As the dramatic highs of the headlines about the $787 bn stimulus plan abate, as politicians addicted to glaring hot klieg lights hit the airwaves for the umpteenth time to argue their votes, a form of post dramatic press disorder has set in down in DC.

Meanwhile, the sickly anemic banking system is still lurching around in a hospital gown and a legislative pork wagon has once again mowed down taxpayers.

What is standing in the way of a turnaround in the banking system? Specifically, what government programs and rules are hurting the economy, the stock market, investors and taxpayers?

What rules were written by bureaucrats with no more sense than a flock of geese?

As the debate about government interventions rages on, layoffs have picked up speed in the financial services sector, with an estimated 250,000 layoffs happening worldwide.

For example, Citigroup is in the process of laying off 72,000 workers--and hopefully Citi is not doing more than that, despite a recent memo from its Human Resources department.

An unfortunate typo in a Feb. 13thmemo from Citi's Human Resources Dept. emailed to staffers last Friday kindly tried to remind employees that Citi has a number of programs to help workers deal with misfortune, noting "other resources are available through the EAP link below."

The memo then directs employees to Citigroup's "Employee Assassinate Program."  

A Government Plan Undone?

To keep interest rates low you need more money in the borrowing system, and that money for borrowing comes into the system when asset-backed securities are bought and sold. An estimated three quarters of the money for consumer loans since the mid '90s came from money recycled in to banks through securitizations.

So the government plans also include getting Fannie Mae and Freddie Mac to buy mortgage-backed securities and using $100 bn in Treasury funds that can be leveraged up to $1 tn, with help from the Federal Reserve, to buy asset-backed securities.

Keeping rates low, too, is the flight to quality by investors into Treasurys, as the financials continue to act like anchors on the stock markets, with the Dow Jones Industrials down dramatically today (DJIA). Interest rates typically track long-term Treasurys.

But the US Treasury now plans to raise $2 tn in new debt this year to deal with the banking crisis, a massive influx that will compete with an estimated $1 tn in other countries' bond issuances as they bail out their own sick economies.

All of these bonds competing for investors will force yields on US Treasurys to rise, undoing other government plans to force lower borrowing rates for houses, cars, student loans and credit cards.

Private Money Waits on the Sidelines

And the private sector is waiting on the sidelines "until the rules are set down in pen, not pencil," a banker tells me, before they'll come in to buy the banks' rotten assets with the help of government financing under the Treasury's latest plan. "We're not committing any money until we see the changes stop," he says. 

$55 Billion in Taxpayer Money Missing

Some $9.4 tn is being spent to fix the banking system, as the International Monetary Fund now estimates that, worldwide, bank losses could reach $2.2 tn. Problem banks at the FDIC now number 171. But some 2,500 troubled banks eventually might have to be forced into mergers, says bank analyst Richard Suttmeier.

But watch this, as the government spends in record amounts--$55 bn of your taxpayer dollars have gone missing.

"In fiscal 2007, for the 11th year in a row, the GAO [Government Accountability Office] refused to opine" on the government's financial statements, notes James Grant of Grant's Interest Rate Observer.

Why? For one, some $55 bn of the taxpayers' money went missing when the books were reconciled, notes Grant. "Curious readers can find an account of the disappearance in Appendix II of the auditor's review of the government's 2007 finances," he adds helpfully.

A Berlin Wall Between the SEC and the FBI?

As the government spends record amounts of your tax dollars, what's being done to protect your investments?

It's clear now, given how the Securities and Exchange Commission ignored the Bernie Madoff whistleblower, that when the credit bubble was blowing up, the market watchdogs mounted the cavalry and rode off in the wrong direction. Instead, the FBI is left to clean up the market mess.

It's true that, because Congress beats it up and threatens to cut its budget after companies complain, the SEC has become more of a market crossing guard than a market cop.

But does the SEC, the stock market's first responder, have any rules that force it to give the FBI the tips it sees to prosecute criminal white collar fraud cases, such as the alleged Bernie Madoff $50 bn Ponzi scam?

Answer: No, say law enforcement officials. Unofficially, they do share info. But the real problem is a potential Berlin Wall between the two agencies.

Top officials aver there is no problem similar to the pre-9/11 absurdity, whereby the US intelligence agencies did not share tips with each other about terrorism and other potential crimes.

Lower level enforcement officials, however, say the SEC should be sending more tips, like the Madoff scam, the FBI's way.

"The SEC does a good job, but I'd always like to see more information, of course," says the FBI's head of its criminal division, David Cardona, in an interview, adding the bureau "would like to see more sharing of information between the SEC and the FBI."

Although Madoff did not run a hedge fund, Cardona sees a bigger problem in that "no regulatory agency really oversees the hedge fund industry," which numbers around 8,000 hedge funds with $1.87 tn in assets under management. The industry has gone so far as to sue the SEC to stop its oversight. 

