Tag Archives: Geithner

Fictitious capital and mark to market accounting

FASB, the accounting entity responsible for setting basic rules of the road for financial statements, bowed to political pressure today and in a 3-2 vote gave breathing room to the same bankers who caused the mess we are in.

Let me explain.

Currently, banks must “mark to market” their assets including now toxic loans they made to subprime borrowers. Thus, if the bank made 100 in loans and then found those borrowers defaulting or late in their payments the value of those loans would fall, as it has in some cases to, let’s say, 30.

Now if a sample Bank A had borrowed 60 and secured equity financing of 40 to make the original loans of 100 then if those same loans are valued according to their market price – the price a willing buyer would pay for them – that is, 30, then Bank A is insolvent, would have to file for bankruptcy (slightly different for banks than, let’s say, GM) or be taken over by the FDIC.

Then the bank would get new management and be resold over time to another bank or broken up and sold off in pieces. It happens every week in the US and has been going smoothly as in cases involving WaMu and IndyMac.

But with the new FASB rules, Bank A can do its own internal analysis and tell investors that voila the loans made at 100 are worth 70 because their own analysis suggests some time in the future those loans will get paid off with interest.

According to The New York Times: “One of the dissenters, Thomas J. Linsmeier, argued that accounting rules already allowed the ‘fiction all banks are well capitalized,’ adding that the changes would ‘make them seem better capitalized.'”

Now apparently the FASB rule which allows this form of fictitious capital to be created (from 30 to 70 despite what the market says) is balanced by better disclosure to the market of the content of the bank’s analysis. That means that outside lenders and shareholders of the bank can have greater transparency into the bank’s real financial condition.

In theory then the market could do its own mark to market accounting of the overall value of Bank A if it thought the internal analysis were overly optimistic.

But notice what happens here: whereas under the current mark to market rules Bank A would be insolvent and the managers of that Bank would likely lose their jobs, under the new rules the managers get to stay in place!

FASB has just rewarded the very people responsible for getting us into this mess in the first place! And along the way the banks now lose their incentive to sell off the now inflated toxic assets to private firms as proposed by Secretary Geithner.

Does the right hand know what the left hand is doing here?

Geithner plan is a wasteful delaying action – nationalization inevitable

I made an attempt to explain to my international finance students today why the Geithner plan won’t work, relying heavily and gratefully on the wonderful analysis of Salman Khan of the YouTube based KhanAcademy.

Turns out Khan is thinking along the same wave length as Nobel prize winning economist Joe Stiglitz who wrote a devastating critique in the New York Times today indicating that the Geithner plan is nothing more than a “Rube Goldberg” machine that “has allowed the administration to avoid going back to Congress to ask for the money needed to fix our banks, and it provided a way to avoid nationalization.”

What is at the heart of the Khan/Stiglitz argument? That the banks are sitting on assets that have a market price that is far less than the money those banks owe to their lenders and shareholders. If they can’t sell those assets at a much higher price they are effectively insolvent.

So the Government is proposing to buy those assets for more than they are worth with the US taxpayer putting up 93 percent of the purchase price and the so-called private “partners” putting up only 7%. That amounts to a huge subsidy to current creditors and equity holders of the banks that caused the problem in the first place. Oh, and probably allows their top managers to keep their jobs.

But wait there’s more.  If the assets turn out to be worth more than that juiced up price paid by the new Public-Private Partnerships in the Geithner reworking of the old Paulson TARP plan then the US Government gets only 50% of the upside, since most of the money put in by the Government is in the form of a loan not equity. The other 50% goes to the private partner, including big financial groups like PIMCO and BlackRock.

And the loan to the partnership from the Government is a non-recourse loan which means if the entity loses money the Government has no ability to go after the assets of the private partner, even though they will have managed the business into a loss!

No wonder groups like PIMCO and BlackRock said they would participate and no wonder Wall Street rallied on the announcement of the plan. It’s a win-win for the banks and for the private partners. The real risk is taken by the US taxpayer.

The AIG Scandal – An Insurance Company that wants to be paid? Surprise, surprise…

I was interviewed on Oakland-based KTVU about the AIG scandal. You can watch it here.

A key point I was not able to work into the discussion: we need to keep in mind the larger picture here.

First, according to a must read profile of the AIG Financial Products unit in Rolling Stone, its 400 employees were paid some 3.5 billion dollars in salary and BONUSES over the last seven years, including $280 million to the group’s founder Joe Cassanno, a veteran of the junk bond fraud run by disgraced financier and now ex-con Michael Milken. And yet the US Treasury – led by Neel Kashkari – thought it essential to hand them $40 billion in new money last fall and only limit the bonuses paid to the top executives of the holding company, AIG parent, not AIG Financial Products!

Second, what value have these financial geniuses brought the US public for our $40 billion (followed by another $100 billion or so since, including a $30 billion line of credit a few weeks ago)? Instead of negotiating with their counter parties to whom they sold the Credit Default Swaps that were at the heart of the AIG-FP business model, they apparently just paid them off at 100 cents on the dollar!

Now, that’s the kind of insurance company I want.