Monday, November 12, 2007

Remember remember the fifteenth of November

Remember remember the fifteenth of November
Derivatives and bad paper amount
I know of no reason
During reporting season
That losses not be taken account

The fifteen of November is going to a very important date when this debacle is writen up for the next generations economic text books. The day itself will probably be rather boring but its importance will come from the effect of the FASB (Financial Accounting Standards Board) statement 157 which changes the accounting rules for the reporting of asset values by companies.

The big losers from this rule change are going to be financial institutions now sitting on tonnes of bad paper which is not easily priced. Unlike Stocks and bonds which have know market values, the world of assets also houses other classes of assets that do not trade readily and are difficult to accurately price. This was a godsend for financial institutions because they could price these items to a model, or to reflect their own assumptions which generally meant they could be priced at what ever value the organization wanted, ie. much to high to hide losses. This Voodoo accounting is about to end.

The gist of the rule is to force companies to attribute fair value to assets based not on internal models or unobservable inputs but rather measure them at the best of their ability as the external markets themselves would price them. As of Nov 15 2007 they must factor in the same non-performance risk that the general market would attribute to this asset, not the original erroneous credit rating they were given on creation.

No longer will companies arbitrarily decide the value of CDOs in their portfolios, they now must report "fair value".

In coming months this new standard will force companies to expose all of their malinvestments and the increase in reported write offs will be absolutely huge in comparison to the losses they have already admitted.

The total could very likely be in the 400-500 billion range and should increase the body count as more than one bank could follow NetBank to bankruptcy. Sure there are funds building up capital to buy CDOs but they have no intention of paying anything near full prices for this paper. The vast amount of paper and the likely weak market for risk makes me believe this stuff will sell, (if it can be sold)at fire sale prices.

This is the big test.
Which Banks will crumble?
Will the Government step in and buy bad paper or bail out banks? Will this generate so much new money that the U.S. dollar collapses?

We had a heavy correction today and it would have been a good day to buy some more silver, unfortunately my bank is closed due to a carry over of the Rememberance day holiday.

If you have cash buy silver now.