Regulatory

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.

Amusing how Bloomberg comes out pumping the CDS monster:

March 11 (Bloomberg) -- European politicians and regulators could initiate a continent-wide ban on speculative trading of sovereign credit-default swaps tomorrow. Making it stick without the Americans won’t work.

Oh there you're simply wrong, my friends.  The assertion is made:

“You need to get the U.S. on board, otherwise the effect will be minimal because trading will simply move elsewhere,” said Jan Hagen, head of the financial services group at the European School of Management and Technology in Berlin. “A ban would allow European politicians to tell voters at least they’re doing something.”

On the contrary.

EU nations can pass laws and regulations that make the collection of bets placed in this fashion unenforceable.  That is, you're free to write all the swaps you want over in London, but you can't force anyone in the EU to pay when the bet goes against them.

This, incidentally, is exactly what the Dutch did when Tulip Mania blew up.  They declared all the contracts that had been written against Tulip Bulbs (which were an awful lot like a CDS!) to be unenforceable gambling contracts and thus void.

POOF!

Such a law, if passed EU-wide would make the European Union a haven for corporations and even banks.  No longer could you be attacked within the EU - and frankly, who gives a tinker's damn what London or Wall Street thinks if they can't reach into your firm if and when their contracts go bad!

Oh, and if you think the Europeans don't have a real solid reason to do this either individually as nations or collectively, you're wrong.  Italian cities, for example, appear to have been scammed with swap contracts written in English rather than their native language by a bunch of High Street shysters.  They're now bleeding from all orifices on these "deals" and looking for a clean way to stop it. 

This is the way to do it and it's entirely within their rights as sovereign nations to do so, just as it is ours.

Should the EU do so America would be forced to go along, lest it be effectively depopulated in terms of large financial and industrial concerns.  Same with Britain.

So go ahead and put forward this sort of BS "firebreak" kind of argument, Bloomberg.  It's abject nonsense.

The creation of a "safe haven" where fraudulent swaps are no longer enforceable would be of tremendous benefit to the western world. 

If London and Wall Street have managed to bribe their respective governments to a degree that makes banning fraudulent conduct impossible, then we will simply have to look to the Europeans to take the proper - and long overdue - step forward in fixing this problem, and suffer the consequences in the loss of both jobs and companies that come from the "big banks" obfuscation and BS.

Will this man ever take responsibility for what he does?

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: "Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans."

How did that happen Mr. Frank?

Oh yeah, I remember!  Your committee pressured FASB to drop "mark to market" accounting requirements last year!

That is, YOU were personally responsible for this crap.

Remember the subcommittee hearing chaired by your fool-in-chief Mr. Kanjorski?  I remember that circus show of horrors well.  In case you've forgotten, let me help jog your memory:

Washington, DC – Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, today announced that the Subcommittee will hold a hearing to examine the mark-to-market accounting rules that many contend have exacerbated the current troubles in the financial industry and in the broader economy. The standard requires companies to value assets they hold at current market values. For assets that are frozen and have a diminished current market value but may recover value in the future, the standard has proven problematic. Companies are then forced to write-down billions in assets, which can lead to further write-downs elsewhere.

Like second mortgages, for instance?

Yeah.

This hearing was what prompted those banks to mark those loans to fantasy values, a practice they are still continuing to this day, even though if the first is underwater and goes into foreclosure the second is in fact worth zero. 

Therefore, a first that is both underwater and is late by 60 days or more is almost certain to either short sale or foreclose ultimately, and under mark to market rules the second would have to be written off.

But your committee, which sits over the subcommittee on Capital Markets, effectively bludgeoned FASB into legalizing the accounting fictions that you now complain about.

Indeed, the testimony of FASB was that:

The fact that fair value measures have been difficult to determine for some illiquid instruments is not a cause of current problems, but rather a symptom of the many problems that have contributed to the global crisis, including lax and fraudulent lending, excess leverage, the creation of complex and risky investments through securitization and derivatives, the global distribution of such investments across rapidly growing unregulated and opaque markets that lack a proper infrastructure for clearing mechanisms and price discovery, faulty ratings, and the absence of appropriate risk management and valuation processes at many financial institutions.

None of which, I might add, your Committee has bothered to address.

Having done nothing but bleat and ram down the throat of FASB changes in accounting standards that have legalized outright balance sheet fraud, you now have the temerity to complain about the results, when I and many others said at the time this would be precisely what would happen.

The solution to the problem is, of course, to reverse the outcome of that idiotic hearing and restore mark-to-market accounting forthwith for all bank assets.

Go look in the mirror Mr. Frank - you made this mess yourself, and while you're at it drag that clown-car occupant Kanjorski with you.

In what I can only describe as a self-serving piece for keeping banking "exactly as it is" (which is inherently unsustainable and thus can't be) IRA tries to refute the value of mark-to-market with a stunning piece.

Finally, on April 2, 2009, FASB allowed banks to use "cash flow" to value bonds when the market was illiquid - exactly like Bernanke said last week. This fixed the immediate problems in the system, and the economy and financial markets have been on the mend ever since. In fact, the stock market bottomed on March 9, 2009 - the very day markets found out that Representatives Barney Frank and Paul Kanjorski would hold a hearing to force FASB to change the misguided accounting policy.

