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Is the recession over? Has the economic recovery begun? Will there be a double-dip recession? The picture is fuzzy and one reason the picture is fuzzy is because so many banks and other financial institutions, investors, and regulators either don’t seem to have a good grasp of the value of many of the assets on the balance sheets of these banks and other financial institutions or because they are unwilling to confess what the asset values are.
Look at some of the recent articles that have been in the news this week.
- “Insurers’ Biggest Writedowns May be yet to Come” by Jonathan Weil
- “Disclose the Fair Value of Complex Securities” by Robert Kaplan, Robert Merton and Scott Richard
- “Citigroup’s Asset Guarantees to be Audited by TARP” by Bradley Keoun and Mark Pittman
- “We Need Daily Data to Get Credit Markets Working Again” by Richard Field
All of these articles have to do with financial institutions knowing and reporting, as well as possible and as often as possible, the current value of their assets. The managements of financial institutions claim that this will inhibit their actions and force them into decisions that are not in the best interest of their institutions or the financial markets. These managements are wrong.
We are hung up right now because we don’t know the value of those assets either because the banks don’t know what the value of those assets are or the banks are not revealing what the value of those assets are.
I believe that we would face less uncertainty now and may have even avoided a good deal of the financial collapse of the last two years if these financial institutions would have been required to regularly report the fair value of their assets and responded more rapidly to changing market conditions.
Even better, it would have been a sign of outstanding management and real leadership if the banks themselves had been more open and transparent with the financial community, rather than require regulation to force them to release this information.
Alas, this didn’t happen.
This whole dilemma, to me, comes under the “No Free Lunch” argument.
Bankers mismatch the maturities of their assets and liabilities and take advantage of the positive slope to the yield curve. But in doing so they take on more interest rate risk. Financial markets move against them and the price of the longer term assets decline. Whoops. The benefit the bank got by taking on the extra interest rate risk has backfired. Well, nothing comes for free.
Bankers add riskier loans to their loan portfolio or buy riskier securities to increase their yield. But, in so doing they take on more credit risk. The economy slows down and now these loans or securities face a larger default rate than the bankers had anticipated. Whoops. The benefit the bank got by taking on the extra credit risk has backfired. Well, nothing comes for free.
Financial institutions leverage up their balance sheets in order to squeeze out additional return on their equity position. But, in so doing they take on more financial risk. As assets prices go down the increased leverage backfires and their solvency comes into question. Whoops.
Bankers can’t get something for nothing. And, they can’t hide behind accounting rules in an effort to wait things out until times get better. As Kaplan, Merton, and Richard argue, banks typically fail to act when markets move against the risky positions they have taken and chalk the situation up to “unusual market conditions” or to “just a bump in the road”. And, if economic declines are relatively short and relatively shallow maybe they can get away with waiting the problem assets out. But, in deeper and longer periods of economic and financial dislocation they get trapped in their own failure to act. The asset values do not return to previous levels and the longer they wait to act on the existing problems the worse the situation on their balance sheet becomes.
Richard Field argues, in the article cited above, that banking and credit markets are having problems, not because the loans and securities on the books of the financial institutions are complex, but because they are opaque. This lack of clarity has helped to get us into the current crises and will continue to plague the recovery if it is not corrected. This lack of clarity allows bankers to continue to postpone action, it prevents investors from knowing the value of their investments, and it hinders regulators in their efforts to understand the true condition of the financial institutions they are regulating.
As I have mentioned in previous posts, I have been involved in several successful bank turnarounds. One of the first things you have to do in turning around a bank is determine the value of your assets and you have to be brutally honest about what the values are. And, in going through this process, in every turnaround I was involved in, it becomes clear that the previous management failed to accept the fact that the value of their assets had declined, they continued to hope that the “unusual market conditions” would pass, and, consequently, by failing to act, the condition of the assets got worse and worse.
Good managements are not afraid of the truth and they are not afraid of releasing that information to the public.
Unfortunately, it is likely that the opaqueness with regard to the value of bank assets will continue.
