baz.com - Brett Thomas' Blog

The Wall Street Journal is reporting this morning that the new, compromise "don't call it a bailout" bill is moving its way through the Senate. It focuses on the proposal that FDIC deposit insurance be raised from $100,000 to $250,000 in an attempt to keep the modestly wealthy from causing a run on already undercapitalized banks. There is a little bit of complexity, there - will they ever be able to get the rates back down, when the crisis is over? Will they be able to get the extra insurance premiums out of already cash-strapped banks? But, overall, that proposal makes sense to me.

However, more interesting, and that I had not heard reported elsewhere, is that the SEC on Tuesday issued guidance on the applicability of "mark to market" accounting for assets that have no useful market at the moment. I haven't blogged about this, specifically, but it's my personal belief that the requirement of "mark to market" on illiquid and untraded items (such as Mortgage-Backed Securities) have been a major player in bank illiquidity and subsequent insolvency. From the Journal:

The SEC said on Tuesday that in some circumstances it might make more sense to judge assets not on what the market will bear, but on their intrinsic value -- for example, if they're from a highly respected company that is unlikely to default.

Like, say, Bear Stearns? Still, any relief from the current cycle of revaluing undertraded items, leading to more revaluing is welcome. Further, the article states that one of the items being debated for the new, revised bill, is a suspension of the "mark to market" rule, altogether. No more details are given - I can't imagine they'd suspend it entirely - but it's nice to see Congress and the SEC at finally starting to think about something that has been clearly a big contributor to the ongoing crisis.

Paulson's original proposal was three pages. When it was defeated in The House, it was 102. Now, it's 451 pages (thanks to the Wall Street Journal for the full text).

On page 88, there is Section 131, "AUTHORITY TO SUSPEND MARK-TO-MARKET ACCOUNTING."

The Securities and Exchange Commission shall have the authority under the securities laws...to suspend, by rule, regulation, or order, the application of Statement Number 157 of the Financial Accounting Standards Board [FASB] for any issuer...or with respect to any class or category of transaction if the Commission determines that is necessary or appropriate in the public interest and is consistent with the protection of investors.

I've elided various parentheticals talking about US Code sections. FASB is Statement Number 157, "Fair Value Measurements", which describes how mark-to-market works from an accounting standard perspective.

Below it is Section 132 (surprise!), "STUDY ON MARK-TO-MARKET ACCOUNTING", which directs the SEC to conduct a study on mark-to-market, and report back to Congress within 90 days. The study is to attempt to determine if such accounting hurts banks, if it helped cause this crisis, and what we might use as a replacement.

I'm sure the rest of it is riveting reading - it starts with the Troubled Assets Relief Program, which it helpfully points out spells "TARP". I guess we'll use it to temporarily cover our Really Outrageous Overwhelming Failure. I am also sure that very few people will have finished reading it by the time it passes.

However, the inclusion of at least the mechanism to suspend mark-to-market shows some hope that perhaps some understanding of underlying causes is beginning to seep in. Mr. Paulson, for one still (as far as we can tell) is a fan of the accounting measure - as recently as July, he said "I think it’s hard to run a financial institution if you don’t have the discipline which requires you to mark securities to market." Perhaps he's changed his mind, or perhaps the near future will, and perhaps the SEC thinks otherwise, in any case. It's nice to see they'll have the choice, anyway (if this measure passes, of course...)

I've known for some time that things aren't working the way people were thinking. I sadly didn't blog about it - in no small part because I couldn't figure out what the heck was going on - but I know the first time I really realized there was a problem was in June of 2007.

I believe it was around my birthday, that year. I went up to San Francisco to hang out with my friend, Jeff, and we went to lunch at Bossa Nova, which I am not nearly cool enough to hang out in, but has delicious food. We definitely went to a baseball game, afterwards - I clearly remember being a bit embarrassed about my Giants gear in such a hip establishment, and I know it was a weekend day, with a fairly rare weekend night game.

Anyway, at lunch, Jeff commented on a colleague from Europe coming to the US and going on a shopping spree because the dollar was so cheap. I'd been vaguely aware the Euro was up on the dollar, but I hadn't realized how much so. I remember being aghast at the idea that, say, a bellhop in London's work moving bags was worth, apparently, so much more than the work of New York bellhop's. Even taking into account things like trade imbalances, it just didn't make any sense to me that the same amount of labor in Europe was apparently worth more than the same labor in the US. I remember at the end of the day just shaking my head and saying, "there's something going on here that people don't understand."

Of course, the Euro was worth $.74 at the end of June, that year - it dropped further from there, hitting its nadir in April of 2008 at $.625. I was baffled why people thought the Euro (and European companies) were a better investment than those here, in the US, given that I believe the US's policies are generally more pro-growth. You can argue that the net trade-off for the average American is worse than for the average European, but I think it's difficult to argue that European companies are going to, on average, grow faster than American ones, or that European GDP will.

The good news (for me) is that it has recently turned around. The dollar is back to being worth about what it was in June of '07, as the financial contagion continues to spread. I say good news, because I'm long on the dollar - I pretty much have to be, since I live here. Most of my net worth is tied up in Silicon Valley real estate and a private, US company. If I measure my net worth in, say, Fiats, or oil I've actually had my net worth go up pretty well in the past few months, simply by virtue of currency exchange rates changing.

The bad news is that I mostly still don't understand what's going on, and I suspect that nobody does. I saw the oil bubble coming - I was advising my brothers to sell oil a good six months ago. But, the current financial crisis in Europe I didn't see coming. I thought the dollar was too low against the Euro, but it at the same time doesn't make sense that, the more we learn about the US crisis, the faster people buy dollars.

The best guess I have right now is that professionals are finally starting to understand that they don't understand. The scope of the crisis in the US, I hope, is mostly known - but what's going on in Europe is even less known. Iceland appears to have bailed out a bank with assets of six times their GDP, and hence literally nationalized the banking risk. Runs (on currencies, banks or any securities) become self-fulfilling prophecies as people panic.

I remain optimistic that this will turn itself around. This is probably just the darkest part, before the dawn. The fact that no one seems to really understand anything, or be able to predict the next problem, does not give me hope.