A new white paper by Harvard’s Joshua Coval and Erik Stafford, and Princeton’s Jakub Jurek concludes that bank assets were mispriced before the meltdown and now are more accurately priced.
“The analysis of this paper suggests that recent credit market prices are actually highly consistent with fundamentals. A structural framework confirms that bonds and credit derivatives should have experienced a significant repricing in 2008 as the economic outlook darkened and volatility increased. The analysis also confirms that severe mispricing existed in the structured credit tranches prior to the crisis and that a large part of the dramatic rise in spreads has been the elimination of this mispricing.”
The paper draws three conclusions;
- “…many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities.”
- “…any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities.”
- “…policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay ““ and perhaps even worsen ““ the day of reckoning.”
In short, the problem isn’t illiquidity or accounting. The problem is that those banks are insolvent.