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Saving the (Financial) World for You and Me

by: Teddy Goodson

Mon Apr 13, 2009 at 12:37:07 PM EDT

So you think accounting is boring, and those green eye shades have no sex appeal? As it happens, these are the very folks who created the computer models for risk that enabled American financial geniuses to bestride the world as "masters of the universe."  They brought us fancy derivatives, Lehman Brothers' bankruptcy, Wall Street meltdown, AIG bonuses, and a global recession, not bad for a bunch of green eye shades. What's even more remarkable, these same folks are now "fixing" the mess they created, supposedly because only they can understand it in the first place. It all comes down to accounting, you see... fairytale accounting, a fantasy which we have not yet outgrown, and which is now plunging us ever deeper into a bottomless hole, supposedly in order to "save" us. (Where have I heard that before?... maybe Iraq?)
Teddy Goodson :: Saving the (Financial) World for You and Me

Briefly, once mortgages were sliced up into tidy parts, put together in securities, and sold around the world rated as AAA credit risks because of being re-insured by the likes of AIG, an amazing number of pension funds, banks, and institutions had these derivatives among their assets.  

These assets were valued according to GAAP (Generally Accepted Accounting Procedures) at what they could be sold for, that is, "marked to market" each day.  You would have seen this "market value" in your own 401-k report, on lists of the securities you owned.

When defaults on mortgages showed up it did not take long for such derivatives to become unsaleable, at least unsaleable at their face value. This meant that the assets the financial institutions used to cover the loans they made had reduced market value, and so the institutions had to sell other assets to increase their reserves that were supposed to cover defaults... or, alternatively, make fewer loans.  It became more and more difficult to increase their reserves, so they gradually made fewer loans. Thus, in simplified form, the credit freeze grew, and grew, and grew, and derivatives became "toxic assets"  because no one would buy them, at least not at a "decent" price.


The Wall Street experts, like Secretary of the Treasury Hank Paulson under President Bush, or Ben Bernancke, head of the Federal Reserve, saw the crisis as a problem of liquidity because the toxic assets could not be readily sold aat the desired price, i.e., they were "illiquid."  The answer, Paulson told Congress, would be for the government to buy those toxic assets, making them liquid, thus enabling banks to make loans again, and he needed $750 Billion or so immediately to do that, but don't ask him for any niggling accounting of how he spent the money.

He got the money but did not use it to buy the "troubled assets;" some say it was because he discovered two things: there were far more billions, say trillions, in such derivatives than he had money to buy, and, anyway, no one could figure out what he should pay for them---- what would Congress do to him in the future if he overpaid?

When Geithner arrived as Obama's Secretary of the Treasury he found he had no middle management left at Treasury, so had to gin up a rescue plan of his own by himself. Being from the same background as Paulson, he finally lit on a plan which was not much different from Paulson's.  By now, though, it was clear that there was no way even the federal printing presses could produce enough dollars fast enough to fill in this pothole on the financial highway.  

Maybe it was more than a pothole, maybe it was a question not of liquidity but of solvency, as one bank after another dosey-doed into the hands of the FDIC, not to mention great American corporations like General Motors.  And then there was AIG, "too big to fail," whose huge quantities of derivatives and insurance policies defied analysis. Geithner kept pouring more and more money into its insatiable maw, mostly so AIG could reimburse its counterparties (like Goldman Sachs) for defaults on the derivatives the counterparties had insured with AIG, and thus prevent a daisy-chain of world-wide bankruptcies by heretofore staid, rock-solid banks.  Such big oaks do grow from such little acorns.


Pumping money into the system has perhaps caused a little loosening of credit, but certainly nothing in line with the sheer numbers spent.  Wall Street and its minions in Washington therefore turned to the accountants, whose GAAP required banks to have reserves based on market value of those assets held in reserve---- and could be said to have caused credit to freeze in the first place.  

How silly, said the bankers and their Wall Street buddies, not to mention numerous Congressmen who were recipients of lush campaign contributions from the same buddies.  Most mortgages perform very well, only a small minority are delinquent, so why punish the whole category by reducing their credit rating?  Why let investors get away with refusing to pay a good price for their derivatives?  In other words, even if there is no real, uh, fair, market for the mortgage-backed securities, why force us to value them at "mark to market?" That lowers the value of our reserves so we cannot make new loans. Why not "mark to model",  which means let us value those assets at what our mathematical formulae says they are worth. That will immediately free us up to make new loans! Unfreeze credit!

