Financials

Baccardax: Here's How to Fix this Mess

Omnes viae Romam ducunt.

For those of you who were lucky enough to avoid daily kitchen inquisitions on Latin grammar as a child (or those who can't google) the above phrase translates to "All roads lead to Rome."

The past weekend's news flow brought to mind this classic proverb as everyone from national leaders to CNBC journalists to member of my tennis club waded into the issue of how best to rescue the global economy.

Europe's political elite pledged (queue the sound of galloping hooves and bolting stable doors) to increase the transparency of financial markets and prevent further systemic risks emanating from the banking sector.

Gordon Brown (keep those sound effects rolling) called for the nation's financial institutions to act "…in the long-term interests of their shareholders and therefore of the economy as a whole, not in the short-term interests of bankers." (remind me again who was Chancellor of the Exchequer for ten years while this culture was left to run riot?)

The White House seems set to part-nationalize Citigroup (imagine floating *this* idea to a trader in 2006?) in an effort to prevent the collapse of what was once the world's largest bank (and avoid the embarrassment of losing billions of Prince Alwaleed bin Talal's money and perhaps the Treasury-buying might of Saudi Arabia).

And, of course, our own Rick Santelli has ignited a truly national debate over in the US about the logic (and indeed the morality) of President Obama's $75 billion plan for mortgage relief.

Many options, many ideas, many rants … many roads, indeed, to the reparation of the world's financial system.

For me, though, these all *first* lead to the most obvious pothole on the road to reparation - mark-to-market valuation – and it remains a mystery to me as to why this less than two-year old accounting rule remains the most ignored portion of debate.

Let's take the over-arching theme of Rick's Rant: mortgage holders current on their payments shouldn't be penalized. Who could argue with that?

The bean-counters who dreamed-up FAS 157, that's who.

Imagine being current on your mortgage, but, through no fault of your own, underwater in terms of the value of that mortgage compared to the value of your house. Then imagine getting a call from your bank for more cash – by the end of the business day – in order to meet the shortfall. If you don't, the bank will foreclose. You'd be angry, and you'd see it as unfair. And rightly so.

Yet this is *precisely* what we're asking of our financial institutions to do: top up, with cash, the value of *performing* assets (mortgage payments) simply based on the price they would fetch on a given day, regardless of whether it's a two-day swap contract or a 30-year mortgage bond.

Our slavish adherence to this rule, and our refusal to even discuss its suspension, has literally destroyed hundred of billions of dollars worth of wealth and value around the world, led to the huge and accelerated fall in contingent asset prices, raised the specter of deflation and exaggerated the cyclical downturn of the global economy.

Just think soberly for moment: House prices have fallen an unprecedented 25 percent in nominal terms since their 2006 peak. Citigroup – a bank that once had a market value of $275 billion – lurches toward oblivion. There are *no more* investment banks in the United States and yet $2 trillion might still be needed to save the rusk of the sector from collapse. Banks around the world which feasted on US mortgage bonds have either gone cap-in-hand for government cash or given back billions in equity value for the right to remain independent.

And why? Because foreclosure rates in the United States are sitting at 4.5 percent? Because 20-year high unemployment rates mean 90 percent of eligible Americans will still be turning up for work every Monday morning, and therefore continuing to pay the $100,000 average mortgage? Because historic-low refinancing rates will make that burden even easier in the coming years?

It makes little sense to destroy bank capital on the altar of a flawed accounting principal, and FAS 157 suspension would, at the very least, arrest the on-going needs for government rescues into the sector, ease foreclosure pressure on borrowers who are behind, but still able to service a restructured debt (if the asset is kept alive, and not written down, its value to the bank remains higher than a foreclosed property) and allow banks to lend against their own reserves (because their capital ratios would instantly improve) and stimulate economic growth.

Fix this pothole, and it you won't need nearly as many roads to get to Rome.