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Aren't we going backwards with the recent elimination of "mark to market?"
Yeah, but that's just a little too idealistic. Reality is that signs of weakness hurt you, particularly in banking. Reality is also that these people are behaving like other human beings have behaved before them. The only management team that's really happy to be open with bad news, is the one that's just come in and replaced the old one.
Bonuses are paid out because of this accounting magic.
Bonuses are paid out because of this accounting magic.
On Aug 21 06:56 AM Takayama wrote:
> Elimination of mark to market accounting is the dirtiest trick I
> could imagine, and it is a disgrace the US condones such an act of
> evil. HFT is another. The US is the axis of evil, and the North Korea
> of the financial world.
> Bonuses are paid out because of this accounting magic.
if u do not understand that.....look it up....
good article, thanks.
> jack
While I'm not one generally for conspiracy theories, the fact of the matter is the results of all the industry, regulator, Congressional, and Administration (Bush & Obama) initiatives has been to make it more difficult to understand the health of the American financial industry. Until we acknowledge their problems, we will not be able to cure them.
"No escape for Fed
By Hossein Askari and Noureddine Krichene
In contrast to Federal Reserve chairman Ben Bernanke's testimony last week, we cannot see a safe "exit strategy" for the Fed from its current loose monetary policy. Bernanke's ambivalent testimony of a safe exit strategy can only heighten uncertainty and exacerbate instabilities. Let's explain.
In his recent testimony on July 21 before the Committee on Financial Services of the House of Representatives, Bernanke was felicitous that aggressive money policy had averted the collapse of the financial system. However, he omitted to say that the same policy had failed to avert a collapse of real gross domestic product (GDP) and private investment and rising unemployment.
The economic recession continues despite interest rates being near-zero, money supply rising at 22% a year, unprecedented stimuli packages, and record fiscal deficits reaching 13% of GDP in 2009. Bernanke and President Barack Obama's team had clearly believed that a combination of aggressive money and fiscal policies would secure the return to full-employment and quickly. After all, Larry Summers had predicted the unemployment cresting at about 8%. These expectations were standard Keynesian predictions that have proven to be substantially off the mark.
As clearly implied by Bernanke himself, this policy has so far been self-defeating: "Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system, an event that would have had extremely adverse and protracted consequences for the world economy. Even so, the financial shocks that hit the global economy in September and October were the worst since the 1930s, and they helped push the global economy into the deepest recession since World War II.
"The US economy contracted sharply in the fourth quarter of last year and the first quarter of this year. More recently, the pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization. The labor market, however, has continued to weaken."
This counter-performance testimony should be contrasted with Bernanke's first testimony as Fed chairman in February 2006: "The US economy performed impressively in 2005. Real gross domestic product increased a bit more than 3%, building on the sustained expansion that gained traction in the middle of 2003. Payroll employment rose 2 million in 2005, and the unemployment rate fell below 5%. Productivity continued to advance briskly."
In his 2006 testimony, Bernanke was claiming credit for high growth induced by the cheap monetary policy he forcefully advocated as Fed governor. However, he never foresaw the financial shocks of 2008 (which he considered to be the worst since the 1930s) his policy would bring about, despite the flash of red indicators such as the housing bubble, oil and food price inflation, widening external deficits, depreciating currency, and rapidly growing subprime credit in the market.
What good is a central bank if it cannot see the approaching storm until after it has devastated the landscape?
In the footstep of his predecessor, Bernanke was not moved by the housing bubble or oil and food inflation until inflation had crippled the world economy. Long-run stability was not relevant for policymakers interested in short-term economic booms. Unsafe money policy and near zero interest can only foster speculation in commodities and assets, exchange rate instability, and increase distortions in the economy. Indeed, the past decade of cheap monetary policy could be appropriately labeled as the speculative decade.
Aggressive policies might have saved bankrupt banks through massive liquidity injections and bailouts and even turned them into profit-making institutions, but these same policies have only shifted the losses to the government and taxpayers, increased the potential of an inflation tax, and could bankrupt the government itself. They have also caused economic losses in form of millions of joblessness and falling economic growth.
