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Beyond mark to market
Posted by WARREN MOSLER on August 19th, 2009
An additional measure was taken a few months ago that just struck me one of the possible reasons for the current economic setback.
This is best illustrated first by an example.
My (very small) bank holds securities in its ‘hold to maturity’ account.
If these securities become ‘impaired,’ as defined by regulation, they are marked to market and capital adjusted for that loss.
But recently an additional measure was taken by the regulators.
If they are downgraded to below ‘investment grade’ they are not only marked to market for net capital calculations,
but also treated as a ‘charge off’ for capital ratio purposes.
For example, if we have $1 million security that is downgraded below investment grade and has a current market value of $500,000,
we reduce our stated capital by $500,000, as had previously been the case.
But now, even that $500,000 remaining value, is, for all practical purposes, counted as 0 for purposes of determining our capital ratios.
The capital ratio is the important calculation as it determines how many assets a bank can carry for a given level of capital.
This means, for example, that if a bank had securities that were below investment grade with a market value equal to all its capital
it could not carry any other assets or deposits.
They call this ’super risk weighting’ or something like that. More details to follow, and any additional info welcome, thanks!
Meanwhile, this has resulted in a sudden drop in the all important capital ratios,
and with every downgrade below investment grade by the ratings agencies, a much larger capital reduction takes place than under previous rules.
And, equally important, all banks holding any securities are at risk of losing all ‘credit’ for even the fair market value of their securities
for purposes of determining their capital ratio compliance.
Additionally, this can force sales of these securities as the proceeds of a sale at least add that much capital back to the capital ratio determination.
And the forced sales, of course, drive prices down below even today’s depressed market values.
This provides high yielding securities with little or no risk at the now lower prices for unleveraged buyers, at the expense of the banking sector.
Banks are public private partnerships, and it looks like the public partner is shooting itself in the gut contrary to any notion of public purpose.
Regulators have told is there is no chance for this rule to be altered.
And as an aside, we have a security that was simultaneously downgraded by one ratings agency and upgraded by another. Interesting how after all the criticism of
ratings agencies our govt has increased its reliance on them for purposes of public policy.
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August 19th, 2009 at 1:54 pm
So let’s say you were a prudently managed bank, you didn’t issue a lot of garbage during the bubble years, and then you decided to clean up by going out and buying some “impaired assets” for deep discounts. Now the regulators are coming up to you and saying, those assets are no longer “investment grade”, so you have to write them off?
Just when you think they can’t get any worse…
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August 19th, 2009 at 3:17 pm
if they aren’t investment grade you can’t buy them in the first place.
so let’s say you bought them when they were investment grade, and then they are downgraded. they now are valued at 0 for purposes of determining capital ratios, even if market value is still solidly positive.
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August 19th, 2009 at 4:13 pm
And I guess since most of the entities who would normally buy them are also under the same constraints, it might be difficult to unload them, anyway?
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August 19th, 2009 at 5:10 pm
yes, they go to prices where unleveraged buyers will buy them, which is fine, if there isn’t a lot of sudden selling
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August 19th, 2009 at 6:34 pm
It’s insane.
The give out money with one hand, and drain it (via FDIC) with the other.
They loosen capital ratios and let banks recapitalize with one hand, and tighten capital ratios with the other.
The roulette wheel is really going round and round. Thank God for unemployment!
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August 19th, 2009 at 10:57 pm
100 per cent capital requirement for something that’s already been marked to market?
Very doubtful. I’ll believe it when I see it.
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Warren Mosler Reply:
August 20th, 2009 at 7:24 am
i’ve seen it and just had my bank’s capital ratios reduced by it.
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August 20th, 2009 at 12:01 am
Winterspeak, the rube goldberg machine of our government keeps many human beings busy and occupied. Sure it is total inefficient madness when viewing the whole forest. I have not heard Warren address the point that perhaps the “public purpose” of full employment has created so many rube goldberg machinations, that the only way to keep full employment, is to hire people to create and others to destroy various government public purpose entities! Like keynes analogy, hire half the people to bury jars of money, and the other half to dig up the jars of money. It keeps everyone working, but they aren’t really accomplishing much or bringing us stargate atlantis cities.
I can’t help but remember several years ago talking to Warren about Hoover’s printing presses and the banks all not willing to lend and someone saying something about we wouldn’t make that mistake again. (sigh) Warren the tower of Babel grew so high, even many smart well meaning people could not keep it growing. Roman society got too complicated, from the political backstabbing to the complex social strata, the solution was for the simple barbarians to raze the city and start anew.
What founding father said FIRST by INFLATION, and then by DEFLATION, the sons of this country would wake up slaves owning nothing. Phil Grande philsgang.com says what they are doing with the banks is total nonsense, it is just allowing 300 rich wealthy families to come in and scoop up all these assets that were generated by this last inflation at firesale prices. It is up to people like YOU Warren to stop them from doing this, the wealth gap from rich to poor is already WAY TOO HIGH!
http://www.businessinsider.com/2008/4/income-gap-widens-recession-fears-grow
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August 20th, 2009 at 2:01 am
The FDIC has also been raising premiums on all risk categories… same old “FDIC is out of money” nonsense!
Warren, forgive my ignorance, what happens when one rating agency rates a security as investment grade and another doesn’t? Do the regulators decide which rating to use for capital ratio requirements?
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Warren Mosler Reply:
August 20th, 2009 at 7:24 am
they use the higher one
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August 20th, 2009 at 9:53 am
Warren, so how does this effect the analysis of the causes of the credit crunch. Was it more of a pro-cyclical (as u have said) ‘demand’ for loans problem or was it more of a under-capitalization ’supply’ problem?
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