Thursday, August 14, 2008

Accounting Impediment to Bank Rescues Coming

(Naked Capitalism) One of the preferred ways for regulators to deal with failed or wobbly financial institutions is to get a stronger firm to take the problem off their hands.

But as Jon Birger of Fortune reports in a profile of bank analyst Meredith Whitney (hat tip doc holiday), new accounting rules may get in the way:

Another negative: two little-talked-about regulatory changes Whitney says will stymie banks' recoveries. One is a new accounting rule known as FAS 141R. Given the depth of the crisis, Whitney expects to see bank regulators arranging shotgun marriages between well-capitalized institutions and foundering ones. Problem is, any such deals would have to happen before FAS 141R takes effect in December. The new rule, she says, "will make it almost impossible to do bank mergers." The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought - and remember, bids for mortgage assets are now few and far between - but also mark to market its own portfolio as well. "Nobody's going to want to do that," Whitney says.
I'm not as certain the impact will be as pronounced as Whitney suggests. On the big end of the food chain, there are not a lot of strong players out there (but that still doesn't mean a weak bank couldn't be combined with a less weak one). But the FDIC will have a very strong preference for getting smaller failed banks folded into bigger ones, so this treatment does have the potential to cause trouble. That in turn might lead to a push to get deals done before the new rule takes effect.

However, the big issue is that the banking industry in the US and Europe is undercapitalized. Ironically, the Japanese are solvent and selectively doing deals (witness the Sumitomo Mitsui Group investment in Barclays, which at the moment is nicely in the money). Banks will have to rebuild their equity primarily via going outside the industry (ie, institutional and retail investors) or earning their way out if central banks can be can engineer a steep enough yield curve.

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