Another Profit Inflator Remains

Right on through the bubble, and still today, regulators let companies legitimately and artificially inflate their revenue by letting them immediately book into their profit figures the entire value of the sale of their mortgages when those loans are repackaged as mortgage-backed bonds--even though the mortgage payments supporting and underlying those bonds come in over the life of the 15 or 30 year mortgage.

The move lets companies front-end their profits, an entirely legal bookkeeping trick that let firms inflate earnings--and banker paychecks--beyond reality.

Generally, the way it works is, a bank makes a mortgage loan, it then sells the loan to Wall Street, which then slices and dices that loan up, splitting out its principal and interest payments.

Those slices, or "tranches," get loaded into a pool of money that then supports a bond. Generally speaking, when the bank sells the loan--which it often does to an off-balance sheet vehicle it actually owns--it books the entire value of the loan as a sale. Same for Wall Street when it sells the bond. Even though the money has yet to come in the door in the form of mortgage payments.

The bank and Wall Street firm gets to make up out of whole cloth what they think the future mortgage payment will be, factoring in things like the likelihood of prepayment, interest rate changes, or defaults.

Fake Bubble Profits

Bankers can then create profits out of thin air, out of mumbo jumbo, churned out by computer models, based on guesswork and estimates about future events.

This sanctioned accounting move, called "gain on sale" accounting, opened the door wide for the Wall Street loan and bond hustlers to one of the oldest accounting tricks in the book, called "channel stuffing."

The move lets companies pad their revenue and profit numbers by stuffing lots of goods and inventory into the system without actually getting the money in the door, and booking those channel-stuffed goods as actual sales in order to goose higher their earnings.

Which is what Sunbeam did when it was accused of accounting fakery in the ‘90s when it shipped a lot of barbecue grills that weren't paid for yet, but booked the sales in profits anyway.

So banks and bond shops stuffed lots of these loans as securities into the system and artificially cooked their earnings ever higher, earning lots of money off of the practice.

The Financial Accounting Standards Board, which sets the rules, clings fast to the Puritanism of their rulemaking by arguing a sale is a sale is a sale, so companies can immediately book the entire value of a sale of a loan or a bond, even though the cash from an underlying mortgage has yet to come in the door.

WashingtonMutual Made Hay

Washington Mutual for years was thought to artificially boost profits with the move and then take writeoffs to reflect the true picture later.

Washington Mutual recorded those profits on the bond securitizations immediately, instead of spreading them out over the life of the underlying mortgage.

Again, entirely legit under the liberal gain-on-sale accounting permitted even today. Look at Wamu's profits in just one year during the runup to the bubble. Such gains more than tripled in 2001 at Wamu, to just shy of $1 bn, or 22% of its pretax earnings before extraordinary items, up from $262 mn, or 9%, in 2000.

But in 2001, Washington Mutual took $1.7 bn in charges, $1.1 bn of it in the final, fourth quarter, to reflect bleaker prospects for the revenue stream of all those servicing rights. It papered over the hit with a nearly identical $1.8 bn gain on securitizations and portfolio sales.  

Mark-to-Market Mess

Other fakery abounds in the mark-to-market rules, which are still set in stone.

The rules let banks inflate their profits beyond recognition, as it let them book their assets as if they were to sell them immediately during the pumped up, artificial bubble years.

The mark-to-market rules have invited Wall Street mischief, as the Street marked these assets to their own cranked up computer models, what's been called mark to myth or mark to madness, a move that let banks inflate their assets and then leverage themselves to the moon.

The move then torqued profits and bankers' paychecks artificially higher. Wall Street and banks earned hundreds of billions of dollars, many of these profits fake, as the rules let these companies systematically and artificially mark higher their assets during the bubble. 

And now, the rules force banks to take profit hits on ever-decreasing values for their assets in a market priced for the Ice Age, as the rules say the banks must price tag these assets as if they were selling them today in a frozen-over market, even if they have no plans to sell the assets.

The rules are behind today's colossal writedowns and losses, more than $950 bn and counting.

The IMF, in reporting its estimate of $2.2 tn in bank losses, notes "much of this deterioration has occurred in the mark-to-market portion of our estimates (mostly securities), especially in corporate and commercial real estate securities, but degradation is also occurring in the loan books of banks."

An Enron Move

Enron used mark-to-market accounting to book in profits future earnings they expected to get on, for example, their energy deals as if those profits were coming in the door on that day.

In fact, Enron was using its own "mark to model" formula on these assets, which the rules allow, and cooking their earnings, and stock price, higher during the dotcom and telecom boom. 

Just like Wall Street, Enron attracted ever more investor capital with its rising stock price and built a house of cards based on leverage and outsized debt.  

The Right Way to Do It?

I know accounting can make you feel like you are bicycling through quicksand, but stick with this, this debate sits at the heart of the banking crisis.

