An interesting article in this week's Economist...
Move over SUBPRIME, the new BIG BROTHER IS COMING...
http://www.economist.com/finance/displa ... d=13062194
grandrake wrote:Credit of Crisis Visualized. Good for people who're lazy to read, or for kids (well, kids old enough to understand).
- http://www.crisisofcredit.com/
Mark-to-Market Rule Gives More Clarity, Not Less: John M. Berry
Commentary by John M. Berry
April 3 (Bloomberg) -- Mark-to-market accounting rules are being brought a little closer to economic reality -- accompanied by misplaced howls of outrage.
True, the ostensibly independent Financial Accounting Standards Board yesterday agreed to alter a portion of the rules only under extreme pressure from Congress, and that’s unfortunate. Still, the standards have forced many financial institutions to overstate losses on trillions of dollars worth of assets, intensifying the global financial crisis.
Defenders of the rules say they protect bank investors and changing them will allow institutions to hide future losses. To the contrary, they have helped drive down the value of bank stocks, made shorting the shares much easier and caused bank stockholders to lose hundreds of billions of dollars in such companies as Citigroup Inc. and Bank of America Corp.
William M. Isaac, a former chairman of the Federal Deposit Insurance Corp., told a House Financial Services subcommittee hearing on March 12 that “MTM accounting has destroyed well over $500 billion of capital in our financial system.â€
Since capital can be leveraged about 10 times in making loans, the rules have “destroyed over $5 trillion of lending capacity,†said Isaac, now a consultant with the Secura Group of LECG Corp.
The problem with mark-to-market accounting is that it officially has presumed there’s a functioning market in whatever asset is being valued -- and that means a deal between a willing buyer and seller that isn’t being forced to sell. Actually, no such market exists for many mortgage-backed securities.
Distress Sale
Nevertheless, according to testimony at the March 12 congressional hearing, accountants have required many banks to calculate values based on distressed sale prices. That has meant large writedowns even on mortgage-backed securities that the institutions intend to hold to maturity.
Take the case of the Federal Home Loan Bank of Atlanta. Following the mark-to-market rules, it wrote down the value of its portfolio of mortgage-backed securities by $87.4 million in last year’s third quarter. Its actual projected loss on the securities: $44,000. For the fourth quarter the bank recorded a further $98.7 million loss on the securities.
That result makes no sense when the bank doesn’t trade such assets. However, if the current market value declines significantly and stays down for an extended period of time -- a condition known as other-than-temporarily-impaired -- mark-to- market has been required, a bank spokesman said.
A writedown might still be required under the changes FASB approved yesterday. Yet auditors can now use “significant professional judgment†when valuing illiquid securities. That’s what they should have been allowed to do all along.
Cash Flow
The change will make it harder for accountants to continue to protect themselves from lawsuits by using some trade, no matter at what low price, to determine a security’s value.
With the new leeway, the Atlanta bank should be able to value its mortgage-backed securities by calculating the expected cash flow -- the monthly mortgage payments from homeowners -- and applying an appropriate discount. That’s the approach the bank used to determine the $44,000 third-quarter loss.
The key points in this example are that almost all the mortgages involved are still performing and the bank plans to hold the securities to maturity -- and yet large writedowns were required.
Think of it this way. There are millions of U.S. homeowners who are “underwater†with their mortgages. That is, they owe more than the value of the home in today’s depressed housing market.
Putting Up Money
That’s hardly good news, and it might make it impossible to refinance the mortgage because of the lack of equity.
On the other hand, the house hasn’t changed. It’s still providing the same shelter and other amenities to the household, and if the family’s financial circumstances haven’t gone into a tailspin, the monthly mortgage payments can still be made.
The family doesn’t have to put up money to cover the difference between the mortgage and the lower market value. Nor should the Atlanta bank have to take a big hit on its reported income because some other mortgage-backed securities owner sold in a depressed market.
FASB wisely backed away from a tentative proposal to allow auditors to assume that limited trades in an inactive market were always distressed sales. That would have gone too far.
Now accountants are supposed to use their judgment in assessing the meaning of such trades. That’s a big improvement over just using the last transaction price, as many auditors have been doing.
Recovering Writedowns
Now FASB has to deal with how banks deal with recoveries of previous writedowns due to other-than-temporary-impairment losses when there’s evidence that loss is no longer there.
