“I wish you to live in the interesting times”, goes the old Chinese course. In times when there are fundamental realignments of interpersonal, economic, social and international relations. From psychological point of view, those realignments are very important, as the tendency of man is not to change something if it works. The only time that something needs changing, improving or fixing is when it is broken.
Crises enable us to reflect, to identify the elements that caused it, and work towards eliminating or modifying those same elements.
If there are too many of such elements, or they are such that they would fundamentally change the product or activity, sometimes this activity has to be discontinued, or rebuilt again on stronger foundations and by keeping the new facts in mind.
If the crisis is strong enough, we quickly start examining the strength of foundations themselves. Then, we examine if the axioms and assumptions on which we have built the foundations still hold true, and whether they should be adjusted accordingly. Every now and again it happens that the foundations lay on so far outdated foundations that in order to move forward, those foundations need to be demolished and rebuilt from scratch on new assumptions. Such examples were the French and October revolutions.
The fact is that today we are at one such breaking point. We realise that some things are fundamentally wrong. We can only hope that the things can be adjusted without demolishing the foundations, as when the old foundations crumbled, and the new ones have arisen to prominence yet, there is Chaos. Chaos is necessary for the Catharsis of mankind, but can be very painful from the point of view of individual person, as people lose the anchor on which their whole life was based.
Chaos happens also when the foundations for decision making are destroyed. One of such events happened when, under enormous political pressure, American agency for accounting standards, agreed that the banks can keep their losses off their profit and loss statements if they claim that they do not intent to sell underlying assets at current valuations. Even more, they are allowed to include those assets in their capital at full value. This can quickly bring the crisis of trust, as capital is sort of warranty that enables bank to cover certain degree of losses. If market value of this capital is considerably lower than the book value, then in case of liquidation, all indicators are wrong as they do not account for the case of liquidation.
After adjusting to new accounting rule, most of the big banks have published profits amounting to a few billion USD each. At the same time, US Treasury is stalling with the publication of the results of the stress test. If there would be even a glimmer of hope that the banking sector is solvent, the treasury would rush to publish the results and calm the markets. Since there is no such hope, we can see slow, drop by drop release of methodology and incomplete disclosure of data, which will happen in may, at least a month after the conclusion of the tests.
It is quite possible indeed that we will also witness an explanation, which will inform us that we had understood one of the rules too strict and that this criteria meant something completely else. After such a “massage” of criteria, we will see that apart from small exceptions (which will remain undisclosed), most of the banking sector has successfully passed the stress test.
Frederick Cannon, an analyst of KBW, claims, based on simulated in-house stress test by KBW, that the US banking system needs at least $1 Trillion ($ 1 000 000 000 000) of additional capital. Many analysts are convinced that if we use strict interpretation of criteria, 16 out of 19 banks would fail.
In an independent world, monitored by an independent regulator, publication of enormous profit, followed by capital raising exercise to cover the losses would immediately send the alarm bells ringing. Even if we leave the moral questions aside, logic claims that those two data are either un-comparable (due to methodology) or that one is an outright lie.
Such “data massage” should cause extreme concern with the majority of investors and cause that they, as rational beings, withdraw from the market due to lack of trust in the data provided.
This is an English translation of an article by Mitja Sadar that was published, in Slovenian, in the leading Slovenian Investment Magazine KAPITAL, on 27.04.2009. Original article is available at the following URL:http://www.revijakapital.com/kapital/poslovnefinance.php?idclanka=6695
