Toxic Bank Assets Exemplify Pain of the Unbitten Bullet

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 |  Includes: KBE, XLF
by: Michael Panzner

Bullet face

(Image: source.)

History suggests the best course of action in the face of a major financial upheaval is to bite the bullet and address the problems head on.

Unfortunately, when it comes to devastatingly far-reaching financial crises that require politicians and bureacrats to take decisive action that might undermine the interests of well-connected individuals and institutions, the correct approach is rarely taken.

Sometimes the official response is to do nothing in the hope that things somehow work out, even though they often don't. Or officials take one or more steps that delay the inevitable or provide protection for the few, which only make matters worse.

In other words, the unbitten bullet still ends up causing a great deal of pain and suffering.

Such is the case with the official response to the Great Unraveling, where problems in the banking system were papered over with trillions of dollars of taxpayer funds and government sanctioned can-kicking. While things might appear to have gotten better, much still rests on shaky foundations.

As an example, I point to a recent Wall Street Journal report, "'Toxic' Assets Still Lurking at Banks," which suggests that at least one issue that spawned and exacerbated the global financial crisis remains as problematic as ever.

During the financial crisis, investors fretted over "toxic," hard-to-value assets that banks were carrying. Those fears have faded as bank profits have rebounded, loan delinquencies have declined, and bank stocks have soared 25% in the past five months.

But banks still hold plenty of the bad assets that once spooked investors: mortgage-backed securities, collateralized debt obligations and other risky instruments. Their potential impact concerns some accounting and banking observers.

In part due to those bad assets, the top 10 U.S.-owned banks had $13.8 billion in "unrealized losses" that have lasted at least a year in their investment portfolios as of Sept. 30, according to a Wall Street Journal analysis. Such losses are baked into banks' book value, but don't get counted against earnings as long as the banks believe the investments will later rebound. If those losses were assessed against earnings, it would have reduced the banks' pretax income for the first nine months of 2010 by 21%, according to the Journal analysis.

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