Interesting and not entirely pessimistic take on the markets

[John Adams]

From today's WSJ. I'd link it but you need a subscription.

 

'Wall Street' No Longer Exists

 

By ALAN REYNOLDS

 

With Goldman Sachs and Morgan Stanley becoming commercial banks, and the other three big investment banks/brokerage houses being acquired by commercial banks, politicians and the press won't have Wall Street to kick around anymore. Headlines now shout about a $700 billion "Bailout for Wall Street." Yet strictly speaking, Wall Street as we knew it no longer exists.

 

The conversion or absorption of all five of Wall Street's big investment banks into commercial banks raises several intriguing issues.

 

First of all, the financial storms over the past year have -- before last week -- been largely confined to securities markets and to interbank loans among commercial and investment banks. Bank loans to commercial and industrial business, real estate and consumers continued to expand nearly every month. Commercial and industrial loans exceeded $1.5 trillion this August, up from less than $1.2 trillion a year earlier. Real-estate loans exceeded $3.6 trillion, up from less than $3.4 trillion a year ago. Consumer loans were $845 billion, up from $737 billion. Credit standards are tougher, which is surely a good thing, but interest rates for creditworthy borrowers remain low.

 

The ongoing slow but steady availability of bank credit helps explain the much-remarked contrast between Wall Street and Main Street -- the shaky condition of exotic financial markets compared with relatively benign statistics for industrial production, retail sales, employment and the rest of the nonhousing economy. Most people go about their business without depending on investment banks or exotic varieties of commercial paper.

 

Second, recent events highlight the absurdity of the attempt by several pundits to blame recent problems on "financial deregulation." That complaint was aimed at the Financial Modernization Act of 1999, which passed the House by a vote of 362-57 and the Senate by 90-8, yanking the last brick out of the 1933 Glass-Steagall Act's regulatory wall between commercial banks and investment banks.

 

...

 

Since the 1933 regulatory wall has collapsed as definitively as the Berlin Wall, all the giant financial conglomerates now face oversight and regulation by the Federal Reserve, the Securities and Exchange Commission, the Comptroller of the Currency and the Federal Deposit Insurance Corp. Innocents who seek security in regulation need to recall, however, that not one of those august agencies exhibited timely foresight or concern about the default risk among even prime mortgages in some locations, or about any lack of transparency with respect to bundling mortgages into securities. People do not become wiser, more selfless or more omniscient simply because they work for government agencies.

 

Wall Street was always a metaphor, of course, but so are words like "bailout" and "toxic" debt. Nationalization of Fannie Mae and Freddie Mac was a bailout for creditors (who received windfall gains), not for stockholders or executives. The federally enforced shotgun marriage between J.P. Morgan and Bear Stearns at the initially ridiculous price of $2 a share was no bailout for Bear. The 11.3% federal loan to AIG, contingent on the potential expropriation of 80% of shareholder value, is no bailout either.

 

By contrast, what was done to stop a run on the money-market funds is a real bailout which could encourage them to hold risky paper and also make it tougher for commercial banks to attract deposits. The proposal to buy up mortgage-backed securities is a bailout too, though the beneficiaries are not just the tattered remains of Wall Street. The bailout consists of shifting the risk of loss to taxpayers. Actual losses could not reach $700 billion unless the securities were literally worthless, which would mean the value of the underlying real estate fell to zero.

 

What was "toxic" for investment banks is not equally toxic for the Treasury Department because the government does not even bother to keep a balance sheet, much less abide by mark-to-market accounting rules. A powerful motive for converting investment banks into commercial banks is to get around those onerous balance-sheet rules that required fire-sale pricing of securities that were virtually unmarketable during a panicky scramble for liquidity. Strict adherence to those rules made patience a vice and a "buy and hold" approach impossible. This confirms what many of us have long been saying about the foolishness of letting arbitrary bookkeeping rules dominate economic reality.

 

Turning Wall Street into a bunch of commercial banks is a solution of sorts to a problem aggravated by foolish mark-to-market regulations, not by the inevitable demise of the 1933 wall between investment banks and commercial banks. Something good may yet come out of all this, because that wall never made much sense in the first place.

[Chilly]

Don't need a subscription...

 

http://wsj.com/article/SB122212959612065505.html

[DC Tom]

From today's WSJ. I'd link it but you need a subscription.

 

Yes, but what about in Second Thessalonians where it says "You're all screwed unless you buy silver..."?

[John Adams]

Yes, but what about in Second Thessalonians where it says "You're all screwed unless you buy silver..."?

 

I have lots of silver. I melt it to form bullets in preparation to kill the soon-to-come undead.

 

Of course, I don't have a gun to fire the bullets but I'm getting to that.

[John Adams]

Don't need a subscription...

 

http://wsj.com/article/SB122212959612065505.html

 

 

Thanks. That site is so subscription-driven that I never knw when I'm in an open part or a subscription part. I just assume it's all subscription.

[bills_fan]

What was "toxic" for investment banks is not equally toxic for the Treasury Department because the government does not even bother to keep a balance sheet, much less abide by mark-to-market accounting rules. A powerful motive for converting investment banks into commercial banks is to get around those onerous balance-sheet rules that required fire-sale pricing of securities that were virtually unmarketable during a panicky scramble for liquidity. Strict adherence to those rules made patience a vice and a "buy and hold" approach impossible. This confirms what many of us have long been saying about the foolishness of letting arbitrary bookkeeping rules dominate economic reality.

 

Turning Wall Street into a bunch of commercial banks is a solution of sorts to a problem aggravated by foolish mark-to-market regulations, not by the inevitable demise of the 1933 wall between investment banks and commercial banks. Something good may yet come out of all this, because that wall never made much sense in the first place.

 

This is absolutely the entire point of the rescue package.

