| Crazy
times. Whatever the political posturing, a plan needs to be passed. Credit
markets are frozen and banks are going bust every day. This is not totally
because of "toxic" mortgages. This has a lot to do with FASB 157, also known
as "mark to market".
Each day lenders must
mark their assets to the marketplace. It's like you having to appraise your
home everyday and if your neighbor was under duress because they got very
ill, divorced, lost their job and was forced to sell their home quickly they
may have sold it super cheap. Now, does that mean your house is worth that
super cheap price? Clearly not. Why? Because you are not under duress. You
have the time to sell your home and get a more normal price, which more
accurately reflects true market conditions. But "mark to market" does not
allow for this, which creates a vicious cycle.
Why is this so bad?
Because as lenders mark down their assets the amount that they have loaned
previously becomes much riskier in relation to their assets. For example,
say a bank has $1 million in assets and say they have $15 million in loans
outstanding. Their ratio is an acceptable 15 to 1. But should they take a
paper write down of $500 thousand due to "mark to market" requirements,
their ratio suddenly changes to 30 to 1. This is because their assets are
now only $500 thousand after taking the paper loss, while their loans
outstanding are $15 million. And at 30 to 1 this bank is viewed as a risky
investment. So the stock price starts to get hit, it becomes harder to
borrow, and most importantly harder to make money. The bank is then forced
to sell some of its loans to reduce its ratio...at cheap prices. And this
makes the vicious cycle continue.
And a quick look at
the holdings of these loans show that 95% are problem free. Additionally,
the Credit Default Swaps (CDS) that are used with the pools of mortgages,
are relatively safe. But this requires a bit of understanding. You see, when
a pool of mortgage loans is put together it isn't just A paper or B paper
etc. it's everything. Its got some A paper, B paper, C paper, and even what
looks like toilet paper. An "A" investor buys the whole pool but because
they are an "A" investor their safety is greater because they can avoid the
first 20% (an example) of defaults. So they own the whole pool but are
sheltered from the first batch of defaults, and for this they get the lowest
rate of return. As you can figure from here the more risk investors want to
take, the higher the return. So the investments are relatively safe, but the
accounting rules currently place undue pressure on the banking institutions.
Now add to all this
the opportunistic shorting done on the financial stocks, much of it illegal
because those shorts did not legitimately borrow shares (called naked
shorting), and you exacerbate this whole problem. Thank goodness for the
recent temporary ban on shorting in the financial sector. As for the plan
the government is the only one who can step in to do this. And they have to
do this. And they will do this. The nauseating political posture from both
sides is just part of the process.
This is not easy to
understand for the general public. In fact most politicians don't get this
either. That's why it is a difficult yet critical bill for them to vote on.
Once this is done it
will take some time but the markets will stabilize. As for our industry it
will take a bit of time but we will make it through this. Rates will remain
attractive and the influx of credit availability will help the housing
market gradually improve. This ultimately will be the medicine needed to fix
our industry. We just need to be patient. Those who can stick it out will be
handsomely rewarded. |