A March 27 letter sent jointly by the five federal regulators of financial institutions -- the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corp., the National Credit Union Association and the Office of Thrift Supervision -- urged FASB to add such a recovery to current earnings.
Since the losses were subtracted from earnings, that would be an equitable way for FASB to go -- and soon.
(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: John M. Berry in Washington at [email protected]
Last Updated: April 3, 2009 00:01 EDT
http://www.nytimes.com/2009/04/27/business/27geithner.html?pagewanted=1
Geithner, Member and Overseer of Finance Club
The Wall street journal
AUGUST 13, 2009
A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum
By KETAKI GOKHALE
RAMANAGARAM, India -- A credit crisis is brewing in "microfinance," the business of making the tiniest loans in the world.
Microlending fights poverty by helping poor people finance small businesses -- snack stalls, fruit trees, milk-producing buffaloes -- in slums and other places where it's tough to get a normal loan. But what began as a social experiment to aid the world's poorest has also shown it can turn a profit.
That has attracted private-equity funds and other foreign investors, who've poured billions of dollars over the past few years into microfinance world-wide.
The result: Today in India, some poor neighborhoods are being "carpet-bombed" with loans, says Rajalaxmi Kamath, a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008, totaling $1.24 billion, according to Sa-Dhan, an industry association in New Delhi.
"We fear a bubble," says Jacques Grivel of the Luxembourg-based Finethic, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure to India. "Too much money is chasing too few good candidates."
Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more.
"I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for $209, another for $293, and then $356.
At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams."
Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.
Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt overload is stirring up social tension. Many borrowers complain that the loans' effective interest rates -- which can vary from 24% to 39% annually -- fuel a cycle of indebtedness.
In July, town authorities asked India's central bank to either cap those rates or revoke lenders' licenses. "Otherwise, the present situation may lead to a law-and-order problem in the district," wrote K.G. Jagdeesh, deputy commissioner for the city of Ramanagaram, in a letter to the central bank.
Alpana Killawala, a spokeswoman for the Reserve Bank of India, said in an email that the central bank doesn't as a practice cap interest rates for microlenders but does press them not to charge "excessive" rates.
Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.
The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they're not about to comply with that.
The repayment revolt has spread to other communities, including the nearby city of Channapatna, and could reach further across India, observers say.
"We are very worried about this," says Vijayalakshmi Das of FWWB India, a company that connects microlenders with financing from mainstream banks. "Risk management is not a strong point for the majority" of local microfinance providers, she adds. "Microfinance needs to learn a lesson."
Nationwide, average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27 or so, according to a survey by Sa-Dhan, the industry association. These sums are obviously tiny by global standards. But in rural India, the poorest often subsist on just a few dollars a week.
Some observers blame a fundamental shift in the microfinance business for feeding the problem. Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.
This change opened the door to more private-equity money. Of the 54 private-equity deals (totaling $1.19 billion) in India's banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chennai-based private-equity research service.
The influx of private-equity cash is the latest sign of the global rise of microfinance, pioneered by Bangladeshi economist Muhammad Yunus decades ago. On Wednesday, Mr. Yunus, a 2006 Nobel Peace Prize winner, was one of 16 people honored by President Barack Obama with the Medal of Freedom.
"We've seen a major mission drift in microfinance, from being a social agency first," says Arnab Mukherji, a researcher at the Indian Institute of Management in Bangalore, to being "primarily a lending agency that wants to maximize its profit."
Making loans in poorest India sounds inherently risky. But investors argue that the rural developing world has remained largely insulated from the global economic slump.
International private-equity funds started taking notice of Indian microfinance in March 2007. That's when Sequoia Capital, a venture-capital firm in Silicon Valley, participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world's largest microlenders.
"SKS showed the industry how to tap private equity to scale up," said Arun Natarajan of Venture Intelligence.
Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, and SVB India Capital Partners, an affiliate of Silicon Valley Bank.
As of last December, there were over 100 microfinance-investment funds globally with total estimated assets under management of $6.5 billion, according to the Consultative Group to Assist the Poor, or CGAP, a research institute hosted at the World Bank.
Over the past year, investors have poured more than $1 billion into the largest microfinance funds managed by companies, a 30% increase. The extra financing will allow the industry to loan out 20% more this year than last, much of it to countries such as the Ukraine, Cambodia and Bosnia, CGAP says.
Here in Ramanagaram, Lalitha Sharma recalls when the first microfinance firm arrived seven years ago. Those were heady times for her fellow slum-dwellers: Money flowed freely. Field agents offered loans to people earning as little as $9 a month.
