The other other way to put this is that they really believe that the revenue stream that will come out of the asset exceeds its current value and therefore they can't afford to take the loss of selling now - they *have* to hold and milk the asset, because that way they have at least a chance of getting out of the hole.

That doesn't prove they're right, of course - they may be merely grasping at straws. But those are the only straws they've got.

I agree with you wholeheartedly which is why I'm not that stressed about Geitner's Plan. I've taken a bit to come around on nationalizing the banks because I just didn't want to believe that such a drastic measure would be necessary. But at this point it seems inevitable.

The way I see it is that we all know that there are a lot of insolvent banks out there but, unfortunately, there is no incentive for any bank to admit the vast discrepancy between the book and market value of the assets that they hold. What CEO is going to even be willing to give up their measly $500K salary to do that?

Therefore, even though I'm well aware that the "stress test" provision in Geitner's plan will waste valuable time in this crisis to only tell us what we already know. It, hopefully, will provide numbers and metrics that will expose the problem as it truly is and not as it's being portrayed on the bank's balance sheets for each individual bank. The evidence will hopefully give the necessary cover to do what a critical mass of people believe needs to be done. Unfortunately, probably at a higher cost than if we just went ahead and did it right now. But, unfortunately this type of gridlock is built into our system of governance and I think we'll just have to deal with it.

Chris has a point, but to accept it you have to abandon the belief that markets are any good at setting prices. If the present value of holding onto a toxic asset were in fact significantly higher than the pittance to be gotten from selling it, then somebody would be doing that right now. In fact, banks themselves would be doing it, even with the scarce, high-priced capital they have access to at the moment. That they're not doing this says either that markets don't work for setting prices, or that the toxic assets really are every bit as bad as the market says they are. (Or both, of course)

Another way of thinking about Chris's point is that somehow every bank seems to think that its portfolio of toxic assets, and its portfolio alone, is best handled by collecting what cash flow comes in and waiting for prices to rise. (If they thought someone else's portfolio would behave similarly, they'd buy it, wouldn't they?)

Or you could just assume a really big agency problem, which is what Mike Allen's source is saying.

I don't understand why people don't just make sure to blow off the heads of the zombies.

It's not as if there isn't a manual for dealing with this.

ezra, did you honestly just realize that this is a big problem? did you really just think that stubborn bankers were putzing around for no better reason than they couldn't grasp how screwed they were?

What's not clear from this post is its not just that they would have to book a loss on what they sold, its that they would then have to revalue the assets they hold they did not sell, to align them to the present market value. Which would clearly show them as insolvent. So games are played with accounting rules about mark to market, so they can continue claiming the assets are worth more, like your neighbor who bought a house in 2006 for $800,000 which, through comps, is now worth $500,000. Said neighbor still telling self and others that the house is still worth $800,000.

Whatever you call it on paper, the reality is no one is buying at $800,000, so whether you mark to market or mark to the moon, its worth what someone is willing to pay for it.

One irony of this is banks are themselves underwater on the mortgages they sold to others who are now underwater on their own mortgage.

But what they can't do is pretend to pay off their debts with money they don't have or assets that don't cover their debts.

How can there be no capital in a capitalist system? I really want to know.

Hey, the dozen or so largest banks with the bulk of the toxic paper (the real stuff, mortages and derivatives thereof) are just kicking the can down the alley because they no only can, but they must in order to survive as is.

Calculated Risk blog had a post yesterday titled "A suggestion for Balance Sheet Transparency and Disclosure" that cited a JP Morgan disclosure (from the Wash. Mutual acquisition) that provided three scenarios on what WM's assets might be worth given decline percentages on asset value. CR comments: "Note: the toxic assets are frequently described as difficult to value, but the real problem is forecasting future defaults." He suggests that this is a good way to uncover the now-hidden horror on the bank balance sheets. This may be what Geithner is talking about when he mentions 'stress testing'.

It is pretty clear that none of the biggies (Citi, BOA, Wells, JPM/Chase, GS could survive as solvent if the worse scenario is reality. And it is.

So, the name of this game is 'who eats the loss' on the whatever it is when the loss is made public. In the Great Depression this loss was masked by the bank holiday/closure nationally, and the assumption of the toxic waste by the government agency for the fire sale later. The savings and loan debacle was handled similarly, and that is what is behind the calls for nationalization now of the US banks who can't prove solvency with open reporting of their positions.

My guess is that the banks have more power than Obama/Geithner (if they chose to battle on this front), and the Congress doesn't want to know the truth (We can't handle the truth!).

In the meantime, anyone who puts money in the bank has to worry if their bank (and the FDIC) will make their deposits good. Uncertainly is the mortal enemy of stable markets and economic recovery in down periods.

I bet we don't have the guts to face this, and more can-kicking will occur.

How can there be no capital in a capitalist system? I really want to know.

They spent the last 8-10 years running the housing market on Monoppoly money and people all of a sudden noticed. The game works until people notice that they weren't playing with real money (money backed by secure assets)and instead with play money (money that is backed by implied worth).

