Dubious Accounting Will Not Solve The Credit Crunch

Various media cover the presentational steps being taken by financial organisations to put their sub-prime losses into a separate account from the rest of their businesses. UBS (Union Bank Of Switzerland) managed to find a further $37 billion of sub-prime losses incurred yesterday to place into this book-keeper’s extra column. The extraordinary thing was that markets took this news as a positive, and an indication that the sub-prime losses were now starting to be more known and quantified and therefore less threatening than they once were.

The FT states that Lehman Bros, recently rumoured to be in sub-prime distress was now optimistically hoping to sell off the illiquid assets that it is holding, even though at this stage these assets are probably worthless. Only if the market for sub-prime debt eventually recovers might Lehman be able to find a buyer, and for the foreseeable future there is not much chance of that happening. See the FT article which just about admits that the moves being taken and positively spun are pretty much worthless. HERE

Extract – Lehman Brothers, which has been forced to deny rumours about its financial health over the past few weeks, is believed to be one of the banks considering a spin-off, or sale, of some of its assets.

“We want to continue to move illiquid assets off the balance sheet,” Erin Callan, chief financial officer, told CNBC this week. The bank declined to comment further.

Other banks hit by the credit crisis, including Citigroup, Morgan Stanley and Merrill Lynch, have said they want to take steps to shrink and de-leverage their balance sheets.

The planned creation of “bad banks” comes as US and European lenders are also discussing the creation of a common fund to buy devalued assets.

According to people familiar with the matter, banks are discussing a joint proposal to regulators to set up a fund, which would absorb US subprime assets and other troubled securities, as a way of restoring confidence in the banking system and ending the pressure to recognise mark-to-market losses.

However, bankers say the prospect of a co-ordinated solution remain remote because of the difficulties in getting banks to agree on the terms and the scope of a common fund.

Similar disagreements among banks this year led to the collapse of talks to create a “super-SIV” to buy distressed mortgage assets from banks.

Under UBS’s scheme, the bad assets will remain on the bank’s balance sheet because the Swiss bank will initially retain full ownership of the new fund. However, UBS is expected to sell all or part of it to outside investors, or to spin it off, according to people familiar with its plan.

The FT is also trying to make a news story about the British property market possibly being about to swing heavily south. The story has also been positioned in political terms as reported HEREon Conservative Home in Today’s Tory Diary, by George Bridges, David Cameron’s ex-director of campaigns, who has written in The Spectator that a collapse of the British property market would hurt Labour’s marginal constituency voters predominantly and possibly influence them not to vote for Labour. Labour’s support is already falling away as the cost of living in Britain soars, with rising mortgage payments only part of the story.

The FT dramatise the position of the UK property market by starting their graph in 1995 when UK property prices were at a low point after all the fallout with the ERM exit crisis, and showing how prices have moved from 3 times average household earnings then to nearly 6 times now. In fact they are about 5.5 times, and 4 times is about average over the last 25 years, so as incomes still continue to rise, property prices in the UK might fall 20% in total, which is not all that dramatic.

Just for a moment compare the UK’s position with that in the US. California saw property prices at around 12 times average earnings six months ago, while 6 times earnings is the US longer term average position. US property prices in all probability have far further to fall than British ones do. Furthermore the numbers of houses in trouble dwarfs the problems in the UK. In 2007, Britain had 27,000 repossessions while in the US there were 1,000,000 foreclosures. Q1 2008 has seen a big increase in the numbers and a figure of 1.5 million or 2 million foreclosures is not impossible this year. The scale of the problem is on another scale altogether.

The losses to be absorbed by the financial organisations that have underwritten the sub-prime risks will not be known until it is seen how many homes are foreclosed, and how much further US property prices fall. In my estimates made in earlier posts on The Tap, I felt that $1 trillion would be nearer the mark than the $400 billion, estimated by Lehman Bros as the total sub-prime losses.

There is the further complication to take into account that, incredibly so many of the mortgages held by the banks have been badly recorded to the point that when the banks go to court, the judges are not permitting the foreclosures to go ahead, as the banks don’t have sufficient proof to get a court order of foreclosure. Obviously if this aspect proves to be a bigger factor than is yet known, the sub-prime losses will balloon towards an unbelievable figure. See report on this HERE

The scale of the problem is in any case such that smart accounting by financial organisations will not be able to obscure or absorb the losses. It will take intervention by governments across the world to maintain the confidence of financial markets. Only governments can draw on sufficient sums of money to address problems of this kind, and ensure that confidence is maintained. Clearly it is easier for the governments around the world with large financial reserves to deploy to handle this kind of situation. By being willing to buy banks or shares in banks or financial assets that are practically worthless in the short term, the Chinese and other sovereign funds are uniquely positioned to assist.

The US Treasury are aware of this and it is not surprising to find the Henry Paulson The Secretary of The US Treasury in Beijing today meeting with Hu Jintao the Chinese President to discuss Chinese American economic cooperation.

As reported on Xinhua –

China would intensify communication and coordination with the U.S. on macroeconomic policies, continuously lift the level of bilateral economic and trade cooperation and make joint efforts with the United States to maintain the growth of the world economy and the stability of the international financial system, Hu said.

Full article HERE

See my earlier post ‘Will China Save The US Economy?’ HERE

The Tap Blog is a collective of like-minded researchers and writers who’ve joined forces to distribute information and voice opinions avoided by the world’s media.

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