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.