I don't think much of this "financial system in crisis" stuff can be understood (leaving the blogreading world at the mercy of gibberish like the Hawise comment above) without a basic understanding of what a bank balance sheet looks like.

see http://www.stlouisfed.org/col/director/Materials/call_balance_components.htm

At the simplest level, Bank Assets = Bank Liabilities + Bank Capital.

this, by the way, is basically "leveraging capital"

If the value of assets falls, there's nothing that necessarily happens to the value of liabilities, so the value of capital falls. Due to leveraging, it doesn't take much of a fall in asset value to eliminate all or more of the value of capital.

A lot follows from that simple set up.

But really, where did all the wealth go? Before the housing bubble (and I guess before the tech bubble), I gather we were sufficiently capitalized. Then the housing bubble came, and the banks acted as if the total wealth in the world had vastly increased. (Which, depending on your definitions, it had.) Then housing collapsed.

So why aren't we back to where we were before the bubble? Did the banks piss away all this extra wealth on bonuses for their employees, calculating that they'd still be solvent, and then got burned? Could the bonuses really have totaled that much? Or did the money go elsewhere?

I learned in law school that "insolvent" means unable to pay your debts when they come due. It is possible for your net worth to be negative and not be insolvent. This idea of 'insolvency" which is what you have to be to seek bankruptcy protection is different from older ideas of bakruptcy. In the first third or so of the 20th century, a corporation could be taken into receivership if its capital was "impaired" when meant that its net worth was less than its liabilities. That seems to be what we are talking about although the banks could be insolvent as well.

It's worth noting that during the Great Depression, many corporations and businesses and banks did not go into bankruptcy but went into receivership, and continued to pay among other things, huge fees to their attorneys and to attorneys for the creditors, as attorneys for "creditor protection committees". The cleanup of this sort of abuse was one of the reforms of the much maligned New Deal.

How to deal with straightening out these banks and other business entities whose financial statements no longer reflect reality is one of the challenges of our new administration.

Allen K.--

The scenario goes like this:

I lend you my last $100 in exchange for a $10 payment at the end of the year and an IOU.

Based on that IOU for $110 payable at the end of the year. To cover my expenses until you pay me back, I borrow another lender's last $90 promise to pay back $95 at the end of the year.

That lender then to cover their expenses, borrows $80 and promises to pay back $82 at the end of the year.

So, based on initial loan of $100, $287 is floating around. A ratio of 2.87 to 1

Now let's say you lose your job, declare bankruptcy and won't be able to repay. I've lost my expected $110. And because I can't repay, the guy I borrowed from lost his expected $95. And because he can't repay, the gal he borrowed from lost her expected $82.

There are estimates that that some banks were leveraged at a ratio of $30 (money they borrowed for every $1 dollar in assets (money they lent)

That's where the money went. It wasn't primarily lost in bonuses or luxury yachts(although that culture of ridiculous pay for shuffling $$$ from place to place is obscene). Because if it was it could simply reclaimed. Those things have value. It is simply that the entire lending structure was being built on shaky foundations once lenders lost their damn minds. The banks are left holding a huge IOU which the borrower can't pay. And because the borrower can't pay, the bank can't pay anyone it borrowed from, and so on...And to make things worse, the original asset that is the basis for the loan is not worth the value on the IOU so you can't even sell it without taking huge losses. If they did they'd owe the difference between the IOU and whatever amount they borrowed against it. AKA Insolvency!

The "wealth" disappeared because the present and future turned sour relative to expectations about them that had been held or promoted. I have a guitar I'd gladly sell for $100K, but I can't claim that as "wealth" unless there's also someone out there who will pay that or more for it. The situation would be even worse for me if I had paid $100K for the guitar in the first place (luckily, I didn't, I'm only frontin')

In the housing case, a lot of the increased valuations are promises to pay. The value of a financial asset (like a mortgage or a mortgage backed security) is intimately related to future cash flows -- the mortgage payments that the homeowner will pay. If the value of the house -- what others might pay -- or the income of the homeowner have fallen, then the likelihood of the promised payments being made is lower and the value of the mortgage asset -- the loan, which the bank holds as an asset, either as a loan on its books or as a piece of a mortgage backed security -- is diminished.

So the wealth that has "disappeared" is not money or purchasing power that has been dissipated or stolen, it is expectations about future wealth and ability to pay, which determines the value of financial assets today. Of course, there are some folks who got money out of all the transactions as fees (e.g., mortgage brokers, ratings firms) or as bonuses. They took that current purchasing power to the bank or somewhere safer, I suppose.

The "capital" was converted to 3,000 square foot houses in less desirable parts of California, Florida, and Arizona. The worst part of a bubble is the inevitable misallocation of resources. That's what makes adjusting so difficult. We've already blown the money we needed to fund the recovery and we can't get it back.

I am going to live 30X higher than my means and then stick the rest of you with the bills

no capital cause we all became greedy, the economy will get a little better, then InFlation(credit cards already up), then the depression scenario. we have to pray to our Lord Jesus, INSOLVENT is unable to pay debts.