Global Agenda: A matter of belief

If the losses were merely the result of poor trading, there would be little cause for concern.

October 18, 2007 20:35
3 minute read.
Global Agenda: A matter of belief

global agenda 88. (photo credit: )


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The state - and the fate - of the banking sector hangs like a dark cloud over the US economy and, by extension, over the entire global economy. What that state is, and hence what that fate might be, depends very much on what and whom you believe. The starting point is that all the banks lost a considerable amount of money in the third quarter, because of what is referred to as the "turbulence" and "volatility" that roiled the financial markets in July and August. But if the losses were merely the result of poor trading, there would be little cause for concern. These nasty things happen every now and again, but it;s behind us now and all that's left is to fire a few people and move ahead. This is the way the first banks to announce losses running into the billions of dollars tried to spin the story. But this is so far from reality that the attempt rapidly foundered. After all, the source of the troubles is bad mortgage lending, and the losses from will not fully emerge, let alone be added up and written off, in a single quarter. Furthermore, there is the question of "contagion." It;s difficult to pretend that the problem is limited to subprime mortgages, because the delinquency rate on all kinds of mortgages is rising sharply. Many banks, however, are sticking to the story that the lending problems are limited to mortgages and neither have, nor will, spread to consumer lending generally. But there were banks who made profits in the third quarter - such as Lehman Brothers and Goldman Sachs. How did they make money when most of their peers lost heavily? Their answer, unsurprisingly, was that they were cleverer, nimbler and better understood what was going on. Goldman Sachs, for instance, did very well by selling short the securitized mortgages that then crashed so they cleaned up, big time. By implication, therefore, the firms that lost a packet were stupid, clumsy or just not on the ball. That line also went down well, at first. But when the banks released their detailed financial statements and the more diligent - and independent - analysts combed through the numbers, things began to look different. First, "taking a position" means, in plain language, gambling. Making big profits by taking big risks is very nice, but it may not be what shareholders in large financial institutions had in mind when they made their investment. But far more serious is the methodology behind the accounting. The big profits in these weird instruments were calculated not on the basis of marking to market - i.e. using prices from an orderly and functioning market - but on the basis of internal models. In other words, Goldman Sachs took instruments it created, valued them using its own models and then announced the result. The outside auditors don't have to chew through quarterly accounts, just to review them. So if you want to believe Goldman and Lehman, that's fine - but if you agree with Warren Buffett, that marking to model is "marking to myth," then maybe it's not fine. Similarly, if you want to accept the line still being pumped out by the main Wall Street houses that the subprime crisis is limited - whether by product (to mortgages, for instance), or geographically (to the US), or sociologically (to low-income households) - you can sleep easier. But if you fear that the long-time bears on the housing crisis (led by Nouriel Roubini) and/or the independent analysts (like Greg Weldon), who crunch data on the economy, the banking system and the financial markets, and who maintain that things are MUCH worse than the Fed, the Administration and Wall Street are claiming - and whose record is far better than the mainstream analysts - then you may not sleep at all. This week, for instance, Roubini launched a blistering attack on the "super fund" that Citigroup and several other mega-banks are trying to set up, to address the problem of off-balance sheets assets that no longer have a market. The banks are, in effect, trying to give these assets a higher value than they would fetch in the market, to avoid realizing the (massive) losses that the market bust has inflicted on them. Weldon's newsletter shows how the Fed's own data highlights the problems rapidly building up in the banks' balance sheets - and how many banks' share prices are already crumbling. Fortune magazine has the guts to say that if Citigroup took its losses now, its share price would collapse to the point where it would be an easy takeover target. All of them want to know who the Fed and the Treasury are really working for. None of this - the crisis, the losses and the questions - are going to go away anytime soon.

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