 

Anyone disagreeing with it or not understanding it should read and re-read these two paragraphs until they get it.

[GG]

This is absolutely the entire point of the rescue package.

 

Anyone disagreeing with it or not understanding it should read and re-read these two paragraphs until they get it.

 

I'm guessing it's the bolded part.

[Chilly]

It seems intuitively that Mark to Market rules would cause inaccurate accounting. What is the original intent behind them?

[Dwight Drane]

Oh...the collapse of the financial system is so yesterday's news. I've moved on to getting the masses riled on the football board by suggesting we could use a crafty vet at WR.

 

I guess I sort of enjoy the mocking at this point. I wish I could quantify in direct proportion the amount of mocking to the void in the mocker's soul that causes one to mock. I am sure there are plenty of people that quietly lurk in the background that have at least gone "Hmmmnn???...." enough times now to be prepared for what is happening. I'll take the "pain" in that case.

[GG]

It seems intuitively that Mark to Market rules would cause inaccurate accounting. What is the original intent behind them?

 

Define "accurate."

 

Accounting for illiquid financial instruments is very complex, and a lot of it involves human judgment. That's why people are up in arms that the collapse of the firms is artificially driven. The Fed/Treasury funding will at least solve the immediate problem of stopping the losses from mortgage related holdings. Then everyone can focus on the underlying problem of falling house prices. Without stabilizing the financial sector first, you may never get to fix housing.

[Chilly]

Define "accurate." Accounting for illiquid financial instruments is very complex, and a lot of it involves human judgment.

 

That's why people are up in arms that the collapse of the firms is artificially driven. The Fed/Treasury funding will at least solve the immediate problem of stopping the losses from mortgage related holdings. Then everyone can focus on the underlying problem of falling house prices. Without stabilizing the financial sector first, you may never get to fix housing.

 

It seems wrong that an MBS, which I'd imagine is typically a 15 to 30 year prospect (at least in the residential market), be subject to such short-term fluctuations in value. Why would you want to report it that way?

 

I must be missing something, but I don't know what it is.

[meazza]

It seems intuitively that Mark to Market rules would cause inaccurate accounting. What is the original intent behind them?

 

In a stable market, it helps manage pricing? Remember these are traders who keep these securities on their books. They all function with bonuses based on their P&L. Brokers spend a lot of money to have analysts monitoring the P&L of their traders so their results & bonuses reflect their returns.

[meazza]

It seems wrong that an MBS, which I'd imagine is typically a 15 to 30 year prospect (at least in the residential market), be subject to such short-term fluctuations in value. Why would you want to report it that way?

 

I must be missing something, but I don't know what it is.

 

To reflect the true value of the firm...

 

As a shareholder, would you like to know what someone paid for an asset 20 years ago or what it's worth today?

[Chilly]

To reflect the true value of the firm...

 

As a shareholder, would you like to know what someone paid for an asset 20 years ago or what it's worth today?

 

Yeah... I guess my thinking was more along the lines of long term investments, but I see what you're saying.

[DC Tom]

Yeah... I guess my thinking was more along the lines of long term investments, but I see what you're saying.

 

You're thinking's not necessarily wrong...it's just that, since these were held as cash, they had to be treated as liquid, which leads to a certan volatility. That's compounded by mortgage bonds' sensitivity to interest rates: not only do interest rates affect the market price of the bond, they affect the behavior of the underlying asset - the homeowner.

 

I suspect that anyone who can buy them now and hold them as a long-term performing asset rather than a liquid cash asset will do rather well. Anyone who's holding them as a cash equivalent right now is pretty much screwed.

[bills_fan]

Yeah... I guess my thinking was more along the lines of long term investments, but I see what you're saying.

 

 

And to make it even worse....

 

Brokerage firms had to mark the assets to market. When there was no market, the asset was worth "zero", even though in most cases the assets were paying what they were supposed to pay and on time.

 

Why was there no market...everyone is afraid of doing a trade, because they don't know what the other guy has. They barely know what they have themselves. These assets are so complex and codependent on one anotehr, that a default at an asset held by a hedge fund, could trigger the value of your asset to fall to zero, even though you did nothing and the payments are made on time. Which is why "credit crisis" is a misnomer..."confidence crisis" is more accurate.

 

Mark-to-market accounting was the SEC's response to Enron. The theory was that if you had to mark your assets to the market value, you could not overstate your position like Enron did. Problem is that no one figured the entire market would freeze up.

 

Now, lets contrast mark-to-market accounting (promulgated by the SEC in a post-Enron world) with commercial banks. Commercial banks (or Bank Holding Companies) are exempt from mark-to-market in long term held assets. They are permitted to mark at historical cost or market.

 

Now you get why Goldman Sachs and Morgan Stanley converted immediately to Bank Holding Companies? This was one of the chief reasons, that and they figured they would embrace the regulation/regulator they knew (the New York Fed) rather than some ambigous, regulatory scheme cooked up by Congress in response to this disaster.

[Dwight Drane]

Mark to market has been around as long as I have. Unless you had investment grade stuff on your books, you would have to take a haircut on the value of your holdings. If something defaulted yet was still worth 30 cents....you were taken down to zero. Thems the rules. For years the SEC had nothing better to do then to bust on balls. That is one of the things that gets me about all of this. Our firm was blown apart back in the day because we bought an issue at 50 cents....sold it to customers at just under 60....and the thing paid in full with back interest. You see....we were only allowed to make 5% on the deal. Customers more then doubled their money over time while earning 12% interest, yet they were cheated.

 

That is how I ended up private. Regulation forced us to. It was impossible to be rewarded enough to take on the risk. I never was a broker, just a trader...so it actually worked out better for me in the end.

 

If the SEC marked to market for real....this would have been blown up a year ago.