World’s Leading Banks React To Write-Down Pain

Posted In: Banking Crisis, Credit, Derivatives, Financial Sector, Housing, Investment Banks, Level 3 Assets, Mortgages, Subprime, Write-Downs

Rules. We’re all taught to follow them at a young age. You know how to spot someone who has real authority and influence? No, it’s not those chumps who break the rules. Rather, it’s those who change the rules of the game to fit their needs. And that’s what we are witnessing with the world’s leading banks as they confront escalating write-downs stemming from the ongoing housing and credit crisis. Earlier today I came across a post by Elizabeth MacDonald from FOXBusiness. In “Emac’s Stock Watch,” MacDonald wrote:

The world’s leading banks are demanding stock market and accounting regulators relax controversial accounting rules in order to stop the “downward spiral” of huge writedowns during the credit and housing crisis, $335b and counting…

The FT says the Institute of International Finance, an alliance of 300-plus companies chaired by Josef Ackermann, Deutsche Bank’s chairman, is promoting a plan that would let financial companies soften the blow of financial crises by valuing illiquid assets using historical, rather than market, prices.

The IIF says: “The writedowns required under current interpretations [of the accounting rules] may be substantially in excess of any actual or reasonably probable loss on many instruments.”

From what I understand, the issue here is the benchmark, the ABX market index, which might not accurately depict the values for bonds backed by subprime mortgages, as it’s a “thinly traded” index that is barely two years old, according to MacDonald. She explained:

The ABX is a synthetic credit derivative index, or a basket of credit default swaps that are basically high-priced gambling bets on where investors think the direction of the underlying bonds backed by subprime mortgages are headed.

I know this is complicated, but bear with me, it’s important. The swaps in the ABX are basically bets on the prices of the 20 supposedly most liquid (not saying much) subprime mortgage-backed bond deals. It’s an understatement to say booking prices based on this index is accounting that is more art than science…

Can an index based on values for just 20 bond deals legitimately be used for an asset class approaching $1.3tn in size? An index that historically undervalues the cash bonds it purportedly represents? An index noted for its negative sentiment and one that is routinely used by short sellers to attack these securities?

Okay, fair enough. So a new benchmark is needed (easier said than done, I’m guessing). Still, that’s not a good reason for permitting the valuation of illiquid assets using historical, rather than market, prices. But, as MacDonald said, “The bankers want the moon here.” Case in point:

The IIF plan would also let banks decide whether to hold asset-backed securities for as long as they want, freed from accounting rules that would force the banks to hold them to maturity. Instead, they would be able to book these securities on the balance sheet without taking the hit to profits, and then sell them after two years.

I’m not too surprised the banking industry wants to change the rules of the game. As Mayer Amschel Bauer Rothschild, founder of the Rothschild banking empire, once said:

Give me control of a nation’s money and I care not who makes its laws.

Source:

“Bankers Cry Uncle”
Elizabeth MacDonald
FOXBusiness, May 22, 2008

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