Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
The AI Mega-trend Stocks Investing - When to Sell? - 28th May 20
Trump vs. Biden: What’s at Stake for Precious Metals Investors? - 28th May 20
Stocks: What to Make of the Day-Trading Frenzy - 28th May 20
Why You’ll Never Get Another Stimulus Check - 28th May 20
Implications for Gold – 2007-9 Great Recession vs. 2020 Coronavirus Crisis - 28th May 20
Ray Dalio Suggests USA Is Entering A Period Of Economic Decline And New World Order - 28th May 20
Europe’s Coronavirus Pandemic Dilemma - 28th May 20
I Can't Pay My Payday Loans What Will Happen - 28th May 20
Predictive Modeling Suggests US Stock Markets 12% Over Valued - 27th May 20
Why Stocks Bear Market Rallies Are So Tricky - 27th May 20
Precious Metals Hit Resistance - 27th May 20
Crude Oil Cuts Get Another Saudi Boost as Oil Demand Begins to Show Signs of Life - 27th May 20
Where the Markets are heading after COVID-19? - 27th May 20
Silver Springboards Higher – What’s Next? - 26th May 20
Stock Market Key Resistance Breakout Is Where the Rubber Meets the Road - 26th May 20
5 Ways To Amp Up Your CFD Trading Today - 26th May 20
The Anatomy of a Gold Stock Bull Market - 26th May 20
Stock Market Critical Price Level Could Soon Prompt A Big Move - 25th May 20
Will Powell Decouple Gold from the Stock Market? - 25th May 20
How Muslims Celebrated EID in Lockdown Britain 2020 - UK - 25th May 20
Stock Market Topping Behavior - 24th May 20
Fed Action Accelerates Boom-Bust Cycle; Not A Virus Crisis - 23rd May 20
Gold Silver Miners and Stocks (after a quick drop) Ready to Explode - 23rd May 20
3 Ways to Prepare Financially for Retirement - 23rd May 20
4 Essential Car Trade-In Tips To Get The Best Value - 23rd May 20
Budgie Heaven at Bird Land - 23rd May 20
China’s ‘Two Sessions’ herald Rebound of Economy - 22nd May 20
Signs Of Long Term Devaluation US Real Estate - 22nd May 20
Reading the Tea Leaves of Gold’s Upcoming Move - 22nd May 20
Gold, Silver, Mining Stocks Teeter On The Brink Of A Breakout - 21st May 20
Another Bank Bailout Under Cover of a Virus - 21st May 20
Do No Credit Check Loans Online Instant Approval Options Actually Exist? - 21st May 20
An Eye-Opening Perspective: Emerging Markets and Epidemics - 21st May 20
US Housing Market Covid-19 Crisis - 21st May 20
The Coronavirus Just Hit the “Fast-Forward” Button on These Three Industries - 21st May 20
AMD Zen 3 Ryzen 9 4950x Intel Destroying 24 core 48 thread Processor? - 21st May 20
Dow Stock Market Trend Analysis and Forecast - 20th May 20
The Credit Markets Gave Their Nod to the S&P 500 Upswing - 20th May 20
Where to get proper HGH treatment in USA - 20th May 20
Silver Is Ensured A Prosperous 2020 Thanks To The Fed - 20th May 20
It’s Not Only Palladium That You Better Listen To - 20th May 20
DJIA Stock Market Technical Trend Analysis - 19th May 20
US Real Estate Showing Signs Of Covid19 Collateral Damage - 19th May 20
Gold Stocks Fundamental Indicators - 19th May 20
Why This Wave is Usually a Market Downturn's Most Wicked - 19th May 20
Gold Mining Stocks Flip from Losses to 5x Leveraged Gains! - 19th May 20
Silver Price Begins To Accelerate Higher Faster Than Gold - 19th May 20
Gold Will Soar Soon; World Now Faces 'Monetary Armageddon' - 19th May 20

Market Oracle FREE Newsletter

Coronavirus-stocks-bear-market-2020-analysis

Let's Play Pretend at Toxic Asset Valuations

Politics / Credit Crisis Bailouts Apr 03, 2009 - 12:55 PM GMT

By: Peter_Schiff

Politics Best Financial Markets Analysis ArticleWhen elementary school kids want to escape the confines of their circumstances they pretend to be pirates, princesses, and Jedi knights. Now, with the relaxation of "mark to market" valuation rules announced yesterday by the accounting trade's self-regulatory body, our bankrupt financial institutions can escape their own reality by pretending to be solvent. The unraveling of our fairytale economy over the last few months has not yet convinced us that the time has come to put away childish things. The applause that greeted the news yesterday on Wall Street is a clear sign that we still have some growing up to do.


