TWO DEGREES OF SEPERATION

We're back.  Great trip, great fun.  Gone fishin' next week but in the mean time...

Way back in the last century, I was testifying before a House sub-committee on sovereign debt which had as one of its brighest members a young congressman from Brooklyn by the name of Charles "call me Chuck"...and I did... Schumer .  Some where between then and now Chuck either ran into a pole trying to get in front of a tv camera or took a stupid pill, but that's another story.  In those days he was really on top of things and the subject about which I was testifying was the valuation of sovereign debt that American banks held on their balance sheets...to wit, should "mark to market" apply.  Two guys from Noo Yawk really mixing it up.

"Why shouldn't we demand to know the real value of this stuff?"

"Because Congressman, the value of a loan is a subjective thing; a very subjective thing."

"Isn't there a market?"

"Yes, but it's not very deep or well-established and as such easily manipulated."

"You're not serious."  (I was but I knew that he knew that I knew the real concern was that if we had had to put a mark on that crap AT THAT POINT IN TIME, half the banks in the U.S. would be insolvent).

"Look Congressman, let me put it this way, there are a lot of intangibles regarding the valuation of a particular credit.  Take my credit for example..."

"What intangibles..."

"My wife."  A Pause.

"You have one of those too, eh?"  (General laughter).

"Sure as hell do."

After the hearing was over he approached me and asked if he could call from time to time...no attribution, totally off the record.  He did ring a number of times and fully understood the problem as well as the enormous loss of flexibility not just for the banks but for the regulators as well.  He never broke the confidence.  I'm going to be interested to see where Chuck comes down on this insanity being proposed by the FASB loonies, the earlier version of which damn near tanked the world 18 months ago. Do these people never learn or is everybody these days simply consumed with their own sense of importance and insatiable thirst for authority?  Consult the archives of the blog to see what I mean.

All of this comes about without a single nod to the reality that we have this country called Greece which has been in the news as of late.  Forget about the fact that the "bailout" is a total charade, that it is stupid, that there should have been a rescheduling on market terms, that as an attempt to save the Euro it might well have been the final nail in the coffin and that the real reason was to save the hides of the French and German banks which will be all for naught if this proposal is adopted on a world-wide basis which is really the only way it can be adopted.  Sure as God made Green apples The Suit and his collection of hooples will be all for it on the basis that it provides "transparency,"  and when the music stops, which I predict will be inside of six months, there are going to be a lot of "Peoples," as my friend Hans would put it, "looking where to for to sit down."  Tomorrow, I'll try to spell out the end game if the players allow it to be played.  Stay tuned.

SAY WHAT?

Ok, where were we? Oh yes, we were just speculating on how long in will take the administration to ram Our Hero's plan down the throats of a bunch of cowed banks when all of a sudden, HEEEEEEERRREE COMES FASB! By a 3-2 vote, FASB agreed to a somewhat different approach to the accounting treatment banks could employ on troubled assets, recognizing for the first time, in public at least, that there might be a problem out there with the market to which things were supposed to be marked. I have read the release a couple of times and frankly it just goes to prove than accountants are simply actuaries with a sense of humor...albeit a dim one. For the life of me, I can't translate the statement into any known spoken language but that is ok. You see, the important thing is that it purports to condone a different treatment and thus ends the insanity under which we have been laboring for the past two years. The other thing it does, if the industry is prepared to stand up on its hind legs, is to kill Our Hero's plan stone, cold dead.

You see further see, if financial institutions are now given some latitude as to the manner at at what level they can value their portfolios and more importantly eliminate or greatly slow the velocity of asset degradation on their balance sheets leading to additional capital impairment, they are going to be even less willing to participate in any action at fire sale prices that eliminates any up-side recovery. Not surprisingly, the FDIC leapt in the conversation this morning with the statement that it might be willing to allow participating institutions to share in any profits obtained by the managing institutions. Lord. Cannot some Knight rid me of the meddlesome woman? Besides being irksome the statement may reveal, however, that the administration is not prepared to give up without a fight as non-participation will certainly reduce the leverage Treasury has over the financial industry. One for the good guys.

