When Krugman Is Correct But Has Wrong Conclusion (William Chirolas)

  To ask bank shareholders to take a greater hit so that bottom feeders can profit from a suspension of classic good accounting for held-to-maturity assets is nonsense.

  Jan. 21, 2009 (World News Trust) -- Paul Krugman, in a New York Times column Monday, entitled "Wall Street Voodoo," states his conclusion that our banks are walking dead and that the shareholder investments in those banks should be wiped out so as to reflect the current values on offer for "toxic assets" (derivatives that are tranches of aggregated mortgages).

  It is hard to disagree with Krugman because he always gets his facts correct, but in this case his conclusion is not one I share.

  There is indeed no current working market for those "toxic assets," and while certain bottom feeders are offering silly prices for the investments, those prices are "the market" only if the concept of "held to maturity" is now dead along with a death of the need of pricing cash flows to a rate of return that is "market.

  Those "toxic" assets are not toxic -- and have a value much higher than on offer -- until such time that the cash flows from those assets actually are greatly reduced. So the missing fact in Paul's comment is that cash flows have held up very well.

  Assuming there will indeed be greatly increased defaults on mortgages and corresponding decreases in those cash flows, the marking-to-market of those held-to-maturity assets at a "market" rate produces values of those toxic assets only a few percent less than face.

  To ask shareholders to take a greater hit so that bottom feeders can profit from a suspension of classic good accounting for held-to-maturity assets is nonsense.

***

  William Chirolas brings 40 years of real-world business experience in local, state, national, and international tax, pensions, and finance to the world of blogging. A graduate of MIT, he calls the Boston area home, except when visiting kids and grandkids. Send an email.