Treasury Secretary Geithner did no one any favors yesterday when he served up an all-bun bank-stabilization plan; it lacks essential details and sufficient scope. Judging from the market’s reaction, it won’t likely have the effect the Geithner intends. Thus did the administration waste an opportunity to improve market confidence.  And Geithner’s presentation skills make Henry Paulson’s look smooth by comparison.  Is Geithner enough of a politician to be a successful Treasury Secretary?

Clearly, much of the “plan” has yet to gel.  With regard to the private-public fund, for instance, no analysis is possible.  Stress testing banks that seek additional public assistance isn’t a plan, it’s a technique--and not a very reliable one, at that.  There’s no aggregator bank, or asset-guarantee program, either. Where, indeed, is the beef?  

Worse, if any imaginative thinking is going on at Treasury, it must have been smothered.  Why, for instance, no mention of mark-to-market accounting for illiquid and hard-to-value investments?  As I’ve argued here before, pricing issues are the centerpiece of the whole debate. The original TARP and now the aggregator good/bad bank stumbled on the issue.  A consensus has developed that FAS 157 results in unrealistic valuations, even as it creates very real capital adequacy and solvency problems in banks, insurers, and others.  For example, the Bank of New York Mellon reported that in the fourth quarter, it wrote down its $5 billion investment portfolio of Alt-A residential MBS by $1.4 billion, or about 25%.  If the bank had accounted for the securities as loans, it estimates these same assets would have been impaired only $208 million, just 4% of the portfolio’s face value. The difference between the two accounting treatments: more than $1 billion.

One Alt-A MBS expert, Thomas Patrick, chairman of New Vernon Capital and a former Merrill Lynch vice chairman, calls mark-to-market accounting a “swamp” in this environment, an “accounting fiction” better reflecting the “financial desperation of sellers than the value of the securities sold.” 

 In 3,700 mortgage securitizations he examined, Patrick found that of $1.4 trillion in Alt-A mortgages, $948 billion were current on interest and principal, while $452 billion were delinquent more than 30 days.   Further, banks carried the performing mortgages at an average 50% of par.  Patrick observes that if owned directly as loans, the banks would carry the mortgages closer to par.  He concludes that the mark-to-market fiction has created enormous financial difficulties.

Patrick proposes that these securities be dismantled.  Banks would be allowed to rebook performing mortgages as loans at par less appropriate reserves.  Accounting gains would absorb remaining losses in the non-performing mortgages. 

Similarly, Dutch banking authorities evaluated a $39 billion portfolio of Alt-A MBS owned by ING and marked-to-market at 65% of par.  They subjected the cash flows of the 600,000 loans comprising the securities to severe stresses (principal assumptions were another 10% decline in home prices, and a 50% decline from peak prices in Florida and California) and concluded that the bonds were likely to return 90% of their original value. 

There are many causes of the current troubles, but the solution set has to include changes in the absurd mark-to-market accounting rules.  So far, we’ve seen few fully formed solutions coming from the new administration, while creative and imaginative private sector approaches fall on deaf ears.

What do you think? Let me know! 

Related:

The "Aggregator" Bank: A Good Idea, Depending On . . . . 

Mark-to-Market Insanity