Nose Cut Off, Face Spited, Now What?

As of this moment (2:50 PM eastern) the House of Representatives has dealt a huge blow against stabilizing the financial markets and avoiding a world economic crisis. The less than perfect Paulson bill would have accomplished that goal in numerous ways. One of them, which has been least understood and grossly underappreciated by most other than those who read this blog, is the method by which the Treasury and the Fed would have finessed the rules and stopped the gasoline that turned a house fire into an inferno – FAS 157.

The Paulson plan’s tourniquet that would have stopped the writedown bleeding is mark-to-maturity, the plan’s component that would have enabled Treasury and the Fed to finesse the insanity of FAS 157’s mark-to-market and ceased the graveyard spiral of lower values, more capital, forced sales, lower value, etc.

What Now?

There is still time for the House to come to its senses and immediately pass a bill that would be far better than the alternative of no bill. On the assumption that such an action did not occur, however, then financial assets and therefrom the world economy will suffer the consequences the likes of which are extreme in the best case.

Yet, there is an alternative, an action that could help alleviate the carnage, one that comes from the source of the carnage – FASB. A repeal or more likely a suspension of FAS 157 would go miles toward accomplishing what the Paulson plan would have achieved – stopping the graveyard spiral in asset values.

As for the odds of that happening, the answer is simply “who knows?” However, the consequences of no action by either the House or FASB are frankly unthinkable. Let’s pray for less principled outrage and more adult, common sense decision-making.

Comments

[MarvinMBA:]

MAIN STREET BAILOUT INSTEAD OF WALL STREET
Its important to save main street instead of wall street brokerage houses...the supply and demand for the toxic paper will eventually reach a equilibrium without a bailout....what the country needs now is to get M1 on the move upward and that requires a return to fundamentals...reduce taxes, lower energy prices, adequate jobs for whoever wants to work. This is the Main Street Bailout that will answer WHAT IT TAKES TO GET THE COUNTRY going forward.

2008 Sep 29 06:12 PM

[tg-2009:]

Main street depends on wall st. If MSFT go to $10, they won't hire but layoff.

2008 Sep 29 06:18 PM

[GKM:]

It might but if you used $1.2 trillion (or more) to build infrastructure and invest in the future, those workers that you would employ would buy Microsoft products and Mr. Softy would hire back those workers and Bob's your uncle. Or alternatively you shore up the finances of some key institutions and you let them take over the ailing assets of other less investment worthy institutions to put money back into the system.

But throwing away $1.2 trillion (and probably more) to over pay for worthless assets only to sell them for fair market value (i.e. less) is truly a waste of money. At what point in time does "I'm telling you the truth this time" make you question the truthfulness of the speaker?

Or think of it this way - you should never double down on a bad investment. You own a house that is underwater. Someone says to you - I can bail you out of your bad investment you just have to buy back the mortgage on your house at more than fair market value. Now think real hard - is it a good idea to double down? Hint: the answer starts with an 'n' and ends with an 'o'.

2008 Sep 29 10:19 PM

[formerhawk:]

Good article. Mark to market certainly helped to get us here, marked to maturity makes so much more sense.

2008 Sep 30 09:10 AM

[Elaine Supkis:]

All the guys running around demanding we bail them out of the messes they made, themselves, is hilarious.

This is because they want their equities and investments to be profitable despite making very bad investments! If they are going to talk about 'blood in the streets' then maybe we should talk about REAL blood; when the working class is hammered by alternately, inflation and then a depression due to the deals of these Wall Street investment bankers....WELL!!!

That will be something big. If the guys who got rich off of creating bubbles and bribing Congress to tighten bankruptcy laws for the workers so they can be crushed forever under debts, the rich who paid Congress to undo all those Great Depression banking laws...they all deserve to lose everything.

I guess, they will all go bankrupt, eh? And I pray the goddess of Justice punishes the rich for foisting that stupid bankruptcy law on all of us! Next: we get a real Congress who will undo all these changes in the law the last 10 years especially the misnamed 'Patriot Act.'

Welcome to the Revolution.