They came to Ms. Sharma's door, too. She borrowed $126. Under the loan's terms, she said she would use it to finance a small business -- a snack stand she runs with her husband. Many microfinance providers require loans to be used to fund a business.
But Ms. Sharma, a 29-year-old mother of three, acknowledges she lied. "You have to mention a business to get a loan," she says. "There was no other way to get the money." She used it to pay overdue bills and to buy food for her family. Ms. Sharma earns $8 a week, on average, in a factory where she extracts silk thread from cocoons.
Over the next four years, she took nine more loans from three different lenders, in progressively larger sums of $209, $272, $335 and $390, according to lending records reviewed by The Wall Street Journal. A spokesman for BSS Microfinance Private Ltd. of Bangalore, another of her lenders, declined to comment on her borrowing history, citing central-bank privacy rules.
This year, she took another $314 loan to pay for her brother-in-law's wedding, again saying the money would be used for business purposes. She also juggled loans from two other microlenders -- $115, $167 and $251 from the Bangalore lender Ujjivan, and $230 from Asmitha Microfin Ltd.
Ujjivan confirmed it issued three loans. An Asmitha official said he had a record of a loan to a Ramanagaram resident named Lalitha, but at a different address.
"I understand that it is credit, that you have to pay interest, and your debt grows," Ms. Sharma says. "But sometimes the problems we have seem like they can only be solved by taking another loan. One problem solved, another created."
Many of the problems in Indian microlending might sound familiar to students of the U.S. mortgage crisis, which was worsened by so-called "no-documentation" loans and by commission-paid brokers. Similarly in India, microlenders' field officers are often paid on commission, giving them financial incentive to issue more loans, according to Ms. Kamath.
Lenders are aware that applicants often lie on their paperwork, says Ujjivan's founder, Samit Ghosh. In fact, he says, Ujjivan's field staffers often know the real story. But his organization maintained a policy of "relying on the information from the customer, rather than our own market intelligence."
He says that policy will now change because of the trouble in Ramanagaram. The lender will "learn from the situation, so it won't happen again," he says.
It's tough to monitor how borrowers spend their money. Ujjivan used to perform regular "loan utilization checks," but stopped because it was so costly. Now it only checks in with people borrowing more than $310, Mr. Ghosh says.
BSS checks how loans are being spent a week after disbursing the money, and makes random house visits, according to S. Panchakshari, its operations manager. The company doesn't have the power to insist that borrowers not take loans from multiple lenders, he said in an email.
Lenders also tend to set up shop where others have already paved the way, causing saturation. There is a "follow-the-herd mentality," says Mr. Ghosh at Ujjivan. Microlenders "often go into towns where they see one or two others operating. That leaves vast chunks of India underserved, "and then a huge concentration of microfinance in a few areas."
In Ramanagaram district, seven microfinance lenders serve 22,500 women (most microloans go to women because lenders consider them less likely to default than men). Loans outstanding here total $4.4 million, according to the Association of Karnataka Microfinance Institutions, a group of lenders.
Lenders in Ramanagaram say the loan-repayment revolt was instigated in part by Muslim clerics who oppose the empowerment of women through microfinance. Most lenders are still servicing loans to Hindu borrowers, but have stopped issuing fresh loans to Muslims. "We can't do business with Muslims there right now," says Mr. Ghosh. "Nobody wants to take that kind of risk."
The irony is that, for years, Indian microlenders have touted themselves as bankers to the nation's impoverished minority Muslim community, which has long been excluded from the formal banking sector.
A 2006 report commissioned by India's prime minister found that while Muslims represented 13% of India's population, they accounted for only 4.6% of total loans outstanding from public-sector banks.
Islam prohibits the paying of interest, but mosque officials don't cite that as the reason for the loan-payment strike. They stressed the overindebtedness of the community, and the strains it's putting on family life.
Ramanagaram's period of wild borrowing irks some residents, both Hindu and Muslim. Alamelamma, a 28-year-old vegetable seller, says that she has benefited from microfinancing and that the profligate borrowers "have ruined it for the rest of us."
One gully away, Ms. Sharma, the heavy debtor, has a different view: She would like to see the microlenders kicked out of the community entirely. "Not just for now, but forever," she says.
—Rob Copeland contributed to this article.Printed in The Wall Street Journal, page A1
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