There is a troublesome part to the announcement. FASB is prepared to announce the new approach to be retroactive to the close of the 4th quarter of 2008. We all need but look at the events of the last few years to realize that bankers may not be the sharpest set of knives in the drawer at least in the realm of strategic thinking. Many in this mob have an attention span slightly less as long as that of my dog (she's a very smart dog) and possess a trader's mentality which often leads them to do something incredibly stupid if given the opportunity. I have a real fear that a few of these bozos may well seize upon this outbreak of sanity and attempt to MARK-UP in value assets on their balance sheets and book the transactions as a profit. To do this would create a $*&^-storm that would dwarf all others up to this point and wreck whatever benefit might be achieved in the future. Take what you have been given: we are going back to the future where banking once again is a subjective industry, where time and sound credit can cure most ills and where the maniacal cries for nationalization and over-regulation will slowly fade. What we need is time and an upward sloping yield curve. Forever has it been such.

Now in this regard, loyal readers will remember what I said a few days ago about the Fed's actions as of late. Gentle Ben, having taken the central bank over to the dark side of the political swamp, is busily gearing to replace the Chinese on the long end of the Curve. To the extent this occurs, one result could be the artificially lowering of medium to long term rates and the flattening of the curve--not a good thing for Mrs. Banker's little boys and girls. The IQ results we find in the scores of commercial and investment bankers occasionally bubble up in the personnel folders of Central Bankers as well. But, for the time being, we have a shot to get out of this mess in the old fashioned way; managing risk and earning money. Let's hope we don't screw it up.

One further point. I have never thought that the Senate of the United States was as collectively dumb as the House, but I may have been wrong. In a move so colossally stupid so as to defy explanation, the Senate voted today to require the Federal Reserve to release the identities of all institutions to whom they have provided assistance. If unchanged, the language could include borrowings from the discount window. Never has the Fed made that information public and it's release could damage the reputation of any institution to whom the facility was made available and discourage many institutions from using the facility thereby exacerbating an already touchy situation. Keep thinking confidence and trust gang. That's what this business is all about.

Tomorrow the G20. Initially, it appears little harm was done...yet. But the IMF? Tune in

STEVIE

I grew up with a kid called Stevie. Stevie was a big kid, a lot
bigger than the rest of us. Stevie was also a mean kid--not for any
particular reason, just because he was bigger and could beat up
anybody on the block. You did what Stevie told you to do and that was
the end of it. Mostly, you just tried to stay away from him. Stevie
was what we called a punk.

As we got older a funny thing happened: Stevie didn't grow as fast as
many of us. One day, one of us...and I really didn't know who it
was...beat the living hell out of Stevie. We never saw Stevie much
after that. About a year later, Stevie's family moved to the
suburbs. Not long after, I forgot about Stevie.

Now let me make it clear that I don't the The Leader is a punk, but
the President of the United States is the biggest, strongest guy
around and he is full grown. It was therefore quite surprising to me
how many people within the media were remarking on how "strong" The
Leader was in dealing with GM and Chrysler. Huh? The only surprise
in my mind was the manner in which The Leader acted yesterday.
Stevie. There was no need for a public execution of Rick Wagoner; a
simple slipping away was all that was needed. There was no need for a
probably unfulfillable ultimatum; a simple statement that the game was
nearly over would have sufficed. We all understand the Power of the
Presidency; less bluster and quiet action is the greatest reinforcer
of this knowledge. Then why?

I hope I am incorrect, but I am afraid that this is a template for the
manner in which this administration plans to deal with the financial
sector because, you see, Our Hero has a stinko and probably unworkable
plan for the so-called "toxic assets" that would probably be an
absolute non-starter without a nudge from The Leader in the form of,
"Sign here, bub, or get out and go home." These boys don't like to
lose and they sure as hell don't like to admit they are wrong. The
Leader's auto council consists of 20 people, none of whom have the
slightest idea as to how to run an auto company but feel uninhibited
in putting forward a strategy that affects hundreds of thousands of
people. Similarly, if there is a task force, formally or informally
arraigned within the Beltway it too, contains not a person who knows
the first thing about the complexity of running a bank much less
having ever run one, including Dear Reader, Our Hero and those above,
below and around him. Nor will they ask for help. It is, I am
afraid, more about their confirmation of their own brilliance than
solving the problem at hand. They have become so concerned with
circling in the glow of one another that they have forgotten their
mission.

