Thursday, July 09, 2009

The Fall of the Toxic-Assets Plan - Real Time Economics - WSJ

Have you noticed that the plans to buy the so called toxic assets to spur more lending has not caught on? Harvard's Lucian Bebchuk gets to the heart of the matter in today's WSJ. EXCELLENT Piece that it well worth reading.

Short version?: Due to changes in accounting and regulatory practices, banks have no incentive to sell off their bad loans. So guess what? They aren't. They are holding assets on the books that are worth less than their financial statements say. This could prolong the downturn.

Guest Contribution: The Fall of the Toxic-Assets Plan - Real Time Economics - WSJ:
"The plan for buying troubled assets — which was earlier announced as the central element of the administration’s financial stability plan — has been recently curtailed drastically. The Treasury and the FDIC have attributed this development to banks’ new ability to raise capital through stock sales without having to sell toxic assets. But the program’s inability to take off is in large part due to decisions by banking regulators and accounting officials to allow banks to pretend that toxic assets haven’t declined in value as long as they avoid selling them."

and later:

"The problem, however, is that banks now have strong incentives to avoid selling toxic assets at any price below face value even when the price fully reflects fair value.

A month after the PPIP program was announced, under pressure from banks and Congress, the U.S. Financial Accounting Standards Board watered down accounting rules and made it easier for banks not to mark down the value of toxic assets....

...In another blow to banks’ potential willingness to sell toxic assets, however, bank supervisors conducting stress tests decided to avoid assessing banks’ economic losses on toxic assets that mature after 2010....

As long as banks don’t sell, the policies enable them to pretend, and operate as if, their toxic assets maturing after 2010 haven’t fallen in value at all.

Bebchuk points out that we will get a sneak peak at the true value of these assets:

"While the market for banks' toxic assets will remain largely shut down, we are going to get a sense of their value when the FDIC auctions off later this summer the toxic assets held by failed banks taken over by the FDIC. If these auctions produce substantial discounts to face value, they should ring the alarm bells."

The article concludes:

" must be recognized that the curtailing of the PIPP program doesn't imply that the toxic assets problem has largely gone away; it has been merely swept under the carpet."

Read the whole article here.

Why is this a problem? It has the great potential of prolonging the problem. One only needs to look back to the Japanese Economy in the 1990s to see what happens when banks fail to admit their problems in a timely manner.

BTW I can't help but think of this cartoon. (and by the way, ostriches do not really bury their heads in the sand but seemingly bankers do.)

Thanks for the great article Lucian!

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