The imaginative conceit that lies behind the accounting change is that the toxic assets polluting bank balance sheets are not really toxic at all. They are in fact highly valuable assets that for some irrational reason no one wants to buy.

Using the "mark to market" accounting method, mortgage-backed securities were valued relative to the latest prices fetched by the sale of similar assets on the open market. Currently, those bonds are being sold at deep discounts to their original value. By "marking" their unsold bonds down to those prices, the insolvency of our financial institutions had been laid bare. The new accounting changes will allow the nervous owners to assign more "appropriate" (i.e. higher) values. Problem solved.

It is important to note that the Financial Accounting Standards Board made their rule modifications only after intense pressure had been applied by Washington and Wall Street. In their heart of hearts, I can't imagine that there are too many bean counters happy with the outcome.

The banks and the government have argued that the assets should be valued based solely on current cash flow. Most mortgages, after all, are not delinquent. Therefore, a few bad apples should not spoil the whole cart, and those that are not yet delinquent should be valued at par. This method assumes we have no ability to look into the future and make assumptions about what is likely to happen, which is presumably what the market is already doing by valuing the assets lower than the banks wish.

All kinds of bonds (corporate, government and municipal, etc.) that are not in default frequently trade at discounts. In fact, the reason that agencies such as Moody's and Standard and Poor's rate bonds is to assess the probability of default. The higher that probability, the lower the value placed on the bonds, regardless of their current cash flow.

For example, GM bonds that mature 10 years from now currently trade for only 8 to 10 cents on the dollar, despite the fact that GM is current on all interest payments. The 90% discount reflects investor awareness that GM will likely default long before the bonds mature. By the new logic, financial institutions with GM bonds on their balance sheets should be able to ignore the market and value these bonds at par.

Some argue that the comparison is invalid because GM's bonds are liquid while mortgage-backed securities are not. However, if sellers of GM bonds were holding out for 70 or 80 cents on the dollar, those bonds would be illiquid too. The reason GM bonds are trading is that sellers are realistic.

The same should apply to bonds backed by mortgages. To assume that a 30-year, $500,000 mortgage on a house that has declined in value to $300,000 has a high probability of remaining current to maturity is ridiculous. The borrower could lose his job, his ARM might reset higher, or he may simply tire of paying an expensive mortgage for a house that is unlikely to be sold at a profit. Any bond investor with half a brain will factor in these probabilities and look for deep discounts. The only way to accurately assess a real present value is to let the market discover the price.

Despite the pleas from bankers and politicians, mortgages are not plagued by a lack of liquidity but a lack of value. If sellers would be more negotiable, there would be plenty of liquidity. Who knows, at the right price I might even buy a few. The problem is that putting a market price on these assets would render most financial institutions insolvent, which is precisely why they do not want to let that happen.

Simply pretending that all these mortgages will be repaid does not solve the underlying problems. It may keep some banks alive longer, but when they ultimately do fail, the losses will be that much greater. In the meantime, solvent institutions are deprived of capital as more funds are funneled into insolvent "too big to fail" institutions - hiding their toxic assets behind rosy assumptions and phony marks.

Going from the sublime to the completely ridiculous, in a speech at the just-concluded G20 summit in London, President Obama urged Americans not to let their fears crimp their spending. It would be unwise, he argued, for Americans to let the fear of job loss, lack of savings, unpaid bills, credit card debt or student loans deter them from making major purchases. According to the president, "we must spend now as an investment for the future." So in this land of imagination (where subprime mortgages are valued at par), instead of saving for the future, we must spend for the future.

I guess Ben Franklin had it wrong too - apparently a penny spent is a penny earned.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book “Crash Proof: How to Profit from the Coming Economic Collapse.” Click here to order a copy today.

For an updated look at his investment strategy order a copy of his just released book ‘The Little Book of Bull Moves in Bear Markets.”  Click here to order your copy now

By Peter Schiff
Euro Pacific Capital
http://www.europac.net/

More importantly make sure to protect your wealth and preserve your purchasing power before it's too late. Discover the best way to buy gold at www.goldyoucanfold.com , download my free research report on the powerful case for investing in foreign equities available at www.researchreportone.com , and subscribe to my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp

Peter Schiff Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules