November 07, 2007

Lying about the economy

We talked about inflation last month, basically how the numbers were a load of crap and that any true measure of inflation must take into account food and energy prices. Now Bonddad has some more. And charts!

I love me some charts!

And for those of you who think inflation doesn't matter, the dollar has been hitting all time lows against foreign currencies, oil is hovering near $100/bbl and gold is $845/ounce. True, commodity inflation in terms of dollars has been extreme and is being caused by geopolitical issues and risks as well as inflationary monetary policy here in the US. However, the move is so extreme and so fast that it neatly points out exactly how wrong supply side theory in a low tax environment is.

Finally, we haven't even hit round three of the credit crunch which will be closely tied to revaluations of level 3 assets and liabilities on corporate and bank balance sheets. Forbes has more on this here with a specific look at Citi. Here's the 10 cent explanation...

On November 15th new FASB rule will alter the valuations than can be placed on level 3 assets and liabilities? What are level 3 A's and L's? Simply, they are assets and liabilities that do not trade in a liquid market environment, like a stock exchange. These are normally specialized assets tied to specific securities or risks that involve, in some cases, multiple counterparties one or more of whom may not be financially solvent. Which means that no one wants to buy the asset from you (they have no marketable value) and you may never collect from the counterparty should the trade turn your way.

What's happening now is that CDO's (a group that included mortgage backed securities) are being moved from level 2 to level 3 assets since there is, in many cases, no liquid market for them. The cool thing about level 3 assets is that they are literally worth whatever you say they are worth. Oh sure, there are some complex financial models that tell you what they're supposedly worth. However, the models all depend on information. If there isn't any, then you're working off best guess and your financial model may as well be a coin you flip.

Citi now says it has more than $140 bn in level 3 assets. Which, right now, effectively means that there is a $140 bn hole in Citi's balance sheet.

When these assets get revalued it's going to suck conservatively $500 bn out of the US economy. Which will help stabilize the dollar at least. I just feel bad for the shareholders who are about to lose a lot of value because of more bad decision making by the management teams that run their companies.

Posted by mcblogger at November 7, 2007 02:02 PM

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