See No Evil, Speak No Evil - The Real Bank Problem

Recently there has been much talk about curbing bankers' bonuses, as if this would make the financial establishment "pure". Other times, and more quietly, there are  stories about the plethora of small banks, particularly in America, that will be going bust. Though this involves several hundred billion dollars, it is actually manageable though tragic.

The real problem no one talks about, however, is the several trillion dollars of obligations banks have that are de facto worthless. Why not? Well at the stroke of a pen the US FASB has effectively suspended the mark-to-market accounting rules for them.

I doubt if anyone knows how much of these worthless assets  banks have, including the banks themselves. Basically much of this is Credit Default "Securities" and other junk the banks had young computer wizards create, who knew little to nothing about banking and finance. Nevertheless, some large banks peddled trillions of this drek all over the world with what  in hindsight looks like superficial explanations. When things started going awfully bad, like the subprime mortgage crisis back in 2008, Guido gets the impression that nobody knew what they created, including those genius computer wonks.

Simply stated, mark-to-market is an accounting rule that requires those who have marketable securities < bonds, stocks etc > to show the market value of these assets at the balance sheet date < balance sheet being the statement of assets / liabilities, for you tyros >. If these marketable securities are more than a firm's purchase price, they would be valued upward and a profit shown. If less, valued downward and a loss shown.

Sounds simple, doesn't it?

Well the only problem for banks is much of this CDS sledge, particularly level 2  "securities", is worthless. Guido seems to recall back in September 2008 one brokerage firm trying to peddle this stuff in the open market. I think they got 10c on the dollar. One large money center bank had close to a trillion dollars of this garbage in October of 2008, as I recall. Probably still does today, for that matter.

The giant banks and their brokerage divisions liked the idea of manufacturing these "marketable securities". That way they weren't restricted by certain capital and reserve requirements; and  were able to leverage their liabilities thirty or more times against their equity. Regulators, including Greenspan and Bernanke's Fed, didn't seem to care. Maybe because it was an "off balance sheet asset" hidden in the financial statement footnotes. < Yeah, I know, that's no excuse. >

Bear in mind that only the most speculative hedge funds were this leveraged.

Well with the mark-to-market rule  suspended in March 2009, banks don't have to admit to any CDS losses, even if they still have the burden of owning this crap and are probably de facto insolvent. In other words, bankrupt. As Guido mentioned to one "billionaire"  < maybe he's worth a little less now >  the banks can make up whatever profit they want. He agreed.

By coincidence < probably not >, the stock markets, particularly bank stocks, started also moving up in March. And have been moving up until recently. The ten most active stocks on the NYSE are usually  financial or related firms < like GE >, at least the times Guido looked. Overall volume traded many times has been anemic.  Judge for yourself how solid this current  market rally is.

Many would consider this an oversimplification and even contend Guido's summary is incorrect. For example, they would argue that the mark-to-market rule isn't that old, some contending it  being in effect only the last 4 years. Others saying it's been around with FASB  157 since 1993. Guido however seems to remember when he took a qualifying test in "the financial area" < more years in fact than he cares to recall >, that this rule has been around  in some guise  for tens of years, maybe even since the 1930s < Guido is not that old >.  Regardless, others in the investment business have agreed with Guido, the latest being someone at a large mutual fund family.

If it walks, talks, and acts like a duck, it's a duck. No matter what disguise covers it.

Many < most? > banks are broke.

"Bro. People like you and me don't mean anything. It doesn't matter what we think - we're told what to think." - The Silence of the Rain by Garcia-Roza