“It’s worth what I say it’s worth”: Part 2, done on paper
[Continued from yesterday’s Part 1.]
Yesterday, using a New York Times article as a springboard, we examined Humpty Dumpty’s question of value: what does value mean, and who decides that it means that?
“Everything’s coming up roses”
For reasons I listed yesterday, the assets are often valued by people who have a vast vested interest in seeing them not fall in value:
Worldwide, banks have written down the value of assets by $380 billion, as high-flying markets have crashed back to earth. Some banks suggest that the write-downs have been conservative and that some assets may be written back up in the future.
They may be right.
Others say the bill will keep mounting.
They may be right.
Pick a card, any card
Bankers like to say that valuing complex investments is part art and part science, but four large firms have said recently that some employees have not been honest.
Pfui, as Nero Wolfe used to say.
Don’t talk nonsense
It has nothing to do with art, and everything to do with judgment. That rare commodity.
I don’t know much about art …
In February, Credit Suisse found a group of employees who had bumped up the value of mortgage assets by $2.65 billion during the fourth quarter last year and through the start of this year. The employees were fired.
In March, Lehman suspended two traders on its equity derivatives desk for overpricing bets in the market by tens of millions of dollars.
In May, Merrill Lynch disclosed a similar incident that cost it about $18 million.
Morgan Stanley was the latest to find misconduct. On Wednesday, the investment bank said it had lost $120 million this year because of a rogue trader. The trader, Matt Piper, is British and has worked for Morgan Stanley in
Do I look like a rogue to you?
“In this sort of environment of stressed markets, one would expect to see people trying to behave improperly,” said Colm Kelleher, Morgan Stanley’s chief financial officer, on a conference call.
“We’re very angry about it.”
Well said on both counts.
Let us show you how we feel
Now, bank executives are increasingly scrutinizing their employees and trying to catch them if they are too optimistic — or downright dishonest — about valuations.
But it is not simply a question of catching rogue traders. Marking the book, as the industry calls the pricing process, has become one of the more controversial topics among finance executives, even in instances where no fraud has been alleged.
Away from Wall Street, plaintiffs’ lawyers are circling.
Did a bank just die?
Suits over losses in funds like Charles Schwab’s YieldPlus Select assert that managers were irresponsible in not knowing how risky the mortgage assets would turn out.
A spokesman for Charles Schwab said the company does not comment on pending legal cases.
“I don’t know if I could tie it to some kind of widespread conspiracy. Certainly the fact that the write-downs have been so massive would mean that somebody was optimistic,” said Ryan Bakhtiari, a lawyer who has filed an arbitration on behalf of investors against Schwab. “It was true from the beginning to the end of the food chain: everybody made inflated money.”
Now that the inflationary strategy has collapsed, might ultra-conservatism be in vogue?
Free your balance sheet, and the rest will follow
Banks are sometimes forced into write-downs because of selling in the market.
This kind of downward pressure is a reason that some, like me, think there ought to be some ability to leaven current-market results with an assessment of intrinsic value.
Lehman Brothers, for instance, said that the collapse of the hedge fund Peleton Partners in February forced Lehman to write down the mortgage assets it owned similar to ones held by Peleton.
Instability headed this way
In an earlier blog post, we saw that in March, the price of Fannie/ Freddie securities – for this purpose, consider them risk-free even though they aren’t – had plunged simply because of a short-term excess of sellers over buyers. Sellers needed liquidity and were selling Fannie/ Freddie not because they were bad objects, but because they were good objects.
Aren’t I a good object?
Some banks say the write-downs caused by fire sales may be overkill.
“There is a bit of this atmosphere that says, ‘Let’s just mark it down, no one is going to question it if we mark it down,’ ” said Christopher Hayward, the finance director at Merrill Lynch, at a recent industry conference.
Not all banks are eager to take their hits.
No bank is eager to take a hit. Some banks just decide that pain all at once is better than paint protracted.
Get it over with, okay?
In the fall, for example, a large city in the Southeast asked Bank of America to write down the CDO’s the city held, said Mr. Bakhtiari, who represents the city but was not authorized to identify it.
Bank of America refused to mark down the CDO’s, Mr. Bakhtiari said, because it did not want to create a mark-down domino effect in its other holdings.
I have no idea whether Bank of America was right or wrong, but domino effects are not rational, especially when one seller moves for reasons specific to the seller and not the assets.
A spokesman for Bank of America declined to comment Thursday.
Investors are increasingly complaining that banks have become too opaque about the assets they own and the trades that make — or lose — them money.
Here lies a glimmer of light. Although in the end, assets may be worth “what I say they are worth,” if that’s so, the valuing bank ought to make its reasoning visible to its investors. The investors may choose, as perhaps they should choose, to rely on their bankers, but at least they will no longer be flying blind.
Returning to Alice the auditor and Humpty Dumpty the investor:
And if you take one from three hundred and sixty-five what remains?”
“Three hundred and sixty-four, of course.”
Humpty Dumpty looked doubtful. “I’d rather see that done on paper,” he said.
365
1
—-
364
—-
Humpty Dumpty took the book and looked at it carefully. “That seems to be done right–” he began.
“You’re holding it upside down!”
You can check my math!
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