I saw this a few days back at Clusterstock and thought the question made a bunch of sense. There are good reasons why accounting hocus pocus (ie banning mark to market accounting) is a bad idea. IMHO we are much better off taking our medicine now.
A key component of successful financial system bailouts in the past has been forced asset writedowns, in which the government makes banks reduce the carrying value of this assets to nuclear-winter levels before the government injects new equity. This move does several important things:
- It removes the fear that banks and bank investors will be hammered by future writedowns
- It turns the banks’ attention 100% to putting the new equity to work
- It attracts private capital (because investors won’t worry about getting sandbagged)
- It eliminates the death-by-a-thousand-cuts scenario that killed Japan.
To put some numbers on this: So far, US financial institutions have taken about $650 billion in asset writedowns. Nouriel Roubini and others have put the total expected writedowns at $1-$2 trillion. This suggests that banks still have $350 billion-$1.350 trillion in losses to take. Losses in this range could wipe out common shareholders, the government, and the financial institutions….unless the banks can easily raise additional equity to offset the losses.
The government may be hoping that 1) the writedowns are done, or 2) the banks can just slowly write off the rest of their crap assets against earnings over the next several years (thanks to the elimination of mark-to-market accounting). Given the magnitude of the projected losses, this seems like wishful thinking.
Alternatively, the government may plan to just keep injecting more and more capital until the writedowns are finally done. If this is the plan, however, other private-market investors are unlikely to follow suit.
So we have one remaining and important question for Messrs. Paulson and Bernanke: What about the future writedowns?