Oddly, the one person that could help in this upcoming debacle is
Barney Frank. Think what you will of him, Rep. Frank is a long way
from being a dope and he actually understands many of the problems we
face. I have never ever met a person within the regulatory community
who has been unimpressed with Rep Frank's acumen. Similarly, I have
never met any member of that community who believes that Rep. Frank
would (or has ever) put the public good before politics or the good
that accrues to Rep. Frank. But as the ads for the New York State
Lottery used to say, "Hey, you never know." Now I freely admit when
one is hoping for the assistance of Barney Frank to set his party on
other than a course than might lead to disaster, one is in deep
trouble. But there it is. If we are to face another session of
legislative insanity and pandering to an public ignorant of anything
except well-constructed (and in some cases well-deserved) outrage,
well, why continue. My views are clear.

Thursday if the date for the FASB decision on any changes as to the
application of 157 which could be very useful in our understanding as
to what the future holds. I will attempt to have a full discussion of
the "plan" before us and what effect the FASB ruling might have upon
the same. I know, I'v been promising this for days and keep getting
side tracked but I promise, I WILL DO IT! Also, keep an eye on the
pronouncements coming out of London on global regulatory matters.
Hopefully, nothing of importance will emerge. Nothing ever does.

A thanks to Mr. Ewan Watt for his kind remarks on his most thoughtful
blog site the other day. I have never met Mr. Watt but from the name
I assume he is one of The People. A lady lawyer once said to me,
"Best have the Scots on yer side Laddie. We're all a bit mad ye
know." As a Hatter was she but mor' an a wee smart.

...COMES A PAUSE IN THE DAY'S OCCUPATIONS...

Our Hero was center stage today. True to his reputation, The Secretary put together every idea that had been put forth over the past six months, mixed them together, shook them up and came forth with his plan to save the financial sector. At last look the Dow was up 380 points with financials leading the way which put a smile on my son's face, he of the long positions, and the talking heads on TV. Not a bad day's work.

Forgive me if I am not quite as ebullient, because for the life of me I can't yet come to grips as to how...much less whether...this is going to work.

As I understand it, Our Hero and his guys are going to partner up with a bunch of investors in the public, each put in a bunch of capital and then Our Hero is going to drop on the private guys a bunch of non-recourse debt to fund the biggest Dutch Auction in history after which, if all goes well, we'll be out of the woods as the banks will be out of "toxic" debt. Shelia Blair has made it clear that she and the FDIC will provide the highest of scrutiny to the entire operation. I'm telling you, this gal must have photos because why in the world bones have to be thrown her way is beyond me but that is a subject for another day.

The private guys must be thrilled. For a small slug of equity, they get a huge load of taxpayer's money that they never have to pay back except from the corpus of the purchases--i.e. non-recourse TO THEM--financing, and the possibility of a huge upside ROE if all goes well. Tim gets a hugh upside as well for the People of America if all goes well but undertakes a huge downside if it doesn't. Funny, it sounds exactly like how Wall Street has been run ever since everybody went public: big risks, high returns but what the hell, it's not your money. This boy learns quick!

Once everything is in place, there will be an auction, conducted by someone, on assets (yet to be determined) held by the banks. Now it has not yet been announced if these assets will be differentiated (or how), size of tranches, maturities or whether there will be reserves placed on the assets (the bid must be at or above an agreed-upon level or else no deal) but there is the belief that all these little details--and others--can be worked out. No mentioned has been made of due diligence or timing but again, details, details. Once again, dear friends into the breach!

Our Hero was on TV today with Erin Burnett on CNBC--where I suspect we would all wish to be--musing that if we could only get a few of these auctions off, we would be able to get a better view of the real value of these assets. Huh? Let's see if I understand this. The consortium bids for 5 million of a certain asset held by a bank and wins. What is the effect? Does this mean that every like asset at every institution WORLDWIDE need be marked to the purchase price? There is no question that many of these assets have been marked to a level well below there intrinsic value at certain institutions but not at others. If the seller of the 5 million has a mark of 40 and he bid is 50, simply to get rid of a small problem a bank may well be willing to lose the asset even though it believes it will be money-good in the end. But what happens at another institution whose mark is 60...and the asset level is 100 million? Are they forced to change the mark to 50 and lose 10 million in capital (tax neutral)? Does the first bank book a profit? Do you mean that due to the size of a relative holding we create a situation in which one bank books a gain and another a loss ON THE SAME ASSET? Riddle me that one Bat Man.

