I agree with John Mauldin's comments on asset valuation; however
his
suggestion to suspend mark-to-market accounting is wrong.
It
does not help investors, depositors or regulators to allow
financial
institutions to overvalue their assets and therefore
overstate their
capital reserves. And to make matters worse,
re-jigging reported asset
values only when it is convenient to prevent
an institution from failing
is just insanity.
Here's an example. I buy a house for $1 million and
finance it with a
$900,000 loan. Let's say its value goes up to $1.2
million, so I
report that value on my credit application to the bank and
borrow an
additional $180,000. A year later, the value of my house
declines to
$600,000. Mark-to-market accounting says I must report a
deficit of
($600,000 - $900,000 - $180,000) $480,000. Suspending
mark-to-market
accounting says I continue to report $120,000 of equity.
Which paints
the true picture? Oh, and following the suspension of
mark-to-market
accounting, with my $120,000 of "equity," I convince you,
an investor,
to put up $60,000 for an equity interest in my
house.
An interesting benefit of Goldman Sachs and Morgan Stanley's
recent
switch to bank holding companies was that certain assets no longer
get
marked to market. They avoid reporting the decline in value
of
billions of dollars of certain assets.
From: Pete Holt <peteholt@xxxxnet>
To: realtraders@yahoogroups.com
Date:
Monday, September 29, 2008, 9:36:52 PM
Subject: [RT] Paulson
Plan
This (from John Mauldin's Outside the Box) would seem to be the
key
deficiency in the Paulson Plan. Don't see how this can be fixed
in
the short run.
There is one practical problem that will plague
the Paulson Plan and
any plan that involves the government purchasing
distressed assets
from financial institutions. These assets are NOT(!!!)
accurately
valued on the books of financial institutions.5
Accordingly, these
institutions are not in a position to sell them to the
government at
current fair market value. Any sales at current market
value would
inflict huge losses on these institutions. The alternative is
for the
government to grossly overpay for these assets, which would
constitute
a disguised capital infusion into these firms that would
short-change
the American taxpayer. This flaw in the plan is why members
of
Congress from both sides of the aisle insisted on some kind
of
profit-sharing structure that would compensate taxpayers in the
event
the government pays above-market prices for assets. HCM fears
that
very little of the $700 billion is going to be spent in the
near
future because of the reluctance of banks to part with assets
at
anywhere near their current value, and the government's reluctance
to
overpay for these assets.
5 Although in fairness all the blame
for this can't be placed on these
institutions. There is currently no
market for many of these assets
and placing a value on them would be an
arbitrary exercise. This is
why mark-to-market accounting should be
suspended for an indefinite
period of time.