Mark to Model Bank Nonsense

This past Monday morning brought forward a more honest appraisal of the financial condition of banks which caused a reversal of last weeks celebration of mark to model nonsense.

According to rock star bank analyst Mike Mayo of Calyon Securities the amount of loans that banks will need to write off over the next year or two will exceed levels seen during the Great Depression of the 1930′s. His report was released yesterday and made financial market bottom feeders nervous.

Mike Mayo gave the banking industry an “underweight” rating, citing “the ongoing consequences” of banks’ increased risk-taking. Mr. Mayo made the point that suffering U.S. banks face a three-fold problem: higher structural risk, cyclical pressures, and “catch-22 government actions,”.

“The seven deadly sins of banking include greedy loan growth, gluttony of real estate, lust for high yields, sloth-like risk management, pride of low capital, envy of exotic fees, and anger of regulators,” Mayo stated in the report.

These “sins” created front-load earnings and pushed costs further down the line, Mayo said. Now those costs are appearing and many of the current problems being experienced are only midstream, he added.

With residential real estate prices still falling, commercial real estate starting to crumble, with record credit card defaults occurring, with student loans not being repaid, and unemployment still soaring, those who think that changing accounting rules to mark to model from mark to market are going to save the banks are delusional. The market action of today, with the Dow down over 200 points as I write, seems to indicate that earnings reports are important and that cosmetic changes in mark to market accounting rules for financial institutions is not going to cut it.

The deteriorating assets being reevaluated by the banks own models do not in the least change the quality of the assets. The assets are toxic and stink under any accounting rules. All it does is to defer the day of reckoning, make public a dishonest accounting of the banks true exposure to questionable and in some cases worthless assets, and delay any hope of recovery.

In spite of the government’s frantic efforts to prevent it many of the banks are insolvent. It is really incredible how poorly the bank’s managers evaluated risk. In a just society the managers should be publicly beheaded rather than be rewarded with bailouts. As the depression deepens I expect that angry mobs of down and out investors will hunt at least a few of them down and administer a frontier type of swift justice.

If you buy into a bank rally you had best be taking very short term positions and kick the stocks out of your portfolio fast on an sort of further rally. Investors taking long term positions in financial stocks, thinking that depressed prices make such purchases safe, are taking on huge risks. Shareholders will be wiped out when the day of reckoning comes and the banks are forced into reorganization.

That will probably be in late 2009 or early 2010 as further losses become too large to hide, even with mark to model accounting rules in effect. As incredible as it may sound many banks are still carrying toxic assets on their books at 98% of face value. This is so far above what they would bring in a free market sell, assuming that any market exists for these securities, that it is laughable. The bankers must be out of their minds but are obviously still expecting a miracle.