The Latest Government Contrivance

The highly anticipated and editorialized changes to the Nation's accounting standards, implemented this week by the Financial Accounting Standards Board, will have the immediate effect of providing a boost to Bank's bottom line earnings. Additionally, the changes will at least delay the need for further Government Capital Injections, as the inevitable near term reduction in bank write-downs(possibly even write-ups for those feeling adventurous) will help provide the illusion of Capital Adequacy for the weaker institutions.

To use a wildlife analogy, think of the Banks as a herd of Antelope that are being stalked by a pride of Lions(the Market). Within the herd, many of the antelope are inflicted with a disease(bad paper) that has caused a noticeable deterioration and weakening of the horns(thin capital levels). The Lions, being savvy predators, have detected this "weak antelope" trait, and have selectively devoured this vulnerable segment of the herd. The Game Wardens(Government), having determined that the continuation of this process is not in the Savannah's best interest, devised a plan whereby they will rush in and attach fake yet healthy looking horns onto those Antelope deemed most "at-risk".

The question is, whether the Lions will be able to discern the difference between a legitimately healthy Antelope, and one that has been artificially aided by the Game Wardens? We think so.

We accept that, at this point, it may be more appropriate to value an illiquid asset based upon the present value of expected future cash flows, provided of course that reasonable assumptions are made concerning the impending permanent impairment to a portion of said cash flows. Unfortunately, we do not think that the Government possesses the ability to assess the present value of anything more complex than a plain vanilla Agency MBS. This reality will likely lead to attempts by financial institutions to grossly overstate the value of assets that are beyond the scope of the Government's evaluation ability. However, returning to a theme commonly espoused on these pages, the Markets are unlikely to be fooled for very long. We expect that the Market, in relatively short order, will digest the practical effects of the accounting rule changes, and judge the viability of financial institutions accordingly. The stronger Institutions will inevitably return their TARP money to Treasury, while the weakest of the herd will be exposed as both insolvent, and completely lacking that layer of the capital structure known as Common Equity. Owners of Bank Stocks beware. Sphere: Related Content