The key to unfreezing the credit markets is the scrapping of Mark to Market Valuation. Because of the U.S. Generally Accepted Accounting Principles (GAAP) bank assets are valued at Mark to Market. Many of these assets, Mortgage Backed Securities (MBS) and other derivatives have drastically dropped in value because of this method of valuation. The Treasury Department and the SEC have branded these types of assets as toxic. However, the reality is that many of these so-called toxic assets are still earning the same return as when they were first bought by the financial institutions. Therefore, even if a bank is very profitable it may not pass the Feds’ stress test, and the Feds may opt to re-capitalize it with bail out money thereby subjecting it to compensation and bonus restrictions. A bank may be considered by the Feds as a troubled institution even if it is drowning in money.
An alternative method of valuation which many economists are now advocating is the Cash Flow Method. As a simple explanation, the Cash Flow Method of valuation takes into consideration how much income the company receives from the so-called toxic assets rather than how much those toxic assets are presently worth. If this valuation method is used, financial institutions will start lending again because they will show a stronger balance sheet, presumably taking them off the government hit list of troubled financial institutions.
Geithner’s “plan” which was revealed yesterday is a hybrid of the solution I proposed in DidoSpin 03/08/09. It appears that the government will indeed create an entity to buy toxic assets (MBS). The difference is that the government will solicit investors from the private sector to partner with in buying the assets. With $1.25 trillion to spend, the government, in partnership with private investors hopes to acquire the assets at close to their toxic asset prices. Obviously the banks will try to get as much money as they can for them. This is a win-win situation because the banks’ stocks will increase in value as soon as the toxic assets are sold and when the housing market recovers as it always does the government’s holdings will increase in value and the government will make a hefty profit. If Wall Street is in favor of the “plan” and liberals are against it, then I am for it.
Any opinions and views herein are the sole responsibility of the writer.