2008 Sep 30 09:10 AM

[doubleguns:]

Dems got us here with thier desire for every one to have a home including those with poor credit because THEY DONT PAY THIER BILLS!!! Now they are not paying thier bills, GO FIGURE!. Congress wants us to bail out the banks so we don’t see who got the banks here WHEN THE INVESTIGATIONS START as to what caused this problem. Barney Frank is so loudly out spoken FOR the bail out you can actually see the fear in his eyes. He is afraid the bloodhounds will pick up his scent since he is all over the problem. You could say he is the problem.

So they want to sell us paper at something over 22 cents on the dollar. The banks are buying each other at fire sale prices of 1 cents on the dollar and they wont accept 22 cents on the dollar, Nooooooo!!!! they want to fleece us for 60-80 cents on the dollar. Are we fools or what?!!

No bail out!!!!! Unless we get the pennies on the dollar deal too!!!! Why should the banks buy at 1 cent on the dollar and sell to us at 60 cents to make a quick mark up of 6000% Don't fall for this bail out. The fox are trying to get tax pays to pay up to keep them in thier crystal palaces. We get shacks AND the debt for the crystal palace.

No one is cutting off thier nose in spite. Its to get to the throats of those that got us here in the first place. A nose for a throat is a small price to pay. Some very astute republicans can see this bail out for what it truely is. ANOTHER TAX PAYER FLEECING!!!!! I am proud they said no. Just say no!!!!

2008 Sep 30 09:30 AM

[sponger:]

Marking to market in itself is not the problem, but assigning the current value of an asset to the balance sheet without considering historical value and future projections is the problem. It is as useless to assign the lowest historical value to a property as it is to assign the highest value.

Real estate value is not a moment in time but decades of time. To drive our mortgage institutions to insolvency by this valuation method is self perpetuating and self defeating. Real property needs to be valuated based on something like a ten year average. Doing so will not only prevent premature insolvency but it will stop banks from giving out unsafe equity loans based on the highest value as well.

The criteria used for assigning real property valuation needs to be
reconsidered. The current method is fundamentally flawed, but
it is carried forward in an effort to provide transparency and honesty.
However, it is a fundamentally flawed concept to apply it as the primary
criterion for institutional health. American society allows its regulators to move from one extreme to the other -- from making decisions based
on non disclosure to making them based on full disclosure as though
financial markets can survive the transition following the same set of valuation rules. At the very least, we can say a home is not really valued until it is sold.
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2008 Sep 30 10:27 AM

[hrant:]

I DO NOT TRUST WALLSTREET OR THIS PRESIDENT ON ANYTHING HE SAYS .
DEREGULATION SO-CALLED FREE TRADE ....

2008 Sep 30 01:54 PM

[Help!:]

Dear Julian Murdoch,

Please help me understand something (I think this is something that some of your other readers might be interested in as well). The issue is the huge variance in trading values between open end mutual funds and closed end ETF’s.

The open end mutual funds essentially trade once per day at the closing net asset value (NAV) of the fund. The closed end ETF’s trade all during the trading day, often at large discounts to their NAV. In this extremely volatile market, why would an investor want to be forced (by utilizing open end mutual funds) to wait until the end of the trade day to get in or out of a security?

In addition, why would an investor want to pay par value (NAV) on an open end mutual fund rather than purchase something with a built-in gain (a closed end ETF at a significant discount)?

For example, the world stock open end mutual fund Capital World Growth & Income Fund (symbol CWGIX) from American Funds trades once a day at its NAV (0% discount) and yields about 2.80%. Conversely, the world stock closed end ETF BlackRock Global Equity Income Fund (symbol BFD) trades during the day at around $11.22 (a 20% discount to its NAV) and yields around 17.00%.

Would you recommend that I buy CWGIX or BFD? Please explain this phenomenon. I do not understand. Thank you.

Sincerely,
Mark J. Mohr

2008 Sep 30 02:24 PM

[BerkeleyBob:]

There may well be theoretical reasons why FSB 157 is not a good fit for evaluation of real property securities, but it has the virtue of forcing some transparency and realistic evaluations (maybe overly pessimistic) on lenders who made bad loans. Problem points include the role of rating agencies and bad appraisal practices. Unintended consequence of creating a secondary market for CDO's etc. etc. is Gresham's law in action, "toxic" loan packages driving out the large number of non-defaulting borrowers and leaving a very bad taste in the mouths of foreign central banks and institutional investors (pension funds).

2008 Sep 30 02:40 PM