Archive for March 2009
The title says it all: my next blog post will likely be up in August 2009, thanks to a four month sabbatical. Hopefully by the time I return from Southeast Asia / New Zealand / Fiji, the various Fed & Treasury efforts will be having a lasting – positive – effect on the economy. Regardless of if things will look better or worse, I am going to be back with charts and commentary on Wall Street and DC in the summer. In the meantime, feel free to continue to leave comments on my previous posts (they’ve been a huge source of value-add so far, thanks to all who contributed!); I look forward to picking up where we left off later this year.
FAS 157, the accounting rule requiring financial institutions to mark their assets to market, has frequently been cited as a factor exacerbating the crisis. Steve Schwarzman is a vocal opponent of the mark to market rule in its current form, arguing that “the rule is accentuating and amplifying potential losses.” And while I’m sure an accounting rule is not the cause of the mess we’re in, I don’t always see the cause for marking assets to market – especially if they are fixed income products intended to be held to maturity which suffer primarily from a lack of liquidity in the market and only secondarily from fundamental impairment.
Today there’s talk of potential changes to FAS 157; at a minimum, it seems like we can expect to see some guidance on the application of the rule that might qualify or relax the mark to market requirement. I haven’t yet made up my mind if I should like this development – one half of me appreciates the potential relaxation based on the above reasoning (liquidity vs. fundamentals), but the other half fears that a decrease in transparency may cause prolonged or additional trouble down the road.
In addition to the impact FAS 157 has on asset markdowns, though, there’s another important side effect of the rule that tends to be forgotten: financial institutions know that they will have to mark their books to market, using whatever price comparable securities last traded at when they value the securities still on their books; as a consequence, when banks unload parts of their portfolios of toxic assets, they will make sure to sell those securities that are of good enough quality to find buyers at the price that the bank’s’ book was last marked at – otherwise the bank would not only take an additional loss on the assets it is selling, but it would also have to take further writedowns on the securities remaining on its balance sheet. In an environment like today – i.e. one of continuously deteriorating fundamentals – this means that sellers will have a strong incentive to sell higher quality assets first. The result: increasing toxicity of the assets left on the balance sheets of financial institutions. Where’s the silver lining?
Over the last few months we’ve seen a drastic increase in bank reserves. As I’ve pointed out on previous occasions, banks are soaking up the liquidity provided by the Fed’s various programs and the credit crunch continues. But what’s the reason? Is it that banks are unwilling to lend in the current environment, trying to cap their losses? JPMorgan recently argued that it’s not the supply of credit that has collapsed, but the demand for it – consumers are hunkering down and have lost their appetite for spending; businesses that suffer from weak demand don’t require as much credit as they do in prosperous times; and hedge funds have grown weary of leverage. It’s a bit of a chicken and egg problem, but what do you think: is the credit crunch driven by the lack of supply or the lack of demand?
The money multiplier is money stock M2 (money & close substitutes for money) over monetary base M0.