Gee, more truth-telling this morning!

In its latest assessment of the $700 billion financial system bailout, the Congressional Oversight Panel warns that banks still hold many risky loans of uncertain value. If unemployment rises sharply or the commercial real estate market collapses -- as many economists fear -- the banking system could again lose its footing, the panel says in a report to be released Tuesday.

"Uncertain value"?

Oh do come on.

Let's look at the actual information that the COP put out, minus the usual media spin job:

The Panel's report raises several questions about the program, including whether accounting rules that allow banks to carry assets at higher valuations will diminish their willingness to sell.

English: We still have banks that are engaged in what amounts to accounting fraud when looked at through any sort of objective lens, but its all "ok" because we have "accounting rules" that say you can claim something is worth more than it really is.

For smaller banks, those not among the 19 stress tested bank holding companies, troubled assets pose special challenges that have not been acknowledged. These banks' troubled assets are generally whole loans, which are not currently being addressed by Treasury's PPIP program. These banks also hold greater concentrations of commercial real estate loans, which pose a threat of high defaults.

English: Intentionally-overstated valuations on paper is more important when you're smaller and have more concentration of trash, especially when that concentration is in the sector where almost no recognition of true value (commercial real estate) has yet taken place.  Bluntly: These banks are screwed (Guaranty, Corus and Colonial are just a few examples.)

Treasury and relevant government agencies should move toward greater disclosure of the terms and volume of troubled assets on banks' balance sheets. Because banks typically disclose few details about the toxic assets on their books, it is difficult to gauge the magnitude of the risk that these assets pose to the financial system.

English: Treasury, including the OTS and OCC, are willfully and intentionally allowing banks to issue overly-rosy statements and valuations, and are permitting the hiding of losses.  Oh, The Fed is too - let's not forget them.

The full report can be found here; a few choice tidbits:

For many years, banks were required to mark their assets to market, meaning they listed the value for many assets based on what those assets would fetch in the marketplace. In response to the crisis, banks have been allowed greater flexibility in the way they value these assets. In most cases we would expect the new rules to have permitted banks to value assets at a higher level than before. So long as they do not sell or write-down those assets, they are not forced to recognize losses on them.

English: In response to the crisis the government has made legal accounting fraud.  So long as this fraud is maintained and the cash flow does not choke off paying the light bill, these banks can pretend to have plenty of assets and capital when in fact they are bankrupt.

Unfortunately if they do run into cash-flow problems the taxpayer will take hideous losses, since when the FDIC finally comes in to seize them the true "value" of these assets will be exposed.  This has and will continue to result in losses of 40% or more of the asset base by the Deposit Insurance Fund, which is immediately passed on to the taxpayer.

One-sentence reduction: We legalized accounting fraud and have and are sending the taxpayer the bill to the tune of hundreds of billions of dollars.

If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value. Banks will incur further losses on their troubled assets. The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix.

English: Unemployment will remain elevated, there is no evidence of actual slack coming out of the employment market (see my previous Tickers on the subject) and commercial real estate has no chance of being "ok" so long as consumers are not only being laid off but are in fact giving up and exiting the labor force! 

One-sentence reduction: The financial system is screwed.

This crisis was years in the making, and it won‘t be resolved overnight. But we are now ten months into TARP, and troubled assets remain a substantial danger to the financial system. Treasury has taken aggressive action to stabilize the banks, and the steps it has taken to address the problem of troubled assets, including capital infusions, stress-testing, continued monitoring of financial institutions‘ capital, and PPIP, have provided substantial protections against a repeat of 2008. These steps have also allowed the banks to take significant losses while building reserves. Nonetheless, financial stability remains at risk if the underlying problem of troubled assets remains unresolved.

English: Treasury has conspired with the banks to intentionally pump stock values which has led to them being able to sucker people into giving them more money for what will soon be proved to be worthless stock.  The bagholder is you.  No real progress can or will be made on "troubled assets" because doing so would force recognition of bankruptcy of these institutions; "waiting it out" depends on the fanciful belief that consumers will be able (and willing!) to borrow, but there is no more borrowing capacity in an amount sufficient to make this happen.

One-sentence reduction: We're screwed and a repeat of 2008, writ even larger, is now visible.  Be long guns, ammo, and food and short banks.

Credit derivatives on sub-investment grade assets create large amounts of unregulated exposure to potential defaults on lower quality loans, amplifying the effect of defaults. Similar to past due securitization assets, credit derivative exposure for subinvestment grade assets experienced a significant uptick in the same period. Sub-investment grade credit derivative exposure for the 19 largest BHCs grew from $1.6 trillion in year end 2007 to $8.9 trillion in the first quarter of 2009 as a result of downgrades. (Page 32, main report)

English: These banks thought they could "hedge" their risk with credit derivatives and as the risks became more apparent they radically increased their reliance on these instruments.  Unfortunately the counterparty almost certainly does not have the money to pay ($8.9 trillion?!) and as such these so-called "hedges' are probably worthless.

One-image reduction:

Given knowledge about the individual or entity that the loan was made to, and the value of its collateral, it is fairly simple to calculate default and recovery rates.71 For these reasons, the Panel focused its quantitative efforts on modeling losses in whole loans, assets which represent over $5.9 trillion in the 719 banks modeled by the Panel.72 The Panel also chose to model only whole loans because they are the only troubled asset for which sufficient information is available.

(The report goes on to talk about how it modeled potential losses, along with some other institutions that have run their own models, including RGE Monitor.  I note that RGE has a total write-down amount approaching $3 trillion, which is approximately where I placed total losses two years ago when this began, under completely-independent methodology.)

English: Under conservative valuation models and assumptions we are about half way down with the write-downs and losses. "Rosy" estimates suggest that we are 2/3rds of the way done.  No estimate at the present time suggests that the banks have sufficient capital, are sufficiently reserved, or have been honest with their forward exposure.

One-image reduction:

The future, according to the COP:

The nation‘s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and that are very difficult to sell without banks experiencing substantial write-downs that can trigger a return to financial instability.

English: The banks are and have been lying about the valuation of these securities.  Telling the truth, whether "voluntarily", by regulatory demand or by sale of these assets will trigger further instability in the market as the lies will be exposed.