Saturday, May 2, 2009

Marked to Reality

To paraphrase Warren Buffet - when you need to see what something is really worth, go try and sell it.

Enron blew up because it tried to created legal subsidiaries designed to stay off of the reported balance Sheet, where Enron could hide its losses. The practice was considered illegal, because it allowed Enron to lie about the true financial health of the company. The heads of Enron went to jail, the shareholders and creditors of Enron were wiped out and Congress created the Sarbanes-Oxley Act to make corporate executives personally liable for the lies of the corporations they ran.

Banks created Special Investment Vehicles (SIVs) that were designed to take assets off the books of the banks, where they would be securitized and sold. When the Securitization Market froze, banks took dead assets and moved them into SIVs so that they would not have to realize the losses embedded in those securities (think mortgages, credit card loans, commercial real estate loans…). Yes, this is the same practice used by executives at Enron that ultimately led to their incarceration.

The large US Banks now have massive amounts of worthless securities crammed into SIVs. I think Citigroup has about $1.2 trillion presently in SIVs. Why is this important?

It is important because the banks are marking this paper at between 88 cents on the dollar and 100 cents on the dollar. The FASB (Marked to Market) rules change now allows these banks to essentially price this stuff at 100 cents on the dollar. Several large banks had record earnings because they were able to mark up the prices on a lot of this worthless debt this quarter – JPMorgan, Wells Fargo, Bank of America, Citigroup all took multi-billion dollar gains on this stuff in Q1 2009.

Now, reality has come to slap the crooks at FASB and the Banks in the face. Yesterday, two SIVs were liquidated at auction. Deloitte & Touche LLP had $5 billion liquidated at 54 cents on the dollar. That was all junk stuff. Whistlejack had $2.5 billion liquidated at 67 cents on the dollar (that was all the junk and the good stuff – so figure that their junk also prices in the 50’s).

This is the same crap that Geithner now wants to purchase at 97 cents for the taxpayer, via TALF and PPIP.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aRnd9hscQaW8&

Geithner’s plan has done nothing more than promise to transfer trillions from the taxpayer to the bank shareholders and bondholders – but it still has done nothing to remove the toxic assets from the books of banks. Moreover, it has frozen the lending market and succeeded in leaving massive over-capacity in the banking sector.

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