Tuesday, February 3, 2009

A Bank Toxic Assets Solution

A simple solution for dealing with the toxic assets on banks' books that goes to the core issue is to have the regulators use their inherent powers to create a new asset category on the banks' books. The new regulatory asset category will be for performing assets with a disputed market price that need not be written down to market price as long as the loan asset is substantially performing and current in its predicted and scheduled payments. The regulators can call these assets Disputed Market Price Performing Assets.

As long as these assets are receiving their scheduled payments or are fully paid off, the banks will receive over time their booked value of these assets plus interest and no write-downs due to mark to market will be necessary. If these assets go into arrears on their payments, the regulators can require, as they do for non-performing loans, that these assets be put into a non-performing category on the banks' balance sheets. If within a reasonable time, such as 120 days, these assets do not become current in their payments, then the bank will need to write down the value of the asset to a more realistic value based on the lower amount of payments that it is receiving. Banks and regulators are well versed in dealing with and valuing loan assets that are not performing as predicted and scheduled.

Having this additional asset category solves many problems. It allows banks to disagree with the current market price without immediately needing to write the asset down to current market value. The asset will be written down and lose value on the banks' books only when it stops receiving the scheduled payments. It avoids the difficult problem of valuing hard to value assets. It decreases the number assets that are potentially toxic on the banks balance sheet to those assets that actually go into default. It spreads the write-downs of the bad assets over their lifetime of many years.

If the banks and the administration are right, that these assets are incorrectly valued currently by the market, then no write-downs by the banks will occur. If these assets do need to be written down, it will be over time as they show their true diminished value through defaults in payments. Time will give banks opportunity to reserve against these losses and preserve their capital base.

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