Wednesday, March 18, 2009


I struggle with what all this means but here’s brief blurb by Larry Kudlow at NRO that helps a bit:

Nevertheless, behind the furor over AIG, there is some good news to report on the banking front. This week’s decision by the Federal Accounting Standards Board (FASB) to allow cash-flow accounting rather than distressed last-trade mark-to-market accounting will go a long way toward solving the banking and toxic-asset problem.

Many experts believe mortgage-backed securities and other toxic assets are being serviced in a timely cash-flow manner for at least 70 cents on the dollar. This is so important. Under mark-to-market, many of these assets were written down to 20 cents on the dollar, destroying bank profits and capital [emph. mine]. But now banks can value these assets in economic terms based on positive cash flows, rather than in distressed markets that have virtually no meaning.

Actually, when the FASB rules are adopted in the next few weeks, it will be interesting to see if a pro forma re-estimate of the last year reveals that banks have been far more profitable and have much more capital than this crazy mark-to-market accounting would have us believe.Sharp-eyed banking analyst Dick Bove has argued that most bank losses have been non-cash — i.e., mark-to-market write-downs. Take those fictitious write-downs away and you are left with a much healthier banking picture. This is huge in terms of solving the credit crisis.

"... destroying bank profits and capital." When the capital of a bank is reduced, then it’s ability to lend is correspondingly (something more than 1:1) reduced because of the (reasonable) restrictions we’ve placed on them. We don’t want to require a bank to have one dollar of gold in the bank for every dollar of loans it makes (just like we don’t require the Treasury to have a dollar of gold in Ft. Knox for every dollar it prints–though I’m starting to hear those grumblings on the really rabid fringe). OTOH, we don’t want the banks to lend everything it has without some sort of capital reserve–think bank runs in the 30s and the S&L crisis in the 80s.

I have no idea which (mark-to-market or positive cash flows) is the proper method by which to value these assets. In today’s market, however, if they really are being serviced 70 cents on the dollar, how can they be worth nothing?

Btw, if only being serviced 70 cents on the dollar, then how can they possibly be considered to be "serviced in a timely cash-flow manner"?

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