailed post, note some have raised objections to some of his assumptions). That has been enhanced by the Fed’s near zero Fed Funds rate. And as we have noted, the fat interest spreads that are good for banks are not so good for borrowers. Yes, some have raised concerns about the requirement that banks participate in various "get the housing market going" programs may work to their detriment, but frankly, we are skeptical that these programs will come close to reaching the number of homeowners Team Obama bandied about.

So the 2009 picture boils down to how much the big banks have in the way of writeoffs, AND let us not forget, how well they do in their trading operations. Ken Lewis seems to still be depicting BofA as a conventional bank, and ignoring that Merrill could deliver losses and further writedowns.

Ah, but relief is coming on that front too. I must confess that I did not watch the Senate hearings, but mark to market looks to be dead. From Bloomberg "Lawmakers Tell FASB to Change Fair-Value ‘Quickly’ ":
U.S. Representative Paul Kanjorski said regulators must act "quickly" to give companies more leeway in applying the fair-value accounting rule that banks blame for exacerbating the financial crisis.

"If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself," Kanjorski, the Pennsylvania Democrat who leads a House Financial Services capital markets subcommittee, said at a hearing today. Fair-value, which requires companies to mark assets to reflect market prices, has "produced numerous unintended consequences," he said….

Kanjorski said he isn’t advocating suspending the rule, because such a move would bring back "the very kind of subjectivity and sleight of hand that made mark-to-market necessary in the first place."

Eliminating fair-value "would diminish the quality and transparency of reporting, and could adversely affect investors’ confidence in the markets," Herz said. The rule "can help to more promptly reveal underlying problems at financial institutions."

Guidance being prepared by Norwalk, Connecticut-based FASB will encourage companies and auditors to use their own judgments in valuing assets, Herz said.

You cannot have it both ways. The Senate is trying to pretend it is going to keep fair value accounting in a somehow friendlier form, but friendlier to the industry means the financial statements are no longer reliable. They cannot be trusted. Anyone who thinks so needs to recall the example I keep harping on, Lehman. Even with mark to market accounting, Lehman delivered $100 billion in losses to unsecured creditors on a $600 billion and change balance sheet. That level of misvaluation should be impossible (absent exempted categories like Level 3 assets, which are openly phony baloney). If this wasn’t accounting fraud (and I am inclined to believe it was) then the existing rules were so loose you could steer a supertanker through them. Lehman says there is ALREADY too much play in the existing rules, not too little.

You cannot be half pregnant here. Either you have objective standards or you don’t. The notion that subjective valuations will be permitted and they won’t be abused is utter fantasy.

The reason fair value was implemented, was, to paraphrase Churchill, it is the worst way to value financial assets except all the others that have been tried. Historical cost is misleading in an environment where interest rates can move significantly over the life of the asset. Banks also tended to avoid writing down or reserving against assets until they were clearly impaired. Hold to maturity (which is what is used for loans, and presumably some variant will be the new fair value compromise) has considerable subjectivity.

One bad feature of mark to market is that it it pro-cyclical. That is, as market values in general go up, the value of assets on financial firm balance sheets go up. Say assets formerly valued at 100 are now worth 120. Oh, and guess what? That gain in value increases your equity by 20. If you are a Wall Street firm, you’ll pay some to yourself, but you’ll lever up the portion you retain. So firms take on more risk even thought their holdings have not changed, merely their valuation. No one had any problems with mark to market when it was making everyone look good. The process operates in reverse on the way down (except those employees still keep paying themselves, funny how that works).
Of course, there is another solution, which is to have procyclical capital requirements (higher when prevailing asset prices rise, lower when they fall) and some have been worked out in considerable detail. But that is far too sensible and offers no quick relief to banks desperate to slather lipstick on the pig of their balance sheets.

Some have contended that the death of mark to market is no biggie, such as David Reilly of Bloomberg, who argues that, based on his analysis, it applies only 29% of assets the 12 biggest banks in the KBW Bank index.

First, if you look at the index, it excludes Goldman and Morgan Stanley. Second, Merrill was purchased by BofA AFTER its latest report date, so its inclusion might boost the total a tad. Looking at mark to market and reaching conclusions based on figures that exclude many of the systemically important global trading firms is silly.

Second, 29% is still vastly in excess of their equity. If the elimination of mark to market allows banks to make their valuations of these assets more flattering by, say, 10%, that would exaggerate their assets by roughly 3%, which goes straight to their net worth. For instance, on a quick and dirty pass, Citi’s balance sheet (conveniently excluding its roughly $1 trillion in SIVs) is $1.9 trillion and shareholders’ equity is $142 billion, or 7.3%. An additional 3% would be an over 41% increase.

So yes, the banks may look just ducky soon. They are going to continue to get plenty of subsidies from the authorities, via super low interest rates. the fancy new facilities that will boost their profits, such as the new $1 trillion asset backed facility (I think TABSF, but I can no longer keep them all straight, which is no doubt part of the point).

In the meantime, the taxpayer will continue to subsidize banks, the banks will get to keep the upside, and (as in credit cards) charge fat spreads. Ain’t capitalism wonderful?

If the banks were really doing as well as their PR suggests, they would not need to use the to be launched public private garbage barge operation. Do you think there is a snowball’s chance in hell of that happening?

We are going straight down the Japan path: propping up banks rather than forcing them to recognize losses, and providing the same sort of accommodative accounting to boot. All it did for them was kick the can down the road a few years, at considerable cost to its society. But that’s what you get when the executive and regulators are unwilling to challenge the primacy of the banking class.

Update 3/13. 12:30 AM: You gotta love Floyd Norris:

If mark-to-market accounting is to blame for the current financial crisis, then the National Weather Service is to blame for Hurricane Katrina; if it hadn’t told us the hurricane hit New Orleans, the city would never have flooded….

Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets – and that is, at best, debatable – changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?…

Although you would not know it from the angry complaints, the accounting board’s Statement 157 did not require mark-to-market accounting. That was already required under earlier rules. What it did do was clarify how such values should be determined. That stopped banks from defining "market value" as meaning whatever they chose it to mean.

Conrad Hewitt, who was chief accountant at the Securities and Exchange Commission when it conducted a Congressionally mandated review of the issue late last year, said at a recent Pace University accounting forum that he asked all the complainers if they had a better way to determine market value than the one prescribed by Statement 157. None did. 

When Giants Fall 

Icelandic News in English (H/T Umapergrina)

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