Saturday, November 3, 2007
Mark to Market
An individual who has a loss - has to realize it - You buy something and it is reduced in value and you have an unrealized loss. When you sell the item, your loss is realized.
In The financial industry, prior to posting financial statements, the Corporations have to "Mark to Market" the "unrealized loss" as though it had been realized - and post that loss to their profit and loss statements. If there is no market for the intended financial holding - they usually leave it where it was, as last determined - or "set-up" a variation to their benefit. They will find some obscure method to value the asset when it is worthless. It will be interesting when the "Genius Corporation" - Goldman Sachs - finally deals with the spider in the web they have spun. Also, interesting will be the Grand Bonuses that will be announced this late fall to their most prized employees - based upon "Profits" for the year.
Take this to the bank: There are going to be more write-downs as more and more mortgages go into foreclosure, forcing more downgrades of mortgage asset-backed paper. Foreclosures are up over 200% in a number of states, and 800-900-1000% in some. Scary. Look at this list of the rise in foreclosures over the last year, from Greg Weldon (www.weldononline.com).
Arizona up + 201.7%, Arkansas up + 254.2%, Connecticut up + 920.7%, Delaware up + 389.4%, Florida up + 130.6%, Iowa up + 180.5%, Maryland up + 491.0%, Massachusetts up + 1,127.7%, Minnesota up + 124.9%, Nevada up + 212.2%, Ohio up + 136.0%, Vermont up + 400.0%, Virginia up + 516.4%, Wisconsin up +155.6%, Georgia up +84.5%, Michigan up + 78.6%, New Jersey up + 56.7%, New York up + 66.7%, North Carolina up + 99.0%, North Dakota up + 85.7%, Tennessee up + 57.3%. And on and on.
A Congressional report suggests that over 2,000,000 homes financed by subprime loans will go into foreclosure in the next 18 months. This means that more and more of the mortgage-backed assets on the books of banks, CDOs (Collateralized Debt Obligations), and SIVs (Structured Investment Vehicles) are going to become losses.
I think we should be getting ready for a second round of the credit crisis. And I would certainly be uncomfortable with owning any financial stock with exposure to the mortgage markets. We may not know the full exposure of many banks until the middle of next year.
The asset-backed commercial paper market declined another $9 billion last week, down for the 12th straight week. It has dropped 26% since August 8, and there is no reason to think that trend will not continue for several months, as commercial paper linked to mortgage assets is simply not being rolled over. The Financial Times talks of one banker who is bartering his mortgage assets to avoid setting a price. (A way around setting the value at Mark to Market)
Bottom line? With rising unemployment, a credit crisis, and a housing bubble imploding, this is not a market or an economy where the Fed will be able to sit tight. We are going to see a Fed funds rate below 4% in two more meetings, at a minimum.
(Some of this material has be paraphrased from John Mauldin's newsletter)