Why the banks won't price their toxic assets
Feb 13th 2009 10:30AM
Updated Dec 4th 2009 10:56AM
Way back in the twentieth century, the stellar Hartford Courant columnist Tom Condon, in his many and legendary battles with the Connecticut Department of Transportation's aggressive tree-trimming program, used to ask: "I know I've said it before, but what is it that the Department of Transportation has against trees?"
Well, at least as it relates to the market and toxic assets, apoplexy loves company. And the crazy question I want to ask again and again is: Why is it that the banks, and the financial community more-broadly, can't price toxic assets? Isn't the market great at price discovery? Well, start discovering prices, then.
DailyFinance momentarily distracted 'Chairman Wang,' economist David H. Wang, from his economic modeling projections Thursday to obtain an answer.
"This is a compelling question, one not without political factors, and the answer to which will likely say a lot about the financial crisis," Wang said.
"One school argues that the banks are waiting for the market to recover, so that they will be able to obtain a better price for the toxic assets," Wang said. "These theorists argue this is the main reason the toxic assets are not trading now and the market is illiquid. In this view, market prices have irrationally distorted prices to the downside and/or they will improve with time."
"Another school argues that most of the toxic assets are nearly worthless," Wang said.
The big stall?
Well, if they are worthless, wouldn't the banks benefit from having the federal government pay slightly above market value for them, for example, at 25 cents on the dollar for a toxic asset that's worth 15 cents on the dollar? "Not necessarily. For some banks and financial institutions, selling the assets, the day of reckoning, if you will, will reveal that they are insolvent, and the bank will either be bought, nationalized by the federal government, or otherwise closed," Wang said. "For these players, this would mean they are not at the poker table. They're out of the game."
So, in other words, the price discovery feature of the market -- which some view as all-knowing, all-perfect, and above all, always working -- may not be working, due to a stall. Some banks don't want price discovery or their toxic assets to be priced. They'd rather have credit markets remain constrained -- with horrible consequences for the U.S. economy -- than to price and sell assets that would result in the end of their operation as a company.
"Yes, that's the argument by the 'survivalist school,' as zany and as irresponsible as that stance seems," Wang said. "From an institutional standpoint it makes sense, but from a U.S. economic health standpoint it makes no sense."
Wang's take? "We need to price these assets, which underscores the importance of the U.S. Treasury's upcoming announcement on how this will be achieved, and we need to get rid of those banks that are zombies. Each week that goes by without pricing and trading toxic assets acts as another credit contraction week for the U.S. economy, and it delays the recovery in commerce," Wang said. "I'm not saying that all of the top 20 U.S. banks are zombies. But consolidation has to occur, and a few banks, for systemic risk reasons, may in fact be nationalized, at least temporarily."
Bank Sector Analysis: Given the interests of the bank executives, one begins to understand why toxic assets haven't been priced. Say you're an $800,000 executive, excluding bonuses, of a bank in doubt, whose stock is trading at $4 a share. You know that as soon as the assets are priced, you have to vacate the corner office, and the prospect of securing a comparable base and bonus at another company is slim. But as long as the music plays, and toxic assets aren't priced, you still draw compensation. As they say, nice work, if you can get it.
Bottom Line: The U.S. Treasury needs to develop a mechanism to price these assets as part of a comprehensive plan to clear out the zombies and get credit flowing again.
Financial Editor Joseph Lazzaro is based in New York.