Wednesday, June 10, 2009

A New Mark-to-Market World - Banks Lie

In today's Wall Street Journal an interesting article was written that focuses on individuals and corporations who are trying to make a buck by buying bad "toxic" mortgages and then working them out, pocketing some money in the meantime. The problem? They can't find any "toxic" mortgages to buy, at least not at prices they are willing to pay. A passage from the article:

"Initially, we thought there would be a plethora of opportunities" to buy loans, says Mr. DellaCamera, 55 years old, who headed trading at hedge fund Elliott Associates for more than a decade. "But we pulled back from buying these loans because the pricing isn't there and we were having trouble hedging." He calls servicing troubled loans a "tremendous opportunity."

Because most mortgage-loan sales are private, statistics are difficult to come by. Prices currently vary from 20 cents per dollar of unpaid principal for some of the riskiest subprime mortgages to nearly 90 cents on the dollar for current loans to borrowers in strong housing markets, says Kingsley Greenland, chief executive of DebtX, an online marketplace for loans.

Those types of prices would produce losses far greater than most have reserved for, says Keefe, Bruyette & Woods analyst Frederick Cannon. "Banks are essentially holding loans in the system at a value of 97.5 cents on the dollar," he says.

Did you get that? Banks are holding loans "at a value of 97.5 cents on the dollar." Can somebody please explain this too me?

This is the result of the change to Mark-to-Market rules which allow the banks to carry worthless or highly suspect loans on their balance sheets at prices that have no relation to economic value. I think that Mark-to-Market was ripe to be changed, however a return to Mark-to-Fantasy has begun.

Do you ever wonder why just a few months ago the banking system was on the brink of insolvency and all the talk was about nationalization.......and now everything is fine and banks are paying back TARP? I believe the answer lies in the loosening of mark-to-market rules and the fact that banks are carrying loans at near full value when in fact the collateral securing those loans are severely impaired and no improvement is expected. The stress-tests were a joke and the banks are not as clean as we are being led to believe. This should scare you, it scares me.

Scott Dauenhauer CFP, MSFP, AIF