Taxpayers and bailed-out banks would be better off if the government were to have bought bank assets at "net realizable value." This would have been based on an evaluation of an asset’s current cash flow, discounted by expected credit losses over time.
Accounting rules relating to assets, including mortgage-backed securities, required that they be marked-to-market if held for trading, or held "available for sale." Most banks hold such assets in one of these two accounts. Mark-to-market rules unfortunately applied.
What happens when there is no real genuine market for assets? The banks first find the net realizable value for the portfolio. That is, what the value of the cash flow would bring in a fully functioning market. That would include discounts for factors such as anticipated future losses. Many of the banks' most troubled assets were flowing cash near expected rates, and therefore their net realizable values were higher than the values which had been written down.
Because there were few buyers, market values were heavily reduced. Potential buyers had no assurance they will be able to resell the assets. Therefore, mark-to-market rules made banks discount their assets' values. and produced write-downs that impaired capital.
If the government bought assets at their net realizable values, and not marked-down values, the capital positions of the major banks would improve.
The taxpayer could not be hurt. Because cash flows would determine value, the government would be able to sell such assets in the future at about what it paid.
In short: Much of the banking problems we have had could have been avoided with clearer thinking by the “experts.”
REMEMBER: The financial meltdown that brought on this deep recession could have been self-corrected by simple market-place principles and no mark-to market accounting.
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