Tuesday, April 07, 2009

Wealth Destruction

Was having a discussion with an old friend from Merrill Lynch and he mentioned the awesome "Wealth Destruction.." that has left him feeling numb.

It has really been something hasn't it?    I feel like ranting... Bear with me.

The Government's approach to addressing the root causes of the financial crisis have, thus far, been totally inadequate.  Market realities are slowly forcing us towards obvious prescriptions but acknowledgment and appropriate action is taking place at a glacial pace.  Sadly, I don't think we have the time - or money - to waste.  Issues of politics, perception and partisanship have to give way to pragmatism before it is too late.  If only our legislators could shed the shackles of short term remedies we as a country, and as a people, would be far better off.

I hate being so pessmisstic but like most, I get sick to my stomach when I read/watch the news. Today we see the Financial Accounting Standards Board (FASB) - the supposedly "independent" rule-making body of the accounting profession - and the US Government are in almost perfect sync.  One week the FASB relaxes FAS 157 - the mark-to-market standards applying to financial asset portfolios - while the next brings the Treasury Department's release of bank stress test results.  No doubt the Treasury has tremendous latitude in how it reports the results of the stress tests, and if it chooses it might well incorporate the expected benefits of the "new" FAS 157 on bank capital balances.  This is manipulation at its finest because it would have a PR impact of showing banks as being much healthier than the former accounting regime would indicate.   That regime is the one that forces banks to deal with the reality of where their assets would clear the market.   And while naysayers would have you believe that marking-to-market assets which are intended to be held until maturity is harsh, I'd counter with this simple question:  Does the bank have the term capital, and, therefore, the ability, to fund these assets until maturity?  If the answer is no, which is invariably the case given the massive size of bank illiquid asset portfolios relative to term capital, then marking-to-market is the prudent way to reflect its true financial position.  The US Government is conveniently staying silent on this part of the debate.  But what else should we expect?

Check this table out from a piece in a Goldman Sachs report a few weeks ago (click for larger image):


Doesn't appear that a lot of stuff has been marked down appropriately.   I've got tons of stuff like this on my hard drive - one presentation I was viewing from T2 Partners a week ago chased me off the computer and to the local pub.   (just kidding)

Alas, the business at hand is that of manufacturing outcomes regardless of their basis in reality. Once reality sets in, the reality that deals with market values, financing terms and solvency, the pretty picture that has been painted won't look so good.

But hey, things are OK for now, right? As Vonnegut so often noted, "So it goes."

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