Monday, May 19, 2008

Chris Farrell is a level 3 asset

What the heck is a level 3 asset, Spotty?

It's an accounting term, denoting an asset of indeterminable value, like a dodgy debt.

And Chris Farrell, he's the Chief Economics Correspondent at Minnesota Public Radio, right?

Indeed he is, grasshopper. And he was singing in the rain again this morning.

Why, what did he have to say?

Spot commends the audio at the link, grasshopper, but in a nutshell:

Oil prices are high, but people seem to be coping by combining their errands, apparently picking up both eggs and milk in the same trip in the 7,000 pound SUV! Farrell reports this "anecdotally." No word on the effect on commuters going from say, Lakeville to Minneapolis and back every day. Oh well, how much could they matter anyway?

Farrell also reports that the stock markets are signaling that we are coming out of the maybe recession, because you know, that's what stock markets do, prognosticate. And just like Henry Paulson and Ben Bernanke, Chris wants to be an optimist! He so wants things to go well.

And just like Katie, Farrell wants us to look at the glass as half full!

But Paulson and Bernanke, both Bush appointees, are paid cheerleaders; we should demand more from the guy who wears the title Chief Economics Correspondent at MPR. If you only listen to MPR and Chris Farrell for your economic news, there will be a lot of things that are, well, "news" to you.

For example, here's what George Soros said recently in a BBC interview:

In an interview with BBC business editor Robert Peston, Mr Soros said that while the "acute phase" of the credit crunch might be over, the fall-out and the impact on the real economy has yet to be felt.

He warned that the "financial bubble" of the last 25 years could well be drawing to an end and the post World War II "super-boom" era could be over permanently.

Spot's favorite Malthusian, James Kunstler, put it a little more prosaically, just today:

This [the financial bubble flim flam] has all failed now because the racket went too far. Every possible candidate for a snookering got snookered. Too much collateral for which there were no takers went into the ground. The insane run-up in house values made a downward price movement inevitable, and as soon as the turnaround happened, it fell into the remorseless algebra of a deflationary death spiral. More importantly, however, this society ran out of tricks for loaning money into existence and instead began to experience the pain of money thought-to-be-in-existence being defaulted into a vapor -- and worse, these defaults led to logarithmic chains of money destruction in its places of origin, the investment banks that had created the racket.

The important part of this is that the money is gone. What makes matters truly eerie is that the "bubble" in suburban houses has occurred at exactly the moment in history when the chief enabling resource for suburban life -- oil -- has entered its scarcity stage.

Remember all those Lakeville commuters, boys and girls? Think of those guys on the boat in A Perfect Storm.

But Spotty, the stock market says we're coming out of our troubles! That surely must be true.

If you say so grasshopper, but consider this story from Bloomberg (a thump of the tail to reader Jim for the link):

May 14 (Bloomberg) -- Freddie Mac, the second-largest U.S. mortgage-finance company, reported a smaller loss than analysts estimated after accounting changes reduced charges by at least $2.6 billion.

Without the use of two new accounting rules, Freddie Mac would have posted a loss of at least $1.7 billion, analysts said. A change in the way the company values some assets that aren't traded reduced credit losses by $1.3 billion, while a separate rule that lets the company pick and choose which assets to measure contributed an equal amount, Freddie Mac said.

``They put a lot of lipstick on this pig including several accounting changes that have given them a one time step-up,'' said Josh Rosner, an analyst at independent research firm Graham Fisher & Co. in New York.

The article continues:

The new accounting had a ``significant positive effect,'' reducing volatility in the value of the company's $738 billion in mortgage holdings, as well as for securities and derivatives used to hedge against credit and interest-rate risk, Freddie Mac said.

Freddie Mac spokesman Michael Cosgrove said, ``clearly, based on the comments and reports this morning by the real, substantive analysts who follow this company, the Street is comfortable with our accounting and reporting, and encouraged by the results we presented today.''

Exactly what did they do, Spotty?

Again, from the Bloomberg article:

Financial Accounting Standard 157 allows companies to estimate a value on holdings that aren't traded. Freddie Mac used FAS 157 to list $156.7 billion in so-called Level 3 assets, a category that indicates the holdings are so illiquid that they can only be priced using the firm's own valuation models.

The Level 3 holdings represent 23 percent of assets and are up from $31.9 billion as of December.

The first-quarter results also benefited from a change in policy for buying seriously delinquent loans, those at least 120 days past due, out of the mortgage pools Freddie Mac guarantees. The company must book the decline in value on loans bought from pools at the time of purchase. It ended that practice, cutting losses to $51 million from $736 million in the fourth quarter.

In other words grasshopper, they took the sewage that nobody would buy and decided themselves what it was worth. And changed the way they count. And you know what happened, grasshopper?

The stock went up?

Bingo. This is the genius of the stock market to which our Chief Economics Correspondent refers. It is also worth noting that Freddie's level 3 assets are within spitting distance of its surplus:

The company said its core regulatory capital rose to $38.3 billion at the end of the quarter, about $6 billion above the 20 percent mandatory surplus.

So, maybe ol' Freddie isn't worth much, huh, Spot?

Perhaps it isn't grasshopper. And perhaps instead of Singing in the Rain, Chris ought to be singing Let's Face the Music and Dance.

No comments: