Just when it felt like it was safe to get back in the water, a second and potentially much meaner version of this summer’s credit crisis has reappeared. This week we look at why there are more mortgage write downs coming (in a self-fulfilling prophecy) in the financial sector, how an obscure new accounting rule is shedding light on a lot of risk in the world’s banking system, how this is all tied to the consumer and is part of the reason for the fall in the dollar. It’s a complex world, and I am going to spend a considerable part of a beautiful Friday evening in Texas trying to make it simple for you, gentle reader. That’s my job, and I love it. And since I can’t think of my usual “but first” we’ll jump right in.
I have written for some time that we are in a credit crisis brought on by a lack confidence which has the real possibility of devolving into a credit crunch which will make loans harder to get and has the potential to slow down the US economy, on top of a weakening consumer. Data released in the past few months, and again this week, have shown that banks and other lenders are tightening their standards for all sorts of loans. And it is not just that they are becoming more like an old-fashioned banker who actually wanted to know that he could get his money back. Their new found conservatism is being forced on them. But let’s start at the beginning.
The Financial Accounting Standards Board (FASB) is the referee for accounting practices. They recently issued a new rule which will be implemented November 15. Essentially, Statement 157 requires a financial firm to divide its assets into three categories called simply enough, Level 1, Level 2 and Level 3.
Under FASB terminology, Level 1 means assets that can be marked-to-market, where an asset’s worth is based on a real price, like a stock quote. Level 2 is mark-to-model, an estimate based on observable inputs which is used when no quoted prices are available. You can go get several bids and average them, or base your assumption on what similar assets sold for.
Level 3 values are based on “unobservable” inputs reflecting companies’ “own assumptions” about the way assets would be priced. That would be market talk for best guess, or in some cases SWAG (as in Simple Wild-***ed Guess.)
Financial companies have never had to break out this information. As you might expect, there is particular interest in how much and what kind of Level 3 assets a bank or brokerage firm might have. It turns out, that there may be more problems lurking in those assets than we realize.
For those unfamiliar with Mauldin’s work, he’s one of the best common-sense, middle-of-the-road analysts out there. It is he who predicted that the late ’00s would be a ‘Muddle-Through’ economy, neither a disaster nor a great boom — consistent with his call that the coming slowdown will be a ‘Slow-Motion Recession.
For what it’s worth, he’s also a brother in Christ and has raised seven children. He’s definitely worth paying attention to, so go to the link above and subscribe to his excellent, free, weekly columns. You’ll be a better steward of your wealth if you do.
Bart: Thanks for this info.
If people would be adults and not borrow money that they cannot afford to borrow and/or if banks and credit card companies would not loan it to them, do you think we’d have the credit problems that we have today? The U.S. spends 90 billion per year in credit card interest and the vast majority of the that is consumer ‘wants’ not ‘gotta’ haves.’
If you missed it when Kendall first posted it, go to this link which tells pretty well what has happened and is funny as everything!
http://www.youtube.com/watch?v=SJ_qK4g6ntM