No it didn't.

Remember FHLB Seattle again?  Their "at market" losses on a portfolio of trash, er, loans was some $300 million.  They claimed that the real loss to be realized over time was in fact $12 million, using model-based accounting.  After all, these loans, while deeply underwater, weren't really impaired.

Or so they told Congress.  I remember the testimony well.

But now, one year later, they are suing the banks that packaged up all this dog squeeze.  Among the pieces of trash being sued over are the very same securities against which they said that a model-based valuation system showed a tiny $12 million loss.

Are they suing for $12 million?

No.

That "tiny $12 million loss" in fact is some $311 million - almost exactly what the market price predicted it would be.

Remember, this was in the "depths of hell" time period too - March of 2009.  It was when the entire world was coming apart, Satan was chortling at the fate of our financial system and the S&P 500 traded - literally - at 666.

Yet that view - that market view - was correct.

To the regulators, it does not matter if the loan is still being paid on time. And it does not matter if the lower valuation of the collateral will force an already stressed borrower to come up with more cash. Regulators have decided that they want banks better capitalized and the way they can do that is to reduce the value of a bank's assets and then force these banks to raise money from shareholders.

It shouldn't matter to the regulators.

As I wrote months ago, the solution to this problem is One Dollar of Capital:

The solution is very simple, but you will notice that Jamie doesn't bring it up.  That's because he finds it unacceptable.

What's that solution?

Prohibit as a matter of Federal Law, and enforce it vigorously under pain of immediately dissolution, THE LENDING OF MONEY UNSECURED THAT EXCEEDS THE FIRM'S CAPITAL.

This is in fact the only way you can both end "too big to fail" and not constrain size or influence.

It is also the definition of sound lending.

It is also how lending was done prior to the banksters corrupting the government and literally usurping the sovereign credit of The United States.

This is what the regulators are trying to back into.

It is the right thing to do, because it is the definition of sound banking.

ONE DOLLAR OF (EXCESS) CAPITAL FOR EACH DOLLAR OF UNSECURED LENDING.

You enforce this, the problem with systemic risk disappears.  Banks can fail without harm to anyone else.  Banks can take all the risk they want - with their shareholders and subordinate bondholders money - but never with depositors or secured bondholders money.  At the point those bets go bad and deplete their excess capital the bank is closed - right then and there.

All secured lenders to the bank get their money back. 

All of it.

All depositors get their money back. 

All of it.

The shareholders and unsecured lenders to the bank take a haircut, which is determined by the actual over-time performance of the outstanding unsecured lending.

The FDIC Deposit Insurance Fund loss, if this regulatory framework is applied and enforced, is always zero.

This regulatory regime exactly matches the bank's lending risk with the expected risk of lending money to the bank.  Those who lend unsecured (e.g. shareholders and subordinate bondholders) have lent money with the expectation that they might lose it.  The bank in turn has lent out capital with the expectation that it might not be repaid.

The secured lenders to the bank - senior bondholders and depositors - lent their money with the expectation that it was a secured loan.  The bank in turn lent that money out secured by an asset that is valued (each and every day) at or above the loan balance.

Statutory law sets a reserve ratio (cushion) between secured lending out and secured capital in.  This gives the market room to move against the bank on the valuation of those secured loan assets without causing the bank to fail.  Management is free to increase that ratio should it desire, but not to dip under it (if they do, the bank gets closed.)

But for each dollar of unsecured lending that is out there from the institution, that bank must hold one dollar of excess capital beyond statutory requirements.

If it does not, at any time, then the bank is closed, haircuts may happen, and the bank's management loses their jobs.

This is the only stable fractional lending system that can be constructed folks. 

It remains difficult or impossible to find support for it precisely because it is so simple and yet it absolutely prevents the playing of "Heads Management Wins, Tails Taxpayers Lose."

If we want a stable financial system, we must impose this, and I call upon IRA, along with the other folks in the private and government sector, to wake up and smell the math.

I am constantly amused by those people who claim there is some vast "conspiracy" in this country when it comes to banks, balance sheets, and fraudulent lending and accounting.

There is no conspiracy.

It is, in fact, "in your face" fraud.

The FDIC does us the courtesy of explaining it virtually every Friday night, right on their web page.

I am simply going to take last night's bank closures, which numbered four.  One of them has no "deposit insurance fund" estimated loss available, because they didn't find someone to take the assets - they're just mailing checks.  But the other three do.

• Waterford Bank, Germantown MD: $155.6 million in assets, $156.4 in insured deposits.  They were "underwater" by $800,000, right?  Wrong:  Estimated loss, $51 million.  That is, the assets of $155.6 million were overvalued by approximately 30% at the time of seizure.
  
  
• Bank of Illinois, Normal IL: $211.7 million in assets, $198.5 million in deposits.  They were "underwater" by $13.2 million (which is why they were seized), right?  Wrong: Estimated loss $53.7 million.  That is, the the assets of $211.7 million were overvalued by more than 25% at the time of seizure.
  
