Many are wondering if Geithner’s plan is left null and void following FASB’s decision to change the mark to market regulation. The simple answer is that Geithner’s plan to purchase these mortgage securities away from bank balance sheets will still be a major part of the toxic asset solution. The primary problem with these assets has been that you can’t trade them during periods of inactivity, it’s like trying to sell a fur coat in August. The public-private investment program, or PPIP, will ensure that there is a market for these assets. Maintaining a market is vital to the pricing mechanism. Even if banks don’t want to sell these securities it is important to know what price they could be sold at for purposes of investor transparency.
Many investment commentators are misreading the impact of the mark to market change. They think it will cause less transparency. This assumption is false. The only thing the change does is provide banks sufficient time before they have to raise capital to meet regulatory requirements. When this capital raising process is rushed, it is difficult to find capital. If no capital is found, the bank is urgently forced into nationalization of failure. Relieving this short term stress is what this mark to market rule change did. That is why Citigroup (C) and Bank of America (BAC) came out with statements saying that this change would not affect their financial statements. They will continue with the same methods of transparency but they won’t be forced into a capital crunch like they were with the old version of the rule.
The real change won’t come from accounting changes but will come as a result of Geithner’s PPIP. This program will create trillions of dollars worth of demand for these toxic securities in an environment that could have very little supply. Most assume that the prices for these toxic assets will rise from .22 on the dollar up to as high as .60 on the dollar. I think these estimates are too conservative. With Geithner’s plan these assets will return to much higher levels...even approaching a full 100 cents on the dollar as housing stabilizes and investors return to the space.
According to an article in Bloomberg, big asset managers such as Pimco, Apollo, and Colony Capital have all expressed interest in participating in the PPIP plan. Pimco co-CEO Bill Gross said, “This is the first win/win/win policy to be put on the table”. There are many signs that the plan is already working as commercial mortgage bonds have risen 5% since the announcement of PPIP, fixed rate ALT-A loan securities ranked between prime and subprime have shot up 12% to 54 cents.
It’s now time for investors to capitalize on the crisis as outlined in Alan Greenspan’s book, The Age Of Turbulence, when he says,
Crisis, at least for a while, destabilizes the relationships that characterize normal, functioning markets. It creates opportunities to reap abnormally high profits in the buying or selling of some goods, services, or assets. The scramble by market participants to seize those opportunities presses prices back to market appropriate levels...
With the financial crisis coming to an end it is finally prudent to look at bank market caps and anticipate a return to more historical norms. Bank of America has a market cap of only $45 billion even though they have $2.4 trillion in assets, a 10.6% tier 1 capital ratio, and a future earnings potential of $30 billion per year with their acquisitions of Countrywide and Merrill Lynch. E-Trade (ETFC) has a market cap of $755 million even though they have averaged over $500 million of annual operating earnings over the past five years. They also have a $25 billion loan portfolio that looks a lot more attractive with PPIP and a more liberal mark to market regulation in place. These are just two examples of banks with market cap disruptions that warrant a run back towards historical norms.
Disclosure: Author holds long positions in ETFC, BAC