Financial Follies

Now that the FASB has relaxed certain mark to market pricing regulations, the hope for the banks was that they can place arbitrary prices on their toxic securities. The banks were only able to syphon artificial support for the securities that they are currently carrying (which have already been aggressively marked down), not the loans that are on their books. Most importantly, these new regulations are not retroactive, so this was largely a non event, as the powers that be wouldn't totally cave in to the bank lobby. Alas the investment community had long ago factored in these shenanigans, as the stocks have rallied (Short Covering) ahead of this announcement, then traded back down marginally. The bigger issue is no longer write downs, but delinquent loans and the reserves needed to cover losses. Its far to late in the cycle for the banks to play these accounting games with the public. This is just another delay of the inevitable day of reckoning for the financials. At best this cosmetic change adds .02 - .03 cents of normalized earnings back unto balance sheets.

The only positive aspect of this is it minimizes future write downs and makes it easier for investors to forecast earnings power going forward. Some analysts still believe that the banks are profitable, but they base that analysis on a robust positive housing/employment picture. I don't see it, the write downs will be smaller, but the losses from other structured investments will be greater then forecasted. Its all about credit deterioration moving forward. Mark to Market didn't drive the downside...and it wont drive the upside.

I have said it before...I will say it again....Every major Financial Institution in America is INSOLVENT. If these banks had to properly mark their loans to market...Kaboom! If these banks had to properly account for their level 3 assets....Kaboom!

As soon as Obama does a "GM" on the banks, the sooner the healing process can begin, and we can finally bottom the right way. We have seen how the markets have responded to a probable GM bankruptcy [Steep emotional drop...then followed by gradual recovery]. This is how any potential bank "Soft Nationalization" plan would be reacted to by the markets. The markets just need certainty, and the current bank situation is totally uncertain. We have seen the banks rally sharply the past month or so for many reasons:

1-Short Covering - Check!
2-Relaxation of Mark to Market Accounting - Check!
3-Phony Bank Asset Rescue Plan - Check!
4-Phony bank profit forecasts - Check!
5-Rumors of Uptick Rule Reinstatement - Has not happened...but soon.
6-Short Selling Limitations - Will never happen.
7-Limits on Short ETF's - To complicated and esoteric.

The PHLX Banking Index rallied some 60% since early March to its most recent highs, only to give back some 15% the last few days....This pullback is going to be severe as earnings time is fast approaching.

SOFT NATIONALIZATION

The most obvious scenario for the financials is this route. Now that FASB has guided back-handily, the banks will not be able to mark up their bad loans, which was their problem point from the beginning, not their securities, which again they have already marked down. The banks are currently in the process of figuring out how they are going to pass any Stress Test that is warranted by the Treasury, there are rumors that the banks want to postpone any Stress Test results into May, after quarterly earnings are announced. This can only be construed as negative information. If the Stress Test results are healthy, why postpone it? The earnings we all know are going to be bad and the forward forecasts even worse.

But back to FASB for a split second...what this change in rule will ultimately do is force the banks to re classify some of their toxic junk into the "level 3" category, which is the least liquid, least predictably priced level of assets that exist. So there will be less transparency going forward with no meaningful change in bank book values. What the banks really wanted out of this was a change in the way very illiquid securities trade or price in the open market. If a security is not quotable or active to trade, then prices are considered distressed, thus cant be marked to market but rather mark to model, which the banks prefer. This particular guideline was stroke down by FASB, which basically means there will be a continuation of current or prior mark to market practices. Most of the changes were cosmetic in nature. Thank god for that. The only reason these stocks rallied was that they were severely oversold, and a fierce rally precipitated by short covering would occur. Once the artificial buying is over, the institutions are back on the sell side, and the short community is waiting to reload shorts.