  
• Sun American Bank, Boca Raton FL:  $535.7 million in assets (so they claimed anyway), $443.5 million in total deposits.  Heh, why did you seize them - they have more assets than liabilities?  Oh wait: Estimated loss: $103.8 million, so the actual assets are worth $443.5 - $103.8, or $339.7 million.  That is, the assets of $535.7 million were overvalued by a whopping 37% at the time of seizure.

This isn't new, by the way.  In August of 2009 I went through Colonial Bank's failure based on BB&T's presentation to its shareholders on the "merger" - and gift it was given by the FDIC.  It too showed that Colonial had been carrying assets on their books at a ridiculous 37% above where BB&T ultimately marked them as a whole.

Folks, your bank is being assessed deposit insurance premiums to pay for these losses.  You are paying these losses through increased fees and interest expense on your credit cards and all other manner of borrowing.

You are paying for outrageous, pernicious and endemic balance sheet fraud.

There is no conspiracy.  It is right under your nose.  One of these three banks, based on their balance sheet, wasn't even underwater - it was "to the good" by nearly $100 million dollars.

The balance sheet was a flat, bald-faced lie.

You want to sit for this?

Why should you?

Now let's ask the inconvenient question:

Are the big banks - specifically, Citibank, Bank of America, Wells Fargo and JP Morgan - all similarly overvaluing their assets?

Why should we believe they are not?  You can go through more than a year's worth of FDIC bank seizure information and in essentially every single case you will find that overvaluations of somewhere from 20-50% have in fact occurred, yet not one indictment for book-cooking has issued.

So let's be generous and assume that the "big banks" are over-valuing their assets by 25% - the lower end of the range of what the FDIC says is, through actual experience, what's going on, and add it all up.

Bank of America shows $2.25 trillion in assets.

Citibank shows $1.89 trillion in assets.

JP Morgan/Chase shows $2.04 trillion in assets.

And Wells Fargo shows $1.31 trillion in assets.

This totals $7.49 trillion smackers.

The FDIC's experience with seizing banks thus far suggests quite strongly that all four of these entities are lying about these valuations, and that were they to be seized the loss embedded in them (and for which you, the taxpayer would be responsible) is somewhere between $1.49 and $2.99 trillion dollars.

Incidentally, neither the FDIC or Treasury happens to have either $1.49 or $2.99 trillion laying around, and it is highly questionable if they could raise it, should that become necessary.

Now of course neither you or I can prove this is correct.  However, we can look at the FDIC's own published bank closing statements, and derive from them a pattern stretching back more than a year now that has disclosed that in essentially each and every case the banks in question have overvalued their assets by anywhere from 20-40%, and that as of the day of the seizure such an overvaluation was in fact a continuing and ongoing practice.

Back in the beginning of 2009 we had people argue that "mark to market" was invalid - that in fact the market-based pricing losses that were being claimed were ridiculous and would never happen.  One of the claimants was the Federal Home Loan Bank of Seattle, which said that the $300 million in mark-to-market losses would not actually happen - that the real loss was only going to be $12 million dollars.

FHLB Seattle recently filed suit against the bundlers of this trash, claiming, surprise-surprise, that the real loss is not $12 million, not $300 million, but $311 million - on that bundle of trash alone.  In all they are seeking $2 billion in damages.

We have now learned, a year into this "experiment" with mark-to-model promulgated at gunpoint by Congress that:

1. The banks indeed have been lying about asset valuation and the proof comes in the form of the FDIC seizures, which in essentially case have documented massive and outrageous overvaluation of assets on bank balance sheets.
   
   
2. The claimed "mark to model" losses, which were tiny compared to the market-price losses, were in fact fictions, to the point that the poster child of the "mark to model" argument is now suing the purveyors of the instruments supposedly not to be marked to the market for losses that exceed what the market-based loss was back in March of 2009. 

If you wish to argue that the economy and banking system are recovering their health, you must deal with this.  If indeed large bank balance sheets are concealing a deficiency of somewhere between $1.5 and $3 trillion in losses not only will the economy and lending environment not recover it can't as the large banks all know the truth.

I believe this is why those very same banks are hoarding cash.  I believe they know that at some point in the future - a point not under their control - the truth may come out and if it does an instantaneous run would occur - not just on their bank, but on all banks.  Such an event could be defended against only with a huge cash hoard - a hoard that, if they lend out said cash, would not be available to them.

The Federal Reserve knows this too.  I believe this is why there is nearly $1 trillion of "excess reserves" sitting at The Fed, up from nearly zero prior to the crisis - it is these large banks' "backstop" against a potential run should the truth of their balance sheets reach public conscience.

The political and regulatory bottom line is simple: As I have repeatedly maintained for nearly three years, we now have the facts from our own government agencies, most particularly the FDIC: The banks have been and still are cooking their books in a manner that intentionally overstates their asset valuations - an act that is exactly identical to that which brought down ENRON.

Something to think about on this fine weekend.