In his recent testimony, Bernanke sent conflicting messages describing an "exit strategy" from the unprecedented monetary expansion while reassuring the political establishment that such exit is not immediately in the offing and near-zero interest rates and abundant liquidity would be maintained for some time to come: "The Federal Open Market Committee anticipates that economic conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period."
Bernanke's message appears to be a campaign for no-exit and for re-appointment as a chair of the Fed, aimed at winning the confidence of two key groups: (i) politicians, that the Fed would firmly maintain its present policy stance; and (ii) foreign investors, particularly China, which holds more than $2 trillion in US debt, and other countries holding such debt, that the Fed has the technical means to rein bank reserves and prevent a dollar collapse and inflation when it is opportune to do so.
Bernanke noted that many instruments are available to a central bank for draining reserves; however "the most important such tool is the authority that the Congress granted the Federal Reserve last fall to pay interest on balances held at the Fed by depository institutions. Raising the rate of interest paid on reserve balances will give us substantial leverage over the federal funds rate and other short-term market interest rates, because banks generally will not supply funds to the market at an interest rate significantly lower than they can earn risk free by holding balances at the Federal Reserve.”
Past experience showed that any slightest attempt to drain reserves could easily send interest rates to two-digit levels. Would the Fed pay high interest rates on reserves, say at 19%, which was the federal funds rate in 1981 when the Fed slightly drained banks reserves, compared with 0.25% it is paying now? If it would, that would entail huge subsidies to banks, at the expense of the US Treasury, with serious implications for financing the US budget deficits.
In 2008, realizing the impotence of aggressive monetary policy to stem an economic recession because of the reluctance of banks to lend to subprime borrowers, a wave of foreclosures, and households' over-indebtedness, Bernanke urged the government to run record fiscal deficits as a direct way to hike up aggregate demand and avert economic recession.
Now, he has realized that the Fed has totally lost its independence and has to accommodate large fiscal deficits through maintaining near-zero interest rates as well as through monetization. In particular, monetary policy can no longer be restrained as long as the fiscal deficit remains very large.
The higher interest cost of the growing fiscal deficits ($1.8 trillion this year and only declining to $1.2 trillion by 2019) for the US Treasury could be potentially devastating.
Suddenly, Bernanke has begun to call for fiscal adjustment as a way to regain control of money policy and prevent excessive monetization of fiscal deficits or a sharp rise of interest rates: "Our economy and financial markets have faced extraordinary near-term challenges, and strong and timely actions to respond to those challenges have been necessary and appropriate. ... The Congress also has taken substantial actions, including the passage of a fiscal stimulus package.
"Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policymakers begin planning now for the restoration of fiscal balance. ... Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult.
"Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth."
The last sentence of the quote could have been re-worded as: "Unless we demonstrate a strong commitment to monetary sustainability, we risk having neither financial stability nor durable economic growth."
Politically, the Fed may not be able to restrain money policy in the context of large fiscal deficits and soaring public debt. Any money restraint will send interest rates rising and make deficit financing prohibitive. Similarly, the Fed may not accept a restrained monetary policy and induce a dollar appreciation when other major central banks have adopted equally unorthodox policies of near-zero interest rates, massive money injections, financing excessive fiscal deficits, and depreciating their respective currencies.
The simultaneous money and fiscal expansion in major industrial and emerging countries may be paving the way for the worst world-wide inflation with negative effects on growth and employment for years to come.
Foreign holders of US debt have become increasingly concerned with the potential of the dollar's collapse as a result of the Fed's inflation-debt trap. The Fed's policy to delay exit until near full-employment is restored may be ill-conceived. Moreover, the Fed's deliberate policy to re-inflate housing prices and the price level would conflict with growth and employment.
US banks hold more than $800 billion in excess reserves. This is a clear indication that the prime market has no ability to absorb unlimited credit and the only outlet is the subprime market. Banks have learned the hard lesson and can no longer extend subprime loans that will be pure losses.
