Imagine if you could purge yourself of all of your sins, bad mistakes, bad debts, toxic loans, and obnoxious relatives in a pot and get rid of them all in one fell swoop. Then the government could buy this potful of disasters you no longer have to worry about. But first Uncle Sam would have to figure out what each bad loan, unpaid credit card debt, or worthless relative is worth in order to pass your disasters on to some willing buyer. Meanwhile, you can go on your merry way and take up where you left off, spending and partying and watching the Super Bowl.
Such is the dilemma of the "Bad Bank proposal" which would be a witches' brew of toxic assets purchased from banks so the "U. S. Government Toxic Bank" could sell the rotten assets over time and, presumably, recover some part of its expenditure on sour and toxic assets. Problem is, what are the assets worth?
Vikas Bajaj and Stephen Laboton have written a lucid and informative article for the New York Times in its February 2 2009 issue titled "Big Risks for U.S. in Trying to Value Bad Bank Assets." The article comes complete with a documentation of "Fazbee" accounting standards, or accounting standards of the Financial Accounting Standards Board. You can read the article and its FASB appendices here.
As the authors point out, low values would force "institutions selling and others holding similar assets to register crushing losses that could deplete their capital and make it harder for them to increase lending." Yet, "inflated values would bail out the companies . . . at the expense of taxpayers." So what should the market price of these toxic assets be? Current market value? Original cost? And if current market value, how can such value be determined?
For the subprime mortgage crisis, the issue centers around the "mark-to-market" ruling of the SEC which requires "banks to "mark-to-market" their assets, particularly mortgage-backed securities." However, mortgage related assets obviously have depressed prices leading to "significant losses" in 2008 by marking prices to market.
Moreover, marking to market rules have led to financial shenanigans in cooking the books under some circumstances as in the Enron case where assets were based on the results of some theoretical model, thereby distorting the value of Enron assets. So you thought accounting was a dreary and tedious profession of sorting out debits and credits? It would require some serious study efforts to master what is known about marking to market rules. But at least you have the general idea when you see the next reference to the topic in the current debate over the financial crisis: that is, should you value assets at current market value, whatever that can be determined to be, or some other standard?
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