The pressure from Wall Street and Washington was overwhelming, and eventually the Accountants surrendered, and made "mark to model" a Generally Accepted Accounting Procedure.  Too bad they did not extend the privilege of demanding a fairytale sales price to desperate owners of homes for sale, the owners whose homes now have a "market value" below the balance on their mortgages.

No, those unfortunate suckers have to live in the real world.  So do GM bondholders, by the way, who face a market value on their bonds of mere pennies on the dollar (if that).  Indeed, the banks could actually sell those derivatives, those "toxic assets" which are now cleverly re-named "legacy assets" in the market if they were willing to accept pennies on the dollar, too. They just do not want to do that, and so Geithner and the Feds connive with them to pretend there is no market, and let them impute a value based on exactly the models of risk that created this imbroglio in the first place.  


In my opinion all this does is let the zombie banks continue to march.  Eventually you and I, the taxpayer, will have to make good on all these bad decisions by bankers, who are clearly terrible businessmen. The bankers will continue their risky behavior, their "hail Mary passes," letting taxpayers pick up the losses, while they continue to keep the profits for themselves.

It's a rotten system, doomed, I believe, to eventual failure. So what if, say, Citi suddenly announces a "profit" for a quarter,? Just how was this manipulated, if not by utilizing the phony "mark to model" to paper over the actual losses, turning them magically into phony profits? Is this supposed to make the thousands of foreclosed homeowners who could not "mark to model" the price of their homes or the amount of their (former) income, feel any better?

Postponing the final day of  reckoning only makes that day even worse. Break up the megabanks, sell off the parts, and re-regulate now.  

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Gen. Westmoreland, Vietnam: "We had to destroy the villiage to save it".
Now it's "We had to destroy the economy to save it". Save it from whom and what ? Sanity, honesty, hard-working people who play by the rules and own the worthless "assets" ?


Obama's advisors
like Summers and Geithner are far too close to The Establishment, too much a part of the Wall Street Gang, to be able to think outside the box. Nothing they are doing even hints at any serious make-over.  What they really are doing is to continue squeezing the American middle class for every last drop of wealth they have, giving it to the same fat cats who got us into this mess, and who are "too big to fail."

Since globalization started there gave been quiet little  voices murmuring that the American workers will "have" get off their high horse and accept third world wages. We are in the midst of a classic Naomi Klein disaster capitalism crisis being used (as well as caused) by the world's elite to cement their control. Or so I believe.  

[ Parent ]
Alarms Sounded in 1981
It began quietly with the move toward deregulation of the airlines. Hailed as a step toward self-regulating free markets, the neos were set back by an unsettling antitrust decision. With the break-up of AT&T, though, they rebounded with the opportunity to create a whole new basket of derivatives, born in firms like Merrill Lynch that spread throughout the markets. In something of the inverse of the holding companies discredited during the 1920s, the hedge funds found ways to spin off bad paper and run a charade that made accountants and accounting the unwary and clueless co-conspiritors. Rememeber the disgrace of the large accounting firms?

This was all predictable. But no one wanted to stand in the way of economic growth. Ivy League schools featured professors teaching that the old rules of valuation no longer applied in the dotcom market expansion. Greed blinds all.

When will they value my 401-k
by mark to model, I wonder. It sure would improve the amount I have for retirement.

Mark to model is an absolutely wonderful invention. We can prepare the budgets of, say, Virginia, and of small cities like Fairfax by marking tax revenues to model. We can qualify for new mortgages by marking to model on our income---- even though we've been downsized and now have no income, we were, after all, worth that much at one time. Who's to say this temporary glitch (loss of income) should not be ignored in favor of the fairytale reality of our truth worth. Besides, I always wanted to move up to a better house, so how else could I afford it unless I marked to model my income?  

Thanks, for this...
Thanks, Teddy.  As always, you have q great way of distilling information.  I am working on a future blog about other facets of banking and economic stimulus issues and what can vs. should be done.  (Not ready to post yet.)  I am not satisfied that we are on the right course.  

"One person, one vote" died at the hands of SCOTUS, January 21, 2010

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