Looks like the new plan to take over $1 Trillion worth of toxic assets will not solve all the problems at banks such as Citigroup, Bank of America and Wells Fargo. The TARP plan covers for toxic assets which are generally classified as “held for trading” securities to which mark to market accounting rules apply. Therefore, these toxic assets have been written down in value to varying degress based on whatever little pricing information is available. However, the banks mentioned above have made loans on assets such as housing which are held in their balance sheets as “held to maturity” assets. These assets are not subject to mark to market accounting rules which means that they can and have been listed at book price i.e at the price of the assets when the loans were made. These loans have not been priced at lower levels given the reduction in the collateral asset values. A realistic valuation of these loans given the lowered asset values would punch a huge hole in the balance sheets of these banks. The government would therefore be loath to purchases these loans at its book value since this would mean giving away taxpayer money at a sure loss while banks would be loath to price down these assets since they would have to raise additional capital.
This is a tricky situation and it be interesting to see how this will play out.
