Excerpt from the Hussman Funds’ Weekly Market Comment (3/22/10):
As we look at the U.S. financial system, and particularly the mortgage market, it strikes me that we’ve created one massive Rube Goldberg machine which is very complicated, but has the end result of obligating the U.S. public to huge bailouts, possibly without their continuing knowledge. At one end, the Fed purchases $1.5 trillion in Fannie and Freddie debt obligations. Then the Treasury guarantees those obligations. Then Fannie and Freddie begin buying back delinquent mortgages, paying off the lenders in full, and taking the losses at public expense. Next thing you know, a mousetrap snaps and a bubble gets popped. I’ve detailed some of these concerns in the 2/16/2010 comment The Federal Reserve’s Exit Strategy: Unlegislated Bailout of Fannie and Freddie.
Meanwhile, the FASB continues to allow banks “substantial discretion” in valuing their assets. This risks creating a zombie (“living dead”) banking system by allowing a growing gap to emerge between stated asset values and the probable stream of cash flows from these loans. This is not wisdom, but is instead a decision to collectively close our ears and hum. An essential part of a sound financial system is the ability to verify assets, and a clear set of standards on how impaired assets should be valued, and equally important, reported. Undoubtedly, “substantial discretion” should end at the point that a mortgage actually goes delinquent, but it’s uncertain that this is the standard being applied. Modifications and foreclosures force a restatement of the asset on the balance sheet, and in the current environment, the ability to obscure valuations appears to be a primary reason for the growing gap between delinquencies and foreclosures, as well as the reluctance of banks to modify mortgages.
Allowing dead assets to stay on the books as if they are alive is precisely what created insolvent zombie banks in Japan, which continued to operate for over a decade at public expense, even while lending activity stagnated. On this front, the growing gap between delinquencies and foreclosures is notable. It’s not at all clear how this growing gap will be resolved. In the coming quarters, it is possible that accounting firms, given the implosion of Arthur Anderson following the Enron scandal, will force greater discipline on the banks than they may be willing to exercise on their own. In that case, we may observe some of the same pressure we anticipated in February 2008 (Watching for Audit Delays and “Unqualified” Opinions), as reported bank losses started to accelerate.
Similar Posts:
- Happy MBS Day
- Bank Failures: 115 and Counting
- Financial Overhaul Unnecessary
- Why You Should Buy That Home Now
- Update on the U.S. Credit Situation
