NOW FASB Wants To Do The Right Thing?

This is unbelievable:

The war over mark-to-market accounting is about to get hot, again. In coming weeks, the Financial Accounting Standards Board is likely to propose that banks expand their use of market values for financial assets such as loans, according to people familiar with the matter. That departs from current practices in which banks hold loans at their original cost and create a reserve based on their own view of potential losses. 

Let's cut the pump-monkey crap and recall for everyone exactly how that "current practice" came to be, shall we?

Back last spring as I have written about more than once, the dishonorable Mr. Kanjorsky, Barney Frank's stooge, held a hearing in which he basically put a gun to FASB's head and informed them that they would allow banks to mark their loans to model - or Congress would introduce a law overriding FASB.

FASB objected, but it didn't matter.  In the end they relented.

This was the catalyst for the huge rally in the stock market.  It was a declaration of legalized accounting fraud from the people who oversee financial accounting matters.

Now, a year later, after Barney Frank comes to realize that it was precisely this "gun up your butt" approach to financial regulation that has made all efforts to modify home loans (including cramdowns) worthless, we see some effort to change things.

Why does it make modifications worthless?  Simple - a second loan behind an underwater first (e.g. a HELOC) is worth zero if the first is underwater and forecloses.  That's because it is a subordinate lien and is only entitled to be paid (at all) if the first is fully recovered.  In a case where the first is underwater, it won't be recovered; ergo, the second is worth exactly nothing.

But "mark to fantasy", otherwise known (by me anyway) as legalized accounting fraud, has these banks carrying the loan on their books at or near 100 cents on the dollar.  That's because "the loss hasn't happened yet", so since they're entitled to "model" a potential outcome 30 years in the future, they can say "well property prices won't stay down for that long, so we don't have to take the loss!"

It's bogus of course as the odds of someone paying on an underwater loan for a decade are close to zero.  Anything that interrupts the borrower's cash flow - a loss of job, a medical problem, or simply being tired of taking it in the cornhole month after month while they could buy a house across town for half the price - results in a foreclosure, because the property isn't worth enough to sell and extinguish the mortgage.

Under mark-to-market rules banks had to price these loans at the current market's appraisal of their worth.  Thus, as home prices declined and people were more and more underwater the market price would fall toward the zero that would be recovered if the foreclosure happened.  This would in turn make the foreclosure no more damaging to the bank balance sheet than not foreclosing, and thus, the market would tend to clear.

But no!  We can't have that!  So instead we have this fantasy.  The consequence is banks letting people live in a house that they haven't made a payment on in a year - and sometimes two.  Nobody cares if the loan is performing or not, because it was probably sold to some poor bastard and the servicer is advancing interest payments anyway!  Moody's, S&P and Fitch keep downgrading these bonds in a furious fusillade, but nobody cares at the bank, because the bank doesn't hold that paper - some fool pension fund does.

(What's left unsaid there, of course, is that said pension fund might be getting their interest payments now, but they sure as hell will not get the principal at maturity - because it doesn't exist.  What that will do to the pension funds is obvious, but heh, so long as the banks get to lie, it's all ok that pensioners get screwed, right?)

What the bank holds is the HELOC and they are often the servicer as well.  They have a terrible conflict of interest in this regard because if they foreclose then the HELOC is worth nothing, and they take the full dollar hit right here and now.  If that was to be done across the board with these delinquent loans my analysis shows that many banks Tier 1 common equity levels would be forced below regulatory minimums and in some cases would be destroyed altogether.  The latter would force immediate FDIC seizure.   It is thus cheaper to advance the interest payment to the bondholder and pretend, even though the payments aren't coming in, praying that somehow the borrower who hasn't made a payment in a year will suddenly come up with $25,000 to "come current."  (Yeah, right.)

Let me be absolutely crystal-clear - this is an outright scam promulgated by the same jackassery in The Government (SEC, Treasury and Congress) and The Fed that led to the destruction of Lehman.  Instead of forcing these institutions to take their marks and admit to their losses they were allowed to put forward abjectly false and misleading financial statements.  In the case of Lehman it appears the law was broken.  But in the case of the big banks today Congress got the rules changed by shoving a gun up FASB's nose so as to make the INTENTIONAL false reporting of asset values a lawful act.

This should have absolutely never, ever happened and those dishonorable knaves in Congress responsible should resign NOW.

These banks should have been taken into receivership by the FDIC and closed.  We would still have the $3 trillion we have blown trying to prop up the economy - well more than enough to pay off the depositors when the assets were liquidated.  Deposits would have been dispersed to strong community banks, lending them further strength and ability to lend to qualified borrowers.  The scam-meisters on Wall Street would have lost their jobs and been closed down, we would have taken a horrific hit in the market but it would now be over and the economy would truly be on the mend.

Instead we lied and pretended, creating a false dawn and a market rally based on nothing more than a scam.  This cannot hold indefinitely, and yet the conditions for a true recovery in those asset prices will not happen for over a decade - if ever.  If we do not stop this insanity cash flow will force the issue eventually and by then The Government will have blown its wad furiously trying to replace 10% of GDP in the private market, as it has for the last two years, and thus be unable to fund the FDIC deficiency.

The simple fact of the matter is that as I have written about for over three years I absolutely believe that if valued on market prices these banks were insolvent then and are today.  Hiding the fact of that insolvency with bogus accounting fictions does nothing to solve the problems that face us and in chokes off lending, prevents markets (especially housing and commercial real estate) from clearing and will absolutely prevent any durable economic recovery from occurring.

Oh yes, it has pumped the stock market to the moon, but the test is not whether the stock market goes to the moon - it is whether the market price reasonably reflects underlying fundamental value, and there the evidence is clear - it does not.

The danger here from continued obfuscation could not be more grave.  We may have already passed the point where the government is capable of funding the deficiency to come in the FDIC accounts, but if we do not stop this crap, it is a certainty that such will occur, exactly as did in Iceland.