I hate to beat a dead horse, but FASB 157 became effective in November of 2007. From that moment the stock market tanked. Hello? If this doesn't get fixed we accomplish nothing because we will never be able to fix the valuation question unless the volatility of these valuations is ended and they are approached on a different basis. Or to put it another way, there ain't gonna be no way to price these things at an auction. Surely, the government will attempt to bully the banks into participating if it gets to that point but that, I am afraid, is more than questionable. This is a moment in time...WHICH WILL BE KNOWN AS THE CHILDREN'S HOUR

GRAY SPOTS IN THE GRAY LADY

One of my loyal readers wrote this morning: "I think I agree with you but I'm not sure I understand all the issues you raise well enough to say I'm sure."

Honesty. Not much of that going around but of course I was grateful for the support. I must say it did occur to me to question why the writer would be reading this blog if he (or she) didn't have the facts or knowledge upon which to reach considered decisions. Then I read Floyd Norris in the New York Times this morning and I asked myself, "If you don't have the facts or the knowledge, why are you writing a column?

Mr. Norris, who is the chief financial writer for the Times, weighed in this morning on the subject of mark-to-market accounting with a somewhat passionate defense of the practice and a sarcastic assault on all who would argue that it is a huge hinderance to a solution to the problem before us. He seems to have been smitten with the idea being floated about Washington of the government financing those who would be a buyer of so-called toxic assets from financial institutions which would, in theory, unlock a major obstacle in the way of the increased extension of credit. Mr. Norris seems to believe that the bankers are standing in the way of this concept because in their eyes, "Cheap volatile assets with a huge upside are precisely the kinds of optionlike investments that clever zombie managers are looking for. If they soar, the banks' stock may be worth something..." he writes, quoting Prof. Edward Kane of Boston College. Well, we certainly can't allow THAT to happen, I guess. But, "if we knew which securities each bank owned and where it was valuing them, we...could reach our own conclusions as to values." Wow! Isn't that easy! "The final step would be to get the market for such securities functioning," writes Mr Norris. Damn! why didn't I think of that?!

The birth of this idea having been reported to taken place in the administration, I can just see Larry Summers, a brilliant academic economist proclaiming, "Assume a market..." and things falling right into line. Mr. Norris feels that markets are created in this manner for as he states in his piece as soon as we have accomplished the forgoing all we have to do is find the buyers.

If you wish to follow FASB 157 Mr. Norris it's the market that sets the price with bids an offers being freely made and accepted or rejected , not a forced pricing mechanism (by the by, who is the "WE" in your example) and a fire sale enriching a whole class of vulture funds at the expense of bank equity and debt holders. FASB 157 works only when there is a functioning market...the eccomist's "Poof, let's make a market," doesn't work. We do not have a mechanism by which these assets can be priced in any objective manner, and to do otherwise is to bare the risk of fraud and outrageous political influence, for the mechanism to obtain the pricing to fulfill the prerequisites of any such scheme will be a political one. I would also like to point out Mr. Norris that your claim that financial institutions were already subject to market-to-market treatment is not entirely correct. Certain assets were indeed subject to such treatment but vast categories of other assets were not. For years, a bank's loan portfolio was not subject to mark-to-market treatment; unless impaired, assets were held at par until maturity and not subject to a market test until sold or otherwise disposed. The movement towards securitization (now THERE'S a subject) certainly enhanced the argument for different accounting treatments but one can argue which came first; securitization or the movement to securitize as a result of mark-to-market. This is the General Patton theory of banking: "The object is not to die for your country but to make the other poor dumb son-of-a-bitch die for his!" Don't hold a loan whose value is not under your control. Securitize and sell it! Not your problem any more. Was the requirement to market-to-market an advance, providing greater transparency or something quite different? Let's think about it over the weekend. But for now, someone had best make it go away. Next week, we'll talk solutions

Final comment. The name of Rogin Cohen was floated out last week as possibly the new Dep Sec. of Treasury.. Mr. Cohen, the managing partner of Sullivan & Cromwell had represented the N.Y. Clearing House since the sun first rose in the East and individually, at one time or another, every bank of any size in the world. He is a brilliant lawyer and appeared to me to have been conflicted as all get-out. He was also dead set against any attempt to nationalize any bank. Why he would even consider working for this mob is beyond me. But from the administration's standpoint they would do well to take the advice of the ESPN crew...JUST SHUT UP!