Merrill Lynch announces a much larger than expected loss, coupled with weak home sales numbers and the pundits are coming out of the woodwork, falling all over themselves to demand that the Fed cuts rate 50bps next week. An analyst on CNBC went further this morning, saying that Hank Paulson's involvement in the creation of the SIV buying facility (designated M-LEC, or designated by me as BOSTONS-Buyers Of SIVs That Others Nevertheless Spurned) was really his way of begging the Fed to cut rates. Not surprisingly, Fed Funds futures are now leaning toward a 50 bp move. What is ironic about this is that the same people who were up in arms about the government (including the Fed) not acting fast enough are still up in arms or at least suspicious, about the government trying to help. Even with videotape and YouTube, TV has a short memory.
The bottom line here is that there are assets on the books of many firms that still have the valuation problems. At this point, that should have been worked out. When a valuation problem occurs, it is imperative to mark an asset to an appropriate level. Sometimes it is difficult what that level might be. At the end of the day, something is only worth what someone will pay for it. Too many times in my career did I come across the theoretical values guys out there, saying a security is worth X because the model says so. This Merrill announcement, and probably more to come from others, tells us that the model devotees are still holding sway. The value of Google stock is readily quantifiable, but the value of SIV-123abc isn't. When in doubt, mark it to a conservative level. When there is no real bid for an asset, the mark should represent the worse case scenario if that asset had to be sold. Clearly, the owners of these assets haven't gotten to that level yet. They are hoping the market bails them out, which is why they set up the M-LEC as a transitional facility until previous liquid market condition return. Then, M-LEC is a home run as it was able to pick up cheap assets.
In the end, it is the role of capitalism to punish entities that get valuation wrong. There is still a way to go, but the system will work and, in the end, economic growth will continue.
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Don't get me started on SIVs. One, these are off balance sheet items for now. We know (we hope) the damage to balance sheets, though some think that Merrill has been more forthright with its losses and other big financials have bodies buried.
I said that SIVs are off balance sheets for now because there is a way they can end up on balance sheets. According to a Bloomberg article if banks and brokers choose to take SIV investmenst off teh hands of valued clients (believe me, if it means maintaining important relationships it could happen), the SIVs would become on-balance sheet entities.
Make no mistake about, SIVs are the same thing as Enron's special purpose enterprises.
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