Time To Focus On The Real Problem At Hand

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August 12, 2009 04:14 PM

Dear Extended Family,

The economic intervention so far in this crisis has been limited in focus and vast in size.

So far all that has happened of note is that the losing side of the OTC derivatives have been bailed out to pay off the winning side. Yes, there has been some direct economic stimulus, but in comparison it is very small.

There has been much talk about regulating new OTC derivatives but this has nothing to do with the huge and growing mountain of WMDs outstanding. Exchanges have been studying listing derivatives, but so far no exchange can devise a method of accurate valuation and as a result no clearinghouse function is possible. No clearinghouse means no listing of the OTC form of derivative. This also has no application to the standing mountain of WMD paper.

All of the above speaks to financial intervention that has not been focused on offsetting the problem of a mountain of worthless paper that still threatens the financial system and therefore in time, as now, the real economy.

Intervention to stop a downward spiral must be focused on the primary economic factor causing the economic downward spiral. It has not been and now the real economy is in trouble.

The standard principle of Management of Perspective Economics is that markets will impact the thinking of all levels of business. Therefore a positive stock market can offset a deep recession and planners have taken comfort in the appreciation of world equity market indices.

The reason that this is a 1932 type rally is twofold. Nothing has really been done that can be called focused intervention to offset the economic downward spiral, and because problems have spread out of finance into the real economy.

Stay the course.

Do not be diverted by MOPE, SPIN or strong PR of technical opinions to the contrary, a form of spin.

We are far from the end to our problems. Very far.

Respectfully yours,
Jim

Banks’ Toxic Assets Still There: The Accounting Cannot Be Trusted
By Dirk Van Dijk on August 12, 2009

The Congressional oversight panel (COP) of the TARP program is just out with its August report (http://cop.senate.gov/documents/cop-081109-report.pdf). In it, it warns:

“Treasury‘s choice to pursue direct capital purchases resulted in a notable stabilization of the financial system, and it allowed the write-down of billions of dollars of troubled assets and reserve building. But, it is likely that an overwhelming portion of the troubled assets from last October remain on bank balance sheets today.

“If the troubled assets held by banks prove to be worth less than their balance sheets currently indicate, the banks may be required to raise more capital. If the losses are severe enough, some financial institutions may be forced to cease operations. This means that the future performance of the economy and the performance of the underlying loans, as well as the method of valuation of the assets, are critical to the continued operation of the banks.

“For many years, banks were required to mark their assets to market, meaning they listed the value for many assets based on what those assets would fetch in the marketplace. In response to the crisis, banks have been allowed greater flexibility in the way they value these assets. In most cases, we would expect the new rules to have permitted banks to value assets at a higher level than before. So long as they do not sell or write-down those assets, they are not forced to recognize losses on them.

“The uncertainty created by the financial crisis, including the uncertainty attributable to the troubled assets on bank balance sheets, caused banks to protect themselves by building up their capital reserves, including devoting TARP assistance to that end. One by-product of devoting capital to absorbing losses was a reduction in funds for lending and a hesitation to lend even to borrowers who were formerly regarded as credit-worthy.

“The recently conducted stress tests weighed the ability of the nation‘s 19 largest bank holding companies to weather further losses from the troubled assets and assessed how much additional capital would be needed. However, the adequacy of the stress tests and the resulting adequacy of the capital buffer required for future financial stability depend heavily on the economic assumptions used in the tests. As more banks exit the TARP program, reliance on stress-testing for the economic stability of the banking system increases.”

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