Remember the movie by that name?
FDIC is starring in the sequel.
In my last post, I talked about the necessity of dealing with the bad debt banks are holding. Until this bad debt is cleared from the bank’s books, it’s my view economic recovery will be delayed.
A central part of Obama’s recovery plan was to help banks clear bad assets from their balance sheets by helping them sell these assets to investors while having the government subsidize the process via cheap financing.
Only problem is, the price investors are willing to pay for these assets is far lower than the price banks are asking. If banks sell the assets for a low price, the bank will then be required to report that actual value on its balance sheet. This value can be far different than some ‘imaginary value’ that can be currently reported thanks to the suspension of the market to market accounting rule in April.
Banks are now faced with the following decision: keep the bad assets on the books, reporting the value at something greater than is accurate in order to keep the balance sheet and profit numbers looking good – OR – acknowledge what the true market value of the asset is by selling the asset to a willing buyer and taking the loss thereby affecting profits.
Banks are choosing the latter and the FDIC is letting them.
In a “New York Times” article published on June 3, 2009, FDIC chair Sheila Bair announced the FDIC was suspending indefinitely a program that would have helped banks clean up their balance sheets by selling off bad debt to investors. Said Bair, “Banks have been able to raise capital without having to sell bad assets through the L.L.P. (the government program), which reflects renewed investor confidence in our banking system.”
That’s the dumber part. Instead of dealing with the bad debt NOW so the recovery can commence, the FDIC has decided to allow banks to continue to ‘gloss over’ the real value of the bad assets they own. The bad assets are there and need to be dealt with – all that’s happening now is the postponement of the inevitable day of reckoning.
Frederick Cannon, Chief Equity Strategist at Keefe, Bruyette and Woods spoke to the issue nicely in the ‘New York Times’ article. “What’s happened is that the government’s programs have addressed the symptoms of the financial crisis, but not the cause. The patient feels better, but the underlying cause of the problem is still unaddressed.”
I couldn’t have said it better.
Some wise folks, until that day of reckoning comes, are raising their cash holdings on rallies and using absolute returns* investment strategies.
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