Understanding the US Economy

I was listening to the Dave Ramsey Podcast Episode (2008-09-03) when I learned some interesting information about the state of the economy which I never knew about before.




There are of course mulitple problems with the American economy, and a lot of it has to do with the media (see here for an explanation)

What I found interesting about this podcast was about a relativly recent change
called "sarbains oxley" (SOX). If you are a public company you may have already heard about it. SOX was basically put in place after the "Enron" Fiasco.

Essentially SOX puts in place several new 'rules' for public companies in at attempt to stop the type of 'fraud/theft' that occured with Enron.

One of these new rules is called "mark to market". This rule requires publically traded companies to restate the value of their assets each and every day.

The reason for this is to prevent businesses from having "loaded balance sheets". By not restating the assets frequently enough it may give a false impression of a companies worth and cause a higher 'expectation' of a company to investors then might otherwise exist in reality.

Makes sense right?

Here's the problem. Let's say a mortage/banking buisness decides to sell sub prime loans for houses. (These are "higher risk" loans that are sold to people with already bad credit who cannot get traditional type of mortages). So let's suppose a company, hmm let's calll them Merrill Lynch sells 30billion in these types of loans.

So essentially the start of the asset would be 30 billion. But there is little (or no market) for other companies to buy this type of loan (probably because it is unlikely the money will get paid back, compounded with how hard it is to sell houses in America these days). So they do as they are told and the "Restate" the value of the asset based on the market. Which ends up happening to be about 6 billion dollars.

Remember, this is not because the houses are suddenly worth less. House values don't suddenly reduce. It's because the type of loan is hard to sell, and is therefore worthless, so the 'value of the asset'. (The asset being the loan and loans are assets to loan companies) is reduced.

If on the other hand, this rule did not exist. The value of the asset could remain higher because it could be related closer to the value of the houses rather then the loan itself)

Confused Yet?

In short, mortage companies make money selling loans. Loans are assets to banks. SOX requiers the value of the asset to be restated each day. The value of the asset of a loan is not based on the item that was purchased with the money, it is based on the ability to "re-sell" the loan in the market to a different company.

You may find Dave Ramsey explains it better then I can, you can view more, with suggestions on what to do (if you're an American) here

http://www.daveramsey.com/tdrs/index.cfm/2008/9/23/Fix-the-bailout-with-mark-to-market?ictid=sptlt