Remember Merrill’s (MER) dumping of mortgage products to Lone Star for 22 cents on the dollar? It is now coming home to roost at the rest of the banks.
JPMorgan (JPM) said since the beginning of July, trading conditions in the mortgage market “had substantially deteriorated . . . causing the company to incur losses” of $1.5bn, excluding hedges.
Bankers said July was the worst month for mortgage-backed bonds since the beginning of the crisis, as a combination of cut-price sales and waning demand from large investors helped to depress prices. Morgan said the writedowns were partly driven by Merrill Lynch’s decision to sell $6.7bn in toxic securities to Lone Star funds, the distressed debt investor, for just 22 cents on the dollar.
The move prompted a fall in the prices of similar securities, forcing JPMorgan to mark down its own assets.
This is the problem with “mark to market” accounting when the market is so dislocated. It is a bit like the bank coming to you because the price of your home fell and telling you to sell your car to raise capital. If you are not selling your home and have a conforming mortgage, its current valuation is meaningless. JP Morgan does not need to sell the securities to raise capital. Now, if troubled firms desperate for cash need to dump additional assets to save themselves, the value of all assets may drop further, causing additional write-down and then the need may arise to restore ratios.
What is being ignored here is the cash flows from the assets. Not all of them are impaired and now are trading at prices below the streams of income they produce. Remember, Thain said that the financed part of the Lone Star transaction was fully financed by the revenue from the CDO’s.
Just because your neighbor gets himself in a jam, it should not force you to liquidate or materially markdown your assets.
Mart-to-market is exacerbating the current banks problem because it is forcing actions that without it in the extremity of the current market, would not be necessary.
Disclosure (“none” means no position):None
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