You know that phrase, “You can’t have your cake and eat it too”? Well aparently you can if you’re a US bank.
The US suspended all mark to market requirements for bank assets back in 08. Since the banking crisis took hold and bank assets became valueless, banks have been allowed to ignore this incovenient fact and mark their assets at whatever value they felt was appropriate. It turns out what is most appropriate for the banks, is almost full value for almost all assets. A complex and technical valuation process it takes years of study and more years of experience as a Wall Street Professional, as well as being naturally very, very smart and extremely well paid, to figure out.
You see you and I might have a worthless asset. And it would be worthless because we are stupid. We might, for example, have once bought a kipper tie and flared cordroy trousers thinking together they were a stunning ensemble which made us look SEXY! Since purchasing these valuable assets we have come to see that they are indeed quite eye-poppingly stunning but not in quite the way we had thought. For you and me, these ‘assets’ are now worthless and the best thing is to move on and not draw any attention to them.
If you are a bank, however, there are no worthless assets. There are ‘impaired’ assets. That is, assets which used to have a great value, and will again, just as soon as the market for them returns to its former robust health. Now this resurrection apparently will work for securities and derivatives of all kinds based on defaulted and ransacked houses, but not for kipper ties and bell-bottoms. You see our mistake? And why those bankers are so smart. They knew! We didn’t.
So while the banks wait for this ‘resurrection’ to happen they don’t need to mark their assets to market price, they just adjust the name to ‘impaired’ and retain the original value.
Now that to me, is the ‘having your cake’ bit.
Here’s how they manage to eat it too.
While banks reject mark to market for their, assets which would loose value if so accounted for, they are very keen on marking their debts to market. Assets no, debts yes.
While the accounting rules for marking assets to market were suspended during the crisis and are still susupended, another rule, called Statement 159, allowed banks to mark all their debts to market as aggressively as they like.
The way it works is that the value of a bank’s bonds (It’s debt) goes up and down in the bond market. When times are good, and everybody is sure a bank (or any any bond/debt issuer ) is going to repay their debts/bonds, then the value at which they are bought and sold goes up. When times are bad, like in the Credit crisis of ’08 for example, or NOW, when everyone is worried the bank might go under and not repay its bond debts, then those debts are less sought after and trade for less. They loose value and become cheaper to buy as people want to get rid of them. This is what has happened to the value and fear associated with bank debt this last quarter.
Now, the key is that when the value of a bank’s debts declines, IF the bank were then to buy back its own debt, it would be cheaper to do so. Got that?
When the debt was worth a lot it would be expensive to buy it back. When tis cheap it would cost less. The difference can be booked on the bank’s accounts as a PROFIT. And not just a little profit. Bank of America is expected to book a billion dollars in proft this quarter from the decline in the value of itsown debts.
Now think about this for a minute. It is when the bank does badly, and fears for its solvency go UP, as measured everyday by the increase in the cost of insuring that debt (CDS cost) – THAT is when the value of its debt goes down and it books a profit.
Statement 159 allows banks, Bank of America, for example, WHEN it has not done so well this quarter, to nevertheless report an increase in proftis, due to the decline in the value of tis debt. And that ‘profit’ based on and as a direct result of the bank doing worse, the worm-brained financial media will describe as ‘healthy’ – profits are aways healthy. BoA is not alone. According to Citigroup analyst Keith Horowitz, Morgan Stanley will probably record $1 Billion in the second quarter. That will be about 60% what analyst’s forecast for the bank’s pretax income.
That to me, is definitely ‘eating the cake too’.