Tuesday, January 27, 2009

Bad Bank as a solution to banking crisis

Debt and equity securities held as "available for trading" are valued on a mark-to-market basis on a quarterly basis. Gain or loss in the securities is reported in the Mark-to-market accounting needs to be reflected in the income statement. When value of the securities fall, firm holding the securities reports a loss. When the value of the securities rise, firm holding the securities reports a gain.

With the value of the securities falling drastically over the past year, banks are writing down the securities on their balance sheet. They are reporting losses. Their balance sheet is shrinking. Shrinking balance sheet is changing their debt/equity ratio.

If the securities which are related to mortgage backed security (MBS) or Asset Backed Securities (ABS - credit card receivable, restaurant receivable), etc are removed from the banks balance sheets, the banks will not have to write down the assets quater over quarter as they have. Government can hold these securities in a "bad bank" structure. Government can hold the securities long-term and off load them when asset prices are reasonable. Due to the ability and intent of government to hold on to the securities till maturity, the accounting will be "at cost" accounting. Banks will benefit. Government will benefit. Citizens will benefit in a long run.

Bailout and curency strength

Bailout should weaken currency. Let's see how it has unfolded since September 2008. Some currencies have fallen significantly against others. Due to this US $ and Japanese Yen have gained their strengths. Yen still remains stronger against US $.

Since September 2008, governments around the globe have bailed out many industries. Where do governments receive the money to bail out. Well, they borrow. They borrow from one another and public. This borrowing takes places against IOU or bond issued by government. By doing so governments increase national debt. When supply of bonds increase suddenly, yield should have been higher to attract buyers. But, due to the plunging equity and corporate debt markets, investors are purchasing government bonds as a safe heaven investment (US Treasury bonds are free from default risk, but still exposed to market risk). This has driven the yield close to 0%. Once national debt increases, currency would lose strength.

Investments move from low interest rate to high interest rate countries for higher returns provided the exchange rate risk is within the investors tolerance. Exchange rate has anything but normal. Many European, South American and Asian currencies have been in a roller coaster ride for over the past 6 months.

US $ has gained strength against GBP, Euro, Ruble, Indian Rupee and all the commodity currencies (Canadian $, Australian $).

Yen has gained strength against almost all the major currencies. Why is the anomaly? Well, this because of national savings.

Thursday, January 22, 2009

Is Bank Nationalization a solution to reviving banks from the current crisis?

Nationalization of banks equates to government running banks. The fundamental question is a solution to the current banking crisis? The answer is "no" and "yes".

Should the government be in the business to run the business? No. Not in a capitalist system. But, the if banks keep falling at the rate they have in 2008 and in January 2009, then it should the last resort. Even if Government can nationalize banks, it is complex to nationalize all the banks. It is only practical to nationalize handful of big banks. Then, if the banks were nationalized, branches will be closed, competition will diminish and service will suffer.

Government has other means to revive banking systems before a drastic step like nationalization take place.

The fundamental problem gripping banks is the falling value of assets; especially, the structure securities. If the first tranche of TARP were used to purchase such assets and the assets were removed from the banks' balance sheets, the problem could have been ameliorated. The new administration has requested for the second half of TARP. It is floating the idea of accountability and transparency as well as requiring banks to lend. Hopefully, the new administration will be able to implement such measures.

Tuesday, January 20, 2009

New Currency World Order

A year ago US Dollar was weak against Euro, Great Britain Pound and even the Canadian Dollar. It was string against Japanese Yen. With the recession commodity prices plummeted. High rising Euro and ever strong GBP started to weaken against US Dollar. Yen on the other hand started gaining against US Dollar. A strong US Dollar is good for inflation, but bad for earnings of multinationals. Americans can take a trip to Europe and Australia without having to spend an arm and a leg. Is this new currency world order good? What will happen if the proposed $850 billion second stimulus package is enacted?

Monday, January 19, 2009

When will the economy recover?

Pundits say that the recession started in December 2007. By December 2008, world economy has been in recession for 12 months. A typical US recession lasted for about 12 months and a typical worldwide recession lasted for 12-18 months. Now, we are into the 13th month of recession. Should the US economy recover in 2nd half of 2009 or it would recover in first half of 2010? When would the worldwide economy recover?