Mark to market

Now that the government eliminated(albeit temporary) the mark to market rules how would they reinstitute right now? i thought they were going the other direction to get rid of mark to market

Potential New FASB Mark-to-Market Rules

FASB is looking at a further expansion of mark-to-market rules. One of the concepts being discussed is marking all loans to market. This seems like a very difficult task in the absence of much of a securitization market, which we're all rather sour on anyway due to the moral hazard. When a bank makes a loan to the corner drugstore (if it still exists in the future) who else would want that loan the next day? So what would the loan be worth? If banks have capital accounts of about 10% of their assets (wishful thinking these days?), if the marked-to-market loan suffered a 10% drop in value the day after it was made, the imaginary capital assigned to that loan would be wiped out. Anyone care to own a community bank under these conditions?

In the past, if examiners "classified" a loan, there was a capital haircut. This facilitated small business lending. Imagine a bank has a niche in lending to these mythical corner drugstores, a long experience of loan-to-value, credit risk, etc. It's a profitable business, and someone leaves the bank and starts to compete. Being new, corners are cut, rates are lowered and higher risks are taken. Yet the old bank loses some share but doesn't relax it's standards. When the new bank becomes illiquid and has to sell the loans, now the old bank may need to write theirs down to the distress price, even though their portfolio is higher quality. In the past, this sort of marking process was reserved for assets that traded, not all assets.

Now that the government owns stakes in big banks, it's time to look for the moral hazard--a regulatory climate that subtly favors the government-owned enterprises. Big banks might actually be able to securitize loans and have a more favorable mark than an unsecuritized loan from a small bank. The financial products czar, who's supposed to approve products, is another potential change in the environment. Upstarts typically compete on service or product innovation. If a product czar inhibits product innovation, doesn't that bode well for branded service providers over the upstarts?

Axcelis (ACLS) is another pick from our recent small cap forum in NY. This manufacturer of ion implantation equipment for the semiconductor space has been hurt by the severe downturn in the industry, but has signed several important deals in the recent months and its unique products are winning important new customers, particularly in Asia. The upside could reach 200% or more based on the value of assets. With the stock currently trading at cash, the downside appears to be limited. The presenter believes there is a fair chance the company could be acquired in the next 6-12 months.

Our NY presenter still likes Walgreen. The big issues raised in his presentation last year, a slowdon in store expansion plans and reduction in operating expenses are finally playing out. The company is generating excellent cash flow. The stock is undervalued here, in his view, with the upside into the high $40's.

Moving the Economy Forward

This earnings season, estimates have generally been exceeded, but it's been done by lowering costs, and revenues have often disappointed. One could make the inference that biggest cost cuts usually come on the labor line. If that's true, it would lend support to the argument that the worst of the jobs recession may be over. If companies are lean, will they hire if business recovers a little? Supposing they do, the next question is where will they hire? Domestically, or abroad?

There are some factors affecting this decision that are in more than the usual state of flux this cycle. First, there is the uncertainty of a government far more favorable to big labor than we have seen in years. Second is the potential of higher labor costs due to health care reform, although there is an argument that the costs may actually fall on the very rich and small business, and that big business may actually get some relief.

But direct labor costs are not the only factor to consider when siting employees. The cost of land, or the rental prices of office, retail and industrial space are also important. The real estate crash is a positive for businesses seeking to add new facilities. Local governments may now be in a mood to encourage job creation through tax breaks and administrative simplification. When considering overseas hiring, views of future transportation costs are a factor as well as the outlook for relative future labor price increases and the dollar.

I've thought for years that nationalization of social costs like retirement advantage mature, slow growth industries, who avoid the full cost of these issues on their older workforces. At the same time, young industries are relatively encouraged, as they are not saddled with any costs but their own. It struck me that this might be one of many reasons the US did well with innovation, while we exported jobs in mature industries to other countries. If we start nationalizing a larger proportion of social costs, do we risk eroding these advantages for new industries?

Since growth is a product of the growth of the labor force times the growth of productivity, how do we get real growth by encouraging mature industries, where it's harder to get productivity growth? As we pointed out in an earlier post on China, the Chinese economy gains substantially when labor leaves the farm and comes into the city to join the industrial work force--that worker's contribution to GDP can triple. without any true productivity increase. It's simply a portfolio effect. The US needs to make sure it can get a positive growth effect from shifts in our labor portfolio. National policies need to encourage this process.

Our New York presenter recommended Cleveland BioLabs. This small biotech boasts an impressive pipeline, with the leading drug candidate potentialy offering a fast-acting antidot against radiation, a space where there are no effective treatments currently available. The company has partnerships with world-class research organizations, including Roswell Park Cancer Institute and Cleveland Clinic. As any small biotech, CBLI is a speculative play, but early test results show great potential. The company is also developing a family of anti-cancer agents.

Health Care: Unintended Consequences?

A lot of the debate on a new health care system is based on costs. But what's the impact of 40 million new customers on the system's ability to deliver services? First, a lot shorter wait in the ER as uninsured patients learn to stop using the ER for anything that comes up. But where do those people go, and what happens to their resource usage? The way our health care delivery system is structured, they would go first to primary care providers. Of course, these are the people being most economically squeezed by the current system, and it seems that there's already a bit of a squeeze--that many doctors have decided to become specialists for financial and lifestyle considerations.

If 40 million new customers spent an hour per year with a primary care provider, that would require about 20,000 more primary care providers. Looking at 2006 data on physicians, it looked to me as if there are about 300,000 doctors who could fill this demand. So the new demand would require about a 7% increase in the number of doctors devoted to this service. Since it's plausible that the uninsured have a backlog of unmet preventive care needs, and possibly a greater need for consumer education, time demands could be greater. It's interesting that Massachusetts, which requires health care coverage of its citizens, is also the state with the largest number of doctors relative to the population. There are many states with substantially fewer doctors per capita. Their resources may be more fully utilized. Anecdotally, many of us have experience with primary care physicians who aren't taking new patients.

Complex legislation almost always has unintended consequences. This may be one of them.