By John P. Hussman, Ph.D
Look. You can play hot potato with the toxic assets all day long, and only outcome will be that the public will suffer the losses that would otherwise have been properly taken by the banks' own bondholders. You can tinker with the accounting rules all you want, and it won't make the banks solvent.
It may improve "reported" earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn't create value. It simply increases the likelihood that financial institutions will quietly go insolvent.
I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A's and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an "orderly transaction."
The reset cycle for Alt-A and option-ARMs (Adjustable Rate Mortgages) might be the next storm to hit the stock market, on the downside.
if I were to make a guess, it would be that the potential downside in the S&P 500 from these levels could approach 30-40%. That is not a typo, and it is not a possibility that should be ruled out.Source:
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