Thursday, March 25, 2010

Duct Tape and String

Sometimes things hold together for the damnedest reasons. I had a silver Rambler that continued running because of a piece of rusty wire I found on the New York Thruway. I was not just relieved, I was proud. Broken down in the middle of nowhere and in a McGiver moment I had us back up and running. Sounds rather like Ben Bernanke and the economy. It's running, but won't pass inspection, but damn weren't we clever to avert catastrophe?

Like Silver Cloud, that Rambler's unlikely name, eventually that rusty wire will give up the ghost but hopefully we'll limp to a safe destination and really fix it. Unlike Silver Cloud we can't scrap the economy for a new one, although god knows, it seems like we could get more easily get financing for a trillion than a new clunker.

FASB, the accounting standards board continues to allow banks "substantial discretion" in valuing their assets. But a financial system without a clear standard for valuing assets if impaired. Currently unless a debt is in foreclosure, it appears banks are reluctant to modify mortgages or restate delinquencies in order to obscure valuations.

This development is exactly how Japan became a stagnant economy for the past twenty years with constrained lending activity and business growth. The unusual and growing gap between delinquencies and foreclosures indicates an increasing need for resolution. As we are progressing now, zombie banks will continue to operate at public expense while performing their function as lenders to private endeavors suboptimally.

The accounting industry needs to force greater disclosure discipline on the banks, however following the recent revelations about Ernst & Young and Lehman Brothers that may be too much to expect. Until things are fixed right, it's anyone's guess when we will again grind to a halt.

John Barnyak
Stonehouse Asset Management