Sunday, July 12, 2009

Are Banks Failing to Mark Down Toxic Assets?

There is a widespread believe that banks are failing to mark their toxic assets to their true value (see, for example, the Economist’s View post “The Fall of the Toxic Asset Plan”). A commenter on this post, however, has a rejoinder that rings true to me:

I believe banks are generally marking to market their troubled assets at appropriate levels, not due to empirical evidence but in view of the audit & regulatory environment faced by the employees who have to sign off on the prices. I must temper the conspiracy theorists who believe banks have not made a sincere effort to mark down prices to "fair value", whatever that is in these markets. On the ground, today's audit teams are paranoid about valuation (PCAOB is watching) and a small cottage industry has grown up around the now 2 year old problem of valuing illiquid assets. Nobody at the big banks wants to sign off on prices they will later be accused of keeping too high. It's just not how it works inside these firms. They may wind up being in error but not for lack of analysis and pulling in every piece of imperfect market info available.I have performed a lot of valuation work that suggests prices are fairly conservative relative to base case expectations of future losses on a given asset-- certainly in the residential private label securities area where much of the problem resides.

There is just no upside to signing off on unsupported values. On the other hand, there is plenty of uncertainty about what values will actually be realized – see my post “Valuing Note Purchases” for more on this.