Although securitization of subprime loans is dead, Bernanke is trying to revive it and even rate it AAA. The Fed has decided to circumvent banks (who have learned their lesson and do not want to extend credit as before to the sub-prime market), inject $1 trillion in consumer loans in the subprime market, and bear potential losses from these loans.
Stabilization policies aimed at extricating inflationary pressure, stabilizing commodity prices and containing fiscal deficits should be introduced without delay. These policies worked with success in Western Europe in the 1950s, notably in France and Germany, and in the US in 1980s. There are other policy instruments, additional to monetary and fiscal policy, for promoting durable growth and employment.
Promoting competitiveness and flexible price adjustment, although refuted in Keynesian economics, is essential for clearing markets. Sectoral policies in agriculture, energy, and manufacturing would help increase output and employment. Addressing world food shortages and energy constraints would make a great contribution to growth. Not all unemployment is conjunctural. A large component of unemployment is structural and cannot be solved with macro-policies. Long-term education and training are essential for matching skills with technologies and available and emerging opportunities.
Bernanke's ambivalent exit strategy can only heighten uncertainty and exacerbate instabilities. Continued fiscal and monetary expansion may widen US external deficits and end-up creating employment elsewhere in the world. Speculation will continue to be fueled by near-zero interest rates, affording speculators huge arbitrage potentials, or free lunches, between money and non-money assets. Rising public debt could weigh on future economic growth.
Bernanke and the Obama team wanted a short-term miracle of full employment through a narrow mix of unorthodox money and fiscal policies, the consequences of which, namely inflation and violent business cycles, are very well known, and they have ignored supply-oriented policies that could remove distortions, lessen foreign dependence, and restore stable growth.
Most disturbing is that exit from unorthodox monetary policies can only come at the cost of a deep recession, much higher interest rates and effectively placing the exit strategy burden on the Congress and on fiscal policy.
We must emphasize that the prediction of large deficits for the next 10 years by the Congressional Budget Office will do more than unnerve financial markets. The latest prediction, that the deficit will only be $1.2 trillion by 2019, leaves it at a still unmanageable deficit level on the order of 5.5% of GDP. How can the Fed have a safe exit strategy when the higher interest rates of a "safe strategy" would blow what are already unprecedented deficits out of the ballpark?
Hossein Askari is professor of international business and international affairs at George Washington University. Noureddine Krichene is an economist at the International Monetary Fund and a former advisor, Islamic Development Bank, Jeddah.
(Copyright 2009 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)
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Someone loses, but it doesn't seem like that someone is the bank.
And they can book the difference between notional and buy-back price as a profit! I'm in the wrong business.
The reason there was a problem was there was a pretense of a market - it was always a pretense, they were valued from the market in CDS which is lunacy.
Unless someone fixes that the never-never land could continue for years.
seekingalpha.com/artic...
You could have fooled me.
The majority of the banks have gotten untold capital for nothing, and the Fed really is not sure how, or what it cost their balance sheet. The unknown is not bank asset values, but the regulatory structure that refuses to pressure the banks. And you know who supports the nondisclosure, the White House, the Fed and Treasury( in spades.)
How can it be fixed? Just as you suggested, full disclosure and maybe some reorganizations to boot. Will it happen? No so long as the administration is so dependent on the banks for political support, brains in finance, and a quiet complicity to paper over the cracks that might sink both politician and bank alike.
It is an historical partnership we have here. Fear it.
The PPIP Program Irks Me In That Tax Payers Are Being "Put On The Hook" For 50% + Administrative Costs TOO PURCHASE STUFF NOBODY ELSE WANTS !!!
So the "Firms" Involved in this program are allowed to "Skim Fees" for "Managing" CRAP WE (The Tax Payer) PAYED TOO MUCH FOR !!!
Shuffle Them With Their Buddies (It Is A Small Market Of Less Than 20) => Tax Payer Will Cover The Losses.
I think if ;I had someone willing to "Make Me Whole Again" at someone else's expense => My Stock Would Rise As Well.