Over the last three months, the pace of this downward spiral has accelerated.
- In Europe, we have seen the gradual re-freezing of the inter-bank loan market and the wholesale funding market as well as bank public debt issuance cease. This was on top of the run on the European bank deposits occurring in the peripheral countries.
- In both Europe and the US, we have seen bank stock prices collapsing.
Fortunately, opacity can be cured with disclosure. Disclosure ends the financial and confidence sapping costs of opacity on the economic system.
I would like to direct readers to an excellent post by Barry Ritholtz on The Big Picture blog. In the post, he looks at the contribution of opacity to the collapsing bank stock prices.
Morgan Stanley in a free fall. Goldman Sachs at multi-year lows. Citigroup looking Ugly. Bank of America off 50% from recent highs.
You may be wondering what is going on with the major firms in the financial sector. While each of these firms have different problems — vampire squids to Countrywide acquisitions — they all have something in common: Their balance sheets are opaque.
This is no accident....
Banks loved ["Mark-to-Market" accounting] during a boom period. M2M made the more unusual balance sheet holdings — derivatives, the mortgage-backed securities (MBS), exotic liabilities, and other assets — look fantastic. The fair value measurements of these items — essentially, yesterday’s closing price — allowed the accounts to show enormous profits. Those were the underlying basis for huge bonuses, stock option grants and of course, company share prices.
The reality was quite a bit different. These were not equities or treasuries or corporate bonds — they were thinly traded items whose prices were ramping upwards on a sea of delusional optimism. As soon as the credit bubble ended and housing began to retreat, these assets would free fall like an Acme anvil in a Roadrunner cartoon — and the bankers were the Coyote.
Uh-oh, this was gonna be a problem. So the bankers began to lobby FASB to change the rules governing Fair Value Accounting. Sure, it was hugely helpful on the way up, but now, reporting actual holdings — previously marked at all time highs — was becoming problematic.
To their credit, the accounting board resisted. What Bankers were proposing — marking to their models — was patently absurd .... Some people began calling the proposed accounting changes “Mark-to-Make-Believe.”
In the midst of the 2008-09 collapse, however, Congress was in a panic. They mandated that FASB accept Mark-to-Make-Believe accounting in the Emergency Economic Stabilization Act of 2008. It gave the Securities and Exchange Commission the authority to “Suspend Mark-to-Market Accounting.” In March and April of 2009, that is precisely what occurred....
The bottom line is this: Investors do not really have a clear idea of how healthy any of these banks truly are. We do not know the state of their balance sheets. We do not know what their exposures are to mortgages, to Europe, to Greece, etc. They could all be technically insolvent, as far as any investor can tell. ...
Investors have decided they cannot take the risk of a holding an opaque, possibly under-capitalized probably over-leveraged financial firm blindly. They are telling the banks no thanks, we are not interested, we are going to be prudent and we have to assume the worst.
Hence, for the second half of 2011, they have been selling off their holdings in these opaque, potentially insolvent too big to succeed entities....