Generally speaking, and I mean generally, if you had to follow these rules, it'd be as if the government forced you to sell your house today at distressed prices on a quarterly basis, and subtract that sum from your bank account, even though you have no plans to sell your home whatsoever.

As one analyst puts it, mark-to-market is an ancient theory tied to the belief that markets are efficient and that the last fire sale price represents the best, or fair, value of an asset.

The rules go against everything in accounting that said an asset should be booked at cost, what it cost a company to buy it.

It used to be that companies could then depreciate the asset, and deduct that depreciation from profits accordingly.  

The American Bankers Association says the mark-to-market rules don't work in illiquid markets, and economist Ed Yardeni points out that last week GE's Jeffrey Immelt said banks end up with an "artificial writedown" that forces them to raise more capital.

Contradictions Abound

Even the U.S. government itself does not mark to market its assets and liabilities.

For one, the federal government does not mark to market the value of its gold reserves--the government claims ownership of 261,498,900 ounces, which it carries at $42.22 an ounce for a grand total of just $11 bn, notes Grant of Grant's Interest Rate Observer.

The government also doesn't mark to market the land it owns-never mind its other assets, such as, shall we be cheeky, the historic, priceless U.S. Constitution. 

Assign to stewardship lands a value of $1,000 an acre, and you come up with an extra $644 bn to the government's assets, notes Grant. 

And for years, state or local governments did not have to immediately mark to market their pension costs-a form of pension deficit disorder, as one analyst puts it.

And if the federal government correctly booked on budget the current value of its health care costs for Medicare, the cost would block out the sun, Grant quips.  

Also, companies do not have to expense immediately the value of the stock options they've given fat cat executives, only having to do so over the term of the vesting period, which is usually five years. That's a recipe for lavish fat cat pay (a vesting period is a form of holding tank that tells executives they only own the options after that time).

Banks also don't mark to market the value of their loans, instead reserving against them.

The Rule Relies on a Bad Index

To price its bonds for mark-to-market bookkeeping purposes, Wall Street uses an index to do its mark to market valuations, an index called the ABX indices, indices that can hold, for example, a basket of 20 different types of derivatives that is highly questionable as a pricing mechanism, says the Bank of International Settlements, the central bank of all central banks in Basel Switzerland.

For one, ABX prices may not be representative of the total subprime universe, due to the indices' limited coverage of the overall market, the BIS says.

The BIS also adds that each ABX index only represents some 5% of the overall universe on average. "It is widely-recognized by policymakers that so-called fair value accounting rules have needlessly exaggerated and exacerbated the credit crisis," the BIS says.

The Index and Rule Inflates Asset Values on the Way Up

Check out this story about how the ABX index and the mark to market rules help inflate the value of asset-backed securities.

"Even after downgrading almost 10,000 subprime-mortgage bonds" by March 2008, "Standard & Poor's and Moody's Investors Service haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments," Bloomberg reported.

"None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent."

"Sticking to the rules would strip at least $120 bn in bonds of their AAA status...AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group."

``'The fact that they've kept those ratings where they are is laughable,' said Kyle Bass, chief executive officer of Hayman Capital Partners, a Dallas-based hedge fund that made $500 mn last year betting lower-rated subprime-mortgage bonds would decline in value." 

"The 20 ABX indexes are the only public source of prices on debt tied to home loans that were made to subprime borrowers with poor credit histories. About $650 bn of subprime bonds are still outstanding, according to Deutsche Bank. About 75% were rated AAA at issuance."

Mark-to-Market Survives

The US Treasury Department and the Securities and Exchange Commission said the two are not discussing any suspension of the controversial rule. The SEC already has told the financial industry that hard-to-value assets do not have to be marked down to fire-sale prices. But that hasn't been enough.

Proponents argue that suspending the mark-to-market rules would weaken transparency in companies' financial statements, and that they help investors see what is truly on banks' balance sheets.

At least one former bank regulator has discussed how to deal with the rules without "walking away from" the standards," says Sen. Christopher Dodd, Democratic chairman of the Senate Banking Committee.

And Rep. Barney Frank, Democratic chairman of the House Financial Services Committee, has said: "One of the things I think we should be exploring is the extent to which you can retain mark-to-market but make the consequences discretionary with the regulators rather than automatic."

Goldman Sachs Does it Better?

Lloyd Blankfein, chief executive of Goldman Sachs in a recent editorial for the Financial Times claimed that Goldman managed risk better than all its competitors, who have not survived.

The "daily marking of positions to current market prices was a key contributor to our decision to reduce risk relatively early in markets and in instruments that were deteriorating," Blankfein wrote.  

Economist Edward Yardeni says: "That's disingenuous to say the least given that Goldman had $66.2 bn in Level 3 (mark-to-myth) assets at the end of its November quarter," the worst of the worst in radioactive assets.