“My” Solution to the Toxic Asset Fiasco–Revised

As I previewed two days ago, “my” solution to the toxic asset problem is for the government to buy these assets at the value the banks currently have for them on their balance sheets—what they have the securities marked at on their books (I use the scare quotes because I cannot remember if I came up with this idea on my own or read about elsewhere).  In return, the seller gives the Government essentially an insurance policy that they will pay for any losses the Government actually suffers, but only when those losses are suffered.  Essentially, the Government will not only be purchasing the assets, but also be purchasing a Credit Default Swap from the bank.

The Public-Private Partnership Does Not Solve the Root Problem: The Pricing of the Toxic Assets

The plan announced by Treasury Department to partner with private investment firms does not solve the root problem–the pricing of the toxic assets.  When one reads the Treasury’s plan, one would think that we simply have a liquidity problem–a lack of of capital in the private markets to buy up these assets.  But as has been reported,  there is plenty of capital sitting on the sidelines specifically waiting to buy these assets.  For example, back in July, Merrill Lynch sold toxic assets with a face amount or notional value of $30.6 bn to Lone Star Funds for 22 cents on the dollar–$6.7bn (and lent them non-recourse, except to the assets, 75%).

An Update On Mark to Market Accounting

In criticizing the Treasury Deptarment’s Bank rescue plan, Paul Krugman, on his blog, expresses the same fear I do if there is a “run on the bank.”  While he is not discussing mark to market in particular, the implication is clear:  unless creditors know what a bank’s assets would be worth now, in a forced sale, their assets will not be safe.

Mr. Krugman writes:

“Start with the question: how do banks fail? A bank, broadly defined, is any institution that borrows short and lends long. Like any leveraged investor, a bank can fail if it has made bad investments — if the value of its assets falls below the value of its liabilities, bye bye bank.

But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts.”

Why We Need More Mark to Market Accounting, Not Less

As of late, there has been a lot of talk of doing away with or at least suspending Mark to Market Accounting.  Many on Jon Stewart’s favorite channel, CNBC,  have blamed it for the banks’ tenuous financial position.  They argue that if we did away with this accounting, the banks would actually look and be much healthier.  Leave aside for the moment that it was the banks’ dumb investments in illiquid residential and commercial mortgage backed securities that got them into this position, not the accounting.  Should we really be looking to suspend, repeal or in anyway minimize the use of mark to market accounting?