Posts Tagged: mortgage-backed securities

American Society / Banking / Business / The Federal Reserve — 0 Comments
27
Oct 10

The US Economy: An Impaired Asset? Part I

Rather than a political entity, for a moment view the United States as a massive corporation with divisions.  Think of housing stock, commercial real estate, manufacturing capacity, technology, mass transportation, infrastructure, airports, power, pipelines, and telecommunication, and one can easily imagine the nation as a conglomerate of assets: US INC.

However, assets depreciate and not may be worth the value assigned by the owner.  Accounting principles recognize that assets must constantly be evaluated.  Enter the concept of the impaired asset:

…long-lived assets and certain identifiable intangibles to be held and used by an entity (must) be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review for recoverability, the entity should estimate the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized. Otherwise, an impairment loss is not recognized. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. Summary of Statement – FAS 121

The accounting profession recognizes that an asset becomes obsolete when its income can no longer support it. Thus it becomes an impaired asset and must be written down to fair market value.

Telephone Companies and Impaired Assets

An example from the mid-1990s is the technological and business transition that faced US local telephone companies. As the industry sought to meet the demand for high speed data services and internet transport, regional phone carriers (the predecessors of Verizon,  AT&T and others) needed to switch from the slower, reliable copper cable network to fiber optic technology.  Similarly, switching went from analog to digital to “soft switches” to handle higher volumes of traffic.  Recognizing that income from voice services could no longer support the sunken costs of the investment in copper cables and analog switches, the companies were required to recognize an impairment charge and write down the value of their assets. See The Future of the Regional Bells

Focusing on the Present State of the American Economy

The current state of the US economy bears a striking resemblance to the telecom industry scenario of that era.   We have a boatload of impaired, non productive assets call residential and commercial real estate.   Encouraged by the government’s desire to create an “ownership society” and artificially low interest rates, Americans overspent on housing.  Housing prices were driven artificially high to the point where incomes could no longer support buyers’ investments in their homes.  Collaterally, commercial real estate mirrored the housing boom with wildly expanding retail and office space.  Again, our national income could no longer support this expansion.

Technology conspired to impair even more assets and reduce our national income.  Faster telecommunications, larger and faster ships, cheaper foreign labor, and transferability of skilled labor made it feasible for offshore production and services.  Again left behind were empty factories, shopping malls, office buildings and warehouses.   The Midwest was particularly hard hit with factory closings and high unemployment.  Returning to our corporate metaphor, US INC  purchased too many assets at historically high prices with insufficient corporate income and profits to support them.

Hiding the Problem

Since FASB has suspended mark to market accounting in 2009, the banks have been the main culprit and beneficiary in failing to mark down these impaired assets.  The Federal Reserve continued the deception when they purchased from the banks over $1.25 T of impaired mortgage backed securities.  So now the taxpayer is another potential holder of impaired assets.

The Federal Reserve is on a maniacal quest to start QE2 (quantitative easing) to purchase even more impaired mortgage backed securities.  If the mid-1990s telephone companies were the object of the Federal Reserve’s affection, perhaps they would have been buying the impaired copper telephone networks and paying top dollar.

Part II will discuss further impairments and solutions.

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American Society / Banking / Financial / Political / Regulation — 0 Comments
18
Feb 10

A Reputation as Good as Goldman? Part I

Part I of II in a series. Part II here.

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Arguably the greatest living investor, Warren Buffet, clearly valued a person’s or an organization’s reputation.   In 2008 Buffet was the “white knight” investor for a struggling Goldman Sachs, investing $5b in the firm.  A mentor of mine had wise complementary counsel to Buffet’s:  when providing legal advice, be sure that you would be comfortable if that advice were to appear in a New York Times, Washington Post or Wall Street Journal front page article.

We live in  an age of greed, and indeed supreme irony.   Perhaps Mr. Buffet never shared his wise advice with the senior management of Goldman Sachs.  Worse, maybe he did and they ignored him.  In any event, how has Goldman’s reputation fared?  Let’s examine three separate front page New York Times articles.

Banks Bundled Bad Debt, Bet Against It And Won (NY Times, December 24, 2009)

Goldman Sachs sold mortgage-backed debt securities to pension funds and insurance companies. To hedge their position and to profit from a decline in the housing market, Goldman created a synthetic derivative security called Abacus. This second security was a direct bet against the position of their institutional clients. The mortgage-backed debt securities sold to the institutional clients performed poorly, with losses in the billions. Some of the original securities were of such poor quality that losses occurred within months of issue. Goldman created these synthetic securities well in excess of any hedging needs, permitting it to profit handsomely at the expense of its institutional clients.  The obvious ethical problem was succinctly stated:

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

The SEC and other governmental agencies are investigating Goldman and other firms to determine whether or not they violated “fair dealing” rules.

Testy Conflict with Goldman Helped Push A.I.G. to Edge (NY Times, February 7, 2010)

AIG insured some of Goldman’s complex mortgage securities.  When the housing crisis deepened, AIG paid Goldman $2b to cover potential losses. AIG later asserted that Goldman had inflated the potential losses and sought monies back. Goldman countered that it was due even more money.  The SEC is now looking into whether or not Goldman’s demands for loss coverage depressed the mortgage market and hastened AIG’s demise.

In another supreme irony, after the government took over AIG, Goldman received an additional $12.9b from taxpayers, one hundred percent of expected losses.

Wall St. Helped to Mask Debt Fueling Europe’s Crisis (NY Times, February 14, 2010)

Goldman’s questionable financial maneuvers were not confined to the United States.

As worries over Greece rattle world markets, records and interviews show that with Wall Street’s help, the nation engaged in a decade-long effort to skirt European debt limits. One deal created by Goldman Sachs helped obscure billions in debt from the budget overseers in Brussels.

Even as the crisis was nearing the flashpoint, banks were searching for ways to help Greece forestall the day of reckoning. In early November — three months before Athens became the epicenter of global financial anxiety — a team from Goldman Sachs arrived in the ancient city with a very modern proposition for a government struggling to pay its bills, according to two people who were briefed on the meeting.

The bankers, led by Goldman’s president, Gary D. Cohn, held out a financing instrument that would have pushed debt from Greece’s health care system far into the future, much as when strapped homeowners take out second mortgages to pay off their credit cards.

European authorities are looking into the role of Goldman and others in skirting EU rules.

Is There Another Way?

Has the American public been lulled into believing that this is an acceptable way of doing business, or do we require the people involved to be publicly excoriated, tried, convicted and jailed before we acknowledge their tactics were shabby?  Is Goldman Sachs an institution now synonymous with crafty machinations and greedy outcomes? Are its tactics symptomatic of a Wall Street “disease?”  Is there an alternative way of doing things?  Does reputation matter?  Part II will examine these issues and possibilities.

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