Yesterday Union banker and Crystal Lake City Councilman Jeff Thorsen took the time to post a lengthy comment under this article:
I think it is worth wider readership than comments get, so here it is:
With one of the items in the mix being a banking concept called “mark to market” and the mark to market becomes complex and problematic when there is no market to mark IT (the derivative) to.
Although arguments on the issue from both sides have substance, derivatives are an asset that really do have underlying value. No one really knows what some particular derivatives values are so no one is buying them thus no market for them. Without a market (i.e., someone buying them) financial institutions have little recourse but to mark them to zero.
So these assets that have been reduced to zero on the balance sheet really do have a value that is not countable when the regulators review capital requirements of current regulation. The result is a paper erosion of tangible capital leading to this credit crunch. Think about this.
Let’s say that a particular derivative represents all that is bad in the subprime market. Remember most do not.
For this example let’s say they all do. This means the loan was 100% of value on the underlying asset on average (remember worst case).
So the value of the underlying asset has lost 30% of its value. Let’s assume an additional 10% cost of foreclosure and related expenses.
This still leaves a 60% value stake. But these financial institutions, for the reason there is no market, must often write down the value of their derivative position to zero.
Does this reflect reality?
I don’t think so. I believe this is a major contributor to the crisis. We have sliced and diced these mortgage pools beyond the point of reasonable ability to value them.
Regulation contributes to this current turmoil, but we have regulated in places we should have left alone (mark to market), while missing the areas we should have been more on point.
Mortgage brokers are not nearly regulated as banks and thrifts. Banks have the OCC, the FED, the various state regulatory bodies, (i.e., one for each state), and OTC overlooking them. Brokers have the FTC. I think that is the only regulatory body although it is hard to keep up with regulatory changes.
Point is, banks have many eyes over the proverbial shoulder and mortgage brokers did not. Banks have investment policies that are reviewed by these regulatory bodies. Yet we still witness this crisis.
Who regulated the subprime mortgage broker?
Not the OCC OTS State or Fed….
Wall Street motivated the slice and dice. Why are we bailing this part of town out?
As for banks and financial institutions…
Many bought the derivative after it was sliced and diced, but carried a AAA rating because we had faith in Credit Default Swaps (an illusion in many cases meant to be insurance).
The real crime happened at the street level. The customer of a home purchase was reduced to a transaction. A transaction where fees are collected and no strings were attached.
The broker moving on to the next deal…
Fact twisting to out and out fraud and a loosening of traditional underwriting standards opened the ball to the real estate orgy we will now have to pay for.
I wish the government could devise a way to take the $700 billion do two things:
First buy up all the already foreclosed real estate and take them off the market. Just get them out of the market. It will shore up real property values as it would reduce the glut of supply. We can afford to sit on these until things turn around. (We sold off the assets involved in the RTC too quickly and lots of privateers made lots of money).
Second, refinance all the distressed loans still alive on the books of the servicers. Some of them will pay off and some won’t but the defaults will occur over time and be absorbed. Not all at once (where we are now). I really think that will shore up the value of real property. More importantly this would go a long way to bringing derivative value up to a reasonable fraction of par, liquidating the toxins. As the Government executes this proposed action, the derivatives will to a great extent have the questionable underlying assets liquidated and converted to cash. What remains in these sliced and diced after that may truly be worthy of the AAA rating.
I don’t have all the answers..just a few ideas.